Pentair plc (NYSE:PNR) Q3 2023 Earnings Call Transcript

Pentair plc (NYSE:PNR) Q3 2023 Earnings Call Transcript October 24, 2023

Pentair plc beats earnings expectations. Reported EPS is $0.94, expectations were $0.87.

Operator: Good morning, and welcome to the Pentair Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Shelly Hubbard, Vice President of Investor Relations. Please go ahead.

Shelly Hubbard: Thank you, Anthony, and welcome to Pentair’s third quarter 2023 earnings conference call. On the call with me are John Stauch, our President and Chief Executive Officer, and Bob Fishman, our Chief Financial Officer. On today’s call, we will provide details on our third quarter performance as outlined in this morning’s press release. On the Pentair Investor Relations website, you can find our earnings release and slide deck, which is intended to supplement our prepared remarks during today’s call, and provide a reconciliation of differences between GAAP and non-GAAP financial measures that we will reference. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP.

They are included as additional clarifying items to aid investors in further understanding the company’s performance in addition to the impact these items and events have on the financial results. Before we begin, let me remind you that during our presentation today, we will make forward-looking statements which are predictions, projections or other statements about future events. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond the control of Pentair. These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to carefully review the risk factors in our most recent Form 10-Q and Form 10-K.

Following our prepared remarks we will open up the call for questions. Please note that we will limit your questions to two, after which, we ask you to then re-enter the queue in order to allow everyone an opportunity to ask questions. A quick reminder before I hand the call over to John. Similar to last quarter, we have included slides 4 through 7 in our earnings slide deck, which provide a brief overview of Pentair. Please see the slide titled Strategic Framework, Pentair at a Glance, Pentair Overview and Making Better Essential for more information. In reference to Slide 7, Making Better Essential, we are proud to share two recent recognitions that Pentair has received for its work in social responsibility and ESG. We’ve been recognized as a constituent of the FTSE4Good Index Series and we have been named one of America’s Greenest Companies 2024 by Newsweek.

This recognition from Newsweek evaluated Pentair’s environmental performance in relation to our industry, assessing our progress against key environmental factors, including greenhouse gas emissions, water usage, waste profile and commitment to disclosing sustainability data. Pentair’s achievement supports our purpose to create a better world for people and the planet through smart, sustainable water solutions. We look forward to continuing to reduce the environmental impact of our operations and further integrate sustainability into our product innovation as guided by our social responsibility strategic targets. Please refer to our published 2022 Corporate Responsibility Report for more information on our sustainability strategy. I will now turn the call over to John.

John Stauch: Thank you, Shelly, and good morning everyone. Let’s begin with the executive summary on Slide 8. We are very pleased with our third quarter results, which surpassed the guidance that we provided on our last earnings call. Q3 marked the sixth consecutive quarter of sales over $1 billion, and the sixth consecutive quarter of adjusted margin expansion. Segment income increased 3% and ROS expanded by 140 basis points. Adjusted EPS was $0.94 versus our previous guidance of $0.84 to $0.89 and year-to-date free cash flow was $453 million, up 115% over the prior year. As we look to the full year, we are updating our 2023 adjusted EPS guidance range to $3.70 to $3.75, which reflects the high end of our previous guidance.

I want to celebrate these strong results with all our employees. The resilience and dedication to serving our customers and delivering value for our shareholders during a year of global macroeconomic uncertainty is making a difference. Thank you for your leadership. Let’s move to Slide 9 titled Strategic Focus. Through our mission to help the world sustainably move, improve and enjoy water, we are enabling the right investments to both deliver the core and build our future to drive long term value for shareholders. In Deliver the Core, we have driven profitability and productivity across all three segments, Industrial & Flow Technologies, Water Solutions and Pool in 2023. We have also been making better essential through our products and solutions for people and the planet with a focus on sustainability and we have been investing in our people to develop talent and build a higher-performing culture.

Another strategic focus of ours is to build our future to accelerate performance. In 2023, we have further invested in the transformation, innovation and M&A. In fact, we’ve seen great results across all three of these areas with our transformation having begun to read out and new innovation launch this year with exciting new products coming in all three segments. And our Manitowoc Ice acquisition is exceeding expectations. Regarding innovation, in 2023, our businesses have launched 25 new products. Examples include a new high-efficiency ice maker for convenience stores and fast-casual restaurants designed in advance to meet the future EPA regulation for refrigerants, expansion of our Energy Star award-winning and smart IntelliFlo3 pump series and the advancement of our Beer Membrane Filtration solutions to operate continuously with higher levels of smart automation.

