Crane Company (CR) Earnings Call Transcript & Summary

All right. Good afternoon, everybody. Welcome to the final presentation. The only one that's still going on this afternoon at Stifel's 2023 CSI conference. We are ending with the best. So we're very glad to have Crane here this afternoon. Very glad to have CEO, Max Mitchell.

[indiscernible]

You're not listening. And CFO ,Rich Maue to see you in this afternoon. As I've been doing all day and as is typical, I'm going to present 3 bear cases on Crane stock. Max is going to tell me why I'm an idiot. I'm going to present 3 bull cases. Max is going to tell me why I'm brilliant. So we'll jump right into them.

Here's the first one. The businesses don't really grow. Average organic growth over the last 10 years has been about 40 basis points. The mid-single-digit growth targets aren't credible.

Thank you, Nathan. Thanks. It's great to be here. Thank you for those of you that are in attendance. I'm surprised that the attendance -- part of a day. So thank you. Yes, this is a question we get regularly from our investors. A good question and it's a valid question. You have to -- now that we've separated post-separation, you have to look at both pieces individually. Aerospace & Electronics, if you look at '18 and '19, actually was growing in the 8% range for those 2 years and then we hit COVID. So we're really -- this investment, the steady investment that we've made in technology going back almost 8 years now across all of our businesses with a longer-term view, developing the technology to win today, not only in the core programs, but -- and we've talked about the [indiscernible] platforms that we were winning that we'll be developing in the '25 time frame and launching. So we just have really solid confidence in the 7% to 9% as we move forward, 3% to 5% on the core just in terms of rate -- continued rate expansion, getting back to and above 2019 levels. Another 2% from the 5% to 7%, on those programs, we already have won -- already solid programs won that we'll be rolling out in the next few years. And then it's the final 2% that is the number of demonstrators that we're on, the technology road maps that we developed everything from Wing of Tomorrow to electrified defense equipment to hard aerospace. You name it. I just feel really -- next-gen engine design. I just feel very, very solid about the demonstrators that we're on. So Aerospace & Electronics well poised. So even though it's historically, we haven't seen that. Maybe if you go back further within Aerospace & Electronics, there was some spikiness there even in terms of some programs and some major programs that rolled on and off for some M&U that came in and out. I just think the whole portfolio has changed and transitioned over that time frame. In Process Flow Technologies, it's similar. You've got to look inside of Process Flow Technologies and what's taken place. So while the top of the waves, it doesn't look like we've grown, there's been growth in the core segments that have been most strategic for us, chemical, pharma, water, wastewater in the 7% range, offsetting over the last decade, just a slow decline in terms of traditional conventional power -- coal-fired power plants, for example, some of the areas of oil and gas power. And they've just seen a slower decline over the years that used to be $250 million of business for us. It is roughly $50 million today. So while it's been flat at the top level, we've actually shifted the entire portfolio away from oil and gas, much stronger in terms of chemical, pharmaceutical, water, wastewater, that trough of the $50 million, I would say, is that at a trough and if anything, provides us with some upside as we move forward. All of our investments in the core business well positioned for the 3% to 5% that we've talked about.

So a few pieces there. I'll start on the process flow. You talked about the parts of the business that you're probably not as interested in having gone from $250 million to $50 million. Are we done on that? Are there other -- any other parts of the business that you look at as maybe there's not as much secular growth there? We're not going to invest in those. We'll let those wither on the vine or are you at a point now where the process flow business has exposure to all the markets you want, all other products you want and we just grow off this space?

I think that within the portfolio, certain product lines have still some exposure to oil and gas. So it's not a simple question of just why do you stay in those businesses or exit. It's a smaller piece of the business that those product solutions still are applied to the core growth areas as well. I think we're very happy with the portfolio that we have today in Process Flow Technologies. And now we -- as we have a very healthy balance sheet to deploy capital, it's all about -- not only the organic growth that we feel very solid about, but the inorganic to accelerate.

