Badger Meter

Badger Meter's sales of $222 million fell nearly 7% year on year despite a $2 million benefit from the acquisition of UDlive. Results were largely in line with expectations, but earnings continue to decline relative to last year, and organic revenue guidance is flat for the remaining year.

Why it matters: Badger Meter's market debate largely focuses on the transition away from mechanical meters and toward advanced metering infrastructure connected to cellular networks. But investors fear a slowdown in deployment of this equipment, which is why the stock declined in recent quarters. One thing that hurts Badger Meter in this debate is the lack of clear order or backlog figures that would provide more clarity supporting the firm's long-term outlook. Still, Badger Meter mentioned it saw a modest increase in short-term order rates within flow instrumentation. Rising orders are a positive leading indicator for the firm, particularly as they support the notion that Badger Meter's long-term outlook still has a runway. While the bear thesis merits consideration, for now, we attribute most of the sales headwinds to an uneven rollout of municipal utility projects.

The bottom line: We marginally reduce our fair value estimate for narrow-moat Badger Meter to $161 from $162, mostly due to timing of cash flows and when orders convert to revenue. That said, we're holding firm on our long-term thesis. The 4-star-rated stock now trades with over 25% upside. We continue to believe that Badger Meter can grow at a high-single-digit percentage organic rate and earn incremental EBITDA margin in the mid-20s. We think most of the market's concerns, like carrying higher inventory and copper pricing headwinds, are transitory in nature. Utility customers tend to be loyal, and once orders are won in backlog, they don't tend to cancel, which evidences switching costs. But projects can be deferred, which is why we posit the selloff is a long-term opportunity.

Following second-quarter earnings, we marginally reduce our fair value estimate for Badger Meter to $161 from $162, mostly due to the timing of cash flows and when orders convert to revenue. That said, we're holding firm on our long-term thesis.

We forecast high-single-digit revenue growth over our five-year forecast, in line with the company’s commentary. However, we expect a slight evolution in revenue growth drivers. Our forecast expects growth in cellular endpoints, which have been a primary driver of revenue growth historically, to moderate over time as market share gains slow. In contrast, we see continued software sales growth along with contributions from around the meter technologies as representing a growing portion of sales during our forecast period.

On a margin basis, we expect continued improvements moving through to the midcycle portion of the forecast period. Structural mix benefits—namely, rising software-as-a-service revenue—should enable continued gross margin expansion. As such, we forecast gross margins to exceed 42% by the end of our forecast period, up from 40% in 2024. We forecast operating margins reaching above 21% by 2030, driven by the aforementioned gross margin expansion. Our forecast assumes slightly less operating expense leverage moving forward as we anticipate potential future acquisitions and related additional operating expenses as the firm looks to expand its around-the-meter product portfolio.

We award Badger Meter a narrow economic moat based on its entrenched position within the US water meter market. Our narrow moat rating is supported by intangible assets and switching costs.

Badger Meter’s product offerings span industrial flow products, smart water meters, and adjacent water utility products via recent acquisitions. We focus on its core US smart water meter business, given that it contributes the vast majority of profitability.

Central to understanding Badger Meter’s moat is appreciating the unique attributes of its customer base, primarily municipal water utilities. The US water utility landscape is highly fragmented, consisting of approximately 50,000 water utilities, mostly municipally owned. This is in stark contrast to the US electric utilities industry, which has much greater concentration, given that it consists primarily of investor-owned utilities.

We believe this market backdrop presents favorable moat dynamics for Badger Meter. The company has a more than 100-year history in water meters and is one of three primary competitors in a largely oligopolistic market structure. We estimate that the three largest US water meter firms—Sensus (Xylem), Neptune (Roper), and Badger Meter—account for approximately 75%-80% of meter sales. Badger’s long history and track record of innovation and product quality lead to favorable brand equity, in our view.

