Carrier Global Corporation (CARR) Earnings Call Transcript & Summary

Great. Well, I think we're ready to begin. It's my pleasure now to have for our fireside chat, Carrier Corporation. Dave Gitlin, President and CEO; and also Patrick Goris, CFO; and Sam Pearlstein from Investor Relations. I think before I dive into the Q&A session and obviously, anyone dialed in, please e-mail me any questions you'd like. I'll hand over to Dave for a couple of introductory remarks.

Well, thanks, Julian, and thanks for having me. It's good to see you again. I'll keep the remarks real brief, so we can get right into the Q&A. But we -- you saw, Julian, and we reported our earnings last week, and we were, frankly, very pleased with the results. We beat sales and cash by $100 million each. Our earnings came in exactly where we had guided and where we expected. And what we really did, by design, in the fourth quarter was play offense. Our focus in the fourth quarter really was on '21 and '22, and we went to great lengths to make sure that we were setting ourselves up for success in '21 and '22. So we look at '21, we're very well positioned for mid-single-digit top line growth, 14% EPS growth at the midpoint. First half looks strong. Orders were strong in 4Q. We come in with a very strong backlog, as you know. H2, we expect that some of the businesses that have been acutely impacted by the pandemic will start to recover, like our light commercial business, parts of our F&S portfolio, like Onity which is tied to hospitality. So we feel well positioned for this year. And then I'm also very pleased with how we've done on the balance sheet. We're sitting on over $3 billion of cash. So we're now positioned for more bolt-on M&A, which we're building the pipeline on. I think at a high level, strategically, we really find ourselves a Carrier at the intersection of 3 critical societal needs. This healthy building focus is not going to go away, it's here to stay. Cold chain and what COVID has done, it shined a light on some of the inherent inefficiencies and suboptimizations of the cold chain, and we have solutions, especially through our digital capabilities. And then sustainability and the focus on climate change. So we feel very good about those on healthy buildings this morning. I was very pleased that we announced a new collaboration that we have with The International WELL Building Institute, because what we're trying to do is give people confidence to reenter into indoor air environments and WELL has a superb rating agencies of giving customers insights into whether or not the building owner has satisfied some of the healthy building requirements. So we're going to collaborate with the IWBI and help customers get to platinum levels, which is a key part of our overall creation of this new market. We're doing more at healthy homes than we've ever done. We've just started selling our first Air Purifier direct to consumers, which is not only going to help with things like microscopic contaminants, but also asthma allergies and other things that have long plagued the society. So with that, Julian, we'll get into Q&A. Excited about where we have come and even more excited about '21.

Perfect. Thank you, Dave And maybe, I suppose, overall, it's been about 9 months since the spin-out of Carrier as a stand-alone company. Maybe help us understand sort of how satisfied you and Patrick and the management team are with that performance since the spin-out? And also, what are the main areas you're trying to sort of upgrade or give another push to over the next sort of year or 18 months in particular?

Well, look, I think I look back on 2020, and we surpassed our expectations just about on every level. We created a new team, a new culture, a new -- leaning into a new business model. I think the team really stepped up and performed in very challenging conditions, not only on operationally to support our customers, but strategically, as we try to create really new markets. So I'm very pleased with the financial, strategic, operational performance of the team. I think it puts us in very strong position going forward. The thing I'm really excited about Carrier is just the amount of opportunity. We performed very well, but there is so much room for improvement really across the board. On the top line, we've laid out our 3 pillars of growth, and we have significant opportunity on all 3 of our pillars. We've talked about growing the core and product adjacencies and geographic adjacencies and services and digital. Especially in that third pillar, we're at a very early stages on that journey. And then the intersection of these 3 critical societal needs, I think I would put us in the first inning on those. So huge opportunity ahead. So top line is very exciting, the amount of opportunity, especially on more recurring revenues. On the cost side, Carrier 700, we're very pleased that we raised it from 600 to 700, but there is so much -- every time you lift up a rock, you see more opportunity at Carrier 700, including G&A. G&A, it's just significantly too high at Carrier. It's not easy to reduce that significantly, but we have a whole process focused on that, and we have to simplify Carrier. We have too many legal entities, too many physical real estate locations, too many ERP systems. So that can eliminate some of the noise in the system and continue to help us focus on customers and growth. And I think there's more work to be done on our balance sheet. I think given that we've improved it, and we have a little bit more to do there. It really positions us well for continued portfolio optimization, which I think looks at both divestitures and M&A.

