Allegion plc (ALLE) Earnings Call Transcript & Summary

Well, look, thanks everyone for being here. It's my pleasure to have up next Allegion, John Stone, President and CEO; and Josh Pokrzywinski from Investor Relations. I appreciate everyone being here.

And maybe John, we'll start off with a sort of fairly open-ended question around end demand. You had your financial results for 2024 a couple of days ago. Give us some flavor as to what you're seeing in the main end market verticals as you look at it right now?

Yes, absolutely. Appreciate being here, Julian, and thanks for giving us some time. I think for Allegion, if we start with the Americas, you see the non-res segment. Last 3 quarters, in fact, a bit of a return to some volume growth, which has been very favorable and continuing on in. We see that mainly driven by the institutional segment that we took some time in Q4 earnings call to talk about, show some data around data centers, of course, is still having explosive growth. It's a small part of our business, but still rapid growth nonetheless, and has certainly made up for some of the softness that you see in multifamily and commercial office. Residential, our '25 guide is not contemplating any housing boom, so to speak. I think we all see stubborn mortgage rates. So definitely, we think the non-res part of our business would outgrow the resi side on the Americas. In international, generally kind of flat. And the tough part for Allegion International is, we are having a fairly sizable hit from FX translation, that's kind of depressing the growth there. But suffice it to say, we've got decent markets in Southern Europe. Germany kind of flat, Australia and New Zealand kind of flat. So not a lot of end market help there in international, but some new product launches, some acquisitions helping us continue to grow. And also really excited about the acquisitions that we've bolted on in the Americas and are carrying over into 2025. So markets are going to do what they're going to do, but there's plenty of levers we've got to pull to continue to profitably grow.

Perfect. And when you look at some of those more troubled markets, multifamily or office in the Americas, those haven't been great for some time. Do you sort of expect we see some bottoming out there and then they could start to move higher 18-months-out type thing?

Yes, tough to say. And I'd say, certainly, we're not perfect market predictors. So we should stop short of doing that. I would say the aftermarket in our non-res industry is surprisingly stable. And that's across all of the verticals. I think Dodge Momentum as an index, if you look at that, they do break it down by vertical. That would be the earliest of the early indicators because that's talking about planning. So just planning activity that's going on. So if that's the earliest, you got to think that's like an 18-month type lead time for a company like Allegion. So I'd say in the interim, where we do still see a return to some volume growth, a return to electronics growth, non-res leading the way. Bolt-on acquisitions continue -- we've announced 2 more just this year. I think that's going to be a more important and a more meaningful part of Allegion's growth here in the near term and really excited to keep that flywheel going.

Perfect. And electronics, I think those are about just over $1 billion in annual sales now for Allegion. How are we thinking about sort of penetration rates, anything moving on the adoption curve in any big countries or verticals that you participate in that could drive an acceleration? And I suppose, the context, you've had pretty volatile growth recently around supply chain variability. Is that kind of all fully behind us now and it's sort of sell-in and sell-out pretty unified?

We think so. We think the choppy -- supply chain choppy comps are in the rearview at this point. Certainly, there's a lot more surface area on your windshield than there is on the rearview mirror. So let's look forward. And we do see a return to growth on the electronics. I think on adoption, if we can talk a couple of things. One is investment in the core. So last couple of years, we have pretty aggressively ramped up our research and development internally and introduced a new commercial electronic lock family in 2024. We highlighted that on an earnings call and made a good splash at CES with 2 new resi e-locks, one in the mid-price-point segment and one in the super-premium segment, if you will, that will actually find its way into Apple Stores. So showcasing some new smartphone technology there. Also took components of our new commercial e-locks family in the United States. We've taken that down to Australia and in half the time it typically takes to develop a new lock and with half the engineering resources have a commercial e-lock family for Australia that can go into the market. So our platforming efforts around electronics is also starting to bear fruit. We talked about that at our Investor Day a couple of years ago. Now we're seeing real tangible results from it. Within the market segments, you're seeing a couple of things going on. Electronic locks have a shorter life cycle than their mechanical counterparts. And the reasons for upgrade that we're seeing in places like higher education is getting away from fabs, getting away from plastic key cards and going to digital credentials in your smartphone or smartwatch. We've been an innovation leader there. We just announced we're the first lock provider to have compatibility with Wear OS on Google Smartwatches. And so adopting digital credentials will continue to drive an upgrade cycle as well as new adoption in -- specifically in verticals like multifamily. We see good potential there. We've got a good integration with Apple. We've introduced their resident key on a couple of properties right now, getting great reviews, and I think that's going to be another driver for -- in the aftermarket, in particular, multifamily properties to convert from mechanical to electronic or even to upgrade from their existing fab-driven electronic access control to Apple resident keys. It's just a much better seamless experience.

