March 20, 2015 Pentair plc (PNR-NYSE) Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Underperform Date of Last Change 01/12/2014 Current Price (03/19/15) $64.38 Target Price $68.00 52-Week High $80.55 52-Week Low $59.84 One-Year Return (%) -16.54 Beta 1.25 Average Daily Volume (sh) 1,211,664 Shares Outstanding (mil) 182 Market Capitalization ($mil) $11,717 Short Interest Ratio (days) 3.35 Institutional Ownership (%) 79 Insider Ownership (%) 1 Annual Cash Dividend $1.28 Dividend Yield (%) 1.99 5-Yr. Historical Growth Rates Sales (%) 28.6 Earnings Per Share (%) 16.3 Dividend (%) 9.5 using TTM EPS 16.9 using 2015 Estimate 15.6 using 2016 Estimate 14.1 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page SUMMARY Pentair s adjusted earnings improved 23% year over year to $1.06 per share in the fourth quarter of 2014 driven by robust margin expansion and strong internal execution. The company lowered its fiscal 2015 EPS guidance to $4.10 $4.25, citing unfavorable impact from foreign currency translation. Pentair will benefit from improvement in the North American residential market, growth in food and beverage and infrastructure vertical, synergies from the Tyco merger and share repurchases. However, weakness in energy sector due to low oil prices and weak mining demand as well as lower orders in the Valve & Control segment remain headwinds. Hence, we are maintaining our Neutral recommendation on Pentair with a target price of $68. Risk Level * Below Avg., Type of Stock Large-Blend Industry Mach-Thrml Proc Zacks Industry Rank * 114 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 1,664 A 1,792 A 1,713 A 1,831 A 7,000 A 2014 1,644 A 1,834 A 1,758 A 1,803 A 7,039 A 2015 1,606 E 1,795 E 1,730 E 1,801 E 6,932 E 2016 7,126 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.54 A $0.84 A $0.82 A $0.86 A $3.05 A 2014 $0.71 A $1.02 A $1.00 A $1.06 A $3.78 A 2015 $0.77 E $1.13 E $1.08 E $1.16 E $4.14 E 2016 $4.58 E Note:2013 & 2014 quarterly figures will not add up due to rounding off Projected EPS Growth - Next 5 Years % 13 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Founded in 1966 and initially based in Schaffhausen, Switzerland, Pentair plc (PNR or the company) delivers products, services, and solutions for water and other fluids, thermal management, and equipment protection in the United States, Europe, Asia and other regions. Pentair has undergone a transformation through the merger with Tyco's Flow Control business in Sep 2012. This has radically changed Pentair from being primarily a water company with a small energy business to a global, diversified industrial business with equal exposures to energy, industrial, residential/commercial end markets, as well as infrastructure and food & beverage. On Jun 3, 2014, Pentair announced that it has completed the change in the place of incorporation from Switzerland to Ireland effective Jun 3, 2014. Pentair will have its tax residency in the U.K. Pentair currently has four reporting segments: Valves & Controls (Approximately 33% of total revenue in 2014) designs, manufactures and markets and services valves, fittings, automation and controls and actuators for the energy and industrial verticals. The segment operates as a stand-alone GBU (Global Business Unit). Technical Solutions (15%) designs, manufactures and markets products that guard and protect some of the world s most sensitive electronics and electronic equipment, as well as heat management solutions designed to provide thermal protection to temperature-sensitive fluid applications. The segment operates as a stand-alone GBU. Process Technologies (26%) designs, manufactures, markets and services innovative water system products and solutions to meet filtration, separation and fluid process management challenges in food and beverage, water, wastewater, swimming pools and aquaculture applications. The segment consists of the Filtration & Process and Aquatic Systems GBUs. Flow Technologies (26%) designs, manufactures and markets products and services designed for the transfer and flow of clean water, wastewater and a variety of industrial applications. The segment operates as a stand-alone GBU. Effective 2015, Pentair reorganized its business segments to reflect a new operating structure and management of its GBUs. As part of this reorganization, the legacy Filtration & Process GBU was combined with the legacy Flow Technologies GBU to form the Flow & Filtration Solutions segment which will operate as a stand-alone GBU. The new Flow & Filtration Solutions segment will include six businesses including Engineered Flow, Water Solutions, Fluid Motion, Hygienic Production Systems, Equity Research PNR Page 2
