(By Balaseshan) Brean Capital LLC analysts Michael Gaugler and Christopher Noon downgraded rating of Watts Water Technologies Inc. (NYSE: WTS) to "Hold" from "Buy" based on valuation.
"The shares are trading beyond our fair value estimate of $42, and we are unwilling to lift our forward estimates or multiple assumptions at this time. We remain optimistic on the company's future prospects, but choose to move to a more neutral stance until valuation or end market conditions become more compelling," analysts Gaugler and Noon say in a statement.
Despite some significant headwinds, 2012 turned out to be a great year for Watts shareholders, with the shares gaining 25.7%. The company overcame some unfavorable commodity costs and product mix early in the year, a change in the CFO position, all while working through some unfavorable macroeconomic conditions in the United States and Europe, the analysts say.
It also faced some new regulations on lead-free manufacturing processes that resulted in some additional costs. Offsetting those headwinds were the successful integration of the Danfoss acquisition, continued cost rationalization and a share buyback, the brokerage noted. All-in, a solid performance in a difficult operating environment.
The analysts had looked carefully at their forward estimates for potential areas to increase forecasts. They noted that while their 2013 estimates are relatively in line with consensus expectations, their 2014 estimate of $2.80 is substantially below the $3.21 consensus estimate.
As looking across the forecast model, the brokerage believes its certainly possible for Watts to have that type of year ($3.21 in 2014), if Europe recovers and North America can continue to show economic expansion and improving GDP growth.
From their perspective, the analysts are not willing to make that assumption (yet). With European GDP expected to be essentially zero and the North America GDP expected at 2%, expectations for a global recovery in demand in the industrial group look a bit early.
"We certainly expect Watts to benefit somewhat from continued expense controls and an improving housing market in the United States; however, those expectations are already factored into our previous (and still current) estimates," say Gaugler and Noon.
WTS is trading down 2.76% at $43.35 on Monday.