Perfect. And I suppose there's been a lot of investor chat around the margin performance in Q4 and in Q1 and the outlook there. From your standpoint, how do you assess that margin performance in the very short term? And do you still feel confident that you can get high HVAC operating leverage over 2021 as a whole?

I do. Why don't you take this, Patrick?

Yes. So maybe a little bit of a recap on Q4. Dave mentioned earlier that we achieved all the projections with sales; free cash, we actually exceeded. Earnings was in line with what we have guided back in October. Sales, we had about $100 million tailwind associated with currency, but with a little profit. And so the margin in the fourth quarter was impacted by the large investments we made by public company costs and by about the $50 million that I laid out on the earnings call. Importantly, though, for 2021, we expect about 70 bps of margin expansion for the full year, and we expect our core earnings conversion. And when I say core, I exclude the impact of currency, the Beijer divestments, and I don't give us any credit for the Q4 items. That core conversion, we expect to be about 30% for the full year. And so margin expansion for the total company, including we expect margin expansion in the first quarter, despite about a 50 bps headwind in the first quarter on the margin side related to Beijer and 2020 Q1 favorable deferred comp items. So I'd say from a margin perspective, comfortable and confident about that 70 bps expansion for the year. And that assumes the net of price and commodity to be about neutral for the company -- not neutral, neutral for the year, not about neutral, neutral.

That's very clear. And if we think about the reinvestment needs, I think you've pulled forward some investment into this year from 2022. What's the confidence that you won't have to increase investment again in 2022? How comfortable are you that you're at the right run rate now of spending and so investors don't see this continuous hike of investment spend in the out years?

Yes. So one, we are -- first of all, we can achieve 30% core conversion while accelerating those investments. And as a reminder, those investments are about 2/3 focused on selling resources. We talked about China, but we also talked about the opportunity we have in our aftermarket, in services. And the balance of the investment is focused on R&D and digital. One of the reasons we -- we are comfortable accelerating those investments within that 30% earnings conversion is the opportunity to accelerate some of the R&D investments and de-risk the 2023 SEER requirements. And so you know that there is a refresh cycle that is in play. And by accelerating these investments, while remaining within our earnings conversion target, we derisk that. Another reason why we're accelerating investments, frankly, is because we've seen some good outcome from that. If you look at our performance in China in fiscal '20, we're comfortable stating that we actually outgrew the market. And so -- and also, you've seen a pickup in our attachment rate or conversion rate for aftermarket in commercial HVAC. Those are 2 areas where some of these incremental investments are paying off. And so therefore, we're comfortable accelerating these investments. And as I mentioned on the earnings call, at this point, we do not expect 2022 incremental investments to be above $50 million.

That's helpful. And I suppose if you look at the market share in general, Dave and also Patrick, how comfortable are you that the company is not losing share in any major areas? There's always that concern that when companies come out of a large conglomerate, it can take years to correct under investments, turnaround share. Doesn't sound like that's the case at Carrier, but maybe lay out the areas where you're happy with share the areas where perhaps your share could pick up from a lower base?

I would say, Julian, it's been the exact opposite. I think that as part of the spin, we've really freed up the organization to go focus externally and focus on share gains. It's an organization that really does fundamentally want to win and know how to win. They just needed the freedom and the investments to go out there and win. And that's what we've seen. So I would tell you that we -- with confidence, we certainly in 2020 gained share in resi. We were up 10%. The market was up high single digits. We gained share and applied, particularly in China, light commercial, even though the whole market was down in light commercial HVAC, we picked up some share there. And overall, in Transicold, we have confidence we gained share in Europe and China. North America truck/trailer was probably about flat in terms of share. And then even and in our F&S portfolio, yesterday, I just went up to Mebane, North Carolina to visit Kidde and then to Bradenton to see our Edwards facilities. And Kidde picked up 300 bps of share last year. And it's a high-margin, high-growth business that struggled on some of the retail side but did very well on e-commerce. So Kidde is doing well. Edwards introduced a new product, EST4, has picked up some share. So the thing that really gratifies me is two things. Number one is, we're not picking up share the wrong way, we're not doing it through pricing. We're doing it through things like focus on our brand, focus on our channel, new product introduction services, aftermarket, stickiness. And in some cases, we're creating new markets. Sensitech was up significantly, not only through share gains, but just because of new needs with the vaccine distribution, and we're seeing some of that in healthy homes and healthy buildings.

And I think attachment rates on commercial HVAC is something that a lot of your peers are very focused on at the moment. You'd mentioned that as an area of encouragement. Where do those attachment rates sit today? And what sort of pace of expansion do you think we should see in this year or the medium term?

