Pentair plc (PNR) Earnings Call Transcript & Summary

All right. Thank you, everybody. Super excited to have Pentair up here with us today. We have CEO, John stauch and the CEO of Pentair Pool, Jerome Pedretti, thank you guys for being here. Maybe just starting off, the company has really built a diversified portfolio, not just pools. Why is that important? And how does that position the company going forward?

Yes, still about $4 billion overall in revenue. We like to talk about our portfolio in the sense that we help our customers and our customers' customers move and proven enjoy water. I think those themes are resonating nicely. And when we think about that, moving is really pumps and it's in flowing of the water, improving is generally filtration and our treatment of the water. And then ultimately, Pool is enjoying the water. Now Jerome will share with you that he does all three of those. But we only let them take credit for the enjoy piece, and that's what we look at. But I think that framework helps us primarily in technologies, it helps us in the way that we think about our channels and go-to-market strategies. And I think it also helps frame how we want to invest in the company longer term and how we go forward.

Yes, absolutely, maybe kind of diving into some of the segments. Maybe I'll start with flow and work our way into the pool and the enjoying. We've seen strength there in commercial. Can you kind of speak about some of the drivers you're seeing on the flow side? And what should we be looking for as we try to assess the outlook?

Yes. So most CEOs aren't this complementary of a segment that I think people pick on. If you go back 3, 4 years ago, people were asking why flow mattered to Pentair and how could this particular segment find its footing and deliver long-term share owner value. And I'm very, very proud of all of the business leaders within the space because I think they gravitated to how do we get a little bit slower growth, more valuable growth? And then how do we really lean in and drive margin expansion and ultimately cash that the other segments can use to invest. And I think if you look at the margin progression of flow, it's very impressive. I think we have industry-leading margins and generally most of the businesses that we have. And I think that really is rooted in the fact that we committed to being better in the commercial industrial spaces and utilizing our strong brands, our 100-year-old brands to go out and win business for buildings, for data centers. What we do well is fire and we also do wastewater extremely well. And for these jobs that we quoted on, we were able to also bring the input water or the general purpose water for the buildings. And by having that focus, we've been able to get really higher margins, and we've been able to deliver our jobs more effectively than the competition, and it's been a really nice growth spot for us.

Yes. Maybe going to Water Solutions. You guys have talked about maybe some opportunity in PFAS, but there's more beyond that. Can you talk about the opportunities you're seeing in that market and how you see it developing into '25?

Yes, emerging, still in the early stages. We have 11 to 13 different filtration capabilities to meet all the PFAS standards. We've always benefited primarily in the food service industry from customers who care about the water quality and invest disproportionately against not having an incident that comes from their water. So that's always been the leading player in the space. It continues to be. It's where our ICE and our Everpure filtration brands work really nice symmetrically together to solve customer issues. It's been a great growth vector for us in an area that I think we see tons of opportunity in the future. We're starting to see emerging plays in PFAS and institutions, institutional drinking water. But the price point of a PFAS filter is going to be higher. So we still see a lot of institutions going to bare minimum. But I think over the next 3 to 5 years, we really think the levels of quality expectations are going to rise, and we're going to see an acceleration of the filtration penetration.

Yes, absolutely. Then to pool, you obviously big kind of surge coming out of COVID. Now we're kind of in that moderation or digestion phase maybe. What kind of demand do you see in the market today? And how do you see that evolving over the next 12 months?

Well, since we have Jerome here, I'll let him jump in and dive in on this one. I will tell you that when my CFO, Bob Fishman, joined the company, he's been with us about 5 years. I told them who will be the most predictable and consistent business he would ever experience. He's seen anything about that. And I just want to lay claim that I think it's been an interesting journey, and I think COVID and supply chain and global inflation have created disruptions in the space that's generally been pretty consistent. I think we're starting to head back to consistency and predictability. And what I really want to give Jerome and his team credit for is if you look at our margins now, going to be somewhere around 33%, that's EBITDA. So think about close to 35% EBITDA. He's going to be in the higher single digits. So when you talk about rule of 40 being the holy grail I think Jerome has done that. And we've done this in the wake of one of the lowest new pool build seasons that we've seen in a very long time, which gives a lot of optimism, a lot of enthusiasm to what this business can do going forward. But maybe you can jump in on.

