Pentair plc (PNR) Earnings Call Transcript & Summary

Good morning, everybody. We're going to keep things rolling here with the team from Pentair. I'm joined on stage by Pentair's Chief Financial Officer, Bob Fishman. Bob, thanks for joining his pleasure as always. Maybe just start off with what you guys are focused on what you're seeing out there? Anything that's kind of on your mind, and then we'll dive into some questions, if that's all right.

Absolutely. Yes. So thank you, Josh. Thanks for the invite. Always exciting for us to be able to tell the Pentair story. We're very much a diversified water solutions company. So think move, improve and enjoying water are the key themes within the move piece of our business is our flow business in terms of improving our Water Solutions business and enjoying is our pool business. What are we seeing out there? You look at our company. We have a lot of balance across those 3 segments but also across residential, commercial and industrial. So roughly 50% of our business is residential, 50% is commercial and industrial. Within residential, we always knew that this was going to be a year of inventory correction primarily in the channel. So what we've talked about this year is really playing out in terms of the inventory corrections happening within Q2 and Q3 of this year primarily. And then we return to more of a normal cycle for that residential business. So excited about turning the corner into 2024. And then our commercial and industrial business remains strong. We within our Water Solutions business, about 2/3 of that business sells to food service companies and hospitality. That business continues to do well. We have a really nice end-to-end offering. Around water quality, filtration, ICE and services. So that piece is doing well. And then on the flow side, what we're seeing there is aging infrastructure, which is helping our business. We have a really nice offering where we can go into not only office space but into places like data centers and warehousing and sell our solutions. So really excited about the secular markets and the end market growth.

Excellent. So it's a helpful place to start. A few things I want to pick up on within that -- so a lot of discussion this week and folks trying to navigate kind of this post supply chain parlor game of orders and backlog and destocking and kind of all things that mask underlying demand. But anything where you would point out that, obviously, we talked about pool a lot you guys talk about pool a lot in terms of the inventory phenomenon there. But any place else where you've seen sort of that post supply chain, maybe volatility in the data that's masking what's going on underneath anything we should be aware of there?

Yes. Again, overall, how you described it is really very relevant for what we've seen as well. The good thing about Pentair is we're back to normalized lead times. So within our pool business, delivering equipment within 5 days of our customers placing the order. So that whole supply chain challenges in the factories around labor are really behind us, and it's all about, to your point, the end demand. And again, it's the direction that those markets are going is really what our indicator is and our -- gives us our confidence in this year, but also going into 2024 around where we see those end markets.

Understood. And I want to come back to the market, but 1 thing that's been certainly very topical and you guys have had a lot of success on is the transformation. So especially with the supply chain backdrop and some of the end market volatility. Maybe update us on where you've had a lot of success so far, what we should expect maybe over the next year or so in terms of focal points and maybe some of the opportunities around that?

Yes, exciting transformation story for us. So I think pricing, sourcing, our operations footprint and then our org excellence piece around G&A and selling and marketing. For us, even with the double-digit declines that we've seen in the residential business as the inventory corrects and which will be a tailwind for our company next year, we've been able to expand our margins. And so making sure that we understood what was happening from a volume perspective, removing a lot of the inefficiencies around spot buys, around air freighting around completing a product to 90% and waiting for that additional part to come in those are areas that have really helped us expand our margins this year even in the residential piece of the business. And what we've said externally is that we're going to go to -- from today's ROS of roughly 21% to grow that to 23% by 2025. And it's really the traction that we have within the transformation, so really exciting for us.

On the sourcing front, obviously, an area of excitement when you launch it, you've had some good success. But it sort of comes across like cognitive distance of sourcing changes in a supply chain constrained environment. Gosh, that sounds hard. How are you able to pull that off? And -- is that some of that disruption still masking maybe what the opportunity could look like from here?

