Pentair plc (NYSE:PNR) Q4 2023 Earnings Call Transcript

Pentair plc (NYSE:PNR) Q4 2023 Earnings Call Transcript January 30, 2024

Pentair plc beats earnings expectations. Reported EPS is $0.87, expectations were $0.86. Pentair plc isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to the Pentair Fourth 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, Investor Relations. Please go ahead.

Shelly Hubbard: Thank you, Drew, and welcome to Pentair’s fourth 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 fourth quarter and full year 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 up 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. Similar to previous quarters in 2023, we have included Slides 4 through 7 in our earnings slide deck, which provide a brief overview of Pentair as well as our investment thesis. I will now turn the call over to John.

John Stauch: Thank you, Shelley, and good morning, everyone. Our record performance in 2023 demonstrates the power of our balanced water portfolio and our focused growth strategy post the separation of nVent. We completed year one with our three-segment structure, Flow, Water Solutions, and Pool, and we finished our first full year with Manitowoc Ice. Our Flow segment, which moves water where it’s needed and removes water where it’s not wanted, along with our Water Solutions segment, which improves water, both posted a record year for sales and ROS; and our Pool segment, which enables people to enjoy water, delivered record ROS despite significant volume headwinds. I’m extremely proud of our approximately 10,500 global employees for their solid execution in a challenging macroeconomic environment.

As we enter 2024, we are leveraging our balanced portfolio for continued growth and profitability with expectations for new records of financial performance. Additionally, we look forward to sharing more about our strategy and three-year outlook at our Investor Day on March 6th. Now, let’s begin with our Executive Summary, Q4 2023 on Slide 8. We finished Q4 with record performance in a fourth quarter post the separation of nVent in 2018, specifically record segment income and ROS, marking the seventh consecutive quarter of ROS expansion. This is important to note with strong comparables in Q4 2022. In the fourth quarter, sales were down 2%, which included slightly better than expected Pool performance. Segment income increased 8% and ROS expanded by 190 basis points.

Adjusted EPS was $0.87, up 6%, and we generated $97 million of free cash flow in the quarter. Let’s move to Slide 9, titled Executive Summary Full Year ’23. 2023 was a record year for segment income, ROS, and adjusted EPS, post the nVent separation, as previously mentioned, despite sales ending the year flat. In full year ’23, we delivered sales of $4.1 billion; record segment income of $855 million, up 11%; record annual ROS of 20.8%, expanding 220 basis points; and record adjusted EPS of $3.75. Flow and Water Solutions set new sales records in 2023, and we delivered significant margin expansion across all three segments, setting a new annual record ROS for each. Transformation and solid execution across all three segments continue to drive operational efficiencies throughout the year.

Lastly, we generated significant free cash flow of $550 million and increased our dividend for the 48th consecutive year, further solidifying our status as a dividend aristocrat. Let’s turn to Slide 10, titled Balanced Water Portfolio. We are helping the world sustainably move, improve, and enjoy water through our three segments, each with over $1 billion in sales in 2023, and together creating a balanced water portfolio. Our strategy is working, and we have been delivering on the expectations that we have shared with you. 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 11, titled Q4 2023 Pentair Performance. I will also be discussing our Full Year Performance on Slide 12. We delivered another strong quarter of earnings and significant margin expansion, despite sales being down 2% year-over-year. Volume continued to improve sequentially, with substantial progress in Q4 as compared to Q2 and Q3, driven primarily by improvement in Pool volume. Sales for Q4 were down 2%, which was slightly better than we guided. Core sales across all three segments were down slightly, as compared to last year’s record Q4, when our lead times began to improve from a recovering global supply chain, enabling us to ship more backlog orders.

As we move into 2024, we expect to see a more normalized operating environment. Fourth quarter segment income increased 8% to $198 million, and return on sales expanded 190 basis points year-over-year to 20.1%. This improvement was driven primarily by our Transformation initiatives. Adjusted EPS of $0.87 was up 6% versus the prior year. For the full year, sales were flat at $4.1 billion, with core sales down 5%, driven by growth in Flow and Water Solutions, which were offset by lower Pool volumes. Segment income grew 11% and return on sales expanded 220 basis points to a record 20.8%. All three segments significantly expanded margins and set new records. Adjusted EPS increased to a record $3.75. Turning to Slide 13, labeled Flow at a Glance, you can see the impressive five-year financial performance.

