Advanced Drainage (WMS) Research Report: Q1 CY2024 Update

Full Report / June 07, 2024

Water management company Advanced Drainage Systems (NYSE:WMS) reported Q1 CY2024 results topping analysts' expectations, with revenue up 5.9% year on year to $653.8 million. It made a non-GAAP profit of $1.21 per share, improving from its profit of $1.06 per share in the same quarter last year.

Advanced Drainage (WMS) Q1 CY2024 Highlights:

  • Revenue: $653.8 million vs analyst estimates of $611.9 million (6.9% beat)
  • EPS (non-GAAP): $1.21 vs analyst estimates of $1.03 (17.5% beat)
  • Gross Margin (GAAP): 43%, up from 36% in the same quarter last year
  • Free Cash Flow was -$29.76 million, down from $187.6 million in the previous quarter
  • Market Capitalization: $12.62 billion

Originally started as a farm water drainage company, Advanced Drainage Systems (NYSE:WMS) provides clean water management solutions to communities across America.

The company solves water management challenges in various industries. Because water can be a valuable resource or a destructive force if left unmanaged, Advanced Drainage Systems and its products address rainwater harvesting, stormwater runoff, soil erosion, and water pollution. The company's products provide durable, corrosion-resistant, and sustainable drainage solutions for end markets such as agriculture and residential communities.

Specifically, Advanced Drainage Systems offers a range of products like pipes, fittings, chambers, septic tanks, and high-tech fabric. In addition to its products, the company provides engineering and design services to help customers successfully implement their water management systems. Innovation is a key focus of the company given how top-of-mind and thematic issues like water conservation and climate change are.

The company primarily generates revenue through product sales, with the sales of its pipe products leading the charge, followed by its chambers and septic tanks. The top industries generating the meaningful revenue for the company include both non-residential and residential construction as well as infrastructure and agriculture. A small percentage of the company’s revenue is made through international markets, most notably Canada and Mexico.

HVAC and Water Systems

Traditionally, home construction materials companies have built economic moats with expertise in specialized areas, brand recognition, and strong relationships with contractors. More recently, advances to address labor availability and job site productivity have spurred innovation that is driving incremental demand. However, these companies are at the whim of residential construction volumes, which tend to be cyclical and can be impacted heavily by economic factors such as interest rates. Additionally, the costs of raw materials can be driven by a myriad of worldwide factors and greatly influence the profitability of home construction materials companies.

Companies offering water waste management solutions include private companies Contech Engineering, Prinsco, and Armtec.

Sales Growth

A company’s long-term performance can give signals about its business quality. Even a bad business can shine for one or two quarters, but a top-tier one tends to grow for years. Over the last five years, Advanced Drainage grew its sales at an incredible 15.7% compounded annual growth rate. This is a great starting point for our analysis because it shows Advanced Drainage's offerings resonate with customers, hinting that it could be a high-quality business.

Advanced Drainage Total Revenue

Long-term growth is the most important, but within industrials, a half-decade historical view may miss new industry trends or demand cycles. Advanced Drainage's recent history shows its demand slowed significantly as its annualized revenue growth of 1.9% over the last two years is well below its five-year trend.

This quarter, Advanced Drainage reported solid year-on-year revenue growth of 5.9%, and its $653.8 million of revenue outperformed Wall Street's estimates by 6.9%. Looking ahead, Wall Street expects sales to grow 4.6% over the next 12 months, a deceleration from this quarter.

Gross Margin & Pricing Power

All else equal, we prefer higher gross margins. They usually indicate that a company sells more differentiated products and commands stronger pricing power.

Advanced Drainage's gross margin is good compared to other industrials businesses and signals it sells differentiated products, not commodities. As you can see below, it's averaged a healthy 34.8% gross margin over the last five years. Said differently, Advanced Drainage paid its suppliers $65.24 for every $100 in revenue to provide its products and services.

Advanced Drainage Gross Margin

Advanced Drainage produced a 43% gross profit margin in Q1, marking a 7 percentage point increase from 36% in the same quarter last year. Zooming out, Advanced Drainage's margin has trended up over the last 12 months, increasing by 4.5 percentage points year on year. If this trend continues, it could suggest better unit economics and more leverage on the fixed portion of its cost of goods sold.

Operating Margin

Operating margin is an important measure of profitability. It’s the portion of revenue left after accounting for all core expenses–everything from the cost of goods sold to advertising and wages. Operating margin is also useful for comparing profitability across companies with different levels of debt and tax rates because it excludes interest and taxes.

Advanced Drainage has been a well-oiled machine over the last five years. It demonstrated elite profitability for an industrials business, boasting an average operating margin of 17.1%. This isn't too surprising as its gross margin gives it a favorable starting point for ultimate operating profitability.

Analyzing the trend in its profitability, Advanced Drainage's annual operating margin rose meaningfully over the last five years, although the starting point was low due to a one-time charge.

Advanced Drainage Operating Margin (GAAP)

This quarter, Advanced Drainage generated an operating profit margin of 20.7%, in line with the same quarter last year. This indicates the company's cost structure has recently been stable.


