Hubbell Incorporated (HUBB) Earnings Call Transcript & Summary

Hi. Good afternoon, everyone. I'm Josh Pokrzywinski, Morgan Stanley's electrical equipment and multi-industry analyst. Thanks for joining us here for our virtual Laguna conference. Joining me this afternoon on the virtual stage is the management team from Hubbell. So with me today, I have Gerben Bakker, CEO; Bill Sperry, CFO; and Dan Innamorato, Director of Investor Relations. Before we get started, I do have to read a quick disclosure just noting that for anyone who has questions about our disclosure to visit the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And that for all other questions they should reach out to their salesperson. I'll kick it over to Dan now, who's going to read their version, their disclosures. And then Gerben, can go ahead and we just start with opening remarks and we'll dive into Q&A. And I just want to encourage everybody as well to take advantage of the question portal as we go through and we'll save some time at the end to get through this. Dan, take it away.

Thanks, Josh. Just a quick reminder on our forward-looking statements disclosure, which you can find in detail on our investor website and in prior investor materials. We may make statements today that relate to expected future results, which are subject to various risks and uncertainties as outlined in those disclosures. So please note them and consider them incorporated by reference here. Gerben?

Great. Thank you, Dan, and good everyone. Good afternoon, everyone, and thank you for listening in. And Josh, thank you for hosting us at your conference. It was exactly a year ago, and it was at this event, Josh, that we announced the CEO transition, and I assumed my new role as we were in the midst of navigating through what I'm going to refer to as the 3 economic phases of the pandemic. This first one being characterized by demand contraction across most of our end markets, and we executed successfully throughout 2020 by aggressively adjusting on our cost structure and continuing to drive strong productivity across the operation, and this enabled us to hold operating margins essentially flat and achieve strong decrementals of about 15%. Then in the first half of 2021, representing the second phase of the pandemic where we saw a sharp V-shaped recovery taking hold. Strong demand from our customers, driven by the ongoing need for reliable and efficient critical infrastructure solutions, generated order growth well in excess of double digits across the portfolio. But along with this rapid recovery came significant inflation in raw materials. And we've worked urgently to offset these at an accelerated pace and magnitude with price increases throughout 2021. We are several quarters ahead of where we were during the 2018 inflationary cycle and continue to expect to turn positive on price material exiting the year, despite the continued inflation in materials. As we've now moved into the second half of the year, the operating environment remains as dynamic as ever. Demand continues to be strong and broad-based and above 2019 levels and price is sticking. But in this third phase, the volatility of the pandemic and the uncertainty created by the new variants has stressed the supply chain across global industrial economy. This has not only driven further inflation in material, labor, freight and logistics, but also more recently, shortages that we're seeing in semiconductors and chips. While these supply chain challenges represent temporary near-term headwinds, we remain committed to actively mitigating them through proactive operational focus as well as price and productivity, which we continue to expect to see accelerate throughout the second half. Our focus remains on successfully serving our customers throughout this dynamic environment while also delivering on our financial results for our shareholders and we are confident that we are executing on both of these fronts of actively. While the supply chain disruptions are more significant than initially anticipated, we continue to expect to deliver within the range of our prior full year guidance. And importantly, as we noted in our July call, we expect the fourth quarter to contribute above historical sales and earnings seasonality relative to the full year. Given our increased backlog as well as the most recent round of price increases, which we expect to be fully reflected in shipments and sales as we exit the year. On a full year basis, we now anticipate generating 5 points of price realization relative to our prior guidance of 4 points. And we have driven additional pricing actions to mitigate the incremental supply chain challenges and headwinds. And now looking ahead, more longer term, we remain highly confident in our ability to deliver consistent and differentiated results for our customers and shareholders. With our unique leading position in front of the meter, behind the meter and at the edge of the energy infrastructure, we are strategically aligned around the clean energy mega trends in electrification and grid modernization. Both of which we expect to drive sustainable growth. Our operating transformation is firmly underway with footprint optimization initiative continue to contribute to ongoing productivity savings benefit from the normalization of price cost set to come. And finally, our strong cash generation and proven capital deployment track record enables us to invest both internally and through acquisition, driving attractive returns on the capital we invest in behind for our shareholders. So with that, Josh, let me turn it back to you for some Q&A.

Excellent. Thanks, Gerben. Those are very helpful kind of table setting remarks, especially on what I think everyone wants to hear about on the price cost and supply chain dynamic environment. Maybe to unpack a few of the things you said a little bit further. It sounds like demand has continued to be strong, especially reiterating that you're going to have that above 4Q seasonality even with some of the supply shortages that we've seen out there. So either demand is that much stronger or the stuff that's getting pushed to the right isn't so austere.Is it fair to say kind of versus a couple of months ago that staying in that EPS range is a function of revenues a little bit higher than you thought and maybe margins are a little bit lower? Or are both pieces sort of kind of within what you would have expected before?

