Allegion plc (ALLE) Earnings Call Transcript & Summary

All right. Good morning. Thanks for joining us. I'm Tim Wojs. I cover building products here at Baird, and we're delighted to have Allegion join us again at our Global Industrial Conference this year. Allegion is one of the world's largest manufacturers of mechanical and electromechanical security products. From the company, we have President and CEO, John Stone. We have CFO, Mike Wagnes; and then we have Josh Pokrzywinski and Jobi Coyle, who are both down here in IR. So we're going to start with a few prepared remarks and slides from John, and then we'll do Q&A. So over to you, John.

Thanks very much, Tim. I'm having trouble getting this to actually advance, if we can click it forward. And one more. There we go. So real quick, Allegion, who are we? Pure-play provider of security and access solutions. So anything and everything around the door, we design the door, we hang the door, we seal the door, we secure the door. Truly iconic brands, Schlage, who invented and patented the first cylindrical lock; Von Duprin, who invented and patented the first panic exit device; LCN, who invented and patented the first door closer, all of these 100-year legacies, steep in innovation and steep in trust. We're in a good industry, and we have the industry's leading margins by far. Our broad customer base, strategic partnerships with people within the industry as well as the mega techs who are doing a lot of the wallet-based credentials, very strategic for access control. We have particular expertise in the Internet of Things with connected hardware, electrification, all forms of communications and cyber security. We do have a healthy growing services business that came to us largely through the acquisition of Access Technologies 2 years ago. Highly engaged workforce. In fact, our employee engagement has reached all-time highs, and we received the Gallup Exceptional Workplace Award just this last year. Leading presence, shaping a transforming industry as we push more and more into electronic access control and a growth-driven capital deployment strategy. Let's advance the slide, please. Global business, just shy of $4 billion sales. You see between electronics and mechanical about 2/3, 1/3 at this point. Institutional would be where we weight, the heaviest at about 40% of the business, commercial 35% and residential 1/4. Not perfectly precision numbers, but you could think of our business as about a 50-50 mix between aftermarket and new construction. The markets we serve, we see a total available market -- addressable market of $40 billion, split between North America at about $20 billion, and the markets we participate in, in our International segment at another $20 billion. Large market, nonresidential, mechanical low single-digit, I think real GDP type of growth. Nonresidential, electronics and software, high single-digit growth, and then our residential business also low single-digit growth. What we offer is convenience, security and increased simplicity of access. We feel, and I think we've demonstrated to have a very resilient business model led by our front end, powerful specification engine and a lot of specification expertise. That's how we generate end-user demand and use that to pull our products through our distribution channel. We have expertise across all end-user verticals. And if one vertical is weak, like you could see multifamily rather weak right now, our specification writers are capable enough to go over and write a data center spec for a mega tech that's building a new data center. We're leveraging this front end into the bolt-on acquisitions that you've seen us make this past year, and really making those bolt-ons just think of that as a low-risk way for us to grow and grow profitably, leveraging that powerful spec engine upfront. Strong execution, we talked about the margins, continuous innovation and highly engaged workforce. Broad end market coverage, again, heavily weighted towards institutional in Americas. That makes for also a stable replacement demand. You could think once you write the spec, you're in the building, repair, replacement, upgrades on electronics, tend to be like-for-like. And again, diverse construction verticals, balanced capital deployment, really, really happy with what we've deployed in terms of capital 2024 year-to-date. You can see a little over $360 million between dividends, repurchase and bolt-on acquisitions. Those acquisitions have had very attractive returns this year. Just to highlight this, again, capital allocation balance between continuing to invest in the core, investing for organic growth. We've released a slew of new products this year in both the mechanical space and the electronic space, continue to be a dividend paying stock, expecting that dividend to grow commensurate with EPS growth. Five notable bolt-on acquisitions you can see in the queue. These are very attractive tuck-ins to the portfolio. They bolt directly on to one of our existing business units and leverage that really powerful front end with specifications and distribution. Lastly, about $120 million share repurchase to date. Now between acquisitions and share repurchase, about, 1.5 points of EPS growth so far in 2024. That's it for the prepared remarks. Thanks for the opportunity. Tim, good to be back.

