Carrier Global Corporation (CARR) Earnings Call Transcript & Summary

Thanks very much, everyone, for being here. It's my pleasure to have Carrier Global up next. Dave Gitlin, Chairman and Chief Executive; Patrick Goris, CFO. And obviously, fresh off the Investor Day a couple of days ago. So thanks very much for making it down here. And just as a reminder to the audience, any questions or for the audience response survey, please submit them via the QR code that you can pull up.

So maybe sliding it off, Dave, you had the Investor Day, any sort of preliminary kind of overall thoughts on the strategy communicated at that?

Well, Julian, first, thanks to you for having us down. It's great to be back in person. We really had 3 themes for our Investor Day. We talked about top line, we talked about bottom line and then we talked about capital priorities and capital allocation. On the top line, we talked about consistent 6% to 8% growth. Last year, we were up 15%. This year, we've got it to high single digits. And we talked about consistent growth being in that 6% to 8% range driven by 2 things: secular trends, things like climate change and the safe distribution of vaccines and foods and also healthy indoor environments; and then our differentiation and our real focus on life cycle solutions and aftermarket to differentiate us and provide high-margin recurring revenue tailwind. We talked about getting consistent 2% to 3% of cost reduction a year. That's going to drive 50 bps of margin expansion a year, making sure that we not only grow the top line, but we also are very aggressive on the cost side to get the margin expansion we expect. And then we talked about playing offense with our balance sheet because when we spun, it's hard to think about this, but just less than 2 years ago with $10 billion of net debt, sitting on less than $4 billion of net debt, are solid investment grade. We have plenty of opportunity to play offense with our balance sheet. Both M&A, of course, we increased our dividend 25% this year, and we have plenty of firepower for further buybacks. So we like our positioning. We talked about where we've come and really focused on where we're going.

Perfect. And then maybe sort of honing in on the near term. Many companies at this conference, it's a very back-end loaded year for various reasons. Revenue comps and then price cost issues start tough, then get easier. Same with supply chain. Maybe any kind of comments on how you see seasonality for the year for Carrier? How has the year started out for you?

Yes. So our outlook for this year is probably a little bit more balanced. So we think that from an operating profit point of view, we expect the first half to be a little bit less than half for the full year. We did share some additional color on Q1 on our earnings call. We expect Q1 to be high single digits. And we did say that for Q1, we do believe that price/cost will be mildly negative -- or not mildly, modestly negative. And we provided a $0.45 adjusted EPS number that we have for Q1 and that includes a $0.15 -- a 15% adjusted effective tax rate. So in terms of margin expansion year-over-year, I'd say that it will be mostly in the second half of the year. And we provided a little bit of color on that. We think Q1 will be similar to last year, maybe a little bit less. Q2, we expect to be similar to last year as well. So margin expansion, we think that will be mostly the second half of the year. But from an overall adjusted operating profit point of view, pretty balanced between the 2 halves.

Perfect. And when you think about the guidance on margins, how would you assess the sort of conservatism or the realism of that around the price/cost side? Now clearly, price/cost has been a moving piece for sort of 6 to 9 months now. It makes it very difficult to peg guidance on 1 day.

So conservatism doesn't come to mind when I think about our outlook for 2022. What we've tried to do, given our experience last year on input costs coming in higher than what we expected, we've tried to do is come up with a realistic view of what we think the headwinds are in 2022. We've quantified headwinds of $1 billion year-over-year, increased basically material and commodity inflation. We have targeted $1 billion of price realization for 2022. And what we've said is $800 million of that $1 billion of price is either carryover from last year or pricing actions that we've already announced and implemented early in 2022. And so a big element is price/cost that clearly has a big influence on our margins and our incremental margins. Besides that, I would say, our factory productivity, we're assuming that, that gradually improves throughout the year. And then, of course, a big element in our outlook for '22 is our productivity. We are targeting $300 million of cost-outs out of the system for this year. And the first quarter is about 20% of that. And so again, that is not very back-end loaded. I think those are the main comments.

That's perfect. And I think at the Investor Day, across the 3 segments, you have a fairly similar organic growth outlook, medium term dialed in. How are you thinking about this year in terms of organic growth across the pieces? And I suppose within HVAC and within Refrigeration, you've got 2 potentially very different movements in each.