Advanced Filtration and Oil & Gas Separation. Water Quality Systems will include the Aquatic Systems, Water Purification, Food Service and Environmental Systems businesses. REASONS TO BUY Pentair s execution on the Tyco integration remains on track. The company expects to achieve more than $275 million in synergies at an annual basis by the end of 2015. This will be driven by repositioning initiatives, improved sourcing, lean implementation, and standardization, as well as modest contribution from sales synergies. During 2014, Pentair returned $1.4 billion to its shareholders through share repurchases and dividends. In Dec 2014, the company announced that its board of directors has approved a 16% increase in its annual dividend to $1.28 from $1.10, marking the 39th consecutive year of dividend increase. During the 2014, Pentair repurchased 16.4 million of its ordinary shares for $1.2 billion. Moreover, the company plans to return at least $440 million through share repurchases and dividends in 2015. Through Jan 2015, the company has already completed $200 million of share repurchases under its current $1 billion authorization. Pentair s balance sheet capacity remains over $1 billion. In addition to share repurchases, M&A activity is likely to resume in 2015. Growth in the second largest vertical, Residential/commercial which accounts for 27% of Pentair s sales remains healthy driven by continued strength in the North American residential replacement market and the ongoing commercial construction recovery. Management expects sales from the vertical to grow 4-6% in 2015, up from the previous expectation of 3-5%. The Food & Beverage segment that accounts for 10% of Pentair s sales is projected to grow 5-7% in 2015. This will be mainly driven by strength in beverage and food services markets, further share gains and customer penetration. The Agricultural market remains weak but management expects healthy and differentiated growth in the irrigation and crop spray businesses. Within the infrastructure vertical, which accounts for less than 10% of Pentair s overall sales, the company foresees modest growth (1 to 3%) in 2015. Even though the electronics business faces tough comparison in the first half of the year, the business is focused on winning new opportunities. In advanced filtration, the company witnessed pick up in orders in global desalination and water treatment markets. Within the engineered flow business, infrastructure backlog improved in the back half of 2014. Based on this, the company expects growth to pick up in the second half of 2015 following a challenging first quarter. Equity Research PNR Page 3
REASONS TO SELL Pentair lowered its fiscal 2015 EPS guidance from the previous range of $4.20 4.35 to $4.10 $4.25, citing unfavorable impact of foreign currency translation. Fiscal 2015 sales are projected at $6.9 billion, lower than $7.039 billion in fiscal 2014. Organic sales are now expected to be up 2 3% (down from previous projection of 2-4%) with a 4 5% negative impact from foreign exchange headwinds. Adjusted operating margins for 2015 are expected to expand 90 basis points compared with 110 basis points projected earlier. In the Valve & Control segment, orders were weak and backlog declined 6% year over year. Given global economic uncertainty and a low inflationary environment, projects are being released at a slower pace as project owners are taking more time to adequately review costs and risks. Valves growth will likely be under pressure in 2015. Sales in the Energy vertical (27% of Pentair s sales) are expected to decline 5 7% in 2015. Oil & gas trends (approximately 19% of sales) remain volatile, particularly in upstream applications where management sees continued project delays and incremental pressure from declining oil prices. Moreover, power (5% of sales) and mining (3% of sales), demand trends remain weak. Overall the energy vertical is expected to remain under pressure in 2015. RECENT NEWS Pentair (PNR) Beats on Q4 Earnings Despite Revenue Miss Feb 3, 2015 Pentair plc reported fourth-quarter 2014 adjusted earnings of $1.06 per share, up 23% year over year and ahead of the Zacks Consensus Estimate of $1.03 per share. The improvement was driven by robust margin expansion as well strong internal execution. Earnings came within the company s guidance range of $1.02 to $1.04. Including one-time items, earnings stood at $0.74 versus $0.81 in the year-ago quarter. Operational Update Net sales dipped 2% year over year to $1.8 billion due to unfavorable impact of currency translation. Excluding the impact of currency translation, core sales grew 2% in the quarter. Revenues fell short of the Zacks Consensus Estimate of $1.87 billion as well as management's guidance of $1.86 billion. Cost of sales decreased 3% to $1.16 billion in the fourth quarter from $1.2 billion in the year-ago quarter. Gross profit in the reported quarter was $641 million, up 2% compared with $630 million in the prior-year quarter. Gross margin expanded 120 basis points (bps) year over year to 35.6% in the quarter. Adjusted operating income increased 10% to $274 million from $249 million in the year-ago quarter. Operating margin increased 160 bps to 15.2%. Segmental Performance Net sales in the Valves & Controls segment amounted to $613 million, down 6% year over year. Sales in the Energy vertical (60% of the segment sales) decreased 3%. Sales to the oil & gas industry decreased 5%, while sales to the power and mining industry remained flat. Sales in the Industrial vertical (balance 40% of the segment s sales) increased 1%. Segment operating profit rose 30% to $103 million from $79 million in the year-ago quarter. Equity Research PNR Page 4
