Enpro Inc. (NPO) Earnings Call Transcript & Summary

This webcast presentation is for Bank of America clients only. If you are a member, a representative of the press or media, please disconnect now. And I would like to return the call -- I'm sorry, I'd like to turn the call over to Matthew Fields.

Thanks, Kim. Matt Fields, I cover high-yield industrials for Bank of America, and I'd like to welcome you all to our 2020 virtual leverage finance conference. It's my pleasure to introduce from EnPro Industries Milt Childress, Chief Financial Officer; and Chris Ravenberg, the Treasurer. Thank you both for continuing to support our conference. Appreciate it. I think Milt is going to walk through a presentation. And then afterwards, we'll do some Q&A. So if you're ready, Milt, please go ahead.

Great. Thank you, Matt, and thanks to all of you who are joining today. Good afternoon. It's good to see everyone -- I guess, see everyone virtually or through audio. I do miss seeing everybody face-to-face. But maybe a year from now, we'll be working on it, either with video or face-to-face. So we'll see how things develop. So I'm going to start with who's EnPro. If you have access to the slide deck, which you should on the Bank of America side, I'm on Slide 4 of our deck. And who is EnPro, and I will say who is EnPro today? Because those of you who have known us for a number of years would have seen how we describe ourselves as having evolved this year, and I'll explain a little bit more about that today. But who we are, a leading technology company using materials science to push the boundaries of the semiconductor, life sciences and other technology-enabled sectors. We are transitioning from an older line industrial company. We previously described ourselves as a diversified industrial engineering company. We still have very, very valuable and important parts of our old industrial base, which will continue to be part of us. But as we invest our capital and grow in the future, we are growing in this direction. If you flip over to the next slide, Slide 5. As many of you know, who have followed us, we're located -- headquartered in Charlotte, North Carolina. We report in 2 segments. You can see about 75% in Sealing Products, 25% Engineered. We have a very healthy aftermarket recurring revenue base of about 57%, a balanced geographic presence with the largest portion in North America. As you can see, we serve a number of markets with balance there. We're roughly $1 billion in revenues. We do pay a dividend, have for a number of years. And based on our share price at the time, which was published, our yield was around 1.5%. Flipping over to the next slide. Just a little bit more detail on our 2 reporting segments. We reported Sealing Products and Engineered Products. As I mentioned, Sealing Products is the largest by far of the 2 segments. And when you look at it from an earnings standpoint, it's even more significantly skewed toward Sealing Products, with -- on an LTM basis, about 84% of our EBITDA being generated in Sealing and 16% in Engineered Products. If you flip to the next slide, I want to comment a little bit about our operating system. And I want to start first with our purpose, shared purpose as a company. We believe in the full release of human possibility, and we've done a lot of work over the past decade in our company to help make that a reality. And we continue to work on it. We've coined something that we refer to as a dual bottom line. And a dual bottom line is that we hold as an equal weight of financial performance and results with human development. And have a belief that we can't, over an extended period of time, we can't do one without the other. That's very important to us. And once again, it underpins our culture and how we work as a company. And our operating system has morphed out of our culture, and there are several components of it, obviously, around strategy, how we think about strategy, innovation, commercial excellence, operations, talent, recruitment, talent retention and development. And underpinning all that are our 3 values of safety, excellence and respect. So our operating system is focused on driving margin and cash flow return on investment with a focus on the elements that I just described. Now more specifically on our strategy, if you turn to Slide 8. There are 3 major components to our strategy. Number one is reshaping our portfolio to accelerate our organic growth of the future, and we're accomplishing that by the addition of some niche, high-margin materials science-related businesses with leading technologies, strong cash flow in markets with favorable tailwinds. And I'll talk a little bit more about this in a moment, how we've been doing that and what some of our results have been over the past 18 months. Number two, we have a focus on, I would say, maintaining now because maintaining now what's already a very strong recurring revenue and cash flow generating model. And as I mentioned earlier, we are currently about -- with moves that we've made recently, we're about 50 -- a very healthy 57% aftermarket exposure. And number three, leveraging the EnPro operating system that I just described on the previous slide, and as I indicated, with a focus there on driving our margins and our cash flow return on investment. So in a nutshell, all of these are designed to support our commitment to a disciplined capital allocation strategy to maximize the long-term shareholder returns. I'm going to flip now to Slide 10 and talk just a little bit about this year because this, as we all know, has been a year that we weren't expecting coming into the new year, and it's required some attention beyond our ordinary way of thinking and way of being. And so I want to talk a little bit about our focus this year on protecting our people, our business and our community in light of the uncertainties brought on by COVID-19. So I want to highlight just a few points. You can read this and get into more detail as you have time. But we have taken a lot of actions to maintain -- to be able to maintain our business operations. We've had very few business operations, or very few disruptions to our business operations during the course of the year. And we have worked really hard to ensure the safety of our employees overall. So for protecting our people, we've expanded our IT infrastructure this year to enable more people to work remotely, those that can that aren't associated day-to-day with producing our -- the products that we produce for our customers. We have installed a baseline -- periodic baseline COVID-19 testing in our facilities. We've also taken a step beyond that and implemented digital contract tracing so that if we have someone who tests positive for COVID-19, we have the digital records of every one that person has come in contact with and how far apart they have been with others during the period of time surrounding their positive test. For protecting our business, we've had a keen focus on our cash, on our balance sheet, on our costs, which we have noted in the past. And as you see here, have resulted in full year 2020 savings of about $30 million. We estimate that about half will be sustainable as we get back up to volume levels that we saw in 2019. We've had a focus on capital spending and headcount as well, associated with some of the cost reduction efforts. And then for our community, our teams have really done a lot of great work working in communities in which our major facilities are located. I think it's just inspiring to see what happens at the grassroot level. And this is just a couple of examples here. And I'll just highlight that through our supply chain effort early on, we were able to secure medical-grade masks for our use and