In addition to these new product launches, our innovation teams continue to make great progress advancing our strategy to build our future as they focus on our longer-term growth being centered on the Pool of the future, re-imagining residential, commercial water treatment and industrial waste to value solutions. Over the last three years, we have launched over 100 new products. Let’s turn to Slide 10, titled Transformation Update. We embarked on this transformation journey nearly two years ago with the intent to transform our business for the Pentair of the future. Our company has evolved substantially with the separation of nVent and then evolving to a leading diversified water company. Through our four key transformation themes, including pricing, sourcing, operational excellence and organizational effectiveness, we are streamlining our processes in building additional capabilities, which add more tools in our toolbox to drive growth and productivity.

In Q3, transformation gained momentum and drove a substantial increase in productivity sequentially from Q2. After implementing Wave 1, both pricing and sourcing, we expected transformation to begin to scale in the second half of this year and we are pleased to note that our transformation initiatives remained on track. Let’s turn to Slide 11, titled CEO Summary. We delivered another strong quarter with significant ROS expansion. Our Manitowoc Ice acquisition continued to exceed expectation. Our IFT and Water Solutions segments more than offset Pool’s volume decline and our transformation initiatives drove margin expansion. Our performance through Q3 resulted in another positive update to 2023 adjusted EPS guidance. All in, we are building a strong foundation to drive long-term growth and profitability across our diverse water portfolio.

We have updated the full year adjusted EPS guidance to a range of $3.70 to $3.75 from the previous range of $3.65 to $3.75. We are mindful of the uncertainty across the global macroeconomic and geopolitical landscape and we continue to closely monitor macroeconomic developments and implement risk mitigation strategies, when and where necessary. We have continued to accelerate transformation funnels, while focusing on investing in the long-term growth of our company. We remain confident in our diversified water business model, long-term strategy and our transformation initiatives, which we expect to continue to drive shareholder returns. We have a long successful track record of generating strong cash flow and being disciplined with capital allocation.

We achieved 47 consecutive years of dividend increases and are targeting high-teens ROIC. We have a strong balance sheet and an enviable five-year financial track record. I will now pass the call over to Bob who will discuss our performance and financial results in more detail. Bob?

Bob Fishman: Thank you, John, and good morning everyone. Let’s start on Slide 12, titled Q3 2023 Pentair Performance. We delivered another strong quarter of significant margin expansion despite sales being down 4% year-over-year. The diversification of our portfolio and our transformation initiatives continued to more than offset Pool’s lower volume impact on margins. Core sales for Q3 were down 7% year-over-year, driven by our residential businesses. Our commercial and industrial businesses performed well in the quarter. While Q3 sales declined primarily due to the volume headwind in Pool, the negative volume impact on Pentair and Pool improved sequentially from Q2. Third quarter segment income increased 3% to $212 million and return on sales expanded 140 basis points year-over-year to 21%.

This improvement was driven primarily by productivity from transformation, accretive margins from the Manitowoc Ice acquisition and some price versus cost benefit. We delivered adjusted EPS of $0.94. Net interest expense was nearly $29 million and our adjusted tax rate was 15% during the quarter with a share count of 166.6 million. Please turn to Slide 13, labeled Q3 2023 Industrial & Flow Technologies Performance. Industrial & Flow Technologies sales increased 3% year-over-year, driven by commercial sales growth of 8%, and industrial sales growth of 12%, which more than offset a decline in residential sales of 7%. Segment income grew 18% and return on sales expanded 250 basis points to 19.4% marking the fifth consecutive quarter of equal to or greater than 200 basis points of improvement.

The strong margin expansion was a result of continued progress on our transformation initiatives. IFT’s continued success was partly driven by a revised go-to-market strategy and industry leadership that has been underway over the last two years. For example, within our industrial businesses, our strong reputation and industry expertise is driving above-industry growth. We’ve been moving away from primarily project-led business to standardized solutions focused on ease of doing business with distributors. And our key accounts have begun to reinvest in sustainable product lines following the pandemic. Within our commercial businesses in IFT, we are focused on driving business beyond warehouses and office space to datacenters and institutions such as universities, airports, hospitals, and government buildings.

