Allegion plc (ALLE) Earnings Call Transcript & Summary

Hey, good afternoon, everybody. Moving on to our next session, second session of the afternoon. We're really excited to have Allegion with us today, Patrick Shannon, the CFO. Patrick, thanks for spending time with us today.

Well, thank you, Joe. It's always good to be here, and thanks for having us today. Really appreciate it.

Yes. Always. So Patrick, look, I'm sure we're going to get into the end market discussions and what's going on with nonres. But before we even get into that, I was hoping you'd spend just a minute or 2, really just discussing some of the innovations that you guys have done. You've announced a lot of things recently. And whether you want to kind of start with Overtur or some of the stuff you're doing within SimonsVoss. But maybe just start through and talk through some of the things that you're excited about that you have from a new product introduction perspective.

So Joe, as you know, innovation has always been a key driver in Allegion, and we've put a lot of investment dollars into new product development and/or channel development to accelerate growth faster than the broader market, and I think we've been fairly successful in that over the last several years. As I look at the opportunities going forward, I'd say they're significant, and we shared a little bit of that view in the last quarterly earnings release with our build-borrow-buy type of strategy. On the build side, new product development, making some really good inroads on electronics, on both the nonresidential and residential segments. And I think this whole trend relative to seamless access, touchless solutions, those type of things will continue to accelerate that development, and I think we'll continue to be a leader in the advancement of those type of products going forward. As you know, the penetration is still relatively low and so -- both on resi, nonresi. And so it does provide a good opportunity for continued growth at Allegion. We'll continue to drive that. We're doing things in partnership opportunities, as you know, to kind of ensure that we can fit into a broader ecosystem of solutions around security and access control and those type of things. We'll continue to drive that. You mentioned Overtur, a great digital collaboration tool as it relates to our specification business and how we interface with architects. And it really -- that tool, in particular, really helps us kind of manage the life cycle of a product in a building. And so not only in new construction build, but also repair/retrofit opportunities. We can now collaborate not only with the architect community, but general contractors can participate, or distributors and service repairs, those type of things. And so working on a lot of fronts to continue to drive innovation in our portfolio of products. That's going to continue to be a driver. And I would expect with the investments we're making, we'll be able to continue to outgrow the broader market.

So Patrick, maybe you can elaborate on that. Your commentary around the architect community, the general contractor community. Is there a way to maybe just maybe talk about the -- you guys have relationships across that entire value chain. How quickly are you signing them up to use Overtur? Like I'm just trying to get a sense for like the network externalities of this business.

So the adoption has been good. It continues to accelerate. We -- I can't recall the specific numbers attached to it, but it is gaining momentum. And think about it in term -- not just collaboration, but a good productivity tool. It used to be you'd send things back and forth via e-mail, PDF, those type of things. And so decision-making has accelerated in this process. And also helps, I think, us provide an advantage, not only on new construction, but if you think about the whole life cycle of the product, once our products are specified in new build construction, the ability to maintain that installed base really important because you have all the products there and the architectural plans and that type of thing. And so really helps going forward from a digital aspect of that solution.

Got it. That's great. Yes, no, look, stickiness is always a good thing. And you guys have shown an ability to outgrow the market historically. So being able to retain that, obviously, is something that could be pretty powerful going forward. I think just -- it may have been the first time you mentioned it, but you guys talked about a new introduction within SimonsVoss as well with the SmartLocker. I'm just curious, just maybe provide a little bit more background on what that actually is. Is that going to help you get some traction potentially with schools? There's a lot of discussion around like education stimulus. Just any other color around that?

