Xylem

Xylem's second-quarter adjusted earnings per share of $1.46 beat the FactSet consensus estimate by $0.12 despite revenue of $2,336 million falling $40 million short of consensus expectations.

Why it matters: Management raised its 2026 adjusted EPS outlook to $5.55-$5.70 from $5.35-$5.60, as more optimistic margin expectations more than offset a slightly more muted revenue growth outlook. Xylem's guidance now bakes in full-year organic revenue growth of 2%-3%, down from 2%-4% previously, which reflects headwinds due to electric metering project delays in the measurement and control solutions segment. The company expanded its second-quarter adjusted EBITDA margin by 150 basis points year over year to 23.3%, driven by productivity, price realization, and favorable mix shift. Xylem expects full-year adjusted EBITDA margin to be up 90-130 basis points.

The bottom line: We've raised our fair value estimate for narrow-moat-rated Xylem to $129 per share from $124 to reflect our slightly more optimistic near-term operating margin assumptions and the time value of money. We see the name as fairly valued, with shares currently trading in 3-star territory. Organic orders were up 41% year over year, including over 300% growth in data center orders. We are optimistic about the long-term outlook, as we believe Xylem is poised to capitalize on growth in the life sciences, food and beverage, power generation, mining, and semiconductor end markets. Management deployed around $650 million into share repurchases in the second quarter, which we consider a good use of capital, as Xylem's stock traded at a rare discount to our fair value estimate for most of the quarter.

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Following Xylem's second-quarter earnings release, we increased our fair value estimate by $5, to $129 per share, to reflect our slightly more optimistic near-term margin assumptions and the time value of money. Management raised its 2026 adjusted earnings per share outlook to $5.55-$5.70 from $5.35-$5.60, as more optimistic margin expectations more than offset a slightly more muted revenue growth outlook.

We project roughly 5.5% compound annual revenue growth from 2025 through 2030, fueled by high-single-digit growth in the measurement and control solutions segment. We forecast long-term revenue growth in the midsingle digits in the water infrastructure and water solutions and services segments and low to mid-single digits in the applied water segment. We project a roughly 200-basis-point adjusted EBITDA margin expansion, from 22.2% in 2025 to around 24% by 2030. We expect this improvement to be driven by operating leverage, the mix shift to digital solutions, cost synergies from the Evoqua acquisition, and productivity and continuous improvement initiatives.

We assume an 8.4% weighted average cost of capital and a 20% long-run effective tax rate in our model.

We think Xylem has carved a narrow moat due to customer switching costs and intangible assets. Xylem’s large installed base of equipment generates recurring revenue driven by aftermarket service and replacement parts in the water infrastructure segment, replacement parts in the applied water segment, and long-term contracts (up to 15-20 years) in the measurement and control solutions segment. The company’s moat is bolstered by intangible assets, including an extensive patent portfolio, reputable brands, and strong dealer relationships. Thanks to its broad portfolio of solutions, Xylem can help utilities address multiple problems of nonrevenue water (revenue lost by water utilities due to physical leaks, unbilled consumption, meter inaccuracy, and so on).

We believe water infrastructure’s narrow moat rests on customer switching costs and intangible assets. Xylem is the leader in the fragmented wastewater transport space, and its Flygt brand has a strong reputation for reliability and efficiency. Having a reputation for reliability is imperative in this segment, as the equipment often performs a mission-critical function (for instance, pumps for wastewater treatment facilities). Thus, while pricing is an important consideration, customers are relatively less likely to aggressively pursue cost savings by switching to a cheaper alternative as the cost of unscheduled downtime or product failures could far exceed potential cost savings. For public utilities, public safety considerations are also important, because equipment failures could even create an environmental hazard (for example, spills or sewer overflow). Furthermore, since water utilities tend to be risk-averse, they do not typically replace an individual pump that is part of a pumping network with an alternative one that uses different technology. Because of high switching costs, most customers are loyal, which makes sales relatively resilient.

The applied water segment benefits from similar industry dynamics as water infrastructure, as it also manufactures equipment that performs vital functions. This leads to relatively high switching costs, as any plant downtime can be extremely costly for industrial and commercial customers. A reputation for quality and reliability is important, and Xylem benefits from a strong portfolio of brands and a large installed base, which leads to a relatively sticky business as customers tend to replace equipment with similar products from the same company. Nevertheless, we think that the moat around applied water might be narrower than the moat around water infrastructure. The latter sells most products directly to customers, whereas the former sells most products through distributors. We think this creates an additional layer of distance between Xylem and the ultimate consumer, which might result in a lower degree of loyalty and make the applied water segment relatively more vulnerable to competition in the long run. That said, the segment currently enjoys a strong market position, solid operating margins, healthy aftermarket revenue, and long-standing relationships with major distributors. As such, we think the segment has a narrow moat and is more likely than not to outearn its cost of capital throughout the next decade.

We believe measurement and control solutions has established a narrow moat attributable to switching costs and intangible assets. Customers in this segment often sign long-term contracts (15-20 years), which consist of equipment purchases in the first few years, followed by a subscription fee during the latter part of the contract, which generates a stream of recurring revenue. Xylem’s Sensus brand is a leader in smart meters, which help avoid costly disruptions, minimize revenue loss due to inaccurate measurements, and significantly reduce labor costs by allowing customers to monitor water quality remotely.

Lastly, we think that Evoqua, which provides a broad range of water and wastewater treatment solutions, has established a narrow moat based on customer switching costs and intangible assets. Evoqua’s integrated solutions and services business offers outsourced water service contracts, including short-term service deionization contracts (averaging one to two years) and longer-term build-own-operate contracts (averaging 8-10 years). We believe that a key element of Evoqua’s moat is its unparalleled network of service professionals, which allows the firm to reach customers within two hours in the United States. Evoqua’s intangible assets include its portfolio of technologies for the removal and destruction of contaminants. Furthermore, Evoqua’s Water One digitally connected service platform has remote monitoring capabilities, which enable the company to offer enhanced reliability and lower costs by optimizing routine service calls. The digitally enabled mix currently accounts for roughly 20% of integrated solutions and services revenue, and management aims to grow it to 40% within the next three to five years. Since there is a more than 1,000-basis-point margin spread between outsourced water offerings and capital sales, we expect the growth in digitally connected revenue to not only reinforce Evoqua’s moat but also drive meaningful margin expansion.

Growing demand for fresh water in developing countries and the need to replace aging infrastructure in developed countries will create long-term growth opportunities for Xylem.

After recent acquisitions of smart meter and leak detection companies, Xylem can offer utilities a comprehensive portfolio of products aimed at addressing the problem of nonrevenue water.

The company has room for further margin expansion, with management targeting cost savings from business simplification, global procurement, lean initiatives, and synergies from recent M&A deals.

Organic revenue growth has been relatively sluggish in recent years due to soft industrial production and low commodity prices.

Persistent strength in the US dollar could make Xylem more susceptible to offshore competition.

Cost inflation (including tariffs) could be a headwind in the short run.