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Pentair PLC
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Good morning. My name is Karenna, and I will be your conference operator today. At this time, I would like to welcome everyone to Pentair's Q4 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.
Mr. Jim Lucas, Vice President of Investor Relations and Treasury you may begin your call.
Thanks, Karenna, and welcome to Pentair's fourth quarter 2017 earnings call. We're glad you could join us. I'm Jim Lucas, Vice President of Investor Relations and Treasury. And with me today is Randy Hogan, our Chairman and Chief Executive Officer; and John Stauch, our Chief Financial Officer. On today's call, we will provide details on our fourth quarter 2017 performance, as well as our first quarter and full-year 2018 outlook, as outlined in this morning's press release.
Before we begin, let me remind you that any statements made about the Company's anticipated financial results are forward-looking statements subject to future risks and uncertainties, such as the risks outlined in Pentair's most recent 10-Q and today's press release. Forward-looking statements included herein are made as of today and the Company undertakes no obligation to update publicly such statements to reflect subsequent events or circumstances. Actual results could differ materially from anticipated results.
Today's webcast is accompanied by a presentation which can be found in the Investors section of Pentair's website. We will reference these slides throughout our prepared remarks. Any references to non-GAAP financials are reconciled in the appendix of the presentation. We will be sure to reserve time for questions and answers after our prepared remarks. I would like to request that you limit your questions to one and a follow-up in order to ensure everyone has an opportunity to ask their questions.
I will now turn the call over to Randy.
Thanks, Jim. I’d like to thank everyone for joining us today. 2017 was an exciting year for Pentair’s who saw organic growth return, strong margin expansion, robust cash flow as usual and the announcement of plan to separate our Water and Electric businesses into two publicly traded companies.
We had two goals in 2017, first, to deliver on our 2017 commitments, and second, to prepare to stand up two independent companies. We accomplished both and believe the momentum we have exiting 2017 will continue into 2018.
Our top line continue to gain momentum, driven by improving end markets and also by growth investments in both of our businesses. We saw very strong margin expansion in the fourth quarter and for the full year. I'll discuss the specifics around this in just a moment.
We’re also introducing our 2018 outlook today, which is approximately $4 per share for the full company, expecting double-digit EPS growth once again. The $4 per share represents approximately $2.25 per share from Water and roughly $1.75 per share from Electrical for the full year. John will discuss the outlook in more detail later in the call.
We remain on track to spin our Electrical business in the second quarter and are targeting April 30th for completion of the spin. 2017 was the year that's our predictability return to Pentair and we believe that both Water and Electrical are well positioned as we approach our separation into two focused growth companies.
Now let’s turn to slide 5 for discussion of our full year 2017 results. In 2017 we saw adjusted core sales increased 2%, which excludes the impact in 2016 of three large jobs in our Electrical business and one large job in Water’s that did not repeat.
We saw the growth rate increase throughout the year, particularly within Electrical, as industrial end markets continue to recover. Segment income increased 7% for the year and return on sales expanded an impressive 100 basis points to 18.2%.
We achieved these results due to the cost actions we took in 2017 read through and positive leverage from sales hit the bottom line, all while still making growth investments in the business.
Adjusted EPS grew 16% and our free cash flow was over $600 million. This was a 100% of adjusted net income when excluding a one-time tax payment. Overall we were very pleased with our results in 2017 and we’re optimistic that this path of improvement is sustainable.
Now let’s turn to slide 6 for discussion of our fourth quarter 2017 results. Our fourth quarter results showed strength across almost all financial metrics. Adjusted core sales grew 4% in the quarter with Water up 3% and Electrical growing 5%.
Segment income increased 11% and return on sales expanded 80 basis points to 18%. Although material inflation remains a headwind, we continue to drive productivity and pricing actions to help offset the impact.
Adjusted EPS grew 19% and met our guidance of $0.93. Free cash flow was over $200 million in the quarter. So we ended the year on a positive note indeed.
Let's turn to slide 7 for a look at Water's performance in Q4. Our Water segment delivered adjusted core sales growth of 3% and 6% growth overall. Segment income grew 15% and return on sales expanded 160 basis points to 19.2%.
Our Water business delivered margin expansion of over 100 basis points every quarter in 2017 due to strong productivity and improved product mix. We don't expect this rate of margin expansion to continue, but we believe the cost structure is right and mix should remain favorable.
Filtration solution saw core sales declined 2%. It remains a tale of two stories, our residential and commercial filtration sales which represents nearly two thirds of the business remains strong, especially in food service. These are higher margin businesses and are a contributing factor to the positive mix comment made earlier.
