Smart metering company Itron (Nasdaq:ITRI) is not exactly a secret anymore. The bull story on water has been droning on for nearly a decade now, and Itron is followed by over 20 sell-side analysts. Unfortunately, the project-oriented nature of the business means that there's a fair bit of unpredictability in the model and ample opportunity for above/below-consensus expectation. So while Itron still has solid growth possibilities before it, investors should expect a bumpy ride along the way.
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Mixed Messages in Fourth Quarter Results
Fourth quarter results from Itron offer a sense of some of the challenges at the company. Sales were substantially higher than expected, but up about 4% in reported terms and 5% in constant currency. North American and International results were similar on a reported basis, with international sales offering a little more momentum on a constant currency basis.
There wasn't all that much margin leverage, though. Gross margin was basically flat with the year-ago level, while adjusted operating income rose by 12. Although orders seem to be improving, backlog dropped on both a sequential and annual basis.
SEE: Analyzing Operating Margins
A Wobbly Growth Outlook
There's ample opportunity out there for smart/advanced meters at electric, water, and gas utilities. The problem for Itron is that customers like Edison International (NYSE:EIX), CenterPoint Energy (NYSE:CNP) and BC Hydro place large orders, install the meters, and then go into more of a maintenance mode - leading to peaks and valleys in the revenue.
To that end, it looks like Itron's revenue is going to decline in 2012 and climb only a little in 2013 before resuming better growth in 2014. At the same time, rivals like Landis+Gyr, Sensus, Badger Meter (NYSE:BMI) and Elster (NYSE:ELT) may well be reporting better revenue as their ordering cycles follow a different pattern. In other words, worries about competitive market share changes may add volatility to the stock over the next couple of years.
At the same time, the company has some operating challenges to overcome. Itron needs to ensure that warranty expenses don't trouble the margin structure and also needs to successfully integrate the SmartSynch acquisition.
Are There Too Many Meter Makers Out There?
I'm frankly surprised at the number of companies out there selling advanced meters and metering technologies. Utilities are, by nature, conservative, and tend to like to deal with established companies. That may ultimately play in favor of companies like General Electric (NYSE:GE), Siemens (NYSE:SI) and ABB (NYSE:ABB) buying into this space and consolidating companies like Itron, Badger, Elster and Silver Spring Networks as part of complete end-to-end solutions.
The Bottom Line
Itron may well be a little too popular for its own good from a coverage standpoint, but the volatility of the company's business seems to be keeping something of a discount in the shares. Assuming less than 8% compound free cash flow growth over the next decade (which is not unreasonable relative to growth potential in emerging/developing markets), the shares could still hold fair value deep into the $50s. Although I expect above-average volatility in Itron stocks, value is value and patient investors may find this an interesting idea on the periodic pullbacks.
SEE: Free Cash Flow: Free, But Not Always Easy
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.