Thomas Bullock/iStock via Getty Images
Thomas Bullock/iStock via Getty Images
Pentair (NYSE:PNR ) delivers a range of water-based solutions to homes, businesses, and industries around the world. They are comprised of two reportable business segments: Consumer Solutions and Industrial & Flow Technologies (IFT).
In the Consumer Solutions segment, PNR designs, manufacturers, and sells pool equipment and accessories and water treatment products and systems to both residential and commercial customers. In this segment, about 65% of total net sales are attributable to the pool business.
In the IFT segment, PNR sells a variety of business-to-business fluid treatment and pump products and systems that are used in a range of applications, including food and beverage, fire suppression, flood control, and agricultural irrigation. Of the company's total net sales, this segment accounts for about 40% of the total.
For the three months ended March 31, 2022, the company reported total net sales of +$1B, which was 15% greater than the same period last year and +$51M more than expected. Non-GAAP EPS came in at $0.85, which also beat expectations by $0.04. In Q2, the company is expecting adjusted YOY EPS growth of 17-20% and a YOY increase in sales of 11-13%. Additionally, full-year top line guidance was increased to a range of 9-11%, reflecting the stronger performance in Q1.
Despite an earnings release and outlook that was largely better than expected, shares are currently trading near their 52-week lows. Furthermore, the stock is down nearly 30% YTD, which is significantly worse than the broader S&P 500. At just under 14x forward earnings, it is worth dipping a toe into this quality pool-oriented company.
PNR is a leader in North American pool equipment, a market that is primarily replacement driven. For many homeowners, ongoing maintenance is one aspect of improving their overall experiences within their homes. For those with pools, maintenance requirements are even higher. To keep it running, owners must commit to reoccurring non-discretionary maintenance cycles. An aged stock of existing homes provides further tailwinds for the replacement market.
NAHB-Provided Chart on Median Housing Age
NAHB-Provided Chart on Median Housing Age
For PNR, approximately 70% of total revenue is derived from the replacement and aftermarket business. This provides stability to the company in an otherwise highly discretionary industry with various demand drivers. Additionally, replacement markets are often characterized as providing predictable cash flows and good margins.
Sales were up 15% in the first quarter of 2022, driven by favorable pricing. Furthermore, at the end of 2021, PNR had a backlog of +$1.5B. While this backlog is expected to come down over the course of the year, pool sales grew by 23% in the first quarter, and the company is expecting the strong demand to continue through the peak 2022 season. As such, the backlog may remain at elevated levels.
During the quarter, a strong rebound was also seen in commercial water solutions, particularly in quick service restaurants and convenience stores. Improvements were also occurring in the hospitality sectors, driven by increased consumer travel.
Return on sales did decline 180 basis points, however. Additionally, margins were pressured by inflationary pressures, supply chain inefficiencies, and the effect of recent acquisitions. Despite these negative externalities, Q1 marked the first time in over a year that price offset inflation. Furthermore, the company is expecting strong sequential improvement in Q2.
While margins have been down in recent periods, they are still generally stronger than the sector median. Net income margin, for example, is nearly 14% versus an industry average of 7%. In some cases, current period returns are even stronger than the company's own historical averages.
Seeking Alpha - Profitability Metrics
Seeking Alpha - Profitability Metrics
Through the end of Q1, demand clearly has not been an issue for the company. The biggest issue, instead, has been supply-related constraints that have impacted PNR's ability to meet rising demand. Moving forward, demand is expected to remain strong, despite numerous economic headwinds confronting individual consumers
With the shift towards more hybrid models of work, many people have been given the freedom to relocate from their current locations. As such, over the past two years, there has been a large migratory shift from colder weather states to the warmer regions. The top ten inbound states from 2020 through 2021, for example, were all warmer weather states. Contrast that with the top ten outbound states, which were weighted more towards colder or temperate locations.
AEI-Provided Chart on Domestic Migration Trends
AEI-Provided Chart on Domestic Migration Trends
With more people buying second homes and moving to warmer states, the demand for pools is expected to increase in-kind. Arizona, Florida, and Nevada, for example, are ranked as the top three "pool-loving" states. Moreover, Florida shares the title with California as states with the most amount of inground pools. These statistics are all favorable structural tailwinds for PNR.
PNR has capitalized on the heightened attention to sustainability and water scarcity by developing innovative products that were designed to address growing environmental concerns among consumers and regulators.
Within water treatment, for example, 50% of consumers in the industry were concerned about water quality. Of all the companies in the space to address these concerns, PNR was ranked as the #1 company to be recommended by commercial dealers.
Stressed water access in certain regions within the U.S. and around the world has also increased the need for pumping solutions to supply, dispose, and move water. In addition to pumping solutions, there is a growing opportunity to deliver clean water and promote water reuse through filtration solutions and applications.
As an industry leader, PNR has already delivered on the growing demand for quality water solutions, and they are poised to capture significant market share over time as a once limitless resource becomes increasingly more scarce.
