Allegion plc (ALLE) Earnings Call Transcript & Summary

Good afternoon. It's Andrew Obin from BofA Merrill. And thank you. Welcome to our afternoon session. We have the management team from Allegion. And presenting, we have Pat Shannon, the company's CFO. I think up until today, I had the only buy on Allegion on the street. So this seems to be changing. Hopefully, people are recognizing that the world is changing for the better. With that, maybe we can go straight to Q&A. For those of you on the phone or listening in, feel free to ask the questions on Veracast. It's very easy. And you can IB me, and I have my own set of questions, but as I said, if you feel like you want to ask something, please do.

So look, with that, maybe we can jump in. And the first question, I'm sure you have not heard this question before, it's very, very unique, maybe you can talk about America's nonresidential construction outlook.

Yes. Thank you for that question. That is a new one, by the way, but...

Okay. So we're trying for something very different today. What is the current outlook for nonres construction, particularly the verticals that are relevant to you? How has outlook evolved since the fourth quarter? And maybe we can talk about, just as a follow-up, sort of we can talk about order activity, backlog and specifications and all the good stuff.

Okay. So a lot in that question, a lot to cover. So let me -- I would characterize it and encourage people to think of the nonresidential market as 2 primary segments within that. You have new construction, which represents roughly 2/3 of our nonresidential business. And that is a -- it goes into the downturn later. Why? Because buildings that were already under construction are being completed and our product is going to ship. It may be a question of timing relative to delay and those type of things, but those projects will get done. But it's always later kind of coming out of the cycle as new construction projects are deferred, delayed. And so you kind of have to think about that in terms of the time lag between when a new building starts and when our products will ship, normally towards the end of that life cycle, and that could be anywhere from -- depending upon the size of the project, 6, maybe up to 18 months. So as shovels in the ground are being delayed, that does have an impact on our new construction business. We would say that for 2021, and included in our outlook that we gave in our Q4 earnings call, that this year will continue to remain soft as it relates to that side of the business. But seeing, hopefully, improvement in 2022, specifically around the institutional segment, which is our largest vertical segment and very rich in profits because of the suite of products that we sell into those various segments, including K-12, university, medical, government, et cetera, we have leading market share positions there and would expect that segment to recover faster than commercial office construction, for example. So think of new construction soft this year, recovering next year. The aftermarket, i.e., the replacement business, brake fix, different story. We experienced a fairly heavy decline in 2020 as we were entering into the pandemic because people were hitting the pause, deferring, delaying projects that's more discretionary in nature. We would expect that to recover faster. And what we indicated in our last conference call was starting the second half of this year, would expect activity to pick up. And we're actually starting to see some signs of that, i.e., renewed interest, more engagement with our wholesale distributors on that side of the business, quoting out jobs, stocking inventory, and would expect that to kind of recover faster going into 2022. And that's, again, 1/3 of our business. So the weight on nonres today is predominantly on the new construction side of the business.

So I actually did get one question on IB on Bloomberg. And the question is, it seems that the vaccine rollout is ahead of expectations. So what does it do to discretionary spend? And when will we see discretionary spend pick up?

Yes. So I believe, and again, the renewal and enthusiasm, perhaps a lot of these projects that were delayed were already approved, but just they weren't funded. And so it's not like we're starting from scratch. I think some of that will kind of work its way through the backlog. And we could see incremental business beginning, I would say, in the summer when a lot of these projects are done on the university side. And so -- which isn't inconsistent with what we had already kind of communicated. The question is, really, I think everybody is asking is, how fast does it move? And I don't have any specific things I can point to that would suggest an accelerated momentum from when we last kind of communicated this, but directionally, would anticipate things to kind of continue to work through the pipeline of projects and continue to show improvement as we progress throughout this year.

Got you. So another very unique question that will come from me, your residential vertical. So maybe you can just sort of talk about what's -- what has been the development in that market, what's your current outlook, what are you seeing.

Yes. Residential business has been very strong for us. We exited 2020 really kind of record backlog. Really good year-over-year growth, particularly in the second half as we're kind of starting to come out of some of the initial downturn associated with the pandemic. And we struggled kind of to meet demand all through the second half of 2020. So as we look forward into '21, we continue to see strong demand as it relates to new build construction. You really need to look at not only new starts, but kind of completions on new home construction, one. Two is the renovation market, the POS at big-box still is strong. People are renovating their homes, would expect that to kind of continue. The only thing I would just remind everyone is that in the back half of last year, we were filling the channel with inventory that had been kind of sucked out of the system because of the increase in demand. And so a lot of that was taken care of in Q4. Still have some of that to work through here in the first half of this year. Expect to be on more of a normalized kind of order revenue kind of momentum going forward, but expect continued strength, not only for 2021, but see that continuing into 2022 and beyond.