we were able to take advantage of our early moves to supply a number of N-95 masks to doctors and hospitals in the United States and Europe. So we're really proud of the efforts of our colleagues in making that possible. If you go to Page 11, Slide 11, I covered our overall strategy. And now I'd like to just follow that with a summary of our financial strategy. And there are 4 prongs, as you see here. First is to reinvest in the business, so protecting and building on our current group of businesses. And I'll talk a little bit more about the businesses that we have maintained. We have sold a number. The portfolio that we currently have is just largely of businesses that meet our financial and strategic thresholds, rooted in materials science, characterized by high EBITDA margins, characterized by high cash flow return on investment. And so we do want to continue to invest in and support our current group of businesses. So I would highlight that as number one. Number two, for the future, as we allocate capital for growth, we are increasingly looking at inorganic growth as a way to see the future organic growth of the company and to move us gradually from what was once an old line industrial company serving most of the mature markets into an industrial technology company that is serving higher growth markets. And all of this is going to be rooted in businesses that have a materials science focus and some leading technology. You can see here that we're noting that as we look at acquisitions, we want businesses that have margins greater than 20%, cash flow return on investment greater than 20%. Serving markets with some tailwinds, so markets that are growing at greater than 7% annually. And we also look for experienced management teams with a proven track record. And a couple of recent examples that I'll highlight later, the experienced management team that's coming with the company, that's made it what it is, it's been very important to us to structure a transaction that helps provide that ongoing incentive for those teams to continue doing what they've done well in the past as we supplement it with our capabilities. I'll talk a little bit more about the strategic acquisitions part later. When we look at our -- at returning cash to shareholders, we pay a dividend. We've been increasing our dividend modestly every year. We increased it a little bit -- a little higher rate in the year of tax reform. And it's -- but it's been growing steadily since we introduced it a number of years ago. And as I mentioned, we're currently yielding about 1.5%. We do -- we did -- the Board did authorize a new 2-year $50 million share repurchase authorization at the Q3 Board meeting. And I'll just note that investing in future growth remains our current priority, but we wanted to have that available to us as things change over time. And I've already mentioned we have a heightened focus on cash flow, and that's part of our financial strategy, part of maintaining a strong balance sheet. Flipping to Slide 12. This just highlights the importance that M&A has been over the last couple of years. You can see the accounts for the vast majority, a big, big portion of our capital deployed. Flipping to Slide 13. Just a profile of our current debt. We currently have net debt, or I should say at the end of Q3, we had net debt of $52 million, which equated to about 0.3x EBITDA. Subsequent to the end of the third quarter, we completed the acquisition of Alluxa. I would just say that even with that addition, we are still on a pro forma basis, well within our stated normalized level of net debt of 1.5 to 2x EBITDA. You can see the maturity of our debt structure over the right-hand of the slide, I won't go into a lot of details there as well as our S&P and Moody's ratings. Moving on to Slide 4 (sic) [ 14 ], I'll highlight just 2 points. One, we generate a lot of cash flow. You can see our free cash flow relative to adjusted net income, and it's quite strong. We expect it to continue to be quite strong. And then on the right side, this shows you our net debt to adjusted EBITDA over the past couple of years, also at September 30. Once again, that was before the Alluxa deal, but we still have a very strong balance sheet subsequent to the Alluxa transaction. I'm going to skip now to -- I'm going to go all the way to Slide 18 and talk just a little bit more about the portfolio transformation that's happened over the past several years. I mentioned earlier that we're focusing on moving our portfolio to an industrial technology focus and slant. And we started out in this transformation, and our way of thinking was what really makes us successful, the businesses that were in our portfolio a couple of years ago, are those businesses that are able to leverage the materials science expertise for some structural benefit to customers to allow them to do things that are difficult to do otherwise, to help them solve problems. So a very applications-oriented approach using materials science in different ways. So we start with that as a premise. We overlay that with our goal of having businesses in our company with margins greater than 20%, with CFROI greater than 20%, serving markets that are growing. And we -- those high-level strategic direction and those filters have driven a lot of the activities that have taken place in our company over the past several years. So if you look over on the right side, you see that in the third quarter of last year, we acquired 2 businesses: The Aseptic Group that serves the pharmaceutical industry; and LeanTeq, which serves the semiconductor industry. And we added another acquisition just earlier this quarter, Alluxa. It's a company that makes optical filters serving a number of technology markets. As part of the reshaping of the EnPro portfolio, we look -- took a hard look at our businesses that really did not meet our criteria going forward. And that led to a number of divestitures, the largest of which was the sale of Fairbanks Morse which closed in the first quarter of this year. It was a $450 million divestiture. And then in addition to that, we have divested several parts, components of our heavy-duty truck business to get down to a profitable core in that sector. And then also, we've announced the sale of our bushing block business, which was a small piece in our Engineered Products segment. So a lot of activity, and we've had a lot of success over the past 18 months in moving forward with our strategic initiative to reshape EnPro. If you then look to Slide 19. This will provide a bridge to give you an indication of the moves that we've made to date and what that has done to our overall financial profile. You can see that our sales have actually shrunk a bit, but our earnings have gone up. And the result of that is our EBITDA margins, as a company on a pro forma basis LTM, have expanded from 15.1% to 16.8%. And I'll highlight here that this is a static view. It's a static view. And what's not captured on this slide is that as a result of the moves that we've made, we have a business that has a higher inherent growth rate. And as we continue down the path of growing serially over time, you'll find that a larger and larger percentage over the coming years will be -- a larger percentage of our business will be serving markets that are growing faster than industrial production. I mean, we're -- we have a goal with businesses that we add, as I mentioned earlier, of acquiring businesses that, through a combination of tailwinds and their focus on niche markets, have an opportunity to grow at greater than 7% per year. So with that, I believe I am going to pause, we have about 10 minutes left, and open up the floor for questions, if there are any questions right now, Matt.