And maybe just on A&E, I think certainly 737 MAX is still significantly below where it was in 2019. When do you think you get back just on your historical programs that you're on, get back to kind of run rate, full recovery from COVID?

I think we're projecting 2025.

Yes, I would say, end of '24 and beginning of '25 would be the latest.

And that should give you some pretty good short-term growth here. I know you have a $50 million, maybe it falls this year, maybe it falls next year. That should give you either '23 or '24, should still be pretty good growth as we're getting back to a normal run rate. Then we were off at that 7% to 9% for the next decade after that? I thought it supposed to be a bear case. So mid-single digits, 3% to 5% on process flow, pretty confident there, and then 7% to 9% on A&E, pretty confident there. And you have really good visibility on the A&E side to most of that growth?

Significant visibility, really feel confident.

Jump into the next one then. Number two, the process flow business competes in very fragmented and competitive end markets, where it is difficult to differentiate product to gain market share or to gain real pricing power.

Did you see our performance last quarter?

I did.

So that's...

I got to have something on my...

That speaks volumes in terms of where we're positioned in the technology developing, as Alex mentioned on our Investor Day, addressing the ceiling solutions, not only inflow, but also from an emission standpoint, we really like to target a erosive, corrosive difficult environments, high-pressure temperature that the customers value the products that we're innovating on and delivering water, wastewater, chopping solutions that we're driving double-digit share gain, double-digit growth and significant margin flow-through. So even in this business, these businesses, I'm very, very proud of where we're positioned in the technology, and I think our margins are the best example of the fact that we are differentiating.

So seeing as you went there on the 1Q margins in process flow, I'm going to go there. They were 600 to 700 basis points up over where they were in 2022. And your guidance is also for them to go back down to about that back down 500, 600 basis points for the rest of the year. Maybe you can talk about -- a little bit about what happened in the first quarter that got you those kinds of margins and why we wouldn't continue at a little bit of a better level here?

Yes. So look, it was one of those quarters where everything sort of fell in the right direction and process flow on the margin side. In the month of March, in particular, we saw some -- the volumes really were a lot better than we anticipated. We had some more supply chain relief than we expected. So the volume level that we saw was quite considerable relative to what our expectations were. And it did, of course, then help the margins on the leverage that we saw readthrough. Price cost was also very favorable. It's been really solid, I would say. All through last year and here in the first quarter was even a little bit stronger. I would say that, that was also a pretty good contributor in the quarter. Will we expect that -- we'll still see some solid margin neutral to accretive performance in that regard as we move forward, but it was really quite positive in Q1. We also had planned some investments in the first quarter where we're going to start to see that really start to readthrough in Q2, 3 and 4, in particular, in hydrogen. And lastly, we had some inventory revaluation benefit, I would say that it wasn't overly significant, but I think most industrials probably experienced the same where you get a little bit of P&L benefit in your first few months or 4 months of a quarter on a year. So a lot of timing is what I would say, Nathan. Now we do expect it to come down as we move through the balance of the year. I would say it'll be gradual. I would expect the second quarter to still be pretty healthy and perhaps we'll do better than the guide that we revised there in the quarter.

But we still feel very, very confident about our 100 basis points improvement year-over-year for the foreseeable future in the segment.

We always appreciate management teams that are conservative with their guidance and then over-deliver all the time as Crane has a pretty good reputation for doing. Maybe we'll touch on the 100 basis points year-over-year margin improvement target that you guys have laid out. The margins in process flow have improved significantly over the last few years. Maybe just talk about the main drivers that you see that lead to that 100 basis points year-over-year for the next few years? So the 100 basis points is very healthy margin expansion when you're talking about that happening over multiple years.

Combination of consistent cost reductions and cost rationalization that we've just been on a steady diet for years that we'll continue to read through. Driving productivity, repositioning the portfolio, as I've discussed, driving new product that is pricing higher because we have higher value creation and just better pricing disciplines across the board overall.