The smaller process business continued to be hampered by low global diesel activity and muted spending in the beverage industry. Although we've been disappointed with the top line performance of that part of filtration solutions in 2017, we expect the business to face easier comps in 2018 and we believe the higher margin residential and commercial business is well positioned to keep growing as we continue to invest in this very attractive space.
Flow technology saw the top line grow for the first time all year, as core sales were up 4%. We saw broad based strength across this business for the first time in quite some time, with agriculture, residential and commercial all up.
Our smaller engineered pump business saw some short cycle recovery and the longer cycle backlog continues to improve, which you believe foretells improvements in 2018 and 2019.
Aquatic systems ended the year on another strong note with core sales up 5% in the quarter and delivering 7% growth for the full year. We saw normal early buy activity and overall demand remained strong, as we continue to gain ground from advanced product adoption and ongoing dealer gains amidst to market ops – optimism.
Now let’s move to slide 8 for a look at Electrical’s performance in Q4. Adjusted core sales grew 5% in the quarter and were up 7% overall. Segment income grew 6% and margins were down modestly, as price and productivity were not enough to offset inflation. We expect material inflation to continue, there's a roadmap to productivity accelerating in 2018, while price headwinds moderate.
Enclosures core sales grew 8% in the quarter and the strength was broad based. The uncharacteristic productivity shortfalls are isolated to Enclosures. Recent plant closures and a distribution center relocation resulted in some near term delivery challenges compounded by very strong demand. We see this demand remaining strong and expect the issues that impacted productivity in 2017 to abate in the first half of 2018.
With the stability of these capacity investments and a strong outlook, we believe Enclosures is poised to stabilize margins and grow income in 2018. Core sales declined 3% in thermal, but this was due solely to the top line headwind in the three large energy jobs last year in Canada that we outlined at the outset of the year and I mentioned earlier.
Excluding these large jobs, thermal grew once again on both the small project and product side of the business with particularly strong sales in the industrial MRO business. Even more positive is that the business dramatically improved its margins in 2017. As a result of its realigned cost structure and better overall mix from higher margin product sales, making this an even more attractive business for Electrical.
Electrical & Fastening Solutions saw core sales increased 7%, as commercial remained strong and infrastructure showed growth for the first time all year. More important price cost within EFS has gotten back to a more favorable position than we saw at the beginning of the year.
Now please turn to slide 9 for an update on our planned separation. Before turning the call over to John to discuss the financial outlook in more detail, I wanted to provide an update on our planned separation.
We made tremendous progress preparing to stand up two companies in 2018. The nVent Form 10 has been filed and the review process is ongoing. The leadership teams for both Pentair and nVent are now complete and the new teams are coming together well.
Enterprise separation activities, such as finance, treasury and IT are all on or ahead of schedule. As we prepare for the separation we expect that both capital structures determined by the end of the first quarter. We're looking forward to sharing our excitement for the prospects of both companies at the Investor Day as we're hosting in New York on February 13. There are both management teams will present their strategies and discuss their futures in more detail.
We remain excited for Pentair's next chapter as we create two industry leading pure play companies in Water and Electrical. We strongly believe that both companies are well-positioned for long-term growth and value creation with the scale and strength to control their own destinies.
The increased focus of both companies should help to raise the execution even further and drive higher differentiated growth. We believe that our performance in 2017 has demonstrated our ability to better forecast our business and execute against our commitments. Both companies can become appreciated for the jewels that I believe they are.
I will now turn the call over to John.
Thank you, Randy. Please turn to slide number 10, titled balance sheet and cash flow. We ended the year with our balance sheet in the best position in over two years. Our ending debt balance was $1.4 billion, which does not include just over $100 million of cash on hand at the end of the year.
Our free cash flow into the year was over $600 million and represented 94% of adjusted net income. However, when excluding a one-time tax settlement payment from a prior year in 2017 free cash flow once again equalled adjusted net income. Our ROIC continued to improve and ended the year at 11.6%.
Please turn to slide 11 titled 2018 outlook. Today we are introducing our 2018 adjusted EPS outlook for all of Pentair of approximately $4 per share, comprised of core sales growth of 2% to 4% and margin expansion of roughly 20 basis points.
Embedded in our guidance is corporate expense of %100 million. Interest expense of $50 million and an effective tax rate of 18%. While we recorded a fourth quarter charge of roughly $85 [ph] million related to US tax reform, actually a gain of $85 million related to US tax reform. We believe the expanded - the expected 18% go forward tax rate to be an improvement over our current 20% tax rate and sustainable.