We track the long-term growth in earnings per share (EPS) for the same reason as long-term revenue growth. Compared to revenue, however, EPS highlights whether a company's growth was profitable.

Advanced Drainage's EPS grew at an astounding 36.9% compounded annual growth rate over the last five years, higher than its 15.7% annualized revenue growth. This tells us the business became more profitable as it expanded.

Advanced Drainage EPS (Adjusted)

We can take a deeper look into Advanced Drainage's earnings quality to better understand the drivers of its performance. As we mentioned earlier, Advanced Drainage's operating margin was flat this quarter but expanded by 31.2 percentage points over the last five years (although the starting point was low due to a one-time charge). This was the most relevant factor (aside from revenue) behind its higher earnings; taxes and interest expenses can also affect EPS but don't tell us as much about a company's fundamentals.

Like with revenue, we also analyze EPS over a more recent period because it can give insight into an emerging theme or development for the business. For Advanced Drainage, its two-year annual EPS growth of 38.4% was higher than its five-year trend. We love it when earnings growth accelerates, especially when it accelerates off an already high base.

In Q1, Advanced Drainage reported EPS at $1.21, up from $1.06 in the same quarter last year. This print beat analysts' estimates by 17.5%. Over the next 12 months, Wall Street expects Advanced Drainage to grow its earnings. Analysts are projecting its EPS of $6.45 in the last year to climb by 3.1% to $6.65.

Cash Is King

Although earnings are undoubtedly valuable for assessing company performance, we believe cash is king because you can't use accounting profits to pay the bills.

Advanced Drainage has shown terrific cash profitability, enabling it to reinvest, return capital to investors, and stay ahead of the competition while maintaining a cash cushion. The company's free cash flow margin has been among the best in the industrials sector, averaging 14.7% over the last five years.

Taking a step back, we can see that Advanced Drainage's margin expanded by 4.3 percentage points during that time. This is encouraging and shows the company is heading in the right direction.

Advanced Drainage Free Cash Flow Margin

Advanced Drainage burned through $29.76 million of cash in Q1, equivalent to a negative 4.6% margin. The company's quarterly cash flow turned negative after being positive in the same quarter last year, but we wouldn't put too much weight on it because a business's working capital needs can be seasonal, causing quarter-to-quarter swings.

Return on Invested Capital (ROIC)

EPS and free cash flow tell us whether a company was profitable while growing its revenue. But was its growth capital-efficient? A company’s ROIC explains this by showing how much operating profit a company makes compared to how much money it has raised (debt and equity).

Advanced Drainage's five-year average ROIC was 13.2%, higher than most industrials businesses. Just as you’d like your investment dollars to generate returns, Advanced Drainage's invested capital has produced solid profits.

Advanced Drainage Return On Invested Capital

The trend in its ROIC, however, is often what surprises the market and moves the stock price. Over the last few years, Advanced Drainage's ROIC has increased (although the starting point was low due to a one-time charge). The company has shown the ability to generate good returns in the past, and its rising ROIC is a great sign. It could suggest its competitive advantage or profitable business opportunities are expanding.

Balance Sheet Risk

As long-term investors, the risk we care most about is the permanent loss of capital. This can happen when a company goes bankrupt or raises money from a disadvantaged position and is separate from short-term stock price volatility, which we are much less bothered by.

Advanced Drainage reported $490.2 million of cash and $1.35 billion of debt on its balance sheet in the most recent quarter. As investors in high-quality companies, we primarily focus on two things: 1) that a company's debt level isn't too high and 2) that its interest payments are not excessively burdening the business.

With $922.9 million of EBITDA over the last 12 months, we view Advanced Drainage's 0.9x net-debt-to-EBITDA ratio as safe. We also see its $65.98 million of annual interest expenses as appropriate. The company's profits give it plenty of breathing room, allowing it to continue investing in new initiatives.

Key Takeaways from Advanced Drainage's Q1 Results

We were impressed by how significantly Advanced Drainage blew past analysts' revenue expectations this quarter. We were also excited its operating margin outperformed Wall Street's estimates. Zooming out, we think this was a great quarter that shareholders will appreciate. Investors were likely expecting more, however, and the stock is down 1.1% after reporting, trading at $161.14 per share.

Is Now The Time?

Advanced Drainage may have had a good quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

There are several reasons why we think Advanced Drainage is a great business. For starters, its revenue growth has been exceptional over the last five years. And while its projected EPS for the next year is lacking, its operating margin expansion shows the business has become more efficient. On top of that, its astounding EPS growth over the last five years shows that its profits are trickling down to shareholders.

Advanced Drainage's price-to-earnings ratio based on the next 12 months is 24.5x. Looking at the industrials landscape today, Advanced Drainage's qualities as one of the best businesses really stand out. Despite the higher valuation, we still like it at this price and believe it's a high-quality company worthy of an investment.

Wall Street analysts covering the company had a one-year price target of $179.33 right before these results (compared to the current share price of $161.14), implying they saw upside in buying Advanced Drainage in the short term.

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