The Process Technologies segment reported revenues of $480 million, up 2% from the year-ago quarter. Sales in the Residential & Commercial vertical increased 5%. Sales in the Food & Beverage vertical also went up 7%. Segment operating earnings remained flat year over year at $67 million. Sales from the Flow Technologies segment decreased 6% year over year to $250 million. Sales in the Residential & Commercial vertical increased 1%. However, the Infrastructure, Industrial and Food & Beverage verticals posted respective declines of 13%, 10% and 6%. Operating earnings, however, increased 5% year over year to $26 million. Revenues in the Technical Solutions segment grew 3% year over year to $465 million. Sales in the industrial vertical increased 6% and in the Residential & Commercial vertical grew 11%. In addition, sales increased 12% in the Energy vertical. Operating profit increased 7% year over year to $106 million from $99 million in the year-ago quarter. Fiscal 2014 Performance Pentair reported adjusted earnings of $3.78 per share, up 24% year over year. Earnings outpaced the Zacks Consensus Estimate of $3.75 as well as management s guidance of $3.72 $3.74. Including special items, earnings in fiscal 2014 was at $3.18 compared with $2.50 in the prior fiscal year. Pentair s sales edged up 1% to $7.04 billion, falling short of both the Zacks Consensus Estimate of $7.121 billion as well as management s guidance of $7.1 billion. Financial Update As of Dec 31, 2014, cash and cash equivalents were $110 million, down compared with $256 million as of Dec 31, 2013. The company recorded cash flow from operating activities of $1 billion in fiscal 2014, compared with $931 million in the prior fiscal. Free cash flow was $889 million in fiscal 2014 compared with $767 million in fiscal 2013. Total debt of the company increased to $3 billion as of Dec 31, 2014 from $2.55 billion as of Dec 31, 2013. The company s debt-to-total-capital ratio stood at 39% as of Dec 31, 2014, compared with 29% as of Dec 31, 2013. In Dec 2014, Pentair announced that its board of directors has approved a 16% increase in its annual dividend to $1.28 from $1.10. This marks the 39th consecutive year of dividend increase. Guidance Pentair lowered its fiscal 2015 EPS guidance from the previous range of $4.20-4.35 to $4.10 - $4.25, citing unfavorable impact of foreign currency translation. Compared with the fiscal 2014 adjusted EPS of $3.78, this reflects an annual growth of 8% to 12%. Fiscal 2015 sales are projected at $6.9 billion, lower than $7.039 billion in fiscal 2014. Pentair also initiated its first-quarter fiscal 2015 guidance. The company expects EPS in the range of $0.75 to $0.77 on the back of revenues of approximately $1.6 billion. Equity Research PNR Page 5
VALUATION Currently, shares of Pentair are trading at 15.6x our 2015 EPS estimate of $4.14. The company s current trailing 12-month earnings multiple is 16.9, compared with the 32.2x average for the peer group and 18.2x for the S&P 500. Over the last five years, Pentair shares have traded in a range of 13.7x to 25.1x trailing 12-month earnings. We have maintained our Neutral recommendation on Pentair, implying that it will perform in line with the market. Our target price is $68 or 16.4x our 2015 EPS estimate. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Pentair plc (PNR) 15.6 14.1 13.3 12.2 16.9 25.1 13.7 Industry Average 17.2 14.8 10.9 16.0 32.2 79.2 12.0 S&P 500 16.6 15.5 10.7 14.5 18.2 18.4 12.0 Zebra Technologies Corp. (ZBRA) 15.3 12.5 8.5 16.5 23.6 24.9 13.5 John Bean Technologies Corporation (JBT) 20.7 17.8 14.1 22.2 25.1 10.2 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Pentair plc (PNR) 2.7 2.7 1.3 13.9 0.6 1.9 13.2 Industry Average 4.1 4.1 4.1 16.4 1.3 0.7 16.1 S&P 500 6.2 9.8 3.2 25.4 2.0 Equity Research PNR Page 6
Earnings Surprise and Estimate Revision History Equity Research PNR Page 7
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of PNR. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1133 companies covered: Outperform - 15.2%, Neutral - 75.2%, Underperform 8.8%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research PNR Page 8