Well, if I start with HVAC, high single digits. You look at resi, we've said high single digits. Almost all of that from price. We might see a point or 2 on the volume side. The year has started fine, generally consistent where it left off. So we get a lot of resi questions because 2 years ago, 10%; this year -- last year, it was up 20%. But this year, I mean the underlying fundamentals remain strong for resi. So movement has remained solid. We haven't seen inventory levels build up in our channels beyond where we would have expected them. We would expect orders to eventually modulate. They should -- orders should be down, but it's not alarming. We're watching more inventory levels and movement. So we do expect resi up high single. Light commercial would be up more than 10%. Light commercial, it's just a very good situation. Last year, we picked up something like 350 bps of market share, high-margin business. We performed operationally. We've done a lot strategically to position ourselves for a continued growth on the light commercial side. Low inventory levels, strong movement. Light commercial just feels very strong and will continue to be strong. Applied continues to be good. The big pieces of the commercial HVAC side is we have a very well-positioned, high-margin controls business, ALC. That will be up double digits, we expect. Aftermarket should be up in that double-digit range. So that's going to be continued growth. And then with commercial HVAC, ABI continues to be north of 50%, which is a good leading indicator. So we feel solid about light commercial -- excuse me, commercial HVAC applied trends that we're seeing globally. And then for transport refrigeration, you're probably in that low double-digit range. And then I think both for Refrigeration and for F&S, it's kind of mid- to high single digits. But no surprises to start the year. It's generally where we thought, and we feel positioned well for this year.

Perfect. And yes, the market share gain, I think, last year in transport, resi HVAC, light commercial HVAC, probably the 3 standout areas at least on the outside. How do you think about the sustainability of that? To what extent was it an unusual year? Maybe some competitors just got jammed up with COVID absenteeism or some procurement missteps.

Yes. I think that we all had some degrees of operational issues. I'm really proud of our operations team. I do think that team stepped up in the face -- especially in some of our U.S. factories, in the face of some elevated absenteeism rates. So I do think part of the reason we picked up share was just our ability to support our customers. Our objective has been, across the board, of course, to make those customer relationships sticky. To not only pick up share by delivering what they need, but then being there for them through a whole bunch of approaches. It's not just operationally now supporting our customers, but it's also can we provide digital solutions? Can we provide aftermarket solutions? It all ties in with our overall strategy at Carrier of transitioning from being just an equipment provider to a life cycle solution provider. And if we can do that for those converted customers, then we should be able to retain them. We won't retain 100%, but our goal is to retain as much as we can.

Perfect. And then maybe looking at China for a second, you have a good presence there, particularly, I think. But...

I'm sorry, Julian, if I just may, because I do not expect our share to go down. Let me say that. That is not in our thinking. We've had share gains. We are pushing our teams to continuously gain share but do it the right way. We are not going after share ever through pricing. That is not -- I mean, in fact, you heard Patrick say, we're going to have 5% of $1 billion of additional pricing this year. Gain share the right way through more value-added solutions. I apologize.

No worries. And I guess following up on that, 1 area that I came up at the Investor Day, came up at the one 2 years ago. Applied HVAC market share, perhaps, is one of the areas that's been more steady the last 2 years. To what extent is that things that happen to Carrier or does it reflect something around price discipline in that segment of the market?

I think it's a bit of both. I do think on the applied side, we said at our Investor Day that we had talked about gaining around 50 bps of share a year. The last couple of years, it's probably been closer to 30 bps. So we are gaining share. We've introduced new products. We have more to come. We've added salespeople. We've increased aftermarket and controls. We're looking at more symbiotic approaches to put, for example, Carrier all under 1 roof. So we may have a city like Austin, Texas, where we would have had a branch dealing with the controls business, dealing with service and aftermarket, dealing with sales for the OEM equipment. Now we're calling a Carrier One, putting our various parts of our commercial HVAC business under 1 roof to really combine it on the back-end and the front-end for our customers. So I do think we've gained share, but we won't pursue share at the expense of getting margins up in that base commercial HVAC business. That is one area within our portfolio where we do need to improve the margins.

And is that a function of sort of greenfield equipment or aftermarket or it has to be both?

It's both. We do want to make sure that we get paid appropriately on the new equipment side, but we do want to look at high attachment rates. It should just be the way we run the business. You sell equipment, you get a long-term aftermarket agreement. You sell controls. You sell complete solutions for our customers. And then within aftermarket, move them to our high-end offerings, which we call our elite BluEdge offering. So I think if we run the business and we sell the business the right way, we support our customers the right way, we can get those margins up to the levels where they should be.