The share count for 2018 is expected to be 183 million shares, inclusive of a completed share buybacks and before any incremental repurchases. While we have not yet finalized the capital structure of both companies heading into the separation, we continue to target investment grade metrics for both companies and our interest expense forecast reflects this target.
We are also introducing 2018 adjusted EPS guidance for Water or RemainCo of $2.20 to $2.30 per share, on core sales growth of 2% to 4% percent. While we continue to make growth investments, we believe return on sales should expand approximately 40 basis points. I would remind you this follows a 140 basis points expansion in 2017.
Corporate expense for Pentair RemainCo should approximate $55 million and interest expense is expected to be around $20 million. For Pentair Electrical or nVent, we are introducing 2018 adjusted EPS guidance of a $1.70 to $1.80 per share, based on core sales growth of 2% to 4%, flat return on sales, corporate expense of $45 million and interest expense of $30 million. Both companies will have more details on their 2018 outlook at the upcoming investor days on February 13 in New York City.
While 2017 was a year of many changes for Pentair, both businesses have seen improving fundamentals and improving growth rates. As a reminder, the key rationale of the separation was to create two focused growth companies, which would require some dedicated growth investments in 2018, which should result in improved top line growth, EPS expansion and robust cash flow to be allocated in a disciplined manner to create share owner value.
Please turn to slide 12 titled seasonality present in both businesses. We wanted to remind everyone that both businesses, particularly Water do experience some seasonality during the year. The past two years have seen similar trends that we would expect to continue. We thought this would be a useful reminder as you think about the quarterly distribution of sales and income for both businesses.
Please turn to slide 13 titled Q1 2018 outlook. We are targeting that the first quarter should represent the last time we will report earnings as one company. With Q1 as a launch point for both companies, we are estimating core sales growth to 3% in both businesses for the first quarter.
Segment income is expected to increase about 6% and return on sales is anticipated to be flat at 15.5%. Also we are expecting a tax rate of 18%. Net interest of around $13 million and shares to be roughly 183 million. Overall adjusted EPS is expected to be up over 20%.
We exited 2017 continuing to build top line momentum, and while we continue to make growth investments in both Electrical and Water, Electrical’s also correcting its productivity issues and dealing with significant inflation challenges. We believe both businesses are positioned to deliver strong overall results, while preparing to stand up as two well positioned industry leading companies.
I would now like to turn the call over to Karenna, after which Randy will have a few closing remarks. Karenna? Please open the line for questions.
Okay. [Operator Instructions] Your first question is from the line of Steve Tusa from JPMorgan. Please go ahead. Your line is open.
Good morning.
Good morning.
Morning, Steve.
So first of all just on kind of the top line trajectory in ’18, you know, your growth this quarter was okay, but not great in the context of the economy. I mean, I think 2% to 4% seems you know, reasonably conservative. Is there anything you know maybe in the Electrical business that you'd want to point out that you know could potentially be an upside surprise you know into next year, whether it's Enclosures or anything else?. Maybe just talk about the profile of some of the sub-segments as you set up in the next year, especially in Electrical?
Yeah, I think - I think that our outlook is realistic, but there's more upside than downside. I mean, we have - a lot of people calling synchronous growth. First time I've seen in 30 years. The markets are good for gaining momentum in Electrical, specifically we've got some the disappointing execution in Enclosures that we have. We've got that stabilized, it’s not productive yet, but now it's stabilized. I would hope that we could gain even more share and get back our rightful share that maybe we lost a little bit of it in Enclosures…
So how fast - so how fast do you think the Enclosures market is growing?
I don't have that number right in front of me, but I'd say…
High singles.
Yeah.
Okay. So you think that it's possible to kind of - if that trend line slows maybe a tad next year you think it's possible to kind of work your way into that. You know something above mid single digits at some point here in the near term as those issues get remedied?
For Enclosures, yes, yes.
Okay. And what exactly are the issues again?
You know, we had a number of plant moves – just a consolidation of a distribution center that we started in 2016, it took a little longer to get them done. And then the market took off and that's just the additional demand just basically overwhelmed the moves. They weren’t stable. So we're getting to the end of that, that's why the first quarter outlook is what it is.
Okay. And then just on the margin side of Electrical, you guys give you know, pretty good bridges as far as you know price inflation, et cetera. Can you just give us a little bit of color on how we get to the you know, margin you're guiding to for next year with regards to Electrical and if you are not kind of prepared to do that maybe just a little bit of color on what you're assuming on kind of the you know the price cost side there?
Let me give you an overview and then Beth will go into it in more detail on the 13th, I think it's fair for her to let her do that. But basically we were very cautious on price while we were having these delivery challenges because of the operational faux pas.
