Carrier Global Corporation (CARR) Earnings Call Transcript & Summary

All right. Welcome back from lunch, everyone. Thanks for showing up for the afternoon. On stage joining me next is the team from Carrier, Chairman and CEO, Dave Gitlin; as well as Sam Pearlstein in Investor Relations. Dave, pleasure to have you, as always. I know you have a few opening remarks. I'll let you get to it, and then we'll dive into some questions here.

Okay. Well, thank you, Josh. Thanks to Morgan Stanley for having us again this year. A few quick upfront remarks. Recall our theme at Carrier, which is performing while transforming. In terms of performing, the team continues to execute very well. Q2 was another strong quarter, 6% organic growth despite resi being down mid-single digits. Aftermarket is up mid-teens year-to-date. Full year projected price/cost, positive of $300 million plus $300 million of productivity, all enabling us to raise our full year top and bottom line forecast, and we remain very confident in that outlook. With respect to transforming, first, on Viessmann Climate Solutions. We're gearing up for day 1 around the end of this year. Thomas Heim and his leadership team were at our headquarters a few weeks ago for planning sessions. All is progressing extremely well. The teams fit together like a glove, culturally, mission, talent, customer focus, innovation, execution. The base business is tracking to EUR 4 billion in sales this year and EUR 700 million retains EBITDA and retains the same double-digit growth profile that we've discussed. The first half sales grew an impressive 20% with heat pump sales up over 40% in the first half. This truly is the best asset in the best space in our markets globally. Also, we announced that Max Viessmann will be joining me for a live webcast event on September 26 at our headquarters, where we'll be discussing their tremendous opportunity ahead for this combined global climate and energy solutions champion. In terms of the business exits, all are tracking to our internal detailed plans. Our formal process of engaging with prospective buyers for security and commercial refrigeration have now officially begun. Having recently sent out our confidential information memoranda, we remain on track to have industrial fire in the market next month. In terms of commercial and residential fire, we have now determined to have these businesses go together in a single capital markets transaction, targeting listing dates in the late spring or perhaps early summer of 2024. All of these businesses are fantastic assets. We are very pleased with the level of interest in these businesses and remain confident in our ability to have clean exits while maximizing value. And while we continue to have all hands on deck to complete the purchase and integration with Viessmann Climate Solutions and execute on our business exits, we have more than 99% of our 55,000 people heads down focusing on executing on our customers for 2023 and beyond. And with that, Josh, happy to get into the Q&A.

Excellent. I want to touch on a few of the things that you mentioned there. We'll get to them. But maybe just to start off, in terms of the demand picture, a lot going on out there. So I don't want us to be overly broad, but I guess a few things that kind of pop up. Obviously, residential inventory is something that people have been watching. A lot of commercial exposure between HVAC and the rest of the businesses, where we've seen some of the Dodge data on more commercial type properties look weaker. So maybe just kind of your overall sense of how demand is trending and maybe the few larger markets or pieces of your business that you're paying most attention to.

Sure. Let me start with resi. What we said for residential for the year in North America was that sales will be flat with volume down in the high single-digit range. As we look at it now, we think volume will be down a little bit more than that. So instead of sales being flattish, it's probably down a few percent in that range. But we think that light commercial -- we had said overall for the year, light commercial would be up around 20%. We think light commercial is trending far better than we thought. So we think, frankly, those 2 offset each other. And the encouraging piece about that, and Josh, you and I have talked about this, is we get so many questions about resi. And we said that resi volume could be down, and Carrier would be -- could still do very well, given that it's only about 20% of our business. We've said this year, revenue up, organic growth of, in mid-single-digit range with volume potentially down in resi in the double-digit range. So that's very encouraging. We're thrilled with light commercial. And by the way, the last thing I'll say on resi is we want to be very purposeful about ending this year with inventory in the channel and balance to where we ended the last year. So that's part of our calculus as we make sure we support our customers but are very purposeful with inventory in the channel being balanced to last year. Light commercial is just strong across the board, 60% growth that we had in the second quarter. First quarter was up 35%. All the underlying verticals, K-12, some of the activity we see in retail and food, that business remains very strong. We're getting also price and mixed team just performing and executing extremely well there. And commercial applied up double digits, driven a lot by our growth in aftermarket. Controls continues to be strong. We have backlog. The overall backlog for Carrier is up 30% on a 2-year stack. We're up 10% over the last couple of quarters with the backlog increasing for commercial applied, which positions us well going into next year. And we can discuss it globally. Yes, there's a little pressure in -- take North American real estate, a little pressure there, but it's less than 10% of our North American applied business. So a lot of strength in some really key verticals. K-12 strong in applied, health care strong, hospitals. We look at data centers is extremely strong. And the CHIPS Act and some of the infrastructure spend, not only here in the United States, but globally continues to be strong.

