Executive Summary / Key Takeaways

• Strategic Transformation Creating Durable Moat: DXP Enterprises is executing a deliberate pivot from cyclical oil & gas dependence toward higher-margin water/wastewater markets, with DXP Water now representing 54% of IPS segment sales and crossing $100 million annually. This diversification reduces earnings volatility while expanding addressable markets.

• Margin Expansion Is Structural, Not Cyclical: The company has sustained adjusted EBITDA margins above 10% for two consecutive years, with Q3 2025 gross margins reaching 31.39% (+50 bps YoY) and IPS segment margins hitting 18.3%. Management's guidance of sustainable 11%+ EBITDA margins reflects acquisition-driven mix improvement, not temporary pricing power.

• Acquisition Engine Running with Discipline: Seven acquisitions in 2024 and three more through Q3 2025 demonstrate aggressive but measured expansion, all funded with cash. The focus on water/wastewater targets accretive margins while maintaining ROIC at 33%, well above the cost of capital.

• Service Centers Provide Resilient Foundation: At 68% of sales and 14.6% operating margins, the MRO-focused Service Centers segment delivers consistent growth (10.5% YoY in Q3) through diverse end markets, providing ballast against IPS project cyclicality.

• Key Risk Is Execution at Scale: While the diversification strategy is working, the company faces macro headwinds from tariffs, potential energy market softness, and integration risks from rapid M&A. The investment thesis hinges on maintaining margin discipline while scaling the water platform.

Setting the Scene: From Oil Patch to Water Infrastructure

DXP Enterprises, founded in 1908 and incorporated in Texas in 1996, spent its first century building a leading position as a maintenance, repair, and operating (MRO) distributor serving the oil & gas industry. For decades, this was a viable strategy—energy provided steady demand for pumps, bearings, and fluid power components. But cyclicality and customer concentration created inherent risk. The company recognized this vulnerability and began a strategic transformation around 2020 that has accelerated through 2025.

Today, DXP operates through three segments: Service Centers (68% of Q3 2025 sales), Innovative Pumping Solutions (20%), and Supply Chain Services (12%). The Service Centers segment represents the legacy MRO business, distributing rotating equipment, bearings, power transmission, and safety products across industrial end markets. This business is characterized by its non-discretionary nature—customers must maintain equipment regardless of economic conditions—and its fragmented customer base, which provides resilience during downturns.

What makes this transformation remarkable is the speed and profitability of the pivot. Since 2020, DXP has achieved a 15.7% compounded annual growth rate, with 2024 marking a record year at $1.8 billion in sales and 30.9% gross margins. More importantly, oil & gas exposure has been reduced to just 23% of the business, with water/wastewater, chemical, food & beverage, and general industrial markets comprising the balance. This isn't just geographic or product expansion—it's a fundamental reorientation toward more stable, higher-margin end markets.

The company's position as the largest distributor of rotating equipment in North America provides a foundation of scale and technical expertise that competitors cannot easily replicate. This scale translates into purchasing power with suppliers and deep customer relationships that span decades. However, the real strategic differentiation lies in the IPS segment, where DXP has built a specialized capability in custom pump fabrication, remanufacturing, and private-label manufacturing that goes far beyond simple distribution.

Technology, Products, and Strategic Differentiation

The IPS segment represents DXP's engineered solutions moat. Unlike standard MRO distribution, IPS fabricates custom pump packages, remanufactures existing equipment, and manufactures branded private-label pumps. This capability requires deep engineering expertise, certified manufacturing processes, and the ability to integrate complex systems for specific customer applications. The economic impact is substantial: IPS generated 18.3% operating margins in Q3 2025, nearly double the Service Centers' margins and more than double the SCS segment.

The DXP Water platform is the crown jewel of this differentiation. Having achieved 11 consecutive quarters of sequential sales growth, DXP Water crossed $100 million in annual sales in 2024 and now represents 54% of IPS segment sales, up from 47% in the prior year period. This matters because water infrastructure spending is non-discretionary, government-funded, and less cyclical than energy capex. Municipalities must upgrade aging treatment facilities regardless of economic conditions, providing a stable revenue base.