Yes, I'd say, Josh, the -- in terms of price, as Gerben had highlighted, the pricing, our actions have been sticking and holding and that has created a little bit of lift. I think the productivity, as you point out, is still hard to come by, just because it's driven by inconsistency on the labor side. We suffered some turnover, suffering some absenteeism and that makes it harder for the factories to perform at their optimum. But also kind of Gerben's comments on that 3Q to 4Q, kind of an atypical sequential seasonality because there's backlog and because there's this incremental price that will be in 4Q. It just creates -- just not -- if you did your 5-year historical average, the fourth quarter just looks like a bigger contributor than it would on average.

Got it. That's helpful. And then, I guess, just to sort of break down some of those pressure points on the supply chain side. You have classic price cost, you have logistics and port congestion, stuff like that. Bill, you mentioned labor inflation and shortages and absenteeism. I guess how would you kind of rank the 3 in terms of how acute the headwind is? And how do you see kind of the time line to any of those 3 normalizing?

Yes. So if we start with price cost, I mean, we were -- as a LIFO company, Josh, we were feeling it part in the first half of the year. We -- as Gerben was highlighting, we were behind. So it was creating a headwind, and we've been pulling aggressively and to get to 5 points of price is a pretty successful job by our salespeople and customer service people across a very broad portfolio. So you could do better or as good a job as I of predicting what's going to happen to commodities. But it feels to us like that price cost equation has come under control. And our expectations are that will enter next year with a tailwind there. And to the extent commodities continue inflate, we'll keep asking for price. So then I think next comes labor. And certainly, there's been an awful lot of attention on wages we pay, recruiting places we go, encouraging temps to become perms and offering incentives for folks to stay on. And so I think that one feels perhaps like that's improving a little bit as well. So I think the materials and transportation area are the 2 maybe bigger question marks, Josh. Certainly, with materials, Gerben mentioned the chips. But there's been other areas, resins, I would call out and certainly even rubber. We've had a hard time keeping a nice, consistent, steady supply. And so as you were describing, some of that's driven by the fact that our suppliers in turn, like us have uneven labor situations inside their facilities. You did a good job of highlighting the port congestion. That's exacerbated by container shortage with the V-shape recovery, really putting very high demand level on consumer goods and absorbing a lot of that container capacity, maybe away from industrial goods or at least, ahead of. And so I think those -- that material piece and the transportation piece will probably have maybe the most nagging persistent throughout the next several months.

Got it. And I guess one thing that sort of stems from the backlog commentary is, I don't traditionally think of Hubbell as a backlog-driven business, much more short cycle, even in utility. I don't think of it as backlog maybe outside of some pieces of [indiscernible]. Where are you guys seeing kind of that backlog accumulation? Is it in a particular set of end markets? Is it a particular set of products? Anything that would add a little bit of context for why, I guess we can figure out why we have the model mix, but the markets that are building up the backlog a little bit faster.

Yes, I'd say the backlog increases are pretty broad-based across our portfolio, and it has a lot to do with the inability to serve all of that demand, right? And that we're seeing pretty much across our businesses. So when you talk about labor challenges, it's no business is exempt from those challenges or transportation issues. So it's really more a function of not being able to fully supply the demand that's out there, and that's what's creating this extension of lead times and this increase of backlog. That's one of the reasons also when we talk about this a typical seasonality going into the fourth quarter is that we have a lot more backlog going into that period than we would traditionally have. So normally, when we see in the fourth quarter, demand kind of taper off. Again, in the outside the fourth and the first quarter are the weakest in the middle ones are the heaviest for demand because of this dynamic of backlog, we see an atypical volume and then on top of that, the price going into the second half. But the backlog is elevated. I think you're right to not think about it our business generally as a big backlog story. Aclara is an exception to that where these projects are a lot further on the horizon. That's actually a very positive story for us as well that throughout this pandemic, that backlog has held up. And as a matter of fact, the first half was very strong in orders going into the next couple of years there. So hopefully, when we're doing all we can to try and take that backlog down and continue to serve our customers here over the second half.

Got it. And then I think at earlier points in the year, Gerben, you guys made comments that channel inventories had started to lift a little bit. Certainly, below longer-term trends, but you've seen some improvement. Everything you're saying today and kind of broad tightness would suggest we're probably destocking again, but what's your sense on that?

Yes, I would say from what we're here, and we have a lot of connections with our distributor partners, is that they're pretty much selling through what's being delivered. So I don't know that there's any significant stocking or destocking. There's, of course, pockets of that, whether it's real supply chain challenges, where that may be happening. But I would say, overall, our distributor partners are kind of treading water in. They'd like to get inventories higher. And there's pockets where they have on the utility business, for example, where stores part of servicing customers. We're in the midst of that. You see some distributors stocking up and that's another good example of where, despite all of our challenges, we've been able to continue to serve our customers on the most critical needs that they have with storms with some of our supply. But yes, I would say, overall, I don't see at this point major stocking or destocking going on with our distributor partners.