Yes. Thank you. Thank you for doing that. If anybody has questions, you can raise your hand or you can e-mail [email protected]. John, maybe just to start, maybe just spend a moment on kind of the overall growth strategy for Allegion. Just has anything kind of changed or evolved since you've kind of taken on the CEO role? And got a great North American business, great margins. Just I guess, how can we kind of accelerate growth back to that kind of 5% to 7% number that we've been accustomed to in Americas?

Yes. I appreciate that, Tim. A lot to unpack there. So has anything changed since I've been CEO? Yes, a lot, all right? When I became CEO, our supply chain was a mess. We were unable to ship a lot of products. Inflation had run well past our price. Our margins were declining. We had just closed on the largest acquisition in the company's history of SAT. And so yes, we had a lot to do. And I think now we're back to driving growth. Margins are back in a good shape. They've been expanding even without the help of a lot of market tailwinds and volume. We've still been expanding margins. I would say, again, employee engagement is at all-time highs. Engaged employees perform better. And then I'd say capital deployment, now that the balance sheet, the liquidity is in the shape we want it, that's starting to turn much more into the steady drumbeat that we expect to deliver to you. So we do expect to deploy 100% of our available cash flow through bolt-on acquisitions like we've been doing, through repurchase when -- that's the right decision for our shareholders. And now is the chance as the house is back in order, Tim, that, yes, we can reignite some growth. I would say, when you look back to the late 2010s, that was a really great time for non-res construction. No doubt about it, right? You were coming out of the early 2010s with the great financial crisis, things had really ground to a halt, the latter half of that decade, it was just a robust time for construction. So certainly, organic growth in that mid-single like you talked, had some help from the market. Lately with the pandemic and the recovery and all the supply chain issues has been very choppy for Allegion and for our industry as a whole. And again, we had a lot of self-help to do internally, but I'd say that focus on driving organic growth, product vitality is up a lot. We've been talking about that on our quarterly calls, so introduce a slew of new products. We're back building muscle on gaining share in the aftermarket and happy with the way that's going this year. So even without really robust end markets, still finding ways to put up growth and margin expansion, and I see that continuing into the future. Now is the time to really turn the growth back on.

Okay. Okay. That's good. I guess, I mean, you guys haven't given guidance for next year, but just as you think about 2025, just what are some of the swing factors we should think about around growth and margins? And I don't know if you want to touch, kind of bounce around on what you're seeing on the individual end markets.

Yes, absolutely. It's a good question. And I'd say commensurate with what we said in the third quarter call. You do have visibility into a couple of verticals that are rather soft. Multifamily is rather soft. I don't think that's a surprise if you watch the construction industry. Commercial office has been rather soft. But then you see the institutional segment still growing, education, higher ed, health care, K-12, et cetera, still growing. Data centers, I know it's way too often used moniker today, but that is a good part of our business, and it's been growing explosively just like it has been for others. And I would say, as we look forward, kind of the swing factors would be interest rate relief, I think for segments like office, like retail, like multifamily that do have a lot of privately financed projects. We are aware, we do hear about when we're out visiting customers and out with the channel. A lot of projects that have been through design, have been through a bid, and then just placed on hold, hoping for a better financing environment. Is there a magic interest rate that uncorks all that? I don't know, we're not economists. We're hardware and software people. But when the Fed cut back in September the 50 bps, there was an immediate spike in quoting activity. I think a lot of GCs were kicking the tires, looking to activate some projects that might have just been placed on hold. So I think that will be one of the swing factors that starts to turn some of these verticals back to positive. And we'll just have to watch how it evolves.

Okay. Okay. And I guess it's topical with the election last week. Any kind of preliminary thoughts on the impact of the election on your business? Kind of review maybe how you source. I know maybe there could be some import competition and things that are kind of in the markets. Maybe just kind of run through a couple of -- tariffs, obviously, but then anything else that you kind of see as a follow-on from the election.