Management's commentary reveals the strategic logic: water and wastewater acquisitions carry higher relative gross and operating margins than the legacy energy business. The segment's average backlog increased 7% compared to Q2 2025, while the energy-related backlog declined 3.3%—its first drop in ten quarters. This mix shift is actively expanding corporate margins, with IPS operating income margins improving 57 basis points year-over-year in fiscal 2024.

The Service Centers segment is simultaneously evolving through technical product expansion. Growth initiatives include automation solutions, vacuum pumps, new pump brands for water and industrial markets, process equipment, and filtration. The addition of an e-commerce channel and expansion into new markets like data centers (which require pumps, cooling, and filtration) demonstrate a commitment to meeting customers where they are. While data centers haven't yet become a "big win," the addressable market is substantial and growing.

Supply Chain Services provides the third leg of differentiation. The segment's SmartAgreement and SmartSource programs offer customers vendor consolidation, inventory management, and customized reporting. While SCS faces near-term headwinds from customer facility closures and reduced spending, the value proposition remains compelling: industrial customers can achieve measurable efficiency gains through outsourcing MRO procurement. The segment's 8.4% operating margins, while lower than the other segments, represent stable cash flow from long-term contracts.

Financial Performance & Segment Dynamics: Evidence of Strategy Working

DXP's Q3 2025 results provide clear evidence that the diversification strategy is delivering tangible financial benefits. Total revenue of $513.7 million increased 8.6% year-over-year, with acquisitions contributing $18.4 million. More telling is the organic growth story: average daily sales reached $8.0 million in Q3 2025, up from $7.39 million in Q3 2024, with organic daily sales of $7.74 million versus $6.95 million in the prior year period. This 11.4% organic growth rate demonstrates underlying business momentum beyond M&A.

The segment performance tells a nuanced story. Service Centers delivered $350.2 million in sales (+10.5% YoY) with 14.6% operating margins, marking the strongest quarter in 10 quarters. This resilience matters because it shows the MRO business can grow even in uncertain industrial conditions. The diversity of end markets and multiple product divisions provide insulation from single-sector downturns. Regions including South Central, California, Southeast, and Texas Gulf Coast all showed year-over-year growth, indicating broad-based demand.

IPS sales of $100.6 million grew 11.9% year-over-year, but the composition shift is more important than the top-line number. DXP Water's 54% share of IPS sales represents a fundamental rebalancing toward higher-margin, more stable markets. While energy backlog declined 3.3% in Q3—ending a ten-quarter streak of growth—the level remains above all historical averages, and the native energy IPS backlog was up 56.2% year-over-year on a nine-month basis. This suggests the energy business isn't collapsing but normalizing after exceptional growth.

SCS sales declined 5% year-over-year to $63.0 million, reflecting customer facility closures and reduced spending from existing customers. However, management expects a mild Q4 2025 followed by a stronger Q1 2026 as new customer implementations come online. The segment's electronic pricing model, while slowing tariff pass-through, provides transparency and stickiness once implemented.

Margin expansion across the business is structural, not cyclical. Consolidated gross margins improved 50 basis points to 31.39% in Q3 2025, driven by a 117 basis point improvement in Service Centers gross margins and accretive acquisitions. The sales mix shift toward IPS (19.57% of Q3 sales versus 18.5% in Q3 2024) further boosted margins. Operating income of $43.7 million represented 8.5% of sales, up from 8.37% in Q3 2024, despite an $11 million increase in SG&A expenses driven by growth investments, incentive compensation, and insurance premium increases.

The balance sheet supports continued execution. With $123.8 million in available cash and $153.4 million in undrawn credit facility capacity, DXP has ample liquidity for acquisitions and working capital. The secured leverage ratio of 2.31x is well below the 5.50x covenant limit, providing financial flexibility. Working capital increased $73.6 million to $364.6 million, reflecting sustained sales growth and acquisition activity.

Capital expenditures of $37 million for the nine months ended September 30, 2025, were elevated due to facility purchases and technology investments, but management expects CapEx to lessen over the next one to two quarters and be lower in 2026. This suggests the heavy investment phase is temporary, with free cash flow set to improve. Q3 2025 free cash flow of $28.2 million, up from $24.4 million in Q3 2024, demonstrates the business's cash generation capability.