Yes. The opportunity for us is huge. We spend -- to have material spend of roughly 40% of our sales. So I think [ $1.6 billion ] of spend. We've broken that into some big chunks, so about $500 million to $600 million of spend was looked at as part of Wave 1. So think motors, electronics, packaging, those type of components. Went through an 11 gate process. To your point, it's heavy lifting. And it's all about creating these long-term strategic partnerships. One thing that we do have at Pentair is scale. And so being able to create a long-term partnership with the supplier really helps us in terms of driving improvement. So it's, again, early innings, we're identifying about 12% savings coming out of each of the waves of different spends. We're now attacking Wave 2, which is, I think, resins and metals. And those savings will find their way into the P&L primarily in 2024 and '25. So -- we just had a supplier show in Las Vegas in August, had 1,000 suppliers come in, explain the Pentair strategy, had the whole executive leadership team there. Put all of our products on display and have our suppliers participate with us in the bidding process. So again, heavy lifting, very strategic, very cross-functional within the company. But that's our funnel of opportunity really within that particular component of transformation over the next 2 to 3 years.

Any place that's been more challenging? It seems like it's been mostly an unqualified success so far, but anything under the surface that you are dissatisfied with?

I wouldn't say dissatisfied. I would say, as you'd expect, there was lower hanging fruit early on around transportation, around some of those spot buys. And then as you look to qualify suppliers for the next phase of the implementation, that piece takes a little bit longer. But in a way, that's good because that creates the nice opportunity for us over the next 2 to 3 years. So I would say that really no frustration, a lot of people in the company hard at work in terms of driving the savings.

Understood. And then you mentioned price. Obviously, it's something that a lot of folks in -- who are attending here have done a lot of work over the last couple of years with all the inflation. When you think about what are the more, I guess, transformational or strategic elements of that? Is it managing leakage? Is it just communicating things faster, so you shorten that announcement window? What does price mean in the context of what you're doing?

Yes. And again, for Pentair, price has been historically very sticky in terms of the 2-step distribution model that we have and the large installed base. From a pricing perspective, we're really looking at 2 different areas. One is to drive incremental pricing over and above inflation. So we're doing that through more of a value-based pricing approach. We have our general managers, including in their toolkit, a strategic pricing playbook that looks at the market, looks at our products, looks at the competitive landscape and allows us to price more strategically. The other piece within pricing is really looking at what we called gross to net. So it's the volume discounts that we have it's the dealer rebates and trying to make -- turn those from 100 different programs that are in place and make them more strategic to drive growth. So looking at those 2 areas to drive incremental pricing benefit.

Understood. I'd like to pivot over to the pool business for a bit, if we could. Maybe just starting off with, obviously, the inventory phenomenon has been kind of the most acute function over the last kind of 6, 12 months. But how should we think about what's happening at kind of the point of sale or customer level? Anything on the mix front or demand front that really sticks out to you?

Yes. So again, really like the pool business in terms of it being a mid-single-digit plus grower historically. The trends are in our favor in terms of more people moving to the south, more people wanting a pool in their backyard. Huge amount of innovation coming to the pool pad as we drive towards an effortless pool experience for our customers, new products coming out really nice ESG story around energy efficiency. Our pool business is broken out into 20% new pool builds, 20% remodels and 60% in aftermarket which we really benefit from being the #1 pool provider, but also having the largest installed base. Automation is also a key player, a key component within the pool business. So in terms of the overall market, this year, new pool builds and remodels are down in that 25% to 30% range. With interest rates staying high, we don't expect the massive recovery next year. But we do like the fact that, that inventory correction is behind us that it will be a big tailwind next year. We will get the manufacturing leverage associated with that. And again, things are always breaking within pools so that aftermarket business will continue to do well for us.

Makes sense. Within the break fix piece of the business, there are certainly a lot of good, better, best options. You talk about things like automation, which make a lot of sense, but they're maybe a little bit discretionary for some folks. Any mix phenomenon within kind of that core installed base break fix that has changed at all as the market has evolved over the last year?