Yes. That is the speculation de jure, I would say. And I think for Allegion, if you look at our core non-res Americas business, all those products are manufactured in the United States. We make Von Duprin exits in Indiana. We make Steelcraft doors in Tennessee and Ohio. We make closures in Illinois. So we manufacture here in the United States and have a lot of products already on the Buy American list. A lot of products certified made in USA. So I'd say the core non-res business I'm not overly worried about any adverse impact from tariffs. Certainly, there are -- if you look just specifically at locks, there is a handful of just say, very cheap, very low-cost imports that do come in. Could a tariff regime impact them? Possibly. I think, that's a possibility. I would say, yes, just in general, sourcing, you could think of our components that we do buy a low double-digit percent from China, and these are pretty simple little parts that if we needed to resource, I don't think it's a very heavy lift. We built a lot of that muscle 2 years ago, you could imagine, as we just had to because of supply chain challenges. So not overly concerned on the tariff environment type conversations we've heard so far, but we have to watch and see what actually happens.

Okay. Okay. And then just maybe on M&A. I guess you've done, say, five tuck-in acquisitions now year-to-date. So I think maybe, a, if you can just kind of talk about the financial contribution to those because they're smaller, but I mean if you start adding them up, I think there's probably something there that gets overlooked. So how are you kind of thinking about the financial contribution of these deals? And then also just the pace because, obviously, if you can get 4, 5, 6 type tuck-ins done a year, I mean it starts to kind of accumulate pretty quickly in terms of growth and EPS growth.

Absolutely. And I appreciate the question, Tim. I think Allegion's history has been successful with acquisitions, but also a bit sporadic. I think what we look to do is be a bit more programmatic just think steady drumbeat of capital deployment, we will deploy our available cash flow. Our objective is not to accumulate cash on the balance sheet. We want to put it to use for our shareholders. And on the acquisition front, really, really happy with what we've acquired. So we found high-growth niche spaces that would be really difficult to try to figure out a way to justify as an internal R&D project. So acquisition makes sense. These acquisitions have brought in Allegion like margins. So yes, those margins are out there. We found good people, good products with good reputation. And the value that Allegion adds is, again, the super powerful front end with specifications and a very strong field sales and marketing force and distribution channel. So we can scale these businesses much, much faster and at a much lower incremental cost than these companies could do on their own. So really excited about that. And if you look again at our most recent 10-Q, you can kind of see what we got and what we paid. And we got these businesses at very attractive multiple, I think high 9s or 10x EBITDA, which is good for us, given where we trade. And it's, I think, very plausible to think about a couple of points of growth from acquisitions from acquisitions from us on an ongoing basis.

Okay. And I guess to your point on the spec network, I mean, is this something where you can build -- effectively, these are people that have distribution, but don't have distribution as well as you. So as you think about buying these businesses, would you make the argument that it's going to actually feather into organic growth 2 years, 3 years, 4 years down the line because you're going to push this into distribution, in spec network and this is going to be a way for you to theoretically accelerate organic growth, too.

Yes, absolutely. When you look at the two acquisitions in the Americas, in fact, so Krieger out in Los Angeles makes specialty doors that are now a growing trend for radio frequency prevention, also bulletproof to a very high level, custom doors. So you get a lot of 3-letter agency type business, you get a lot of specialty business there, and growing trend. Also data centers very much like radio-frequency proof doors, and that's a growing space for them. And we can accelerate that because we have developed end-user standards for everybody who's anybody that builds a data center. And now we can expand our own offering, but also grow the Krieger business. It will turn into organic growth. And Unicel's portfolio helps with privacy in health care facilities, behavioral health, mental health, major hospitals, et cetera. Super profitable business, and with our specifications and our end-user relationships, we can help grow that much more rapidly than anyone else could.

Okay. And you talked about the margins being Allegion like in terms of -- do they have to be Allegion like? Or are you willing to buy good margin businesses that you can maybe improve? Or do they have to kind of meet margin threshold for you to kind of -- because your margins are so good. I just -- I don't know how many those types of businesses are out there, I guess.