Yes. So I think this year, on the new pool side, we're think going to be about 60,000 new pools, but I think that's really low level, I think going through financial recession. And I think that the more natural number would be 75,000 to 80,000. That's what it was pre-COVID. So I think we've got to have a good lift coming up in the coming years on the new pool side. The remodel is going to follow kind of a similar trend. And after, I think that we are excited because we have a strong aftermarket business, about 50% of our business, but there is a lot of COVID installed base that has to be serviced in the coming years. So I think that really, we're going to have some good growth. And that's why we think that we can grow mid-single digit plus for the coming years and expand margin at the same time because growth are going to help us to continue to expand margins.

Yes. A lot of focus in the market on rate cuts. It feels like we're on the eve here of a rate cut cycle certainly brings implications for residential. What do you think it can mean for pool? I don't know if you could look back at past rate cut cycles? What do you think the opportunity there is?

Well, I think we came into the year, I don't think we thought there would be 6 rate cuts like some people did, but we thought we'd have 3 or 4. And we built our plan around that as a company, and we're about 50% exposed in Pentair to residential globally, probably 30%, 40% of our portfolio is North America. We could definitely will benefit from rate cuts. So I'm looking at '25 maybe being a deferral of what we thought would happen in '24. But I would say when we start to see 1 or 2 meaningful cuts, I think we're still about 6 months away from what I feel will be the real recovery in our spaces. We'll see it first in pool right, because it's mostly a cash buyer or a buyer who has more money. But some of our other residential business is going to need time for people to position themselves to sell their homes, position themselves to move into the next home. And when they do that, they usually taste the water or see water that they're not used to. And then they want to change that water out to what they had before. And so I think it would be a little delayed in the Water Solutions and Flow space. And I think a couple of rate cuts this year will at least spur the excitement level of the pool industry next year.

And I think it has been a drag sort of the new pool in the past year and the remodel. So I think even if we just see that flattening out understanding to start to grow, I think it's going to be a benefit.

What matters more for your business? And maybe it's different if we look at pools versus filtration. But between new home sales and existing home sales, what's the bigger catalyst for demand?

On the pool side, there's a pretty good correlation between new pools and new housing store, residential housing store. So I think that those studies work hand-in-hand. So if that starts to grow, we're going to see that on the new pool side, but 80% of our business is with existing pool. So I think that when you say existing home sales, people moving, I think that has an impact. The aftermarket, there is a piece of that, and there is a piece of the natural kind of upgrade or natural life, I would say, shelf life, that something has on the equipment pad.

As consumers have come under some pressure over the last 12, 24 months, has there been any mix changes in your business? Or is that maybe the high-end consumers just hung in better?

No, I mean overall, the portfolio, absolutely. I mean, I think you hear about defeaturing or you hear about good enough. I think the last couple of years have been about selling products that are generally good enough. It's been harder to sell some of the more technologically advanced store, more expensive products upfront that really save you money over the longer term. And I'm hopeful that as the financing comes back in play, we're going to be able to get back to that level of penetration as we go forward. You can answer the pool one.

Yes. I think the pool one is slightly different, because I think that, like John said before, I think there's more cash buyers now. So it's a bit more in the high end. And I think both cash values before we just didn't have the good start date of the project they wanted. So I think that now they can enter the market and they can buy a pool. So I think that mix has helped us, especially on the Pentair side, I think. I think that it will go back to the more normal mix after that.

Yes. Maybe stepping back from the market outlook and going to some more strategy and company initiatives, transformation in 80/20. I've heard a lot about 80/20 from a lot of companies in the past couple of days, but it's something that's very core to you guys, and it's delivered very tangible results. So what does it mean to you guys? And ultimately, how does it affect top line and margins?

