Allegion plc ($ALLE)

Good morning, everyone. We are excited to kick off day 1 of the Wells Fargo Industrials Conference and to start the day with CEO, John Stone from Allegion. So John, thank very much for being with us.

Thanks, Joe.

My name is Joe O'Dea. I lead the multis group here at Wells. Over the course of this, if you have a question, please just raise your hand. And so that way we want to enter all of it, we'll just get to your during the questions.

To kick things off, John. I think one of the things that I find really special about the business is the different elements of the model itself. And so you serve long-cycle demand patterns. You do that with a short cycle book and ship, lots and lots of SKUs, expertise around the spec side. And so maybe just a stage for us in terms of Allegion and talk about the business model a little bit.

Yes, absolutely. I appreciate it. And it's obviously, in my opinion, it's a very special company and got that long-term durable and very distinct competitive advantages. As you mentioned, we do manage millions of SKUs in the total hardware space. So everything that it takes to hang, seal, secure a door, keep people safe in the building and manage the access. Managing those millions of SKUs is quite a capital-intensive effort. It's a barrier to entry. And I think that's why you see only a couple of companies in the world that do what we do. That does a lot in terms of our pricing power. We've got category-leading brands. We've got category creating brands, in fact, that enjoy strong market positions, industry's highest margins. And the way the model works, is we do a consult very early on in the project phase with both the end user, the ultimate customer, as well as the architect, the general contractor. We serve as subject matter experts to create specifications for all the doors and the door hardware. That turns into hardware schedules and take off drawings that our distribution channel then uses to fulfill the last mile. Typically in a made-to-order fashion in about 2 weeks lead time. Managing all that is difficult. And I'd say, again, a lesion has carved out a leading position there, and that's why you see such long-term durable earnings growth from our company. And you will continue to see them in the future.

Can you elaborate on that last part a little bit in terms of the complexity around millions of SKUs, but being able to ship in such a short period of time to understand a little bit more around is the standardization of the product suite and then the different SKUs are a function of configurations around that standardization, what enables you to shift that so quickly?

Yes. Yes. So material from both 2023 and 2025 Investor Day, we talked about platforming, we called it, so a modular design focus. We've made a lot of progress there on the mechanical and on the electronics side. And that certainly helps. That keeps us in a leading position, and that helps us innovate new products even faster. On the manufacturing side, yes, absolutely, it generates economies of scale in the plant and on the assembly line. It generates economies of scale in your supply chain. And again, I think, keeps us out in front of short-line competition.

And then on the customer side of things, how fragmented is that customer base? And particularly, when we think about some of the strong positions you have in institutional, whether there's some concentration there as well as the stickiness of those customers, do you tend to find that certain customers will be Allegion customers and certain customers blown? Or are they mixing and matching?

Yes. That's a great question. And I think the -- a couple of things to go through. One would be on the end user standard side. So if you think large institutions like hospital chains, like school districts, like universities, we've got Allegion customers that have been our customers for decades. Relationships are very sticky. These products are very sticky. That's why our aftermarket business is so stable because you tend to replace brake fix like-for-like. So once you're spec-ed in, it is extremely sticky and that just adds to our already very large installed base. I would say the other thing about our customers, it's a good saying from our field sales force, if you've seen 1 customer, you've seen 1 customer. So that's why these millions of SKUs is such an important aspect of our business model and such an important barrier to entry because customers have different needs. Doors are different sizes, entry, egress, all those paths have their own little nuances. That's why it's so complex and that's why architects don't want to mess with it anymore. That's why they outsource it to Allegion and our largest competitor. I think it's very rare that we would flip an ASA Abid spec it's very rare that they would flip one of ours. It does happen, but very rare. And I would say it's about a Six Sigma event for someone else to flip either of ours. So very sticky relationships, but each customer is somewhat different. And again, I think that's why we've been able to carve out such an important space in the industry.

And then high level, but demand trends, we'll watch it through some of the higher frequency data points out there. I don't even know really how much value to put on ABI anymore these days watching DMI. But you see the spec activity. And so that's a pretty good indicator for you. And we'll get into it more in terms of some of the segment focus later on in the discussion. But just high level, kind of what you're monitoring out there that spec activity?

