Carrier Global Corporation (CARR) Earnings Call Transcript & Summary

Well, thanks, everyone, for being here. It's my pleasure to have up next Carrier Global, David Gitlin, Chairman and CEO; and Patrick Goris, CFO. So thanks very much to both of you for being here. I think we'll head straight into questions.

I think first off, maybe start with Viessmann, as that closed relatively recently, a very large transaction. Maybe help us understand sort of how did that business kind of close out the year? How has it started the current year? And you've given some sort of revenue growth outlook for it for the year ahead. Any main assumptions?

Sure. First, Julian, thanks to you. Thanks to Barclays for having us back. Look, we could not be more excited about this Viessmann combination. We never bought it because what we thought was going to happen either in December or January. We looked at it and said there is an unambiguous transition in the European market to heat pumps. That premise will 100% continue. So you look at what the EU is saying, 55% reduction in greenhouse gas emissions by 2030, 90% by 2040, and they specifically call out heat pumps because there's no way to get to those targets without a transition. So the underlying premise of that transition remains 100% intact. What happened towards the end of last year is that as some of the legislation in places like Germany was being debated, it did have a dulling effect on new orders. But when we constructed the plan for this year, we were very purposeful about looking in the very silver way around what would the heat pump market do in each country. We did a country-by-country assessment. We then looked at, first, share gains. Second, boiler sales, which we assume short share gains. We assume that boilers will be a little bit higher than what we initially had anticipated. Aftermarket, which is a little over 10% of the business will be up double digits. We'll get a couple of percent of price, some of which is carryover. We have high confidence around working with our installer channel partners that we will get that price piece. We'll get double-digit battery. We looked at PV and then we did a country-by-country assessment. Mid-single-digit growth for us on the top line in Germany, double digit in France and in Poland. Poland's going to have some pent-up demand because of the change of administration's going to drive more sales this year. And Italy, we think will be down. So we feel very good about the mid-single-digit numbers. It does require double-digit growth in the back half because we said the first quarter for us could be flat, could be down a little bit. We'll see what happens. But remember, their heating season starts -- it's kind of the opposite of our -- in the United States -- in North America. Our air conditioning system, we're starting to build now in anticipation of the summer months. They are going to be focused on subsidy applications, which can start in Germany at the end of this month. So there would be no real subsidy applications in January and February. They were high in December. We've seen increased activity on the web pages, which is preorder activity. We do need to see subsidy applications pick up a lot as we get into March, April that will feed demand that gets into the critical months of September, October. So we feel very calibrated on the plan. And if you looked at January, you would not be surprised to see that the heat pump association could say that in Germany, heat pump volume growth was down, and it could be down significantly. I will tell you that Viessmann sales for us in January were flat. So what happens is either a competitor or an industry association says a number and you get a whole bunch of inbound questions around what does this mean for Viessmann and the thing. The Viessmann EBITDA for this year will be higher than we had in our base plan. Sales will be a little bit lower, but we feel calibrated on where we are. And we are going to pull forward cost synergies.

And when you think about the sort of price discipline in the market as the volume comes under pressure in certain products, in certain countries and so forth, how does the overall sort of pricing environment at Viessmann climate look for the year ahead?

Well, remember that we compete on a country-by-country basis. The competitors in each country will vary. And we also compete in the very premium end of the market. So when you get to a specific country and to specific competitors, we believe that we will be rational and we believe that any rational player will be rational. So we also have a very unique channel because we can go to the direct installers. We are not looking as maybe some of our peers are, is the amount of inventory that may be held by a wholesaler, 1 of 10 brands, and they have to start calibrating how do they drive sales with a destocking issue. We feel very calibrated on the inventory that our installers have and the pricing approach that we have for this year.

Perfect. And on the point on sort of the boiler mix versus the heat pump mix, how does that play into the EBITDA and the sort of profit margin profile of Viessmann?

Well, the margins are very comparable, boilers and heat pumps, and they're both high margin. Obviously, we sell heat pumps for something like 3x the price of a boiler. So it will affect the top line. And -- but apples-to-apples, the margin percentage is the same, but if it affects the top line, it will affect the overall a bit.

Go ahead, Patrick, what do you say?

No, that's great.