Yes. So just as a reminder, about 24 months ago, we embarked upon a transformation journey. And think of this as within Pentair underneath the 3 segments, we're a collection of acquisitions over 30 years. And I just didn't feel comfortable as coming from my CFO position and the CEO position that we had addressed how to run these businesses most effectively in the channels that they serve and driving efficiencies business by business. So underneath this is the ability to look at 11 individual business and home business leaders accountable for the results. And the beauty of the transformation is providing 4 proven tools to those business leaders for them to use differentially across their businesses. So those tools, again, are value-based pricing capability. We're probably halfway through that journey from realizing the differentials. And what's different about this pricing activity is this really matches our products against our competitors looks at the value proposition that we're claiming versus what our competitors are claiming and tries to get the appropriate end value price and then how do we optimally share that through our channels. The sourcing initiative is bringing an outside partner in, we needed to do that because so many people inside your company are defensive around saying we've sourced it effectively. So we needed a fact-based solution with a partner that had a database of global suppliers and we needed to concentrate our sourcing spend that way. Our footprints are more than just factories. They're also warehouses, sales offices and everything else. And so those are the 3 big streams that we're ultimately going after. The fourth stream is organizational efficiency and excellence, which is really how do we spend less adding it up and how do we spend more creating it. So moving G&A to sales and marketing. Those are the four bodies of work. When we were going through that journey, I stepped back and realized that all of the complexity wasn't being fixed. We were still giving to sourcing partners only a percentage of what they could source. We're only looking at value pricing and sourcing. So I decided to embark upon the 80/20 journey. Now ironically, when I said this at Analyst Day, I thought we were dusting off a 1980s tool from ITW. And my channel checks were with companies and a couple of them speaking here today that are really 80/20 sells. And so we embarked with an outside partner, and I was very clear on the fact that they had to be P&L leaders who understood how to implement 80/20 in a pragmatic way. And so now we've done all the training across the company. We've had 3 deep dives into 3 businesses where we're further along. We're not really going to expect to see that benefit the next year but I'm really excited about the progress. So I challenge everybody here. You'll hear companies talk about 80/20, I would ask you to ask about their metrics, what's in Quad 4, what's in Quad 1? What's their strategy? You'll find in a hurry if they're just saying 80/20 as a prioritization tool if they're actually using 80/20 as a value creation tool. And I do think there'll be a separation there because people want to be 80/20, but you've got to be really deep in the data to do it effectively. And I'm proud of the teams doing it. And then as a CEO, I have to give them permission to walk away from non-value-added revenue, and we have to change our metrics and our incentives to encourage the whole organization to drive value. Last point on this, I said this earlier, I changed my numerator for revenue to realize standard margin. And that's where we compensate because what we want is high-quality revenue, we don't want lower quality revenue.

You mentioned being about halfway through the 80/20 journey. Is the second 50% harder than the first 50% in that maybe low-hanging fruit came first? Or is now, it's actually easier because we set the foundation and now we're leveraging that?

So we finished all the training for everybody, which is the training is you learn how to use the tool and you get the math and the real data associated with your business. The first wave of 80/20 will really just be Quad 4 exits, getting you low-hanging fruit, Quad 4 is their parts that you're selling that you don't really want to sell to customers, you don't really want to sell it to. The next stage is how are we performing in our Quad 1, our most valuable products to our most valuable customers, you should see an improvement back on on-time delivery, quality and growth. And then the next two are the harder ones, as you mentioned, which is how do you migrate your B parts to your A customers that you don't want to really sell, they don't really want to buy, but you created an industry that needs it. And then the final one is also hard in the quadrant 3 in the lower left, which is you've got loyal dealers for long periods of time, but you're probably over discounting them, overvaluing them, and they're becoming a little pesky to the larger dealers because they're going and competing on price. And you basically have to start to exit away from them. But those are the harder parts of it, to your point, and I think those won't happen until '26 or '27, and the way we're looking at it. We'll get the low-hanging fruit in '25 primarily.