We've been pleasantly surprised. But I would say not everybody is going to come with commercial Americas margin. We get that. I think we've got muscle. We've got capability. We've got capital as well to invest in productivity and build pricing discipline, pricing muscle and help these acquisitions who might need to expand their margins. I feel pretty good about our capabilities there. Primarily, what we're going to look for is a good ROIC for our investors.

There's a question here from the audience. Just if you could talk about opportunities within service and just kind of recurring revenue.

So I'd say today, if you're just kind of lump in like we've done software services is a small like mid-single-digit percent of the total sales. it is growing. It's primarily concentrated in two areas. One is more on the mechanical side with our Access Technologies, our automatic door business here in the U.S. And then our Interflex business, which is a software business, primarily also with some electronic hardware in the Germanic region of Europe that is electronic access control, time and attendance management, workforce management, kind of a suite of solutions all around credentials and employee identification that's very popular in Europe and growing well in Europe. We are looking for ways to transfer the learnings from both of those business units into other parts of the company. And I'd say growing well, but growing from a small base. So I think it is important for us to continue to invest there, but do so in a very pragmatic way that builds this up in a more gradual way that just helps dampen our dependence on the construction cycles.

Okay. When you bought the Access Technologies business, I mean, part of what came with that, I think, is an installation kind of service type business. So from being a manufacturer to kind of getting into installation and service. I mean, how attractive is having that type of business model? Or do you feel like that's kind of a one-off situation? Or do you see that as a business model that you'd want to Allegion to be, I guess, larger end?

I think it depends on the product for exits, closers, locks, it's not really applicable. I think our distribution model today with the specification engine, that's the right model there, and that continues. For automatic doors, just given the continuous usage of it, the install and the service is very relevant and very important. What we have found, Tim, if you recall, a lot of the synergies that we talked about at the time of that acquisition were, again, consolidated on the front end. We see that coming through frequently as you go to a major health care project, and now you're bringing all the traditional Allegion hardware, you're also bringing the automatic doors that service element that Stanley Access technology brings has frequently put our bid over the top and we win the business. So I think it is focused where it's appropriate for a lot of our portfolio, it's not appropriate, but I do see it continuing to grow.

Okay. Maybe just on software, could you kind of elaborate on your strategy there? How you can try to own some level of software, but then also not compete with some of your channel partners. So how do you -- I guess, what does that mean your software strategy can look like? And I guess, how do you kind of balance any sort of potential channel conflict?

Yes, it's a good question. And I think without a doubt, software is now core to Allegion. We write the software that sits embedded in the lock or the exit device, those electrified components today. We write the software that integrates those hardware devices with the big single pane of glass guys like Lenel, Honeywell or JCI or them. So there's no channel conflict. There's no competition. We plug into them, and they get value then from easy integration and working with Allegion or Schlage locks. I'd say elsewhere, we have worked on, we've developed much more automated ways, cloud-based ways for those integrations to happen and happen a lot easier. It takes a spectacularly surprising amount of time to integrate a new device with all these access control guys. With the cloud platform, we've developed based on the Yonomi acquisition over few years ago, you take what was taking multiple weeks or even a couple of months down to just a few days. So we're excited about that innovation and that efficiency, and we think it will make us an even better partner of choice for the JCIs and the Honeywells and Motorolas, whoever. Elsewhere, like we do have in Europe, with Interflex and SimonsVoss, we do have access control, time and attendance, workforce management. And when you lump all that together with the plano acquisition from a year ago, that's our own internal rule of 40 business. It's very attractive, and we do look to continue to grow that. And it's getting to a meaningful size at this point. I think there's a similar potential when you look at some underserved verticals in the U.S., where something like a Honeywell system or a JCI system is just way too expensive and weigh too much like an apartment complex, a multifamily complex. They don't need a super sophisticated enterprise access control system. They need something simple. And the hardware OEMs like us and our two major competitors, it seems like we're seeing the future in a similar way. We're bringing a suite of electronic locks together with a very simple access control system that does generate some recurring revenue, albeit very small today. But that kind of complete solution for that kind of vertical, K-12 might be another one that is ripe for that kind of simple solution. I think holds good potential for us. And it's definitely a space where we have a right to play and a right to win.

