Pentair

Pentair's second-quarter core sales declined by 17% year over year, primarily due to pool channel inventory destocking. Adjusted EPS was $1.14, slightly above the $1.12 guidance issued with the preliminary second-quarter results announcement on July 14.

Why it matters: Pentair's stock has plunged by over 35% year-to-date amid concerns about its pool business. Although Pool faces significant near-term headwinds, we believe that the market is pricing in a worst-case scenario, making shares attractive for investors with a long-term horizon. Second-quarter pool core sales plummeted 42% year over year, primarily due to a $170 million impact from channel inventory destocking. Pentair has relatively high exposure to Pool, making the company more sensitive than competitors to the wholesaler's inventory fluctuations.

The bottom line: We've lowered our fair value estimate for narrow-moat Pentair to $91 from $95 on a more muted near-term pool outlook. The stock is trading at a nearly 30% discount to our updated fair value estimate. Management expects channel inventory levels to normalize by the end of the third quarter, positioning pool to return to growth in 2027. We expect pool to return to normalized growth in the midsingle digits once channel inventory levels normalize.

Between the lines: While the channel inventory destocking accounted for the bulk of the sales decline, Pentair's pool business has also ceded some market share. Management specifically acknowledged losses in aftermarket share for 10- to 15-year-old pool pads. Pentair has focused on premium equipment and automation solutions, so we believe that it has been disproportionately affected by customers delaying upgrades due to affordability concerns. Pentair aims to remedy these challenges by more clearly communicating the availability of like-for-like replacement options. Furthermore, the company will prioritize dealer engagement, as the firm's 80/20 actions have disrupted some dealer relationships.

BLANK PAGEPentair announced the acquisition of Taco Group for $1.425 billion, reflecting a multiple of 10.5 times adjusted EBITDA. We expect the acquisition to bolster Pentair's commercial water business and increase the firm's exposure to the data center infrastructure buildout.

Following Pentair's second-quarter earnings release, we lowered our fair value estimate to $91 per share from $95, driven by our reduced near-term sales growth expectations in the pool segment, partially offset by the time value of money. Management expects channel inventory levels to normalize by the end of the third quarter, positioning pool to return to growth in 2027. We expect pool to return to normalized growth in the midsingle digits once channel inventory levels normalize.

We assume average compound annual organic revenue growth of roughly 4% through 2030. In the long run, we forecast revenue growth in the low single digits in flow, midsingle digits in water solutions, and mid-single digits in pool. We think the firm still has ample room for growth in the swimming pool market, thanks to the growing penetration of variable-speed pumps and automation systems.

We project the adjusted operating margin to expand from 25.2% in 2025 to roughly 27% in 2030. We expect this margin improvement to be driven by business simplification, corporate rightsizing, mix shift, and a focus on more profitable product lines. We assume an 8.7% weighted average cost of capital and an 18% long-run effective tax rate in our model.

We believe that Pentair has developed a narrow moat attributable to customer switching costs and intangible assets. Pentair derives roughly two-thirds of its revenue from aftermarket service and replacement parts, which are tied to its large installed base. Because many of the company’s products (including pumps, filters, and control valves) perform mission-critical functions, any product failures could lead to costly outages for customers. Thus, quality and reliability are paramount, and customers seldom pursue cost savings by switching to cheaper alternatives, which leads to a loyal customer base. We believe the company is well-positioned to earn excess economic profits over the next decade, thanks to its narrow moat.

We believe the pool segment has carved out a narrow moat, allowing it to generate high-20s operating margins. The segment derives roughly 80% of its revenue from aftermarket service and replacement parts, which are tied to its large installed base of equipment. While we estimate that pool equipment typically accounts for only around 10% of the installed cost of a swimming pool, it plays a vital role in the pool's ongoing operation. We estimate that around 50% of the aftermarket sales are nondiscretionary, as broken pumps or filters typically have to be replaced within 72 hours for the swimming pool to remain operable. As such, a reputation for quality and reliability is paramount, resulting in a loyal customer base, as pool owners tend to either replace equipment like-for-like or upgrade to newer equipment from the same manufacturer. Not only do robust aftermarket sales make revenue less cyclical, but they also reduce Pentair’s reliance on new construction starts, as the bulk of the firm’s revenue is derived from the large existing market of around 5.5 million installed swimming pools in the United States.

We believe that Pentair is well-positioned to capitalize on customers upgrading their pool pads, thanks to its competitive position in variable speed pumps, heaters, LED lights, and automation solutions. Variable-speed pumps can cut electricity consumption by up to 90%, significantly reducing customers' utility bills. Adoption of variable-speed pumps has been accelerated by a Department of Energy regulation that became effective in July 2021, establishing a minimum energy-efficiency standard for swimming pool pumps. This has been a tailwind for Pentair’s revenue growth, as variable-speed pumps can be 2-2.5 times more expensive than single-speed pumps.

Furthermore, we think that Pentair’s IntelliConnect automation platform has the potential to reinforce customer switching costs. IntelliConnect connects multiple pool devices and allows owners to remotely monitor and control their pools (including variable-speed pumps, LED lights, water temperature, sanitization, and so on) from a smartphone app. We believe that Pentair is well-positioned to continue increasing the value of its content per pool pad by offering automation solutions, energy-efficient products, and software-enabled devices. We also think that connected solutions have the potential to reinforce switching costs in the pool business, as we believe offering an ecosystem that integrates multiple Pentair products and allows customers to remotely monitor and control their pools will enhance customer loyalty.

We think water solutions garner a narrow moat due to switching costs. 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 and coffee shops. 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. As such, customers tend to be loyal, and roughly half of the segment’s revenue is aftermarket-based.

Pentair’s moat in water solutions is bolstered by intangible assets. For instance, one of its brands, Everpure, has strong brand equity as a leader in the food and beverage industry, serving well-known companies such as Coca-Cola, Starbucks, and United Airlines. Manitowoc Ice is another leading brand, with around 50% market share in cubed ice machines in the US. Pentair’s filtration solutions not only improve water quality and flavor consistency, but can also extend the life of beverage equipment.

The flow segment benefits from similar dynamics to those in the water solutions business, as reliability is important for customers, especially in applications such as fire suppression, flood control, or wastewater pumps. Flow has a large installed base of pumps and separation technologies, and roughly three-fourths of sales are derived from aftermarket services and equipment replacement.

Pentair is a pure-play water company poised to benefit from demand for sustainable and energy-efficient water solutions.

The pool business continues to deliver solid revenue growth, consistent market share gains, and lucrative operating margins.

Pentair's transformation initiatives have continued to drive strong margin expansion in recent years.

Growth has been relatively sluggish and may remain elusive in the flow segment.

Persistent strength in the US dollar could make Pentair more susceptible to offshore competition.

Cost inflation could be a headwind in the short run.