So first of all, for the listeners there, the SimonsVoss business is based in Germany and has been a leader in digital cylinders, locks, access control solutions within the Germanic region. The business has grown fairly significantly over the last several years since we acquired the business. And you saw it in the numbers in Q1, really getting good momentum, not only in the Germanic area, but starting to expand outside of Germany. And as a leader in digital electronic cylinders in access control. So as part of their solution and a retrofit type of opportunity, one of the gaps in the portfolio was this locker solution. So I think it enables us going forward, particularly in the Germanic region, to participate in a broader solution set and maybe not lose out for not having that product in our portfolio to participate. So I expect continued growth there relative to SimonsVoss in their home country. As it relates to coming over to the U.S., no immediate plans in place to expand that technology in the U.S., but certainly an opportunity, something we would look at going forward.

Okay. We'll get into the stimulus discussion later because I know you do have some good exposure to the education end markets. But just sticking along this theme around innovation, you mentioned seamless. So maybe just talk about that a little bit more. Clearly, I think it's been an important opportunity for you, I think, going forward, whether that's the opportunity with Walmart or what you're doing on college campuses. Just provide some more color around like your seamless opportunity.

Yes. So it's becoming a -- as you would expect, it's more engaged now in the conversations around touchless, seamless access solutions. My belief is it's not going to be a landslide of activity per se, but I do believe it's going to accelerate the adoption of electronics, which is what we're trying to drive, higher price point, similar margin profile, higher EBIT dollars, if you will. And so the faster we can turn that, the better. Electronic solutions also provide probably a faster life cycle because folks will adopt to the newest technology. We're seeing that in the residential business, in particular, consumers wanting the latest and greatest technology. So we believe it's going to accelerate electronic adoption. I would say if you kind of look at our solutions today in percentage relative to touchless solutions, not a big part of the portfolio, but it will become bigger and be part of a broader set of ecosystem solutions. And our strategy has always been, hey, ensure that our products can interface extremely well seamlessly with other solutions, like a CBORD, for example, that can help integrate these solutions in a broader university campus and those type of things that will give us a competitive advantage.

Yes. No, that makes a lot of sense. It's interesting that, historically, we've talked about the electronic opportunity as being predominantly really more of like a residential play for you guys than it has been a commercial play. And -- but it is interesting because given your starting point is so low, I guess, how does that kind of change the addressable opportunity or the addressable market for you guys on the commercial side?

I think it -- with our large installed base, we are seeing an acceleration, particularly in the repair/retrofit market opportunity. That's start -- that's accelerating. It's always been an opportunity. I think it does expand a little bit more to the addressable market. But there is -- you take in the institutional vertical, for example, K-12 schools, where we have a large presence, and it's just -- the average age of a school is extremely old and due for an upgrade. And you talked about earlier some of the stimulus monies, well, we believe some of that is going to accelerate adoption to not only upgrade the current product, but to provide a better security solution for our children. And so I believe that's a good opportunity for us going forward.

You take all this together, and I know you have like a venture arm as well as part of the organization. How do you guys think about it? Is there a way you're thinking about how this accelerates growth or improves growth, whether it's like 1 to 2 points? Or I know we used to always talk about like the channel opportunity for the company and what that did for your growth profile. Is there a way to think about how innovation impacts your growth profile over time?

So we would say that our -- we're always going to participate at market or better. We've targeted 1 to 2 points better than the overall market growth if you kind of look at the numbers relative to our peers, and I think we've done a pretty good job in terms of outgrowing those guys. And it's all really centered around both innovation and channel development and filling gaps where we've got underserved markets there. So yes, I think this innovation, continued investment in that area, touchless access, seamless solutions will continue to drive that. Our market position, particularly in the U.S. and the strength we have, I think will continue to do that. Accelerating on the residential side of things as well. People understand the value proposition there, and we're going to continue to kind of see that going forward.

Okay. Great. Maybe since you started -- since you mentioned residential, kind of shift gears into the Americas division and focus there for a second. But you mentioned residential. I'm just curious, you've seen a pretty nice uptick in new construction. The resi market has been red hot. You announced this Lennar partnership not too long ago. I'm just curious like if there's any update on how that partnership is going for you. And specifically, how you're seeing your residential market trend.

