Boring Portfolio

Boring Buying PNR
April 13, 1998

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Buying: 100 shares, Pentair Inc.

Pentair, Inc. (NYSE: PNR)
Waters Edge Plaza
1500 County Road B2 West
St. Paul, MN 55113-3105
(612) 636-7920


With approximately 10,000 employees worldwide and 1997 sales of $1.84 billion, Pentair is a diversified manufacturer operating in three principal markets: professional tools and equipment, water and fluid technologies, and electrical and electronic enclosures. Headquartered in St. Paul, Minn., Pentair operates from 50 manufacturing and distribution locations in North America, Europe, and Asia. Pentair is a Fortune 500 company and is part of the Standard & Poor's Midcap 400.

Pentair got its start in 1966 as an acquirer of paper mills. After about a decade in the paper business, the company began to diversify, gradually acquiring new business lines and, in 1995, selling off its paper operations. By that time, Pentair had accumulated an array of companies that manufactured portable power tools, automotive lube gear and related vehicle servicing equipment, firearms ammunition, enclosures for electrical equipment, and assorted pumps, valves and water handling systems.

Pentair made four additional acquisitions in 1996 and three more in 1997, as well as divesting some underperforming operations. Late last year, Pentair sold its Federal Cartridge Co. to Blount International (NYSE: BLT.A) for $112 million, and reorganized its nine remaining businesses into three operating groups: Professional Tools and Equipment, Water and Fluid Technologies, and Electrical and Electronic Enclosures.

Though Pentair's operations are decentralized, the company's businesses share a common code of conduct that guides the development of the organization and its operations. An experienced management team sets clear goals and objectives. Pentair's strategic objectives include: strengthening its enclosures, tools and equipment, and water products markets; maintaining the diversity of its business mix; growth through internal development and acquisitions; globalization; and improved performance while maintaining a strong balance sheet. Pentair emphasizes product development in all of its segments, with products introduced within the last five years averaging 25 to 50 percent of annual sales.

Delta International (woodworking machinery), Porter-Cable (portable electric tools), Lincoln Automotive (vehicle service equipment, or VSE), and Century Manufacturing (also VSE) make up the Professional Tools and Equipment segment. Century includes Toronto-based P & F Technologies, a maker of refrigerant recycling equipment that Pentair acquired in 1997. Pentair companies in this operating segment focus on trade professionals and high-end do-it-yourself users and place a high value on developing innovative products and leveraging the strength of their well-established brand names. They also share a common goal: to grow twice as fast as their respective markets.

The Water and Fluid Technologies segment consists of the Pentair Pump Group, Fleck Controls (the leading name in the worldwide water treatment control valve market), and Lincoln Industrial (number one in the global automated lubrication market). Included in this segment is the General Signal pump business unit, a $200 million acquisition that Pentair made in August 1997 to create a major presence in the water and wastewater pump markets. With its collective brands, the Pentair Pump Group is now the second largest water and wastewater pump business in North America and the tenth largest worldwide. The global water products market exceeds $4 billion in size and is growing at a 10% annual rate due to increasing demands for potable water in developing countries and more stringent requirements for water quality in developed nations.

Hoffman and Schroff comprise Pentair's Electrical and Electronic Enclosures segment. Products include metallic and composite cases, subracks, and cabinets that house and protect electrical and electronic controls, instruments, and components. In January 1997, Schroff acquired Transrack, a French manufacturer of cabinets, enclosures, subracks, and workstations. Transrack in turn owns 30% of SAITEK, an enclosure manufacturing business located in Barcelona, Spain. Hoffman has a leading share of the electrical enclosures market in North America, while Schroff leads the electronic enclosures market in Europe. HS Systems, a new arm of the Hoffman/Schroff partnership, was established in September 1996 to focus joint capabilities on high-growth opportunities. Through HS Systems, the broad electrical and electronic product offerings of Hoffman and Schroff are marketed to industrial and wide area network (WAN) telecommunications original equipment manufacturers.

Geographic Information

                 Revenues        Assets
(In millions)    1997     1996   1997      1996 
United States $1,275.5 $1,047.1 $1,031.0  $761.9
Canada            98.3     77.7     27.9    24.6
Germany           99.4    115.7    200.6   240.0
Other Europe     164.5    136.0    116.9    65.0
Pacific Rim       49.5     38.9     15.9    14.5
Rest of World     26.6     21.8      0.0     0.0
Total         $1,713.8 $1,437.2 $1,392.3 $1,106.0

Liquidity and Capital Resources

At December 31, 1997, Pentair had $34.3 million in cash and equivalents, $705.4 total in current assets, and $1,473 million in total assets. Current liabilities stood at $392.2 million, long-term debt was $294.5 million, and total shareholders' equity was $630.6 million, thus yielding a long-term debt to equity ratio of 0.47 and a ratio of current assets to current liabilities of 1.80.

