Primo Water Earnings: Progress on Customer Acquisition, but Labor Cost Pressure Persists

We are not planning any material changes to our $16.20 (CAD 22) fair value estimate for Primo PRMW after absorbing second-quarter results that met our projections, with sales up 4% and EPS at $0.13. We are maintaining our 2023 forecasts for $2.35 billion in sales and $465 million in adjusted EBITDA, in line with management guidance, and we see no reason to alter our 10-year estimates for mid-single-digit sales growth and 10% average operating margins. Shares trade in a range we’d consider fairly valued.

The 3% top line growth in North America (76% of sales) appeared soft at first glance, but after adjusting for the 2022 exit from small bottled water, the expansion was solid at 6% on the back of pricing and user base expansion thanks to the tie-up with wide-moat Costco. We expect limited pricing in the coming quarters as Primo looks to protect its value proposition, but volume expansion from new clients (brought in through water dispenser sales on pace to reach 1 million units annually) and tuck-in acquisitions should enable the firm to meet our 6% 2023 sales target. Europe sales (13% of total) grew 9% on a currency-neutral basis, though its exposure to office blocks (versus client-facing businesses in the U.S.) will likely hold the region back from recovering to prepandemic levels soon.

Gross margins expanded an impressive 390 basis points to 62.1%, although we view the metric as being flattered by temporary factors such as the exit from small bottled water (prudent in our view) and one-time dispenser import tariff refunds. The benefits were partially offset as selling expenses climbed to 53.5% of sales (up 250 basis points) on higher commissions paid to delivery personnel to maintain service quality, which reaffirmed our concern that Primo lacks pricing power in labor or fuel. Although we have modelled a 9.5% 2023 operating margin (versus 6.4% in 2022) on various temporary benefits, we expect little further upside from 2024 onward given persistent cost pressure.