So residential business is red hot right now. It continues both on new home construction as well as DIY. So the point-of-sale continues to be really strong through big box and Amazon, in particular. So we see that continuing to go forward. Maybe 6 months ago, the question was, was this going to be a flash in the pan type of thing and kind of fade away into the sunset. And if you look at the demand relative to new build construction, you look at all the economic indicators would suggest that there's going to be continued strength, not only in new build, but also in the renovation market. Consumers have strength. I just saw something earlier, paying down debt at a record pace. So financially able to make those investments in their homes. That's good news for us, particular considering, again, this electronic adoption. It's still only high single-digit adoption. And so there's a lot of growth opportunity there. So I think that's going to bode well not only for the continuation of this year, but the next couple of years. It is kind of our expectation, resi will kind of continue to grow. The nonresidential segment, we've talked about repair/retrofit improving. That was kind of the first end market to kind of hit the pause when COVID hit. And so that's starting to see a resurgence, particularly on the discretionary spend there, and that could be around electronics or other projects that were delayed. New construction is, as you know, takes a longer while. It's a long lead cycle business. And so when you start seeing the leading economic indicators, like ABI, Dodge Momentum Index, those type of things turning green, which they are, it's going to take a while for that to kind of build into our backlog and to see revenue on the growth there. But sequentially, the declines will start improving, i.e. get less as we progress throughout the year and should be in a good position beginning in '22 to start showing year-over-year growth at the beginning of the year.

Yes. You guys are late cycle within a late-cycle subsector, right? So that makes total sense. And just to contextualize the nonres point. I guess, nonres has been down for, what, 4 quarters in a row now. And you mentioned the repair/retrofit market upticking. That's about, what, about 35% of your business -- of your nonresi business?

Right.

Is that fair?

Yes.

Okay. Okay. And has that shifted to growth? Like, the repair/retrofit piece is still -- is now growing, but the new construction component is not? Are we quite at that point?

We'll start seeing that this quarter and going forward. Part of the -- what you're seeing in the marketplace is more enthusiasm from our distributors. End customers are getting those projects completed. And so you'll start seeing that portion of the business start showing year-over-year growth beginning this quarter. And that's why our outlook that we kind of gave relative to where we were at the beginning of the year, the acceleration of that business has given us a more favorable outlook than what we had at the beginning of the year.

That makes sense. When you think about like some of those broader macro indicators, whether it's the ABI or Momentum Index or whether you're looking at nonres construction starts, which one do you pay attention to the most for your business? And how do you think about the lag versus any one of those macro indicators?

Yes. So great question. And the short answer is we look at them all. If you look at one individually, it doesn't necessarily tell the total picture. And so we look at those -- we'll look at month supply or kind of backlog in terms of construction activity, employment and these type of things are also kind of feeders in trying to figure out the economics behind market demand. So they're all important. I think your question in terms of lag time, probably the most important. Historically, it's been 12 to 18 months, maybe on average, 12 months type of thing before when you see maybe the ABI index showing positive above 50, which it has the last couple of months, which was a turn from where it was in a trough maybe 6 months ago. And that normally takes about 12 months until that starts to turn into revenue for us.

Okay. That's fair. And then just for the purposes of the audience, like when you think about nonres construction for you guys in the verticals that you play in, do you overindex in any particular verticals either on the commercial or institutional side?

Institutional vertical is the most important segment for us. So think of K-12 schools, universities, medical facilities, government institutions, we do very well. We would say our belief would be we're the leader in those market segments, large installed base. Those segments of the market have not been as impacted as the commercial segment, and I believe will be faster to recover, which is good for us. And I would say, particularly on new construction, normally, what we see is it's a richer mix of products in those verticals, higher-end, higher price point products that go into new construction for those segments. And so that's all beneficial for Allegion.

