All right. Good morning, everybody. We're gonna keep things rolling here with the team from Pentair. I'm joined on stage by Pentair's Chief Financial Officer, Bob Fishman. Bob, thanks for joining us. Pleasure as always. Maybe just start us off with, you know, what you guys are focused on, what you're seeing out there, anything that's kinda on your mind, and then we'll dive into some questions, if that's all right.
Absolutely, yeah. So thank you, Josh. Thanks for the invite. Always exciting for us to be able to tell the Pentair story. We're very much a diversified Water Solutions company. So think, move, improve, and enjoying water, are the key themes. Within the move piece of, our business is our Flow business. In terms of improving our Water Solutions business and enjoying is our Pool business. You know, what are we seeing out there? You look at our company, we have a lot of balance across those three segments, but also across residential, commercial, and industrial. So roughly 50% of our business is residential, 50% is commercial and industrial. Within residential, we always knew that this was gonna be a year of inventory correction, primarily in the channel.
So what we've talked about this year is really playing out in terms of the inventory corrections happening within Q2 and Q3 of this year, primarily, and then we return to more of a normal cycle for that residential business. So excited about turning the corner into 2024. And then our commercial and industrial business remains strong. You know, we within our Water Solutions business, about two-thirds of that business sells to food service companies and hospitality. That business continues to do well. We have a really nice end-to-end offering around water quality, filtration, ice, and services, so that piece is doing well. And then on the Flow side, you know, what we're seeing there is aging infrastructure, which is helping our business.
We have a really nice offering where we can go into not only office space, but into places like data centers and warehousing, and sell our solutions. So really excited about the secular markets and the end market growth.
Excellent. So it's a, it's a helpful place to start. A few things I wanna pick up on within that. So a lot of discussion this week and, you know, folks trying to navigate kinda this post-supply chain, parlor game of orders, and backlog, and destocking, and kind of all things that mask underlying demand. But anything where you would point out that... Obviously, we talked about Pool a lot. You guys have talked about Pool a lot in terms of the inventory phenomenon there. But any place else where you've seen sort of that post-supply chain, maybe volatility in the data that's masking what's going on underneath? Anything we should be aware of there?
Yeah, again, overall, how you described it, you know, is really very relevant for what we've seen as well. The good thing about Pentair is we're back to normalized lead times. So within our Pool business, delivering equipment within five days of our customers placing the order. So that whole supply chain challenges in the factories around labor are really behind us, and it's all about, to your point, the end demand. And again, it's the direction that those markets are going is really what our indicator is, and gives us our confidence in this year, but also going into 2024 around, you know, where we see those end markets.
Understood. I wanna come back to the markets, but one thing that's been certainly very topical, and you guys have had a lot of success on, is the transformation. So especially with, you know, the supply chain backdrop and some of the end market volatility, maybe update us on, you know, where you've had a lot of success so far, what we should expect maybe over the next year or so in terms of focal points and, you know, maybe some of the opportunities around that.
Yeah, exciting transformation story for us. So think pricing, sourcing, our operations footprint, and then our org excellence piece around G&A and selling and marketing. For us, even with the double-digit declines that we've seen in the residential business as the inventory corrects, and which will be a tailwind for our company next year, we've been able to expand our margins. And so making sure that we understood what was happening from a volume perspective, removing a lot of the inefficiencies around spot buys, around air freighting, around completing a product to 90% and waiting for that additional part to come in, those are areas that have really helped us expand our margins this year, even in the residential piece of the business.
You know, what we've said externally is that we're gonna go to from today's ROS of roughly 21%, to grow that to 23% by 2025. And it's really the traction that we have within the transformation, so really exciting for us.
On the sourcing front, obviously an area of excitement when you launched it, you've had some good success, but it sort of comes across as, like, cognitive dissonance of sourcing changes in a supply chain-constrained environment. Gosh, that sounds hard. How are you able to pull that off, and is that, you know, some of that disruption still masking maybe what the opportunity could look like from here?