I would say that, to your earlier point, there was this buy forward with things like heaters, LED lighting as people spend more time in their backyard, those particular product lines ramp during COVID. That's a big piece of the inventory correction that's happening now. But the innovation piece, the -- what we're able to bring from an LED lighting perspective in terms of a better environment, a better look and feel for the pool. Better filtration, being able to use some of our membrane technology from our other parts of our business into the pool business. So just continuing to innovate will help drive the growth.

Understood. And then on share, obviously, during kind of the deeper parts of supply [ chain ] crunch you guys fell behind a little bit on shipments, maybe we donated a little bit of share. How would you see that kind of that catch-up going? Do you think you've clawed back maybe some of the share that you lost in '22?

Yes, very much. And so what's helped is those 5-day lead times and going after certain product categories where we might have lost share, we are regaining share this year.

And then anything on the stimulus front, [ IRA ] has a lot of energy efficiency provisions, anything that would help you guys in the pool space. I know that there's -- those things can be energy hogs and obviously, there's a lot of ways to mitigate that with some equipment refresh. Anything that we should be cognizant of there or that you've been able to kind of size in terms of an opportunity?

Yes. And I wouldn't isolate it just to the pool business. There's a lot of regulation. There's a lot of areas happening within the environment that are really going to help propel our business within the pool space, to your point, Josh, energy efficiency, hugely important. So very focused on that piece. And then within our other businesses, the improve and enjoy water space again, you have lots of different regulations coming out that are going to help our business.

Understood. Maybe to bring over to more of the water treatment side of the portfolio, specifically resi, how has this performed over the last few years? Where do you see maybe the next few years? Is there something that needs to happen for growth to accelerate? Because it's -- it seems conceptually to have a lot of opportunity. And it's been certainly fine, but maybe not as growthy as I think you guys would have expected initially.

Yes. Within Water Solutions, there's no doubt that the 2/3 of the business, the commercial water solutions has been driving our results, really strong top line growth, really strong ROS expansion. Within residential water treatment, we think of that business as being components but also systems and being able to provide that extra value with the systems is a key focus area for us.

Understood. And then I guess maybe Water Solutions as a whole, how should we think about growth in the segment over time? And then, I guess, kind of navigating the cycle here. Is that something that we should expect to trough here in the second half.

Yes, the underlying themes are really helpful for us. So the focus on water quality, the focus on PFAS, within the commercial space for us, expanding beyond just food service and hospitality to places like hospitals and schools, office buildings. If you look at what we have to offer to our customers in terms of that end-to-end solution within the quick service restaurant space, for example, a lot more of these restaurants changing their footprint change to us is very helpful in terms of drive-through in terms of in-store, so lots of opportunity there as well.

Understood. And then maybe just spending a minute on Manitowoc. Maybe give us an update on how that's performed and things like synergies and some of the opportunity to bundle that with filtration that you guys already have?

Yes. That's really exciting for us. So we closed on that acquisition in July of last year. The business has been doing phenomenally well, grew 30% last quarter and being able to, again, offer to our customers' water quality with the filtration, the ice-making ability as well as services. It's one-stop shopping for one of our customers' biggest pain points which is providing water and ice to their customers. So business is doing extremely well, being able to sell filters within our ice machines, hugely important. Looking at the top 50 quick service restaurants and looking at cross-selling opportunities that are available to us. On the services side, we can do predictive preventative installation for our customers. So that part, very early days in terms of revenue synergies, but really excited about the opportunity.

Understood. And maybe zooming out on kind of the commercial-facing businesses, at large. I mean we can see in the macro data, obviously, commercial construction in some of those verticals, kind of laboring under things like higher interest rates. You guys are more of an installed base sort of place. So I don't know if the new piece matters a lot, but are you seeing that represented in the business? Is that something you have to keep an eye on in terms of maybe that newer construction being slow?