Sales rose over 4% compounded annually and margin expanded 300 basis points since 2019. In 2023, Flow continued to reach new records in sales and ROS. We have also provided a sales view by region, channel and solution reflecting 2023 sales and the diversified nature of the business. We have eight iconic brands, some over 100 years old, and we rank first in quality, technical support and customer service. Please turn to Slide 14, labeled Q4 2023 Flow Performance. In addition to the fourth quarter performance for Flow, I will also be referencing the full year performance on Slide 15. Note that we have recently renamed our Industrial & Flow Technologies segment to Flow. In Q4, Flow grew sales 1% in the quarter to $379 million, a record fourth quarter.

Industrial solutions was up 9% and commercial was up 2% with residential down 7%. Segment income was flat and return on sales decreased 20 basis points to 17.2% due to a return to more normal seasonality following a record Q4 2022 and an unfavorable mix from our residential business. For the year, Flow sales increased 5% to $1.58 billion primarily due to double digit growth in commercial and industrial solutions. Residential was down 4% showing improvement sequentially from Q3. Full year segment income grew 17% and return on sales increased 170 basis points to 17.8%, a record margin for Flow driven by Transformation and price more than offsetting inflation. Turning to Slide 16, titled Water Solutions at a Glance, you can see the strong five year financial record with a compounded annual sales growth rate of 17% and over 400 basis points margin expansion since 2019.

Our iconic brands include Everpure and Manitowoc Ice. Our residential Water Solutions products have helped reduce the need for 7 billion single use water bottles in 2023. Please turn to Slide 17, labeled Q4 2023 Water Solutions Performance. In addition to the fourth quarter performance for Water Solutions, I will also be referencing the full year performance on Slide 18. In Q4, Water Solution sales decreased 5% to $270 million following a record Q4 2022. Commercial sales were down 4% primarily due to the timing of projects within our services business, partially offset by growth in Manitowoc Ice and filtration. In residential, Q4 sales were down 6% but reflect significant improvements sequentially from Q3 of this year in which residential sales were down 14%.

Segment income grew 15% to $52 million and return on sales expanded 320 basis points to 19.1%, a new Q4 record driven primarily by productivity from our Transformation initiatives and Manitowoc Ice. For the year, Water Solution sales grew 19%. Segment income grew 66% and return on sales increased 590 basis points to 21%, a new full year record. Commercial sales increased 54% driven by the acquisition of Manitowoc Ice and growth in filtration. Manitowoc Ice had a record sales year with growth of 23% versus the prior year. Please turn to slide S9 titled Pool at a Glance. Looking at the five-year financial performance, Pool was able to grow the top-line significantly and increase margins to a record 31% or up 320 basis points since 2019. Our Pool business benefits from a very large installed base with roughly 80% of sales coming from remodel and break and fix.

Please turn to Slide 20 labeled Q4 2023 Pool Performance. In addition to the fourth quarter performance for Pool, I’ll also be referencing the full year performance on Slide 21. In Q4, Pool sales declined 2% to $336 million driven by a six-point drop in volume which was partially offset by four points of price. Note that volume improved significantly compared to the 28-point decline in Pool volume in Q3. For the year, Pool sales were down 18%, segment income decreased 10%, and return on sales increased 270 basis points to 31% driven by price and our Transformation initiatives. Please turn to Slide 22 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.

We have been targeting ROS of approximately 23% by the end of fiscal 2025, expanding margins over 400 basis points as compared to fiscal 2022. In 2023, we delivered ROS of 20.8% as Transformation began to read out in Q3 and Q4, and we expect to deliver roughly 22% by the end of full year ’24, which we believe puts us on track with our Transformation initiatives. Please turn to Slide 23 labeled Transformation Runway. We have kept this slide as a reference to illustrate the staggered nature of each of the four initiatives and the various stages of each. We are pleased to note that we believe we are executing well on these initiatives going into 2024. Please turn to Slide 24 labeled Balance Sheet and Cash Flow. In Q4, we generated $97 million in free cash flow, up nearly 100% year-over-year, reflecting another strong quarter.

