Primo Water: Recent Strategic Shift Displays Promising Signs (NYSE:PRMW)

Primo Water Corporation (NYSE:PRMW) has shifted toward a North America-focused pure water approach, which has displayed promising results, especially considering the consistent upward momentum in both top and bottom-line performance across the last three quarters. The recent Q3 2023 results further validate this upward trend. However, it’s crucial to acknowledge underlying concerns within the company – specifically, its high debt levels and the fact that it is reducing its international revenue sources. While recent updates indicate encouraging inflows, this stock has shown limited growth over the past five years. Given this new landscape, I lean toward a wait-and-see approach, opting for a hold.

Company overview

Primo Water Corporation has been strategically refining its operations, honing in on the North American water market. The company has witnessed a substantial boost in its financial performance by divesting from non-core businesses and prioritising its focus on the water sector. This shift has notably elevated both its top-line revenues and bottom-line profits, showcasing a rise in positively leveraged cash flow and the ability to improve its debt-heavy balance sheet over the last three quarters.

Amidst this transformative phase, the company has welcomed a new CEO and will strategically offload portions of its international ventures to Culligan International in a deal valued at a potential $575 million, an all-cash transaction. These proceeds could further propel organic growth, reduce leverage, expedite water-related acquisitions, explore adjacent water opportunities, and generously reward shareholders through share repurchases. Over the next year, the company plans to continue divesting its international business.

Revenue by segment

The Q3 2023 revenue breakdown across various water-related segments reveals a consistent upward trajectory in total revenue over the last nine months. This growth has been predominantly fuelled by an increase in water direct and water refill segments, indicating a promising trend in the company’s performance.

During Q3, the company achieved significant milestones by selling approximately 252,000 water dispensers, pacing confidently toward its annual target of one million units. Such successes have been underpinned by securing a lucrative five-year exclusive partnership with Costco, fueling robust customer growth of over 40,000 through the Costco booth program and strategic acquisitions. Another benefit since 2022 is the removal of 25% tariffs on imported dispensers – which has substantially bolstered sales performance over the last three quarters, indicating notable margin improvements.

Growth potential

As I assess the future trajectory of the company, I find the reaffirmation of its FY 2023 Revenue and Adjusted EBITDA outlook quite reassuring. Notably, the elevation of FY adjusted free cash flow guidance by an additional $10 million to approximately $160 million highlights the company’s improving financial health. Looking ahead to FY 2023, revenue growth estimates between $2.32 billion and $2.36 billion, projecting a 7% to 9% expansion, alongside an adjusted EBITDA range of $460 million to $480 million, furthering my confidence in its growth prospects. The anticipation of unveiling guidance for the following year alongside the 2023 year-end earnings in February 2024 keeps me intrigued and invested in tracking the company’s progress closely.

Financial overview

In Q3 2023, the company has sustained its upward momentum in both top and bottom-line performance. Notably, there’s been a year-on-year revenue surge of 6.3%, amounting to $622 million. What’s even more encouraging is the TTM revenue, which stands at $2.29 billion, surpassing FY2022 figures. This sets an optimistic tone for the year-end outcomes. Another significant indicator of the company’s progress is its gross profit margins. The TTM gross profit margin sits at a substantial 60.85%, a notable increase from the 49.68% recorded in FY2017. This upward trajectory signals a consistent and substantial growth trend, reflecting positively on the company’s financial health and potential future success.

We can see that over the last nine months, the company has improved its net income YoY to $60.6 million. Furthermore, the TTM net income reaching a five-year high at $118 million indicates a positive trend in the company’s financial performance. This milestone reflects a noteworthy increase in profitability compared to previous periods.

The levered free cash flow for the trailing twelve months has seen a rise, reaching $148.8 million. This uptick in cash flow reflects a positive trend in the company’s ability to generate cash after accounting for financial obligations. Furthermore, this improved cash flow has positively impacted the dividend program, which is evident in the recent quarterly dividend of $0.08 per share, marking a 14% year-on-year increase. This increase in dividends per share indicates the company’s capacity to distribute more to its shareholders, potentially driven by enhanced financial performance and strengthened cash position.

Analysing the balance sheet, the company’s total debt stands notably high at $1.64 billion, while its total cash and cash equivalents amount to $97.8 million. This balance reflects a significant debt burden compared to available cash resources. The liquidity ratios below one, particularly the quick ratio of 0.6, indicate potential challenges in covering short-term liabilities promptly. This aspect raises a cautionary flag for potential investors, suggesting a need for careful consideration. Notably, the company won’t face maturity until 2028, providing some breathing room. To manage this, the company plans to settle the outstanding balance of its cash flow revolver with a long-term objective of maintaining net leverage below 2.5 times adjusted EBITDA, indicating a strategic focus on reducing debt levels over time.

Valuation

In my assessment, the stock valuation of this company presents an interesting perspective. Comparing its Diluted EPS trajectory with industry peers reveals a promising upward trend, boasting an appealing $0.73 EPS, placing it as the second most attractive in its sector. Furthermore, the recent divestiture of its international segment has garnered attention for its valuation multiple of approximately 11 times, trailing 12 months of Q2 adjusted EBITDA. This strategic move not only showcases the company’s smart decision-making but also suggests the potential for enhanced value creation from such initiatives.

Risk

Despite the solid third-quarter results, investors should be cautious of risks related to the company. The ongoing divestiture of international businesses, while aiming to refocus efforts on North America, introduces uncertainties in the transition process, potentially impacting revenue streams and operational stability. Financial restructuring plans, including debt reduction and shareholder returns from proceeds, pose risks if execution falls short or if expected cash flows from remaining international divestitures face delays. Operational disruptions in markets like Israel and potential challenges in tuck-in acquisitions may hinder growth targets. Moreover, ongoing optimization efforts, if unsuccessful, might lead to increased operational expenses. Regulatory changes impacting water rights and access could also pose significant operational challenges.

Final thoughts

Primo Water Corporation’s recent strategic shift towards a North America-focused pure water approach has exhibited promising signs, evident in its consistent upward momentum across the last three quarters, notably reflected in the latest Q3 2023 results. However, amid the company’s positive strides lie concerns, primarily centred around its high debt levels and the ongoing reduction of international revenue sources. Although recent updates suggest positive incoming flows, the stock’s limited growth trajectory over the past five years demands caution. Given this landscape, while there’s potential for future growth, I recommend a wait-and-see approach hold recommendation.