So I want to pull on that thread a little bit more on light commercial because it's just been so surprising. I think generally, folks regard that as maybe one of the more cyclical parts of commercial equipment because you get more like commercial like retail type exposure, restaurants, stuff like that. What do you attribute this to? You mentioned it's broad, but it's also broad in the face of higher interest rates. And you have commercial comps that are not terribly easy. Sort of unpack that a little bit, if you can.

Well, first of all, we have picked up about 200 basis points of share over the last year, and we picked it up the right way. The team introduced a new beltless design, and so we've got a variable vein, Axiall, which is 40% more efficient than the light commercial unit that it replaced. So it's very attractive to our customers, especially with the drive for more energy efficiency, especially some of our scale customers that have a very large footprint. We look at some of the activity, again, ESSER funding for K-12, $190 billion, there's still about $100 billion left to be allocated, but that's now become a very significant piece percentage of that portfolio. And we're seeing some of the best growth we've ever seen in K-12. But then when you look within the verticals within retail, some of the lower-end vertical -- the lower-end retail continues to be very strong. That mix might change as you go into next year. It may be that the higher-end retail starts to get more attractive. But within that retail space, we've been able to flex to where the customers are, national accounts. But the same as food, some of the lower-end fast food has done better than some of the higher end, but that's played to our advantage as well.

And you're not seeing a drag from verticals like warehouse where we add a ton of growth and obviously, a lot of tough comps now, which I would presume is the light commercial market.

It is. Warehouse has been down. So I would say one of the really encouraging things about our portfolio is that -- one of the expressions we use is that when you fish, you go where the fish are. Well, we go where the strength is. So if warehouse shows some weakness, we double down on K-12. So we have hired people specifically from that vertical, people that were on the buy end now work for us. So we're very targeted, not only within K-12, by which -- but by district, that's actually allocating the most funding. So yes, warehouse is a little bit weak, but we allocate our resources elsewhere where they're strong.

Got it. And then just on the resi front, with the inventory position, you mentioned you wanted to get there sort of by year-end. Are we going to be the bulk of the way through with the third quarter? I mean, does that leave you sort of extra work to do in the fourth? How do you think about kind of the timing of that?

No, we're working in now a few weeks left in the quarter, but that will extend into -- the destocking will continue into the fourth quarter. We feel very calibrated. We know what we have to do to kind of end the year where it should be. We're working very closely with our -- not only our distributors, but our dealers to make sure they have what they need. And then as we transition into next year, now you're starting to see the benefit from the new refrigerant because we will start shipping the 2025 refrigerant change as you go into next year. So we won't -- we don't know for sure the take rate, but there are some of the new units will start shipping in the first quarter of next year, and we will see price benefit. Because as we look ahead, as we start thinking about '24 and '25, there's really 3 elements of pricing that we're looking at. One is a typical annual price increase that we would see for resi. Two is that we are seeing some cost pressure for us on the 410(a) new refrigerants. So we will pass that along. And three is that for the 454B-refrigerant with the new refrigerant that kicks in, we will have pricing associated with that as well. So if you look at -- when we think about '24, '25, we're probably looking at about a 15% to 20% price increase over those couple of years attributable to those 3 elements.

I think someone else presenting here with the same sort of analysis would have come up with a similar number, I think, close to 20%, kind of 10-ish a year. So it seems like people are dialed in on that. How does that impact, in your mind, the replacement dynamics for next year? You mentioned it's kind of hard to anticipate what the take rate will be. But buying a 410 system in 2024 also feels like you're kind of buying the last of the line, and it gets hard to maintain. Now the homeowner won't know the difference, but how does the contractor get comfortable with sort of the useful life on those being shorter?

Yes, there's sort of a double-edged sword there. On the one hand, there may be a gravitational pull towards the 454B because you don't want to be one of the last to buy the 410(a). On the -- at the same time, 410(a) will likely be overall less expensive than the new refrigerant. So there could be a mixed bag as we go into next year. We don't know exactly what the take rate of the 454B new refrigerant will be for '24. There will almost certainly be some level of pre-buy. What's not clear is how long into '25 that you can sell the existing 410(a) refrigerant. So that needs still a bit of clarification. So I think there will be some level of prebuy. Our #1 priority is making sure that we support our customers. So that's why we have so many different model, so much mix in the system. We want to start introducing the new units with the new refrigerant as early in the year as possible just to get the dealer base comfortable, get them properly trained on the new refrigerant and make sure we do everything we can to minimize risk. We did it for the '23 SEER change, which went incredibly well. Hats off to Justin Keppy and that team that did a phenomenal job. So we're going to position ourselves the same for the '25 refrigerant change.