In the last five years, Pentair has invested approximately $300 million in its businesses, excluding acquisitions. Capital expenditures in 1997 totaled $77.5 million. Pentair expects 1998 "cap ex" to be close to 1996's level of $71.6 million. Contemplated uses include computer systems, cost reduction projects, new product development, and reconfiguration of manufacturing facilities.

Free cash flow (cash from operations less capital expenditures) was $40 million in 1997, up from $30 million in 1996. Pentair is targeting continued growth in free cash flow as a percent of sales through improved profitability and working capital ratios. The company believes that cash flow from operations will continue to exceed its needs for capital programs, smaller acquisitions, and dividends in the next year. In addition, the company has stated that it has significant financing capacity to continue its acquisition program and to support an announced stock repurchase program.


Winslow Buxton, 57, serves as chairman, president, and chief executive officer. Buxton was previously vice president for Pentair's Paper Group and prior to that president of Pentair's Niagara of Wisconsin Paper Corp. Buxton holds a BS in Chemical Engineering from the University of Washington.

Richard W. Ingman, 52, is executive VP and chief financial officer. Ingman was formerly president of Hoffman Engineering. Ingman holds a BS in Mathematics from the University of Manchester, England, and has pursued advanced studies at Carnegie Mellon University.

Other executives include: Joseph Collins, 55, executive VP, Tools and Equipment; Rick Cathcart, 52, executive VP, Water Products; Randall Hogan, 42, executive VP, Electrical and Electronic Enclosures Group; James White, 52, senior VP and president of Pentair's power tool businesses; Louis Ainsworth, 49, senior VP and general counsel; Roy Rueb, 56, VP, treasurer and secretary; and Deb Knutson, 42, VP for Human Resources.

Pentair is governed by a 10-member board, chaired by Mr. Buxton. The other nine members are outsiders and have extensive experience in corporate and other settings.

The board sets Pentair's executive compensation according to a formula that takes into account the company's EPS growth, return on invested capital (ROIC), and return on sales (ROS). Under the formula, achievement of EPS growth of 12%, ROIC of 20% and ROS of 10% results in a company performance factor of 1.0. For 1997, EPS growth was 22.0%, ROIC was 19.1% and ROS was 9.8%, resulting in a company performance factor of 1.67.

Business Ethics

As noted above, Pentair's operations are guided by the company's code of conduct. That code expresses the company's commitment to: ethical practice; respect for shareholders, employees, plant communities, customers, suppliers, investors, and all other stakeholders; a strong work ethic; the highest regard for the environment; the well-being of employees and their families; nondiscrimination; and open communications.

As do a number of companies based in the Twin Cities area, Pentair has a notable record of charitable giving and community service. In March, the company formally established the Pentair Foundation to continue the company's charitable giving, which directs up to 2% of pre-tax corporate earnings to charitable organizations. In 1997, Pentair contributed more than $2.5 million to a variety of civic and social causes.


According to data from Value Line and Morningstar, Pentair's ROE has increased fairly steadily during the 1990s from 10% to 16.3%. Over the same period, EPS has compounded at an annual rate of 14.4%, excluding non-recurring events. Pentair has increased its dividend payment each year since 1976, with dividends increasing since then at an average annualized growth rate of 15%.

The fourth quarter of 1997 was Pentair's 17th consecutive quarter in which EPS improved over the same quarter in prior years. Fourth quarter 1997 earnings were $0.65 per share (excluding a three-cent gain on the sale of Federal Cartridge) as compared with $0.52 in the year-ago period. Fourth-quarter sales increased 23% to $523.5 million.

In 1997, consolidated sales increased 17.4% to $1.84 billion, bolstered by strategic acquisitions and continued growth in North America partially offset by sluggish European markets and the strong dollar. Gross profit margin was essentially flat at 29.8% in 1997 versus 29.9% in 1996. Operating profit margin improved slightly from 9.1% to 9.2%, and diluted EPS increased 20.2% to $2.08.

Pentair's 1997 results were driven primarily by its tools and vehicle service equipment businesses. Sales in the Professional Tools and Equipment group totaled $747.1 million in 1997, a 28% gain over the previous year. Operating income for the group was $84.4 million, up 39% from 1996 levels.

