Allegion plc (ALLE) Earnings Call Transcript & Summary

Perfect. Thanks very much, everyone, for coming to the afternoon session. It's my pleasure to have here Allegion, Dave Petratis, Chairman, President and CEO; and Kevin Sawyer, Investor Relations. I think as a reminder, any questions you have, please open up the QR code on the screen and you can send them to me and of course, anything around audience response survey, I greatly appreciate it as well. So maybe Dave, open up with a couple of prepared remarks, and then we'll have Q&A.

So first, thanks for the courage to host us here. I'm sure January is like, is the show going to go on? This one's the last dance. 2 years ago, we were here, and it's the first public investor event. So thanks for hosting, and thanks for having the courage to move on. From Allegion's perspective, market condition is extremely robust. I continue to be impressed. Incoming order rates, construction activity, leading indicators, of course, it could all be blown up to date based on the events in Russia, but I don't see that. But the market is extremely strong. We have some supply chain headwinds, particularly in the second half of '21. Balanced, we've built record backlogs between the mechanical and electronics. It's a balance between those opportunities that created some headwinds in the second half of '21, which we think will mitigate. Been extremely aggressive on the price lever to offset inflation. We will -- our pricing actions will exceed inflation in '22, I think just the speed of them in '21. We leaned in hard to make sure on things like air freight, and on the input side in '21 that we had to get ahead of, but I'm confident price increases, all channels, all customers, all fronts, and we'll continue to be aggressive. I think as we think about '22, we go into '22 with record backlogs, maybe 4 to 5x normal. I think you've got to look at that and say a robust -- it validates a robust market. We see 7% to 8.5% organic growth and a return to peak margins probably well into '23, '24. But we like the business. We like the incoming amount of activity. I think Allegion's extremely well-positioned. I'd say the last observation, there's a convergence going on across the security world, we call it seamless access. The advancements of smart locks, integrated capabilities that influences human productivity, the flow and access of people. Allegion, throughout the pandemic, invested significantly in new electronic products, but more importantly, our software stacks that allow us to partner and provide new experiences going forward in terms of the software stack as a facilitator for software development kits, APIs that allow integrators, our ability to use our venture capability and technology to provide new value proposition to customers. Never been brighter in our opportunity to be able to provide this, and it's a long-term trend in access and security that through your edge device, you're able to move through the events of your life on a daily basis and make it more secure. So those would be my thoughts.

Perfect. Thank you, Dave, for that opening. I suppose maybe in terms of a first question around one new topic, for years Allegion outgrew the market. And obviously, the last 6 to 12 months, you've had ASSA ABLOY out there seemingly doing very well in the Americas relative to Allegion. I understand sort of differences in business mix and so forth. But how do you see what caused that undergrowth on the Allegion side? And when do you think you get over that and back into that share recapture mode?

So said another way, ASSA ABLOY, the world leader, took me to the woodshed in '21, or at least the second half. I appreciate the question. I think, number one, you've got to look at it and say the market is robust for both companies. Number two is, is it a sprint or is it a race? I acknowledged that particularly in the second half, we took on some water head-to-head with them competitively. I think even if you turn the page to '20, we outperformed them pretty significantly. We've been a publicly-traded company for 32 quarters and consistently have grown, particularly in the Americas, but more recently, internationally. Some pretty good performance. We think that mojo returns as our supply chain correct itself. I think there's another vector to look at our '21 performance, particularly the second half. You load in our backlog, we're head-to-head. And I think ASSA, a very good competitor, we certainly think about how we compete against them. But I think if there were any areas where we may have lost share, if you needed it today, the discretionary market, and we were not able to fulfill that. It creates some share loss opportunities or their gains. The second is there's a lot of stickiness to what we provide, especially in the commercial institutional. As an architect designs a platform, customers tend to wait. It can be an aggravator. But if they absolutely got to have it today, we could have lost some share there.

Got it. And you mentioned the sort of the supply issues with chips. How does that sort of look today? What's the confidence level in getting that problem easing quickly?

