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Morningstar | After a Fresh Look at Pentair, We Modestly Trim FVE but Remain Optimistic About Long-Term Prospects

After taking a fresh look at Pentair, we modestly trim our fair value estimate to $44 from $45, primarily due to a slight reduction in our midcycle operating margin assumption from roughly 22% to 21%. That said, we remain optimistic about the company’s long-term prospects. After Pentair sold its valves and controls unit to Emerson in 2017 and spun off its electrical unit as nVent in 2018, we contend that the remaining water business can generate excess economic profits thanks to its narrow moat, which rests on switching costs and intangible assets.

Pentair has built a narrow moat around its large installed base, deriving roughly two thirds of its revenue from aftermarket service and replacement parts. Since many of its products perform mission-critical functions, reliability is paramount as any product failures could result in costly outages. As such, Pentair benefits from a strong reputation for quality and a large installed base, and its customers tend to remain loyal, driving robust aftermarket sales.

Furthermore, since Pentair has transformed into a pure-play water company, we think the new corporate structure will allow management to execute a more focused strategy emphasizing growth in its core segments. At the company's 2018 investor and analyst day, management outlined its strategy to focus on growing the aquatic systems and filtration solutions segments, as well as expanding the company’s presence in emerging markets. We expect that the firm will continue to pursue strategic bolt-on and tuck-in acquisitions, such as the recently announced Aquion and Pelican Water deals, which will bolster Pentair’s residential and commercial water treatment portfolio.

We currently view Pentair’s stock as fairly valued, with shares trading in 3-star territory. That said, we think it deserves a spot on investors’ watchlists given its narrow moat, solid growth prospects in the aquatic systems and filtration solutions segments, and room for further margin expansion.