We also believe there are large opportunities in municipal infrastructure as driven by the Infrastructure Investment and Jobs Act legislation in the US, with a focus on investments in clean water, flood control and broadband. Interestingly, one of our customers is the leader in directional drilling equipment for fiber optic cables. We continue to believe the aftermarket is a good opportunity for future growth because of our significant product install base. Lastly, we believe we are in a strong position to benefit from the Build America, Buy America Act as our compliance is expected to give us a strategic advantage. Within our residential businesses in IFT, we have seen a return to normalization. Recall that these products are typically not a discretionary spend.

When a sump pump or a well pump breaks, it’s critical to get it fixed. Please turn to Slide 14, labeled Q3 2023 Water Solutions Performance. In Q3, Water Solutions sales increased 9% to $299 million, driven by our Manitowoc Ice acquisition and price. Segment income grew 40% to $69 million and return on sales expanded 510 basis points to 23%, driven primarily by our accretive Manitowoc Ice acquisition and productivity from our transformation initiatives. Margins have expanded over the last seven quarters from 10.8% in Q1 of 2022 to 23% in Q3 of 2023. Within our residential business in Water Solutions, we noted last quarter that we are seeing North America stabilize. This was evident in Q3 as residential sales declines improved sequentially from Q2.

Within our commercial business in Water Solutions, filtration sales in North America remained strong and Manitowoc Ice continued to exceed our expectations. Please turn to Slide 15, labeled Q3 2023 Pool Performance. In Q3, Pool sales declined 21% to $309 million. The volume decline of 28 points was primarily due to continued channel inventory corrections in the quarter and reflects a strong Q3 2022 comparison. Sequentially, the negative impact of volume, significantly improved from Q2. The pricing benefit of 7 points helped partially offset the volume decline. Despite lower Pool sales in Q3, return on sales expanded 130 basis points due to price offsetting inflation, prior actions to rightsize direct labor to align with lower volumes, and improved productivity driven by our transformation initiatives.

Please turn to Slide 16, labeled Transformation Initiatives. Similar to last quarter, we believe this slide provides a good illustration of our transformation initiatives and our ultimate goal of driving margin expansion. For reference, our transformation initiatives focus on four key themes, pricing excellence, strategic sourcing, operations excellence and organizational effectiveness. As we’ve mentioned in past quarters, we expect strategic pricing actions to benefit the top-line of all three of our segments. We expect our other three transformation initiatives to help improve our overall cost structure. As a result, we are targeting ROS of approximately 23% by the end of fiscal 2025, expanding margins over 400 basis points as compared to fiscal 2022.

Please turn to Slide 17, labeled Transformation Runway. As you look at each of the four key themes, you can see that the work within these transformation initiatives is in various different stages. For example, in 2023, we have begun to see early readouts from Wave 1 within pricing, sourcing and operations. We are beginning Wave 2 within each of these three themes and expect margin benefits to read out in 2024. You can see how each new wave is expected to compound on the others to drive expected margin expansion year-over-year through 2025 and beyond. In pricing excellence, the strategic pricing playbook has been developed, which is just beginning to roll out across segments and categories. For example, in Q3, we began to implement strategic pricing actions across select products within our Pool segment.

Within these price actions — while these price actions are reflected in our recent annual price increase, please note that these strategic actions differ from annual price increases. Typically, on an annual basis, we evaluate overall inflation, both materiality costs to determine the appropriate price increase across our products. With regards to strategic price actions, we are evaluating all products through a value-based model and identifying which ones have opportunities for adjustments. Recall that in the past, we primarily evaluated pricing through a cost-plus approach. In sourcing excellence, the implementation of Wave 1 is underway with savings currently reading out. As a reminder, Wave 1 included materials such as electronics, motors, maintenance, repair and operations spend, packaging and logistics.

Additionally, we successfully kicked off Wave 2 this summer with over 800 suppliers attending our supplier show. For reference, Wave 2 materials include metals, moldings, resins, ocean freight and purchase finished goods. We expect Wave 2 to begin to read out beginning in 2024. Incremental to our strategic sourcing waves, we have seen benefit from our rapid renegotiation process that is a part of our transformed sourcing excellence work. In operational excellence, we have completed the consolidation of three facilities while continuing our execution on lean transformation plans across our sites. In organizational effectiveness, we are in the earlier stages with Wave 1 and expect margins benefits to be realized beginning in 2024. Due to the staggered nature of these transformation initiatives, we expect Wave 3 to begin to read out post 2025 in operations excellence and organizational effectiveness.

