Pall - Great Business, Great Past Returns, But Appeal Is Limited Going Forward

| About: Pall Corporation (PLL)


Pall reported very strong results for the first quarter.

The company is sticking with its strong outlook for this year, despite the stronger US dollar.

The company runs a great business, and has a great track record, but the multi-year bull run has left the valuation too expensive currently.

Pall Corporation (NYSE:PLL) reported very strong sales and earnings growth this quarter. On the back of the operational momentum, Pall expects further earnings growth this year despite a stronger dollar.

Despite the great business and track record, the appeal remains limited in my eyes, with shares trading at a huge premium to the overall market as future opportunities to expand margins even further will arguably become more limited going forwards.

Very Strong Start To The Year

Pall started its fiscal year on a strong note, with sales being up 11% to $696.5 million. The strong growth was actually limited to some degree as a result of the strong dollar, as sales would have been up by 13% in constant currencies. That being said, deals added to the reported growth as well, although organic growth rates of 9% have been very impressive as well. The strong sales numbers positively surprised analysts which have been anticipating sales of $686 million for the quarter.

Growth has been split evenly between the life sciences business and industrial activities. Sales at the life science business were up by 11% $352 million on the back of strong biopharmaceuticals sales. Even as gross margins have been down by 80 basis points to 56.3% for this segment, operating earnings were up by 160 bias points to 24.5% of sales thanks to strict operating cost control.

Industrial sales were up a similar 11% to $344 million, driven by a strong performance of the process technologies business. Gross margins of the business were up by 110 basis points to 47.3% as strict operating cost control allowed the industrial business to expand earnings by 250 basis points to 18.7% of sales.

As a result of impressive sales growth and margin expansion, net earnings have been up by 23.4% to $88.3 million. Following significant share repurchases over the past decade, earnings growth on a per share basis has been even more pronounced. Earnings per share were up more than 28% to $0.81 per diluted share.

Backing out restructuring costs and a five cent headwind from currencies yielded non-GAAP earnings of $0.89 per share. Analysts have been anticipating that Pall would report earnings of $0.81 per share.

Solid Guidance Despite Dollar Strength

Pall sees the stronger US dollar providing a significant headwind for earnings growth in the upcoming year. At the same time, the operational momentum in terms of sales growth and margin expansion, should provide more than enough support to show continued earnings growth.

Consequently, Pall sticks with its full year earnings guidance which calls for growth of 9-15% in earnings per share to $3.75-$3.95 per share. The guidance meets consensus estimates at $3.88 per share.

Strong Balance Sheet, Premium Valuation

Pall has access to plenty of liquidity, having a billion in cash on its books. Combined with a net debt position which totals just $1.18 billion, this yields a very modest net debt position of little less than $200 million. This is a very manageable amount with the business generating EBITDA comfortably above the $500 million mark at the moment, resulting in a leverage ratio of just 0.4 times.

With some 109 million shares outstanding, which currently trade around $96 per share, the valuation of Pall's equity has risen to a whopping $10.5 billion.

Based on the performance over the past twelve months, a period over which Pall has generated revenues of nearly $2.9 billion, EBITDA of almost $540 million and net earnings of $380 million, this results in elevated valuation multiples. Shares trade around 3.6 times sales, nearly 20 times EBITDA and 27-28 times earnings.

Pall, A Combination Of Growth And Margin Expansion

Over the past decade, Pall has demonstrated impressive operational advancements in its operational performance. For starters, the company has grown its sales by roughly 50% since 2005 which translates into average growth in terms of sales of little more than 4%. In that light, the current growth rates of close to 10% are much stronger than they have historically been.

The pace of revenue growth has not been that impressive over this ten year period, as the quality of the growth was superior. Operating margins have risen from about 10% in 2005 to approach the 20% mark currently, which is simply very impressive. This factor combined with the 50% revenue growth allowed for earnings to triple over this ten year time period. The final gift for shareholders came in the form of share repurchases with the outstanding share base being down 10-15% over this time period.

Final Thoughts

Pall is a unique combination of roughly a 50-50% composition of the industrial business and the life science business, which combined with strong margins and solid revenue growth warrants a premium valuation. This premium valuation resulted from a relentless focus on innovation, advanced technology, a strategy of building ¨moat¨ and focus on return on capital.

The strong growth and margin expansion combined with valuation multiple inflation has resulted in a huge run in Pall's share price. Shares traded at just $20 in 2009, having fallen by 50% from their 2007 highs. Ever since, shares have roughly five-folded on the back of margin expansion and sales growth, but mostly as investors have attached a higher valuation multiple to Pall's business.

I had a look at multiple occasions in the past to check out Pall's prospects. I ended up concluding that the strong track record and balance sheet ought to be rewarded by a modest premium to the overall market at around 20 times earnings. Based on those multiples I stick with my targeted entry price around $75 per share, as I won't chase the current multi-year momentum ride. This is as opportunities to boost future margins are becoming less apparent going forwards.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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