Outlook, Management Guidance, and Execution Risk

Management's guidance frames a confident but realistic outlook. The consistent message across earnings calls is that 11%+ adjusted EBITDA margins are sustainable, with CFO Kent Yee stating, "we feel plenty comfortable with 11%." This isn't aspirational—it's a baseline expectation built on mix improvement and operational leverage. The company has already achieved this target for two consecutive years, and the water platform's continued growth provides margin support.

The acquisition pipeline remains robust. After seven deals in 2024, management anticipated closing two to three acquisitions by mid-2025 and has delivered, with three deals completed through Q3 2025 totaling $25.6 million in purchase consideration. The focus on water and wastewater continues, with subsequent acquisitions of Triangle Pump Equipment and Pump Solutions in late 2025 further expanding geographic reach and end-market capabilities. This disciplined approach—funding deals with cash and targeting accretive margins—reinforces the strategic transformation.

End-market commentary suggests constructive conditions. While the ISM Manufacturing Index has trended from growth to slight contraction (50.9 in January to 48.7 in April 2025), management believes price increases and continued demand will offset macro softness. The energy business, while representing just 23% of total sales, remains resilient with backlog above historical averages. Water infrastructure demand appears durable, driven by regulatory requirements and aging asset replacement.

Tariff management demonstrates operational sophistication. Chairman and CEO David Little's commentary reveals a nuanced strategy: leveraging deep product knowledge and supply chain expertise to guide customers toward alternative products and minimize cost increases, while maintaining price-cost neutrality. The company passes through tariff costs but hasn't seen demand destruction, with projects remaining active and backlog healthy. This ability to navigate supply chain disruptions without margin compression is a competitive advantage.

The SCS segment's outlook is improving. While Q4 2025 is expected to be mild due to seasonality and customer facility closures, management anticipates a stronger Q1 2026 as new customer implementations ramp. The segment's proven technology and efficiency gains for industrial customers position it for renewed growth, with demand increasing as customers seek cost reduction through outsourcing.

Risks and Asymmetries: What Could Break the Thesis

The most material risk is execution of the M&A strategy at scale. While acquisitions have been accretive and well-integrated, the pace of deals increases integration risk. The $12.2 million in goodwill recorded for nine-month 2025 acquisitions reflects expected synergies and assembled workforce value, but any failure to realize these benefits would impair returns. The company's 33% ROIC provides cushion, but a major acquisition misstep could dent investor confidence.

Energy market exposure, while reduced, remains a vulnerability. At 23% of sales, a severe oil & gas downturn would impact results, particularly in the IPS segment's heritage energy business. The Q3 2025 energy backlog decline, while modest and from elevated levels, bears watching. If this marks the beginning of a sustained downturn, growth could slow despite water platform gains.

Tariff and trade policy uncertainty creates near-term headwinds. While management has successfully passed through costs to date, a significant escalation in trade tensions or a shift in customer willingness to accept price increases could compress margins. The electronic pricing model in SCS slows adjustment timing, creating a lag effect that could pressure margins in a rapidly changing tariff environment.

Competitive pressure from larger MRO distributors is an ongoing concern. W.W. Grainger and Fastenal have superior scale, e-commerce capabilities, and geographic reach. While DXP's technical expertise in rotating equipment and pumping solutions provides differentiation, the larger players could encroach on DXP's markets through acquisition or product expansion. DXP's smaller scale—$1.8 billion in sales versus GWW's $16+ billion—limits purchasing power and negotiating leverage with suppliers.

The IRS examination of 2018 tax returns presents a contingent liability. Notices of Proposed Adjustment received in October 2024 could result in the loss of federal income tax credits for research activities. While management intends to vigorously defend its positions and has accrued a reserve, an adverse outcome could materially impact financial condition. This risk is particularly relevant given the company's R&D investments in technical products and automation.

Competitive Context: Niche Dominance vs. Scale

DXP's competitive positioning is defined by depth versus breadth. Against W.W. Grainger (GWW), the largest industrial distributor, DXP's $1.8 billion in revenue pales in comparison to GWW's $16+ billion. GWW's 39.1% gross margins and 15.2% operating margins reflect superior scale and e-commerce efficiency. However, DXP's 18.3% IPS margins demonstrate that specialized engineering capabilities can outperform general distribution economics in niche applications.