The 80/20 initiative, I think it's pretty clear why it's good for margins, being more efficient, focusing on what really matters. Over -- ultimately, is it also positive for revenue? And how does it kind of go from a margin driver to ultimately a revenue driver?

Yes, I'll talk and you could talk a little bit about pool. I think you got to take on faith. The first part is math would say there's about 4% of your revenue in the bottom quadrant. There's no way my team is going to listen to me because I've been telling them they have to get out of it, right? But the reality is, I think if you got half of that revenue out of your organization in year 1, that would be very impressive. So think about maybe going backwards, a couple of points in revenue. But then what should happen is because you freed up all these resources and think about resources today being compliance resources. We got ESG reporting. Any time you put a product out there, you've also got to support it with customer service, you've got to support it with inventory, you got to support it with freight. You got lower volumes. That's the complexity that you're really trying to manage through. When you free yourself in that complexity, you've got time now to focus on why customers came to you in the first place, which is how do we grow our very best parts with our very best customers. You should see a pickup in organic growth with that set of customers. And it's measurable. And I think then you know where your core growth is going. So yes, I would believe it's a core growth accelerator, probably 6 months into the journey, and we should be able to have measurable differential core growth acceleration from the 80/20 efforts.

Yes. I think on the pool side, we measure how we perform with our top customers, right, differently, we are outperforming with this one, because I think we convert it to get to perfect. So we sign one, our biggest customer at pool to perfect. And then after, we'll do with the other one. And we do that also on the dealer side, what tools can we provide to those dealers -- the top dealers to be doing much better and help them grow. So I think it helps us really to focus that simplification has really to focus on growth.

Yes. Maybe turning to margins. I mean, 2023, really nice 200 basis point expansion in 2024, guide costs or something 200-plus. I guess the company seems very well on its way to hitting that 26% margin in '26. I guess what else is needed to get there? And how do you feel like the company is running against that plan?

So publicly, we committed to 24% by 2026. In our Analyst Day, we pointed to the fact that things went right, we believe we could achieve that 26% ROS. Again, not really knowing what revenue number it's tied to. The real commitment was $100 million of EBITDA contribution every year in that. Clearly, as you take a look at our forecast this year, we're ticking 23%-ish which would mean that if we get this type of progress and we've got $100 million of the $260 million of transformation realized, and we still have $160 million more to go in the next 2 years. It's probably not going to take a rocket science to say, hey, John, Bob, you need to take these margins higher. And I think as we come out in '25, we'll assess the progress we've made, and we'll start to share what we think we can really achieve in the longer range.

Yes. So I don't mean to get ahead of you with that 26%, but a lot of momentum seen. All right, maybe before I kind of get to the rest of the question list, does anyone in the audience have questions that they would like to ask? Okay. Maybe going to -- going from margins to competition. There's definitely more public competitors versus history. I guess, do you feel like competition in the market has changed versus 5 years ago?

Pool has more public companies. And yes, I do believe competition has changed, and I think it's gotten better. And I think when your competition gets better, it forces you to be better. And I think the whole industry is going to benefit from it. I think we've always competed with the same companies, but when you have to publicly disclose your results and you have to publicly disclose your performance, it's a whole different feeling, right? And so we now have comparables on the equipment side a pool to 2 other publicly traded companies. We can also see what public company distributors are reporting and I think data is more free or flowing. Share is less of a guess and more known. I think that's all good for business. And it's good for customers, too, because it keeps us all honest.

Yes. I mean maybe kind of staying up in pool. Can you talk about the go-to-market selling strategy? Why are the relationships with the distributors and the pool builders or installers so critical?

Yes. So I think that for us we focused with the dealer or the pool builder is important because I think the dealer does 2 things. And then when they sells a pool, sells basically an equipment pad, the consumer is going to buy a pool, but doesn't know what goes on the equipment pad. And then the second is going to select the brands and pick which brand is going to go. So that's why I think that we have a strong, strong relationship with those dealers. And especially what I was saying, we have seen 17,000 when we have a loyalty program with but 4,000 which are really, really strong. And then the relationship with the distributors is very important because we are a manufacturer, we let them distribute, so they have branches. They really have a day-to-day relationship with those leaders. And I think that pull-through between the dealer and distribution is really works well. And that's why I think that we have a strong value prop for distribution for the dealer but also for the consumer at the same time. And when we align those, that's where we went.

