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Geoffrey Jordan

PNR AT A GLANCE

P/E ► 28.4 AVG EV/EBITDA ► 16.9 AVG ROA ► 3.1% AVG ROE ► 4.5% AVG Debt to Equity ► 0.990 AVG Current Ratio ► 2.02 AVG Interest Coverage Ratio ► 4.75 AVG

 

 

 

 

 

 

Pentair Inc. (NYSE: PNR) is a manufacturer of fluid pumps and water treatment systems, in addition to specialized enclosures for electronic equipment. Pentair's Water Group manufactures pumps for commercial and municipal water projects, filtration and water treatment equipment, and water systems for pools and spas.^[1] Pentair also manufactures enclosures and thermal management systems such as cabinets, cases, and heat exchangers for sensitive electrical devices used in the telecommunications industry.^[1] Pentair's revenue in 2007 reached $3.4 billion, a nearly 8% increase over 2006 revenue. Pentair's water business grew from a $125 million business in 1995 to a nearly $2.3 billion business in 2007.^[2]

Increasing competition in the water technology industry has forced Pentair to restructure its business and to focus on filtration and flow technology. In 2008, Pentair formed a joint venture with General Electric called Pentair Residential Filtration.^[3] In 2007, Pentair acquired a number of small companies, including Calmark Corporation, Porous Media Corporation, and Jung Pumpen GmbH.^[4] These acquisitions contributed to Pentair's net sales increase of 7.7% in 2007, and they have also broadened Pentair's technical capabilities while expanding its customer base. Pentair has also divested several of its businesses, including its pool tile, spa, and bath businesses.^[4] These divestitures have allowed Pentair's Water Group to focus on its core pool equipment business and to pay down debt.

Pentair's Water Group sales are largely driven by the residential housing market. Pentair estimates that construction of new homes and new pools in North America accounts for 12% of its total sales, and approximately 50% of Pentair's sales are generated by commercial and residential real estate markets.^[2] In 2008, banks' stringent lending standards led to high housing inventories despite falling mortgage rates, depressing housing prices. The overall downturn in the economy has taken a toll on the residential and commercial real estate markets and Pentair's sales in North America. Although the Asia-Pacific market constituted only 7 percent of Pentair's water sales in 2007, growing demand for clean water in emerging markets such as China and India has boosted overseas sales, partially offsetting falling water sales in North America and Europe.^[5]

Company Overview

Pentair's Water Group manufactures products and systems such as pumps and filters for the movement, storage, and treatment of water.^[1] Pentair's Technical Products Group manufactures enclosures and thermal management systems for sensitive electrical devices used in residential, commercial, and industrial applications.^[1]

Business and Financial Metrics

Pentair Net Income and Revenue from 2005 to 2007 in millions of USD^[6]

Pentair Revenue by Segment in 2007^[7]

In 2007, Pentair reported free cash flow of $285 million, or 135% of net income.^[2] Also in 2007, gross profit increased by $1.0 million (30.1% of sales), a 1.4% increase over 2006 gross profit.^[8] This increase was attributable to savings generated by Pentair's lean supply management practices and selective increases in selling prices to mitigate inflationary cost increases.^[8] Finally, operating profit margin in the fourth quarter of 2007 reached 11.6%, a 330 basis point increase over the fourth quarter of 2006, due to productivity improvements and positive operating leverage.^[9]

In 2007, Pentair's net sales increased 7.7%.^[7] This increase was primarily attributable to an increase in sales volume due to the acquisition of Jung Pump and Porous Media, an increase in organic sales of 2 percent, growth in the Europe and Asia-Pacific markets, higher second quarter sales of municipal pumps related to large flood control projects, and growth in commercial and industrial water markets.^[7] This increase in sales was offset by lower Technical Products sales in North America due to contraction of the telecommunication equipment industry and lower sales of pump, pool, and filtration products related to the downturn in the North American residential housing market.^[7]

3Q08: In the third quarter of 2008, Pentair's debt to total capital ratio was 33.6%, about average for an industrial company.^[10] Its third-quarter earnings per share declined 29% from the third quarter of 2007 due to restructuring costs.^[10] Sales of $864 million were 5% higher than the third quarter of 2007.^[10] Operating margins were 9.7%, 160 basis points lower than in 2007, partly due to the costs of combining Pentair's water buisiness with that of GE.^[10]

Acquisitions and Divestitures

On May 7, 2007, Pentair acquired Calmark Corporation as part of its Technical Products Group for $28.5 million.^[4] Calmark’s product portfolio includes enclosures, guides, card locks, retainers, extractors, card pullers and other products for the aerospace, medical, telecommunications and military markets.

