Dividend Aristocrats Part 5 Of 52: Pentair plc (PNR) by Sure Dividend
Pentair was founded in 1966. The company is an opportunistic industrial equipment manufacturer based in Ireland.
Pentair’s focus has shifted substantially over the last ~50 years. Through the 1960’s and 1970’s, the company was involved mainly in the paper industry.
In the 1980’s, Pentair acquired Porter-Cable and became involved in the manufacturing of tools.
The 1990’s marked significant international expansion for Pentair.
In 2004, Pentair acquired Wicor Industries and entered into the water industry. Wicor manufactures water filtration and pool equipment under the Sta-Rite, SHURflo, and Hypro brands.
In 2012, Pentair and Tyco Flow Control Solutions merged, further diversifying the business.
Today, Pentair classifies itself as “a global provider of systems and solutions to serve the world’s food, water, and energy needs”.
The image below breaks down the company’s sales by segment, geography, and industry
Source: Pentair 2015 Bernstein Strategic Decisions Conference, slide 5
The Valves & Controls segment designs, manufactures, sells, and services valves, fittings, automation and controls, and actuators for the energy and industrial industries.
The Flow & Filtration segment designs, manufactures, sells, and services filtration, separation, flow, and fluid management systems for the agriculture, food and beverage, industrial, and water supply industries.
The Water Quality Systems segment designs, manufactures, sells, and services water systems and products for filtration and fluid management applications in food and beverage, swimming pools, and aquaculture industries.
The Technical Solutions segment designs, manufactures, sells, and services electronic equipment protection products and fluid management equipment protection products.
Competitive Advantage
Pentair has paid increasing dividends for 39 consecutive years. The company’s long dividend streak is evidence of a sustainable competitive advantage.
Pentair’s competitive advantage comes from its lean manufacturing processes and ability to redeploy capital form lower margin businesses into higher margin businesses.
The company has a 14 year legacy of using its Pentair Integrated Management System (referred to as PIMS). PIMS focuses on lean manufacturing practices and continuous improvement.
The PIMS system emphasizes individual responsibility down to the operator level – so all employees can be held accountable for their actions.
The PIMS system is more than a corporate buzzword/buzz-acronym. Net profit margin has increased by a compound rate of 3.5% a year over the last decade (from 6.3% to 8.6%).
Pentair also has a tax-based competitive advantage. In 2014, the company reincorporated to Ireland. Ireland has very low corporate taxes. In 2005, Pentair payed a corporate tax rate of 34.7%. In 2014, the company’s tax rate was just 22.6%. In full fiscal 2016, the company’s tax rate is expected to be around 23%. The effective tax rate for several of Pentair’s competitors is shown below:
- Parker Hannifin (PH) had a 2014 tax rate of 28.5%
- Flowserve (FLS) had a 2014 tax rate of 28.9%
- Dover (DOV) had a 2014 tax rate of 29.6%
For every $1 of profit Pentair earns, it generates an extra $0.05 to $0.06 of after-tax profit more than its competitors just because it is based in Ireland.
Future Growth Prospects
Pentair’s tax advantaged status was first discussed in detail by activist hedge fund Trian. Trian currently owns 7.2% of the outstanding shares of Pentair. Pentair also recently announced it is recommending adding Trian CIO Ed Garden to the company’s board of directors in the upcoming shareholder general meeting.
Trian believes that Pentair has tremendous growth potential through consolidating the highly fragmented industrial manufacturing industry.
Indeed, Pentair is uniquely situated to do so. As discussed in the beginning of this article, Pentair has a long history of growth through acquisitions. The company’s low effective tax rate allows it to acquire companies and immediately raise their net margins through its lower tax rates.
Additionally, Pentair’s management is highly effective at integrating acquisitions. The company has a long-standing 5 step question process to find worthy acquisitions. The 5 questions are listed below:
- Does the deal make strategic sense?
- Does the deal make financial sense?
- Is Pentair the right buyer?
- What’s the implementation plan?
- Who’s leading the implementation plan?
Pentair’s management has set its growth goals very high. The company is expecting long-term earnings-per-share growth of 15% to 20% a year.
The image below shows how the company has actually accomplished this level of rapid growth since 2012, and how it plans to do so going forward.
Source: Pentair 2015 Bernstein Strategic Decisions Conference, slide 8
It appears that Pentair is taking Trian’s advice and ramping up its acquisition activity. The company recently announced it will acquire ERICO for $1.8 billion in cash, including the assumption of ERICO debt. The deal values ERICO at price-to-EBITDA multiple of 12x. ERICO will add to the product offerings of Pentair’s Technical Solutions segment.
Valuation & Final Thoughts
Whether or not Pentair manages to grow its earnings-per-share at more than 15% plus a year is irrelevant when one considers the company’s valuation.
Pentair is currently trading at an adjusted price-to-earnings ratio of 15.5 – the company is not priced for growth, but it has excellent growth potential.
In addition, Pentair currently has a 2.2% dividend yield. While not outrageously high, the company does have a slightly above average dividend yield.
Pentair appears undervalued at current prices given its growth ‘story’ and strong growth potential.
Pentair is a high quality business with a long history of rewarding shareholders through increasing dividends. The company appears cheap at this time. Its dividend yield may not appeal to investors seeking high current income, but its qualitative growth story and low price-to-earnings ratio should not be ignored.
