Primo Water (NYSE: PRMW), a leading pure play water supplier, has been making significant strides in the right direction, positioning itself as a strong investment opportunity. With an improved financial profile, attractive valuation, and a dividend yield of 2.5%, initiating a buy recommendation seems prudent.
Over the past five years, Primo Water has successfully transformed itself into a pure play water supplier. This transformation was facilitated by the acquisition of Legacy Primo, the divestiture of its S&D Tea and Coffee business, and subsequent rebranding efforts. Previously, the company had struggled to find its strategic focus, but now it stands as a formidable player in the industry.
Primo Water recently resolved its differences with activist investor Legion Partners, appointing a new CEO and revamping its board. This outcome, coupled with the company’s focused outlook on growth and profitability, signals long-term potential for investors. Despite strong operational performance and a recession-resistant business model, PRMW trades at a discount compared to its peers, making it an attractive investment option.
In its latest earnings report, Primo Water delivered impressive results. The company reported a 4% year-on-year revenue increase, driven by 11% growth in Water Direct and 21% growth in Water Refill. Although there were some setbacks, such as exiting the Russian market and discontinuing single-use bottled water in the US, Primo Water managed to achieve robust gross margins of 60.1%, the highest since its transformation. This margin expansion was driven by pricing improvements and the exit from low-margin retail in North America.
Adjusted EBITDA margin also expanded, growing 70 basis points year-on-year to 17.4%. While there was some deleverage in SG&A expenses due to higher wage and freight costs, these were outweighed by gains in gross margins. Primo Water’s balance sheet position has also improved, with a net debt-to-EBITDA ratio of under 3.5x, no significant debt maturities until 2028-2029, and a cash balance of approximately $100 million.
Looking ahead, Primo Water expects continued growth, with a projected 5% revenue increase in Q2 and a reiterated forecast of 5% revenue growth and an EBITDA margin of 19.8% for FY23. The company acknowledges that the pricing benefits it has enjoyed may plateau as it faces tougher comparables in the future. However, it anticipates achieving volume growth through its expanding partnership with Costco, increased booth programs, and positive April trends. While free cash flow guidance remains negative due to working capital pressures, Primo Water remains committed to returning cash to shareholders through share repurchases and a raised dividend.
The company’s strong operating trends can be attributed to its price elasticity and sell-through performance. Primo Water has witnessed a continued uptrend in its refill rate, thanks to digital initiatives and its partnership with Costco. Additionally, automatic route optimization has increased operational efficiencies in water exchange and filtration, resulting in enhanced delivery frequencies.
Primo Water’s focus on digital initiatives has paid off, as evidenced by an increased digital penetration of total sales. The company’s app, rated 4.8+ on both Android and Apple play stores, has contributed to its success in this area.
Despite its impressive performance and potential, Primo Water trades at a discounted valuation of 7.5x EV/Fwd EBITDA compared to its peers and historical average. Given its strong operational track record and recent improvements, a multiple rerating seems likely.
Improving leverage and cash flows have been key objectives for Primo Water. The company has consistently reduced its net leverage over the past three years and aims to achieve a net leverage ratio of under 3.0x by 2023. Primo Water’s strong operating cash flows, along with value-accretive capital allocation focusing on M&A, capex, debt reduction, dividends, and share buybacks, further enhance its financial profile.
While Primo Water has a promising outlook, there are some risks to consider. Unfavorable foreign exchange movements could impact the company’s revenue and profitability, as seen in Q1 when adverse FX movements reduced revenue growth by 2%. Additionally, a significant consumption slowdown due to macroeconomic challenges could pressure gross margins if Primo Water chooses not to implement price increases. Execution challenges, such as lower customers per route and higher logistical costs, may also squeeze operating margins.
In conclusion, Primo Water has successfully transformed itself into a leading pure play water provider, with strong operational performance, solid financials, and an attractive valuation. With an improved financial profile, the resolution of activist investor disputes, and a dividend yield of 2.5%, the risk-reward balance suggests a favorable upside. Initiating a buy recommendation seems fitting for investors interested in this promising opportunity.