Yeah, the opportunity for us is huge. You know, we have material spend of roughly 40% of our sales, so think $1.6 billion of spend. We've broken that into some big chunks, so about $500 million-$600 million of spend was looked at as part of wave one. So think motors, electronics, packaging, those type of components. Went through an 11-gate process. To your point, it's heavy lifting, and it's all about creating these long-term strategic partnerships. One thing that we do have at Pentair is scale, and so being able to create a long-term partnership with the supplier, you know, really helps us in terms of driving improvement. So, it's again, early innings.
We're identifying about 12% savings coming out of each of the waves of different spends. We're now attacking wave two, which is, think resins and metals. And those savings will find their way into the PNL, primarily in 2024 and 2025. So, we just had a supplier show in Las Vegas in August. Had 1,000 suppliers come in, explain the Pentair strategy, had the whole executive leadership team there, put all of our products on display, and have our suppliers participate with us in the bidding process. So again, heavy lifting, very strategic, very cross-functional within the company, but that's our funnel of opportunity, really within that particular component of transformation over the next two to three years.
Any place that's been more challenging? It seems like it's been, you know, mostly an unqualified success so far, but anything under the surface that, you know, you are dissatisfied with?
I wouldn't say dissatisfied. I would say, as you'd expect, there was lower-hanging fruit early on around transportation, around some of those spot buys. And then as you look to qualify suppliers for the next phase of the implementation, that piece takes a little bit longer. But in a way, that's good because that creates the nice opportunity for us over the next two to three years. So I would say that really no frustration. A lot of people in the company hard at work in terms of driving the savings.
Understood. Then you mentioned price. Obviously, it's something that a lot of folks in, you know, who are attending here have done a lot of work on over the last couple of years with all the inflation. When you think about what are the more, I guess, transformational or strategic elements of that, is it managing leakage? Is it just communicating things faster, so you shorten that, you know, that announcement window? What does price mean in the context of what you're doing?
Yeah, and again, for Pentair, price has been historically very sticky, in terms of the two-step distribution model that we have, and the large installed base. From a pricing perspective, we're really looking at two different areas. You know, one is to drive incremental pricing over and above inflation, so we're doing that through more of a value-based pricing approach. We have our general managers, including in their toolkits, a strategic pricing playbook that looks at the market, looks at our products, looks at the competitive landscape, and allows us to price more strategically. The other piece within pricing is really looking at what we call gross to net.
So it's the volume discounts that we have, it's the dealer rebates, and trying to turn those from 100 different programs that are in place, and make them more strategic to drive growth. So looking at those two areas to drive incremental price and benefit.
Understood. I'd like to pivot over, pivot over to the Pool business for a bit, if we could. Maybe just starting off with... Obviously, the inventory phenomenon has been, you know, kind of the most acute function over the last, you know, kind of 6, 12 months. But how should we think about what's happening at kind of the point of sale or customer level? Anything on the mix front or demand front that really sticks out to you?
Yeah. So again, really like the Pool business in terms of it being a mid-single digit plus grower historically. The trends are in our favor in terms of more people moving to the South, more people wanting a Pool in their backyard. Huge amount of innovation coming to the Pool pad as we drive towards an effortless Pool experience for our customers. New products coming out, really nice ESG story around energy efficiency. Our Pool business is broken out into 20% new Pool builds, 20% remodels, and 60% in aftermarket, which we really benefit from being the number one Pool provider, but also having the largest installed base. Automation is also a key player, key component within the Pool business.
So in terms of the overall market, you know, this year, new Pool builds or remodels are down in that 25%-30% range. With interest rates staying high, we don't expect a massive recovery next year, but we do like the fact that that inventory correction is behind us-
Mm-hmm
... that it will be a big tailwind next, next year. We will get the manufacturing leverage associated with that. And again, things are always breaking within Pools, so that aftermarket business will continue to do well for us.
Makes sense. Within the break-fix piece of the business, there are certainly a lot of, you know, good, better, best options. You talk about things like automation, which, you know, make a lot of sense, but they're maybe a little bit discretionary for some folks. Any mixed phenomenon within kind of that core installed base, break-fix, that has changed at all, you know, as the market has evolved over the last year?
