Crane Company (CR) Earnings Call Transcript & Summary

Good morning. Again, my name is Tony Bancroft, I follow the Aerospace and Defense and Environmental Services industry. And this morning, I'm honored to introduce our next company, Crane. Crane is based in Stanford, Connecticut. It operates in 4 segments, Aerospace and Electronics, Process Flow Technologies, Payment Merchandising Technologies and Engineered Materials. The company has 56 million shares, trades around $117, $6.5 billion market cap and $580 million of net debt. The company plans to separate into 2 companies, Crane and Crane NXT with expected completion in April of 2023. Now I'd like to introduce who are representing Crane today. Today, we have with us representing Crane Rich Maue, CFO of Crane; and Alex Alcala, Executive Vice President of Crane. Alex is responsible for Process Flow Technologies, Aerospace and Electronics and the Engineered Materials segment. He joined in 2013 and was promoted to Executive Vice President in 2023. Rich joined in 2007, became CFO in 2010 and Executive Vice President in 2023. Welcome, gentlemen. It's great for you to be here today. Thank you. And they'll give a brief presentation and will followed by a fireside chat.

Well, good morning. Thanks, Tony. I appreciate you all being here and expressing an interest in our story here. We'll just make sure I'm on the right slide. Briefly, I direct your attention to the forward-looking statements that you have here on the slide and also in your handouts and the related content in our Form 10-K and other SEC filings. So this morning, I'm going to provide just a brief overview of our recent results that we had followed by an overview of the 2 exciting investment opportunities that we are creating with our upcoming separation that's planned for early April. Then Alex will discuss the Process Flow Technologies business in much greater detail. So to start, we reported an extremely strong fourth quarter last month. Adjusted EPS of $2.13 was an increase of 63% compared to last year. We had what I would say is broad-based, strong operational execution with core sales that were up 11%. We drove operating margins up 660 basis points to a record 18.6% for Crane, accompanied by record quarterly adjusted free cash flow of $220 million. And those results followed a great year overall as well. So record adjusted EPS of $7.88, up 15% compared to 2021, which was, by the way, also a record year for Crane, driven by 6.4% of core growth in 2022 and 220 basis points of margin expansion to a record full year adjusted margin of 17.7%. Really incredible performance across the group, and that's in the face of significant levels of inflation that you're all aware of, the foreign exchange headwinds that we all experienced, supply chain constraints, and also in the middle of the year, we divested one of our business units within our Process Flow Technologies business, our Crane Supply business, which carried with it about $0.25 of EPS. So we had that headwind as well in this past year. So an excellent year and excellent momentum here as we move forward. So that performance then positions us a really nice year as we move into April. We are establishing, as part of the separation, 2 best-in-class industrial technology companies. Crane Company itself will include our Aerospace & Electronics and Process Flow Technologies global strategic growth platforms. Alex will speak at length with respect to Process Flow Technologies today as well as our Engineered Materials business. It's a $2 billion company competing in attractive end markets, differentiated proprietary technology with leading positions in the markets where we participate. Crane NXT will include our Crane Payment Innovations business and our Crane Currency business, that will be a $1.4 billion company with trusted technology solutions focused on security, detection and authentication. In terms of the strategic rationale, we have continued -- we continue to have very high conviction here in the separation and what it's going to do to create value. It lets us develop capital allocation strategies that are optimized for each company and their individual business and financial profiles. The separation will make it far easier for each company to attract a shareholder base fully aligned with each business' strong and distinct value proposition, and we do believe that it will make M&A more viable at both companies. Simply, the separation will create 2 more closely aligned pure-play companies, each better positioned to deliver long-term growth and sustainable value creation. We are on track for an April 3rd separation. And since our earnings call, what I can share is that another significant milestone was achieved with the SEC declaring effective our Form 10 registration statement. We'll provide a lot more details about the transaction at our May -- I'm sorry, our March Investor Day. In terms of highlights for Crane NXT, a premier industrial technology company with a strong, resilient and durable business. It has an enviable track record of delivering solid mid-single-digit core organic growth, driving substantial margin expansion. This past year, this business was at 25% operating profit, which translates into just under 30% EBITDA margins and executing on numerous successful high-return acquisitions over the years. Looking forward, NXT will continue to deliver profitable core growth, leveraging its strong free cash flow to expand into near adjacencies, building on its strong technology and capabilities and security, detection and authentication. An exciting story while not the focus today, I encourage you to listen to our Investor Day or come to the Investor Day in March -- on March 9 to learn more. From a Crane Company perspective, the highlights here post separation will include our Process Flow Technologies business, Aerospace & Electronics and our Engineered Materials business, all of which manufacture highly engineered solutions for attractive end markets. We have respected brands and leadership positions in our key market niches in each of these groups. And across the board, we provide solutions for mission-critical, high cost of failure applications supported by consistently high levels of investment in research and development and new product development. A business that grows in the mid-single digit range is our view with strong operating leverage, driving profit growth at twice the rate of sales with substantial upside in our view from potential capital deployment opportunities. Aerospace & Electronics, very briefly, this is one of the two platforms, a true gem in the portfolio, proprietary technology. Much of our sales are sole sourced to our customers, great positions on virtually every critical military and commercial aircraft platform and numerous recent wins that will drive above-market growth for more than a decade. We invest about in this business, 10% of our sales and engineering, and that is reading through to the success of our new product wins and platforms that we've announced over the last, call it, 18 months or so. Our strong position on current platforms, along with recent wins and our positioning for the next generation of aircraft demonstrator programs, electrification and so forth, gives us confidence in what we've put out there on a 7% to 9% core growth CAGR for the next decade. So with that, I'm going to hand it over to Alex Alcala our -- with respect to our Process Flow Technologies business. Thanks.