On April 30, 2007, Pentair acquired Porous Media Corporation as part of its Water Group for $224.9 million.^[4] Porous Media is a privately held filtration and separation technologies business. Porous Media’s product portfolio includes high-performance filter media, membranes, and related filtration products and purification systems for liquids, gases and solids. Porous Media enhances the technical capabilities of Pentair's Water Group, especially in engineering, material science, and media development.^[4]

On February 2, 2007, Pentair acquired as part of its Water Group Jung Pumpen GmbH (“Jung Pump”) for $229.5 million.^[4] Jung Pump is a German manufacturer of wastewater products for municipal and residential markets. Jung Pump is known for its new line of water re-use products, submersible wastewater and drainage pumps, and wastewater disposal units and tanks. The acquisition of Jung Pump has expanded Pentair's presence in Europe, as it owns training facilities and sales offices in several countries in Western and Eastern Europe.^[4]

In February 2008, Pentair sold its National Pool Tile business unit to Pool Corporation in a cash transaction.^[11] Pentair sold this business unit in order to focus on its core pool equipment business.

On November 18, 2008, Pentair sold its spa and bath business to Balboa Water Group. Pentair used the cash proceeds from the sale to pay down debt.^[12]

Partnership with General Electric Company (GE)

In June 2008, Pentair announced a partnership with GE Water & Process Technologies. The venture combines the global water softener and residential water filtration businesses of the two companies. The venture, called Pentair Residential Filtration, is 80% owned by Pentair and gives Pentair access to GE's membrane filtration technology.^[3] Pentair Residential Filtration serves as the primary sales channel for Pentair’s and GE’s global residential water filtration and water softener businesses.^[3] It also serves as the manufacturing arm for residential and commercial tanks, valves, and some limited filtration products for the parent companies.^[3] Pentair and GE continue to serve municipal, commercial, and industrial water treatment customers separately, but they both source products from Pentair Residential Filtration.

Business Segments

Water Group (69% of total sales)

Water Group Sales by Geographic Region in 2007^[5]

Pentair's Water Group provides products and systems used worldwide in the movement, storage, and treatment of water. In 2007, the Water Group's sales increased by 9% to $2.35 billion.^[13] This increase was driven by an increase in sales volume from the acquisition of Jung Pump in April 2007, an increase in organic sales of 2%, growth in China and other Asia-Pacific markets, higher sales of municipal pumps related to flood control projects, and growth in commercial and industrial water markets.^[13] These gains in the water segment were offset by a decline in sales of pumps and pool and filtration products in North American residential markets and overall weakness in residential pool construction markets.^[7] Pentair's Water Group has grown from a $125 million business in 1995 to a $2.35 billion business in 2007.^[2] The subdivisions of Pentair's Water Group are:

Flow Technologies (40% of group sales)^[13] manufactures pumps for residential and municipal wells, water treatment, wastewater solids handling, pressure boosting, engine cooling, fluid delivery, circulation, and transfer. These pumps are distributed through wholesale distributors, retail distributors, original equipment manufacturers, and home centers.

Filtration (30% of group sales)^[13] designs and manufactures control valves, tanks, filter systems, filter cartidges, and pressure vessels. Pentair's filtration products are used in the manufacture of water softeners and in filtration, deionization, and desalination systems.

Pool & Spa (30% of group sales)^[13] produces residential and commercial pool and spa equipment including pumps, filters, heaters, lights, automatic controls, cleaners, barbeque deck equipment, pool tile and finishing surfaces, and maintenance equipment.

Technical Products Group (31% of total sales)

Technical Products Sales by Geographic Region in 2007^[5]

Pentair's Technical Products Group designs and manufactures enclosures that house and protect sensitive electronics and thermal management products. Products include metallic and composite enclosures, cabinets, cases, subracks, backplanes, heat exchangers, and blowers.^[14] The Technical Products Group sells it products for applications in industrial machinery, data communications, networking, telecommunications, automotive, medical, security, defense, and general electronics. The Technical Products Group distributes its products through electrical and data contractors, electrical and electronic components distributors, and original equipment manufacturers.

