Pat McKeough recently replied to a member of his Inner Circle who is looking for an opinion on Xylem Inc. International sales for the water management company have been hurt by the high U.S. dollar, says Pat. But trends in global water supply should buoy long-term revenue.

Q: Pat: I’d appreciate your analysis of Xylem Inc. Thanks.

A: XYLEM INC. (symbol XYL on New York; www.xyleminc.com) sells equipment and services related to managing water.

The company takes its name from “Xylem,” the Greek word describing the vascular tissue that carries water and nutrients through plants. With its products, Xylem Inc. helps clients collect, distribute, use and return water to the environment.

The company operates through two divisions:

The Water Infrastructure division (61% of its 2015 sales) sells a wide range of products, including water and waste-water pumps, controls and systems, as well as water treatment and testing equipment.

The Applied Water division (39%) focuses on residential, commercial, industrial and agricultural water users. Its main products include pumps, valves, heat exchangers, controls and dispensing equipment.

Xylem was formed on October 31, 2011, after ITT Corp. split up into three separate companies: Xylem; Exelis Inc. (defense and information technology); and the new ITT Corp., symbol ITT on New York (industrial engineering). Harris Corp., symbol HRS on New York, acquired Exelis in May 2015.

ITT shareholders received one Xylem share for each share of ITT they held, plus one share of Exelis and one share of the new ITT. Xylem, as well as the other two companies, began trading on New York on November 1, 2011.

In 2015, Xylem’s earnings before unusual items fell 7.2%, to $336 million from $362 million in 2014. Due to fewer shares outstanding, per-share earnings declined 6.1%, to $1.85 from $1.97.

Growth stocks: Stock up 46%

Xylem’s sales fell 6.7%, to $3.7 billion from $3.9 billion. The company has clients in more than 150 countries. Customers outside the U.S. account for about 60% of its revenue, so the high U.S. dollar hurts their contribution. If you disregard currency rates and the impact of acquisitions, sales rose 2% in 2015.

The company now holds cash of $680 million, or $3.81 a share. Its long-term debt of $1.2 billion is a reasonable 18% of its market cap.

Xylem has expanded rapidly since its spinoff from ITT, mainly by acquiring other companies.

It latest purchase is Tideland Signal Corp., a Texas firm that specializes in navigation equipment for vessels and onshore facilities like lighthouses. It also makes analytics software for clients who manage offshore wind farms, ports and harbours. Xylem paid $69 million for Tideland.

Xylem aims to take advantage of a number of facts and trends currently shaping the global water industry. They are:

More than 80 countries have water shortages, and less than 1% of the world’s total water is usable. As well, water demand tends to grow twice as fast as the world’s population, so continued population growth and economic development will spur rising demand for clean water.

Water infrastructure will need significant repairs and upgrades over the coming decades, especially in the developing world.

Changing weather patterns are resulting in more storms, floods and droughts, which can hurt water supply. As well, people are becoming more aware of health issues; this is leading to increased efforts to improve water quality.

To meet the large financial commitments involved in repairing and upgrading water infrastructure, governments are increasingly outsourcing these functions to the private sector. More than one billion people still rely on unsafe water sources around the world, so this market offers great growth potential.

However, Xylem’s growth-by-acquisition strategy adds to its risk. In addition, low commodity prices could prompt customers in the oil and mining industries (8% of its 2015 revenue) to spend less on water-treatment equipment. Still, the long-term outlook for both the water business and for Xylem itself is positive.

The stock is up around 46% since it split from ITT. It now trades at 19.0 times the $2.00 a share that Xylem will probably earn in 2016. The company recently raised its dividend by 10.0%. The new annual rate of $0.62 a share yields 1.6%.

Inner Circle recommendation: HOLD

For our report on another growth stock with a niche product, read Earnings for DIRTT Environmental jump.

For our advice on taking full advantage of growth stocks, read Growth investing balances an investor’s portfolio.