And maybe can you just talk to us because I think before COVID, you were sort of partnering up with a lot of -- you were partnering up with builders. You had new developments with big-box retailers. I think it also sort of goes into sort of the electronic strategy. Can you just remind us what's your go-to-market strategy with the residential channel and how is it different from competitors?

So I would say we've got 3 primary means of distribution on the residential: big-box, which would be 50-plus percent; we do e-commerce and then the -- through Amazon predominantly or Build.com, for example; and then we have new homebuilders, which is done either direct or through wholesale distributors. Our distribution strategy hasn't changed. Our competitive profile, when we look at any changes relative to what our primary competitors are doing, no significant changes there. Our strategy has always been ensuring that we have the best products available with the latest technology features, look, design, style, all those type of things, both on the mechanical and electronics and ensuring we have a good supply chain. We were able to manage through all the COVID disruption, plant shutdowns that were government-mandated, et cetera, with very little kind of disruption and then catch up to some of the peak requirements driven from the market extremely well. And so I would say we're in pretty good shape. The other thing I would mention, Andrew, is that maybe a unique item in our strategy is we have very intricate relationships with the mega-techs. So we work collaboratively together with them in terms of new product design and development, looking at in terms of consumer requirements, expectations, think of connectivity in terms of an IoT platform, what are the requirements there. And that drives our new product development strategy and innovation going forward. And it's helped us. I mean we were the first ones out with the WiFi-enabled lock, Encode, which is doing extremely well. And we would expect to kind of continue that platform going forward.

Got you. So maybe we can shift with that to the international business. You have announced some changes, I think, in your corporate structure, combining EMEA and the Asia Pacific business. So can you just talk about what will be the strategic priorities of the combined international business? And maybe can you just give us more color as to what regions are important to you, for those maybe who are more of a generalist?

Yes. So as you and I have talked before, a lot of kind of businesses included in that portfolio. We have a traditional mechanical business in Southern Europe, Italy, France, predominantly. We've got electronics businesses in the Germanic area through SimonsVoss Interflex, and we have a global portable security bike lock business that has a really good position in the Netherlands and a kind of pan-European business as well. All of those have different kind of market strategies, go-to-market strategies. They're different in terms of the maturity relative to product portfolio, electronics. But I would just say, the strategy really is each of those is different. Electronics is all about growth. We have great margin profiles. We really made some good inroads last year in terms of expanding those businesses. And you saw it in the numbers and the organic growth in the back half of the year. We expect that to kind of continue going forward. The mechanical side of the business is really about how do we improve profitability in some of the lower-margin geographies in Europe, i.e., Italy, France, so we've made good progress on that, did a lot of cost takeout last year. That will carry forward into this year. And global portable security, we don't talk about a lot, but on the backdrop of the pandemic, it really had a good growth profile, people, leisure activities, buying bikes and that type of thing, drove some good growth there. And so that's a steady business for us and expect that to go forward. But the primary segments of our business for growth would be kind of the Germanic area. Australia is coming out of a residential downturn, and we've got a pretty good business there in that market segment. I would expect growth beginning this year and kind of going forward as that market recovers. So it's, I would say, continued margin expansion. We ended kind of high single digits. I would expect over a 2-year period to be low double digits in that segment of our business. We did a lot of cost takeout when we combined Europe and Asia together, and that will help us going forward as well.

And when you combined the 2 businesses, did you guys take out one set of corporate headquarters? Or what are the immediate effects of sort of running the 2 businesses together?

So more of a regional cost, cost takeout. So we had 3 regions previously, Americas, Europe, Asia. Now we have 2, Americas, international. And so combining Europe and Asia together, we only need one regional support structure associated with that. And we even lean that out further so it could be more focused on specific opportunities in the market and where we need to go after the cost base.

But generally, your level of comfort with -- because I think you guys talked about crossing this double-digit threshold in international for a while. But all of a sudden, it seems that with the consolidation of the businesses and the steps you've been taking, both on the electronics side and mechanical side, finally, we're going to see it after sort of several years of sort of trying to get there. Is that fair?

Yes. Yes. Not probably this year. Again, we ended kind of high to mid-single digits this year. But we have a lot of momentum at our back, and things that we executed last year are going to help propel this year. And we're getting good growth, and we would expect as the market recovers in the pandemic, there's a good backdrop for continuous improvement, both on top line, as we outlined, and margin improvement as well.

