Tickers in this Article: PLL, GE, SI, CLC, DCI, BA
Being a disciplined value-oriented analyst can be a real pain sometimes, as it often forces you to hold off from buying names you'd really like to own. Filtration specialist Pall (NYSE:PLL) is a good case in point. The company has appealing returns on capital, a great, broad-based filtration business, and appealing upside to internal improvements. Unfortunately, the Street knows all about this name and the value just isn't there.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

A Very Solid Start to the Fiscal Year
Pall certainly got its fiscal year off to a good start, posting nearly 12% revenue growth in constant currency terms and beating the average Wall Street guess by about 10%. Growth was led by 19% higher sales in the industrial category, while life sciences was hardly a laggard at 14%. Biopharma, energy/water and aeropower, were notable subcategories with strong growth, while performance in medical, food/beverage and microelectronics was less impressive.

Profitability was more mixed. Gross margin declined half a point, largely due to both the greater contribution of lower-margin industrial sales and lower margins in that business. Operating income showed a similar story; overall operating income rose 14%, as good margin expansion in life sciences was outweighed by the industrial business. (For related reading, see A Look At Corporate Profit Margins.)

The Challenge is Clear - Lift Industrial Margins
One of the prime directives for the new CEO of Pall is to improve margins and working capital efficiency, particularly in the industrial space. Even allowing that results were hampered by the relatively poor conditions for companies in tech categories like chips, panels and solar, Pall needs to do better here to really maximize its growth potential.

On one hand, Pall has good things working for it here. Demand in markets like energy has been very solid and the company's aerospace business should benefit from relationships with both Boeing (NYSE:BA) and EADS. On the other hand, Pall faces major competitors, like GE (NYSE:GE), Siemens (NYSE:SI), Donaldson (NYSE:DCI) and Clarcor (NYSE:CLC) in these markets, and that may limit the margin potential.

Life Sciences Still a Fortress
Although health care has had its trials and tribulations lately, Pall still has a very valuable foothold here. Apart from companies like Merck KgA, Pall does not have quite as much competition here and the margins are attractive. With the need for contamination-free blood, water and pharmaceuticals unlikely to go away any time soon, this should be an excellent source of profitable revenue and cash flow for years to come, particularly as emerging market countries garner the resources to upgrade their medical facilities and demand more from their domestic health care companies.

The Bottom Line
Although Pall gets about two-thirds of its revenues from outside the U.S., it does not look as though the malaise in Europe has had a major negative impact, so far. Some of this is no doubt helped by the company's exposure to fast-growing emerging markets like China and Brazil, while some of it may also be a byproduct of the fact that much of Pall's business comes from high-margin replacement consumables (filters and the like), as opposed to original equipment. Whatever the case may be, 11% constant currency order growth is an encouraging sign for the quarters to come.

The biggest problem with Pal is that its qualities are not lost on the Street. Even adjusting the discount rate for its solid returns on capital and its rare participation across a broad range of markets, does not produce an especially compelling target price. Should the stock pull back I would love to revisit it, but for now I will have to admire from a distance. (For related reading, see What Is The Difference Between Return On Equity And Return On Capital?)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

comments powered by Disqus

Trading Center