For the year, our free cash flow was $550 million, up nearly 94% year-over-year. Our net debt leverage ratio was 2.0 times, down from 2.6 times in Q1. Our total debt was less than $2 billion, and the average interest rate was approximately 5.2%. Our ROIC was 14.3%, which includes the full impact from the Manitowoc Ice acquisition. With the focus on being good stewards of capital, we continue to target high teens ROIC. We plan to remain disciplined with our capital and continue to focus on debt reduction amid the higher interest rate environment with the potential for share buybacks. Moving to Slide 15 titled Q1 and Full Year 2024 Pentair Outlook. For the full year, we are introducing our adjusted EPS guidance of approximately $4.15 to $4.25, which represents a year-over-year range of up 11% to up 13%.

We expect total Pentair sales in fiscal 2024 to be approximately $4.2 billion or up about 2% to 3%. We expect Flow sales to be up low-single digits reflecting low to mid-single digit growth in our commercial and industrial businesses offset slightly by a low-single digit decline in residential. Water Solution sales are expected to be essentially flat, comping record 2023 performance driven by our commercial water business. Commercial sales in full year 2024 are expected to be up low-single digits and residential to be down low to mid-single digits. Pool sales are expected to increase approximately 7% in full year 2024 which aligns the historical compound annual growth rates of mid-single digits pre-pandemic. We expect Pool sales to increase driven primarily by inventory headwinds in 2023 that we do not expect to repeat in 2024 and some benefit of price.

We expect this growth to be slightly offset by the uncertainty that still exists regarding the macroeconomic environment, higher interest rates, the potential impact of financing for new and remodeled pools and potential repair deferrals in the aftermarket. We believe Pool remains a highly attractive market for us and we look to deliver strong growth in 2024 while being mindful of macroeconomic dynamics. We expect segment income to increase approximately 10% with ROS expansion of roughly 150 basis points. Also for the full year we expect corporate expense of approximately $95 million, net interest expense of roughly $100 million, an adjusted tax rate of approximately 16.5% which is inclusive of changes in the global tax standards for a total impact to Pentair of about $0.07 per share and a share count of approximately 166 million to 167 million.

Lastly, we expect to deliver approximately $1 billion in EBITDA in full year 2024, a milestone we are very proud of. For the first quarter, we expect sales to be down approximately 2% to 3%. As a reminder, many of our businesses were working down large backlogs in Q1 last year as supply chains improved and we were able to ship more backlog orders, in 2024 we expect more normalized seasonality in our businesses. We expect first quarter segment income to be flat to down 3% primarily due to lower sales with corporate expense of approximately $25 million, net interest expense of roughly $29 million, an adjusted tax rate of approximately 16.5% and a share count of approximately 167 million. We expect Q1 to drive ROS expansion both sequentially and year-on-year.

We are also introducing adjusted EPS guidance for the first quarter of approximately $0.88 to $0.91. For the first time since 2020, we believe we are seeing a return to a more normalized operating environment globally. Thus we expect to see seasonality resume to historical norms across all three of our segments in 2024 with Transformation driving margin expansion. In the first half of 2024 we expect adjusted EPS to be slightly less than 50% of our full year adjusted EPS guide. Q1 is expected to be the lowest quarter for sales, segment income, ROS and adjusted EPS as compared to the remaining three quarters in full year ’24. We have continued to accelerate transformation funnels and remain focused on investing in the long-term growth of our company.

Turning to Slide 16 titled 2023 Reflection, our business continued to execute well and delivered what we said we would do. We drove margins as a result of our balanced water portfolio and Transformation initiatives. Manitowoc Ice posted a record year exceeding expectations. We drove performance accountability across the organization, ended the year with an even stronger balance sheet and free cash flow and maintained a disciplined capital allocation strategy. We believe we are well positioned going into full year ’24. I would now like to turn the call over to the operator for Q&A, after which John will have a few closing remarks. Drew, please open the line for questions. Thank you.

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Q&A Session

Operator: We will now begin the question-and-answer session. In the interest of time we ask that you please limit yourself to one question and one follow up. [Operator Instructions] The first question comes from Brian Lee with Goldman Sachs. Please go ahead.

Unidentified Analyst: Hi, thanks for taking the questions. This is Grace on for Brian. First question on margin, kudos on the margin executions. Just a quick question on the margin expansion trajectory here, so if I do a math correct here, your full year guide implies 140 basis point expansion while your 1Q guide implies 20 basis points at the midpoint. So how should we think about the margin expansion trajectory moving the year and which segment should we see the most margin expansion? Thanks.

