Parnassus Digest November 2016
The
Parnassus View
Sept 2016 Nov. 2016
Investing for Principles and Performance® for more than 30 years.
Innovative Water Management Products from Well-Managed Companies Parnassus Investments seeks to invest in companies that both have a positive impact on society and are poised to generate good returns for its clients. Water management is a key area where cutting-edge products offered by skillfully managed businesses can help solve environmental problems. In this brief paper, Todd Ahlsten, CIO, discusses water shortages and quality issues, and explains why the Parnassus investment team has invested in Xylem and Pentair, two companies that sell products designed to manage water more efficiently.
Water and wastewater utilities in the U.S. release as much CO2 each year as 10 million cars. Xylem is the world’s largest provider of water and wastewater treatment solutions. The company holds leading positions across the water transportation, treatment and testing segments, as well as in the industrial water and irrigation markets. Highlights of the firm’s applications include: • Water quality analysis and measurement systems, such as monitors for automated leak detection • Water treatment and purification products, including emergency treatment solutions for disease outbreaks and chemical contaminations • Water recycling systems that combine filters, energy saving pumps, mixers and treatment technologies • Pump station backup systems that can prevent sewer overflows • Intelligent sensors that provide early warnings of water quality degradation due to flooding and rapid drainage solutions.
Water Challenges: Shortages, Waste and Quality Global challenges are mounting in all areas of water management, from available supply and quality to distribution. Below are a few examples of the many water problems that require flexible solutions: • Global water demand is expected to exceed supply by 40% over the next 15 years, according to the United Nations.i • Leaks from aging infrastructure result in an estimated loss of 2.1 trillion gallons, or about one-sixth of the total drinking water in the U.S. annuallyii, while developing countries lack the water infrastructure to support development.iii • Water and wastewater utilities in the U.S. release as much CO2 each year as that released by 10 million cars.iv • Climate change is projected to reduce water supplies due to heat and evaporation and to increased water quality problems attributed to flooding and rising sea levels.v
Pentair also offers compelling, cost-conscious water purification solutions, including filtration and desalination products designed to expand and improve the quality of the fresh water supply. Additional water-related products offered by Pentair include wastewater pumps, water-efficient irrigation systems and flow management valves and controls. These products aim to curtail water waste and sustain productive agriculture for the growing global population.
The Business Cases for Xylem and Pentair
Companies that both possess expertise in longstanding water infrastructure and offer the latest technologies have the potential to create innovative and meaningful solutions to these challenges while building successful businesses.
Changing demographics and population growth, increasing energy demand, shifts in food consumption and water availability will be powerful trends driving growth over the coming decades. Given the industry’s secular tailwinds, we believe that the water industry offers long-term investment opportunities.
The Relevancy of Xylem and Pentair: Tackling Water Problems with Modern Technology
In addition to the growing relevancy of their businesses, both Xylem and Pentair have the investment characteristics that we require for all our holdings, including sustainable competitive advantages, strong management teams, reasonable valuations and strong environmental, social and governance (ESG) profiles.
Two companies in the Parnassus portfolios help address complex and varied water problems like those highlighted above by enhancing water products with cutting edge software and analytics: Xylem and Pentair.
1
Principles and Performance ® | Nov. 2016
The
Parnassus View
May 2016 Nov. 2016
We view Xylem’s portfolio of products as one of the strongest in the industry. The company has a sticky installed customer base, strong brand loyalty, technology leadership and a global reach. Their large installed customer base allows Xylem to sell highermargin aftermarket products and services. This aftermarket business represents close to 40%vi of the company’s revenue and provides a predictable and stable source of revenue and income. We also believe CEO Patrick Decker, who joined Xylem with a background in lean manufacturing and Six Sigma continuous improvement processes, has shown that he has the right skills and experience to lead the company.
Xylem and Pentair combine deep industry experience and new tech-rich solutions to build smarter infrastructure. Likewise, Pentair implemented lean techniques nearly a decade ago with the objective of reducing costs through operational efficiencies, supply chain management and cash flow management. We think that there is more upside to Pentair’s cost synergies target. As the company continues to exercise control over its margin-improvement trajectory, its operating margin will continue to improve, and the company will depend less on volume growth to drive earnings growth.