And when you look at the route to market, I think, is something different at Viessmann Climate versus many of its peers in Europe. A lot of the peers, I think, have suffered much more from the sort of wholesaler destock. I guess a couple of questions. One is, how do you feel about the inventory levels in the channel for Viessmann product today? And then also, when you look at the industry levels, I guess they have some effect if competitors are just going to dump product. How do you feel about sort of industry inventory levels?

I think for Viessmann and I would say now for our resi business, say, in the United States, it's kind of back to normal. We went through a phase coming out of COVID, coming into the supply chain challenges that we all have elevated backlogs. Now we're back to kind of business as usual. We feel very good about the inventory levels in the installer channels. So I think what some of the Viessmann peers will go through with the destocking, those that have inventory in the wholesalers, may see some of what we saw last year for resi business in the United States. We suffered from some of that. And the question, I think, that folks have per se, our U.S. resi business is did we take our medicine last year? We believe we did. We -- if you look at the number of splits sold in the United States, it used to hover in the mid $6.5 million range. We got as high as a little bit back in '22 or so just north of $8 million. Last year was back to that $6.5 million. So now we're kind of growing off what would have been traditional levels. And there may be some players in Europe that have to go through some of that, which we went through last year, where our volumes in the United States were down in the high teens last year. They were down in the high 20s in the fourth quarter. Some of that was very purposeful. Our #1 objective for U.S. resi in the fourth quarter was end with inventory levels down in the mid-teens. We ended down 16% year-over-year. If we look at where we are today, it's actually a little bit even lower than that. So we feel very good. I know one of our peers said yesterday destocking could go into the second quarter. We happen to not see that. We may -- they may be right. We might be wrong. But we think that destocking is kind of largely behind us over either now or over the next month or so. So now we're kind of both Viessmann and us, it's sort of back to that same phenomenon, is back to basics. What's -- we feel calibrated on residential new construction. We feel calibrated on what we're going to see with some people moving homes and some of that add-on replacement business. And now we're back to true orders driving true growth without having an unusually high backlog.

When we look at that, to your point, it's maybe more now about final demand, health of the consumer, consumer confidence, those types of things, not so much inventory adjustment. How are you kind of assessing that in the U.S. that you've given that the final demand is more sluggish or resi-HVAC than 1 year ago or pretty similar? And then I guess in Europe it starts to fall apart from the subsidies moving around. But any thoughts around that final demand piece in some of Viessmann's biggest countries?

Well, I start with the premise, both in the U.S. and in Europe, it's fundamentally a replacement business. So in both locations you're dealing with an 80% replacement business. So the unit sales in August, you're going to replace it in the United States in December. In Europe, you're going to replace your heating system. Now If you look at the new construction piece in the United States, it is good to see that for single family, there does seem to be some more recent pent-up demand there. We believe, in the United States, there's 4 million, too few homes in the United States. So you are going to see some increase over time on residential new construction. We have it kind of flattish this year. There's more pressure on the multifamily side. Mortgage rates, as they go from kind of 8% to below 7%, we do think there's going to be pent-up demand for people moving home, which drives air conditioning and heating sales as part of the new inspection of the new home. And then there's going to be pent-up demand for replacements because remember, our volume was down in the high teens last year. So we do think for a bunch of factors, there's going to be some increased demand. Now we're very sober about the fact that there's big populations in the United States and Europe were slowing economies and inflation that still hasn't completely gone away that are under pressure. But we do -- we haven't seen a huge mix down. We haven't seen people replacing parts rather than the entire system. And then we'll have to see about the new refrigerant as that starts to come in this year, the new units into next year that provides some lift as well.

Perfect. And on that point, on the refrigerants, do you feel that most of what the industry needed or wanted to hear from the EPA has happened now? Is there still some gating factors holding distributors back from stocking activity? Any thoughts on that and next steps on the EPA?

Well, the big one was this 1-year window we got and that was important and that was helpful, and we were glad to see that clarification. There's one more clarification that we are strongly as an industry encouraging EPA DOE to make. And that is that prevents kind of an unintended loophole that you can replace for unit only, with the 410A unit. I don't think that was ever intended. And we're optimistic that, that will get resolved, but that is important that, that get resolved.

Perfect. And one thing we didn't touch on first finishing off the Viessmann discussion was the potential for revenue synergies, timing, scale. What types of products do you think that synergy could be most powerful?

