Primo Water Looks to Pump It Up

2011 was a year to forget for Primo Water (NAS: PRMW) . The company, which sells multi-gallon water systems, saw its stock go as high as $16 before falling off a cliff in August when rollout delays caused an unforeseen loss and lowered guidance. After a mild recovery, another disappointing earnings report in November along with delays in its SodaStream-competitor (NAS: SODA) product, FlavorStation, beat the stock down to around $3 (where it has traded since). While both stocks are down over the last six months, SodaStream is down 14% against Primo Water's nearly 60% loss.

The sharp drop has created what looks like a buying opportunity for some, as the fast-growing thirst quencher trades at a forward P/E of just 11. With Primo set to release fourth-quarter earnings Thursday after closing, let's take a look at a few things investors are hoping to see.

  • Improving gross margins: Gross margins have shrunk in each of the last four quarters, down from 29.6% in Q4 2010 to just 22.4% in Q3 2011. Investors should look for improving gross margins in any company, but especially in a growing one like Primo. The slimming margins indicate that either basic production costs, such as raw materials or labor, have gone up, or that the company has had to drop its price to maintain volume sales. Both of these spell trouble for a young company still in the red.

  • Positive news on FlavorStation: FlavorStation, Primo's at-home soda-making system, has been nothing but a disappointment for investors thus far. The company largely missed out on the holiday shopping season because of delays in reformulating its flavors, but investors may be rewarded for waiting on the SodaStream competitor. Just last week, Primo announced a strategic alliance with Sparkling Drink Systems which will bring their lineup up to 70 different varieties of home beverage carbonation systems. Though fourth-quarter FlavorStation sales should be minimal, expect to hear more on this new partnership and what it means for Primo's bottom line in the earnings report.

  • Promising guidance: With analysts predicting a loss of $0.08 a share for the quarter, investors may want to look ahead to see if management can keep up with 2012's high expectations. First-quarter 2012 EPS of $0.04 and full-year EPS of $0.26 is an ambitious swing into positive territory. If management can keep up with these expectations, expect the stock to jump. Based on past history, though, there's a good chance guidance will come in lower.

If Primo has an advantage over SodaStream, it figures to come from the distribution channels already in place from its water products, which sell to a wide range of retailers, including Wal-Mart (NYS: WMT) and Lowe's (NYS: LOW) . Primo's systems and exchangeable containers are currently sold in 20,000 retail locations, and the company hopes to expand to 50,000-60,000 in 2012. By comparison, SodaStream was available in 9,500 American retail outlets at the end of 2011, and continues to be notably absent from Wal-Mart, the world's largest retailer.

Investors seem to be anticipating a refreshing report from Primo, as its stock was up as much as 8% Wednesday on higher than average volume. Check back Friday for full analysis on the earnings release.

One reason stock watchers see Primo as a potential winner is its razor-and-blades business model -- first with its exchangeable water containers, and now with the Flavorstation syrup refills. It's a successful model, and it's being replicated across industries. There's a company in the health-care space that makes surgical robots and benefits from the same system. It's still a small company with a market cap under $2 billion, but our experts see huge profits in its future as the baby boomer generation ages. Find out more about this hot stock that's poised for success in our newest free report: "Discover the Next Rule-Breaking Multibagger." All you have to do is click right here.

At the time thisarticle was published Fool contributorJeremy Bowmanowns shares of SodaStream International but holds no other positions in the companies mentioned in this article. The Motley Fool owns shares of Wal-Mart Stores. Motley Fool newsletter services have recommended buying shares of Wal-Mart Stores, SodaStream International, and Lowe's. Motley Fool newsletter services have also recommended writing covered calls on Lowe's and creating a diagonal call position in Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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