Industrial Whiz Pentair Gaining Muscle Through Merger

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There's nothing like a promising corporate marriage to make a big splash on Wall Street.

That's how the scenario has played out for water products industry leaderPentair ( PNR ). Its stock has spurted up about 62% since the company tied the knot withTyco International 's ( TYC ) Tyco Flow division, in September 2012, six months after announcing plans.

The $10 billion stock-for-stock merger created a roughly $8 billion-a-year powerhouse in flow control, filtration and equipment protection. Tyco Flow complements Pentair's offerings and gives it a strong position in fast-growing markets, including the energy arena, while giving a nice lift to revenue and profit, as well as generating cost synergies.

The combo also gives Pentair an opportunity to apply its Pentair Integrated Management System to Tyco Flow's business with the goal of boosting efficiency, performance and productivity -- in turn driving earnings growth, analysts say. The PIMS approach, as Pentair calls it, involves a studied set of methods and processes for finding new market opportunities, speeding product development and planning rollouts, while trying to stay lean and sharp as a company.

Pentair was already a big player in the water and fluid systems arena prior to the merger, with products ranging from energy-efficient pumps and point-of-use filtration to engineered pumps and fluid processing systems. It also had a strong position in technical solutions with products that guard and protect electronics and electrical equipment such as enclosures and cases, and made heat management equipment and thermal management systems.

Tying With Tyco

Tyco Flow, a maker of flow control products, added to the mix a lineup including highly engineered valves and controls used in energy, general process, mining and water industries.

"The deal was transformational," said Canaccord Genuity analyst John Quealy. "It gets Pentair into the energy market where they weren't a player, and from a financial perspective it doubled the size of the company."

Pentair posted revenue of $4.4 billion in 2012. It estimates 2013 sales will grow to $7.4 billion.

The rationale behind the deal was diversification, says Quealy.

Prior to the merger, he says, Pentair was "very strong" in water and electrical equipment, but had "de minimis" exposure to energy. Meanwhile Tyco was "very strong" in energy-related applications, he adds, and energy was an area in which Pentair intended to participate.

The combination gives Pentair more exposure to energy applications in industrial sectors and doubles its presence in the energy sector as a combined company, said CEO Randall Hogan on a conference call in March 2012 announcing the deal. Pentair expected the transaction to be "highly accretive" to earnings, adding 40 cents a share to 2013 earnings. It estimates combined company earnings will be greater than $5 a share by 2015, reflecting synergies through efforts such as streamlining operations and economies of scale.

Since closing the deal, adds Quealy, Pentair has "encouraged the Street" it can hit the 2015 earnings target. Most recently, on Dec. 10, Pentair said in a statement that it "remains committed to the target synergies from the transaction, and its $5 per share 2015 EPS goal."

Pentair is able to drive earnings through operating efficiencies and continuous improvement processes, says Wedbush Securities analyst David Rose.

"It's still very early in the process, but right out of the gate it looks like the company is a little ahead of expectations in cost-saving synergies," he said. "The outlook so far is encouraging."

Fruits Of Synergy

Investors believe the merger was a good move for the company, he says, and consequently the stock has made a fairly large move.

"We think there are a lot of opportunities ahead and clearly see the path to more operating efficiencies and cost reductions," Rose said, "probably on the higher end of expectations."

Pentair now expects its "realized synergies" relating to the merger integration in 2013 to be about $120 million, above the $90 million previously estimated, said Hogan on the company's Oct. 22 third-quarter conference call.

"The increase over previous estimates is being driven by sourcing and lean savings in Flow Control and is the result of building momentum around our proven PIMS operating system," Hogan said.

Quealy figures Pentair is in about the "third or fourth inning" of the merger integration process.

Pentair will likely shed more light on its prospects in the wake of the merger when it gives its full-year 2014 outlook on Tuesday.

Quealy says he expects the forecast to be "consistent with other industrials," and that he doesn't expect any "major surprises."

Analysts polled by Thomson Reuters see 2014 earnings rising 24% to $3.96 a share.

Meanwhile, Pentair is faring well on the financial front, with double-digit profit gains the past two quarters. Earnings rose 34% to 86 cents a share in the third quarter. Sales jumped 111% to $1.8 billion. Analysts expect full-year earnings to rise 34% to $3.20 a share.

"The third quarter met our expectations on the bottom line, as margins expanded 210 basis points to 13.6%," said Hogan on the quarter's conference call. "Price and productivity more than offset inflation, mix was positive and synergies read out better than expected. Our adjusted EPS grew 25%, even though sales declined 1% organically."

Regional Ups And Downs

But sales were $50 million below Pentair's expectations, he added, due primarily to weak results in Australia. The weakness was not only related to the local economy, but also "a significant foreign exchange head wind," he said.

On a brighter note, Pentair continues to see strength in the residential end market as it benefits from an improving housing market in North America and more spending on dwellings amid rising home values.

Pentair's huge lineup for this market ranges from treatment products that filter and purify water to energy-efficient systems that ensure water pressure is just right. Pentair is also a leading provider of pool and spa equipment.

Sales in the residential and commercial end markets, which accounted for about 45% of the company's Water & Fluid Solutions segment revenue in the quarter, rose 12% from a year earlier.

The food and beverage sector -- also a part of the Water & Fluid Solutions segment -- remained "very strong" in the quarter, Hogan says. Sales to that market grew 20%.

In the Valves & Controls segment, created after the Tyco Flow merger, sales declined 1% in the quarter. They would have been up 1% if Australia were excluded, said Hogan on the call.

Sales to the oil and gas industry were flat, he added, as many "downstream" customers deferred annual maintenance shutdowns due to high activity.

Pentair is the fifth-largest company by market cap in IBD's Machinery-General Industrial industry group, afterIllinois Tool Works ( ITW ),Parker-Hannifin ( PH ),Ingersoll-Rand Co. ( IR ) andDover (DOV). The group currently ranks No. 20 of the 197 industry groups IBD tracks.

On Tuesday Pentair announced that its board has authorized a share buyback program of up to $1 billion through Dec. 31, 2016. The buyback will leave Pentair with another $2 billion in cash and balance sheet capacity for additional business reinvestment or share repurchase by 2015, Hogan said in a statement.

The same day, Pentair said that its board has approved changing the parent company's place of incorporation from Switzerland to Ireland. Shareholders are expected to vote on the proposed change at an anticipated second-quarter shareholders meeting.

The current Swiss firm Pentair Ltd. will become a newly-formed Irish company named Pentair PLC.

That will be the parent company of Pentair and its subsidiaries, and will have tax residency in the U.K. It will trade under the current Pentair stock symbol PNR on the NYSE.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: IR , ITW , PH , PNR , TYC

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