Fastenal (FAST) presents a different challenge. With 45.2% gross margins and 20.7% operating margins, FAST's vending and on-site inventory solutions create sticky customer relationships and high returns. DXP's SCS segment competes directly here, but FAST's 3,000+ location network and digital maturity exceed DXP's capabilities. Where DXP wins is in technical complexity—FAST cannot match DXP's pump fabrication and remanufacturing expertise.

MSC Industrial (MSM) is the closest peer in metalworking and MRO supplies, but with 40.8% gross margins and 9.1% operating margins, it trails DXP's profitability in overlapping segments. MSM's recent sales decline and margin pressure highlight the value of DXP's diversification strategy. DXP's 8.6% Q3 growth significantly outpaced MSM's struggles.

Applied Industrial Technologies (AIT) competes directly in bearings, power transmission, and fluid power. AIT's 30.4% gross margins and 10.8% operating margins are comparable but lower than DXP's, reflecting less exposure to high-value pumping solutions. AIT's acquisition-driven growth strategy mirrors DXP's, but DXP's water platform provides a unique growth vector.

The key differentiator across all comparisons is DXP's integrated pumping solutions capability. This isn't just distribution—it's engineering, manufacturing, and lifecycle management. When a water treatment plant needs a custom pump package, DXP can design, fabricate, install, and maintain it. This creates switching costs and pricing power that pure distributors cannot match. The 33% ROIC reflects this advantage.

Valuation Context: Reasonable Multiple for Quality Business

At $95.74 per share, DXP trades at 18.2x trailing earnings, 9.9x EV/EBITDA, and 0.77x sales. These multiples are reasonable for an industrial distributor with accelerating margins and double-digit growth. The 19.6% ROE and 8.0% ROA demonstrate efficient capital deployment, while the 1.41x debt-to-equity ratio is manageable given stable cash flows.

Peer comparisons provide context. GWW trades at 27.4x earnings and 16.4x EV/EBITDA, reflecting its scale and market leadership premium. FAST commands 39.2x earnings and 26.7x EV/EBITDA due to superior margins and growth. MSM trades at 23.2x earnings and 12.6x EV/EBITDA, while AIT trades at 24.9x earnings and 17.1x EV/EBITDA.

DXP's valuation discount to peers appears warranted given smaller scale and higher cyclicality, but the gap may narrow as the water platform grows and margins expand. The 35.6x price-to-free-cash-flow ratio reflects recent investment in acquisitions and CapEx; management's guidance of lower 2026 CapEx should improve this metric.

The balance sheet supports continued value creation. With $123.8 million in cash and $153.4 million in undrawn credit, DXP has $277 million in total liquidity against a $2.07 billion enterprise value. The 2.31x secured leverage ratio provides ample headroom for additional acquisitions. The company's return on invested capital of 33% remains measurably above its cost of capital, indicating that incremental investments—whether organic or acquired—are creating shareholder value.

Conclusion: Execution of Diversification Strategy Will Determine Returns

DXP Enterprises has engineered a remarkable transformation from a cyclical oil & gas distributor to a diversified industrial platform with durable competitive advantages. The water/wastewater platform's growth to 54% of IPS sales and $100+ million in revenue provides a stable, high-margin foundation that reduces earnings volatility while expanding the addressable market. Combined with the resilient Service Centers business and improving SCS segment, DXP is building a more balanced, profitable enterprise.

The financial evidence supports the thesis: 8.6% revenue growth, 50 basis points of gross margin expansion, and sustained 11%+ EBITDA margins demonstrate that the strategy is working. The 33% ROIC and disciplined cash-funded acquisitions show capital allocation is creating, not destroying, value. Management's guidance appears credible based on execution to date.

The investment case hinges on two variables: continued successful integration of water-focused acquisitions and maintenance of margin discipline during the scaling phase. If DXP can execute on its pipeline while navigating tariff and macro headwinds, the valuation gap to higher-quality MRO peers should narrow. Conversely, a misstep in M&A or a sharp energy downturn could pressure the stock despite diversification progress.

For long-term investors, DXP offers a rare combination: a 115-year-old company reinventing itself through strategic M&A, with tangible evidence of margin expansion and market share gains in growing end markets. The water platform's momentum and the Service Centers' resilience provide downside protection, while the acquisition pipeline offers upside optionality. The key is execution—and the data suggests management is delivering.