Got it. Last supply chain question, then I promise you can put across -- put aside your supply chain notes for a bit. Anything that you're thinking about in terms of reshuffling your own supply base, based on what's happened? I mean I think everyone would like more chips, and more chips in their backyard and sort of outside of most people's control. But anything that's within your control view would say, gosh, we just we let this stuff go too long and relied on episodic shipments and we'd rather not do that going forward.

Yes. So there's really a couple of things. First, Fran, working capital to us is an extremely important measure, and even during this time, it continues to be. One thing that we've really looked at especially where there is critical materials to make sure that any supply we can get, we do get in the door. Certainly, over the last couple of years, and this was pre pandemic till when we had the big tariffs a few years ago. We really looked hard at our supply chain and have done work to reshore operation, to bring more under our own umbrella. So I'd say those efforts have continued to happen during COVID. There was another reason to do some of these things. But you have some of the supply that's more embedded in these regions where you talk about chips or whether you talk about our lighting business where the whole supply chain is more in Asia that are just harder to lift and shift back to the U.S. But I do see a general trend for industries to continue to bring more of their capacities nearshore.

Got it. So heading to the utility business. Obviously, a host of things that are happening here to drive growth rates higher. We've already seen it. So as much as these are mega trends. We have a few years under our belt where you kind of have evidence of this happening. So grid hardening, renewables, broader electrification and some of the investments that need to be made there. I guess, how are you seeing this evolve with spending type or project scope and any kind of buying pattern, I guess, maybe more broadly from your customers? Or is it just buying a little bit more of everything? Like how does this impact you beyond the obvious of we're growing faster?

Yes, yes. So I mean, it's right to point out that this has been a business that's is on a higher growth trajectory. We typically -- when I ran that business, I used to talk about low single-digit GDP-type growth for the utility business. That clearly shifted now to more of a mid-single-digit GDP plus growth and a couple of factors that are driving that. First is the need to upgrade the aged infrastructure, and that's become more important every time there's a storm, every time there's an outage on the system, it's recognized more that those investments need to happen and we benefit from there throughout our portfolio. But the other area is the renewables that have come on and related to the decarbonization. And that's really benefited our overall portfolio, but particularly in our transmission and substation as these sources are come on, these generation sources come on that we bring them back to the population centers. And the other thing that this has done is by putting more renewables on the grid, it stresses the grid more. So it makes the first one of hardening the grid, even more important. The third thing that I would say that has happened over the last couple of years is the shift by utility companies to spend more CapEx over OpEx. And a lot of this hardening now is under CapEx budgets that generally requires a regulator approvals, but regulators recognize the need to harden this grid as well. So there's a lot more support of that. So these are some general macro trends that are driving us to a higher sustained growth rate. Specific within that market and an area that we find very attractive over the next few years and are focused on is distribution automation. And this is really the result of the legacy business coming together with the Aclara acquisition. This was strategically something we saw when we made this acquisition. We have several areas here. We have now an organization in place that is driving that growth organically. So taking our legacy products and putting communications and smarts into them, but also acquisition. You saw us doing earlier in the year, the back with acquisition that's clearly in that distribution automation space that's growing higher. And there's more opportunities, both organically as well and as the acquisition side to produce. We're very bullish on this. And there's really sustainable macro trends that are helping to drive this higher-than-traditional growth in this business.

Do you think we're at sort of that run rate today? Or is there sort of a gear missing in terms of utility spend or something else to come in on an infrastructure build that would take this to another level? I mean not to look a gift horse in the mouth, but it still seems like there's some longer-term dynamics that have yet to show up.

I would agree. I would agree. Certainly, the infrastructure build would help accelerate, I would say, some of not necessarily that they would do it, but it could help accelerate it. And I think this whole automation, distribution automation, the smart grid is still in the early days of that. So I do see that, that has upside.

And is the adding automation or other grid intelligence, something that utilities can get regulators to put in the rate base?

Right. Yes, because 2 things that, that need to drive is, a, it drives a more efficient operating system for you to that clearly does that, right? So when you talk about automation, you don't have to have a truck roll to an outage. And that's that shift, too, right? If the utility can spend CapEx to automate it, and they can eliminate OpEx, a truck roll to a utility. That's taking cost out of the overall system that benefits ratepayers. So the regulators are very supportive. The other one is the reliability of the grid, right? We don't -- we can't be without power to tolerance. To be without power is very short here, so -- and that's recognized that, that investment in it. So yes, I'd say there is support -- regulatory support to make this investment because there's a benefit to it. And that's what utilities have to show to regulators, that there's a true benefit for making these investments.