We're optimistic there. I would tell you, I think that we put in our model virtually zero, but I think the reality could end up being hundreds of millions. And I usually think about it in three categories. The first and the sort of soonest is the sort of multibrand, multichannel. Us pushing air condition sales in Europe, which will increase very small percentage, less than 20% of Europeans have air conditioning. So we see that as a growing market, and we could push the Carrier brand air-conditioning or Toshiba or both through their channel. And then, of course, the heating as a secondary brand, probably Toshiba for the wholesale market and then Carrier through the Viessmann channel. That, we see, as a really good opportunity. And we see an opportunity for Viessmann growth here in the United States. It's a phenomenal brand. We see the growth there in Asia. There's another category around just based innovation. Viessmann has great technology. For example, their one-day system, which allows for real-time problem resolution remotely. You can almost think of them as like a Tesla. So real-time software upgrades, real-time interaction with the end unit. They do a better job of that than we do, and we see -- and we expand some of our remote prognostic, diagnostics, upgrading capabilities through a 1-day type application. And then the third is sort of system-type integration like HEMS, the home energy management systems. They're the only ones in the world that do it very well between TV, battery, heat pump and the digital overlay. Is that an opportunity for us in the United States and elsewhere? Yes. And then you look at district heating, which is going to become bigger in places like Germany, we can do the chillers, of course, the -- what are called chiller, they can do the apartment transfer units. So we think there's some nice synergy there.

Perfect. And then on the sort of capacity expansions by competitors in heat pump that's kind of spin time that people talk about sort of 2 years now. Are you seeing the industry go down in [ caps ] like slowed down that capacity so you don't get this huge imbalance of supply/demand in the medium term. [indiscernible] your own capacity expansion plans in Europe, inclusive of Viessmann?

I think with capacity, you don't shut it off like overnight. So I think if you have a facility that's halfway constructed, you're going to see it through. We have that with Viessmann. Viessmann's building, what I think will be the most state-of-the-art heat pump facility in the world par none, in Poland. I had -- Patrick and I had an opportunity to visit it, and it's going to be tremendously automated. It's going to be complete state-of-the-art from an inventory management movement perspective. It's going to be truly benchmarked, and we're going to see that through. It will be done here sometime this summer. And I do think everyone's going to be very sober about how much capacity is needed in the system and making sure that they throttle back to anything that would indicate some kind of overcapacity.

Great. And then looking at your commercial HVAC business for a second, I think data center and education verticals have been very strong the last 2 or 3 years, probably continues. And any sense of kind of scale of how much of your commercial HVAC business is exposed to those two verticals?

Double digits. We said that data centers is low double digits. And by the way, we're kind of in the first or second inning at data centers. And you know that as we go to GenAI, those chips produced 7x the heat that a traditional chip would produce. So criticality of heat dissipation in new technologies to facilitate that data center growth is right in our wheelhouse. We're working on some very unique technologies. We already have some. We're working on some new. I know you asked one of our peers about liquid cooling. We do that as well. So we're working on some very interesting technologies. Data centers been strong, and it's kind of go -- kind of remain strong as far as the eye can see, of course. And higher ed, K-12. There's still about I think something like $53 billion of [indiscernible] funding to be spent on K-12, and it needs to be allocated here in the coming months. So we think that is -- health care continues to be strong. We'll watch -- commercial real estate been weak, probably continues to be weak for a bit. But overall, orders have been great and our sales output have been great for commercial HVAC. We were up north of 20%, I think, in North America in the fourth quarter. Our orders in January were strong in the United States and Europe. So we already had a strong backlog for commercial HVAC coming into the year and the order rate has continued at high levels.

Perfect. And you got that push underway on the aftermarket front in commercial HVAC, maybe just kind of any update on that and the confidence in that aftermarket sort of growth continue? Go ahead, Patrick.

Aftermarket continues to be strong, frankly, across the company, not just in commercial HVAC. We actually don't talk a lot about aftermarket and in our transport refrigeration business. You may be aware, we have about 1.8 million cooling units in the market today. We have about 100,000 now sea containers attached with aftermarket contracts, paid subscriptions where we can monitor the performance of these units remotely, again, helping our customers reduce downtime, reduce their energy costs and providing better visibility through either the operators or the end customers. The overall aftermarket remains a focus, I would say, the #1 commercial focus across the company, across all of our businesses. And the acquisition or the combination in Viessmann won't change that. Yes, we will call it, divest or exits of the aftermarket business. But Viessmann today, its aftermarket sales represent about 13% -- 12%, 13% or so of the total. Again, we expect to see that grow at attractive rates through our overall objective of aftermarket revenue growth, the recurring revenue nature of it, the asset light margin accretion of it, all remains really valid. And as I said, it's commercial priority #1 across all of our businesses.

