Allegion plc (ALLE) Earnings Call Transcript & Summary

Good afternoon, everybody. Welcome back to some of the afternoon sessions for Virtual Laguna. I'm Josh Pokrzywinski, Morgan Stanley's electrical equipment and multi-industry analyst here in the U.S. Joining me this afternoon is the team from Allegion, including President and CEO, Dave Petratis. Dave, thanks for joining us. Rest of the team, thanks for joining us as well. Always a pleasure to have you in Laguna. Obviously, virtual format this year. So we'll promise more sand next year. But before we get started, I just want to read a quick disclaimer here. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, guys, thanks for making the time today. Like I said, pleasure is always to have you.

And our pleasure. I think 12 months ago, the beautiful views from The Ritz-Carlton, still in my mind. I lived in Orange County for a decade. So I know exactly what that venue is like and look forward to getting back to that normal. I'd say, in the face of a pandemic -- my manufacturing career is about 40 years. I guess a pandemic had to go along. Couldn't be prouder of the performance of Allegion in the face of the pandemic. I think utmost, we kept our people safe and healthy during the ongoing events. This -- our strong value at Allegion has been safety. We're one of the safest workforces in the world. As a business strategy, Allegion kept its foot on the gas globally. And as we continue to navigate through 2020 and into '21, I believe the strength of that strategy and keeping our people safe is going to continue to shine on Allegion performance. I'd say, number two, global supply chains have been stressed. The Allegion supply chain strategy is to produce and keep our supply chains within geographies. That delivers some of the highest margins in our industry. But supply chain within the major markets that we participate have been extremely strong. And I believe we're gaining share today because we've been able to keep our foot on the gas and minimize any supply chain reductions. The third, a long-term push has been seen with access. The pandemic put some adrenaline shots in things like e-commerce and the growth. We see the strength in DIY, touchless access, visitor management electronics. We believe true seamless and touchless access continues to be a driver that will benefit Allegion. And last, Josh, we're in great financial shape, generated good cash in the first half of the year that will continue. And our philosophy not to sit on cash and be a good steward of capital deployment remains on our mind. So couldn't be prouder of Allegion. And with that, I'll take your questions.

That's terrific. Dave, so I think for most of these, it's good to get kind of a sanity check on demand. But I want to get to that in a minute because you raised an interesting point in some of those opening remarks about employee health and safety. And I think you guys are probably one of the more consistent companies we cover in terms of talking about that and kind of broader societal awareness in terms of your workforce. So it definitely does not go unnoticed. So when I asked how you think some of the workplace kind of life after COVID trends may evolve, it comes with the credibility of someone who takes it pretty seriously. So what do you see happening in buildings, whether it's schools, office buildings, manufacturing facilities, whatever, in terms of how folks kind of alter their strategies or alter some of the hardware to make those safer and anything that Allegion is doing for that matter?

So I think any President, CEO in the world is going to be looking at what's dedicated to space allocation for employees and it's going to be challenged. And that includes here at Allegion. I think the opportunity in that is how space will be redeployed, how space will look like in terms of efficiency. I like opportunities like touchless access, visitor management. Why do I need a reduction as -- when technology will allow me to manage the density of people in the building? If that's a restriction or just even regulating who gets into a building or not, that can move into what we call a seamless electronic environment. I like that. I think second, you get into hospitals, we've clearly seen the hospital system globally be stretched. The COVID-19 is an infectious pandemic. I believe things like seamless access can help reduce the travel of infection inside a hospital. When you go to a hospital, it's not the procedure that you're going in for. It's the infection that you'll catch that will kill you. I think the pandemic will challenge, well, why -- when I get past the access point in the hospital, I can really go untethered. Why not control that? So if I got a procedure, a visitor, my edge device and seamless access controls that. I like that type of opportunity. I think third, there's huge investment in commercial retail that's going to be under pressure. That will be redeployed. We just talked -- I was talking with Tom about, you see the move by Simon Properties with Penney's and that they'll become e-commerce sites, e-commerce is going to continue to grow. These spaces will be redeployed. I look at that as opportunity for Allegion. And so a couple of things to think about.

Got it. And have you seen any customers -- thinking about some of the big verticals out there, offices, hospitals, education, where they are coming to you to put heads together on what they need to do? Or is it still a little too early in the process?

I think we're in a position that we're promoting those access. I think you've got to get in the mind of your customers. Generally, customers don't even want to see on site. There's really tight restrictions on ability to get in. We did see some early activity within hospitals, and it's -- you're getting capacity, new flows of people. We saw some shots in that, especially in the Americas. But I think still to be determined. I think about the institutional part of the market that's important to Allegion. If I'm on a college campus today, it's all about safety and health and preventive maintenance. Project work gets kicked down the priority list, that will come back. If it's an emergency, it gets done. But I think we'll actually see some snapback. And I think when the pandemic subsides, they'll be rethinking about, okay, what -- how do we manage access to drive efficiencies within buildings?

And then I guess just thinking about the markets out there, nonresidential, I think you were early amongst your peers to say, look, this could generate some softness in 2021. And look, we live in cyclical markets and they're long-cycle and they're high-quality, but they can still be weaker. Compared to maybe 5, 6 months ago for that initial observation, are things kind of generally unfolding as you've seen -- as you've expected where you're starting to deplete some of that backlog of activity? Or have there been any kind of surprises along the way?