Yes. And what are sort of the economics for Allegion look like as that transition plays out in terms of sort of dollar per unit or margin rate?

Yes, very good. The way to think about our electronics business is an e-lock will be 2 to 2.5x the average selling price of its mechanical counterpart at roughly the same margin rate. What we're now bringing into the market and our largest competitor is doing the same thing. So I think this is kind of an interesting development in the industry. So if you look at small, medium business, multifamily, K-12 schools that are adopting electronic locks and electronic access control. We, hardware guys, if you will, have a role to play in the controlling software to manage credentials, manage visitors, manage access and do that with a software product that stitches all the e-locks together and just makes it a better economic value prop for the end user. That's a very fragmented space when you look at a lot of small little software-only guys out there. And I think we, on the hardware side, have a much more complete value prop to offer. So we're going to continue to drive electronic adoption with these tools, but also -- and it's small today, but start to generate more software revenues as a solution set into these underserved verticals, these smaller verticals.

And if you think about that, I think you sort of break out services and software, it's about 5% of revenue. So does that kind of get pulled through like alongside the electronic products? Or how do we think about the go-to-market for services and software? Anything different there in terms of like sales channel or how you win business?

Yes, there is. There is, absolutely. I think in that slice of our business, the services would be primarily Stanley Access Technologies. So think more automatic door service, which has both an attachment rate to an install that we look at, but then it's also -- there are service contracts that are independently called on and independently sold. The majority of our software revenue today comes from Interflex in Germany, which has really blue-chip clientele, large enterprise-type access control. The business model there is direct sale to that end-user customer. The relationship is also direct. And you could think of that business as for every EUR 1 of electronic hardware that Interflex sells, they sell EUR 1.50 of software and service on top of that. In the Americas, it's very small, but also growing very rapidly. Our tool is called Zentra. You can find it out on LinkedIn. It's targeted at multifamily today. So that's what's bringing in credential management, visitor management, commissioning of your locks, bringing efficiency to the office and bringing a more seamless and more modern experience to the tenant. If we started really from nothing in 2024, you could think of start-up kind of growth, like 10x kind of growth, and we would see that again here in '25.

And do you think that you can do most of what you need with organic investment there or it really requires kind of steady, maybe small software acquisitions to keep building that business up?

I think the majority is organic investment for us at this point. And what you've seen from us on the inorganic side, on the acquisition side, has been primarily bolt-on acquisitions, really high-quality companies. I recall, Julian, I don't think you said it, but I heard a lot of people tell me as I came into Allegion, John, Allegion's margins are so good. Any acquisition you do is going to dilute them. So how do you think about that? Well, I proved that wrong in 2024, and I fully intend on proving that wrong again in 2025. Our pipeline looks really good, split between electromechanical and core mechanical for bolt-on acquisitions. Some you would categorize as chunky, but things that -- think on things that plug right into our existing business unit structure, plug right into our front-end sales, easy and fast integration, quick capture of cost synergies and really a great low-risk way to profitably grow a great company.

And if we look at the -- that software and services sort of profitability, is sort of investment mode. So margins are low, but as you get economies of scale, they'll increase. Like how do we think about the...

So you could think on the margins of -- if you just take that software and services. Sliced margins consistent with overall Allegion margins. And that's what I really like about it is that it's not just a heavy cash furnace, but it's generating good profits for us right now. If you recall, we acquired a company called Plano in early 2023. So workforce management software, very popular, growing rapidly in Europe, in particular. Internally, that's our own little Rule of 50 business. So very profitable and growing very rapidly.

And I think on that point on sort of workforce management, you have this sliver called sort of time, attendance, workforce productivity. It's not something we've heard that much about in the past. So maybe just expand on that a little bit, like what kind of offerings is it? How much of a growth focus is it for the management, right?

Yes. That's Interflex, if you will. And it's primarily based in Germany, also extends to other European countries and where we have multinational clients, they do take us with them to wherever they have a particular manufacturing facility or office. I would say the link is, if you're managing credentials and that data, it's a very easy extension to then track time, track attendance and then move work and move labor around if you're such like a port or an airport or a retail where you have flexible labor needs. That's what our teams have identified as a rather acute customer need that we can very easily extend the Interflex access control system, which is readers and electronic locks plus this access control software, easy product extension to have a workforce management module that you can buy alone or you can bolt on to the overall system. So it's a small part of our business, will continue to be, I think, a pretty interesting growth vector for Allegion. But software for us means directly related to our hardware. We don't have a need to go adjacent. We don't have a need to make big acquisitions and try something new. I think there's a both organic investment and inorganic investment in the bolt-on sphere, if you will, where we have a long runway of profitable growth in front of us. I think it's totally underappreciated in our share price as well. The performance we delivered in capital deployment in 2024, what we think we can deliver in '25, '26, et cetera, underappreciated story, and we look forward to earning the reputation that you can count on us as balanced, consistent and disciplined capital deployment as really helping drive profitable growth and additional shareholder returns.