So if I were to take a step back and talk about kind of electrification more broadly, whether you want to call that EV infrastructure or microgrids, distributed power, storage, electric key and the list goes on. Where do you think Hubbell has the most benefit? Is it on kind of the utility and renewable and the utilities role in EV infrastructure side? Because I would imagine kind of on the other side of the meter, low voltage maybe doesn't play as big of a role is what you would see, at least in your mix of business.

Yes. Certainly, I would say all of the above kind, but I realize that that's the easy answer to this, but it truly does benefit with our leading position and the depth and breadth of our product and what all of this needs is electrical devices to enable this, and that's what we do. So I would say all of these areas are really benefiting. And I'd say both sides of the business, both in the utility as well as the traditional electrical business. But within that, there are certain verticals or certain trends that we're paying particular attention to. One example that I can give you is in the solar area right now. There's a lot of investment going into solar. We're very well-positioned when you think about the balance of systems, the components to put this in place. And that clearly goes across our portfolio with connectors and grounding and wire harnesses in the electrical to the enclosures, our product lines that we have in our utility business. Here is where we can truly shine and bring that together under one umbrella to the EPCs, to the distributors that are serving that. And it's proven to be a high growth and very attractive area for us. So this is just one example that I'll give you on it, but what do you think of that in EV, you thinking that in wind or electrification in general, our portfolio really benefits from that.

And I guess specifically on the Aclara pipeline, this is something that I think in the early days of that acquisition, yes the numbers there were pretty punchy. It doesn't seem like secularly anything is moderated there, if anything, accelerated. How has that played out? I know that there have been some specific bottlenecks, COVID-related project business there. So I don't know if that tempered demand, but maybe kind of level set us on what that pipeline looks like today and how that's evolved over the last few quarters?

Yes. So certainly, if you talk about the backlog and the pipeline, it remains strong. So we today still sit on $1 billion-plus backlog and order commitment or the bank. Our pipeline of projects is still in the $3 billion to $4 billion. So plenty of visibility. This hasn't changed or certainly declined, if anything, it has increased some. So you're right to point out some of the near-term challenges with this business. We had access issues on the first couple of phases of the pandemic. We're certainly dealing with chip and electronic shortages in that business right now. But those we will overcome, right? And then more about what's the underlying demand and interest for this. And it's very positive. It ties into this more connected, more intelligent grid that we're building. In particular, part of that is on the comp side for us. We're introducing a technology with a RF system that continues to take hold. We continue to see more customers go on that. That has a big refresh cycle coming up with the IOUs. And that's still a couple 2, 3 years out, but that's what we're trying to position for with our business, with the name of Hubbell behind, it with [indiscernible] to really benefit from that longer term. So we're very bullish on this business and the order bank continues to support the demand for these products.

So just given the kind of the transition that's happened at the portfolio level and some of this is secular and outside of Hubbell, and some of this is the Aclara deal, which is a home run. I mean we went from a few years ago, the tail-wagging the dog on lighting. It seems like a lot of the pain is been digested there, and that business is no longer kind of grabbing the attention it used to, at least, externally. I know it's probably still hard work internally. You have all these other kind of growth vectors, utility-facing or otherwise in notification. Is there a broader view on portfolio composition and what assets you want to own or expand long term? Has that changed as you guys have seen this unfold over the last couple of years?

Yes. I think, Josh, you've described it as an evolution, which I think is fair as opposed to some revolution and thinking I do agree with your commentary on lighting. Ultimately, the way our portfolio has grown, Lighting's now less than 10% of our operating profit, right? So it just by its contribution is more in the background than in the foreground. And so we spent an awful lot of time evaluating growth potential and margin expansion potential and try to listen to our customers and figure out where we have opportunities to shape our portfolio to be higher growth and higher margin. And we continue to have quite a bullish view that there are a number of investment opportunities for us out there on the M&A side. I do think the market is a little bit frothy right now. We see some aggressive valuations. But I think we can manage our way through that. We see some aggressive processes out there, too. But I do agree with you that part of what's been important when Gerben mentioned that working capital is an important part of how we manage the company. I think we've become more efficient at generating free cash flow out of income and out of EBITDA. And so that leaves more to invest. And we're quite bullish that we'll be able to do so and to find high-growth, high-margin opportunities. Some of the recent acquisitions we made inside of the Electrical segment are really well on board and really reinforce, I think that strategy. So we're encouraged by that. And I think there's a lot and lots of runway ahead of us.

Excellent. Well, I see we're out of time. Gerben, Bill, Dan, thank all 3 of you for making the time. Hope to do it on the beach next year. Good to see you all, and be well until we speak next.

Thank you. See you on the beach.