Yes, absolutely. I think if we start with the earliest of the early leading indicators that is Dodge momentum, it has been strongly positive for a long time. So there has been a lot of planning activity what that index measures. And if you take it down in that to the ABI, it's been contractionary for most of my tenure with the company. It's been challenging. And if you look back in history, you have to go all the way back to the aftermath of the great financial crisis to see a window of time this long that the ABI has been contractionary. Now what happened after that was a pretty nice period of non-res construction. History may not repeat itself, but sometimes it rhymes. I think the other things that we're seeing and we just heard in your analyst conversation there at the breakfast was some other trends, earth-moving machinery demand is going up. Some of that is certainly supply side, but it also doesn't feel like it's all roads and bridges, like it was a couple of years ago with the Infrastructure and Jobs Act. This is something else. We see company formation in some major metropolitan areas, bringing back office demand, which had been really flat after the pandemic. We see multifamily and pockets of the country making a bit of a comeback. Starts have been turned positive on multifamily for the first time in a couple of years. So I say, when I look at all of that, I think if I just zoom out, [indiscernible] has agreed, you can't ever read too much into these leading indicators, but it does feel to us with the spec activity we're seeing and if you heard me on the Q1 call, I'd call it very strong and broad-based, very strong. So we start to feel that the next 5 years are going to be better than these last 5 years.

It's a really interesting dynamic with good DMI and challenged ABI. And so good planning activity but not yet converting to the actual architectural billings out there. How do you explain that because it's been persistent for a while. And we can even look like to Dodge's credit, they do pull out data centers, so you can see commercial ex data centers. It will vary, but it's not bad. So like the planning activity...

Planning activity is certainly there. I think the culprits at this point are well known as to what may be is tempering that in terms of shovel-ready or shovel-in-the-ground type projects. It's persistently high interest rates, and that's even changed over the course of this year. Inflation has kind of ticked back up to. So the 2 of those certainly aren't helpful to a construction bone. And so while we've got these good early leading indicators from momentum to a slight uptick in starts and ABIs to our own spec visibility into the future, we've still got persistently high interest rates and inflation to just to monitor and deal with. And I think just near term for the company, we're still in a good position. We're still growing earnings. We're still doing the right things. And so as the cycle turns, I feel we're extremely well positioned.

And you would have just partially answered the next one. But when we think about the growth algorithm that you put out at the Investor Day and still looking for kind of mid-single digit, you were there last year. This year, the guide is kind of low, mid. What are those obstacles to getting into mid maybe beyond the macro, which would be more the interest rate or the inflation, anything else watching out there?

Yes. The key for us, we're primarily a nonres company, is nonres volume as nonres volumes have essentially been flat for the last many years. a slight uptick in nonres volume goes a long way for Allegion's success. And I think our business would grow at -- the core mechanical at least would grow at about a GDP rate. Volumes have been flat for a few years, and we don't think they stay that way forever. On top of that is our electronics portfolio, which has been a continual source of outgrowth for us, typically around the high single digit over the cycle. And we've continued to innovate there. We've continued to add new products there. We've added complementary software products to that portfolio and see that still as a long-term driver of above-market growth that keeps us in the mid-single -- solid mid-single type organic growth.

What about the labor availability side of things, anything with immigration policy and labor availability in the market? And we hear a little bit about like data center crowding out, the degree to which that's attracting a lot of the labor. Do you observe that as a dynamic at all in the market that's also an obstacle?

I haven't come across that in channel checks as a particular hurdle. I would say the immediate aftermath of the pandemic, you definitely felt some time of projects being way off schedule or project time lines extremely volatile because of labor availability. That has subsided and I haven't heard a lot of evidence of it creeping back up. On the data center side, I would again say Allegion has done a fantastic job on getting specification standards and end-user standards with the who's who of data center builders. And so it's a small part of our business, growing very nicely, and I think we've carved out a leading position there, at least in our industry.

And then pivoting to the AI side of things, both in terms of opportunities for you and things that you keep an eye on disruption. And so how are you using it today? What benefits are you seeing? And then at the same time, is there anything that you observe as this is a disruptor potentially, and we want to make sure we're paying close attention to it.