I'd say, number one, my words were caution lines. You had to look at the overall demand. Our backlogs remain healthy. Number two, projects in flight continue. I think three, bond issues in flight also continue. And I think we've got to look at the elections that are coming up and bond issues that are driven at K-12 universities. I've been surprised with some of the resiliency of institutional projects. You've got to balance that with the ABI index. But I think we still got a ways to go to sort that out. Surprises for me have been the strength of residential driven by, one, an undersupply, and that's nationwide; number two, discretionary spending that would go into restaurants and entertainment. People are investing back in their homes and we happen to have one of the best lineups of residential locks on the continent. It's been good for Allegion. And then you get back to that supply chain. I believe our supply chain in that residential space is stronger than our competitors. It's certainly more local and that helps when you're not shipping product from halfway around the world. So the other thing, Josh, I'd point to is just the continued strength of electronic and seamless access. As homeowners are thinking about how I can improve my IoT capability, our Schlage Encode lock continues to be just the best product out there on the market, the highest ratings. And people are willing to invest in it as you see the growth of e-commerce, as I've got potentially children that are studying from home, whether their movements, there's clearly benefits. McKinsey would state that the smart lock is growing at a high single-digit pace. We're stronger than that. And it's a product that's resilient where you might have a smart speaker that you adopt and it goes in the drawer. These smart locks are a product that sticks.

Got it. And I do want to come back to some of the phenomenon on the resi side. But just to close out nonresi maybe by some of the different market verticals or the way you address the market, anything between some of those major verticals where -- things that maybe have been a bit stronger than -- now you mentioned bond issuances, which kind of speak more to the institutional or maybe education side. Anything on, I guess, the private side that is an observation that you can make?

So this may sound elusive, but I'd say too early to tell. We have seen recovery in booking trends. We track like our hollow metal business with frames in a couple of dimensions. Backlog remains healthy. But specs, hardware quotes, those types of things, I describe as tepid. Wholesale sell-through, pretty good shape. So it's a mixed bag. We're still in the middle of a pandemic. Construction continues, but I'd say too early to really make strong trends.

Got it. And then on the retrofit side, I think as much as your distributors do hold inventory, maybe it's not quite as subject to shifts as some other verticals out there. But any observation on kind of inventory levels out there in distributor channels and whether they've bled things down or are looking to restock kind of that relative to where you would expect to be at the end of the construction season?

I would say inventories on the commercial -- or contract hardware distributors and wholesaler, I would say they're taking a conservative approach. As you move to the big box side, I think Allegion was quite clever. We used some of that wholesale inventory to offset supply problems when we had the 16 days down in the Baja. And I really complement the Allegion team. We went in and if you look at our point of sale versus our drop in revenue, point of sale was really high. We achieved that because we were working the inventory. So we got to rebuild that wholesale as well as the retail e-commerce, big-box inventories. And the business is responding phenomenally to that. I really couldn't be prouder of our ability and it's that strength of the supply chain to position in that opportunity.

Agreed. That was a pretty clever move, just kind of maximize the effect of the inventory you had out there. How long does it take to replenish those various channels? And clearly, point of sale isn't exactly letting up on the DIY side either.

So in a like-for-like, a lot -- 16 days, it was really more than that. So you've got to say a couple of months, but we've also got increased demand. And so we'll be well into the first quarter of next year before we normalize. I would point specifically to the res base. Feels like we're gaining share. And so that tends to keep those backlog high. I just -- I'm an old manufacturing guy, as you know, but have been just super impressed with our ability to respond. We're producing new -- more residential locks than we have maybe since the peak of the housing 2005, 2006.

And on that front, I mean clearly, the electromech side of residential is kind of in its own orbit at this point. And it seems like you guys have the right product and certainly a fresh product lineup there. Any changes, though, in the mix, the channel, competitive dynamics that have popped up as demand has been a little stronger as of late?

I just would -- if you really think about the competitors that we go in U.S. res and where their supply chain is oriented versus our in-geography supply chain, it delivers superior margin in terms of what we do and it has much less complexity. And I think when you look at the security industry, Allegion performed extremely well because of that simplicity.

Was that kind of -- I mean I think you guys have already kind of put the bear case to bed on this whole kind of commoditization of resi electromech. But still, if you go on Amazon, you can find some weird products on there. In your mind, has that kind of put that off to the side permanently? Or will those folks still come back from time to time?

I think we'll continue to face competitive pressures. I think that's where -- when you start digging into the star rating, in our very strong position as a replacement product in res, we're not only forming great customer relationships with players like Lennar. You've also got homebuilding that is on a surge and they want confidence in supply chain. And we can back it up and then put one of the best online capabilities in the marketplace. You've got to like Allegion. That online capability, Josh, is driven by a couple of things. One is overall mechanical design, which you've got to keep customers safe. Two is battery life, which we have the longest in the industry. And third is the connectivity within the IoT ecosystems. You've got to be able to unload and do that extremely well. By being one of the early producers of both off-line and online electronic locks, we've learned a lot over the years. We've got some very good capabilities that I think customers recognize.

Got it. That is helpful. Any stratification that you see happening of a good, better, best offering, where maybe there's an entry-level price point that needs to come in the market that wasn't there before? Or as people are buying in the pandemic, it's the same stuff they would have bought before?