And so price – price is still going to be a headwind in the first part. And we're not counting on productivity in the first you know, five months or so, four months of the year…
And inflation - and inflation?
Kind of run rate continues…
For Electrical?
In the fourth quarter we didn't get any productivity.
Okay. And then one last question, your ForEx up 1% what rate is that based on?
Roughly a $1.20, the euro. You know, obviously lots of currencies, Steve, but that’s the main one.
Okay. Great. Thanks a lot guys.
Thank you.
Your next question is from Deane Dray from RBC Capital Markets. Please go ahead. Your line is open.
Thank you. Good morning, everyone.
Morning, Deane.
Good morning.
Hey, maybe start with John, if you could give us some insight into the puts and takes in tax reform, you can count us among the people that were pleasantly surprised to see you actually benefiting more than what we expected. So on top of this whole separation, you also had to flow through tax reform. But just give us a sense of how it turned out that it's as favorable as it is.
Yeah. So I mean, I think when the legislation emerged we thought we'd - just like you did probably thought we'd have a slight headwind and a couple of things went favorable for us. One is there's less of a border adjustment tax impact on us, you know, US manufacturing tax than originally assumed and then also we were able to carry forward our deferred tax assets related to debt and debt restructuring for an infinite period of time which allows us to utilize those in the future. Those are the two main changes.
Got it. And then going back to the Water discussion in Randy's prepared remarks, and I'm not sure if Randy answered this or John, but the idea of the mix being more favorable on residential and especially on foodservice's side remained strong, and Randy said where you look to invest in this business going forward. So what are the kinds of opportunities for investing? Is this internal growth or are these acquisitions?
Well, I think you know we'll talk about this definitely in length on the 13th. But first and foremost, we have lot of organic growth opportunities. I mean, one of the reasons we want to separate both these companies is they both have the ability to focus on organic growth.
Organic growth is you know - delivering that growth muscle for us is key and what that means is we're going to focus on where we're really good, which is residential, commercial water treatment. That is our strong position globally and we want to continue to invest in that area and maybe deemphasize a little of the other pieces of portfolio.
That's helpful. And just last question for me. Is there any news or development on the hurricane impact, the rebuild especially on the Aquatic side?
No, I mean, we continue to see the order rates continue in that area both in - definitely Florida and the Houston area. So you know, as both the states continue to rebuild outside of that hurricane damage that they suffered.
The optimism - I mentioned this in the prepared remarks, the optimism in this business is as high as I've ever seen it. Its - growth is really, really solid there.
Great. Thank you. See you on the 13th.
Exactly.
Your next question is from Jeff Hammond from KeyBanc Capital Markets. Please go ahead. Your line is open.
Hey. Good morning, guys.
Good morning, Jeff.
Just on - back to Electrical margins being flat you know in the guide, outside of this Enclosures issue it sounds like it'll be you know cleared up by 1Q. What are the other kind of headwinds to not getting you know more leverage out of Electrical?
I want to see more yields from price, right. And you know I'm taking a bunker attitude here, you know, which is don't shoot until you see the whites of their eyes. In other words, let's see some delivery here.
This is a business that just delivers. So it's - I expect to be an anomaly what we're seeing now.
Okay. And then on Thermal, I mean, it looks like the - you know the big projects you're lapping, kind of the big project com, you know, we're at $65 oil, it sounds like after markets been better. Can you just maybe carve out where you think the outlook is for that business into ’18?
A shout-out to the Thermal team. They did an incredible job this year. You know, if you look at their overall and the top line coming down those was big projects. They not only right sized cost structure, but actually made investments, they made investments against driving MRO and driving product sales only much higher margins than the products that were coming down.
So we saw a nice increase in margins in that business and frankly with a little bit of mojo behind capital spending in energy that's going to bode well for the smaller projects and the product sales and our investments we made in MRO. I expect another dazzling year for Thermal.
Your next question is from the line of Mike Halloran from Baird. Please go ahead. Your line is open.
Hey, Mike.
So on kind of a comparable question though you guys have been answering on the Electrical side, maybe similar puts and takes on the Water side for the margins into next year, just how you're looking at the price cost curve and also how you're looking at productivity?
And then for the cumulative company also some thoughts on the restructuring side how much benefit for both Electrical and Water you're assuming in numbers for next year?
Yes. So Mike, you know, on the Water side, we had a strong productivity year in 2017. But you know, we have to get back to investing in organic growth. So for 2018 we've got some $25 million of incremental investments in primarily sales, marketing and innovation technology into the outlook for 2018. And we want to get back to investing to control our destiny as far as the future and begun to build an organic growth muscle.
