Watts Water Technologies (NYSE: WTS ) , the manufacturer of products used in water quality treatment, water conservation, and water safety, declared its first-quarter results this month.
The short and dirty of it is that the top line looks pretty attractive, but the low operating cash levels take some sheen off the top-line improvement. Let's take a deeper look at the quarterly numbers to get a sense of what went wrong.
What the numbers say
The company's total revenues increased 3.3% to $329.9 million from $319.3 million in the year-ago quarter. This rise was primarily because of an increase in revenues from its key wholesale markets in North America and Europe.
Net income also recorded a decent improvement. However, what worries me the most is the massive decline in cash from operations. It plunged 98% to a paltry $0.7 million this quarter from $46 million in the preceding quarter and was down 76% on a year-over-year basis. Let's find out the reason behind this massive decline.
Making dollars make sense
Huge rises in inventory levels and increases in accounts receivables are mainly to blame for this drop in cash from operations. For Foolish investors, this special combination is a very serious problem for two reasons.
One, huge growth in inventories means that the company is not moving product off the shelves. There is likely to be a lot of slack in customer demand. Two, accounts receivable growth may very well mean that the company is extending more liberal amounts of credit to its customers and/or is having problems collecting on prior accounts. Together, the combination of these is pretty damning for a company whose cash flows are nowhere close to where they need to be. I would be very cautious.
Making matters worse
To boost its cash level, the company raised funds through long-term debt that has resulted in an inflow of cash. This has led to a jump in the company's long term debt/equity ratio, which shot up to 49.5% from 42% in the preceding quarter. This number isn't dangerous on an absolute basis, but it certainly should be a matter of concern to the shareholders.
Where it counts
Let's take a look at how efficient the company is at converting shareholders' money into profits. The return on equity gives me the answer to this. ROE for Watts Water declined to 4.5% in this quarter as compared with 5.6% in first quarter of 2010. But this is much lower than its peer Flowserve (NYSE: FLS ) , whose ROE is 17.9% for this quarter. Well, that's a big difference. Shareholders really need to make a note of this.
The company faces stiff competition in both domestic and international markets. To address competition concerns, Watts Water is planning to expand its foothold in Asia, particularly in China. Also, its recent acquisition of French firm Danfoss Socla is a step in that direction and would likely help the company face competitors such as Duoyuan Global Water (NYSE: DGW ) in those markets.
The Foolish bottom line
The company's business looks really shaky. To shore up its cash from operations, it has to manage its working capital much more efficiently. It needs to solidify its credit management with customers. It also needs to keep a tab on its high debt levels to keep its financials in a better shape. This stock is definitely not a buy right now. Let's wait and watch as to how the company manages its short-term challenges.
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