The Water and Fluid Technologies group, which grew substantially as a result of the acquisition of the General Signal Pump Group, reported 1997 sales of $404.0 million, up 25%, and operating income of $46.0 million, up 3.5%.

Strong performance in North American enclosure markets failed to offset the impact of weakness in Europe during 1997. Pentair's Electrical and Electronic Enclosures group's sales grew 6% to $579.4 million, but operating income decreased 11% to $53.3 million.


According to Pentair's most recent proxy statement, as of February 23, 1998, there were

38.3 million shares of common stock outstanding and 1.59 million shares of convertible preferred stock. The latter are held by a company employee stock ownership plan (ESOP) and are converted into common shares upon the retirement or other termination of employment of an ESOP participant at the ratio of approximately 2.3077 common shares for each preferred share. Directors and company executives as a group own 2.9% of combined shares, and Brinson Partners Inc. owns 7.9%. Total institutional ownership is approximately 63%.

Pentair stock significantly outperformed the S&P 500 and S&P Midcap 400 over the five period ending December 31, 1997, as shown below. Those superior historic returns come with below-average volatility. The Beta for PNR is 0.71. Standard & Poor's gives Pentair's stock a four-star rating.

Cumulative Five-Year Return

12/31/92 12/31/93 12/31/94 12/31/95 12/31/96 12/31/97
PENTAIR, INC. 100 128.0 169.0 200.1 264.4 299.4
S & P 500 100 110.1 111.5 153.5 188.7 251.6
S & P MIDCAP 400 100 114.0 109.9 143.9 171.5 226.8

On December 29, 1997, Pentair announced that its board had authorized the repurchase within the next 12 months of up to 350,000 shares of the company's common stock, with the repurchases intended to offset any dilution caused by stock issuances under employee stock compensation plans. The company repurchased a total of 25,000 shares on December 30 and 31.


Pentair's current performance targets are a 17% annual return on equity (ROE) and at least 15% annual EPS growth. Consolidated sales are expected to continue to show double-digit percentage gains in 1998, reflecting further volume gains in Pentair's core segments and contributions from acquisitions. The company is targeting to surpass $2 billion in sales in 1998, excluding contributions from any acquisitions made during the year.

Pentair intends to continue to pursue smaller, bolt-on acquisitions but will also carefully review larger targets that have the capability to significantly expand its current segments. The company has stated that other kinds of acquisitions are possible but only if they present extraordinary opportunities.

In its 10-K filing for 1997, Pentair stated that it believes its Professional Tools and Equipment segment has "tremendous momentum" going into 1998, with sales growth "expected to continue to be in double digits due to product line expansions and cross marketing through multiple channels of distribution." Margins are anticipated to improve slightly, especially from the full impact of improvements currently being made in recent acquisitions. Porter-Cable's new "Bammer" portable air-powered nailer is receiving particularly strong market acceptance.

The Water and Fluid Technologies segment will benefit from full-year operations from the recently acquired pump businesses as the overall integration of the Pentair pump business continues, driving down costs and improving productivity via rationalization of products, redesign of processes, and the anticipated divestiture or closure of unprofitable product lines. (Pentair announced in March that it will close Layne & Bowler, which it acquired last year as part of the General Signal pump business.) The automated lubrication and material dispensing business will work to increase its presence in global markets and will expand its product offerings as a result of its January 1998 acquisition of ORSCO Inc.

The Electrical and Electronic Enclosures segment has a solid leadership position in the global enclosures market. This segment is expected to benefit from the strategic investments made in 1997, economic recovery in Europe, new product introductions, and cost savings. A new 300,000-square-foot facility in Mt. Sterling, Kentucky produces large enclosures with lower production costs and enables Pentair to offer customized solutions for customers' particular needs.

With only 2% of sales generated in Asia, the company is not expected to be materially affected by weak economies there. Operating profits are projected to benefit from synergies, improved productivity and cost control efforts, as Pentair plans to cut $60 million in costs over the next few years. About two-thirds of the company's growth should be generated internally, with the remaining one-third coming from acquisitions.

According to First Call, analysts estimate that Pentair will earn $2.43 per share in 1998, which would constitute a 17% improvement over last year. The consensus projection for 1999 is for EPS of $2.79, or a 15% increase over anticipated earnings for 1998.

At its recent price of $43, PNR trades at 17.7 times projected 1998 earnings, a slight discount to its projected near-term percentage increase in earnings plus dividend yield and a significant discount to the S&P 500's multiple of approximately 23 times 1998 earnings.

Pentair will report first-quarter results on April 16. Analysts are looking for EPS of $0.53, which would be an 18% increase over the $0.45 earned in the same quarter a year ago.