Yes. I mean, I would echo all the same points. Just some perspective in 2021 coming out of COVID, our margin profile was 14.8%. We were up at 16.2% last year. We guided to 17% this year or 17.2%, and we just raised to 18%. So it's, I would say, demonstrated margin performance. We have high confidence that we'll be able to deliver the 100 basis points.

This third one here, probably is we've covered a little bit, but maybe we can expand on that. After you've turned my first 2 bear cases into bull cases. Let's go on the third one. Portfolio has been operating under the Crane business system for over a decade. All the big improvement in operations has been achieved, and we're only going to see incremental benefits from here.

And I would say it's actually the opposite, if anything, we continue to accelerate with how we're deploying. We don't like to talk about -- everybody talks about their business system and what they're driving and continuous improvement, philosophies. And as an investor, you don't know who's telling you what, honestly, in my opinion, because when I listen, I can't -- so we like to just -- we drive a very holistic business system. It's real. If anybody is interested, we can walk you through in much more painstaking detail. We just let the results continue to speak through. Having said that, it's not a static system. It's one that continues to look for best-in-class tools. As we become more and more sophisticated, we continue to strive for application of even higher functioning, continuous improvement tools. So it's not just Lean. It's not just Six Sigma, it's not just strategic sourcing, it's not just strategic selling. But as we continue to think about moving forward, the sophistication that we continue to have that we've developed in terms of just commercial execution from strategy all the way through to execution is -- I'm very, very proud of. But no matter how good we are, it's never good enough and our team knows that. We set a high bar. And so we see -- we constantly see opportunity, no matter how good we get. We just see new opportunity to move it to the next level. And that's our philosophy. That's our culture across all of our entities, and it's a key formula for our success.

Are there particular areas within the businesses that you're focused on applying continuous improvement or that you're finding tools that you haven't used before that could generate benefits in one way or another that we'll all see as growth or margin expansion that you can highlight?

So we're -- we've continued to add if I overgeneralize a bucket, we're continuing to try to push for tools for growth in terms of very structured approach. Meanwhile operationally, we continue to just be quite good. We're investing in training our associates on a whole host of -- just what you might just think of as fundamentals, but we're also applying the metrics of a follow-up around it. Everything from strategy to marketing, product placement and pricing disciplines. And there's been tremendous work that we continue to do around pricing and the value that we should be getting for our products, not just new, but also existing. And in some cases, we want to really overserve top customers, and there's some particular customers that are not strategic, and we do it in a very thoughtful way. We don't want to do in a punitive way, but there are some decisions that need to be made that you want to exit those that are taking up significant time and effort that you're not driving the same level of profitability. And I would say that this is accelerating across Crane.

Where would you say Crane is in its application of 80-20, right? I mean, basically, what we're talking about here, right over serving your best customers, underserving or raising prices or moving them into a different quadrant for -- for some of those less profitable, less growth customers. I mean, is that part of -- has that always been part of the Crane business system? Is there something new that you're implementing or using more widely?

I think it's always been a part of how we've driven fundamental product management. I would say that the level of rigor in sophistication over the last few years has increased significantly. But I would still say that it's early days in terms of how far we still have to go. Just one of many though, unlike others that may only drive one specific tool, it's becoming a very important part of a wide swath of very powerful tools for us within CBS, which is why the benefits that we'll unlock, I feel very good about it.

Is it well used within the organization? Like are people well trained in how to use these kinds of things? Are these tools that you still need to go out and drive further down into the organization, train people on how to use them properly?

Always. And there's always -- to reinforce, there can tend to be -- look in any process, there can tend to be a backsliding. If you take your eye off and you think you have something solved over here and you move over here, you're going to start to backslide. So part of driving continuous improvement as we talk about this discipline and cadence and rigor of how we continue to drive, continuous improvement in safety, quality, delivery cost growth all in as we move forward. That's the Crane Business System.

