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Pentair Riddled by Cost Inflation, Post Separation Concerns

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On May 4, we issued an updated research report on Pentair plc PNR. The company’s results in the near term will bear the brunt of material and other cost inflation. Further, concerns pertaining to the separation of the Electrical business remain.

 

Sound Q1 Results

 

Pentair delivered first-quarter 2018 adjusted earnings of 88 cents per share, up 35% from the year-ago quarter. Earnings exceeded the Zacks Consensus Estimate of 83 cents as well as management’s guidance of 81-83 cents.

 

Guidance Reflects Electric Business Separation

 

Pentair initiated second-quarter adjusted earnings per share guidance range of 67-69 cents. Sales is expected to be around $0.79 billion, up 4-5% on a reported basis and up 3-4% on a core basis compared with second-quarter 2017. For fiscal 2018, the company anticipates adjusted earnings per share between $2.25 and $2.30. Sales are projected at $2.96 billion, up 3-4% on a reported and core basis over 2017.  Both the guidance ranges reflect the separation of its Electrical business, nVent Electric plc.

 

Electrical Business Separation Completed, Risks Persist

 

Pentair has completed the separation of its Electrical business, which is now held by nVent Electric plc ("nVent"), a new independent, publicly-traded company.  nVent shares began trading on the New York Stock Exchange on May 1, 2018, under the symbol "NVT".

 

This will create two industry leading pure play companies in Water and Electrical — Pentair plc and nVent Electric plc ("nVent"), respectively.  Both the companies are well-positioned for long-term growth as well as value creation and also possess the scale and strength to flourish as separate entities. Pentair will continue to operate as a leading global water company focused on smart and sustainable solutions.

 

Although the separation of the Electrical business from the Water business will provide financial, operational, managerial and other benefits to the company as well as its shareholders, risks persist in connection with the separation. Pentair will incur certain costs and expenses relating to the spin-off, such as legal, accounting and other professional fees along with ongoing costs in connection with the spin-off, including costs of operating as independent, publicly-traded companies.

 

Those costs may exceed its estimates or could negate some of the expected benefits. If the intended gains are not realized or costs exceed estimates, it would have an adverse effect on the financial condition. Further, each management team's inability to control additional stranded corporate costs or to deliver a smooth transition might affect near-term business performance.

 

Following the spin-off, trading price of Pentair’s shares is likely to decline and may experience greater volatility as it will no longer reflect the value of the Electrical business. Until the market has fully analyzed the company’s value without the Electrical business, the price of shares may experience higher volatility. Moreover, the shares may not match some holders' investment strategies or meet criteria for inclusion in stock market indices or portfolios, which could cause investors to sell their shares. Excessive selling pressure could cause the market price of Pentair’s shares to dip.

 

Factors That Might Restrict Results

 

The company has identified attractive opportunities in specific product and geographic markets, both within and outside the United States. The company is reinforcing its businesses to effectively address these opportunities through research & development as well as additional sales and marketing resources. Unless it is successful in its endeavors, the company’s sales growth will likely be limited in the near term or may decline.

 

Sales outside the United States accounted for 40% of net sales in fiscal 2017. Fluctuations in foreign currency exchange rates, most notably the strengthening of the U.S. dollar against the euro, could have an adverse material effect on the company’s revenues.

 

The company continues to witness inflation in material and other costs. The current economic environment is likely to fuel the persisting price volatility for raw materials.

 

 

Pentair underperformed its industry’s performance with respect to share price, over the past year. The stock slumped 33%, while the industry recorded growth of 4%.

 

Zacks Rank and Key Picks

 

Pentair currently has a Zacks Rank #5 (Strong Sell).

 

Some better-ranked stocks in the same space include Caterpillar Inc. CAT, H&E Equipment Services, Inc. HEES and Avery Dennison Corporation AVY. While Caterpillar sports a Zacks Rank #1 (Strong Buy), H&E Equipment Services and Avery Dennison carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

 

Caterpillar has a long-term earnings growth rate of 13.3%. The stock has appreciated 47% in a year’s time.

 

H&E Equipment Services has a long-term earnings growth rate of 17.4%. The company’s shares have been up 63% during the past year.

 

Avery Dennison has a long-term earnings growth rate of 7%. Its shares have rallied 26% over the past year.

 

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