Thank you, Rich. Good morning. So Process Flow Technologies is the largest part of Crane Company. We're a provider of mission-critical valves, pumps, instrumentation, and other solutions. And we're focused on 4 key markets, chemical, wastewater, general industrial, and pharmaceuticals. And what I'd like to do over the next few slides is talk about how we are structurally changing our business, repositioning to drive stronger growth and margin expansion. So the results are reading through today, as Rich covered, we delivered record margin in 2022. So let me talk a little bit about how we're doing this. We've always been good with consistent execution, but there are 4 key areas that are helping us position the business for higher growth and further margin expansion. We repositioned the market focus of the business with substantial expansion in our higher-growth markets with about 2/3 of the business now in growth markets and with exposure to the challenged markets now immaterial. We also developed strong capabilities driving growth from commercial excellence and localization to new product development and breakthrough innovation. And we're driving further margin improvement through deployment of the cadence and discipline of the Crane Business System as well as through targeted growth with our new product introductions, which carry a very strong margin profile. All these actions have resulted in very strong financial performance including consistent margin improvement. We're confident that we're positioned to drive 3% to 5% growth across the cycle with an average of 100 basis points of margin improvement per year. This slide tries to explain the change in our portfolio. We showed it at the Investor Day last March, and we'll provide an updated version next month. On the left, you see 2016 sales. Each bar has 3 colors. In blue are the higher growth markets we serve; dark green, markets that are slower growth; and light green, markets that are declining. I would draw your attention to the top blue portion. These are our focused growth markets where we have invested to grow. Our sales have grown at a 5% CAGR. On the right, you see 2021 sales, and the blue growth markets are now close to 2/3 of our business, again growing at 5% over the last 5 years, while helping us improve our margins. As you can also see, our exposure to the challenged oil and gas and conventional power markets is minimal. This is why we're seeing stronger growth rates now and why we are confident that our growth over the next decade and beyond will be substantially better than our historical growth rate. Talking a little bit more about the markets. The first of those target markets is chemical and petrochemical, our largest market, where customers deliver products that are essential to our daily lives and growing economy. Our chemical customers are also providing the products and solutions necessary to support sustainable infrastructure, clean energy and advanced electronics. We help our chemical customers solve their toughest problems in corrosive, toxic, hazardous and abrasive applications with our innovative process valve portfolio. And our position continues to improve as our customers' needs become more and more challenging. Next is wastewater treatment, which will continue to grow driven by investments needed to support a growing population, along with tightening regulations and sustainable solutions to reuse water in a circular economy. Our wastewater pumps are designed to solve flow distribution problems, increasing performance and reducing operating cost in the collection and treatment of wastewater. In the pharmaceutical market, we expect strong growth ahead driven by demand for biologics to treat chronic diseases by advancements in personalized medicine and increasing R&D spend to support new drug approvals. Our expanded aseptic valve portfolio is solving tough problems in hygienic production, and our products are differentiated by their extended life and lower maintenance costs. And in the industrial space, our customers have a growing need to invest in solutions that increase efficiency, support sustainability targets and lower operational costs. Our portfolio of pumps, valves and sanitary solutions is designed to solve maintenance and reliability challenges through quick installations, extended service life and lower energy consumption, strong positions in growing markets. Our share gains in these markets are fueled by new product innovations. That's the key to our growth in these spaces. And the rate of innovation is accelerating and having an increasingly positive impact on our business. As an example, on this slide, you can see the trend of new product sales. This is for the process solutions portion of our business. The rate of improvement has been impressive, tripling over the last few years, and we have clear line of sight to hitting 20% within a few more years. And this is an industry that is risk averse and typically resistant to change, so quite an accomplishment. These new products are coming in at higher margins, so they are accretive to both overall growth and margin profile. In addition to product innovation, we continue to drive improvement throughout our enterprise, generating growth and margin improvement through commercial and operational excellence, driving enhanced commercial processes with tools that help us improve hit rates and drive growth, reducing lead times to help us win in the marketplace, driving productivity and cost improvements by reducing waste and often reinvesting these savings into initiatives to drive further growth. This is all enabled by the rigorous cadence and disciplined execution for which Crane is well known. That cadence and discipline has helped us develop a strong track record of margin expansion. We have already achieved mid-teen margin performance and we expect 2023 to be another record year from a margin profitability standpoint. We're on track to high teens and beyond. So again, we have been driving and expect to continue to drive 100 basis points of average margin improvement per year, summarized by the 3 drivers shown on this slide. We expect substantial operating leverage on the higher volumes driven by market growth, continued share gains and our improving end market mix. Our new products are generating well above-average margins and we continue to drive productivity as well as improvements in commercial excellence. I will close with key 3 takeaways. Our repositioned portfolio, success with product innovation and continued drive in commercial and operational excellence have created an accelerated growth profile, long-term growth of 3% to 5% through the cycle. At the same time, we are delivering and will continue to deliver strong operating leverage to drive 100 basis points of margin expansion on average per year. And more than ever, Process Flow Technologies, post-separation, is an attractive platform for acquisitions. It's certainly an exciting time for Crane Process Flow Technologies. Thank you for your time. Look forward to your questions.