Yes. For us, again, not solely focused on just commercial office space, but also on areas like data centers, on warehousing broadening what we offer within those types of buildings. So not only can we offer fire pumps as a solution, but also the whole water supply, the water disposal the wastewater management. There's at least 5 different spaces within an office building or a commercial building that we can play in. So continuing to educate our customers around the aftermarket, the services capability. And then when we do find our sweet spot going at it in a very targeted way with a standardized offering hugely important for us.

Understood. I won't let you off stage without -- you mentioned data center, obviously, like the second most important buzzword in the market right now, unless I said NVIDIA. Where do you guys play in the data center that content look different as we shift to this higher performance environment?

Yes. Again, for us, to my earlier point, any time there's an opportunity around water supply, water disposal, fire suppression needs. Huge opportunity for us. So we plan on taking advantage of that growing market.

Understood. Maybe just pivoting over to IFT. This business probably had more of the cyclical kind of ebb and flow over time, and that makes sense based on their end markets. But how should we think about what is the long-term margin entitlement in this business? And what does it take to get there, either from a length of time or specific areas of opportunity on the cost side.

Yes. Yes. Thank you for that one. So we started with pool, which is our enjoy piece talked about Water Solutions. This is our move piece. So think about $1 billion of flow small pumps, large pumps, moving water, where you need it, when you need it with our products and then about a $500 million industrial solutions piece in that business. So again, from our perspective, it's probably in that low single-digit space. So when you think about Water Solutions, you're mid-single digits, you think about pool mid-single-digit plus. We don't like to get ahead of ourselves from a top line perspective but huge opportunity from a complexity reduction, SKU reduction and ROS expansion piece within IFT. We've seen the margins improve significantly this year and last year, and we'll continue to do so. primarily through the transformation.

Is there -- now I know that within IFT, there's maybe a little more business fragmentation than in some of the other portfolios. Is there sort of an opportunity perhaps to benchmark those a little bit more? Or are there more kind of this 80/20 phenomenon where there really are bigger opportunities? Or is it a little bit more level set or even across some of the various businesses there.

There are certainly businesses within our portfolio in IFT that fit more with the overarching company strategy of move and prove and enjoy water. So obviously, the flow business fits in really nicely and being able to expand our offering in that space and innovate is hugely important. The industrial solutions, we really like because it's all about turning waste into value, which is really important to our customers. That's where we have to continue to focus on smaller deals. More of a standardized offering to help drive the margin expansion. But we like each pieces of those business, it fits nice within our ESG story.

Understood. And then maybe putting all of this together in the context of the portfolio, you guys have been acquisitive over time. Obviously, I'm going to talk is a bigger deal. How should we think about the priorities for capital allocation? And then maybe separately, anything in the portfolio that is maybe having a harder time earning its entitlement and as you go through transformation, could be -- it could be an exit opportunity.

Yes. So I mean, really big picture. We've resegmented this year and went to the 3 segments that we've talked about. We love the end markets in terms of the growth that we see there. From a capital allocation perspective, our goal is to continue to stay very disciplined. We acquired Manitowoc again late last year. We've now delevered from 3x down to 2x by the end of the year. That's about the target debt ratio that we like 2x, plus or minus 0.5 turn. Staying investment grade hugely important to us. This was a year of debt pay down. We've increased our dividend 47 years in a row, so it puts us in a really rarefied space there. We typically look at doing about $150 million of share buyback every year. So very balanced from that perspective. We think there's plenty of opportunity within our portfolio but using M&A to drive more growth from a top line and profitability perspective, very important to us. Our most important measure within the company, though continues to be return on invested capital. All of the senior leadership team is measured on that. We're at mid-teens now. Our goal is to be high teens. We were at high teens before the Manitowoc acquisition, and we're getting back to that space. So a very disciplined approach, M&A, a big piece of our strategy, but doing it in a very disciplined way.

Understood. Appreciate the color. I really appreciate your time here today, Bob.

Absolutely, Josh. Thank you.