So I think a huge opportunity. AI will be additive and helpful to a company like Allegion because, again, we make hardware. AI is not going to replace hardware. It's not going to replace a deadbolt or the exit device on the door, but it will make us faster and better at what we do to get that spec delivered and installed on the job. We also, as you've seen, do have a small but rapidly growing complementary software business that goes to market with our electronic locks. We're already experiencing within our development teams, the 5x impact each developer is getting 5x more productive there, which is interesting for a hardware company to be able to add software to their portfolio has become a lot easier as a result. So as we talk about this electronics growth driver really having legs, this gives me even more confidence that we've got more value to add more value to create around the electronic lock with complementary software and we can do it faster than ever before. Broadly speaking in Allegion, think of AI like a Claude or a ChatGPT as I tell my employees, think about it as your own personal intern. It should just do a lot of work for you automate workflows for you and make you more productive. Definitely seeing results across the company. We summarize wins every month and share them. It's pretty fun and engaging, just to drive advocacy. On the threat side, I think it would be easy to think, AI might write a spec for a building. You still have to make the hardware even if AI write the spec. And the only 2 companies that have the data to make an AI-driven spec work is us and our largest competitor. We're investing in it. I would have to assume they are too, so we'll get there first. And then it will just make our spec writers more efficient like it would a software program or engineer. So I think that's also additive. We are plugged in very acutely on all things cybersecurity that comes up with AI, and I think are investing heavily to make sure all of our tools, all of our processes and our enterprise itself is as protected as it can be.

And you can't really have hallucinations as part of the spec. What do you think about in terms of the time line to where you could have a product that can reliably facilitate that spec process?

A long time. But you'll always need human oversight for that exact reason. AI can produce things that's wrong. So we've invested to continue to bring in new civil engineers into the company and train them on specs. It's a great way to learn the business. So that pipeline of talent continues to come in. And again, just think of AI as your intern. If I'm the spec writer. I have an intern to do a lot of the groundwork, but then I'm still the quality control. I still manage the changes with the end customer. I still provide that level of expertise to supervise that intern.

On the innovation side of things, first of all, just how do you measure it internally. How do you think about the right amount to spend on R&D. We've seen that amount go up actually over time. And what are some of the primary areas of innovation outside of AI that you're focused on?

Yes. So we're pretty proud of that, Joe. I think over the last few years, very nice margin expansion on the operating income line at the same time as stepping up our R&D spend. We measure product vitality really by brand. And that means in the last few years, how much of your revenue was derived from new product launches. And that's how we govern that. I think that is how we're going to pace our organic growth, the better that we can get there. And it's not just about how much you spend, but it's how efficient do you spend each dollar. I think Allegion does that very, very well. Leveraging these AI tools will continue to get faster and more productive there on the new product development side. The primary area, while we do have various R&D efforts going on across all of our brands, primary area of focus would still be in the electronics and complementary software area. We do see that as the long-term growth driver for our business. So that's where we'll invest the most.

Can you touch on the mid-price products a little bit because you've talked about that recently? I think primarily with a focus on accelerating aftermarket growth. But just are these products that are really designed to replace Allegion equipment in the field? Would they replace competitor equipment? And really, it's an aftermarket product, not so much in an OE product.

Yes, it's a great question. And I think a couple of points. One is our engineers have done a great job across the 3 big brands, the LCN closures, Von Duprin exits and Schlage locks, in terms of designing to value and designing to cost. So those mid-price point products serve a particular customer need at essentially the same gross margin as the premium products. That being said, this was primarily in response to aftermarket business that we simply weren't very competitive for. And then also, if there was ever VA/VE exercise that might happen on a particular project, past years, Allegion would just lose that business to a competitor. Now we have our own portfolio that should there be a need to step down to that and again, step down at the same gross margin as our premium product. You still have an Allegion suite that can go in there and take care for that job. So it's primarily a competitive play, gaining market share in the aftermarket and having an allegiance suite, there should you need it in a VA/VE exercise.

And the start, like the OE sale would be at a premium product level.

That's always the start.

And then the mid-tier can come in after that as a replacement product.

If need be, Typically, the replacement would be like-for-like. But I would say there will be certain customers that will be certain verticals that do gravitate more towards this mid-price point segment, now Allegion has a full offering to compete there, too, where previously it was a business we just didn't win.

Can you just elaborate on the time line around this product suite? When you say you have a full suite today, how long it took to get there? And really, the heart of the question is the growth opportunity that this presents moving forward.

So I think -- and this would date to well before my arrival in the company, but the idea of having a mid-price point family of exit devices from Von Duprin, a mid-price point commercial lock family from Schlage, thought about for a decade plus. Von Duprin delivered in '24 and Schlage delivered in '25. So this is very recent. I think we're just starting to see the benefits from that.

To the degree that you can -- there's growth contribution, but that can accelerate moving forward.

