Pentair plc (PNR) Earnings Call Transcript & Summary

Okay. Moving on. It's -- we've got Pentair up next. So Pentair's headquartered at Manchester, U.K., although operationally in Minneapolis. It is a diversified industrial manufacturing company that designs, manufactures and distributes water products, such as energy-efficient pumps, filters, heaters and associated controls for use in residential, industrial, construction, food and beverage and municipal applications. PNR has 166.1 million shares outstanding. Stock is trading around $57 per share, giving a $9.5 billion market cap with $758 million of net debt for a $10.2 billion enterprise price value. Pentair operates under 2 segments, the Consumer Solutions segment of about $1.7 billion, and the Industrial & Flow Technology segment of $1.3 billion. On April 30, 2018, Pentair completed the separation of its Electrical segment into what is now nVent Electric. Joining us today is Jim Lucas, Senior Vice President and Treasurer of FP&A and Investor Relations. Prior to his current role, Mr. Lucas was Vice President, Strategic Planning and Investor Relations after joining the company as VP of Investor Relations in 2012. Before joining Pentair, Jim spent over 20 years as a sell-side analyst at Janney Montgomery Scott, NatWest Securities and Raymond James. So he's going to give a brief overview of the company, and then we'll going into the Q&A. With that, I'll kick it over to you, Jim.

All right. Thank you very much, Jose. And I have to technically say we're in London, U.K., not Manchester.

Got it.

That changed a couple of years ago with the separation. Wanted to just spend a couple of minutes with a quick Pentair overview for folks not as familiar, and I know you have no shortage of questions today. But Pentair, we ended last year at $3 billion of sales; return on sales, just over 17%. And the thing we're very proud of is 45 consecutive years of increasing our dividend puts us in very august company as a dividend aristocrat. As Jose mentioned, we are 2 segments: Consumer Solutions, industrial & flow tech. As you can see, we're 80% residential and commercial with a little bit of industrial exposure and roughly 2/3 in the U.S., so very focused portfolio. What we do is important, and we can talk about our smart, sustainable solution for life. Whether it's our energy-saving pool pump and lighting and filtration equipment to residential and commercial filtration, eliminating the need for water bottles, to even our CO2 recapture business, which saves over 11 million metric tons of CO2 annually, what we do matters. And one of the things that is not a shortage, you hear from companies today is around ESG. And we, like many others, are very committed. And I think what you'll see from us is continuing to talk more about what we're doing because it is important. It does matter. Wanted to share one slide before we get into Q&A, just -- this comes from our Q4 earnings deck. You've got to deliver the core and build the future. So we see our residential businesses remaining strong. We're seeing our commercial and industrial businesses stabilizing, continuing to manage price and cost inflation. I'm sure, inflation is a topic that we're going to touch on. And from a capital allocation standpoint, we ended last year with a very strong balance sheet, which is a great position to be. And when we build our future, there's really 3 growth initiatives we're focused on: continuing to build out our pool business, where we have a leading franchise; continuing to build out our water treatment business, which is the other piece of Consumer Solutions and see a lot of good growth opportunities there; and the sustainable gas business that I just alluded to a moment ago. So as we look, we're -- we know we need to deliver the core, which is both top line and margin expansion while building for the future. So that's the quick intro, and would be happy to go Q&A now.

Perfect. Thanks, Jim. Appreciate it. And yes, correction, it is London, an efficient [indiscernible]. So just kind of looking at 2020 in kind of retrospective, one of the kind of more unusual shifts, particularly as pool did just so well with stay at home, we obviously talked about other residential products. Anything kind of outside of the pool market that kind of surprised you guys in terms of level of interest as the dynamics kind of from work from home and people focusing on their home life more?

I wouldn't necessarily call it a surprise, but we definitely -- if you touch on the other pieces of our residential businesses, water treatments, people are staying at home and looking at things that they can control, and water quality is one of those. And so we did see an increase in lead generation as well as conversion. And so one of the things that we've done in this business is going from a component supplier, up the food chain into systems and services and have enjoyed some good success there. And whether it was in -- we do have an omnichannel approach there, and whether it was direct-to-consumer, leads through homedepot.com, our RainSoft dealers or our channel partners, historically, what we referred to as unaffiliated dealers, very strong demand that. So once the shelter in place went away and people were comfortable letting folks back into their home to test the water, we did see a nice increase there. I think the other one was in our IFT business, what we call residential and irrigation flow, if you've got a sump pump or a well pump or a booster pump and it breaks, it doesn't care if there's a pandemic or not. And so when the -- when the shelter in place went into effect last year would have been when we normally would have been stocking that channel, which obviously didn't happen because there was more of a focus on liquidity at that point for a lot of distributors. And we saw very strong demand in the second half last year. And as we enter this year, we should see more normal stocking patterns. But that's a piece of the residential exposure that I think often gets overlooked because it's in the non-consumer segment. But it's one that we were pleasantly surprised with the strength that we saw, particularly in the fourth quarter.