I would say that to your earlier point, there was this buy it forward with things like heaters, LED lighting. As people spent more time in their backyard, those particular product lines ramped during COVID. That's a big piece of the inventory correction that's happening now. But the innovation piece, what we're able to bring from an LED lighting perspective in terms of a better environment, a better look and feel for the Pool, better filtration, being able to use some of our membrane technology from our other parts of our business into the Pool business. So just continuing to innovate will help drive the growth.
... Understood. And then on share, obviously, during, you know, kind of the deeper parts of supply chain constraint crunch, you guys fell behind a little bit on shipments, maybe donated a little bit of share. How would you see that, you know, kind of that catch-up going? Do you think you've clawed back, maybe some of the share that you lost, you know, in 2022?
Yeah, very much so. You know, and what's helped is those five-day lead times. Going after certain product categories where we might have lost share, we are regaining share this year.
Then anything on the stimulus front? IRA has a lot of energy efficiency provisions. Anything that would help you guys in the Pool space? I know that there's, those things can be energy hogs, and obviously, there's a lot of ways to mitigate that with some equipment refresh. Anything that we should be cognizant of there, or that you've been able to, you know, kind of size in terms of an opportunity?
Yeah, and I wouldn't isolate it just to the Pool business. There's a lot of regulation, there's a lot of areas happening within the environment that are really going to help propel our business within the Pool space. To your point, Josh, energy efficiency, you know, hugely important. So very focused on that piece. And then within our other businesses, the improve and enjoy water space, again, you have lots of different regulations coming out that are gonna help our business.
Understood. Maybe pivoting over to more of the water treatment side of the portfolio, specifically Resi. How, how has this performed over the last few years? Where do you see maybe the next few years? Is there something that needs to happen for growth to accelerate? 'Cause it, it seems conceptually to have a lot of opportunity, and it's been certainly fine, but, you know, maybe not as growthy as I think you guys would have expected initially.
Yeah, within Water Solutions, there's no doubt that the two-thirds of the business, the Commercial Water Solutions, has been driving our results. Really strong top-line growth, really strong ROS expansion. Within residential water treatment, we think of that business as being components, but also systems, and being able to provide that extra value with the systems is a key focus area for us.
Understood. Then, I guess, maybe Water Solutions as a whole, you know, how should we think about growth in the segment over time? Then I guess, you know, kind of navigating the cycle here, is that something that we should expect to trough here in the second half?
Yeah, the underlying themes are really helpful for us. So the focus on water quality, the focus on PFAS within the commercial space, for us, expanding beyond just food service and hospitality to places like hospitals and schools, office buildings. If you look at what we have to offer to our customers in terms of that end-to-end solution within the quick service restaurant space, for example, a lot more of these restaurants changing their footprint. Change to us is very helpful in terms of drive-through, in terms of in-store, so lots of opportunity there as well.
Understood. And then maybe just spending a minute on Manitowoc. Maybe give us an update on how that's performed and, you know, things like synergies and some of the you know, opportunity to bundle that with filtration that you guys already have.
Yeah, that's really exciting for us. So we closed on that acquisition in July of last year. The business has been doing phenomenally well, grew 30% last quarter. And being able to, again, offer, to our, our customers, water quality with the filtration, the ice-making ability, as well as services. It's one-stop shopping for one of our customers' biggest pain points, which is providing water and ice to their customers. So, business is doing extremely well. Being able to sell filters within our ice machines, hugely important. Looking at the top 50 quick service restaurants and looking at cross-selling opportunities that are available to us. On the services side, we can do predictive, preventative installation for our customers. So that part, very early days in terms of revenue synergies, but really excited about the opportunity.
Understood. Maybe zooming out on kind of the commercial-facing businesses at large, I mean, we can see in, you know, the macro data, obviously, commercial construction, some of those verticals, you know, kind of laboring under things like higher interest rates. You guys are more of an installed base, you know, sort of play, so I don't know if the new piece matters a lot, but are you seeing that represented in the business? Is that something you're having to keep an eye on in terms of maybe that newer construction being slow?