I think a couple of strong observations on the supply chain. One year ago, I needed to be here. Because I looked at the markets, our incoming order rate and the broader macros a year ago looked pretty bleak on the commercial institutional. We were down double digits December, January, February, March. We put in a build plan that was reflective of that environment. We should've continued to put our foot on the gas. What gave us strength in '20 versus the competition is we put our foot on the accelerator and really perform nicely. We blinked, so that was the driver. Second, particularly in our exits business. You've heard me say we have the ability to make 2,200 variations of this Von Duprin exit device today. There are some unique manufacturing capabilities inside, they're called investment castings. Also some particular extrusions. We source those from Louisville, Kentucky, Northern Indiana. And again, the pandemic drove fluctuations, but there were pretty -- there were severe labor constraints in those areas. As an example, they've sent in the National Guard to drive school buses. So it was pretty severe. Those are suppliers that we depended on and they reflected that distress, and it hurt us on investment castings extrusions. Those have improved and will continue to improve as we have worked with them and have developed alternative passive supply on the mechanical side. So as I think about our backlog, particularly around that exit device, we have significantly more control as we think about reduction in the '22 backlog as we move through the year. And we'll improve month-to-month, quarter-to-quarter. On the electronics side, the chip, which is the other half of the backlog, our '22 guidance is based on the chip allocations. If we can get more chips, the revenue growth will be even hotter. I probably feel better about chips today than I did a month ago, than I did 3 months ago. Chip capacity, especially on backward-looking technology, industrials like us, you've got today's chip design, electronics supporting up to 7 years back. That actual output of chips has come up pretty dramatically, especially versus pre-pandemic. You've also got customers, manufacturers that are overbuying. Our success beyond allocations will be in the secondary market. We're working those hard. It's a little bit of a day-to-day, week-to-week fight. But I believe that, that will improve as we go through the year and give us some upside capability.

And then on the margin front, I suppose the sort of price cost aspect. Many companies gets a tough first half, easier second half as pricing comes in. Maybe kind of remind us what sort of price tailwind is embedded in the revenue guide for the year? And how do you see that price sort of playing out through the year?

Yes. So I think on the call, they kind of intimated that half of the growth is going to be driven by price. And so as you think about that dynamic with the pricing cost inflation and productivity all together, first half going to be problematic still. We're still working through some of those things. As we get into the back half of the year, it turns positive such that for the year, it's going to be positive for us.

And how do you see that cost environment today? Are you seeing that kind of leveling out and the price coming through? Or is more second quarter, you'll feel you got a better read on that?

So the inflation is going to continue into the first quarter for sure because we didn't start to see that impact until roughly about second quarter last year. So we'll still see that increase. We've seen things kind of level off in some areas. Steel starting to come down a little bit, but we'll see kind of how that goes, but other commodities kind of still at those peak levels.

Julian, I would add. I still see a mountain of inflation moving through all business, oil at $100 a barrel today is a great example. Pressure on wages, chips, up 25% to 30%. We will -- price will exceed inflation in Allegion. All channels, all customers, we've proven our ability to get price. Inflation spike so quickly in '21, we could have done a better job of getting a hold of it. But it will -- I don't expect inflation should mitigate, but we're not going to be surprised by it. We're going to be aggressive in pulling that price lever at every stop.

And maybe looking forward, who knows, a year, 18 months away, when that inflation sort of mountain is subsiding. Do you think you should capture a good positive margin tailwind at that point? The pricing will stay up, the costs come down. Do you think there could be a good opportunity there?

I think incrementally, yes. I think you got to think that there really hasn't been normal inflation for a decade going into this. So I think prices will stick. There'll be a new adjustment. I do believe there'll be opportunities in a couple of areas. One, as supply chains normalize, there'll be some downward pressure, especially on commodities. But inflation creates a flywheel for cost reduction opportunities that had really kind of run some of its course. I like the reload on that in terms of our product mix, the ability to go out in a self-help basis, get good cost reduction opportunities but also our industry has proven to be sticky because of the spec nature of it, particularly in the commercial institutional. So I like our position.

And when you look at the residential market, your business has been very volatile in the last 6, 7 quarters, and that's partly comps and then the supply chain aspects. How do you think about the overall health of that market today? What are you kind of assuming volumes do there in 2022?

So as you think about the last 24 months, severe ruptures in that supply chain, we performed very well because for the bulk of the North American business we produce in North America. That helped us through their belief that we gained share. But I'm more of a historian. This country for post World War II built 1.5 million single-family homes. That hadn't happened since the rupture in 2008. There's an undersupply. Even with rising interest rates, land prices, the country is going to continue to build homes at a pretty robust rate. And it's so dramatically different versus what we would have seen in 2015, that a good market out there propelled by electronics and retrofit. So I'm -- I feel good about the residential end markets. Certainly, forces working on them, land, labor, interest rates. But particularly in this country, we don't like to live in caves, and there's an undersupply of housing.

And the -- when you're thinking about the nonresidential side, how are the different verticals kind of playing out? And also, Allegion has a lot more in nonres greenfield exposure. But I think a lot of the other sort of the HVAC companies who have been here or whatever, how are you thinking about that sort of greenfield slope of recovery in nonres?