Perfect. And if we look at the sort of competitive landscape across some of the way you slice the products, anything sort of changing there? I know traditional residential locks, there's always been tough competition at the low end of that, and you don't really participate much in that tier of the market. You see much more competition on the electronics side? And then I guess, software and services, it's a lot of smaller companies that you come up against?

Yes. I think when we look at our -- and we've had this conversation in the small group meetings, too. So when you look at our portfolio, if you start with automatic doors, once Allegion acquired Stanley Access Technologies, that industry, you could see the big 3, DORMA, ASSA, Allegion probably have 70%, 75% of that market, so rather concentrated. As you look in some of the core hardware like an exit device, probably pretty consolidated as well with the main large players. As you go further through the portfolio, there does become a lot more fragmentation. And if you look at some of the acquisitions we've made, those are in fragmented spaces. We're finding very high-quality, very high-margin bolt-on companies in those spaces that probably had reached the limit of how they could grow as a small independent company. And when you plug them into Allegion's front end, which is very powerful, certainly, we can grow those businesses faster than they could on their own. And we've done that again at really good margins. So I think that's still the emphasis for us. And this year, we brought in about 1 point of carryover revenue from M&A. I would certainly like to see that more in the 3% to 4% range. And the potential is there. The pipeline tells me that that's possible.

Great. And on that point on sort of consolidating markets, I think you've always had good pricing power for the vast majority of the business. I suppose one point of discussion on the earnings a couple of days ago was the sort of PPII, price, productivity, inflation, investment, the sort of net of those 4 items, people were concerned a bit that, that net number was negative to sort of profits in the fourth quarter. Maybe walk through the conviction in that number becoming a tailwind for the year ahead? And is that more in the second half we see that? Any kind of thoughts on that point?

Yes. If I could first, if you'll allow me to zoom out a little bit on margins. It's in the print, about 230 bps. [Technical Difficulty] in those 2 years. At the same time, revenues have grown quite a bit. At the same time, we delivered that 230 bps, we aggressively grew our own internal R&D spending. So 230 bps EBITDA margin expansion and R&D went from about 2.5% of sales to over 3% of sales. CapEx from 1.5% to over 2.5% of sales. So we did not expand our margins by starving the businesses from investment. I think that PPII equation drove it. We did find ourselves behind the curve on price cost back in '21, '22. I think we've got mechanisms and scar tissue in place to make sure that doesn't happen again should raw mat inflation or something come in and impact us. But those R&D dollars, if the rate is a lot more, the absolute dollars is significantly more. And we're going to take opportunities in each quarterly earnings call, spotlight new products, product vitality that's going out in the market that's going to help continue to drive volume, drive market share and profitably grow the business. So that would be the high-level perspective I'd like you to take a look at and contemplate in our '25 guide that implies about 50 bps of margin expansion. I do think we've got the discipline and the operating rhythm to maintain that positive PPII tailwind. Q4, we felt like it was important to talk about. So we're going to talk about it. And the rebate conversation at the end, want everybody to know that's the same rebate policy we've had since forever. There's a year-end true-up every single year. There's no carryover. It's a calendar year event with us and our distribution partners, and it just gets trued up in December, and that's typically a small number. Every now and then, you'll get 1 year that goes one way, the next year goes the opposite way. So it does become big enough to go ahead and talk about. And so we talk. But it's -- I'd say [Technical Difficulty] and it's something that happens all the time. Anything, Josh, you would say to add on PPII or the margins there?

I would just say that we would expect that to be a positive contributor to 2025. And you should expect to see price consistent with what Allegion has delivered throughout history, right? A lot of value we provide to customers, a lot of ability to take price based on that, and you can expect that to be the case.

And inflation sort of assume it's a steady headwind with last year type thing, sort of low single digit. Okay.

Right, right. And then again, scar tissue is there. Business process is there so should inflation ramp up a lot. I think we've got mechanisms in place to make sure throughout the year, we're making the adjustments necessary to cover that inflation with price.

Julian, just to clarify, core inflation, I think you're probably right in terms of the underlying assumption there. We do have implemented tariffs, so China and the metals contemplated in guidance. Yes.

Okay. Got it. And is that sort of the PPII swinging positive? Is that a function of kind of price increases you need to push through much later in the year? Or no, even early in the year, you should see.