Yes. I basically compare internally and externally to the HVAC space to pool. Industry-wise, it's similar. I think what's different is and unique, which I believe drives our equipment margins is that we ultimately own our own technology. So if you take a look at the technology on our Pentair pool pad, it's going to be different than what our 2 equipment competitors have. And I think that's good because we're claiming that ours is better. They're claiming theirs is better, but it's proprietary to you. But what's unique about this industry is you think a lot our margins, our distributors make almost like margins and our dealers make like margins. And so that helps pull the professional channel. We're dealing here with electricity and water. So we don't believe that this should ever become a do-it-yourself space. This should be a professional trade channel space. And our equipment is getting more technologically advanced. It's working with each other more integrated as a system. And so having the best dealers who understand that product and can install and having distributors can answer those questions and then us as a company, being able to field support those dealers, that's critical to the growth strategy of this business. And where we're all doing it well and we're pulling incremental content in convincing consumers that they should have saltwater pools, they should have water chemistry testing, they should have automation, we all win. And when we all win it's a much better space.

Can you talk about why automation is so important for Pentair? And ultimately, how you can use automation within pool, maybe to increase the value-add that you're providing to the installer and ultimately, maybe use that to take more share in their wallet?

Yes. I think it's important for everybody around the chain. I think it's important -- automation is important for our consumer or pool owner, just because I think they're looking for that effortless pool. Managing the pool with the phone rather than having to go in the backyard. I think it's important for the dealer because dealer not just makes money, but it can control also those kind of pools and being able to be much more efficient because they can go to that backyard only if they need to and I think improve that from distribution as well. So I think that it helps the whole channel. And what we've seen is that pads, which are automated, pulled more equipments, more technology. So I think there's a 30% uplift. And then after you capture that also on the lifetime value after the fact. So I think it pulls a lot of auto equipment as well, and that's why automation is good overall.

Yes. Pentair competes on the higher side of the market and it's always kind of known as being an innovator kind of leading that in the industry. What do you guys see in the pipeline that gets you excited on the innovation side and keep that differentiation versus the competitors?

I think that there the 2 main ones are the one we just talked about, which is automation. The second one is about water quality, how do we improve the water but the people are swimming in. It's all the less chemicals and I think it's more healthy, so they can enjoy the water even more. I think those would be the top 2 one, but I think the other ones continue to innovate on lighting, heat and the other products as well. I think are all important so that people can really enjoy that pool.

I just want to add that I'll give you a fun fact, hot off the press that we spent a lot of time calculating too, mainly because of our ESG efforts as a company. When you have a pool today, let's pick an area that's had 100 straight days of 100 degrees, maybe Phoenix or Scottsdale, you're saying what's going on with water evaporation and -- the levels of water usage in a pool are about the equivalent of having half an extra person in your household. I know you don't think about that, but think about showers, think about toilets, think about dishes and dishwashers. So pools by their nature, don't consume that much water. I just want to make sure that we throw that out there. But it does have an energy consumption. And most of our technology advancements have always been about energy savings but it's now really geared to energy usage. And so listen, people want to leave a better world for their grandchildren and they want to be able to use products and an enjoyment like a pool and say this is not hurting the footprint of the world. And I think we are continuing to evolve our innovations in that way. And the next one is the water chemistry. We don't need to use the types of chemicals that we do today in pools because of advanced filtration treatment. And so I think it's always about being the leader of what's next that makes us more environmentally sustainable, makes it more enjoyable and makes it more effortless is what Jerome said.

Yes. I think there's a question.

With some of the advancements you've made on the technological side with a lot of these innovations, how do you see that changing your pricing strategy going forward, especially looking across the different segments and customer bases?

