Primo Water: Execution Remains Solid, but Commoditized Water Leaves Little Room for Margin Lift

We are trimming our fair value estimate for Primo Water PRMW to $15.70 and CAD 20.90 (from $16.20 and CAD 22), which implies a 19 times multiple against our 2024 earnings estimate. The decline is driven by trimmed annual sales growth assumptions over the next five years to 5.0% (from 5.5%), reflecting normalized demand from pandemic levels, and by a 160-basis-point reduction in operating margin estimates to an average of 9.9% (from 11.3%) to incorporate higher labor and fuel costs. Primo Water shares are moderately undervalued, trading at an 11% discount to our intrinsic valuation, but we suggest investors wait for a wider margin of safety before buying into this name.

Over our 10-year forecast period, we have modeled 4.4% annual sales growth, driven by our expectation of steady, low- to mid-single-digit volume growth (consistent with Euromonitor’s estimate for the water category) in North America and Europe. Customer acquisition (through widening retail distribution of water dispensers) should be a key growth driver to help Primo tap demand for better-quality drinking water. Meanwhile, given the commoditized nature of water, we expect prices to stay flat at best. We have modeled operating margins to expand by 390 basis points to 10.3% by 2032, relative to 2022. While the expansion may appear material at first glance, we project the bulk of it to take place in 2023 (with operating margin expanding 290 basis points to 9.5%, from 2022), driven by the firm’s exit from the small bottled water segment and Russia. From 2024 onward, we have projected more-modest margin lifts, with an 80-basis-point expansion in operating margin to 10.3% by 2032, relative to 2023, thanks to manufacturing efficiency gains and labor and fuel savings aided by higher route density.

We continue to believe Primo Water lacks an economic moat based on intangible assets or cost advantages, given the commoditized nature of its water solutions and intense local competition in fragmented water delivery.