Gentlemen, thank you for being here today. That was a great overview, Rich and Alex. Jason, thank you for being here. Let's start out with, you were talking about a little bit about pricing in the presentation. Your pricing and your costs, what are you seeing with your input costs? And how is that affecting your pricing and margins? And how are you dealing with that?

Yes. Thanks for the question. Definitely, an important question given the last couple of years. So we continue to be net price positive overall. As you recall, we were ahead of it early when inflation started at a fast pace, and we continue to stay ahead of it. What we're seeing on the inflation side is still costs are going up, especially on the material side. Freight, with the energy prices going down, have softened, so those have come down quite a bit. When you think about wages, you've seen the reports, labor markets are pretty tight still, so we have that wage inflation. So on the net, there's still increasing cost, but we're able to successfully pass on with price. We expect to be on the positive side in 2023 as well.

It's good to hear. Maybe over to supply chain. How has the supply chain improved? And where are you still seeing issues? And what are lead times versus maybe pre-COVID, how does it look currently?

Yes. So the supply chains have changed quite a bit. There's been improvements in some areas and stagnant, still and others. So we still expect some constraints overall in 2023. When you think about one of the things that was hurting most industrials last year and the year before was transit times, things getting stuck in ports, supply from Asia. Those have all improved pretty significantly. So there's quite solid improvements there. What is still happening are the more elaborate components when you think about electrical motors, actuators, things like that, many produced in North America, suppliers are still dealing with huge backlogs, just like we have a huge backlog. So those are the things that we still see constrained mostly today.