I've seen some of your travel schedule, so I see how the cadence works. All right. We'll go on to the book cases now. Crane has a strong record over the last few years of not only improving the margin profile of acquired businesses, but also continuing to drive margins higher in legacy businesses, driven by the Crane Business System. Financial targets imply significant upside from current levels. I guess we've probably been through the process flow margin outlook. So maybe if we just concentrate on A&E here, and talk about targets and how you get from A to B on the margin profile in A&E?

Do you want to take that one?

Well, yes, I'll start, I guess. So A&E, we were at about 24%, 24.3% OP margins back in 2019 pre-COVID. This past quarter, we delivered just under 21% with still a ton of runway to go from a volume point of view. So in terms of our targets and target setting, we feel really, really good about getting back to that, call it, 23.5% to 24.5% level in the next couple of years. It's going to come largely from leverage on the volumes that we would expect to see read through. And this business leverages at roughly 40% on the incremental sales. It will also come from continued discipline around pricing. In the first quarter here, that just passed about 50% of our core growth in this segment was coming from price. So we see that continuing as we move through this year and we'll continue that discipline next year. The other thing I would just point out is in terms of our margin, both back in 2019 and what we have today moving forward, roughly 8% to 9% of our sales is reinvested in research and development. So on a gross basis, that's about $100 million a year that we're spending in development dollars to continue to grow for the long term. So -- that would be -- we're excited about the prospects that come from that and the continued growth and that 7% to 9% leveraging at that 40% really is the summary.

7% to 9% growth, leveraging and 40% sounds pretty good. I'm going to go on to the bull case #2. And before I get into this, there's a mention of Crane NXT here. I'm just going to say Max was right and I was wrong. When the spin happened, I talked about NXT having to repurchase shares because it was trading -- it's going to trade at 7x EBITDA and Max said they won't have to repurchase shares because I was wrong about the multiple in Max.

Thank you for that. Thank you. It's played out brilliantly, I think. Nicely done.

Perfectly, right? So just to acknowledge, Max was right, and I was wrong. Before I get into it to this one here. Bull case #2.

I think that was the title of your write-up.

Max is right and I was wrong? Wasn't it Max was right and Rich was wrong? Anyway, post the split from NXT, Crane has essentially no debt and the ability to deploy $4 billion in capital through 2028 where your numbers in the Analyst Day. With significant near-term availability given this no net debt. At current prices, this represents effectively the entire market cap of the company, providing significant financial flexibility to add value. So let's talk about capital deployment and priorities for that over the next few years.

Yes. So this is what's incredibly exciting. So post separation, no asbestos, clean balance sheet, proven execution track record and certainly a proven track record of integrating acquisitions and outperforming expectations. So now we want to -- we were put on hold through the separation and we are ready to go here. We have an active funnel. We prioritize everything from our family-run businesses where we establish relationships with family members. You never know when a no turns into a yes. We cultivate those relationships. We understand what's coming out of private equity. There's a number of opportunities, both in A&E and process flow technologies that we're monitoring and waiting for them to come on the market and have expressed interest will be part of that process. The consolidation has taken place both in process flow as well as A&E. Many of the large, diversified industrials are looking at the portfolio and realizing what was strategic years ago was no longer strategic. There's going to be a number of opportunities that are coming out. Our funnel is full. It's robust. Our activity is active. There's 4 active M&A opportunities right now that are in process that we're participating in, not saying that they're all going to come to fruition, but we're participating, bidding both. It's 2 in 2. 2 in A&E, 2 in PFT. I think the market has changed in our favor. I think private equity will be a little less able to compete. And I think some of the strategics may be out in certain areas because of their own capital positions, leverage position and so forth. So we're pretty excited, and we're going to remain disciplined. We're not going to do anything outside of our hurdle rates and [Indiscernible]. But solid on the core growth. We just talked about that. Incredibly confident, now supplemented with the inorganic. I would like nothing more than to double the size of this business in 5 years and provide future opportunity.