Right.

Okay. On tariffs and the price/cost dynamic. I think normal price timing for you, generally, we would start to see new pricing hit the P&L towards the end of Q1. Since then, there were also tariff announcements and so some additional pricing that could be required as a response. And just explain to us the pricing you've done, magnitude of it, timing of when it's hit is everything you need to get in the market today?

Yes. So I think if you zoom it out and just include all inflationary pressures, Typically, our industry does have an annual price increase in the spring time, early spring, think end of February, first of March. That did go to market. This year was probably a little different for our industry because many of us, Allegion included, had some surcharges in place to deal with 2025 tariffs. As we went through that, a lot of those were then rolled into the price in the springtime price increase. Subsequent to that, there have been more inflationary pressures. We do have a series of pricing actions that have been announced to the market. We do have a series of cost actions we've been taking internally to compensate for that. And I think our commitment same as it was in '25, we do expect to be able to cover this for 2026 on a dollar basis at operating income and earnings line. Margin rate though, will face some pressure because of this.

What about the manufacturing footprint, sometimes there's focus on where the tariffs are applied, what kind of an impact that could have to the competitive dynamic, just anything that you've seen in the as a result of tariff policy?

Yes. So I think if you go back to 2025, we disclosed pretty clearly like here's our footprint, primarily on the nonres side, at least, just think manufactured in the country that you sell. So very heavy North American factory footprint for our nonres business. Our residential business is primarily sourced from Mexico, but essentially all of it is USMCA qualified. Then as tariffs have changed and evolved, we do look through the supply base very carefully. We do look through the various material content on different products very carefully. As there are just, call it, value engineering changes to make or supplier changes to make, I think we've been pretty nimble in that regard. In terms of has it really hurt this competitor, really hurt that, I obviously don't know their supply chain or their impact and just have focused on managing this for our company. I think the short liners who are purely trading houses probably have been hit harder, if I had to guess because they're bringing in all typically Asian imports and then distributing those. So that's probably taken a harder hit than those of us with U.S. manufacturing footprint.

But stepping back kind of the same message as what we've heard in recent time where there are these iterations of inflationary pressure, price for it, there might be a margin impact. It's not an EPS impact.

Right. Right.

Okay. Shifting to Americas, kind of the demand and margin side there. Non-res volume was flattish in Q1. Spec activity is good. I mean how are you seeing those volumes trends? How do you expect to see them unfold over the balance of the year?

Yes. I think just we would have to refer back to the opening guide for the year and then the Q1 call that we did raise the revenue outlook based on our DCI acquisition by a point. And I think just consistent with the guide on the Americas side. The Americas Q1 came in right about where we thought it would. I think the markets behaved right about where we thought they would. And I'd say nothing more than just affirm the guide based on the strength of the Americas business.

If we think about the different verticals on the institutional side, how different are the growth rates that you're seeing between the education and the health care hospital markets?

So I think at any given time, based on this project or that project, maybe super large hospital, 1 quarter to next, the rates change. But broadly speaking, the institutional verticals have less volatility than you'd see in the commercial verticals. They don't necessarily move together. But for our business, we've got the portfolio, the spec writing expertise and the channel reach that broad end market exposure is really how you have to think of us. So as there's strength here, a little bit of softness here on balance. That's where our algorithm still comes back to that mid-single organic growth.

And similar to a question on commercial for a while, it was appreciated, things like office and multifamily under pressure. It seemed like we were nearing the end of that. I'm not sure where we are with interest rates and inflationary pressure, if there's kind of another stage of pressure in those markets or if you've seen continued stabilization in that kind of mature down...

Yes. It's right. It's the same as the opening question, I think, Joe, is that there are encouraging signs out there, little single data points like Metro New York, Class A office demand is like all-time high. Company formation has been very active. So tenant turnover and things like that, it's good work for a company like Allegion. We heard similar comments out in San Francisco just last month. So there are encouraging signs. That being said, headwinds are still present. And so we need to watch how this moves forward. And for the balance of the year, I [indiscernible]. Resi has been under pressure for a few years now. And I think we indicated that when we released the guide, we felt it was still a kind of flattish, still under some pressure. I think we and others have had some positive price realization to overcome the inflationary impacts of our resi business is aftermarket. So it's not a little bit underweight tied to new build. But I think we have released some new products in that space. We're not here to call a market as to this is when resi will inflect. But I would just remind everyone our overall business mix is much heavier tilted towards the nonres side.

