PNR - Pentair plc: Outlook After Hitting 52-Week High

2023-08-15 10:50:02 ET

Summary

• Water solutions company, Pentair, recently hit a new 52-week high following the release of record Q2 results.
• The outperformance can be attributed in part to successful execution of their Manitowoc acquisition in fiscal 2022.
• The company has also benefitted from the recovery in the food service and hospitality industries.
• Though their Pools division still lags, the weakness is more than offset by strength elsewhere.
• Following the recent run higher, I view shares as fairly valued.

Water solutions company, Pentair ( PNR ), is having a good year. Shares are up over 50% YTD and 40% during the past year. And the stock recently hit a new 52-week high shortly after the release of their fiscal Q2 results. PNR is also up over 25% since my prior update on the stock. This compares to a 10% gain in the broader market index.

The outlook ahead remains positive. Improvement in their Pools unit could provide the catalyst for further gains. But at current trading levels, investors may find it best to wait for a better entry point.

Pentair Q2 Earnings Recap

PNR’s reported Q2 results surpassed expectations on both the top and bottom lines. The management team also announced positive revisions to the full-year outlook.

Overall net sales grew 1.7% YOY, driven by their Water Solutions segment, which grew 51.3%. The outsized gain in this segment was attributable to the sales contribution from newly acquired Manitowoc Ice, whose acquisition was completed in the third quarter of 2022. The accretive effect of this acquisition on sales was 42.6%, meaning the overall core segment grew 9.2%, excluding currency impacts.

Their other two segments, Industrial & Flow Technologies (“IFT”) and Pool, reported 9.1% sales growth and a 28% decline, respectively. The weakness in the latter segment was primarily attributable to sales volume declines relating to weather challenges, as well as lower overall demand.

Moving to the bottom line, PNR reported a 36.9% gross profit rate, 310 basis points (“bps”) improved from last year. Operating margins, too, were up 140bps to 19.3%. Similar to their sales strength, operating income was powered higher by the Manitowoc acquisition. This moved operating margins higher in Water Solutions by 10.1%. Productivity enhancements added another 3.5%. And even with inflationary headwinds of 560bps, segment margins were still up 760bps.

Taken together, this resulted in GAAP and adjusted EPS of $0.93/share and $1.03/share, respectively. Both represented a YOY increase of 1%.

PNR Key Stock Metrics Following Earnings

Through the first half of the fiscal year, PNR has increased total net sales by 2.3% to +$2.1B, with their IFT segment accounting for the largest share at 38%, followed by Pool and Water Solutions, at 33% and 29%, respectively.

The company is currently operating on gross and operating margins of 37% and 18.6%, respectively, each of which are 350bps and 230bps improved from last year.

Free cash flow (“FCF”) through six months of the year stands at over +$300M. And looking ahead to the full year, management sees FCF approximating 100% of net income.

The overall balance sheet also remains healthy, with a net debt multiple of 2.2x EBITDA, down from 2.6x at the end of Q1. Additionally, the company has over +$141M of cash on hand and operates on a favorable debt ladder. The strength of their financial position is further supported by their long-standing history of dividend increases, a 47-year streak at present.

Why is PNR Stock Outperforming?

First, the PNR team has demonstrated solid execution of their Manitowoc acquisition, which completed last year in Q3. Results since then have been materially propped up. The acquisition, for example, had a 42.6% impact on the Water Solutions segment and a 10.1% impact on segment income. Overall operating margins are now up 230bps YOY, with an 810bps improvement from the Water Solutions division.

The accretive benefits of the acquisition are also being supplemented by success in their productivity initiatives, especially on the residential side of Water Solutions. Improved productivity here contributed 3.5% to the 7.6% increase in quarterly segment margins.

PNR has also been an under-the-radar play on the consumer shift from products to services. As a water solutions provider to industries, such as food service and hospitality, the company would be a beneficiary of any expansion of these types of businesses.

And that is what has occurred. The number of locations of top 500 chain restaurants, for example, surpassed 2019 levels in 2023, according to CEO , John Stauch, citing data from the Technomic Top 500 restaurant report. As an industry leader with a diversified brand portfolio, PNR has adequately capitalized on the market opportunity.

Is Pentair Stock A Buy, Sell, Or Hold?

PNR put out a record quarter in Q2 in nearly every measurable category, including sales, segment income, and EPS. This was paired with an increase in their full-year EPS target to $3.70/share at the midpoint. It shouldn’t be a surprise, then, that shares are trading at new 52-week highs.

Yet, many appear to have been caught off guard by the outperformance. The consensus rating summary, for example, has generally been a “hold” over the past year, myself included.

Given that their Pool division accounts for about a third of total quarterly revenues, it’s perhaps understandable why some would hesitate to get bullish on PNR. After all, in an inflationary environment, installation of a new pool would likely be among the lowest priorities for most.

And to an extent, PNR truly is being held back by their Pool division. Demand has fallen off and it shows. Segment sales were down 28% during the quarter on a 35% decline in volume. Division sales are also down by over 20% through the first half of the year, as is segment income, which is down 12.5%.

But what has been overlooked is the strength of their other two divisions, particularly Water Solutions. The accretive effects of the Manitowoc acquisition and the resurgence in the food service and hospitality industries are more than offsetting the weakness in the Pools unit.

The other significant point to note is that sales in PNR’s Pools segment are not necessarily dependent on the sale of new pools. Instead, 60% of sales are attributable to the aftermarket, with the remaining 40% attributable to new and remodeled pools. Given the inherent maintenance requirements of having a pool, there is some degree of assurance that PNR will benefit from increased demand as the average pool begins to age. Improvements in the weather outlook could also prop up sales activity in later months.

In addition to an expected bounce back in the Pools segment, PNR should also continue benefiting from the sales strength in their IFT and Water Solutions divisions. Looking ahead, I do see PNR attaining their sales and EPS targets. But for investors seeking to catch the momentum higher, I believe shares have mostly run their course.

Consensus price targets currently stand at about $75/share. That’s not a significant level of upside, given current risk premiums. To justify a further run higher than its targeted levels, PNR will likely have to demonstrate a faster-than-expected rebound in their Pools division. For investors, it may be best to wait until there are emerging signs of that. In the meantime, shares would make for an attractive buy on any notable pullback but I rate the stock a “hold” at current trading levels.

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