Okay. Okay. I want to ask Mike a question. So I guess on Americas margins, I mean, you obviously have very good margins. They're kind of back to basically pre-COVID levels. And I think that on an underlying basis, they're even better because of the access business you bought. I guess what's the go-forward opportunity on margin expansion? Should we kind of still think of this as a 35%, 40%-plus type incremental margin business over time?

The U.S. business, the Americas business, we're blessed with a high variable contribution margin. So as we grow, we should be able to leverage that for margin expansion. I would expect on a long-term basis, that 30% to 40%, we've always done to continue. Obviously, that changes year-to-year, depending on the amount of volume we get, but we should. And you've seen in the last few years, we did run into troubles in '21 and '22, but we've recaptured that lost margin. And moving forward, I would expect to see margin expansion. And then incrementals in that 30% to 40% range that we've done, and it kind of changes year-to-year depending on like the big factor would be volume. But it's still in that 30% to 40%.

Okay. I mean you used to talk about incremental investments as you kind of spun out of Ingersoll and kind of rebuilt the business. I mean, are you still making a lot of those incremental investments? Is that kind of investment pool kind of leveled out?

I think it's important to understand, we're always going to invest in our business. We showed in the slides earlier today, some NPD activity that drove this year. Look for us to continue to invest but we're going to drive the productivity to pay for it. So one of the things you'll hear us talk about on the earnings call is price plus productivity is going to cover the inflation and the investments and that is something we use to help manage the level of investment spend and how we pay for it. So we'll continue to invest, but we're just going to pay for it by driving productivity in the enterprise.

Okay. And I guess, just there's been a lot of price and moving pieces with inflation and things, but maybe just kind of remind us your philosophy around pricing on kind of an annualized basis? And just kind of how that works in the industry?

Yes. For us, the big input is what is going to be inflation. We're going to drive the pricing necessary to cover inflation, especially if you look at our business, our nonresidential business in North America, has the best pricing power in the portfolio. But look for us to continue to drive that. If you think about the last few years, pricing was higher because inflation was much higher. We are in an inflationary environment. We expect to have pricing and inflation moving forward, and we expect the pricing to be adequate to cover it. But I wouldn't expect to see the pricing that you saw a couple of years ago when you're at double-digit pricing. I think we're a more normalized pricing environment where you could see, depending on the level of inflation, 1 point or 2 of pricing, not the double-digit pricing environment.

Okay. Any questions from the audience? Maybe just on electromechanical, just maybe big picture, where are we on the adoption curve in electromechanical, recognizing resi and commercial are two totally different markets there.

Yes. I think adoption is still growing. And at the same time, we're starting to see some of the early adopters of electronic locks, particularly in higher ed, now upgrading to a new device or a new credentialing technology primarily to work more seamlessly with mobile phones as your identity and your credential. So again, the mantra is still twice the price, half the life. So adoption is growing, but the replacement cycle is also kicking in. So we feel good about electronics and our portfolio continuing to be a high single-digit growth driver for us.

Okay. And I guess in the spec business, just how should investors think of like the typical lag between like quoting starts and when your products go in relative to a lot of the construction indicators that are out there because...

This has been interesting to learn, Tim. And I think the spec engine never turns off. It's always running. And if it's a mega project like a huge hospital campus, it could be measured in years from spec to hang in the door, if it's multifamily, it could be mid-single-digit months, from spec to hanging the door. So it's quite a wide variety, difficult to tie it spec activity to a particular time period revenue. So I would just say it's always on, we're aggressive, and we can deploy resources wherever we need to across all the different verticals.

Okay. We've got 45 seconds. So can you just kind of -- I mean, data center business, I think, is pretty small as a percentage of construction. But just can you talk about where Allegion is on the data center business?

So think of a data center, huge structure, security is paramount. And the openings could be 200 to 400. So there's a lot of doors, let's just say. Security is very important, like I said, so that also means typically very premium product from Allegion. So across the board, growing and growing good business for us.

Okay. Okay. Great. Please join me in thanking Allegion team for being here today.

Thanks, everyone.