Maybe a little bit more on backlog, Alex, and visibility. Your core growth guidance is at 4%. That's a pretty strong number, particularly for this industry. You have a record backlog. How much visibility do you have maybe mid of '23 and further out, and is there something that will go better or worse than '23? Maybe sort of give us the puts and takes of that.

Yes, sure. So when you think about our Process Flow Technology business, about half of it is longer cycle. So we work mostly off of backlog. Like you mentioned, Tony, our backlog is record, historic record high. So certainly, demand is there in the longer cycle of businesses. In fact, if you look at our fourth quarter, we're still 8%, 9% on orders growth year-over-year where we finished. So demand has been pretty strong on a net basis. We have seen some softening on the shorter-cycle businesses, especially in Europe, the nonresidential construction. Even last year, we started seeing some declines. But on a net basis, still expect some positive growth. I think the biggest variable that we're looking at right now, given we have the backlog is just how the supply chain constraints play out. We expect some improvement, but still some constraints. So we'll see how that develops through the year.

Let's move to margin outlook. Again, you talked about your 100 basis point margin improvement annually. I mean that seems like a pretty healthy number there, again, particularly in this industry, so that's a good outlook. Why are you so confident? I know you talked about a couple of the points there, but maybe you could sort of walk through a little more on your confidence. And could we see higher margins? What's the opportunity maybe in the longer term?

Yes. I mean, certainly, on the longer term, we expect to continue to drive this 100 basis points get into the higher teens. Think -- there's 3 areas that give us confidence. The first one being, I showed a little bit of our margin -- market mix and how that's changed. What I didn't talk about in the presentation is that those particular markets where we're growing and we're bigger are inherently more profitable for us. So just by increasing that and growing in those spaces, we get tailwind in our margin expansion. When you think about our record backlog, a lot of that backlog is in these spaces, in these higher margins. So we have a lot of confidence because of that. We have the backlog to support that expansion. The other 2 areas are sort of the fuel that keep driving the improvement, one being the new products. When we introduce new products, they are accretive. They're the highest differentiated, so we're able to have more pricing power. And then the third one has been a track record for us, as you know, for long term, which has been this consistent operational commercial excellence, which gets better and better every year.

Maybe you can walk -- go through your general market trends in a little deeper dive. What are you seeing in your core markets, any decelerations anywhere? And maybe go by geography, and how is it versus project versus recurring aftermarket MRO business?

Yes. So I'll give a little color on that. It's quite interesting, as everybody knows. So starting with chemical, petrochemical, our largest market. So on a net basis, we're still seeing growth in the demand from our customers. I'll talk about the regions in a second. But when you think about what's driving that, I would mention 3 things. One, the end market demand of markets that are growing on clean energy, electric vehicles, things like that, fuel cells, that's driving investment from our customers. Secondly, in the chemical industry, you might know there's a change happening around sustainability, customers are trying to convert their products to more sustainable solutions and their own operations to reduce carbon exposure. So even though end market demand may swing up or down, there's investment happening on that sustainability transition. And the third one is just these energy cost dynamics for feedstock. So customers that may have capacity in Europe, as an example, may need to de-bottleneck in the U.S. and invest just to shift capacity and more economical. So there's that dynamic still holding up better than the end market demand in chemical regionally, Europe, a little bit softer, Americas, China picking up a bit more.

Wonderful. Is there a question from the audience?

I have to ask, I'm sorry. Your Form 10 when you initially filed it was 700 pages. Can you distill it down to 1. A couple of -- you got the SEC out of the way now. You obviously had to hold up. You don't want to make any changes to delay the process further in terms of doing deals and so on. So just give us a quick couple of numbers. Number one, Crane NewCo and Crane NXT revenues, and Alex did a great job. But just the number for 2022 revenues, EBITDA and any debt on NewCo.

