Zurn Elkay has had an impressive run over the past six months as its shares have beaten the S&P 500 by 17.2%. The stock now trades at $44.03, marking a 22.6% gain. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Zurn Elkay, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Do We Think Zurn Elkay Will Underperform?
We’re happy investors have made money, but we don't have much confidence in Zurn Elkay. Here are three reasons why we avoid ZWS and a stock we'd rather own.
1. Slow Organic Growth Suggests Waning Demand In Core Business
In addition to reported revenue, organic revenue is a useful data point for analyzing HVAC and Water Systems companies. This metric gives visibility into Zurn Elkay’s core business because it excludes one-time events such as mergers, acquisitions, and divestitures along with foreign currency fluctuations - non-fundamental factors that can manipulate the income statement.
Over the last two years, Zurn Elkay’s organic revenue averaged 2.7% year-on-year growth. This performance was underwhelming and suggests it may need to improve its products, pricing, or go-to-market strategy, which can add an extra layer of complexity to its operations. 
2. EPS Trending Down
We track the long-term change in earnings per share (EPS) because it highlights whether a company’s growth is profitable.
Sadly for Zurn Elkay, its EPS and revenue declined by 6.1% and 4.3% annually over the last five years. We tend to steer our readers away from companies with falling revenue and EPS, where diminishing earnings could imply changing secular trends and preferences. If the tide turns unexpectedly, Zurn Elkay’s low margin of safety could leave its stock price susceptible to large downswings.
3. Free Cash Flow Margin Dropping
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.
As you can see below, Zurn Elkay’s margin dropped by 5.5 percentage points over the last five years. If its declines continue, it could signal increasing investment needs and capital intensity. Zurn Elkay’s free cash flow margin for the trailing 12 months was 17.4%.
Final Judgment
We cheer for all companies making their customers lives easier, but in the case of Zurn Elkay, we’ll be cheering from the sidelines. With its shares beating the market recently, the stock trades at 31.3× forward P/E (or $44.03 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think other companies feature superior fundamentals at the moment. Let us point you toward a safe-and-steady industrials business benefiting from an upgrade cycle.
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