Okay. And you touched on this a little bit. You guys were very well set up and kind of been going through the process on your residential water treatment business with Aquion and Pelican in 2019. Just talk to us about relative to acquiring those basically 2 years ago, what have been kind of the challenges that you guys faced? And how much more operationally do you guys think you can go through before you -- it's where you really want it to be?

I would tell you that it really hasn't been challenged. I mean both of those acquisitions turned out great. Aquion was an acquisition that brought us the RainSoft affiliated dealers. So it was a chance to learn more about that channel as well as they did have a historical relationship with homedepot.com. Pelican was, I would say, more of a new for us because that what's brought us into the direct-to-consumer. And so as we've been investing in building out the Pentair brand, putting more of these Pentair vans on the road. Pelican started as a Florida business, and we've expanded into other markets, certain markets in Texas, like Austin. And we've also gone to Nashville and actually just launched here in the Twin Cities. And seeing the Pentair van on the road is kind of neat to see. But the reality of water treatment is you have to solve it zip code by zip code is not a one size fits all. You're in New York, where you've got great source water. You can be in the Midwest, where you've got hard water that has to be softened. Or I grew up in Florida, where you've got -- everybody always had the 5 gallon Poland Spring bottle in there house, but began to realize over time, well, what am I cooking with? What am I brushing my teeth with. And that over time is not just, okay, how do we get rid of these plastic bottles, but looking at it from a total health perspective.

Yes. Okay. So -- and it's been a nice expansion story there for you. I guess, just kind of -- you talked a little bit about omnichannel. Where are still the pockets where you guys can kind of expand that business to have kind of a true omnichannel experience for everyone? And anything in the, I guess, the portfolio that maybe you still need in that business?

Yes. I would say that it's -- we've got the foundation, like -- so now it's going to be expanding. As I said, you have to solve this zip code by zip code.

Yes.

So for instance, we did a small dealer acquisition in Arizona last year just to kind of learn what made this person so successful. At the same time, while we've got the systems capabilities, we're looking at building out the services side. Before the end of last year, we bought Rocean, which gave us a product. Think of it as SodaStream meets Keurig on the water side. It's a really cool system. Encourage you to take a look at the website. This was a company that came up with a great idea that didn't have the distribution or the manufacturing scale, and we had those. So it was in the classic of make versus buy, we could have developed this internally, but found that it was a quicker way to get to market. And equally important is they have a lot of intellectual property like -- I mean, this allows hot, cold, carbonated, dosing flavor, so a lot of the stuff that consumers are looking for today. But whether it's residential treatment or commercial treatment, I think services would be an area that we'd see as an opportunity, both organic and inorganic.

Okay. Actually -- no, I mean, it's a very exciting growth opportunity for you. And maybe I will have to shop for Rocean. My SodaStream is looking a little old. So -- okay. So just kind of turning over to pool now. Great performance in 2020, I think, up 17%. Just walk us through, it's $1 billion or so business at this juncture. So walk us through kind of the remaining growth pipeline there, I guess, both short term and then maybe long term?

Yes. We've always described pool as a mid-single-digit-plus business. And the plus comes from new products, from market share gains, from dealers' availability of skilled labor to keep up with their demand. We talked about of the 17% growth last year. Maybe 5% or 6% was pandemic-related. But strong underlying growth. We saw very strong natural demand in Q4 and end of the year. Been getting a lot of questions about the freeze in Texas last week because Texas is the third largest pool state so as an example of adding to the plus over time because some of those pools will likely need some new equipment. No different than when a hurricane goes through. But it doesn't happen in the same quarter, is what I have to keep reminding people. Now that being said, we do talk about pool being a seasonal, not a cyclical business because there is -- you're going through 2-step distribution, and there's always going to be a lag in selling and sell-through. But that being said, I mean, there's 5.3 million pools installed. There's 80,000 to 100,000 new pools being built a year, so you're adding to that installed base. And the fact that 80% of what you do is replacement-driven is a nice secular tailwind to have. At the same time, we've got 2 competitors: one publicly traded on the Spanish exchange, the other just filed for an IPO. We've got -- our largest customer is publicly traded, and then there's another large pool retailer that went public last year. So a lot of data points out there that point to why people like the space so much. So I mean, again, it's seasonal, not cyclical. I think that the long-term, secular trends remain positive. And I think if you see a continued exit of the urban environment into suburban, that only feeds into it.