So our vision of seamless access, touchless access, edge device as the key, those are long-term trends that are going to positively impact our unique position on the door, one. Number two, if you look at some of the verticals, K-12, the average infrastructure 40 years, I've said that consistency. K-12 is like a big iceberg. There's $2 billion or $3 billion of market out there every year that continues to grow. Parents want modern infrastructure for their children. It's a nice, long-term driver. Higher ed, again, the investment there differentiating. I think our ability to redefine the access and security experience through edge device and electronic is compelling. And the example would be at Auburn University, where -- highlighted with our partnership with Apple, you can navigate the entire campus with your edge device, your cell phone, purchase a meal in the dorm room, whatever. Those things will continue to advance. I think, third, you think hospitals. If you -- nobody wanted to go to hospital in the last couple of years unless you're in big trouble. But there's been an underinvestment there or a void because small projects, renovation projects, the rethinking of how we deliver things like emergency care capacity. Again, it's a critical part of our business. Performance architectural specs matter. So as I think about the commercial, institutional and those particular segments, interesting. I'm challenged and have been for the last couple of years on the commercial office side. Let's face it. We're not going back in the office at the pace. You can easily save 30% of the workers that were office dwellers pre-pandemic are not returning. Again, I look at that as opportunity. Those spaces will be redeployed, which will take -- retrofit investment will be a part of that. I don't know that it -- how it comes out on the other end, but there's money out there to put to work. These spaces will be redeployed, and it should benefit Allegion.

Got it. And you think that the -- how do you assess kind of the different, say, this year of the aftermarket and replacement versus the OE side in nonres?

I think we're still working through the drop of activity that happened in '20 particularly. Again, you go back to this time a year ago, that drop in activity, particularly around the retrofit, was pretty pronounced, and it's taken off. I think that's part of the strength we're seeing in the market today. People allowed access back into working on hospital environment, K-12, a college campus, where they really didn't want to increase their exposure. So there's a lot of backlog to uncover, and I like it as a positive driver.

Then on sort of electromechanical penetration. Where do we stand on that today if you're looking at sort of main nonres, res in, say, Europe and North America?

I'd say you've got to think about electronics and seamless access or access through your edge device or by fingers, U.S. residential or residential around the world less than 10%. Commercial buildings, institutions, the perimeter doors, maybe 30% to 40% penetrated. Inside, the buildings completely wide open, less than 10% penetration. All of these opportunities, there's 40 billion openings in the world, probably less than 10% connected, electronic, seamless, that's our sandbox. Our industry has a unique position on the door. They're going to be more connected. They're going to be more electronic. We use a venture firm. We have a venture arm, Allegion Ventures, that try and look into these vectors of connected opportunity, along with these software stacks that I think will give us incremental growth as we think about the future in that emerging space.

And when you think about that sort of seamless access on the software stack, do you think you can -- what you've been doing organically is enough? Or you feel you've got to kind of step up the M&A a bit to make sure you stay ahead?

I think M&A will continue to play an important part of this. But thought through deeply, where do we have the right to play? Where does Allegion have the right to play the development and advancement of the software stacks, which we've made great progress on? And then what is the problem we're trying to solve? It could be visitor management in a K-12 school. It could be capacity control. It could be totally seamless access. An example I like if you're at Purdue University, that access systems are connected to the registrar's office. And we turn upside down the availability in the physics building instead of the building being open 16 hours a day it's available to the people that should be in the building. These are good opportunities to be solved. It first takes great hardware that's connected, WiFi-enabled, Bluetooth-enabled. It also takes software stacks and the ability to drive that. This is where we've maybe made the greatest advancements opening up literally hundreds of partnerships with integrators from Siemens to Honeywell to Bosch to Johnson Controls, but also gives us the ability to extend to provide visitor management of the K-12 school. It could be bullet detection that allows us to exit a building or go to shelter quicker. I like the opportunities. M&A will be a part of it. Ventures allows us to put our toe in the water. Can we learn, observe, partner, own? Yonomi, an acquisition, small $15 million that we made helped enable those software stacks. Openpath would be another one acquired for $400 million by Motorola Solutions, fully integrated there as a venture partner. It's just our venture arm looks at about 1,200 files a year. The software stacks help us to enable that new customer experience in areas where we have the right to play.

Perfect. And then one thing, Dave, you mentioned was getting back to kind of peak margins maybe next year. Even about the Americas business, on your operating margin line, you've hit that sort of 29% margin a couple of times in the last 5 or 6 years. Is there anything about that competitive dynamics or what have you, that means that's some kind of natural ceiling? Or no, there's no reason why you couldn't keep pushing?