And then I think sitting on the same stage across the street a year ago, heat pumps sort of felt like the free bingo square in the middle for a lot of different companies, certainly, the HVAC complex. IRA gave a lot of incentives. I haven't really seen much so far just because of the rulemaking, but how do you size that up today? Anything you're particularly watching there?

Well, we're excited about that. We always anticipated the benefit this year would be a bit muted because getting from legislation to effectuation, there is a transition as it works its way through IRS in some of the different states that need to take action. But when you look at how the regulation has gone into effect, the 25C change, the $2,000 credit that you get for implementing heat pumps in the Southern part of the country, we think that's going to be very impactful. We don't know exactly how to handicap it for '24 and '25. But you're going to effectively have the ability to use the $2,000 credit to upgrade to a variable speed mid-tier heat pump effectively for nothing. So that will be very attractive to consumers. And by the way, very attractive for the environment as well. So we're very bullish on that. And we're also bullish on the 179D change that's associated on the commercial side. We, typically with heat pumps with the IRA, talk more about the residential side, but there's still some detail that needs to be clarified on the commercial side, but the credit you get per square foot has gone from $2.50 to $5. There's limitations. You only get that credit once the building is at least 25% energy -- more energy efficient than what it was. But that could be a meaningful incentive as well.

How does that -- how do those figures, the $2.50 or the $5 sort of relate to some of the product or service offerings within there? Because I think everyone's added kind of these IoT capabilities, cloud-based stuff like Abound, but I think redoing like a chiller and the air handling system is probably way more than $5 a square foot. So what falls within that? And is that like a real incentive for action?

Oh, yes. I mean I think what we're seeing with chillers, and I think it's one of the reasons our space is so attractive, is we are seeing customers absolutely replace chillers before the end of their life. Say it's a 15-or-so year useful life, we're seeing customers, when you're getting into a 2- to 3-year payback, to replace a chiller before the end of its life because of the energy efficiency. You're often -- in many cases, you're looking at a 40% more energy-efficient unit than the one that you're replacing. So your payback is very positive. It will be further enhanced by that 179D credit. And then you overlay that with something like Abound, which now we've implemented a digital platform that we can put into one of our scale customers' facilities around the world that gives them real-time visibility into their carbon emissions. Once you have that visibility, you can then take action to look at why do my Chinese factories have more emissions than my Indian factories? And then you can either do control set points, rooftop unit upgrades, other things to drive towards their ESG commitments they've made but also towards more energy efficiency.

And then in terms of what's driving that 2- or 3-year payback versus history, because I think if we were to have this conversation a decade ago, I think the paybacks were closer to a decade, is it the digital tools like Abound? Is it that the equipment is just so much more efficient? I know that, not to get too deep in the weeds, you have like these magnetic bearings now.

Yes.

But what's driving that step function change? And could there be another step function change?

There could be. And I think the biggest thing is the products. Clearly, the new digital tools provide a lot of capabilities and some of the controls provide a lot of capabilities. But you mentioned, we introduced a new chiller that has mag-bearing design. In our screw chiller portfolio, we have 5 new offerings, by the way, all of which have the natural refrigerant as well. So we have increased R&D at a Carrier level from something like $400 million when we spun to $550 million over just a few years, really driving towards a portfolio focused on all things energy efficiency. It's one of the reasons that we had to make the difficult decision to exit our Fire & Security businesses. So now when you think about our R&D as a company, compressors, controls, heat exchangers, it's all -- all of those product lines cascade across 100% of our portfolio. And we think the top 1, 2 and 3 differentiator for us versus peers and the most attractive thing to our customers is going to be all things energy efficiency. So that is the primary reason you're seeing a quicker payback.

And how would you sort of rank yourselves competitively, what you do well, what you could still do better? Because I think a lot of the folks in the space have seen this just kind of generational shift in the paybacks, and the equipment has gotten better. Obviously, the controls and the software. I think everyone says they have the best mousetrap, and I'm not an engineer, so I can't qualify that yet. But I guess, maybe saying it differently, what do you think of are the particular strengths of what Carrier brings to the table?

