I'd hate to be short Pall (NYSE:PLL), as large companies in the filtration space often seem as close to bulletproof as you can find in the market. So even though sell-side analysts chronically overestimate Pall's free cash flow, investors remain happy with a company that admittedly enjoys strong share and a very lucrative channel of repeat business. While I think Pall's shares remain overvalued, I don't have any particular reason to believe that the shares will sell off dramatically, as the life sciences business should be stable and the industrial business should start improving next year.
On Target In Fiscal Q4
There are always plenty of moving parts within Pall's results, as the company sells into so many different end markets, but the end result performance was pretty much on target.
Revenue fell almost 1% as reported to close the fiscal year, but revenue in local currency terms rose half a point. Life sciences was up 6% for the quarter, as strength in biopharma offset weaker conditions in the Chinese and European food and beverage sector. Customer utilization levels in industrial markets remain a real issue, though, and the company saw a 5% decline (local currency) in industrial sales, with particular weakness in microelectronics and municipal water.
Improving the company's cost structure has been a key topic at Pall, though this quarter didn't really show the progress that the company has been making. Gross margin was flat, as a slight improvement in industrial was offset by a nearly one point decline in life sciences. Operating income declined 3% at the corporate level, while life sciences segment earnings were flat and industrial improved 1%.
Not Many Surprises, All Things Considered
This really looked like an “as expected” quarter all across the board. Pall's life science performance was consistent with an earlier report from Sartorius, while Donaldson (NYSE:DCI) reported weakness in the industrial sector and Entegris (Nasdaq:ENTG) gave weak guidance on the basis of soft trends in semiconductors and microelectronics.
There really isn't that much joy (or momentum) in industrial filtration/fluid handling right now. Leading fluid handling company IDEX (NYSE:IEX) saw just 2% organic sales growth in the calendar second quarter, though orders were better. Likewise, Xylem (NYSE:XYL), a “water technology” company, saw sales decline in the quarter, though Flowserve (NYSE:FLS) saw mid single-digit revneue growth. With industrial activity lower almost across the board, utilization rates have been quite poor (50% or below in some cases), and that has reduced the need for replacement consumables. As industrial activity picks up, so should Pall's industrial business, but management's guidance doesn't suggest a big recovery next year.
Strong Share And Ample Liquidity, Plus Cost-Cutting
I understand why Pall is popular. A very large percentage of the company's revenue comes from very profitable replacement/consumable components, and once the company makes a system sale, the relationship tends to be long and lucrative. Moreover, while Pall's products are quite profitable to them, they're typically not expensive enough to the end customers to justify replacing entire systems and interrupting operations.
It's also certainly true that the company's balance sheet is in good shape, which gives the company a lot of options in terms of returning capital to shareholders or growing the business through acquisitions. Last and not least, a relatively new management team still has room to maneuver with operational improvements that can boost margins.
The Bottom Line
The only thing I don't like about Pall is the price – this company rarely ever gets very cheap and investors are willing to pay a lot for its consistent cash flows. With that, even the fact that Wall Street sell-side analysis often over-estimate free cash flows doesn't really impact the stock. Not surprisingly, I don't think these shares are much of a bargain today, but I'd be in no rush to sell just on that basis.
Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.