Todd C. Ahlsten
Parnassus Investments, CIO Lead Portfolio Manager Parnassus Core Equity Fund
Incumbency and Innovation Xylem and Pentair bring together the heritage of deep industry experience and new tech-rich solutions to build smarter infrastructure, drive energy efficiency and improve the quality and quantity of usable water. Their management teams know how to grow businesses while contributing to positive change in society. As leaders in the water industry, their technologies provide solid competitive advantages, and their visions target solutions to key generational water themes that touch all segments of society. i Mis, Magdalena, “’Business as usual’ will create a thirsty planet in 15 years, says UN,” March 20, 2015. http://in.reuters.com/article/environment-wateridINKBN0MG0B620150320 ii Schaper, David, “As Infrastructure Crumbles, Trillions Of Gallons Of Water Lost,” October 29, 2014. http://www.npr.org/2014/10/29/359875321/asinfrastructure-crumbles-trillions-of-gallons-of-water-lost iii “World Water Council and OECD call for global action on financing water infrastructure,” April 13, 2015. http://www.worldwatercouncil.org/news/ news-single/article/world-water-council-and-oecd-call-for-global-action-onfinancing-water-infrastructure/ iv “Water Efficiency Saves Energy: Reducing Global Warming Pollution Through Water Use Strategies,” March 2009. https://www.nrdc.org/sites/ default/files/energywater.pdf v “Climate Impacts on Water Resources,” U.S. Environmental Protection Agency website, accessed August 26, 2016. https://www3.epa.gov/ climatechange/impacts/water.html vi Xylem Investor Briefing, August 2016, page 7.
As of September 30, 2016, Pentair Ltd. represented 3.1% of the Parnassus Fund TNA, 3.1% of the Parnassus Core Equity Fund TNA and 3.4% of the Parnassus Mid Cap Fund TNA. The views expressed in The Parnassus View are subject to change at any time in response to changing circumstances in the markets and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or the Parnassus Funds. Investment return and principal value will fluctuate, so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Any specific securities discussed may or may not be current or future holdings of the Funds. The Parnassus Funds are underwritten and distributed by Parnassus Funds Distributor, a subsidiary of Parnassus Investments and a FINRA member. Before investing, an investor should carefully consider the investment objectives, risks, charges and expenses of the Funds and should carefully read the prospectus or summary prospectus, which contains this information. A prospectus or summary prospectus can be obtained on the website, www. parnassus.com, or by calling (800) 999-3505.
As of September 30, 2016, Xylem Inc. represented 2.7% of the Parnassus Core Equity Fund TNA and 2.9% of the Parnassus Mid Cap Fund TNA.
1 Market Street, Suite 1600 l San Francisco, CA 94105 (800) 999-3505 2
www.parnassus.com
Parnassus View
Sept 2016 Nov. 2016
Investing for Principles and Performance® for more than 30 years.
Innovative Water Management Products from Well-Managed Companies Parnassus Investments seeks to invest in companies that both have a positive impact on society and are poised to generate good returns for its clients. Water management is a key area where cutting-edge products offered by skillfully managed businesses can help solve environmental problems. In this brief paper, Todd Ahlsten, CIO, discusses water shortages and quality issues, and explains why the Parnassus investment team has invested in Xylem and Pentair, two companies that sell products designed to manage water more efficiently.
Water and wastewater utilities in the U.S. release as much CO2 each year as 10 million cars. Xylem is the world’s largest provider of water and wastewater treatment solutions. The company holds leading positions across the water transportation, treatment and testing segments, as well as in the industrial water and irrigation markets. Highlights of the firm’s applications include: • Water quality analysis and measurement systems, such as monitors for automated leak detection • Water treatment and purification products, including emergency treatment solutions for disease outbreaks and chemical contaminations • Water recycling systems that combine filters, energy saving pumps, mixers and treatment technologies • Pump station backup systems that can prevent sewer overflows • Intelligent sensors that provide early warnings of water quality degradation due to flooding and rapid drainage solutions.
Water Challenges: Shortages, Waste and Quality Global challenges are mounting in all areas of water management, from available supply and quality to distribution. Below are a few examples of the many water problems that require flexible solutions: • Global water demand is expected to exceed supply by 40% over the next 15 years, according to the United Nations.i • Leaks from aging infrastructure result in an estimated loss of 2.1 trillion gallons, or about one-sixth of the total drinking water in the U.S. annuallyii, while developing countries lack the water infrastructure to support development.iii • Water and wastewater utilities in the U.S. release as much CO2 each year as that released by 10 million cars.iv • Climate change is projected to reduce water supplies due to heat and evaporation and to increased water quality problems attributed to flooding and rising sea levels.v
Pentair also offers compelling, cost-conscious water purification solutions, including filtration and desalination products designed to expand and improve the quality of the fresh water supply. Additional water-related products offered by Pentair include wastewater pumps, water-efficient irrigation systems and flow management valves and controls. These products aim to curtail water waste and sustain productive agriculture for the growing global population.