Well, I think at a high level, we have a very attractive brand. I was in a conversation with a major customer recently, and he said, no one's ever gotten fired for picking Carrier. It's considered -- in his words, it's considered the Tiffany of our industry. It has the premier brand recognition globally. We have -- and it's not just the Carrier brand, but other brands that are part of our portfolio like Toshiba. We love our channel access. We have a very deliberate channel approach that we use globally that really works for us. And then when you get into sort of the product portfolio, we're very pleased of how we've implemented our new digital platforms, Abound and Lynx, because we were purposeful in designing those in a very agnostic way, so they could interface with anyone's BMS versus others that made them proprietary. And then when you get into the product portfolio, we have an ability to design not only for cost, but for differentiation. So when we bought Toshiba's HVAC business, one of the many reasons that we originally set our synergies was going to be $100 million, and now it's going to be certainly north of $200 million is value engineering. Toshiba has some of the best technology in the world, triple rotary compressor design. But what we have is the ability to take some elements of cost out, but also drive some efficiency as well. So I think we have more than 5,000 engineers, and that scale really matters.

And then on the service side, because I think that's ultimately where the opportunity is very long-lived assets, a ton of opportunity post installation, where do you stand today on attachment rates? Where has there been kind of success or frustration on the service part of the journey?

Very pleased on aftermarket. We talked about going from $4.5 billion to $7 billion over 5 years. We're certainly tracking to that. We said we'd grow high single digit to low double digit. Our internal mantra is double digit forever. This year, we set an internal stretch target. We're up 15 -- we're up in the mid-teens through halfway through the year. You mentioned things like coverage. We had 70,000 chillers under coverage. We said we'd add another 10,000 this year to 80,000. 70,000 going to 80,000, certainly on track to do that. Attachment rate growing 5% a year, 45% growing to 50%. But when we talk to our Board strategically, we have 2 major themes that we talk about. One is all things digitally enabled life-cycle revenues. That is a major, major theme. It comes with higher margin, higher stickiness, higher recurring revenues, kind of mute some of the traditional cycles that we've seen. And we are seeing so much traction in terms of not only number of connected and connectable devices, but a number of subscription-type deals that we're starting to do with our customers. So very, very pleased with everything associated with aftermarket and the playbook underlying it. The other major theme that we will talk about with our Board when we have our strategy offsite and that we talk a lot internally is all things sustainability. That is a major differentiator for our industry. So when we talked about being the global leader in intelligent climate energy solutions, that is where a lot of our focus goes as well. So aftermarket tracking extremely well.

Got it. And I want to move on to the portfolio, but before we get there, on the data center side, obviously, hugely topical in the market today. Things need a lot more cooling. How would you define your position in data center? How you kind of specking out into some of these higher performance applications like the GPU-based stuff? Anything you can share there would be helpful.

Well, there's 2 big elements that's really boding well for us with data centers. First of all, the verticals up exponentially, and we're very well positioned, both in Europe and the United States and data centers. So we're pleased with our share and our share gains in data centers. Part of it comes through the heat pumps and the chillers and the underlying products that we have. And the second piece is around, as you just said, Josh, all things associated with data. So we bought the company in the U.K. called Nlyte. So our combination to not only cool, all the heat that's generated. As you said, it's -- a data center emits exponentially more heat than a traditional building. So our combination to not only dissipate it but understand where those heat loads are coming from and use algorithms to optimize that heat dissipation is gaining a lot of traction for us.

Excellent. And is that something that you're seeing sort of in the order book today? Or is that surge sort of on the comm still?

No, we're absolutely -- I mean when we look at -- our commercial applied business is going to be up double digits this year, and that's even with some pressure on real estate in places like the United States, Europe and China. So some of the big beneficiary we have is not only K-12, higher ed, some of the infrastructure act, but data centers is a big driver for some of that lift.

And just given that the category, especially kind of the high-performance version of the category is still new, is that competition more fragmented? I mean we've seen some M&A in the space of companies that I wouldn't have heard of, if not for their data center expertise, certainly not broadly focused on commercial assets. Do you guys feel like you have what you need? Do you run into a lot of new folks when you're bidding on jobs?

We feel good about it. I mean I think the traditional equipment providers or the traditional competitors that we would have seen, I think our peers are probably doing things that are similar to us, which is buying a company like Nlyte that has very unique algorithms around understanding where the heat is being emanated from. We understand how to dissipate it. So looking at some holistic control solution for data centers is a bit where the puck is going. Credit to the team. They got out a bit in front of that with a nice acquisition.

Got it. I want to shift over to the portfolio now. You mentioned sort of a few kind of more strategic details on some of the exits in your prepared remarks. Can you just remind us how much you would look to go to capital markets with sort of an IPO as part of that piece of the business? Can you just size that for us?