Yes, there's a runway to go beyond that, right? So obviously, you need the volume leverage to come through there. But yes, I'd say peak margin comment more so for the total company for '23. Americas is probably thinking more 2024 time frame. But once you get there, yes, as long as the volume is flowing through there, there's no reason why you can't bump up past that.

An electronics-rich environment also accelerates that. Electronic walks in a variety of forms carries some very nice margins.

And in the Americas, do you see the scope for both resi and nonresi margins to move to new highs? Or is resi just very competitive and means most of the margin runway medium term is in nonres?

Well, the nonres is definitely more -- on the more profitable side of the business, so it's easier to lever there. Residential, yes, more competitive. You've got more entrants coming in that make them more competitive space, but there's no reason that those margins can't go up as well.

Look for us on the res side of it, continued advancement of the electronic portfolio. If you go to Consumer Reports, 3 of the top 10 preferred e-locks are ours, Allegion, Schlage. I think second is new value propositions, integrations that help drive that margin profile. It's a good space to be in. And product innovation, the refreshment as around battery performance, I think you'll see power to the door, which opens up new capabilities that will help us grow.

And as you've seen in resi, things like Amazon key are not that new anymore. They've been around a few years, worked with different partners. Have you seen anything evolve in the competitive landscape with that kind of offering? Or it's pretty much using the same vendors and suppliers as it did near the beginning of the launch?

There's definitely a shift and it's crowded the field. So people like SimpliSafe, Ring, Alfred. You've got Resideo kind of playing on that. What I'd call low-tech residential bundling. If you look deeply into most of those players, the lock continues to be a bit elusive. And it's because you've got to continue to mechanically perform. We've got features on a slick residential walk that are hard to duplicate. And that's why we command the presence that we do, and we're going to continue to try and defend that.

Perfect. And then looking beyond the Americas, I guess, international, it's been, what, over a year now that you merged Europe and Asia together. How satisfied are you with the sort of the turnaround and the improvement in that business since merging the divisions? And where do you see the sort of the longer-term margin entitlement today?

I think when you look at Allegion International, you've got -- it puts a smile on your face. We have grown and significant improvement in the operating income during in a pandemic. Two, the planning for that had gone on for a couple of years. We just didn't wake up. There's also, I think, a human capital deployment message in that. When you run Allegion and you spend a lot of time in reviews, it was pretty clear that major moves for us in the traditional mechanical world, whether it was China, Europe, whatever, we could incrementally continue to grow this, but spending the amount of management oversight in that structure was just a waste of human capital. We said, how can we reposition it? It yielded the formation of Allegion International and allows us to put more financial and human capital into the forward-moving future of seamless access. Critical. If you look, peel back, our SimonVoss Interflex business is performing extremely well. And also, when we first met, Julian, 8 years ago, the portfolio of our Allegion International, which its genesis was Asia Pacific and Europe is significantly better reflected in the numbers, but focused on where the market is going.

And do you think that to get kind of much further margin upside, you've got to kind of bulk up with M&A to get scale?

We still lack global scale. But look for us, there's maybe 1 or 2 transformational moves out there, hard may not happen on my watch. We're mindful of it. The second is continue to bid on where the market is going. Margins in the Nordics. Margins in the dock. Software, electronics connected. I think we've built a very good platform in Australia and New Zealand, and we'll see what happens in the rest. There's regions and countries that you want to compete in the world, and that's what we need to be focused on. Those regions connected to our vision of seamless access.

Perfect. And then lastly, perhaps on capital deployment, how -- several companies at this conference have talked about sort of stepping up buybacks recently, which is understandable. What's Allegion's view of the merits of that right now? And then on the acquisition front, how attractive is the kind of doors business in general, there's 1 or 2 assets that may be sort of floating around there?

So I'd say look for Allegion to continue to have a balanced capital allocation policy outlook. We've been rather robust in our share buybacks, look for that to continue. But on the assets of scale, especially if they're powered and connected look for us to lean in heavily. I'd say this, Julian, the amount of effort on the M&A side over the last 24 to 36 months is not reflected in the output. We have put a lot of thought energy strategy, repositioning into the opportunities that are out there either couldn't get it done or didn't like the price. We'll continue to be disciplined, but we're still optimistic in our ability to grow through inorganic means.

Perfect. Well, unfortunately, we're out of time. But thanks so much, Dave, for coming down and having a chat. Thank you very much, Kevin.

Thank you, Julian.