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  • Pall Corporation (NYSE: PLL)

    Analysts Dalton Friedhoff dalton-friedhoff@uiowa.edu

    Zhendong Jin zhendong.w.jin@gmail.com

    Company Overview Pall Corporation manufactures and distributes high-tech filtration, separation, purification consumables and systems. Pall Corp has positioned itself as a global leader in the filtration industry, with operations in Europe, the Americas, and Asia. The company reports revenues under two segments: Life Sciences and Industrial. The Pall Life Sciences business segment serves end-users in the biopharmaceutical, food and beverage, and medical markets. The Pall Industrial segment serves end-users in the process technologies, aerospace, and microelectronics markets. Excluding the impact of foreign currency translation, Pall Corp experienced a 1% sales increase in 2013, due to a lack luster industrials segment performance, offset by tremendous growth in the biopharmaceutical end user market.i

    Stock Performance Highlights 52 week High $91.83 52 week Low $62.72 Beta Value 1.30 Average Daily Volume 667,206

    Share Highlights Market Capitalization $9.47 b Shares Outstanding 109.78 m Book Value per share $5.42 EPS (2013) $5.10 P/E Ratio 27.39 Dividend Yield 1.27% Dividend Payout Ratio 19.61%

    Company Performance Highlights ROA 16.86 % ROE 34.58 % Sales $2.648 b

    One Year Stock Performanceii

    Current Price: $85.45

    Target Price: $85.47 - $89.85

    Separates from Competition

    Favorable Regulatory Environment: As the global population keeps growing, water scarcity becomes an increasing concern for developing countries. Regulations in China currently limit the annual consumption of water, therefore increasing the need for water recycling facilities. We believe stricter regulations coupled with greater filtration awareness will provide a channel for long-term sustainable growth.

    High Growth End Markets: Within the filtration industry, the life sciences end user segment offers the highest growth rates. Pall Life Sciences is currently responsible for just under 50% of sales, which we believe will increase 700 bps to 56% by 2019. The membrane filtration industry for biopharmaceutical companies is expected to grow at 16% CAGR.iii

    Diversified Business Portfolio: Pall Corp. currently serves 14 different end user markets within three major geographic regions. Not a single customer of Pall represents more than 3% of annual sales. We believe Pall Corporations robust business portfolio will enable the company to capitalize on high growth prospects, while mitigating risk through diversification.

    Strategic Acquisitions: Pall Corporation continues to expand its position in the filtration industry through strategic acquisitions. Identifying a growing need in the biopharmaceutical industry for single-use filtration systems, Pall acquired ATMI LifeSciences in 2014. We believe this strategic acquisition will provide many synergies for Palls already high growth pharmaceutical segment.

    Operational Improvements: Due to the highly fragmented nature of the filtration industry, Pall Corp is continuously looking for operational improvements to stay ahead of the competition. In 2013, Palls restructuring yielded over $50 million in costs savings, with expected incremental savings of $25 million per year in fiscal 2014 and 2015. We believe these operational improvements will allow for at least a +200 bps improvement on the COGS and SG&A lines combined.

    Krause Fund Research Spring 2014

    Industrials

    Recommendation: HOLD April 22, 2014

    Page | 1

  • Based on the current economic environment, our research conducted on the industrials sector, and company-specific analysis, we recommend Paul Corporation (NYSE: PLL) as a Hold. We believe Pall Corp and its sub-industry, filtration, are currently in the growth stage. Pall Corps relatively large market share in a highly fragmented industry coupled with leading technologies, distinguishes Pall from its other main competitors. Pall Corp has strategically positioned itself to generate over 60% of its revenue from the Process Technologies, and Life Sciences end user markets. Compared to other filtration markets, these business segments have the highest growth potential, along with the highest margins, and the replacement needs for end users is high. While we believe the filtration industry and Pall Corp have huge growth potential, we do not find the value of the company inexpensive, as it is currently trading at 30x earnings.

    US Gross Domestic Product US Gross Domestic Product (GDP) measures the dollar amount of goods and services produced in the United States within a specific time period. GDP growth fluctuates regularly during economic cycles. Within the past 10 years, US GDP growth reached as high as 3.8% in 2004 and fell as low as -2.8% in 2009 due to the financial crisisiv. For Q4 2013, the final estimate of real GDP growth was 2.6%v. After observing the trend of the GDP growth during the past two years, we believe the overall US economy is warming up and heading to the expansion side. During 2014-2018 we expect GDP will grow 3.0-3.5%, reaching a 3.2% growth rate thereafter.

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    Historically, US GDP growth has a high correlation with the performance of the industrials sector. Improvement in GDP indicates a positive sign for industrials companies, like Pall Corporation. Gross domestic investments on machinery and equipment have been increasing in the past two years and grew at 10.9% in Q4 2013vii. We expect the demands for industrials products will maintain its growing momentum during the next 5-year period, and in turn will support the healthy revenue growth for the industrials sector.

    Interest Rates

    Interest rates are especially important to the industrials sector as most industrials companies are capital-intensive. Fluctuation in interest rates directly affects companies ability of financing, especially through issuing debts. Companies that have access to cheaper capital often can generate more economic profits from their business operations.

    In the US, yield on the 10-year Treasury bonds is considered as one of the most important numbers in the world of interest rates and serves as the benchmark to calculate corporate costs of debt. The yield has kept climbing from its lowest level at 1.93% in May of 2013 since the Feds first announcement of tapering on the quantitative easing program. The 10-year Treasury currently has a yield of 2.721%viii, which is still considered low compared to historical records.

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    We expect the 10-year Treasury yield will stay below 3.0% throughout 2014 since Fed has the intention to keep interest rates low until unemployment rate falls below 6.5%. As a result, Fed will not likely fully phase out its asset purchase plan by the end of this year, which will keep suppressing the yields on Treasury bonds. Low interest rates lead to low cost of debt, which in

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    Average Monthly 10-Year Treasury Yield

    EXECUTIVE SUMMARY

    ECONOMIC OUTLOOK

    Page | 2

  • turn will translate into more profits for industrials companies with large-scale capital expenditures.

    Commodity Prices A major group of customers for the industrials sector are commodity producers, such as oil and gas companies. Therefore, commodity prices, like crude oil, indirectly influence the performances of many industrials companies, including Pall Corporation. Decreases in commodity prices often signal lower demands for products and services from industrials companies.

    According to the data from the US Department of Energy, world crude oil price, traded as high as $104.07/barrel in 2013, will continue to drop below $100/barrel until 2016 due to the decreasing demands from emerging markets, like China, Europe, and Indiax. However, we expect the crude oil price will pick up again in the long run, as oil is more expensive to extract because of the diminishing marginal returns in global production. As a result, we estimate the short-term decrease in oil price will drag the growth of industrials companies, but the situation will reverse in the long run.

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    Currency Exchange Rates Most industrials companies have extensive operations around the world, which means those companies revenues are susceptible to fluctuation in foreign currency exchange rates. Companies exporting goods and services oversea generate less revenues in a strong US dollar environment. While, companies spend less to import products from foreign suppliers when dollar appreciates against other currencies. On the contrary, a weaker dollar is unfavorable to companies that demand products from abroad.

    Due to the large presence of US industrials companies in Europe, Euro US dollar plays as one of the most critical currency exchange rates in the industrials sector. According to the below chart, Euro has kept appreciating against US dollar during the past year, which benefits industrials companies that supply goods to European countries.

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    Considering the current low interest rate environment paired with the continuing quantitative easing program carried out by the Fed, we