Well, what we're talking about there with a capital markets play is our commercial and residential fire. And we're looking -- I mean -- and that can take -- when we say capital markets, that can take a bunch of different forms. A spin, a split of IPO and different color. So it will be a public market play. And look, we've said the entire thing on the Fire & Security side that we're selling is a few billion. And we're already in the market with security, and we will be in the market with industrial fire within the next 30 days, and then the remainder will be the part that we take into the public markets.

Got it. Is there a prioritization there on the capital market side to do something that, I guess, brings in more cash? Obviously, if it's more of a spin, the leverage profile that matters a lot, et cetera. Like is that something that factors in just given the Viessmann debt load?

The way we think about it is we always come back to our priorities of how we want to dispose of these assets, which is, number one, we want a clean exit. So that guides so much of our decision-making is that we will absolutely have a clean exit. Number two is maximize value. And then what we've talked to our shareholders about is giving our leverage ratio back down to the levels of around 2 by the end of '25, could happen sooner. We've talked about paying down debt once -- as we improve our leverage ratio. And we've talked about doing a share buyback that's at least commensurate with the $2.6 billion that we're issuing as part of the Viessmann acquisition. So we look at all of those parameters, and that will help guide exactly how we do that public market exit for the commercial and residential fire piece.

Got it. And then just pivoting over to Viessmann. Decent amount of news on the policy front out last week from Germany. I guess, what's your initial take on that? And how that colors your views?

Look, it's all systems go. I mean, the legislation that got through the house that now has to go through the upper house is exactly what we thought it was going to be prior to the summer. So is there going to be increased funding at a German level for all things sustainability with $18 billion, $19 billion going specifically towards buildings? Yes. The German government has said that they're going to go from -- their intent is to go from 250,000 heat pumps being sold last year to 500,000 heat pumps being sold in 2025. And that's still very much on track. Subsidy levels went from 40% to 70% under this legislation. You have to look under the covers at -- some of that is -- there are some caps in there. There's some level that goes into low income, but subsidy levels remain very encouraging. And then you might see an increased adoption of district heating, which is a win-win for both Carrier and for Viessmann. We may sell more commercial heat pumps. Viessmann may sell more -- have a bigger presence now in some of the municipalities for apartment heat transfer units that you see in the individual apartment buildings. And then under every circumstance, you're going to see heat pumps for new construction, new home construction, and you're going to see more heat pumps for replacement. And if you -- and during some interim periods, if you see a little bit more boiler sales, Viessmann makes great margins, very well positioned, especially at the premium end. So the legislation is what we thought. It's very encouraging. And at the end of the day, what's going to happen throughout Europe is everyone aligns with the framework at the highest level, which is European Green Deal, Fit for 55, REPowerEU, 55% renewables by 2030. As every country ladders up, legislation may change 1 year to another as we saw this year in Italy, but Italy went from 110% subsidies to 90%, Germany going from 40% to 70%. Things may move around. You may have some different compares 1 quarter to another. But the trajectory for heat pumps and the greenification and sustainability trend with Europe is 100% going to continue.

Given that the boiler phaseout takes a little bit longer, I would imagine it gives the industry, as a whole, maybe a little room to breathe and kind of figure out what comes next rather than some sort of forced transition. What does that do to the competitive pool out there? I know Viessmann is good installer base. It's part of why you like the business in the first place. I would imagine that just given the growth required, that you're going to see some new faces pop up. What's your thought on that? And are those folks sort of present today?

Yes. Look, any time you have such a unique market where you look at sustained hyper growth, it's going to attract new players, 100%. We've always thought it. We expected it. It's the #1 reason it was our top priority to get into that space. And anyone that's doing a strategic assessment will want to have a presence, if they can, in the residential heating space in Europe. The issue is that Viessmann not only has the premier brand and the premier team, they have the premier channel. Like when we talked about the acquisition, we talked about direct to 70,000 installer relationships. We now talk about direct to 80,000 installer relationships. So people may come. They build some capacity. They might white-label under someone else's brand. They might, instead of a wholesaler carrying 10 brands, they may carry 11 because someone else wanted it in. No one has the channel that Viessmann has. That is a very effective moat and it's an enormous differentiator. So the only -- the biggest challenge that we're going to have is just keeping up with the demand, making sure that we continue to add certified installers to keep up with the demand that we are -- we've said that heat pumps are going to grow in the 20% range on a sustained basis, and we absolutely stand behind that.

Excellent. And I see we're at time. Dave, I appreciate the time. Very helpful, as always.

Thank you, Josh.

Good to have you.

Appreciate it.

Thank you.

Thank you. Yes.