Yes. Thanks, Milt. I'll kick things off with a couple of them. I think just sort of to go over the backdrop heading into next year on some of your major end markets. So maybe you can talk about the truck cycle and maybe what you're seeing. I think we're seeing orders pick up again for Class 8 trucks after a pretty steep drop off for most of 2020, also Class 5 through 7 as well. Can you sort of see -- tell us what you're seeing in those end markets heading into next year?

Yes. I mean, what you're seeing is consistent with what we're seeing, what our team is seeing. We went just a little bit of historical perspective. We were in a super cycle of building on the OE side for a couple of years, I guess, which peaked maybe in 2018. And then 2019 continuing into 2020, we saw a pretty sharp correction in the number of truck builds. So yes, our team is seeing the same thing with some encouraging signs of pickup. The aftermarket part of trucking, which is what really drives our remaining business in trucking because we're probably at this point, 70-plus percent after market in our remaining heavy-duty truck business. We've seen, as we talked about in our Q3 earnings call, we are seeing some uptick after kind of a mid-teens decline in the first part of the year, and that's just a function of improving economic environment. Our OE exposure is small. And then most of our OE exposure is tied to trailer production as opposed to tractor production. We do have exposure on both, but we just -- we had more exposure on trailers. And -- but it tends to follow the same general cycle as the tractor builds. It's -- maybe trailers lag a little bit, the tractor build cycle. So it's encouraging to see that. I will just note, we have far less exposure to that industry than we once did. If you look at the market -- segment chart that I provided earlier, I didn't review it, it was on one of the slides. I think it shows heavy-duty trucking on LTM being 25% of revenues. And if you look at it going forward, with the moves that we've made this year, it's going to be probably below 20%, maybe closer to 15% of our revenue exposure going forward.

Okay. That's helpful. And you've made a lot of progress on increasing kind of your portfolio of sales through aftermarket as opposed to OE. Can you talk about how you've been able to increase aftermarket exposure versus a few years ago?

Yes, part of it is -- it's the focus that we're giving it and our strategic portfolio reshaping. Some of the businesses that we have sold in heavy-duty trucking had higher OE content. The acquisitions that we've made, the recurring revenue model is something that we look at going in. And I'll just give an example of that with the LeanTeq acquisition that we made a little over a year ago. LeanTeq is a business that provides cleaning services, coding, other refurbishing services to -- the end customer would be the foundries that make semiconductor wafers or chips. And so the business itself is tied to the production of chips or the production of wafers. It's not tied to new tools that are being produced to be used for chip production, but rather for chip production itself. And so that's just one example because if you look at the historical growth rate of wafer production, it's a pretty straight upwardly growing curve over a number of years, as you would expect, because of the digitization of our economy. And so that's one example. So that business is essentially all tied to what we would throw in the aftermarket bucket because it's a recurring revenue business.

Okay. That's helpful. And then another thing you emphasized in your M&A has been materials science as a main driver. Why the focus on materials science? Why is that so important to EnPro?