Okay. So the revenues on Crane Company about $2 billion. EBITDA is going to be around, I think it's 18%. Is that right, 18%, roughly 18%, 19% on EBITDA from yes, about $350 million in EBITDA. From a debt point of view, we're going to have roughly $300 -- we're going to have $300 million in prepayable debt. We're raising that debt, Mario, to dividend monies over to Crane NXT for them to take out the near-term bond maturity that's coming at the end of this coming year in 2023. So that's Crane Company. So the net leverage profile there is like a 0.5x.

Okay. And is it a fair statement that if you were looking to do deals, you have to hold up for a while?

Not necessarily. So there's nothing that prohibits a transaction from occurring right after the separation.

No, no, I agree with that -- it's -- but I was talking about since you filed the 10.

Yes. No, there's -- there really is no prohibition at this point. And just there's like a 6-month...

And just 30-second sound bites on your Aerospace and Defense business. What are the big drivers? And how robust is that looking into '22, '23, '24.

Yes. So thanks for the questions, Mario. So from an aerospace and defense point of view, I mean, the tailwind is really still the market recovery. There's quite a bit of tailwind just on commercial OEM build rates. And we have a wonderful mix of commercial platforms that will sustain us for a very long time in this business. We're on all the major platforms. So we have the normal commercial recovery, together with the aftermarket stream that comes with it. A tailwind that we haven't included yet in our guidance for next year, there's a couple of them I had mentioned on our earnings conference call that we had about $50 million of orders on our books today that just from a supply chain perspective, we can't necessarily get all out this year, and is a potential to hit us in the second half of the year, maybe more likely in 2024. So supply chain is the other, I would say, tailwind to future performance beyond what we've put into our guidance for 2023. The other major part of that business that I would point to is our defense business. This is a very -- we've been very successful over the last, I would say, 24 months in securing some pretty major program wins, ground-based radar applications, sort of more electric solutions that require our high-power defense solutions. In addition, we've also secured -- I'll point to a couple more. The F-16 brake control upgrade -- to upgrade the brakes, which are the brains behind the brakes is what we provide. And we're sole source to Boeing, but on -- as well as on the solution for the F-16, the F-35 and so forth. So we have a massive program there that's going to start rolling through at the end of '24. It's a little north of $100 million, and you'll probably go about 7 years. So that's just another very nice tailwind. So there's just a number of programs that we've won in that space. I would say they're all similar size to that F-16 program. That all start in that '24, '25 time frame, and they're not replacing existing business. It's new business wins based on the investments that we've made. And so this business -- I'll just say one more thing. This business is highly invest -- we invest about 9%, 10% of our sales into the business to make sure that we can continue to win on programs like these that are strong profit tailwinds for us in the future.

Thanks, Rich. Very helpful. Maybe we could talk about the growth. Again, your growth outlook, the confidence in that. Historically, this segment in this industry has been a relatively low-growth business. What gives you confidence that you can accelerate and stay at that 3% to 5% annually going forward?

I think if you look at where we were 5 years ago, and we'll talk more about it as we clean up the results for 2022, but our market mix has dramatically changed, right? Less than half in, 5 years ago, what we considered higher growth markets, 2/3 in 2021, 2022, the number is even bigger. So the underlying market growth is different, just that pure market. Second, we've had a lot of success with our new product introductions. So we're actually outperforming the market, we think, around 2x. So when you factor those things together, different markets growing at different rates, momentum on outgrowth of the market, that's what gives us confidence. That's what's helped us already start delivering and gives us confidence for the future.

Maybe I'll get one more in here. You -- Mario asked about the M&A. Maybe what are you looking at for M&A in -- specifically in Process Flow? Is there an area that you see as a higher growth area or more accretive to you? Or maybe you could sort of walk through that a little bit.

Yes. From a market standpoint, we are prioritizing what we're calling these growth markets, these critical chemical solution applications, water, wastewater, industrial automation, some of the clean energy aspects of hydrogen as well. That's where we're focused primarily for targets. And then within those markets, we prioritize based on ability to differentiate, drive pricing power and also extendability right of that space to be able to do bolt-ons and add onto it.

We're up on our time here. Gentlemen, thank you for being here today. Great job and looking forward to having you back next year hopefully.

Thank you very much.