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Maybe Zurn Water Solutions (NYSE:ZWS ) isn’t exactly a unicorn stock, but it’s an under-followed water-focused company that has line-of-sight to excellent margins and above-market growth that is still trading below fair value.

With leverage to strong institutional spending, improving commercial activity, and healthy residential activity, not to mention a richer mix of more advanced solutions (leak detection, IoT, BrightShield hygiene solutions, et al), I like the prospects for ongoing above-market growth. Add in the acquisition of Elkay and the leverage to more growth opportunities in drinking water (as well as cost synergy opportunities and increased scale), and the outlook gets better.

Although Zurn doesn’t look “can’t miss” cheap to me today, and there’s a risk of further sentiment erosion in the once-popular water space, I do find a lot to like here.

Zurn’s fourth-quarter results weren’t flawless, but they were still pretty good with a top-line beat and better operating income, though much of the reported EPS beat came from lower taxes.

Revenue rose 16% in organic terms, beating expectations by close to 5%. While straight-up comparisons can be challenging, Watts (WTS) does compete in similar markets (head to head, in some case) and generated 19% organic growth in its Americas segment, and 18% growth overall, so I’d argue that Zurn was no worse than “in the ballpark” on a comp basis.

Gross margin was weak, falling more than six points year over year and around two and a half points to 36.7% on a reported basis, despite what sounded like around mid-single-digit pricing leverage. Even so, adjusted EBITDA rose 27% yoy in the quarter and adjusted income rose 33%, leading to a modest beat versus expectations, though margins (EBITDA margin down 50bp to 19.4%, adjusted operating margin down 110bp to 15.9%) were about a half-point weaker than expected.

Management guided to double-digit revenue growth for 2022, fueled in no small part by strong repair/replacement demand in institutional verticals like education and health care. With underlying market growth in the low-to-mid single-digits for ’22, Zurn management is expecting further market share gains (around two points of market outgrowth), as well as leverage from pricing actions taken to offset cost pressures.

The largest part of Zurn’s business is with institutional customers, and that market is finally seeing long-delayed replacement and retrofit activity; particularly as a lot of work was deferred by the pandemic. Looking ahead, the infrastructure bill should help in segments like education, and I see ongoing opportunities in areas like hygiene retrofit (touchless sensor-based fixtures) and leak detection/automatic shut-off, as well as IoT-based remote monitoring.

I also expect a healthy underlying construction market in 2022. I expect residential construction to continue at a good pace (both single-family and multifamily), and I would expect non-residential construction to pick up later in the year. In the meantime, retrofit opportunities around touchless and remote monitoring are still meaningful.

It hasn’t been that long since Zurn completed its Reverse Morris Trust transaction with what is now Regal Rexnord (RRX), turning Zurn into a pure-play water company, but the company is already back at M&A in a big way, recently announcing a $1.56B all-stock deal for family-owned Elkay.

Elkay is a sizable company relative to Zurn at around $700M in expected revenue, and will diversify the company into drinking water. More than half of Elkay’s business comes from drinking water-related products like fountains and bottle stations, where it is a market leader, and most of the remainder comes from sinks for residential and commercial markets.

While Zurn didn’t provide much detail about Elkay’s recent growth rates, replacement of traditional water coolers and fountains with dual fountain-bottle filling stations should be a meaningful driver. Looking at the information that Zurn did provide, it would seem that Zurn expects something in the neighborhood of 10% top-line growth at Elkay between FY’22 and FY’23 (driving management’s $1.9B pro forma target for FY’23).

Post-deal drinking water will become over 20% of Zurn’s revenue base and the addition of Elkay will expand the company’s addressable markets by about 50%. Moreover, while Elkay’s current margins are below Zurn’s (around 16% estimate for FY’22 versus mid-20%’s for Zurn on an adjusted basis), there should be some meaningful synergy opportunities amounting to around $50M of incremental EBITDA, including better leverage of Zurn’s corporate cost base.

I find a lot to like with Zurn now, particularly after the Elkay deal. Sustainable above-market growth with superior margins is usually a winning formula on the Street, and I expect Zurn to continue to grow above the market on the back of newer offerings like touchless hygiene, automated monitoring/shut-off, and Elkay’s bottle-filling stations. As for margins, I expect Zurn to get back to mid-20%’s EBITDA margins in a couple of years after the Elkay deal.

While the Elkay deal will vault Zurn to a double-digit long-term revenue growth rate, I expect longer-term organic growth to be more on the order of 4% to 5%, still comfortably above what I expect for construction growth over the next decade. I’m currently modeling long-term FCF margins in the mid-to-high teens, driving around 7% long-term FCF growth. Given that net debt will be around 1.0x EBITDA post deal, I would expect to see further M&A moves from Zurn, though likely not on this scale.

To value Zurn today, I assume that the Elkay deal goes through and I am using margins in Year 2 of the deal to drive my EBITDA model, as well as my typical long-term discounted cash flow approach. Discounted cash flow suggests total annualized return potential in the high single-digits now, while a 15x multiple on my 2024 EBITDA estimate, discounted back two years, gives me a mid-$30’s fair value.

I do worry about the risk of clutching at a falling knife with Zurn given how sentiment has soured on water-related stocks, but I really do like the long-term set up here. Combined with Elkay, Zurn will generate the vast amount of its revenue from markets where it is #1 or #2 (75% from market-leading products), and I like the focus on continuous operational improvement (a descendant of the time-tested Danaher (DHR) Business System).

Moreover, as I said before, above-market growth and strong margins is usually a winning combination. Given all of the above, this is a stock that I find very tempting at current levels.

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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. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.