And when you look to sort of our overall sort of first quarters playing out, it sounds like you mentioned Viessmann holding up orders in commercial HVAC in the U.S. and you're growing strongly. Any other sort of things we should bear in mind for how current demand is trending in the U.S. resi HVAC, for example, or transport?

Yes. [ One is about March ] and so I know that with maybe some anxiety what [indiscernible] sales would do. As Dave mentioned, these new sales were flat in January, basically what we expected. But what's really going to determine the outlook of the quarter is margin that's where we stand at this point, there's no reason to change anything but obviously on the earnings call back in early February.

Perfect. And operating margins, how should we think about with the new portfolio operating leverage or annual operating margin expansion [indiscernible] for Carrier.

The value creation framework we laid out in our Investor Day in early '22 was 6% to 8% organic growth, operating margin expansion of 50 bps or more every year. And if you go back just, for example, what we did last year, our core incrementals or core earnings conversion. And by that, I exclude the impact of acquisitions, divestitures and currency, our core incrementals were 40%. Our guide for this year, and our margins expanded by about 80 bps, excluding the consolidation impact of Toshiba, Carrier JV. If I look at our guide for this year, core earnings conversion into our guide of over 30%. And again, we are projecting 50 to 100 bps of margin expansion. With a faster growing portfolio post transformation, with continued opportunity to drive the cost synergies within Viessmann Climate Solutions or just running a simpler company, we certainly would not expect anything less than that type of margin expansion in the year going forward.

And on the divestments front, sort of what are the thoughts around that and some of the considerations around what exactly -- how inside what should be done with common resi, fire? And when do you sort of [indiscernible] the decision or announcement on that part?

Yes. So if you look at the four divestitures or the exits we have in flight, we've announced two. We're quite pleased with the expected net proceeds. And so our key focus is ensuring we close these as soon as we can and of course, working with our partners and certainly that happens. That takes us into the third exit steps, industrial fire where we expect to be in a position to announce a definitive agreement around the end of this quarter, the March quarter, and then that leaves the residential and commercial fire. And then given our key focus on ensuring that the first two, we exit these as soon as we can and then, of course, industrial. This -- I could say, residential and commercial fire, we still expected that this calendar year either through a public market exit or through a sale. And if I look at all the exits, it really puts us in a position that by the end of the year, we don't need the exit of a residential commercial fire for that. We expect to be back to about 2x net lever. That's 1 year earlier than what we expected back in April of last year. And those will basically -- is a strong hint towards our intention to resume [indiscernible]. And of course, the objective there is you [ reprice ] as soon as possible the equivalent shares issued to the Viessmann family is about 58 million, all of which, of course, within a strong credit rating, and we continue to target BAA too.

Fantastic. And on the sort of cash generation profile of Carrier, once the transformation of the portfolio is complete, how should we think about free cash flow margin rates or conversion rate?

Yes. I know you like to look at free cash flow as a percent of sales. I think it's a really good metric and we have consistently increased our free cash flow as a percent of net sales over the last 10 years, even though our free cash flow has had some unique headwinds with respect to larger-than-usual restructuring charges as we did last year, cash restructuring costs. But also, last year, we had over $200 million of M&A-related fees given all the exits that are happening. So free cash flow this year, the headline will be impacted because we have some large gains in some exits already announced. We will pay taxes associated with those large gains. And if you disregard some of the free cash flow impact related to the large gains and the taxes thereon or some of the additional M&A related fees, we expect free cash flow to be up another 10% this year. And we would expect to be at or above free cash flow at 100% of what we call reported net income that takes into account restructuring charges. So there, I think with the exits a little bit of noise, but underlying continued improvement, double digits now free cash flow as a percent of net sales, even though there are some headwinds [indiscernible] this time. And we've seen a change in behavior there within our company because we have changed our intent of compensation plans just last year, 1/3 on organic sales, 1/3 on adjusted operating profit and 1/3 on free cash flow. And everyone [indiscernible] never a big incentive on and certain that working capital continues to improve, which it does. And then going forward, of course, it will be continued a very high focus on free cash flow.