Badger’s moat is also supported by switching costs due to the risk-averse nature of water utilities. Based on our discussions with water utilities, these entities tend to be reluctant to switch from a given meter brand. This dynamic is particularly true for small and midsize water utilities, while larger utilities are willing to buy meters from multiple providers. Many utilities refer to themselves as a “Badger,” “Sensus,” or “Neptune” utility, and it’s not unusual for these relationships to span decades.

While Badger, Sensus, and Neptune have been the traditional dominant players in US water meters, there have been past attempts by new competitors to enter the market. Namely, the advent of ultrasonic metering technology in the 2010s, on the margin, lowered barriers to entry in the US water meter market. In response, European meter firms such as Diehl and Kamstrup have entered the market. However, we view success to date as relatively minimal, underscoring new entrants' lack of brand awareness and difficulty in persuading utilities to switch from their existing meter provider.

Utility water meters are generally classified as either manually read meters or remotely read meters via radio technology. A manually read meter consists of a water meter and a register that provides a visual meter reading. Meters equipped with radio technology receive flow measurement data, which is transmitted to the water utility’s usage and billing systems. Remotely read systems are classified as either automatic meter reading systems, where a vehicle equipped for meter reading purposes collects the data from the utilities’ meters, or advanced metering infrastructure systems, in which data is gathered utilizing a network (either fixed or cellular) of data collectors or gateway receivers that are able to receive radio data transmission from the utilities’ meters. AMI systems eliminate the need for utility personnel to drive through service territories to collect meter data and provide utilities with more frequent and diverse meter data.

The adoption of AMI has transformed the buying process for utilities and reshaped the moat dynamics within the US water market. Traditionally, meter companies such as Badger would sell one piece of hardware—a mechanical meter. Under AMI, Badger now sells a meter and a radio, as well as ongoing communications and software fees, oftentimes via a long-term contract spanning 10 to 20 years.

The relatively high cost of AMI (compared with standard meter replacement) can lead water utilities to be more open to switching from their legacy meter provider. Moreover, since meters are interchangeable with third-party communications devices, a communications network provider can be separate from the meter provider. Firms such as Itron, Aclara, and Landis + Gyr offer communications networks for water AMI but do not sell a water meter.

Competitive dynamics in communications networks differ from traditional water meters. AMI communication networks largely come in two forms: private fixed networks and cellular. Under the private fixed network approach employed by Sensus, Aclara, and Itron, firms set up a private fixed network for transmitting data from water meters. In contrast, Badger Meter is the pioneer of the cellular AMI communications network, which utilizes existing cellular networks to transmit data. Fixed networks can create a cost advantage, given that upfront infrastructure investment can be leveraged when utilities are geographically adjacent or across utility services (water, gas, electric). In contrast, we see cellular AMI as allowing for less competitive differentiation, given that this approach relies on a third-party cellular network.

Once a water utility has adopted AMI, there are significant switching costs in changing a network provider. While larger water utilities will often have multiple meter brands within the same utility, the communications network is almost always from a single provider. This is due to the significant time and monetary investment associated with upgrading to AMI as well as the convenience of having your service territory and data management software uniform across a utility. Further, communications networks provide for long-term recurring revenue. While a meter sale is a once-every-15-to-20-year hardware sale, ongoing communication network fees and high-margin software sales provide a recurring revenue stream over the expected 20-year life of an AMI. Ongoing software and network revenue accounted for approximately 7% of Badger Meter's revenue in 2024, which we expect to rise to 11% by 2029.

The adoption of advanced metering infrastructure, or AMI, represents a secular growth driver for Badger Meter.

Water meters sales have limited cyclicality, with 85% of sales being for replacement demand.

Badger Meter’s expansion beyond water meters provides an increased total addressable market for a wider array of product offerings.

Badger Meter trades at a relatively elevated valuation across traditional valuation metrics.

Recent acquisitions pose risks and could dilute returns on invested capital if they fail to achieve expected results.

Competitors expanding offerings of cellular AMI may reduce Badger Meter’s market share within AMI deployments.