Can we just talk about competitive landscape? And I know you guys don't necessarily talk about direct competitors, but it's not like you have a lot of them. So after, I think, ASSA bought August, we did see them sort of gain traction in North America, lasted only maybe a couple of quarters on a relative basis. I'm sure still a great competitor. But how is the competitive dynamic in North America? And how would you compare the competitive dynamic on the mechanical side and electronics side and maybe just sort of look at both institutional vertical and residential vertical?

Okay. No significant changes on the nonres side. There's -- we have 2 primary competitors, we would say, in the U.S. market segment, more fragmented when you go across into Europe, kind of on a country-specific basis. But no significant changes here on the nonres side. On the residential side, again, no big changes. You mentioned ASSA and their acquisition of August gave them maybe a broader product profile and technology capability on the IoT thing, but haven't really seen any significant changes recently in terms of our ability to compete effectively. They're a notable competitor. But I would say we've got a broader product portfolio, both on the mechanical electronic side and a broader distribution base, predominantly through big-box, where ASSA doesn't have as large of a position in aisle space as what we have.

And has COVID changed who the competitors are because I think there are a couple of specs out there focusing on access control, the sort of the idea of touchless entry. Well, is that even real in the market? How has COVID changed the competitive landscape and product requirements?

Yes. So I think good question. I would characterize it this way. The COVID and people thinking about touchless, seamless access solutions will help accelerate the adoption of electronics from mechanical. I think it's going to become an ongoing part of the narrative in terms of how customers think about those particular solutions. It's even helped us internally maybe, even though we had projects on the pipeline, maybe accelerate some of those things faster, put more dollars into the development of those. But it's not going to be a tsunami of activity, new products to market type of thing. Our industry, as you know, moves a little bit slower in terms of adoption and some of those technology. I think at the end of the day, it will be how we can continue to develop the existing products into an ecosystem that is connected, has good connectivity to different partners that maybe have the head-end systems on access control software. That's an important ingredient that we'll continue to develop. So it is a factor. It will help accelerate adoption, but it's not going to change overnight. Our portfolio today on electronics is 20% of our aggregate revenue. It's not going to go from 20% to 30% overnight. I do believe it helps improve some of the change incrementally, and that's good for us. The life cycle on electronics is moving faster, and customers will continue to adapt to the changes in technology upgrade from prior technology. That is a good trend in terms of the security industry and one that we'll kind of continue to participate in as well.

All right. Got you. So maybe with that, and by the way, to everybody, as I said, everybody on the webcast, don't be shy. Ask questions. Very happy -- I'm sure Patrick is going to be very, very happy to answer all of them, and I'm sure Tom and Kevin will let him answer all questions, particularly about [indiscernible] I can just see, Tom and Kevin going, of course, Patrick, [indiscernible] But -- and with that, maybe we can sort of shift to -- you talked about electronic locks. Maybe we can unpack a little bit your electronics portfolio. So can you just sort of talk about the evolution of the electronic lock strategy on the resi side, on the commercial side? How does the software sort of fit in because whenever we talk to investors about Allegion, clearly, I think this is a huge theme. And maybe we can just chat a little bit more about what's inside electronic locks today and how has the strategy evolved.

Okay. So again, a lot there. Let me start on the residential side. Today, I would say, we have a full suite of electronic products. We'll continue to upgrade, update those basis of changes in technology and connectivity. Again, I mentioned earlier, we have relationships with the mega-techs in terms of how do our products fit into some of their solutions. They're thinking about, a couple of years ago, it was all about last-mile delivery, Amazon Key, those type of solutions. We've got a WiFi-enabled lock. We were first to market in that with the Encode. That continues to be a bestseller for us. But those are going to be kind of this continuous evolution there of electronic locks, and a lot of the adoption is DIY. And so consumers understand the value proposition, to have an electronic lock, get rid of your key. And today, it's a huge opportunity. Today, the penetration on single-family homes with electronic lock might be 8%, 9%. It's growing. We would love to see it grow faster. We believe that it will continue to grow, and that penetration will continue to grow higher. We are pushing that in conjunction with the mega-techs. And I think people will continue to understand kind of the value there of upgrading from mechanical to electronics. New home builders, i.e., companies like Lennar, are starting to outfit new home construction with electronic locks. We're a provider for them for those new home builds. So you have more entry into new home construction, which is really good. On the nonresidential side, you mentioned some of these new guys kind of coming in into the market. Their play is kind of software, access control, having a full suite from that to be able to control one particular vertical. What people may not understand is that Allegion does have access control software products. We acquired ISONAS, would be one example. Interflex is a time and attendance, work management software capabilities. We have software capabilities. The key for us going forward is putting that capability together as a package solution with hardware, where you can manage access control, not only in the entry of like a multifamily resident unit, what through exit devices, general common areas and those type of things will be critical. And we'll have the capability to do that and focus on a vertical market like a multifamily type of area, I would say, in the near future. That's kind of being worked on. Software will continue to be an important part of the package solution. Our residential platform, the IoT platform, we bought Yonomi, there's millions of devices today on the Yonomi platform that operate through fincloud, mobile credential technology. Taking that capability and developing it for nonresidential will be critical going forward for us as well. And those are some of the things that we're working on to ensure we remain competitive. We've got really good products that can integrate with different partners. That's another strategy of ours, open platform, this ability to be able to connect seamlessly with multi providers on head-end systems, very important. And that's always been kind of a key strategy for ours, has been and will be going forward.