In 2007, sales of the Technical Products group increased 5.1 percent to $1.05 billion. This increase was the result of strong sales in Asia and increased sales in electrical markets. These gains were offset by lower sales in North American electronics markets due to consolidation of the telecommunication equipment industry.^[7] The subdivisions of the Technical Products Group include:

Commercial and Industrial (55% of group sales)

Telecom and Datacom (20% of group sales)

Electronics (20% of group sales)

Networking (5% of group sales)

Key Trends and Forces

Weak residential and commercial construction markets contribute to declining sales volume

Pentair estimates that construction of new homes and new pools in North America accounts for 12% of its total sales.^[2] Similarly, approximately 50% of Pentair's sales are generated by commercial and residential real estate markets.^[15] When new construction for residential housing fell in 2007, Pentair's revenue declined dramatically, especially in the pool/spa and flow technologies market; Pentair's revenue was down 10 percent from the third quarter of 2007 in the third quarter of 2008.^[16] In December 2008, Pentair announced that it would cut 1,600 jobs, or 10 percent of its work force.^[17] Pentair projected fourth quarter 2008 revenue of $770 million, down from $864 million in revenue in the previous quarter.^[17] As a result of the downturn in real estate markets, Pentair also announced that it would freeze hiring and salaries and that it would operate 15 fewer facilities by the end of 2009 than it had at the end of 2007.^[17]

The U.S. housing market saw a record downturn in 2008. The Standard & Poor's/Case-Shiller home-price index fell 18% from October 2007 to October 2008, the sharpest decline in the data's two-decade history.^[18] The index has fallen 23.4% since its mid-2006 peak, pushing average housing prices down to March 2004 levels.^[18] Additionally, the Conference Board's consumer-confidence index fell to an all-time low of 38 in December 2008 from 44.7 in November 2008.^[18] The measure, based on a survey of 5,000 households, stood at 90.6 in December 2007.^[18] In 2008, banks' stringent lending standards led to high housing inventories despite falling mortgage rates, pushing housing prices down even further.

A weak U.S. dollar and growing demand for clean water in developing countries have boosted overseas sales

Pentair has steadily expanded its water treatment business in India and Asia. A weak U.S. dollar and increasing international demand for water filters and pumps boosted Pentair's revenue in the first quarter of 2008 despite the decline in North American real estate markets. In the third quarter of 2008, Pentair's Water Group delivered $566 million in revenue, up four percent year over year. In 2008, demand in the Asia-Pacific market increased by 21 percent.^[19] Although the Asia-Pacific region constituted only 7 percent of Pentair's Water Group sales in 2007, double digit growth in sales in this region have partially offset weakening sales in North America and Europe.^[5]

Pentair's water sales in Asia continue to grow due to industrialization and population growth in countries such as China and India. China's water resources are among the lowest in the world per capita, and close to 600 million people in China have water supplies that are contaminated by animal and human waste.^[20] In northern China, a region that produces 45 percent of the country's economic output and is home to 40 percent of its population, the annual renewable per capita water supply falls 50 percent below the United Nations-defined danger threshold for minimum social and economic stability.^[20] Water scarcity continues to constrain China's economic growth and limit economic efficiency: China uses 7-15 times more water to produce a unit of GDP than developed economies.^[20]

Technology Group sales have slowed due to consolidation in the telecommunications industry

Pentair's Technical Products Group produces metallic and composite enclosures, cabinets, cases, subracks, backplanes, heat exchangers, and blowers for commercial and industrial uses. In 2007, Pentair's North American electronics sales declined 15% compared to 2006.^[2] This downturn in sales was caused by consolidation in the telecommunications industry. For example, the share of communications-related jobs has declined over the past decade, from 1.7% of private-sector jobs in 1998 to 1.3% in 2008.^[21]

Product liability litigation reduces Pentair's profit margin

Pentair has faced litigation for product liability which has resulted in considerable costs to the firm. For example, twenty-eight separate lawsuits involving 29 plaintiffs and a class action suit were brought against Essef Corporation, a company acquired by Pentair in August 1999.^[22] Essef designed, manufactured and marketed two sand swimming pool filters that were installed as a part of the spa system on the Horizon cruise ship, owned by Celebrity Cruise Lines. The filters allegedly contained Legionnaire’s disease bacteria that infected passengers on cruises in July 1994. The individual and class claims by passengers were tried and resulted in an adverse jury verdict finding Essef contributorily liable, and Pentair paid $7.0 million in punitive damages and interest of $1.6 million in January 2004.^[22] In June 2007, Pentair also paid Celebrity Cruise Lines damages for lost revenue of $15.2 million.^[22] In total, damages against the Essef defendants in this litigation totaled $30.5 million, inclusive of interest through 2007.^[22]