Yeah, for us, you know, again, not solely focused on just commercial office space, but also on areas like data centers, on warehousing, broadening what we offer within those type of buildings. So not only can we offer, you know, fire pumps as a solution, but also the whole water supply, the water disposal, the wastewater management. There's at least five different spaces within a office building or a commercial building that we can play in. So continuing to educate our customers around the aftermarket, the services capability, and then when we do find our sweet spot, going at it in a very targeted way with a standardized offering, hugely important for us.
Understood. I won't let you off stage without... You mentioned data center, obviously, you know, like, the second most important buzzword in the market right now, unless I said NVIDIA. Where do you guys, you know, play in the data center? Does that content look different as we shift to this higher performance environment?
Yeah, again, for us, to my earlier point, any time there's an opportunity around water supply, water disposal, fire suppression needs, huge opportunity for us, so we plan on taking advantage of that growing market.
Understood. Maybe just pivoting over to IFT. You know, this business probably had, you know, more of the cyclical kind of ebb and Flow over time, and that makes sense based on their end markets. But how should we think about, you know, what is the long-term margin entitlement in this business, and what does it take to get there, either from a length of time or, you know, specific areas of opportunity on the cost side?
Yeah. Yeah, thank you for that one. So we started with Pool, which is our enjoy piece, talked about Water Solutions. This is our move piece, so think about $1 billion of Flow, small pumps, large pumps, moving water where you need it, when you need it with our products, and then about $500 million Industrial Solutions piece in that business. So again, from our perspective, it's probably in that low single-digit space. So when you think about Water Solutions, you're mid-single digits. You think about Pool, mid-single digit plus. We don't like to get ahead of ourselves from a top-line perspective, but huge opportunity from a complexity reduction, SKU reduction, and ROS expansion piece within IFT.
We've seen the margins improve significantly this year and last year, and will continue to do so, primarily through the transformation.
Is there... Now, I know that within IFT, there's maybe a bit more business fragmentation than in some of the other portfolios. Is there sort of an opportunity, perhaps, to, to benchmark those a little bit more? Or are there, you know, more of kind of this 80/20 phenomenon, where there, there really are, you know, bigger opportunities, or is it a little bit more, level set or, or even across some of the various businesses there?
There's certainly businesses within our portfolio in IFT that fit more with the overarching company strategy of move, improve, and enjoy water. So obviously, the Flow business fits in really nicely, and being able to expand our offering in that space and innovate is hugely important. The Industrial solutions we really like because it's all about turning waste into value, which is really important to our customers. That's where we have to continue to focus on smaller deals, more of a standardized offering to help drive the margin expansion. But we like each pieces of those business. It fits nice within our ESG story.
Understood. And then maybe putting all this together in the context of portfolio, you know, you guys have been acquisitive over time. Obviously, Manitowoc is a bigger deal. How should we think about the priorities for capital allocation? And then maybe separately, anything in the portfolio that, you know, is maybe having a harder time earning its entitlement and, you know, as you go through transformation, could be on the, could be an exit opportunity?
Yeah. Yeah. So, I mean, really big picture, we resegmented this year, and went to the three segments that we've talked about. We love the end markets in terms of the growth that we see there. From a capital allocation perspective, our goal is to continue to stay very disciplined. We acquired Manitowoc again late last year. We've now delivered from 3 x down to 2 x by the end of the year. That's about the target debt ratio that we like, 2 x, plus or minus half a turn. Staying investment grade, hugely important to us. This was a year of debt paydown. We've increased our dividend 47 years in a row, so it puts us in a really rarefied space there.
We typically look at doing about $150 million of share buyback every year. So very balanced from that perspective. We think there's plenty of opportunity within our portfolio, but using M&A to drive more growth from a top-line and profitability perspective, very important to us. Our most important measure within the company, though, continues to be return on invested capital. All of the senior leadership team is measured on that. We're at mid-teens now. Our goal is to be a high teens. We were at high teens before the Manitowoc acquisition, and we're getting back to that space. So very disciplined approach. M&A, a big piece of our strategy, but doing it in a very, very disciplined way.
Understood. Appreciate the color, and really appreciate your time here today, Bob.
Absolutely, Josh. Thank you.
Thanks a lot.