I just figured out why Yonomi is named Yonomi. Sorry, it took me like, it's you-know-me, I just figured that one out.

Yes.

But maybe we can talk about the sort of difference in electronic lock adoption by regions because you have a place like Korea on one hand, where you did make an acquisition, and then you have the U.S., I think ASSA is particularly vocal about it because they do come from Scandinavia, where I think electronic lock adoption in the institutional market is so pervasive. What are the big barriers? What keeps people from adopting electronic locks? And which markets are it's the most pervasive at? And what lessons can you take from these markets into the markets where you are present, but maybe it's not as pervasive?

Yes. The way to think about it, again, is exterior would be -- have a higher penetration entry into a building. You see that through a reader and card credential type of technology it's more of the interiors of an office building that may not have any electronics. And I think that's where a big opportunity is. We would estimate it's 1%, 2% penetration. So huge opportunity there. Multifamily would be another area, a huge opportunity. It's all about getting the value proposition, getting people to think about getting away from managing keys and lost keys and that type of thing and being able to control access through software that are connected to the devices, a very important value proposition. I would say U.S. is probably, in my mind, further along in the journey in terms of adoption, understanding the value proposition. Europe further behind. You mentioned Korea, electronic access, kind of 70% penetrated. So it kind of it advanced much faster in the inflection point. And then China is making headways, but more on the residential side. So I look at it, you got to think about it in terms of the opportunity is huge. It's significant. It will adapt over some period of time. The question, I think, everybody's asking is what is that journey, how long, and what's that going to take. So I'm still bullish, positive, that the value proposition is there. And the more that you can connect these products with an access control system, I think the better people will be willing to adapt.

So a couple of more questions from the audience. One, once again on Bloomberg, one on Veracast. So the Bloomberg question is, could you quantify the size of your software business?

Yes. So embedded in our overall electronics, which I commented earlier, 20% of our overall portfolio, within that number, would be software. Smaller -- much smaller is the piece of that business. So we have bits and pieces spread throughout kind of the globe that does that. But the predominant segment or products within electronics will be products. Locks, electrified exit devices, those type of things would be the majority of our electronic portfolio.

And would software grow in line with the products or would software outgrow the products within the electronics vertical?

Yes. So in the near term, products will outgrow software for us, okay, just kind of given the breadth of our product portfolio. But software will become a bigger part of the equation and so look for continued investment, internal, associated with that, again, to improve the connectivity and access management. And let me comment, our idea here is not to compete with the big guys that do this today. It's, hey, could we sell a package bundled solution and do it very well on smaller, midsized type of opportunities, where there's, we'll call it, 100 to 250 entry doors or openings.

Got you. That makes a lot of sense. And then another question, on raw material prices and pricing, any thoughts on raw material headwinds in 2021 logistics costs?

So we commented, with the rapid increase in commodity costs, it's going to be a headwind for us in '21. We had suggested $0.25 to $0.30. So a big impact as it relates to raw material cost. That's predominantly steel, aluminum, zinc, and it's not only on the raw materials, but also the -- our supply chain, packaging, freight. These type of things are going to be kind of continued pressure. However, one of the great things about our industry, historically, what we've been able to do is mitigate that through pricing, and we recently went out with a price increase that's effective beginning Q2, would expect to get north of 1-plus percent realization. And that will help mitigate the majority of the cost inflation on the material costs. The rest we'll get through productivity. And some of the carryover benefits on the restructuring that we implemented last year, the consolidation of the Europe and Asia businesses into one segment, all of that will help mitigate the inflation. And we kind of commented on that previously. I don't see any big changes right now. But that's what we're managing through this year.

And maybe now that you brought up restructuring cost takeout, can you just update us on the progress of cost takeout in the international side? Is it mostly the headquarters, or we're taking out some rooftops as well? And what are the structural savings for '21? And just remind us, I think you gave us a glimpse of it, what's the explicit number baked into the margin guidance on that?

