Pentair: What's Up With This Water Company?Mar 29, 2021
Price Target: $78
Target Date: 10 months, and also bullish over a multi-year horizon
🔎 Stock Profile
Getting to know Pentair:
We are initiating coverage of Pentair (PNR) as we believe it is a blue chip name in the ESG (Environmental, Social & Governance) stock space, with best in class residential and commercial water products.
Pentair is a pure play water company manufacturing a wide range of sustainable water solutions, including energy-efficient swimming pool pumps, filtration solutions, as well as commercial and industrial pumps. Pentair’s business is organized into two lines of business: consumer solutions and industrial & flow technologies. Consumer solutions account for 58% of Pentair's sales in 2020, and focuses on sales to homeowners including aquatic systems as well as residential filtration systems. The aquatic systems business, which offers a full line of energy-efficient equipment for residential and commercial swimming pools (including pumps, filters, heaters, and other equipment and accessories), is the part of Pentair’s portfolio that has the most attention, as it is both its fastest-growing and most profitable business.
Industrial & flow technologies (42% of sales in 2020) focuses on business-to-business sales and consists of industrial filtration (including the food and beverage end market), residential irrigation flow, and commercial and infrastructure flow. Pentair’s product is a verified blue-chip in the sustainable water solutions space, verified by its largest customers being some of the top names in food and beverage, like Starbucks and Coca Cola.
We believe that Pentair has developed a loyal customer base through a combination of its best in class product, and high customer switching costs.
Let’s look at an example of those high switching costs in action. In 2006 Pentair introduced its IntelliFlo variable-speed pool pump. Energy-efficient pumps are an economically smart investment for customers because they can significantly reduce their utility bills. According to the U.S. Energy Information Administration, pool pumps consume on average 8% of total annual electricity in homes with swimming pools. Switching to a variable-speed pump can cut electricity consumption by over 50%, and the savings can allow customers to recoup their up-front investment within the first two to three years of ownership. Pentair’s home pool products business is full of examples like this one.
We see massive opportunities for growth in the pool segment, as only 20% of pool pumps in the U.S. are currently variable-speed pumps.
Pentair also continues to allocate capital towards innovating and enhancing its current product suite. For example, the company recently introduced a new mobile app, IntelliConnect. IntelliConnect is a pool automation system that won the Best New Product award at the 2018 International Pool Spa Patio Expo. The system connects multiple pool devices (such as pumps and filters) and allows owners to remotely monitor and control their pools (including lighting, variable speed pumps, and so on) from a smartphone app. This integrates multiple Pentair products, will make customers even more faithful to the company.
Because of examples like this of innovation, and reputation for quality, Pentair has been able to steadily gain market share in the swimming pool segment, capturing roughly an additional 1% of market share annually over the last seven years.
Pentair derives roughly two thirds of its revenue from aftermarket service and replacement parts, which are essentially up-sell events of its large installed base, as its products are currently installed in 5 million US pools. Aftermarket sales enable Pentair to sell to a captive audience, and also reduce Pentair's reliance on new construction starts.
- This is important, because it decouples Pentair’s performance from the housing economy. In the swimming pool industry, oftentimes the majority of sales revenue is realized on the construction of the pool that's created when a home is built. Since Pentair’s revenue is largely tied to pool’s that already exist, it reduces the company’s reliance on homes being built, which means it can remain more profitable than the competition even if the housing and construction market experiences headwinds.
On the commercial side, many of the company's products perform mission-critical functions which are tied directly to revenue, meaning any product downtime or outages could lead directly to time that it’s customers cannot produce its product. For this reason, quality and reliability are greatly valued, and we believe its customers will continue to pay up for Pentairs premium priced product instead of switching to cheaper alternatives.
This segment sells products that are critical for its customers' operations. As such, a reputation for quality and reliability is decisive, especially in the commercial and industrial verticals, as any product failures could lead to costly outages or downtime. For example, filtration systems are critical for breweries, coffee shops, and commercial fish farms. Customers in these end markets are unlikely to aggressively pursue cost savings by switching to a cheaper alternative, as the cost of outages could outweigh any potential cost savings. Similar to its residential business, roughly half of Pentair’s commercial revenue is aftermarket-based.
Lastly, Pentair shares should see some additional demand, and subsequent upwards price momentum from ESG (Environmental, Social, & Governance) funds. Because Pentair's product is an environmentally superior solution, it is likely to continue to catch the eye of fund managers looking for strong companies to include in ESG funds. ESG fund flows (amount of money pouring in) has increased exponentially over the past 3-5 years, and we see this trend continuing. As more money flows into ESG funds, demand for shares of environmentally smart companies like Pentair increases, which has positive impacts on the share price.
Overall, we view Pentair's stock benefiting from being a best in class, environmentally friendly solution in the residential and commercial pool markets. We view high customer switching costs and customer loyalty as continuing to drive profitability for years to come. We assign a $78 price target and believe February 2022 (10 months) is a reasonable timeframe.