The Business Cases for Xylem and Pentair
Companies that both possess expertise in longstanding water infrastructure and offer the latest technologies have the potential to create innovative and meaningful solutions to these challenges while building successful businesses.
Changing demographics and population growth, increasing energy demand, shifts in food consumption and water availability will be powerful trends driving growth over the coming decades. Given the industry’s secular tailwinds, we believe that the water industry offers long-term investment opportunities.
The Relevancy of Xylem and Pentair: Tackling Water Problems with Modern Technology
In addition to the growing relevancy of their businesses, both Xylem and Pentair have the investment characteristics that we require for all our holdings, including sustainable competitive advantages, strong management teams, reasonable valuations and strong environmental, social and governance (ESG) profiles.
Two companies in the Parnassus portfolios help address complex and varied water problems like those highlighted above by enhancing water products with cutting edge software and analytics: Xylem and Pentair.
1
Principles and Performance ® | Nov. 2016
The
Parnassus View
May 2016 Nov. 2016
We view Xylem’s portfolio of products as one of the strongest in the industry. The company has a sticky installed customer base, strong brand loyalty, technology leadership and a global reach. Their large installed customer base allows Xylem to sell highermargin aftermarket products and services. This aftermarket business represents close to 40%vi of the company’s revenue and provides a predictable and stable source of revenue and income. We also believe CEO Patrick Decker, who joined Xylem with a background in lean manufacturing and Six Sigma continuous improvement processes, has shown that he has the right skills and experience to lead the company.
Xylem and Pentair combine deep industry experience and new tech-rich solutions to build smarter infrastructure. Likewise, Pentair implemented lean techniques nearly a decade ago with the objective of reducing costs through operational efficiencies, supply chain management and cash flow management. We think that there is more upside to Pentair’s cost synergies target. As the company continues to exercise control over its margin-improvement trajectory, its operating margin will continue to improve, and the company will depend less on volume growth to drive earnings growth.
Todd C. Ahlsten
Parnassus Investments, CIO Lead Portfolio Manager Parnassus Core Equity Fund
Incumbency and Innovation Xylem and Pentair bring together the heritage of deep industry experience and new tech-rich solutions to build smarter infrastructure, drive energy efficiency and improve the quality and quantity of usable water. Their management teams know how to grow businesses while contributing to positive change in society. As leaders in the water industry, their technologies provide solid competitive advantages, and their visions target solutions to key generational water themes that touch all segments of society. i Mis, Magdalena, “’Business as usual’ will create a thirsty planet in 15 years, says UN,” March 20, 2015. http://in.reuters.com/article/environment-wateridINKBN0MG0B620150320 ii Schaper, David, “As Infrastructure Crumbles, Trillions Of Gallons Of Water Lost,” October 29, 2014. http://www.npr.org/2014/10/29/359875321/asinfrastructure-crumbles-trillions-of-gallons-of-water-lost iii “World Water Council and OECD call for global action on financing water infrastructure,” April 13, 2015. http://www.worldwatercouncil.org/news/ news-single/article/world-water-council-and-oecd-call-for-global-action-onfinancing-water-infrastructure/ iv “Water Efficiency Saves Energy: Reducing Global Warming Pollution Through Water Use Strategies,” March 2009. https://www.nrdc.org/sites/ default/files/energywater.pdf v “Climate Impacts on Water Resources,” U.S. Environmental Protection Agency website, accessed August 26, 2016. https://www3.epa.gov/ climatechange/impacts/water.html vi Xylem Investor Briefing, August 2016, page 7.
As of September 30, 2016, Pentair Ltd. represented 3.1% of the Parnassus Fund TNA, 3.1% of the Parnassus Core Equity Fund TNA and 3.4% of the Parnassus Mid Cap Fund TNA. The views expressed in The Parnassus View are subject to change at any time in response to changing circumstances in the markets and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or the Parnassus Funds. Investment return and principal value will fluctuate, so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Any specific securities discussed may or may not be current or future holdings of the Funds. The Parnassus Funds are underwritten and distributed by Parnassus Funds Distributor, a subsidiary of Parnassus Investments and a FINRA member. Before investing, an investor should carefully consider the investment objectives, risks, charges and expenses of the Funds and should carefully read the prospectus or summary prospectus, which contains this information. A prospectus or summary prospectus can be obtained on the website, www. parnassus.com, or by calling (800) 999-3505.
As of September 30, 2016, Xylem Inc. represented 2.7% of the Parnassus Core Equity Fund TNA and 2.9% of the Parnassus Mid Cap Fund TNA.
1 Market Street, Suite 1600 l San Francisco, CA 94105 (800) 999-3505 2
www.parnassus.com