Yes. So it's mostly headcount reduction, not any rooftop reductions. We did exit a business that had a lower-margin profile. So that will help in the accretion side of things. That's been executed, completed. All of the majority of the headcount actions have already been implemented. There's still some laggards kind of to come. But by the end of Q1, we'll be at kind of a full run rate, if you will. And you'll see that continuous improvement going forward. So hey, look, I feel really good about the progress we made in the back half of '20 and what we're going to demonstrate in '21 here in our international segment.

Got you. Can we just talk a little bit, if you -- I think COVID has been highlighted, at least by some, as an opportunity to sort of rethink the supply chain. You have noted that you have not had supply chain issues. But are you thinking about supply chain differently post-COVID? I know that, on the residential side, Mexico is a big source. I would imagine, for electronic locks, you're probably importing a meaningful number of components out of Asia. I believe you have moved some electronic components to Colorado, but just maybe give us a sort of your latest thinking, how you think about the supply chain.

Yes. So we build in-region predominantly, sell in-region. And so it's helped us through some of these challenges and to down -- to kind of adjust production, kind of to meet demand and both on the downside and the upside. No significant change in philosophy, strategy relative to manufacturing. However, on sourcing, because of electronic components, you want to ensure you've got multiple sources, a product, you've got inventory on the shelf. And so the latest change would be we're better off having on the shelf more inventory, at least in the near term. And so we're stocking up. We're providing longer lead times to our supply chain and so kind of rethinking about sources of supply more than changes in terms of our production base.

Got you. That makes sense. And maybe we have a couple of minutes left. Capital allocation, I know we've tried -- well, I should be -- we sort of talked quite a bit about doing a large acquisition in Europe. And I think other deals in Europe between your competitors happen instead. So what's the landscape for acquisitions in Europe today? And sort of what's realistic to achieve over the next 12 to 24 months given that a lot of these, frankly, a lot of these smaller companies are perfectly happy to make a lot of money and do nothing?

Yes. Right. Yes, collect the dividend check. And a lot of them are family-owned and -- right, and hey, they've been in business as long as we have and they enjoy their relative market position and what they do well. And so maybe there's no immediate impetus, but maybe the pandemic has created an opportunity also where people are kind of rethinking these things. I would characterize it this way. Allegion probably better positioned if there's going to be a consolidation, just given the fact of our lower business profile. ASSA is kind of locked out, to some extent, just from a regulatory perspective, and so we're maybe in a better position to consolidate the European businesses. But like you say, a lot of the nice larger businesses are family-run, and it's harder to unlock. We engage in conversations. We continue to do that. We'll see how things shake out. It would be nice to add to our business in some of those markets. There are some really good businesses there that would be additive and accretive to our business.

I think we are almost out of time. Let me ask just in terms of -- I think maybe time for one more question. Can you just remind us, structurally, what has your pricing been over the past several years, and how do you think about pricing, sort of any changes to pricing that you see? Why do you think the industry structure remains fairly stable for the past couple of years?

Industry structure stable, haven't seen any significant changes from a competitive perspective, very disciplined, is how I would characterize it. Yes. I mean you're aware, in the U.S., is there's essentially 3 major players on the nonres side. And we historically been able to get price in both deflationary, inflationary environments. And the idea here is manage it so we can offset inflation, at least to kind of a worst-case net 0 impact. 2020 helped us. We had a tailwind because of deflation. And we'll continue to push it. And one of the benefits of our industry, given the complexity, highly engineered products, codes and standards, et cetera, we have the ability to kind of pass along price. And the market is able to absorb it and get it kind of from the end customers as well.

And one more, actually, I got one more question. With your domicile, how are you positioned on potential for higher taxes? Does it give you extra flexibility?

We have flexibility. We're not immune to legislative changes in tax rates, if they go up in the U.S. But we might have more arrows in our quiver to kind of help mitigate that. What's absent of legislative changes, we can manage our tax rate to be in the low teens for the foreseeable future. It's how I -- that's it.

I think we are out of time. It's always a pleasure to have you guys. It's usually more fun having you guys in London. Hopefully, things move back to sort of in-person sooner rather than later. And as I said, hopefully, we can grab the pint of beer, if not in London, maybe at your headquarters or in New York. And...

We're glad to host you guys anytime. And thanks again for having us. Really appreciate the support. And grateful for you maintaining a buy through all the difficulties. Thank you.

Thanks a lot. Well, hopefully, we're -- it's usually a good sign. I really prefer to be the only buy than like the 20th buy, a better position to be in. Thanks a lot, guys.

All right. Take care. We'll see you.

Yes.