Got it. That makes sense. I guess if you think about the retrofit -- like when we think about the stimulus package and what that could mean either for whether it's K-12 or federal buildings, we think about that as being, I guess, more of a retrofit opportunity than potentially new construction. Is that fair to say like for your business as well to be more of like a retrofit opportunity? And then are you -- I mean because you guys are so late cycle within this value chain, are you having those discussions yet? Or like they're still -- or you're likely to see those at a later date?

So I can see some of those monies being positively impacted for new construction as well as repair/retrofit. I think the broader opportunity would be the retrofit side of things. I mean just to kind of put it into perspective, there's a couple of hundred billions of dollars available that's already been passed through legislation, right, in the last 3 stimulus bills specific to K-12 schools. Now that's going to serve a lot of purposes, right? But a portion of that, I'm sure, is going to go towards improving security; access solutions; seamless, touchless solutions, what we talked about previously. And so I think that will help accelerate growth in our business. I don't see it as happening all at once, over an extended period of time. But that's a good, hopefully, stimulus to help accelerate some of these, in particular, aging schools that need to upgrade and put in electronics and better secure systems.

Yes. Makes sense. And then, Patrick, just maybe shifting gears a little bit to margins. The margins in the Americas business have been outstanding for a very long period of time. Clearly, seeing some degradation here with the growth rates. I guess, as you kind of think about growth returning and then sequentially improving, how should we be thinking about like a potential improvement in margins as well sequentially throughout the rest of the year?

So we always get the margin question. So appreciate that...

It just finally came like -- it came 20 to 25 minutes in. So I didn't lead with that.

Yes. I appreciate that. Look, we have had good expansion in margin, and we have high contribution margins. And the story has been, manage the input costs well and the incremental growth, we'll get some margin accretion. And that has been the story. It's been a good driver for earnings per share, as you know. And this year, a little under pressure. The mix component, resi being stronger than nonresi. We have the boomerang effect of some of these costs coming back end of this year, incremental investments. Inflation is a headwind. But having said that, your question kind of on a go-forward basis would be some of those headwinds decline next year. And with the recovery of the nonres business getting stronger with a higher-margin profile, I would expect we're back to margin accretion next year. We did a very good job kind of coming out of this pandemic in terms of managing the cost base, reducing the cost where we need to, being more focused in areas we need to drive growth and really prioritizing things. And so I think we're better positioned from a margin accretion than we ever have been going forward. And it should help as we get to a growth mode on the nonresi side, really start to help accelerate margins faster than maybe what we saw previously. Particularly if we're in a -- let's say, a steady state of inflation, where we can get the incremental price, pass it through the channel, we'll be in a pretty good position to get further margin expansion next year.

And Patrick, I don't remember off the top of my head, but the -- if I -- when you talk about like kind of like the mix dilution from resi versus nonres, how much of a gap is there between like the resi -- what you're selling in resi versus nonres from a margin perspective?

It's 10-plus points.

That's what I figured. Okay.

It's fairly substantial. And so that does weigh on margins. I don't want to use it as an excuse, but it's part of the math. Particularly when you got resi growing at 20% and nonresi is down, it does have an impact on your margin profile.

That's fair. And then just thinking about pricing, is that also partly because your commercial/institutional customers are a little bit more pricing elastic than the resi customers and there's ability -- there's an ability to earn -- to get more price? Or how do you think about the pricing dynamics of both end markets?

So historically, pricing in nonres, easier to get. The channel absorbs it, well-disciplined industry. It's just -- even in a deflationary environment, we've been able to kind of pass it on. So I would expect that to continue. We did go out with a price increase at the beginning of this quarter. All indications would be it's going to stick. It never rolls back. So with a -- as the market continues to grow, there's not going to be any discounting to kind of go back to where you were historically. And so there is stick-to-itiveness there on the nonresi side. Residential has been harder to come by, particularly in big box. The environment here is a little bit different given the accelerated inflation and has opened the door maybe to be more, I'd say, proactive and kind of get some there as well. But nonresi historically has always been in a -- the industry would suggest just kind of the mechanics and then how it operates it is easier to get as well.