So we're excited about the opportunity to you know focus on where we think we're strong, which is residential, commercial, water treatment and then starting to invest in the longer term growth trajectory.
So other than that, price cost for us is not as big an issue as it is in Electrical you know, we deal with the trades channel and usually have the ability to take the price and cost and mitigate them through our channel. So we're a little bit blessed in that regard. And then Randy, do you want to add to the Electrical.
Well, I just did on the margin side, I think I’ve...
Yeah. No, no I was comfortable on the Electrical side. Was there any restructuring benefits for either the two pieces into next year?
Oh, yes, significant. I mean, both groups have taken the opportunity to optimize their portfolio and both sides are looking at you know some tailwind associated with 2017 restructuring.
And kudos to John and Beth both as they - built the structures as you recall when we first said we're going to separate, we thought we might have a $20 million headwind in the corporate cost and we actually came out with a neutral, no headwind. A lot of good work too.
And any willingness to give a dollar number on those or too early and just want to leave it up to the individual companies over time?
Too early.
That’s fair. And then on the engineered pump side, first positive commentary in a while there, maybe just some thoughts on what you're seeing in the market and sustainability of what could be an early turn toward something more positive?
Yeah, the market is definitely recovering and has been recovering throughout 2017. And we have built the order backlog for the breaking fix side of primarily municipal. So I think we – we’re now moving from what used to be a headwind to let's say a slight tailwind.
Sounds good. Thanks for the time.
Thank you.
Your next question is from Scott Graham from BMO. Please go ahead. Your line is open.
Morning, Randy and John, Beth.
Morning, Scott.
Couple questions for you. You know, where we were talking in 2017 about what felt like about a 1%, maybe 1% to 2% headwind to sales from businesses that were sort of - let's just call it being run off so to speak.
Could you tell us kind of what that is in Water and if there's any in Electrical as we stand today still happening?
Yeah. So what we are referring to is you know, we shipped some projects in 2016 that had a headwind you know, and we looked at those as being somewhere around a point of headwind on the Water side. And then you know, larger impact in the Electrical side, primarily all in Thermal, which was the large jobs that had completed in 2016 that had no revenue in ‘17.
That's all behind us now. And as we look forward we no longer have those challenges and each of the businesses will produce the organic growth or the core growth that - that will be just reflective of no longer having those year-over-year challenges.
Right. I guess, John I was referring to and what I thought and may - correct me if I'm wrong, that you were even in some of like the lower margin Water businesses, residential, maybe you were walking away from some customers there, did I have that wrong?
No. I mean, it was more about more geography prioritization. You know, we as two smaller focused companies can't afford to be in every geography in the world. And you know, it gets very difficult to have a small scale and compete in Russia or a small scale and compete in Brazil and so both sides we’re looking at optimizing those opportunities.
But those will be some surrounding headwinds next year, Scott as we look to move the revenue that we have to a distribution or an alternative channel, but we removed the costs – associated [ph] structure, being cost structure of being local there.
Got you. Last question from me.
Okay.
You know, as these companies take their - you know, each independent paths, have you - I know that there's a lot of work going on behind the scenes in terms of what you want to be and all that and the separation mechanics themselves.
But if you thought about M&A pipelines. I know you mentioned John where you kind of want to be just now, but have you started to identify some things on the Water side and on the Electrical side. Is there one of the three platforms you maybe want to develop a little bit further?
So I'll handle the Water side. I mean, clearly you know, disciplined capital allocation is important for both sides. And I think in the near term we think we have a significant amount of organic growth opportunities and I'd like to see our businesses demonstrate the organic growth that that they have and then tuck in behind it the M&A.
So yes, we're identifying them. I think you know, where we have strong organic growth and they probably have a readiness and an ability to move sooner. But I really want to see the discipline around that steady consistent organic growth and then putting the fuel behind them as a bolt on. Randy, if you want to answer the Electrical…
Yeah. In Electrical you know, there's quite a few parts of the business, if you look at all three of what will be the segment, they are actually all three very attractive from a profitability standpoint and they all have opportunities on the M&A.
But I would say 2018 as a prove it year from an operation standpoint and a continuation year from driving the organic growth that we're really building great momentum on.
At the same time there have been and there will be opportunities I think to do little plug and play acquisitions, particularly in the EFS side, Electrical Fastening Solution side and maybe some Thermal too. But again, I think Beth could talk more about that on the 13th.
Got it. Thank you.
Thank you.