And how do you think about the -- on the commercial side -- so yes, #1, what's going on in sort of U.S. greenfield? Naturally, that lags replacement on the upturn. But how do you see the pace of that greenfield recovery in the U.S. in commercial HVAC and Fire & Security product? And then sort of similar question, I suppose, what do you see in those areas in demand in China right now?

Well, in the U.S. and Europe, I would say, is that our orders have been very strong. We -- on the commercial HVAC side, whether it's the ALC or the aftermarket or the new equipment side, our backlogs are at record levels. Our orders have been very strong last year, as we talked about in our earnings call, continued into this year. So one thing not keeping us up right now is orders. China is a watch item. We are, I think, taking a very sober view on China. But I will tell you that for us, China is about 8% of our sales. And the biggest piece that seems to be at risk in China is this multifamily residential piece. And that's less than 1/3 of that 8%. So we look at it. We have clearly a watch on what's going on there with Evergrande, some of the other things we've seen. But China over the long term, we remain very bullish on. And we'll see what is growth this year -- this quarter. No one knows exactly, but I think it will be less than it has been in recent years. But we feel calibrated and I can tell you that we are in China for China for the long term.

Perfect. And then maybe looking at the kind of operating margins medium term. I think investors reacted well to that 30% to 35% core operating leverage ambition that you laid out. I think there have been concerns since the spin around the reinvestment needs at Carrier and if that would weigh on the operating leverage. Doesn't seem like that's in the outlook. So maybe just update us kind of where you think you are on that reinvestment needs. Are you at a good sort of run rate now?

Yes. I think the one area where we have said that we probably needed to catch up on investments was with respect to commercial HVAC, particularly for the North American market. And as David just mentioned, we've not only invested there, we've come out with new products there that we think are very competitive in the market. I'd say that the balance of our investments are more to play offense than to play catch up in any way, whether that's with respect -- whether that relates to the sales resources we've added. We shared a chart on that a couple of days ago. The R&D, which is continuing to go up across the company. If I look at the investments we've made, for example, in Refrigeration electrification, I think we're the clear market leader in that area. We have units in more than 11 countries at this point. And so I think that the framework we laid out was really balanced between attractive growth, attractive incrementals, while at the same time reinvesting in our business for long-term shareholder return. And so I do not see a need and we have not identified any need that says that there is a continued step function increase in investments. Certainly not to play catch-up.

And if we look at the aspects around pricing, price, dollar-wise, will cover a lot of those cost headwinds this year. When you look at Fire & Security as well versus HVAC, I think most investors are comfortable with the idea that HVAC has very good discipline on pricing. Fire & Security, it's a bit more of an unknown or a question mark. There's a lot of emerging market competitors in Fire & Security products. So how do you think about the sort of pricing power in that division?

Well, if you think about our $1 billion, we haven't broken it out by segment. But I will tell you that Fire & Security is going to get definitely its fair share of that $1 billion. So Jurgen and the team have been very aggressive, appropriately so this year, whether it's with the scale of customers or with some of our distributors to make sure that we're getting the pricing that we need. And I think we've had success. We've had success on the pricing side. I think we, in the last, I would say, 3 to 5 months, we've reacted more aggressively in that space. Certainly coming into this year, we've been eyes wide open on the criticality and he has seen the drop through that he would expect. He's had some challenging discussions for sure, as you would expect. But we've gone through those in a very constructive way with more to come.

And once we look beyond maybe this year, cost inflation perhaps subsides next year. How do you think about the sort of the price stickiness that Carrier -- should people expect you have a pretty good gross margin tailwinds in that sort of environment? Or do you think the pricing could follow costs sort of lower pretty quickly?

We don't expect the lower prices. I mean we just -- we do not -- we have no intention of doing so.

That's helpful. And then if we look at -- I suppose the -- in the VRF area, that was one of the main focus points for reinvestment when you demerged from TCC. Scale of that business is much bigger now. I think you've mentioned the sort of 4x higher revenue base versus 2 to 3 years ago pro forma. How easy is it do you think to sort of integrate those different pieces of the VRF? You've done 2 acquisitions. You had your base business, cobbling it together, making sure the brand strategies are clear. Just talk us through sort of that process.