I think that with every innovation, technology innovation, I think we will be pricing that to what makes sense for the value proposition for our channels, so for the dealers and for the homeowners. So I think that when we launch new products, usually, we see an improvement in a pickup in margin. So I think we feel pretty good about it.

Yes. I think I want to make sure we all recognize that we don't look at our automations in app. I mean, an app is how you interface with the things that you control in your house. You could have home automation unit or whatever. What our automation really is, is how do we work within the protocols and the sophistication of the equipment to optimize the use of that equipment. And you could do that through our app, which we think is a simple way to do that or you could use that through a home integration system. Either way, we have to continue to maintain all those protocols to evolve our technology. We think the biggest opportunity is most people don't calculate how large the pool is and they don't optimize the variable speed pump to only turn the water once every 24 hours, which is really all you need to do. They turn high, low, medium? And there's a way that you could calculate that. There's also a way that you could control or start to control the auto fill on your pool to take advantage of weather patterns like rain in certain areas. So that's how I believe the technology is going to evolve, and I think there's a value proposition on that.

No, I appreciate that. You talked about clearly pools use electricity. Electricity prices have...

We're natural gas. We are solar.

You are solar, yes. Obviously, people want to be energy efficient to help the environment, but also as electricity prices go higher, the savings go up as you move to energy efficiency. Is there a lag? Do you think there could be room like a high-grading opportunity as people maybe prioritize the more premium energy efficiency, not only because of the environment, that's great, but also because they're saving more money each month.

I think we look at our products, we're not just prioritize the ones which are more energy saving. I think we provide that energy saving across the board across our different products. So our pumps we sell are actually -- which is the most efficient one. I think it's sold across all type of pools. You can turn the water on a simple pool, but to manage 2 or 3 on the high end pools. And I think that's why we managed to deliver some very impressive energy savings year after year after year and we've been an ENERGY STAR for more than 10 years.

We are the innovator on hybrid heating and we still have it, and we sell it and it could work off multiple different heating sources and you could optimize which one you want to use when. So those tools are out there. That's not as deeply penetrated as you would think because most regions are either natural gas dependent or they're electricity dependent.

Yes. Maybe if you could just follow on Toby's question a little bit. As it relates to pricing and promotional activity in the markets today, just kind of what you guys are seeing real time through the quarter, any real change or anything of note there?

Well, we'll speak to what we did. We won't speak to what competition did because we don't necessarily know that, but you can -- we're now through the early buy, the price increases for next year. We announced in September 1, and Jerome?

Yes. We are now to a 3.9% price increase on average on September 1. And then that's what's been communicated to the channel, I think it's going through. And I don't think we see a lot of pushback from our dealers. I think it's kind of...

Yes, for the rest of the portfolio outside of pool, we make those decisions closer to January 1. And we see we're in a normal inflationary environment. And I'd say normal will be in wage inflations feel like they're going to be back to more normalized rates. And from a commodity standpoint, there's nothing really accelerating on the heavy headwind basis. So I think we're going to be looking at more normalized price environments -- where what we expect our realized price to do is offset 100% of that cost play. Does that answer your question?

[indiscernible].

No. I think we continue on doing what we do, what we do well and stay close to the dealers and then making sure we have loyal dealers and try to get people -- more people in the county, that's the goal.

We do try to incentivize dealers for the things we really want to sell, and we throw some more money at that.

I mean maybe last one for me. Are you -- how is demand in the market across the 3 verticals? Are you -- anyone where you're seeing rate of change to the positive or negative?

No. We -- unfortunately, we had to adjust our revenue downward for the year. I say that because we didn't adjust income or EPS down, which lends you to believe we would have crushed it if we would have got that revenue. And that was disappointing, but I think for our residentially exposed businesses and the demand in industrial and commercial, I'd say flattish from quarter-to-quarter. Where everybody is sitting there waiting or deferring bigger decisions until they know where interest rates are going to go. So I think we get better from here is the way I would describe it, but I don't know when it gets better from here.

Yes. Yes. And I appreciate that. Well, we're up on time. I really appreciate you guys come in. I love the conversation. Thank you.

Thank you so much.