Pall (UNKNOWN:PLL.DL) presents one of the most compelling investment propositions in the industrial sector. The filtration and separation company's operations span a wide range of industries, where it competes with companies such as 3M (NYSE:MMM) and Donaldson (NYSE:DCI). However, with the stock trading on 29 times current earnings, it's hard not to conclude that much of the good news is already in the price. With that said, what  can Pall do to take the stock higher?  

A nice mix of stability and growth
The interesting thing about Pall is its combination of earnings drivers that ensure it can generate operating income through the economic cycle. The company operates out of two operating segments. The life science segment generates underlying demand from throughput activity in relatively stable industries such as pharmaceutical production. Meanwhile, the industrial segment is more focused in cyclical industries such as aerospace, microelectronics, and process.

A quick look at its segmental revenue (broken down into industry groupings) shows its life science segment has done relatively better than the industrial segment in recent years -- which is  to be expected given the sluggish global economic recovery. The life sciences end market is in blue with dotted lines. I'm focusing on consumable sales, rather than systems, because they made up nearly 89% of sales in the last quarter and tend to be higher margin.

Source: Pall Corp. presentations

The shift in revenue over the years means that life sciences contributed 49.4% of segmental revenue in 2013, up from 47% in 2011. Moreover, since the life science segment tends to have higher a profit margin than the industrial business (24.4% versus 16%  in 2013), its growth led to it contribute nearly 60% of segmental profit last year.

While the life sciences segment has clearly taken over the workload from the industrial segment in recent years, the latter will need to make a greater contribution in order for the stock to go higher.

Pall's industrial segment set for better days
Fast-forward to Pall's latest third-quarter results, and a familiar refrain is being played out, with life science consumable sales growing 9.9% at constant currency and industrial consumable sales only growing 1%.

End Market Q3 Consumable Sales (k) Q3 Constant Currency Change
Biopharmaceuticals 235,724 12.0%
Food & Beverage 46,097 8.4%
Medical 56,212 2.9%
Process Technology 137,348 (0.4)%
Aerospace 54,088 (13.4)%
Microelectronics 74,403 17.5%

Source: Pall presentations

Biopharmaceuticals continues to be the standout performer, but its food and beverage sales are improving. Indeed, Pall competes with 3M in the biopharmaceuticals and food and beverage markets, and 3M reported that 3M Purification saw "strong double-digit organic growth" in its latest quarter. It's reasonable to expect Pall's life science segment to continue to generate good growth.

Moreover, there are some signs that the industrial segment is going to see better conditions in future, too.

First, the industrial segment's orders grew 9% in the third quarter, with consumables orders up 10% -- a sure sign of future growth. Second, microelectronics sales remain strong and have bounced back from the year-over-year declines demonstrated in the first chart above.

Third, aerospace sales continue to struggle against tough comparisons from last year, and with ongoing declines in military flight hours. Indeed, Pall rival Donaldson also reported weakness in aerospace in its third-quarter results. In fact, Donaldson reduced its guidance on aerospace, as defense sales declined faster than expected, but COO Tod Carpenter also said defense "should be stabilizing at current levels." In addition, aerospace-focused Precision Castparts recently said it saw its military spares business improving in the second half.

The fourth indicator is somewhat open to debate. The process technology end market continues to be subject to disappointment, and Pall management was straightforward in highlighting that its customers still weren't aggressively undertaking capital expenditure expansion plans. Donaldson management delivered a similar message, noting "dampened and delayed capital investments and capacity expansions by our customers." Moreover, a company with a significant exposure process technology, Emerson Electric, also sounded a cautious tone on current spending. On a more positive note, Emerson also said its process customers increased orders by 9% in this past quarter, so it appears that there could be some pent-up spending about to be released in future quarters. If so, it's good news for Pall, too.

The takeaway
All told, Pall Corp needs to see business increase in its industrial segment in order for the stock to move higher, and there are some tentative signs that this will happen.


PLL EV to EBITDA (TTM) data by YCharts.

It's hard to argue that the stock is a good value right now, and there are probably cheaper ways to play a recovery in process technology spending, but momentum stocks sometimes have a life of their own. Don't be surprised if an improving industrial environment takes shares higher.