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Advanced Drainage Systems (NYSE:WMS ) has a positive growth outlook as a designer and manufacturer of thermoplastic corrugated pipes and related water management products and drainage solutions. ADS offers materials that tend to be lighter, more durable, easier to install, and more cost effective than other competing materials. These advantages can help drive key customers to use ADS for their water management needs.

WMS is benefiting from the growth of residential and non-residential developments. The company is showing strength in fiscal Q4 2021 with a 20% increase in net sales. The company achieved a 17% sales increase in the legacy ADS business and a 23% sales increase for the Infiltrator business (a 2019 acquisition). WMS has a target of 4% to 6% organic sales growth (sales for existing businesses not including new acquisitions) per year for the next 3 years.

My thesis is that the company's strong earnings growth is likely to help drive above-average stock growth over the next three years. ADS achieves high returns with an ROE of 27.6% and ROIC of 11%. Advanced Drainage Systems also has a high net income margin of 11% as compared to the sector median of just 5%. These strong metrics helped ADS achieved a 31% increase in consolidated adjusted EBITDA for FQ4 2021. The EBITDA margin increased 7% to a record level of 28.6%.

My reasoning for ADS's strong future growth is due to the company's positive sales momentum, demonstrating that it is a key drainage supplier in the industry. ADS is seeing strong demand in both residential and non-residential markets. Another reason is because the company has a good focus on operational efficiency initiatives to reduce costs.

ADS is experiencing 21% sales growth in the residential market and 11% sales growth in the non-residential markets. New home construction, the repair/remodeling business, and the onsite septic market are driving the strength in the residential market. Homebuilders have been acquiring more land to help fill the void of low inventory of existing homes for sale on the market. More new residential developments are likely to need drainage systems put into place. This should keep demand strong for ADS over the next several years.

In the non-residential market, ADS is seeing strength in datacenters, distribution centers, and warehouses. The agriculture market was also strong for ADS where the company achieved a 50% increase in sales. Strength for agriculture has been in the Midwest in the following states: Iowa, Ohio, Minnesota, and Michigan.

The company has been striving to increase market share by investing in strategic regions. Missouri and the Southeast are areas where ADS has efforts in progress to drive growth.

ADS is also doing well in International markets where it achieved a 49% sales increase for FQ4. This was driven by growth in the Canadian business with strength in the agriculture and construction markets.

The company's Infiltrator business is also experiencing growth as it achieved a 23% sales increase. Double-digit growth was achieved for tanks and leachfield systems. ADS saw strong growth in multiple states such as Alabama, Florida, Indiana, Tennessee, and others. The growth of the Infiltrator business has been the conversion of concrete septic tanks to plastic tanks and the economic advantages of septic chambers in leechfield systems.

source: ADS Q4 2021 Investor Presentation

We can see in the graphic above that ADS is performing well in each category (internationally, domestically and in residential and non-residential markets). The company has a chance to build on this positive momentum as the economy reopened with increased business activity. This can spur drainage projects that may have been postponed during the early phases of the pandemic.

The Infiltrator acquisition diversified ADS's revenue since it increased the company's exposure to the residential market. The company now derives a better mix of revenue from both residential and commercial markets. This can help set the company up for strong future growth with more diverse revenue sources.

Overall, ADS has a target of 4% to 6% organic sales growth per year for the next 3 years. The company is projecting higher sales growth of 12% to 16% in the range of $2.22 billion and $2.3 billion for FY22. ADS is experiencing a high backlog of orders, which is driving this strong projection. This should help drive the stock higher if these projections are met or exceeded, leading to annual revenue and earnings growth.

We are seeing extreme weather events throughout the world, bringing heavy rain and flooding to various areas. Look at the recent flooding in Germany, the flooding in Florida, and in many other regions. Flash flooding seems common as thunderstorms, tropical storms, and hurricanes remind us of the need for proper drainage systems. These extreme heavy rain events have a high potential of increasing demand for ADS's products.

The company's efforts at operational efficiency keeps costs contained for strong margins. For example, ADS runs a large internal fleet of 750 trucks and 1,350 trailers which keeps transportation costs down. The company has a partnership with SmartWay to help ADS maintain transportation efficiencies such as vehicle use, optimal routes, and shipping methods. ADS's EBITDA margin of 24% and net income margin of 11% are significantly higher than the sector median EBITDA margin of 13% and net income margin of 5%.

WMS is currently trading with a forward PE of 31.6. This is well above the Building Products & Equipment industry's forward PE of 18. I see the stock as a bit overvalued at the moment.

Advanced Drainage Systems has the advantage of being the largest corrugated HDPE producer in the United States. ADS has a national footprint, while the other HDPE producers are fragmented and have much smaller footprints. ADS also competes with companies that produce concrete pipes, PVC pipes, and corrugated steel pipes for drainage purposes. ADS has the advantage of having HDPE as a lighter, less expensive, and easier to install drain pipe option as compared to many other competitors. ADS's advantages could be priced into the stock. I would be more comfortable entering the stock at a lower forward PE ratio, perhaps in the mid-20s.

The daily chart above shows the RSI at 63 (7 points below the overbought level of 70). This is positive in the very near term as the stock has been rising and showing strength. However, since the stock is close to an overbought level, I don't see this as a time to jump in. The green MACD line has been chopping back and forth above and below the red signal line. The money flow [CMF] dropped off in late July, suggesting that the stock price may follow soon with a dip.

It would probably be wise for investors to wait for a better time to enter the stock (after a dip with a sign of recovery). For example, watch for an opportunity like in early April, where the stock began to recover after a sizeable dip. All three indicators lined up to show a positive change in trend at the beginning of April.

While anything can happen in the near term, long-term investors can benefit from keeping their eyes on the horizon of 3 to 5 years or longer into the future. Flooding is happening on a regular basis in various regions around the globe. This keeps the demand strong for the solutions that ADS offers. There are likely to be ongoing drainage projects in residential and non-residential settings to help minimize the effects of flooding.

Those looking to get drainage projects completed are likely to consider the ease of installation, effectiveness, and cost benefits of using HDPE. Projects can be completed at less cost with high effectiveness with ADS's HDPE products as compared to heavier installations of concrete or steel pipes.

ADS has a good chance to achieve strong, above-average revenue and earnings growth for multiple years as businesses, governments, and individuals look for drainage solutions to prevent the damaging effects of floods where it is possible. While I like the growth prospects for ADS, I would rather wait for the stock to present a better buying opportunity with a lower valuation and a more opportune technical position.

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This article was written by

Through diligent analysis, he is ranked in the top 1% of blogging analysts on Tipranks.com for performance and accuracy. David previously contributed to Kirk Spano's Margin of Safety Investing [MoSI] Marketplace Service and Risk Research Inc.

David focuses on growth & momentum stocks that are reasonably priced and likely to outperform the market over the long-term. He is a long term investor of quality stocks and uses options for strategy.

David told investors to buy in March 2009 at the bottom of the financial crisis. The S&P 500 increased 367% and the Nasdaq increased 685% from 2009 through 2019.

He wants to help make people money by investing in high-quality growth stocks.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. Business relationship disclosure: The article was written by David Zanoni for Kirk Spano's Margin of Safety Investing service [MoSI].

Additional disclosure: The article is for informational purposes only (not a solicitation or recommendation to buy or sell stocks). David is not a registered investment adviser. Kirk Spano is an RIA. Investors should do their own research or consult a financial adviser to determine what investments are appropriate for their individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate. Investing in stocks involves risk and could result in losses.