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Industrial manufacturer Pentair (NYSE:PNR) has strong secular emerging market opportunities that will be enhanced by the Clean Process Technologies (CPT) acquisition, in my view, beyond what management was originally expecting. Integration of the buyout has come smoothly and revealed more synergistic value than the earlier-cited $20M and $10M worth of revenue and cost improvements by 2014. Indeed, CPT is presenting considerable cross-selling opportunities for Pentair in the emerging markets on a few different levels.

First, I had anticipated that the company's technical products group would be forced to focus more on top line growth versus margin improvement, but now anticipate a favorable reversal that will help in long-term value creation. Operating margins, I believe, will increase by more than 260 basis points to 13.6% in 2013. Taxes, at the same time, will decline from 32.4% to 30.8%. Much of this improvement is being driven by LEAN management and supply chain optimization. It will catalyze profitability in the emerging economies by transitioning those regions from being low-margin regions to high-margin regions. The company has had the capacity to increase scale for a while, but its ability now to increase scale without eating into margins will go a long way to improving long-term ROIC.

Furthermore, management has been conservative about sales and targets 7% growth from 2011 to 2015. I anticipate water segment revenue growing by 20% to $2.5B in 2011 and then by 11.4% the next year. My model predicts technical products growing by 22.3% to $1.2B in 2011 and then by 4.3% the following year. Increased R&D spending from 2.2% of revenue currently to around 3.7% by 2013 will also result in increased market share, importantly in China where the industrial company is far from saturating the market. A variety of new products will also be seen in the water segment, which has high-growth potential.

With emerging market sales expected to represent upwards of one third of sales by 2015, Pentair is well positioned to hedge against domestic and European macro stagnation. Higher volume, reduced costs, and synergies from the CPT acquisition will result in market share gains and improved sustainability for the industrial manufacturer. Given that the company has a beta of 1.1, diversification abroad will also be helpful in reducing risk.

On a negative note, the stock is trading at higher multiples than peers: 14 and 10.8 for P/E and forward P/E, respectively. Dover Corporation (NYSE:DOV), ITT Corporation (NYSE:ITT), and IDEX Corporation (NYSE:IEX) are trading at at 9x, 8x, and 10.6x forward earnings while offering in-line dividend yields. At the same time, Pentair's investments in food security and infrastructure will largely drive growth in a way that more than justifies this premium. Possible new offerings in thermal management should also be carefully watched as a sign of market penetration.

Consensus estimates for EPS are that it will grow by 23.5% to $2.47 and then by 15.8% and 16.1% in the following two years. Accordingly, analysts rate the stock around a "buy". I find the stock is also undervalued given increased international exposure and improved operational efficiencies. With a decent dividend yield of 2.58% and a beta of 1.1, I anticipate the company being one of those few gems that generate high risk-adjusted returns while actually providing for favorable risk asymmetry.

Source: Pentair: Undervalued Given Market Expansion And CPT Acquisition