We're very excited about this piece, Julian. What Chris is going to do -- Chris Nelson, leader of our HVAC business, is he's going to create a third segment focused on VRF and international light commercial led by Saif Siddiqui, a longtime Carrier leader that we've had. And that will connect the dots globally for our VRF, international light commercial for U.S., Europe, of course, Asia Pacific. And then as we start to think about one of the big benefits of VRF is heat pumps. And as we think about how we grow in that very important space, we can combine some of that into that segment as well. So the integration, I think, is going to be phenomenal because we have Giwee, we have the traditional business that we have. And then when we add Toshiba too, we really have now critical mass. It's not going to be an easy integration. But I can tell you that we have a playbook around integrating acquisitions. We did it with Giwee. That's gone extremely well, the team there. We now have a team. We're putting boots on the ground to go work with the legacy TCC folks to really have a cohesive strategy going forward. So I think our ability to integrate that and run that as 1 business is laid out well. And I'm sorry, Julian, but I got to tell you, I'm just -- we are so energized internally because it's something that, as a business, we've looked at VRF as the highest growth market in the HVAC space. And we've largely been, I don't want to say on the sideline, but we haven't been a major player because all we've really participated for the most part is through these minority JVs. And it was a tough nut to crack to figure out how do we become a scale player. So you add Giwee, you add Toshiba. We have a seat at the table in the fastest-growing space within the HVAC market with great brand, with great technology, multichannel, multi-brand strategy. This is something that can be really transformative, especially as we think about trends around sustainability. So there's a lot of energy in the system around this acquisition.

Perfect. And then as you mentioned, one, there's a strategic aspect of bulking up in VRF. There's also the sort of cleaning up organizational point of the partnership being clarified. Where are you across Carrier in that sort of JV cleanup part?

We went -- we started with around 40 minority JVs. We said we'd end the year last year in the low 30s, which we did, 32, 33, something like that. And we see that going below 30. What we found is that one of the big themes for Carrier is focus. What we had is senior leaders sitting on Boards of minority JVs that didn't really move the needle for the business. Those are hours spent on things that they should be focused elsewhere. So we said get rid of a lot of the distractions within the business. And just stay -- I hate to overuse the words, but stay laser-focused on what's going to move the needle for our customers, and our people and our shareholders. So get rid of some of the -- we had too many legal entities. We have too many minority JVs that don't move the needle. We have too many -- we cleaned up some of the back-end digital pieces where we had too many applications and too many ERPs. So we're really focused on simplifying how we run the business so we can focus on innovation and customers. So if there's minority JVs that don't move the needle, we'll continue to eliminate those.

And then I think aftermarket and services was a very big focus 2 days ago, understandably. Maybe explain how much of the team has changed perhaps to drive that? How you see kind of service, pricing and volumes playing out? When we think about the composition of the aftermarket, contractual service versus sort of break fix, any concept around those and the growth assumptions.

Yes. I mean it's scary for me to think about the fact that we only really have about 25% of our own aftermarket. And that's like our aftermarket. We put those pieces of -- we innovated the design and the products. We sold them. And it's our job to make sure that we support those products throughout their entire life cycle. So there is so much white space ahead for us to go after this aftermarket growth, which we've said is 10 basis points of higher margin than our traditional -- than our OE business. Higher margin, higher recurring revenues help smooth the cycles in some of the parts of the business. And it's ours for the taking. So we used to grow aftermarket before our spin at, say, 3% per year. We've now said high single digit, low double digit. That is our aftermarket and we should be managing it in a much more effective way. We brought in Ajay Agrawal. He was put in. He plays the playbook, working with the business units. Everyone is rallied around focusing. We move more talent into the aftermarket. We've been working with channel partners, in some cases, many direct with our end customers. And I think the playbook works. We know how to drive it. We just have to continue driving it. It's going to be one of the big tailwinds for growth for Carrier for years to come because we've talked about growing our aftermarket from $4.5 billion to $7 billion over the -- through '26. That's just getting started.

And maybe give some background as to the momentum around, say, service attachment rates where you think sort of retention and attrition are moving in that.

We went from like in the 20s on attachment rates to last year, we ended around 38%. We said we got to get that into the 40s on our way to 60% attachment rate. So if we can continue to grow that 5 to 10 points a year -- 5 to 10 percentage points a year, that's, for me, part of the price of admission. That is what we should be doing. But we also talked about total coverage because you not only redefine attachment rate as you sell a new piece of equipment, you then get -- after it comes off warranty, you get a long-term agreement. What's the most important thing is, if your total 330,000 chillers out there, how many are covered by some kind of long-term agreement? We went 50,000, 60,000, 70,000. So we want to improve that 10,000 a year. That's what we want, is to attach our devices through an edge device. Now they're connected, then get them under some form of long-term agreement. That's where really the target is. Max coverage. Not only for the chillers, which we use kind of as a proxy for our aftermarket, but we have 1.8 million reefers out there with very few under some kind of long-term agreement. Applied links a digital strategy, connect those reefer units, whether they're on -- used for cargo ships or they're used for trucks and trailers, connect them and then attach them to a subscription-based long-term agreement. We have more than 2 million light commercial rooftop units out there. They should be connected, they should be under a long-term agreement. So for me, I look at that whole space. It's transformative to how we run the business. That is all growth tailwind, high margin, high recurring revenues.