And then shifting to the international side and just markets within that business and kind of a multiyear stretch of volume declines in those markets. Just what you're observing now kind of as you move into the back half of '26, do you see opportunities for volume in some of those markets?

Yes. I think what we see in international, and we really gave ourselves a black eye in Q1 with some the difficulties we talked about on the call. I'm not happy about that at all. It was our first, I think, operational execution missteps since I've been CEO. So not happy there one bit, and we're going to fix that. I would say what we see in international is a year of sequential improvements quarter-to-quarter, a bit of a build through the year and work off some of those operational difficulties over the balance of the year from Q1. And then our electronics businesses that are both hardware and complementary software always tend to ramp sequentially through the year, and we see that playing out the same this year. Our acquisitions in international have actually been performing very well. We noted that in the slide back on the call in Q1, margin accretive, accretive to growth. So happy with that. We do have some legacy mechanical issues we've just got to work through and perform better.

On the ERP side of things, how should we think about the impact in the remaining parts of the year? So there's still work to do in Q2, for example, not the kind of impact that it had in Q1 by the back half of the year as that resolves. Just how we should think about it?

Yes, yes. That's right. So the easiest way to put it is we -- that legacy mechanical business dug a hole in Q1. First step is stop digging. So we stopped digging. And then get back to producing at rate, get back to selling at rate. I think we're largely there. Then the recovery of the miss continues to happen over Q3, Q4. But we do expect to have it covered this year.

Okay. Got it. On the M&A side of things, so 2025, you did 9 transactions included mechanical. It included electronic product side, Americas International, so a lot of activity. Any common denominators behind what you were doing on the M&A side because it was fairly broad in terms of the deals we saw it, but what you were targeting there?

Yes. I think strategic acquisitions that are a part of our portfolio that help add to the portfolio and then further differentiate our competitive position. So stick to what we do, which is doors and door hardware and the complementary software that makes the electronic locks work stick to the geographies where we've got brand and distribution strength. So that means Americas, that means Western Europe, that means Australia, Newzealand. We are not looking for super extra large speculative acquisitions. We're not looking to acquire our way into a new geography. But we see a long runway of just industry consolidation and roll-up in some spaces and then adding to our portfolio where we've had competitive gaps in the past.

Yes. This year, you've announced 1 deal. Just in terms of the capital allocation side of things and priorities around capital allocation when you think about M&A and you think about share repo and just in the context of what you see in the stock, like how you're thinking about those priorities?

Yes. Certainly, we are committed to balance consistent disciplined capital allocation. We are very much returns-focused. Our priority is profitable growth. But given where we're trading right now, repurchase is very attractive.

You mentioned no large deals. I wanted to ask a little bit about access control as a market and you have a product for multifamily. A couple of years ago, there was speculation on what might happen with the larger asset that was out in the market. Just how you think about your access control offering today and where you want to go with that?

Yes. A great way to think about that is, think of it like you hear the phrase technology stack. So think of the stack. You've got the base hardware, which is really us and our largest competitor. Two of us here in that space. And the access control layer them next, there's probably 50. So it's a quite fragmented space, sometimes very vertical-specific. And that's where we found multifamily as underserved market, something that we can develop organically and go to market with. And it's going pretty well and growing pretty rapidly. Does there more that can happen there? I think probably, yes. As you go up further, you see the video surveillance companies. Think of Motorola, Genentech, these type of guys, they've been working their way down into some of the access control space and partnering with us as the hardware partner choice. So I think that segment of our industry is ripe for a little bit of disruption. Some of it's going to come from the video guys, some of that's going to come from the hardware guys. And like I mentioned earlier, it just became a lot easier to develop software products, and we intend to keep going in a pragmatic way.

We have time for one more, just on electronics. You saw really good growth in 2022, 2023. I think that led to some tough comps, maybe a little pause in '24 back to good growth in '25. Just where you think you are in that trajectory? And you talked about the growth algorithm is that really now set to operate at that kind of algo target?

Yes, I think so. And 2022, you almost have to throw away because 2021 was not great for our Allegion's ability to ship electronics because of supply chain problems. But overall, you see this as adding about 1 point of outgrowth of above-market growth to Allegion's business because of electronics, and that is where the majority of our R&D is going.

Yes. Terrific. Well, thank you very much. Really appreciate the time. Thanks for being here.

Thank you. All right. Thanks a lot.