Well, remember, last year, we started a 20% attachment rate. We ended the year at 30%, it will get to 50% in the next few years. The bigger thing that we've really focused on is overall coverage. And we even debated internally, do we just keep kind of the external community focus on attachment rates, while we focus internally on overall coverage because, frankly, coverage is going to move the needle more for the business than attachment rates. Attachment rates was once a new unit comes off warranty, how often are we converting that to a long-term agreement. But we have a significant installed base across our portfolio out there. And what we really want is to have our units under some kind of long-term agreement. So less than 25% of our commercial HVAC units are under some form of long-term agreement. We need to get all of those connected through some kind of edge device or some connectivity. We need to put those under a long-term agreement. Now a piece of those will be through attachment of a conversion of after the initial sale. But a lot of it will be through modernizations and just customer stickiness, converting people to LTAs with us. And that's what's going to move the needle for the business. So that's what we're measuring ourselves internally on, and that's what we're measuring ourselves externally on, which, as we've said, we'll get 10,000 additional chillers per year under some form of long-term agreement starting this year, and that's one of the key drivers that gives us confidence to say our aftermarket is going to grow about 10% in 2021. That has to happen, that has to be part of our business model, and we're confident that we're not only going to do it in C-HVAC, but we're going to do that same kind of formula across the portfolio.

And in commercial HVAC, how much of that service business or replacement business over time do you think could become a contractual service or some genuinely sort of recurring business?

I think a high percentage. I mean, we're starting from a low base, given that less than 25% is on some kind of recurring long-term agreement. So there's huge runway, but you know my background in aerospace. It was -- the expectation was 100% that you owned your own aftermarket, and there would be a pretty uncomfortable conversation internally if we were sacrificing our own aftermarket, that -- we protected that. And those that didn't, there would be some consequences for that. And we expect -- we have to change our thought process, which is that we want to provide long-term value to our customers, not only through the upfront sale, but then supporting them through recurring services that they turn the keys over of their HVAC services or in their fire needs in their building or they turn the keys over to us, let them worry about their customers and their tenant, let us worry about the back end and using digital and tiered offerings to really differentiate ourselves. So I think there's just huge opportunity in this area.

Maybe switching to the residential side. You've got very strong growth first half. Maybe help us understand what slope of decline we could see in the second half of this year? And also, do you think 2022 can still show a healthy growth after what's been very, very strong demand for much of 2020 and 2021? Just thinking about the longer-term health of the U.S. resi HVAC replacements?

Yes. I think when you -- Julian, when you look at resi, we were up 10% last year. We were down about a little over 10% in the first half, like 12% in the first half, but we were up significantly in the second half, just under 40%. I think it was 37% in the second half. So you're going to see somewhat of the inverse of that this year, of course, given the compare. So we're starting with a very strong backlog. And given the compares, we expect first half to be up over 20% year-over-year and the second half to be down about 20% year-over-year. So we feel very good about the next -- this quarter and next because, as we mentioned on the call, our backlog is up 3x coming into January over where it was last year. January orders have continued to be extremely high. We worked very carefully with our channel partners to make sure that we don't let inventory levels at our distribution channel get away from us. So they were about in balance. It was 10% up year-over-year at the beginning of this year versus last year. We've seen inventory levels increase a little bit in the channel in the month of January. But again, the demand is very strong, both from the dealers and from the distribution channel. And the good news is movements continue to be strong. Movement in the fourth quarter was 20%, movement, we watched it very carefully in January continued to be strong. Our whole focus is giving our customers what they need when they need it and managing it. As we think about 2022, we're going to have to keep a very close eye on it. You'll get some prebuy because of the new SEER units that are coming into '23. So the second half of '22, you'd expect to see a bit of lift from that. And then as we think about the first half of 2022, we're going to have to keep an overall eye on that. But right now, we're confident that we're supporting our customers, the inventory levels are not getting away from us. And we're very pleased with the new home construction piece where you know where outweighed there. And we have very strong relationships with the key homebuilders. And with them growing at 7%, 8% a year right now, that positions us quite well there as well.

And within the context of that strong volume demand growth in resi, are you seeing price increases commensurate with what's happening on the cost inflation side in residential?

Yes. We're going to -- our intent, and we've announced our price increase, and we're working with our distribution channel to make sure that we can cover, not just in resi, but across the whole portfolio, is cover any commodity headwind that we're seeing in '21 with price increase.

And do you think that the competitor set or the peer set in most of Carriers' product ranges even beyond resi there will be a similar disciplined response?