Xylem: Reiterating Narrow Moat Rating and $97 Fair Value Estimate After Evoqua Acquisition

After reviewing our assumptions for Xylem XYL following the completion of its acquisition of Evoqua, we reiterate our narrow moat rating and $97 fair value estimate but downgrade our moat trend rating to stable from positive. We see the name as fairly valued, with the stock currently trading in 3-star territory.

We think Xylem has carved a narrow moat based primarily on customer switching costs and secondarily on intangible assets. Xylem’s large installed base of equipment generates recurring revenue driven by aftermarket service and replacement parts as well as long-term contracts (up to 15-20 years) in the measurement and control solutions segment. Xylem’s moat is bolstered by intangible assets, including an extensive patent portfolio, reputable brands, and strong dealer relationships.

Likewise, we believe that Evoqua has established a narrow moat based on customer switching costs and intangible assets. Its integrated solutions and services business offers outsourced water service contracts, including short-term service deionization contracts and longer-term build-own-operate contracts (averaging 8-10 years). We believe that a key element of Evoqua’s moat is its unparalleled network of service professionals, which allows the firm to reach customers within two hours in the United States. Evoqua’s intangible assets include its portfolio of technologies for the removal and destruction of contaminants.

We remain optimistic about Xylem Vue, the firm’s digital ecosystem that uses smart water solutions and data analytics to help utilities solve multiple problems, including leak detection, water treatment, and monitoring. Nonetheless, while we believe that Xylem’s smart water strategy will reinforce customer switching costs by combining connected devices with software, we have reset the moat trend rating to stable as we see a similar trend across our diversified industrials coverage.