Your next question is from John Walsh from Vertical Research. Please go ahead. Your line is open.
Hi. Good morning.
Good morning.
So one question about the Q1 top line guide, in prior slides you'd called out you know, a days comparability issue on a on a year-over-year basis, we obviously lived through some of that in 2017. I think the last update I saw Q1 ‘18 actually has one less selling days from your prior slide. Is that still the case or how should we think about that?
Yeah, I would say it's a rounding error. I mean, a day is not all that meaningful and that's reflected in what we have in the core guide for Q1.
Okay. And then you know, clearly good cash conversion execution here. You know I like or applaud that you do it on the adjusted net income. As we think about next year, you know, in working capital I mean, clearly as you execute on that it does get harder to keep getting gains out of that line.
You know any particular cash items you have visibility into next year that give you know, confidence in that 100% conversion on the adjusted net income, whether it's on the inventory line or payables or anything like that?
Yeah, the first thing I'd like to state, maybe it's clear already, is both Water and Electrical have and will convert at 100% level. So the capability is on both sides. There's a seasonality in Water that John talked about that's important, but for the year both will deliver.
I believe that Electrical it does because of the distribution - short term distribution challenges that I just talked about will have some inventory opportunities, as well as we've really only begun to think - make - scratch the surface on EFS opportunity on inventory.
Yeah, I think the biggest tailwind opportunity for both companies as we go forward is to read – the reducing of the separation related costs and the severance and restructuring costs. I mean, on the gross cash rate both companies will start to you know get into more of a stabilized mode and no longer have these large restructuring actions that have hurt us on the cash flow side.
All right. Thank you.
Thank you.
Your next question is from the line of Nathan Jones from Stifel. Please go ahead. Your line is open.
Morning, everyone.
Morning, Nathan.
Morning, Nathan.
John, on the Water side, you talked about focusing on the areas where you're seeing good growth, where you're having strong positions and maybe deemphasizing some of the other businesses. Given the opportunity you have with the split, is -- have you given a thought and consideration to perhaps disposing of some of those assets using that capital to bolster the businesses where you have better and stronger positions?
Yeah. I don't know if we're there yet. I think it's really about the fact that it's prioritization. And you know, we've been - we have a lot of great growth opportunities across all of Water, but we have to focus our energy and focus our actions - our actions.
And so you know, it's about not chasing the large jobs that are one and done. It's about focusing on the aftermarket. The annuities, the stability of our customer base and that's really what it's about at this point Nathan.
And then I know you guys said you're looking at investment-grade balance sheet for both companies. But judging by the interest expense line that you have there, Electrical is going to get more of the debt on what is a somewhat smaller company. Does that indicate that you guys believe that the Water business has more opportunities for M&A?
Obviously that that reflects roughly what we think will do. As you recall you know, now that we've retired all - retired the debt with the proceeds from Valves & Controls, while money is fungible, the debt that remains is really around EFS.
So I just think by rights it sort of an Electrical debt, which is the guiding principle. I think there are more opportunities on both sides, but Waters is been on the sidelines for first because of Valves & Controls and secondly because of the EFS acquisition for a while. So those are the guiding principles that I gave the team to use as they put this together, still have to finalize things though.
Okay, fair enough. And then the $25 million of incremental investments, I think that was related to Water. Can you quantify what incremental investments are related to Electrical? And then maybe talk about some of the major initiatives, some of the major investments that you're making to drive growth here in the future?
Yeah, about 50 basis points on the Electrical side. You know, and again I mean, those are to further off the automation, get the delivery and quality issues and also to be creating the one event opportunities across the portfolio for some of the key initiatives that they have, like rail and data centers.
So I mean I think each of these companies feel that the incremental investment in 2018 is really going to create a sustained and more predictable organic growth in ’19, ‘20 and beyond. And so obviously if it doesn't materialize that's an opportunity, but it would be disappointing if we weren't able to invest that in the future growth.
Is that a number that you think is a run rate number? This $25 million in Water, 50 basis points in Electrical, is this a step-up for 1 year that will step down again? Or a step-up to a level that you would imagine sustaining as we go forward investing in growth opportunities?
We'd like to sustain it.
I think we need to build the business model to be able to sustain that, so we keep it going. John made a good point earlier about these large projects that are won and done. And I mentioned earlier about Thermal, as redirecting and restructuring their cost to go after smaller sustainable MRO and product that's really an opportunity in Water as well, which as John said that those investments should sustain, those investments should give us more reliable organic growth.
Excellent. Thanks very much for the color.
Thank you.
Your next question is from the line of Josh Pokrzywinski from Wolfe Research. Please go ahead. Your line is open.