Great. And where are we -- [indiscernible] clearly but sort of on this KFI process and that cleanup there.

Yes, that's basically no surprises that we -- our understanding is that KFI is in the process of selling itself, and then there will be an auction for those -- for that in mid-March. We have been in mediation proceedings with the creditors, and that's progressing well. And we can either come to a resolution with the creditors that would be then approved by a bankruptcy judge or we can go through the proceedings and win in the proceedings. So we can come to a resolution or we have high confidence in our position and go through that, and we'll see which makes more sense for us. But that's all -- I would say hats off to all the folks that have been working that -- clearly on the KFI side, both on the carrier side, that's progressing well.

Great. And longer-term growth profile in aggregate, you have that 6% to 8% target. I guess the sort of confidence around that now we've seen maybe price tailwinds shrink a little bit versus a couple of years ago, but your own portfolio has changed a lot. So what should investors expect, I guess, on that through-cycle growth? And also capital deployment, it's very different sort of year-to-year. Last year, a lot of cash out for M&A or January of this year, sorry. Early next year, probably a lot of cash out for buybacks. Anyway to think about, I don’t know through-cycle capital deployment?

Maybe I will take the growth and you take the capital deployment. It’s just, look Julian, we feel good about the growth [ algorithm ] that we have. Our whole goal is to start with – we are going to be an HVAC-R pure play and we also think of ourselves as the leader in intelligent climate energy solutions, so it’s HVAC-R but it’s this whole climate solutions provider. Our goal is to be the market leaders in the highest growth markets knowing that right now, commercial HVAC is particularly strong, and we're benefiting from that. And we have peers that have that as a higher percentage of their portfolio, so they benefit from that. We like balance. We like the fact that we are now the market leaders in what we think over the next 10 years will be the highest growth consistent market in HVAC or globally we'll be the residential heating market in Europe, and now we're market leaders. Will there be a bumpy quarter here and there as things reset? For sure. Will there be hyper growth over the coming decade and then beyond? Yes. So we like the fact that we have Toshiba better positioning us in Asia. We have Viessmann better positioning us in Europe. We like our commercial HVAC position. So we look at -- and we like the fact that we just announced the deal 2 days ago in Saudi Arabia, where they're going to spend $5 billion on infrastructure spend between now and 2030. And we are -- we try to make ourselves synonymous with market leadership when you think about HVAC. And that's to the Saudis for their HVAC partner decided to partner with through a lot as the subsidiary of Fifth. So we like how positioned we are globally, and we feel that as market leaders, we feel good about that 6% to 8%. And then you want to take market...

Capital deployments, short term, very clear, debt paydown, followed by share repurchases, the equivalent 58 million shares or so. Longer term, our priorities remain unchanged. Organic growth, inorganic growth, and there, we focus on a free cash flow yield as a primary metric, then a growing and sustainable dividend. And we continue to target there about a 30% payout and then followed by share repurchases. And given the free cash flow generation profile that we have, I think there's a tremendous amount of firepower for either acquisitions or share repurchases. At this point, we don't see the sizes of the Viessmann-type acquisitions. That's not our focus. Now our focus is debt paydown in purchasing shares, and then we'll go from there.

Great. Any last comments from Dave?

No, I just -- Julian, first thanks to you again, and we're excited. We often say that we paint on a very blank canvas because we all know that sustainability is a megatrend. HVAC has to have a critical seat at the table. And as market leaders, we feel so poised to ride this wave for the coming decades. So we love the position that we have. And while we're transforming, I think our investors should be incredibly confident that we will be heads down and continue to execute.

Great. And we'll just finish off quickly with the audience response survey questions. So please grab those gray boxes. First question, sort of ownership levels of the stock today. Mix of overweight and nothing. Number two is sort of general disposition towards Carrier right now. Generally positive. Third question is around -- number 3 around sort of EPS growth and again, this would be versus multi-industry peers, so a very broad group. So generally above peers. The fourth question -- yes, this one is less sort of relevant for now, but excess cash uses.

I have a guess.

Reduction. Next question is around valuation. So what PE on year 1 should carry a trade at? Generally sort of 20-ish times. And then the last question is around what's the main sort of gating factor? Why doesn't someone own more of Carrier right now? Core growth.

Interesting.

Good question. Fantastic. Thank you, again. Appreciate it.