Last year I wrote about how Advanced drainage systems (New York Stock Exchange: WMS) has good multi-year growth prospects, but was overvalued and needed a pullback. The decline of the WMS has since occurred alongside the market decline. I see strong upside potential for the stock now that the pullback has taken place.
Advanced Drainage Systems produces HDPE (High Density Polyethylene), Polypropylene and PVC pipes for drainage management. The company also provides drain grates, water storage chambers, building fabrics, septic tanks/accessories and related products. WMS products have the advantage of being less expensive than alternatives such as steel or concrete pipes. Projects can also be completed in less time with HDPE. ADS is a leader in corrugated plastic drain pipe with more than 10 billion feet of pipes in service worldwide.
ADS has strong tailwinds as the global stormwater treatment systems market is expected to grow at a healthy pace. compound annual growth rate of 8.5% to 2028. This growth would grow the market from around $13 billion in 2021 to around $23.5 billion in 2028. We have witnessed many extreme storms leading to flooding in recent years all over the world. Thus, ADS solution needs are likely to be in high demand for many years to come.
ADS solutions cover the following phases of water disposal management: collection, conveyance, storage and treatment. This provides a complete package for customers covering all aspects of stormwater management. The company is a key water solutions provider globally. WMS provides solutions for large non-residential projects as well as smaller residential projects.
ADS beat revenue and profit estimates for the third quarter of fiscal 2022. Revenue rose 47% year-over-year in the third quarter to $715 million. This marked record sales for ADS. Third-quarter revenue also beat estimates by about 10% or $64 million. Revenue growth was driven by the price and volume of stormwater management systems (ADS business) and on-site septic systems (Infiltrator business).
Normalized EPS rose 57% to $1.27 in Q3, beating estimates by 26%. Consolidated adjusted EBITDA increased by 27%. ADS’ strong profitability returns, such as ROE of 26% and ROIC of 12%, are contributing to its earnings growth. This is higher than the industry median ROE of 14% and ROIC of 7%.
ADS is expected to report results on May 19 for the fourth quarter of fiscal 2022. The quarterly EPS estimate is $0.64 for the fourth quarter and $3.48 for the year. If the annual estimate is reached, this would result in a 34% increase in profits over the previous year. FY23 also looks promising, with analysts expecting earnings growth of 37% to 38%.
ADS notes a favorable order book and order rate. The company expects demand to be strong for the foreseeable future. Given the positive momentum the company has achieved, the fourth quarter has a good chance of being positive. We’ll have to see what the ADS says in the fourth quarter report, but I doubt anything has changed much regarding the outlook for the next fiscal year.
Another advantage is that the ADS could benefit from the infrastructure bill. the US Infrastructure Bill allocates $330 million per year to improve stormwater management. As a leader in stormwater management, ADS could get continued orders to address some of these concerns under the bill.
When I previously wrote about ADS in July 2021, the stock was trading with a forward PE of around 32. The recent market sell-off has brought the forward PE down to around 21 based on expected EPS of 4 $.79 for FY23. Admittedly, this is not a favorable valuation, but it is a significant improvement over last year.
There could be a hidden valuation for ADS. Several sources, including Seeking Alpha, do not report a forward PEG ratio for ADS. This usually takes the forward PE divided by the estimated earnings for the next 3-5 years. We know that the one-year forward PE is 21. We also know that the estimated earnings growth is expected to be 37% to 38% in FY23 compared to FY22. So the forward PEG ratio over one year is 21/37 = 0.56. PEG ratios below one are considered a favorable valuation for growth stocks. So I think WMS is now trading at an attractive level for a long term position.
Bullish technical outlook
The daily stock chart above shows a bullish divergence between the RSI and the stock price. The stock price was in oversold territory in January on the RSI. However, the stock declined over the following months, while the RSI remained just above the oversold level. The RSI and stock price have recently risen from the near-oversold condition. The highest trough of the RSI from January to May and the lowest trough of the price during the same period constitute a bullish divergence.
The green MACD line appears to be about to cross above the red signal line, indicating a possible shift towards a positive trend. The flow of money [CMF] moved from a negative level and reached the zero line. These indicators point to a potential positive trend change for the stock. Of course, this depends on the behavior of the market as a whole in the short term.
Advanced Drainage Systems: Long-Term Investment Prospects
The improved valuation leaves room for a lot of upside for WMS. The company is likely to get regular orders from the residential and non-residential markets for stormwater management. There has been an increase in flood frequency and duration during the last years. This creates an ongoing need to improve store water management. ADS will benefit as the company provides solutions for all phases of stormwater management.
Investors should read the May 19 earnings report to see if there are any changes to the company’s performance and outlook. I suspect the company’s outlook will remain positive given the need for its solutions.
Analysts have a one-year price target of $150 for the stock, which would be 48% higher than the current price. That would bring the PE to 31 based on an expected EPS of $4.79 for FY23, where the stock traded last year. ADS is one of those companies that is likely to maintain an above average valuation in terms of PE due to its positive multi-year growth outlook. This is why the PEG ratio is likely to remain attractive as the ADS increases its earnings at a healthy pace.