John Stauch: Yeah, let me just take the first part and I will hand it to Bob. I just want to remind everybody that last year’s Pool inventory correction didn’t happen fully until Q2. So we are up against one more quarter of Pool compare from a Q1 perspective. And if you actually look at the performance exiting Q4 and compare it to our Q1 guide, you will see that the continued operating performance is there. And the last point I will just make before handing over to Bob is our Q1 EPS guidance is back to our normal seasonality as a percentage of the overall full year. So what you’re really seeing is a reflection that we’re back to our normal seasonality contribution and therefore the year-over-year compares are harder one last time in Q1. So, Bob?

Bob Fishman: Yeah, I would agree with your numbers. So ROS expansion will continue in the first quarter as we drive approximately 150 basis points of ROS expansion for the full year and as you’d expect, with Q2 being our largest quarter, the ROS expansion will be significant in Q2 and will also play out well as we close out the year in Q3 and Q4.

Unidentified Analyst: Great. Thank you. And then my second question is more on Pool. So you’re up 7% year-over-year. That’s about like $90 millions of revenue incremental. I think I believe you talked about like the destocking was about $150 millions in ’23. So I’d assume that delta is driven by, you’re cautious around you called out like uncertainty in the macro, higher interest rate. Is that correct? And second, its how much visibility do you have on that 7% growth? And can you talk about like the early buy activity? Is that — does that give you enough confidence to guide 7% year-over-year growth?

John Stauch: That’s two questions with a lot of subparts. But let me see if I can summarize it. I mean, first of all, we have given two numbers on the inventory piece. We’ve given $150 million and $120 million. I just want to remind everybody it’s about a $150 million for Pentair from the end of Q1 to the end of Q4 2023. On a year-over-year basis, it’s actually closer to $120 million, which is, you know, then if you think about exactly what you’re saying, you take our reported sales, add the $120 million, you’ll get to the conclusion that price and volume is down. And I think that reflects several factors. One is that we expect new Pool builds to decline only modestly but then we are not so sure what’s going to happen with remodeled pools.

And we’re also expecting some level of discretionary purchases in the aftermarket in the first half for sure, as people are maybe a little more cautionary, depending on where the interest rates are. Net-net, it’s still a fundamentally good growth rate for us as we set up the year. And we’re expecting really good conversion of ROS on that contribution.

Operator: The next question comes from Julian Mitchell with Barclays. Please go ahead.

Julian Mitchell: Hi. Good morning. Just wanted to circle back to the sort of profit bridge numbers and maybe looking at Slide 12, to try and understand what’s embedded for 2024. Any help you could give us around the sort of that inflation bucket, what you’re dialing in, it was that sort of $190 million number in ’23. And when we look at productivity, very good exit rates in terms of, $30 million or so tailwind in Q4. How are we thinking about that number for full year ’24 as well, please? So, yeah, inflation and productivity, any finer points on the guide assumption?

Bob Fishman: Yeah, I understand. Thank you for the question, Julian. So as we look at 2024 in the context of the walks, we’re thinking that price will offset inflation. So think roughly two points of price offsetting inflation. That would mean that in order to grow to the midpoint of our guidance, we’ll have, roughly $40 million of volume. That $40 million is compared to the negative $460 million that we saw in 2023. So when we talk about moving to a more normalized environment, we are very pleased that the challenging years are behind us and we can start to grow. That’s really how you bridge the revenue piece. When you move over to segment income, the price of, call it two points, will offset inflation, will get some drop through, call it in the 30% range of that $40 million of income.

And that leaves you with roughly $75 million of Transformation to drive the 150 basis points of ROS expansion. That $75 million compares to the $67 million that we did in 2023, but it also includes us making investments back into the business. So as we drive innovation in places like commercial water and Flow and Pool, as we look to drive opportunities to improve and make life easier for our dealers and distributors, that’s all included in that net $75 million number. And that’s the bridge that would take you from the $855 million of income in 2023 to the midpoint guide of around $940 million. I hope that’s helpful.

Julian Mitchell: That’s extremely helpful. Thank you. And maybe just a quick follow up on the top-line outlook. So you start out Q1 down a couple of points, the full year is up a couple of points, how are you thinking about the sort of rate of improvement in that year-on-year sales line through the year? Is it just each quarter year-on-year gets slightly better? And is that true across all three segments kind of moving in a synchronized wave from down slightly to up slightly? Any clarity on that, please?