Yes. No, that's definitely an interesting dynamic ongoing there and, obviously, benefits you. And I guess one of the key things is the shortages in labor in the market for these pools. So you can still kind of sustain that growth here.

It's the governor on growth for -- I mean, ever since the last housing bubble burst. I mean if you go back over the last dozen years, that's been one of the limiting factors on growth is getting enough people to come out to do the electric both -- with the plaster and what have you. So people think about just the pool, but it tends to be a total backyard experience that's being built. So you got to keep that in mind.

Yes. No, absolutely. In the sense of then, you're also layering on -- maybe this is why there's so much public interest. You're layering on the new pump regulations midyear. What is that dynamic as Pentair sees it? And over time, whether that conversion translate to in maybe outgrowth?

Yes. For those not familiar, there's a new DOE regulation that goes into effect later this year for variable speed pumps, which was a category we created about a dozen years ago. As we talked about on our Q4 earnings call, about 60% of the pumps we sell today are variable speed, so we're already far ahead. The industry is probably closer to 50%. They're catching up. That being said, I would tell you that 80% to 85% industry adoption is probably as good as it gets because there's smaller pools, there's spas, even above-ground pools that will still not fall under that DOE regulation. Single speed pumps can still be used. But we're far along. So I think by the end of 2022 is when you'll see the industry close to that 80% number. And so it helps you gain your content. Because a single speed pump, let's say, sells for $500 versus $1,000 or $1,200 for our variable speed. But that variable speed pump is going to last 7 to 10 years, but the single speed pump is lasting 3 to 5. So you got to balance the value proposition. So we tend to just focus on continuing to add content, whether it be going from single speed to variable speed, LED lighting, upgrading filtration, hybrid heaters but -- and now the new category around automation. I mean only about 10% of pools today have some form of automation. We are the industry leader and are going -- we have a head start, so it's incumbent upon us to continue to move down that path.

Yes. Okay. And I guess you have to be mindful of that channel of distribution as well in that case, right, and how you do that. So your -- as you guys have talked about, you want to be a point for the consumer but also drive that consumer to effectively a dealer network. So I think that's a really interesting distinction in the market. Okay. So -- and thinking about Pentair has historically been very good at bringing out productivity. Just talk about your guys' system and the type of runway that you guys see over the next several years?

Yes. We alluded to this the last couple of quarters but around, for lack of a better term, transformation in different areas. And this doesn't just mean that, oh, restructurings coming, not by any means. This is just continuous improvement. So we talk a lot about, PIMS, our Pentair Integrated Management System. Last year, we hired a Chief Supply Chain Officer, who had been a long-term Pentair employee, went to another company in the private sector, and rejoined. And I would say that this is more of a recommitment to PIMS, while a lot has gone on at this company over the last half dozen years with selling a business, separating. So you...

Buying a business, separating.

On and on, so on and so on. So a lot of change, let me say that. Now that being said, we have a lot of opportunity inside the 4 walls still. But at the same time, we did some benchmarking and found that our G&A is probably at least 150 basis points too high against other companies our size. But I continue to caution people, that doesn't mean it's going all to the bottom line. But as you're funding those growth initiatives on the Consumer Solutions side, it's going to have to come through some self help. At the same time, our Industrial & Flow Tech business, which we have commented had been under-earning already in 2019 when margins were closer to 15%, they were the business that was hit hard last year with the global shutdown, particularly around some commercial and industrial CapEx. So a lot of opportunity to drive the margin expansion in the IFT side as well. So you look at the G&A bucket, you look at opportunities within the 4 walls and just continuing to be smarter about how you do business. It's -- the biggest thing we've done is fewer, bigger best as a company so we can be more targeted with our investment dollars.

Okay. And I guess -- and thinking about investment dollars today, how should investors think about -- let's say, you have $100. How much are you spending on kind of productivity initiatives versus some of the digital initiatives that you guys have? Like just contextualize that for how Pentair is approaching that today versus maybe in the past.