Yes. And because your margins, I guess, are where they are in the Americas business, even if you run price-cost-neutral dollar on a dollar basis, it's still mix dilutive or margin diluted for the year, just, I mean, mathematically.

Correct. Yes. And that's how we're trying to manage it this year is to offset material inflation with the price increase.

That makes sense. As you think about then 2022, 2023 and your ability to get back to the, call it -- I don't want to call it the high watermark, but like the 29% margins that you've posted in Americas in the past, like what do you think the path is to -- in the framework to getting back to those levels?

More of a normalized growth environment on nonres would certainly be beneficial. A lower inflationary environment. The ability to continue to pass on price. If those areas are kind of all in place, then the margin profile would accelerate because some of the cost reductions we put in place will help us maybe accelerate that faster than what we've seen historically.

Yes. And so maybe said differently, if you get back to your -- you guys have been done a very good job of kind of growing 5%, 6%, 7% on an annual basis before this downturn, right? And then secondly, inflation holds, right, and we don't get much inflation. I mean it's fair to say that your incremental margins in Americas should be well above, I guess -- your gross margins are in the low 40s, it should be above that 40% range, right, in that kind of environment?

Yes. Incremental, yes.

Okay. That all makes sense. Maybe switching gears, international. Tim ran Americas for you guys for a long period of time. He's now running international. Like what expertise do you think he's bringing in from running Americas to help -- I know we're only like 1 quarter in, but international margins were great this quarter. Just what do you think he's bringing in to help drive better performance in international?

Yes. So he does bring a different, unique perspective. I think that's very helpful. A lot of things were in place for that margin profile improvement in Q1. It doesn't happen overnight.

It would have to be for 800 basis points.

So you don't wave your magic wand and that happens overnight. But he -- I think going forward, he's going to kind of continue with -- Tim is a great executor, operational excellence and kind of continue to improve the margin profile going forward. Now I think he brings a different perspective in terms of how to leverage company assets maybe more so than what we have in the past, taking what we do really well in Americas and maybe expanding that internationally, whether it be growing in underserved markets or what have you. Things, for example, in Australia, where there's a lot of similarities in the DIY channel and the residential business that Tim knows very well in the U.S. that he can carry over there. And so things like that, I think, will only benefit us going forward in the international arena.

Yes. Australia, you mentioned back in like 2018, you made an acquisition in Australia. And you launched your first electronic Trilock in the region. And you said it's like really -- like you're starting to see some benefits from it. Just can you talk about like the DIY trend there? It's just not something that, candidly, I'm as familiar with. And so it would be helpful to get a better understanding of it.

Yes. So the last couple of years downmarket, the overall resi market down fairly significantly. I'd say, stable to up, this year is a recovery mode, and that will play well for us. The Gainsborough acquisition there, leading brand name in residential locks there in Australian market, good channel access. And with this electronic new product, I think we'll accelerate some of the electronic adoption there. So well positioned. And Tim, as we talked about previously, brings some of that expertise from Americas here to that market. Merchandising, packaging, all those type of things -- aisle, how much share of the aisle you have, all those things really important there as well. And so I expect we're well positioned for good growth there, particularly with the recovery in the market.

Okay. That's great. As you think about international margins longer term, I know one quarter doesn't necessarily make a trend as we just discussed, but how are you thinking about the -- just the entitlement of the international business now collectively over the next couple of years?

Think about this year ending at peak margin will be the best performance we've had, again, combining both Europe and Asia collectively together, double-digit territory. So good step-up improvement. I'd see continuous margin accretion going forward, not at what we experienced this year or hope to experience this year, but steady improvement going forward. One of the benefits going forward will be on growth. So we're driving our electronics. We've got really good organic growth. SimonsVoss, Interflex, those are high-margin businesses, very profitable market segments. We're going to continue to drive that going forward, and that's going to help with the margin accretion. So it's not as dependent on cost reduction. I see that kind of continuing to move forward. But think of good growth and steady margin accretion with that growth going forward.