Is there a preference or better availability, better pricing in A&E or PFT? Would you like to keep the portfolio balanced between the 2? Like is -- would you like to avoid a situation where you deployed all the capital into PFT or A&E -- or would you rather do that?

I had a choice. I think we're going to make the right decisions. When the opportunity comes up, if it overweights to one. We'll have to assess that at the time. I would ideally like to have it balanced and across both as we grow and get continued scale in both organizations and see the leverage flow through on that. But we're going to do what's best for the business at the time with the asset that's available.

And so you've clearly been a little handcuffed, waiting for the spin or probably not that you couldn't do it, but you were waiting until after the spin to get everything sorted out. The shackles are off now. Rich is allowed to cut as many checks as you want.

Exactly.

Okay. Well, I guess we'll stay tuned and expect that to -- to ramp up here over the next couple of quarters.

The other thing I would say is we're very conscious of leverage ratios and seeing what some others -- how the market has reacted to some other larger deals. We're going to be smart about it in this environment. We want to make sure even in a period of uncertainty that we don't lever up too much and do anything undisciplined. So I want to make sure investors recognize that also.

Where would you be comfortable Max and kind of what's optimal?

Look, in a pre-inflationary environment, pre-COVID, I think we could have easily [indiscernible] would have rewarded up to 4x if we could show that we could quickly pay it down. I think that's something that's off the table right now. So I'm looking at 3x, but and 3x and below and...

I think that [Indiscernible] has become over the last few years. I think that's about right. All right. We'll jump on to the last one. So deploying the balance sheet into acquisitions could add value, but so good divestitures spins or asset sales, and you guys have proven certainly receptive to the potential of that should it create value which gives multiple paths to value creation for Crane.

Agreed. And I think we've proven this, certainly in the Engineered Materials that we tried to sell. There was a very slight overlap in building products that Department of Justice found objectable and by the time that we had to separate and they paid us $12 million of breakup fee, the market had changed dramatically. And RV inflation was up and oil prices were up and RV started to tank. Look, so I think investors shouldn't worry about that piece of the portfolio. We love the people. We love the business. It's a great business. It's just cyclical, and it's not the best strategic fit. We're going to wait for the cycle and then decide when and if we might look at opportunities there. Again, Crane supply, another great business. The distribution business, Crane has been in distribution going back forever. And it's core. I used to have distribution in the U.S., sold that in the '80s. So it was a legacy business that was incredibly well-run. The margins were 3x what you'd see in any other distribution business. We just found a better owner and continue to shape the portfolio, plus the separation. So with everything that we've done, I think -- right now, it's about focusing on the growth. It's about focusing on additions versus the subtractions. But in the future, we'll always look at opportunities in the portfolio.

If I think about the long-term, maybe end game for the portfolio, there was no need for CXT to be with what is now Crane. There's probably no real reason for PFT and A&E to be together. Is it a reasonable expectation that you will build both of those businesses up to a point where some kind of transaction makes sense? Particularly if it's trading at 13x, which it was trading at yesterday.

Well, I would say that I think the street understands these types of businesses together, a lot more than they did the currency part of the business and the Payment & Merchandising Technologies. There's a number of peers out there that have flow as well as Aerospace and Defense. So that's many. So I think it's clearly understood. Having said that, to gain the kind of size and scale that provides future optionality. I think in the spirit of driving shareholder value, we're going to do what's right for shareholders over time, and I would love to have that challenge. That's a clear goal in terms of getting that type of scale as we move forward.

Yes. I think you guys are clearly proving that. I mean it's fairly unusual to find executive management who deliberately goes to running a smaller company that Crane has done here this year after the spin. So I think investors will certainly commend view on that. Questions from the audience before we wrap this up? If not, I'm going to call CSI 2023 over. Thank you very much for attending the last session. We appreciate it. Thank you very much Max and Rich for being here late in the day.

Thank you, Nathan. Appreciate it.

Thanks, Nathan.

Thanks, Man.