Competition

Competition in commercial and residential flow technologies markets focuses on brand names, product performance, quality, and price. While home center and national retailers are important for residential lines of water and wastewater pumps, they are much less important for commercial pumps. For municipal pumps, competition focuses on performance to meet required specifications, service, and price.^[23] Competition in the technical products markets (telecommunications, data) is driven by product design, prototyping, global supply, price competition, and customer service. Pentair's primary competitors include:

• ITT Corporation (ITT) is the largest supplier of pumps and systems in the transport and treatment of water for commercial and industrial applications, reporting $9 billion in revenue in 2007.^[24]
• Flowserve (FLS) competes with Pentair for precision equipment used to regulate fluids through the use of pumps, valves and seals.^[25]
• General Electric Company (GE) has a Water & Process Technologies business that is a supplier of water treatment, wastewater treatment, and process systems. General Electric competes directly with Pentair's Water Group.
• Emerson Electric Company (EMR) has a Process Management business which provides wastewater treatment and other water services that compete with Pentair's Water Group. Emerson also has a Network Power business which provides power and environmental conditioning to telecommunication systems, data networks and critical business applications. This business competes with Pentair's Technical Products Group.

References

1. ↑ ^{1.0 1.1 1.2 1.3} PNR 10-K 2007 Item 1 "General" p.3
2. ↑ ^{2.0 2.1 2.2 2.3 2.4 2.5} PNR 10-K 2007 Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" p.22
3. ↑ ^{3.0 3.1 3.2 3.3} "Pentair and GE Water & Process Technologies Form Global Residential Water Filtration Joint Venture" 30 June 2008
4. ↑ ^{4.0 4.1 4.2 4.3 4.4 4.5 4.6} PNR 10-K 2007 Item 1 "Acquisitions" p.6
5. ↑ ^{5.0 5.1 5.2 5.3} Pentair Investor Information
6. ↑ Google Finance: Pentair (PNR) Income Statement
7. ↑ ^{7.0 7.1 7.2 7.3 7.4 7.5 7.6 7.7} PNR 10-K 2007 Item 7 "Results of Operations" p.25
8. ↑ ^{8.0 8.1} PNR 10-K 2007 Item 7 "Gross Profit" p. 27
9. ↑ ^{9.0 9.1} Google Finance: Pentair
10. ↑ ^{10.0 10.1 10.2 10.3} Seeking Alpha: Pentair Inc. Q3 2008 Earnings Conference Call Transcript
11. ↑ PNR 10-K 2007 Item 1 "Discontinued operations/divestitures" p. 7
12. ↑ Yahoo Finance: "Pentair sells spa, bath unit to Balboa Water Group" 18 Nov. 2008
13. ↑ ^{13.0 13.1 13.2 13.3 13.4} PNR 10-K 2007 Item 1 "Water Group" p.3
14. ↑ PNR 10-K 2007 Item 1 "Technical Products Group" p.5
15. ↑ Star Tribune: "Pentair's growth starts overseas"
16. ↑ PNR 10-K 2007 Item 1A "Risk Factors" p.9
17. ↑ ^{17.0 17.1 17.2} Minneapolis Business Journal: "Pentair cutting 1,600 jobs, 110 in MN"
18. ↑ ^{18.0 18.1 18.2 18.3} Wall Street Journal: "Home Prices Declined at Record Pace in October" 31 Dec. 2008
19. ↑ Pentair Reports: "Pentair Reports Third Quarter Net Income Per Share from Continuing Operations of $0.42; Adjusted EPS of $0.55, up 2%"
20. ↑ ^{20.0 20.1 20.2} China's Imminent Water Crisis
21. ↑ BusinessWeek: "A Broadband Stimulus Plan" 6 Jan. 2009
22. ↑ ^{22.0 22.1 22.2 22.3} PNR 10-K 2007 Item 3 "Legal Proceedings" p.14
23. ↑ ITT 10-K 2007 Item 1 "Competition" p.5
24. ↑ Reuters: ITT Corp
25. ↑ Google Finance: Flowserve Corporation (FLS)
26. ↑ Google Finance: ITT
27. ↑ Google Finance: Flowserve
28. ↑ Google Finance: General Electric Co.
29. ↑ Google Finance: Emerson Electric Company