So you -- yes, and it's already out in the public domain. You can look it up if you want to. Our competition is out as well. Our industry tends to put and list price increases right around 1st of March. That's what's going to happen this year. You could think across the product lines, depending on the product, 3% to 5% is what you'll see. And then as you take that down to a net price realization, you could see that 1.5%, 2% type.

Perfect. And thinking about margins between the 2 segments, you're back to that 29-something percent operating margin level in the Americas, which you hit before and then it got pulled down with acquisition and it's bounced back up there. I suppose the point would be the entitlement is in the 30s. There's no reason to see a natural ceiling. And then international, to get much of a margin step up, do you need something big to change on the portfolio?

I think in international, it's important to point out, you saw in the Q4 release, we did go ahead and wind down our operation in China. So that's about a $5 million haircut off the top line. We had done something similar in 2022. We've done some other selective pruning within the portfolio to get out of some underperforming businesses. So we have more or less intentionally capped International's top line revenue. And I think what we started in 2024 and what you can look for us to do more of is now think of Allegion International having earned the right to grow, so prime for growth, finding good acquisitions like Boss Door Controls, like DORCAS with electronic strikes, like Lemaar, we just announced down in Australia. So now adding back into that portfolio, higher quality, more profitable businesses that we know how to grow. I think that will be a key driver of margin expansion in Allegion International for the next few years. And your point on Americas, we're proud of that. I think our teams worked really hard to digest a very large acquisition that was Stanley Access Technologies. It was margin-dilutive. As we look at the performance of that business, top-line growth has been very good, right on or even a little better than the business case we envisioned. Margin performance has lagged. I'll be perfectly honest. We acquired a couple of factories that had been starved of capital investment. So there's investments we need to make, productivity we need to drive. And so still a lot of headroom that we owe the business case. I just reviewed this with my Board a couple of meetings ago, and they were pretty tough on us. So margin expansion there in the Stanley Access business, very much needed, very much possible and the capital investments are going in to make that happen.

And what's the rough sort of delta of that former Stanley business with the, say, Americas segment margin?

Just say it's a fair amount.

Fair enough. Yes. But in the end, it should be well into...

Yes. I think that segment has its own dynamics. It's not the same as Von Duprin, LCN kind of margins. The profile of the industry is different. But certainly, up in the high teens type operating margins is kind of our -- the floor of our expectation. And again, there's a ways to go to get there right now.

Got it. And then the sort of base business outside of that in the Americas, you've got that 50 to 100 bps annual range.

Yes. And look back on the zoom out, 230 bps of margin expansion, while we increased R&D and we increased CapEx, that was also done without a lot of volume help. And last 3 quarters, volumes have turned positive. We've been really happy to see that. As volume comes to these businesses with super high gross margins, the operating leverage is quite good. Operating leverage in the 30s or mid-30s. So that's another key tailwind that we've been without for a while. And primed to maximize it as it comes around.

Yes. And if we think about capital deployments, you've mentioned the appetite to get acquisitions maybe to 3%, 4% contributor this year, probably every year is feasible in the fragmented market. Also, I don't think anyone in this room would say your stock is particularly expensive. So kind of how do you think about buyback merits right now, even though you clearly want to do more acquisitions?

Yes. Of course, as any sitting CEO, I think we are dramatically undervalued in the market right now. And I'd say count on us to deploy our cash. We're not looking to hoard cash on the balance sheet in the hopes of some massive acquisition. That's not the point here. And what you saw in 2024 is a good example. So we were on a steady diet, if you will, of about $40 million of repurchase per quarter. Q4 comes around. We don't have an acquisition to close. So we ramp up the repurchase to $100 million in Q4. I think that type of rhythm and cadence that you can expect to see from us. So our priority is to invest for growth, organically, number one; inorganically, number two. I think we've done a very good job on bringing in high-return, very profitable bolt-on acquisitions into the business in '24. We're going to do that again this year. And when we don't have an acquisition to close, yes, let's look for us to deploy that cash to get it back to shareholders.

Perfect. Great. Well, with that, let's turn to the response questions, please. So the first question, do you currently [indiscernible] Allegion? So 90% no, a lot of scope for that to go lower.

[indiscernible]

Yes. The second question around sort of general attitude or perspective for the company right now. So generally neutral. Third question is around EPS growth for the company versus the multi-industry average. So about just over half, say, below peers. Fourth question is on use of excess cash. So 2/3, say, share buybacks. Next question is around valuation. What should the PE of the company be? So most say a slight discount to the market multiple. Then the last question is kind of what's the single biggest reason why Allegion deserves a valuation discount? So core growth, the biggest concern. So with that, thanks so much, John and also Josh for being here.

Thank you.

Thank you.