Overall, we are excited about the savings we have begun to realize from the early waves and remain confident that our teams can execute on pricing actions and savings we have identified particularly in sourcing. Please turn to Slide 18, labeled Balance Sheet and Cash Flow. In Q3, we generated $143 million in free cash flow, up nearly 100% year-over-year, reflecting another strong quarter. Year-to-date, our free cash flow was $453 million, up nearly 115% year-over-year. Our net debt leverage ratio was 2.1 times, down from 2.6 times in Q1 and 2.2 times in Q2. Our maturity stack is very manageable. Total debt is now less than $2 billion. And the average rate is approximately 5.3%. Our ROIC was 14.1%, exceeding our cost-of-capital and includes debt from the Manitowoc Ice acquisition.

We continue to target high-teens ROIC in the long term. We plan to remain disciplined with our capital and continue to focus on debt reduction amid the higher interest rate environment. Moving to Slide 19, titled Q4 and Full Year 2023 Pentair Outlook. For the full year, we are updating our adjusted EPS guidance to approximately $3.70 to $3.75 from our previous range of $3.65 to $3.75. Also for the full year, we expect sales to be roughly down 1%, segment income to increase 10% to 11% with corporate expense of approximately $85 million to $90 million, net interest expense of roughly $123 million to $125 million and adjusted tax rate of approximately 15%, and a share count of 166 million. For the fourth quarter, we expect sales to be down approximately 3% to 4%.

This is mainly attributable to expected lower Pool volume year-over-year and the return of seasonality in our business now that lead times have normalized. We expect fourth quarter segment income to increase 3% to 8% with corporate expense of roughly $23 million, net interest expense of roughly $28 million to $30 million, and adjusted tax rate of approximately 15%, and a share count of 166 million. We are also introducing adjusted EPS guidance for the fourth quarter of approximately $0.82 to $0.87. Moving to Slide 20, titled Full Year 2023 Guidance at Midpoint. We continue to expect total Pentair sales in fiscal 2023 to be approximately $4.1 billion or down about 1%. We continue to expect IFT sales to be up mid-single digits and Water Solutions sales to be up high-teens.

For Pool sales, we have made a slight adjustment to down high-teens from previous guidance of down mid-teens at the high end of the range. Segment income is expected to increase approximately 10% to 11% with ROS expansion of over 200 basis points to 20.9%. Moving to Slide 21 titled Q3 Progress Summary. We are very pleased with our Q3 and year-to-date performance. As John mentioned earlier, our third quarter marked the sixth consecutive quarter of sales over $1 billion, and the sixth consecutive quarter of adjusted margin expansion. We have executed well in a dynamic environment and delivered on our commitments. Specifically, our diversified water portfolio and transformation initiatives have driven significant margin expansion despite Pool’s volume decline.

Our Manitowoc Ice acquisition has exceeded our expectations. We have instilled performance accountability across the organization, which is being measured through key metrics. We have a very strong balance sheet and free cash flow generation. And we have a disciplined capital allocation strategy that aligns to our high-teens ROIC target. I’d now like to turn the call over to the operator for Q&A, after which John will have a few closing remarks. Anthony, please open the line for questions. Thank you.

Operator: We will begin the question-and-answer session. [Operator Instructions] Our first question will come from Brett Linzey with Mizuho. You may now go ahead.

See also 20 Highest CPM YouTube Niches in 2023 and 10 Best Dialysis and Kidney Disease Stocks to Buy.

Q&A Session

Brett Linzey: Hey, good morning all.

John Stauch: Morning.

Brett Linzey: Hey, first question just on pricing in Pool. So it sounds like you’re going to have two different actions here. So, one being the normal course of business and then on top of that, some surgical. If you could just square that comment. And then anything you can share in terms of the magnitude of the actions that you’re contemplating there?

John Stauch: No. I think just to clarify, as we go into next year, we’re only counting on a price increase, which would be a more normalized price increase and modest compared to prior years, but slightly higher than what we would have said would have normally occurred, which is covering the inflationary aspects. Not aware of anything incremental than that and those price increase, they’re already been announced to the market.

Bob Fishman: Yeah, our comment towards that, not only did we use an approach that looked at inflation, but for certain product lines, looked at adjustments based on a value-based model. But that is all included in the pricing that went out to be effective Jan 1.

Brett Linzey: Understood. Thanks for that. And then just wanted to circle back to the comments around the market extensions within IFT commercial. Great to see some opportunity outside those traditional verticals. Is there any way to quantify the total addressable market size that will increase here, given this new reach, this new focus?

