Xylem (XYL)

Water technology company Xylem (NYSE:XYL) reported revenue ahead of Wall Street’s expectations in Q1 CY2025, with sales up 1.8% year on year to $2.07 billion. The company expects the full year’s revenue to be around $8.75 billion, close to analysts’ estimates. Its non-GAAP profit of $1.03 per share was 8% above analysts’ consensus estimates.

Company Overview

Formed through a spinoff, Xylem (NYSE:XYL) manufactures and services engineered products across a wide variety of applications primarily in the water sector.

Trends towards conservation and reducing groundwater depletion are putting water infrastructure and treatment products front and center. Companies that can innovate and create solutions–especially automated or connected solutions–to address these thematic trends will create incremental demand and speed up replacement cycles. On the other hand, water infrastructure and treatment companies are at the whim of economic cycles. Consumer spending and interest rates, for example, can greatly impact the industrial production that drives demand for these companies’ offerings.

Competitors offering similar products include Sulzer (SWX:SUN), Veolia (EPA:VIE), and Graco (NYSE:GGG).

A company’s long-term sales performance can indicate its overall quality. Any business can have short-term success, but a top-tier one grows for years. Thankfully, Xylem’s 10.9% annualized revenue growth over the last five years was impressive. Its growth beat the average industrials company and shows its offerings resonate with customers, a helpful starting point for our analysis.

Long-term growth is the most important, but within industrials, a half-decade historical view may miss new industry trends or demand cycles. Xylem’s annualized revenue growth of 22.8% over the last two years is above its five-year trend, suggesting its demand was strong and recently accelerated.

Xylem also reports organic revenue, which strips out one-time events like acquisitions and currency fluctuations that don’t accurately reflect its fundamentals. Over the last two years, Xylem’s organic revenue averaged 7.5% year-on-year growth. Because this number is lower than its normal revenue growth, we can see that some mixture of acquisitions and foreign exchange rates boosted its headline results.

This quarter, Xylem reported modest year-on-year revenue growth of 1.8% but beat Wall Street’s estimates by 1.5%.

Looking ahead, sell-side analysts expect revenue to grow 2.9% over the next 12 months, a deceleration versus the last two years. This projection is underwhelming and indicates its products and services will face some demand challenges. At least the company is tracking well in other measures of financial health.

Xylem’s unit economics are great compared to the broader industrials sector and signal that it enjoys product differentiation through quality or brand. As you can see below, it averaged an excellent 37.5% gross margin over the last five years. Said differently, roughly $37.54 was left to spend on selling, marketing, R&D, and general administrative overhead for every $100 in revenue.

Xylem’s gross profit margin came in at 37.1% this quarter, in line with the same quarter last year. Zooming out, the company’s full-year margin has remained steady over the past 12 months, suggesting its input costs (such as raw materials and manufacturing expenses) have been stable and it isn’t under pressure to lower prices.

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

Xylem has managed its cost base well over the last five years. It demonstrated solid profitability for an industrials business, producing an average operating margin of 10.5%. This result isn’t surprising as its high gross margin gives it a favorable starting point.

Analyzing the trend in its profitability, Xylem’s operating margin rose by 3.2 percentage points over the last five years, as its sales growth gave it operating leverage.

In Q1, Xylem generated an operating profit margin of 11.2%, in line with the same quarter last year. This indicates the company’s cost structure has recently been stable.

Revenue trends explain a company’s historical growth, but the long-term change in earnings per share (EPS) points to the profitability of that growth – for example, a company could inflate its sales through excessive spending on advertising and promotions.

Xylem’s solid 10% annual EPS growth over the last five years aligns with its revenue performance. This tells us its incremental sales were profitable.

Like with revenue, we analyze EPS over a more recent period because it can provide insight into an emerging theme or development for the business.

Although it performed well, Xylem’s two-year annual EPS growth of 13.7% lower than its 22.8% two-year revenue growth.

In Q1, Xylem reported EPS at $1.03, up from $0.90 in the same quarter last year. This print beat analysts’ estimates by 8%. Over the next 12 months, Wall Street expects Xylem’s full-year EPS of $4.40 to grow 8.1%.

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

Xylem has shown impressive cash profitability, enabling it to ride out cyclical downturns more easily while maintaining its investments in new and existing offerings. The company’s free cash flow margin averaged 8.9% over the last five years, better than the broader industrials sector.

Taking a step back, we can see that Xylem’s margin dropped by 2.2 percentage points during that time. It may have ticked higher more recently, but shareholders are likely hoping for its margin to at least revert to its historical level. If the longer-term trend returns, it could signal increasing investment needs and capital intensity.

Xylem burned through $38 million of cash in Q1, equivalent to a negative 1.8% margin. The company’s cash burn increased meaningfully year on year and is a deviation from its longer-term margin, but we wouldn’t put too much weight on the short term because investment needs can be seasonal, causing temporary swings.

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

Although Xylem has shown solid business quality lately, it historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 8.2%, somewhat low compared to the best industrials companies that consistently pump out 20%+.

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, Xylem’s ROIC averaged 3.9 percentage point decreases over the last few years. If its returns keep falling, it could suggest its profitable growth opportunities are drying up. We’ll keep a close eye.

Xylem reported $1.06 billion of cash and $2.02 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 $1.93 billion of EBITDA over the last 12 months, we view Xylem’s 0.5× net-debt-to-EBITDA ratio as safe. We also see its $6 million of annual interest expenses as appropriate. The company’s profits give it plenty of breathing room, allowing it to continue investing in growth initiatives.

We enjoyed seeing Xylem beat analysts’ revenue and EPS expectations this quarter. We were also happy its full-year revenue guidance was raised. On the other hand, its full-year EPS guidance slightly missed. Overall, this quarter had some key positives. The stock traded up 1.9% to $118 immediately following the results.

Updated: June 14, 2025 at 10:57 PM EDT

Before investing in or passing on Xylem, we urge you to understand the company’s business quality (or lack thereof), valuation, and the latest quarterly results - in that order.

Xylem is a fine business. To kick things off, its revenue growth was impressive over the last five years. And while its diminishing returns show management's recent bets still have yet to bear fruit, its expanding operating margin shows the business has become more efficient. On top of that, its healthy gross margins indicate the value of its differentiated offerings.

Xylem’s P/E ratio based on the next 12 months is 26.4x. Looking at the industrials landscape right now, Xylem trades at a pretty interesting price. For those confident in the business and its management team, this is a good time to invest.

Wall Street analysts have a consensus one-year price target of $139.96 on the company (compared to the current share price of $126.46), implying they see 10.7% upside in buying Xylem in the short term.