Author's Summary of Strength of Fundamentals
Author's Summary of Strength of Fundamentals
At the end of the 1st quarter, PNR had total current assets of +$1.5B and total current liabilities of +$1.0B. Of their total current assets, they had about +$100M in cash. The company has not had any negative liquidity events, and they have been effective in managing their working capital.
Author's Calculations of Various Short-Term Liquidity Ratios
Author's Calculations of Various Short-Term Liquidity Ratios
Inventory turnover has remained strong, despite supply-related headwinds. Furthermore, collections have not slowed, even during the worst months early in 2020. With 43 days of sales in cash, the company has a limited need for other financing sources.
Author's Calculations of Other Days of Required Financing
Author's Calculations of Other Days of Required Financing
From a longer-term standpoint, there are no solvency concerns. Total debt is at manageable levels, and the high interest coverage ratio indicates the company has a strong ability to meet its interest obligations with their current earnings.
At period end, the company had a leverage ratio of just over 1x. While leverage is expected to increase due to the acquisition of Manitowoc Ice, it is not projected to lead to any negative revisions to the company's credit quality.
Author's Calculations of Various Long-Term Solvency Ratios
Author's Calculations of Various Long-Term Solvency Ratios
With limited near-term debt and no apparent issues satisfying current obligations, the risk to PNR's long-term viability is minimal. The strong balance sheet also enables the company to invest in growth opportunities and return any excess to shareholders via dividends and buybacks.
Long-term holders of PNR have been rewarded with over 40 years of dividend increases. In the past three years, the payout has grown at a CAGR of 15%, with the most recent being a 5% raise. At present, the dividend is yielding 1.6%. While this is not a high yielding payout, it is still a predictable source of income for many investors.
In 2021, total payouts, including repurchases, were nearly +$300M, and they were fully covered by operating cash flows, free cash flows, and net income. Furthermore, the dividend payment only represented a quarter of net income. When including share repurchases, it increased to 50%, but that is still quite low.
Author's Summary of Cash Flow Statement
Author's Summary of Cash Flow Statement
In Q1FY22, PNR reported negative cash from operations, but that is expected due to the seasonal nature of the business. In the following quarters, cash flows are expected to catch up and will likely end the year modestly higher than 2021. For income-focused investors, the dividend appears safe for the foreseeable future.
PNR is currently trading at just under 14x forward earnings versus their five-year average of 18x. When considering the historical trading multiples of the shares, a price range of between $57 and $68 is obtained.
When incorporating a discounted valuation model, using both projected free cash flows and a multi-stage dividend discount model, a price range of $40 to $77 is obtained. Since the rate on 10-YR Treasury's is a critical variable in the models, two different rates were used. The current rate of 3%, as reported in The Wall Street Journal, was used for the first set of calculations. For hypothetical purposes, a higher rate of 5% was then used for the second set.
Author's Summary of Average Price Target
Author's Summary of Average Price Target
When considering the results of all valuation methods used, an average price target of $60 was obtained.
Sales to the company's largest customer represented 20% of their consolidated net sales in 2021. While this was the only customer to account for over 10% of total net sales, the company does have several other customers that are critical to the success of their business. This level of concentration in sales exposes the company to a heightened level of risk. The loss of one or more of their largest customers or the cancellation, reduction, or delay in purchases of products from these customers can have a significant adverse effect on the company's results of operations.
Sales outside of the U.S. in 2021 accounted for about 30% of total net sales. Exposure risk to international markets subjects the company to potential economic/political instability in the host country. Additionally, the company may be negatively impacted by geopolitical conflicts that may arise between the U.S or their allies and any of the countries that the company operates in. Tariffs and counter-tariffs, increased regulation, boycotts, and long-winded lawsuits are potential complexities that could raise the cost of doing business for the company. In addition, the rising strength of the U.S. dollar against other currencies is another headwind that can materially affect reported revenues.
While PNR's management office is in the U.S., the company is structured as an Irish public limited company, with jurisdiction of organization in Ireland and a tax residency in the U.K. Some risks inherent to a foreign-based corporate structure include different regulations, tax considerations, and securities-based restrictions. Unexpected changes or uncertainties can result in an adverse effect in the company's business.
PNR is a leader in providing water-based solutions that reported strong quarterly results, given current market dynamics. Additionally, they increased their top line guidance to reflect the strong performance to start the year. Despite the positive news, shares are trading at their lows and are significantly lagging the broader market.
The pool industry is not a sector that comes to mind in a period marked with recessionary fears. But that should not distract from the long-term potential of the company. Consumer demand remains strong, and favorable housing trends support continued growth in the pool-related equipment industry in future periods.
In return for holding shares, investors will receive a steady dividend payout that has been increasing for 46 consecutive years. The payouts are supported by strong cash flows and a strong balance sheet with limited debt-related risks.
At just under 14x forward earnings, shares are trading at a discount to historical averages. Considered with other valuation metrics, PNR appears to be undervalued by nearly 20%. For investors with a longer-term horizon that are bullish on the broader housing market, a dive into PNR may be just what the diversified portfolio needs.
This article was written by
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.