That was closer, John.
Hello, Mr. Pokrzywinski.
Yeah, I thought it was closer. We're again improving, hopefully another 10 years and we'll be all the way there. So John just to follow up on something you said about you know, emphasizing versus deemphasizing points within Water.
Does deemphasizing you know, could that mean outright sales of businesses? And you can kind of ring fence you know, maybe not the exact lines of business, I don't want to spoil the fun for the Analyst Day. But you know the rough size of businesses that could be in that deemphasization [ph] you know bucket?
Josh, let me take - let me take it and of course, probably will come up again on the 13th [ph] But you know, the fact is that, we have always focused on capital allocation, if look at all the things we did, I mean, we just - we sold the pipe business right after we bought Tyco. We ended up making different calls and selling valves.
You know we have trimmed and pruned the business, as well as replanted it. And so that sort of I think almost in the DNA of the business to think that way. And I would expect both businesses to continue to do that.
Yeah, Josh, I mean to put it into context, 85% of what we do falls into one bucket in Water called residential commercial water treatment. I want to focuses to be there. We've moved to more of an enterprise model where we have the ability to look at marketing across the enterprise you know, in innovation across the enterprise and we want the extra energy to be focused on where we think we can differentiate against the competition and differentiate on behalf of the customer.
One of the big areas that we have to invest in is digital marketing to pull the consumer through our professional channel and that's going to be done first on the residential commercial side.
The technology is transferable, I mean when we take a look at what we have and what we do in Industrial Filtration that technology is useful in residential commercial, it hasn't been used that way in the past. And so it’s more about a redirection as we go forward than it is necessarily an asset sale.
Got you. So when you think about that - the 15% that doesn't fall into the core, we shouldn't you know think about Pentair long-term is maybe parting ways with those as we add in other things that are closer to the core. That's not necessarily in the agenda?
That's correct.
Okay. That was all. Thanks a lot.
Your next question is from the line of Brian Drab from William Blair. Please go ahead. You line is open.
Morning, everyone. Thanks for taking my question.
Good morning.
Morning.
So back to Water if I could just for a second, you mentioned that the pace of margin improvement in Water shouldn't continue, but you are guiding up 40 Bps for ’18 and this is really good operating margin in Water in the back half of the year here and really for the whole year.
I guess my question is just can we continue to track up above 20% and as I look back at the old reporting structure, you know Water quality was of course sustain margins above 20, but flow and filtration was well below that. And I'm just wondering if you know combined what is the longer term trajectory for this combined business?
Yeah, what Randy meant was even though we delivered a 140 year-on-year this year and we're up 100 every single quarter, we did not make those future investments in the growth that we're doing in 2018. So if you add back that $25 million of incremental growth I shared with you it suggests that these margins continue to expand before that growth. And I would just look at it that way.
The other thing we did and you know we used a playbook that's been proven in the PIMS for some period of time and we did a lot of product rationalization, SKU rationalization and reprioritizing some of the lower margin product and really didn't suffer all that much in the top line - significantly expand margins.
So I mean, there's a ton of opportunity still remaining in these businesses from an operational standpoint, but we want to invest in future growth.
Okay. But we shouldn't think about 19.6 or wherever we are as a ceiling in 2019, 2020 we can continue to move up?
No, and our peer group demonstrates that too. I mean, if you take a look at some of the older water peers they have really nice margins as well.
Yes, for sure. And then if I could just a couple of questions on Thermal. Are you starting to see demand specifically in the in the petro-chem market. You know, there's talk of - a lot of talk of a second wave of investment there in over the next few years, could that be a tailwind for you?
Yeah, we are we're seeing a pretty broad base. As we mentioned before, particularly now with the tax law change, I expect - I would expect the investments in petro-chem on the chem side, right, on the plastic and monomer side is going to be quite substantial here with low cost natural gas in North America. The whole industry should be here. So with the tax law change you know, I think it could be - we could have a sustain capital spending even at this oil price level, that would be pretty exciting.
All right. Okay. Thanks. And then just one last quick one. You mentioned MRO again is picking up steam in Thermal and in the Americas. And can you kind of break that down into what…
It’s also in Europe, its everywhere.
Okay.
Now if you want to go back and just look at the energy side, you know, now they're back $65. You're back to more normalized maintenance level and this is a business and has a wonderful MRO flow. And our focus now on our investment as we took down the elephant hunting, forgive me - forgive the metaphor, but of the large projects we invested in the things out to more aggressively focus on getting that after marketing and serving it and we're enjoying that. So I expect it to continue.