Yes. So the growth point is a super interesting one because I look at my own forecasts, and it doesn't seem like I'm baking in a lot of growth into international in the next couple of years. And I mean, is it your sense that you -- that your -- or expectation that the growth in international could start to mirror the growth that you're seeing in the Americas? I know it won't happen overnight, but is that kind of like what your expectation is over a longer-term period?

Potentially, but it's -- the mechanical business in Europe, in Southern Europe, in particular, lower growth business. And so that kind of weighs on the overall growth in the international segment. But looking at the electronics area, you could see pretty significant growth profile there. And the adoption of electronics through SimonsVoss, Interflex is starting to accelerate and just basis of the new products, cloud-based solutions, these type of things. And I like the prospects going forward there. And I think you'll see a better growth profile than what we've seen there historically, for sure.

And Patrick, growth can either come organically or inorganically. And we've talked about some of the acquisitions that you've done, whether it's SimonsVoss or you mentioned Gainsborough. How are you guys thinking about M&A today? Are there specific areas you're looking to expand in? Is there a geographic focus? Any color there would be helpful.

We look across the globe. Conversations are certainly more active than they were last year. So activity has picked up, but prices have as well. Our criteria for acquisitions hasn't changed. We look for accretive deals that are synergistic, core to our business, strategically make sense. So we'll continue to work the files. Our capital deployment is -- yes, would love to do some M&A, some tuck-in deals that are important to us. But if not, we're going to return capital to shareholders through accelerated distributions.

Yes. I was -- speaking of which, the first quarter, I think you had about $150 million. That was a little bit more than I anticipated. So is that just basically like you expect to redeploy your capital to buyback if you don't find any M&A as the year progresses?

Yes. That's kind of what -- there's no need to build excess cash, and we're a good cash generator and would expect that to continue. And so we'll put it to use for our shareholders.

Great. Maybe one last question for me, Patrick. I guess I know it's only been, yes, I think a couple of weeks since you reported. But just any other comments that you'd like to make on trends since you've reported and what you're seeing in May thus far?

Nothing in particular. Relative to our guidance, the revised outlook, we saw continued strength as kind of Q1 and April unfolded. So our outlook remains positive from where we were at the beginning of the year, particularly in the repair/retrofit. Again, it's going to take probably a little bit more time on the new construction. But I will say this, and I don't have any specific data relative to this, but as you do think about new construction, I would suggest that maybe things might recover faster than what we've historically seen in other cycles because if you kind of -- there was momentum going into the pandemic on new construction. And just like repair/retrofit, you kind of hit the pause button. Well, maybe the financing was in place or something and now people want to move forward with projects. And so I could see a situation where maybe that comes back a little bit faster. I mean we'll kind of monitor and see. But nothing in particular that I would highlight on that.

Maybe -- I said it was my last question, but you spurred a follow-on. How much of an issue is labor at this point? It's like -- is that -- could that potentially constrain the cycle? And what are you seeing specifically, whether it's in your own business or your customers or your contractors that are working on facilities, in terms of having enough labor availability?

I haven't heard it become an issue. It's been more on the supply chain, component shortages, perhaps. But labor constraints is always going to be a question mark. I think we've done a pretty good job in balancing production and being flexible in adding temp labor where we need to. So it hasn't been a deterrent in terms of top line growth, but that's something, obviously, we're going to have to kind of continue to monitor going forward.

Yes. You guys were our canary in the coal mine a few years ago on labor constraints. And so...

Yes. Yes. Yes.

But Patrick, I appreciate the time today. Always great to see you. Thanks for participating in the conference, and I hope you have a great rest of your week.

Okay. Thanks, Joe. Appreciate the time.

Thank you.