John Stauch: No, but I mean it opens up what we would say would be at least $1 billion plus for our particular opportunities. And I think that’s a conservative estimate, Brett.

Brett Linzey: Okay, great. Best of luck, thanks.

John Stauch: Thank you.

Operator: Our next question will come from Andy Kaplowitz with Citigroup. You may now go ahead.

Andy Kaplowitz: Hey, good morning everyone.

John Stauch: Morning.

Bob Fishman: Morning.

Andy Kaplowitz: John, can you update us and give us more color on what you’re seeing in the Pool market? It looks like you’re suggesting with your Q4 guide slightly bigger inventory correction in the $150 million you were guiding to. Maybe you could give us some more color on that. And then how do you think that sets up Pool for 2024, especially given the higher interest rate environment?

John Stauch: Yeah, so I think, first of all, we’re pleased that we were able to predict the way that Q3 was going to unfold, and it played out, generally, as we expected. I think we focused on sell-through data. And then also focused on the metrics of our channel partners and I think that data is providing clarity of what’s going on. I think the inventory is generally behind us. I don’t think that’s what Q4 represents. I think Q4 represents what we would say is reflecting the higher interest rates and the impact it could have on the sell-through aspects within the market and it’s helping to position ourselves for the best possible 2024 that we can have. So it’s a modest participation in early buy, it’s making sure that we’re not continuing to build inventory ahead of next year. And it’s setting ourselves up for a really good 2024.

Andy Kaplowitz: That’s helpful, John. And then you beat your forecast for Q3 sales overall, were down 4%. I think you were expecting down 7%. You didn’t change anything other than Pool, which we just talked about. But my question is whether you’re seeing anything in IFT or Water Solutions that stopped you from raising your forecast at all? I would imagine you want to be conservative as you talked about, but any more color there on current economic conditions, how they’re affecting the other segments?

John Stauch: No. I mean I think Water Solutions has benefited from significant performance at Manitowoc Ice and we’re really pleased with how that acquisition came in and has performed. Just a reminder though, we’re going to start comparing against really good delivered quarters in the prior years and so that year-over-year performance is going to moderate. I think the market outlook for that business continues to be strong, but it’s going to be hard to continue to put up those types of numbers on a consistent basis.

Andy Kaplowitz: And then in IFT, anything you’re seeing in terms of channel destock or anything like that?

John Stauch: No, but I think it’s only fair to suggest that higher elevated interest for longer makes sure that productivity-based projects and/or expansion investments are going to be up against higher hurdle rates and we’re reflecting that in our particular revenue forecast as we go forward.

Andy Kaplowitz: Appreciate the color, John.

John Stauch: Thank you.

Operator: Our next question will come from Brian Lee with Goldman Sachs. You may now go ahead.

Brian Lee: Hey guys, good morning. Thanks for taking my questions. I know there’s a lot of questions around Pool. I’ll just throw another one in there. And lot of moving parts and the macro is still uncertain, but is there sort of a framework you guys can provide us to think about for Pool? Because if all goes right, it sounds like by the time we get to end of ’23 here, channel destocking is fully complete, you’ve got normal seasonality returning, price is still kind of elevated in the mid-single digits, so I guess, first off, do you see that holding in ’24 on the price side? And then just from a volume framework perspective, assuming all those things, do you play out as you expect channel destocking seasonality? Like, what is the framework we should be thinking about in terms of the Pool volume outlook here as we think about the next kind of 12 to 18 months?

John Stauch: Yeah, first, I think we’re feeling really good about the ability in 2023 to have — continue to raise our guidance through the diversified portfolio, offsetting really consistent performer in Pool. I mean Pool has generated a lot of income and growth for us over the years and I think it was a little bit worse this year than we anticipated coming into the year, primarily because that inventory was larger and the overall market wasn’t as strong as we had hoped it would be. But as we head into 2024, we’re looking at the framework as being that we do pick up the tailwind from not having that inventory correction. And then as we get closer to the end of the year, we’ll predict what the markets are going to be. I think it’s fair to say that we’re not thinking that overall Pool builds expand from here.

And we don’t think overall remodeling expands, but I do think we’re going to see a little bit of recovery in that aftermarket, which I think was accelerated into the prior years and now has been normalized. And a lot of those are non-discretionary purchases and we think we get back to a potential overall growth, plus the benefit of the tailwinds of inventory.