Okay. So my question is going to be, just thank you for that. But my question is going to be within the Americas are you seeing the same kind of momentum in Canada versus the US and kind of broad based across end markets or are there any specific pockets of strength?
As I mentioned it is broad based. So it is Europe. It has come back from Canada, it has – it is strong in North America.
Great. Thanks very much.
Your next question is from the line of Joe Ritchie from Goldman Sachs. Please go ahead. Your line is open.
Good morning, guys.
Hi, Joe.
Hey, maybe I'm going back to Electrical for a second and your commentary earlier around price cost. So if I kind of take a look at 2017 it looks like you've been running last few quarters about $10 or $11 million price cost negative last few quarters and it sounds like that's going to continue now at least through next four or five months.
On top of that you've got strategic investments call it $2 to $3 million a quarter in Electrical. What I'm trying to do is I'm trying to bridge to flat margins. Is there any expectation then as we get into the back half of the year that price costs reverses or are there other things that are coming through on your bridge to get to a flat margin guidance for ’18?
Yeah, I mean the productivity – the stabilization then leads to positive productivity and you know that's more in the third and fourth quarter as opposed certainly not first quarter a little bit the second that I think about it.
Okay. So is there an expectation also from a pricing standpoint and I guess my understanding was that and I could be wrong here with that typically you guys put price increases through at the end of the year, early part of the year and so I'm just wondering whether there's an opportunity for you to get additional pricing as the year progresses?
Let me say this carefully, but I hope there is an opportunity. You know, we haven't broken that process. But this business, I mentioned it's an anomaly and most in the Enclosures business for this kind of performance. So controlling your destiny means controlling what you can.
So there's been a price increase but do we count on that or we count on the productivity that we own and we drive, you kind of what you can - would you own and drive that's what controlling our own destiny means. If the price really read through that would be good. But we want to deliver on our commitments in any case.
Got it. And maybe then just kind of following on what you can control, which is partly the cost angle. Do you guys plan to typically hedge any of your commodity costs or are we just kind of going to roll through because we've seen a little bit of an increase here in copper and steel and just wondering like you know, whether we should – what kind of headwind we should be expecting from that?
What our process is you know, we're not commodities traders. So what we'd like to do is we would like to lock in our price so that we can have good operating plans and predictability in our business. So we typically are locked out about 6 months on those commodities and copper is one of them.
Got it. Okay, guys thanks very much.
Thanks.
Your next question is from the line of Steven Winoker from UBS. Please go ahead. Your line is open.
This is actually Chris on behalf of Steve. Can I just - can we just go back to the price cost and productivity kind of topic. You know, you guys said that you control your own destiny with regard to productivity. Are you seeing customers being more reluctant to accept price. Is that kind of something that you know you're seeing with their customer base right now?
Well, again, talking about Enclosures, it’s really hard to actively set price when you can’t get deliver, right. And so we've got stable and we'll see whether they accept it.
Okay.
But I mean, people are seeing inflation, so any material inflation that typically in that business has led us to be able to achieve some price.
Okay. And then you know, I know you said you're not - did the elephant hunting is a thing of the past, but in terms of just project activity in general, I mean, are you - is there more activity or is there anything you guys are seeing there or is the growth going to continue to be kind of more shorter cycle in nature more MRO kind of mix there…
In this kind of a robust economy there will be - there will be larger projects, but we want projects to come to us and we want to own other parts of the business. And so it's a different - we certainly will accept them as they come. But we're not going to have the major effort that we had in the past and the cost structure associated with that.
Okay. And again just one more, on Electrical & Fastening, I know there was year-over-year comp, but you know the strong sequential acceleration there. Is there anything more to that and how should we kind of expect that to flow through ’18?
Well, the CADDY business, the CADDY brand product line which is largely commercial is seeing – it saw some variable growth in EFS, but CADDY was pretty solid, it was it was really solid in the fourth quarter and then the industrial - the infrastructure business was - really came back and I think again in this economy with what's happening, I would expect infrastructure to continue with some strength.
Okay. Thanks a lot.
Thank you.
There are no further questions on the phone at this time. And turn the call back over to presenters.
Thanks for your questions and your attention. Just to wrap things up, we remain on track for the separation to be completed by April 30th. But this still remains work to be done. Both businesses are well positioned entering the New Year with improving top line fundamentals. We expect both companies have strong balance sheets upon launch. We report to updating you further on February 13th with Pentair and nVent presenting their strategies and we hope you share our excitement for the future of both companies. Again thanks for your continued interest and operator you can conclude the call. Thanks.
This concludes today's call. You mean now disconnect.