Perfect. And then kind of strategically, in nonresidential buildings, you obviously have a good HVAC presence, Refrigeration, Fire & Security. So a fairly sort of one-stop shop hardware offering. You have ALC kind of sitting on top of HVAC. What are the sort of the aspirations to move more broadly into workplace management software or broad BMS type systems? How willing are you to go into that type of layer?

Well, we're very purposeful in our launch of Abound. Abound didn't exist a year ago. And it actually -- truthfully, Abound started as a solution to how we make the investments around healthy indoor air are sticky because what we didn't want is everyone's focused on healthy -- everyone in this room has some level of thinking about, in an indoor air environment, is this building keeping that air safe? To make it safe, you have to make it visible, so you know whether if you have high particulate matter. And then what we've done is expand Abound from a digital dashboard for a healthy, safe indoor environment to now a comprehensive solution to combine with our ALC business and our Fire & Security business to make it a digital solution for buildings. Healthy indoor environments, but then sustainability. So if you had 10,000 stores all over the world, you'd have 1 pane of glass to look at your sustainability because 1,000 companies have made commitments around 0 net emissions. So if they could just see the greenhouse gas emissions from all of their facilities globally through 1 pane of glass, that's Abound. Combine it with our ALC business and our Fire & Security, it's personalized experiences. So we're really bullish on where we can take Abound. It's in the first inning, a lot more apps we're going to add and functionality we're going to add to it every year.

Perfect. And then I think commercial refrigeration has been an area that suffered some pressure recently. Maybe help us understand kind of what you expect from that business in the medium term. Realize that it shouldn't be an overnight kind of transformation. But as you reinvest in it, restructure it, where can it get to? So the challenge for investors is when they look at peer businesses in the commercial refrigeration or station refrigeration, it can be -- it feels like a lot of people struggle there a lot of the time, either on growth and/or margin?

I think that's the question is, is it a challenge faced from a margin perspective because there's just fundamental issues with the structure of that space or is it a performance issue? I would say that we have not, as a company in commercial refrigeration, been performing at the levels that we need to. We're starting to see some more pricing stickiness over the last, I would say, few months than we have in the past because we have to. It's a business that's been performing in that mid-single-digit range. It toggles. Maybe it's 5%, 7% -- kind of -- the business is not performing at the levels that we would expect of ourselves. And it will not be a 5% to 7% business forever. It's not acceptable and that team knows that. So that is an area that we are, of course, in all of our businesses, focused on growth. That business is focused on margin expansion. If that business doesn't grow this year, I'd be fine with it. They got to get the margins up. And they got to get the margins up quickly, and that's what we expect of ourselves. And I can assure you that internally, there's no ambiguity around that.

And then on the sort of acquisitions front, I suppose, lastly, give us some sense as to the firepower you think Carrier has to deploy when you're thinking about balance sheet leverage. And any sort of weighing up of buybacks versus M&A? And I think Carrier's share price obviously is coming along with a lot of the other HVAC businesses this year.

So at our latest earnings call, we included the slide that basically identified we have $7.5 billion available for deployment and $3.75 of that, about half of that, has already been accounted for. $1.6 billion of repurchases this year. We're going to pay down $750 million of debt after that. Further debt pay down not a priority. Toshiba is $900 million of capital deployment and then our increased dividends. So just for this year, we have another $3 billion of additional capital that we can deploy. Our priorities are very clear, inorganic growth. After that, acquisitions. The beauty is we have the financial position to do both. What I also shared earlier this week is that on an ongoing basis, after paying down the -- after paying an increased dividend, we have $1.5 billion available each year for acquisitions and repurchases, and that $1.5 billion, of course, is growing because we intend to grow free cash flow. And so without touching the balance sheet or getting additional leverage, leave alone equity, we have plenty of capacity available to us, but we will remain disciplined just like we did with TCC. Right within the fairway and what we believe a very attractive financial transaction as well.

Perfect. Well, I'm afraid we're out of time. But thanks very much, Dave.

Thank you, Julian. It's great to see you.

Thank you.

Thanks, everyone.