Hubbell Incorporated (HUBB) Earnings Call Transcript & Summary

All right. Good morning, everybody. Thanks for joining us for day 3. I'm Josh Pokrzywinski, Morgan Stanley's electrical equipment multi-industry analyst. Joining us next on stage will be Hubbell's Chief Financial Officer, Bill Sperry. Bill, thanks for joining us. Excited to get into some questions. Obviously, a lot of good things going on in your end markets that we want to hear about. Just a reminder for everybody in the room, that if you have any questions about our research disclosures please visit the related website or ask your salesperson. With that, Bill, again, good to see you. Thanks for making the trip out. Maybe just spend a minute or 2 kind of talking about what you guys are focused on and what you're seeing out there?

Yes. Great. Thanks, Josh, and thanks for having us. Nice to see the tenth annual. That's nice, and thank you all for hanging in there for day 3 to be with us this morning. I thought it would be worthwhile to just give you a couple of comments about what we see from market conditions and trends that shaped our performance in the first half and then maybe update you on what's been new in July and August since we reported out on the second quarter. So really 3 themes I wanted to highlight. First is our end markets and the strength of them. The second is our positioning in those end markets, which we believe continues to improve. And the third is execution, which we're pretty happy net-net, given some of the supply chain challenges, how we're doing there. So starting with end markets, they're in good shape still, Josh, and they're certainly positioned to outgrow GDP significantly on the utility side. There continues to be an awful lot of demand to continue to upgrade and modernize the grid. And I think we're really trying to make up for several decades of underinvestment there. And so that is a great pace on the Electrical side. Also in good shape for the residential market, which is a small part of our Electrical business. But the commercial, industrial applications are still very strong. I think within those end markets, we're really happy about how our position is strengthening. We sold our C&I Lighting business earlier this year. I think that's allowed us to focus with our customers on higher margin, higher growth business for them and for us. That's actually proved, I think, to strengthen our relationship. It's allowed us to focus a little more on innovation and allowed us to focus on those areas, which we think have more potential. And I'd say on the execution side, '21 was tough for us with inflation being so persistent. We responded with aggressive price increases. Those allowed us finally by the fourth quarter of last year to kind of get neutral, and really now have enjoyed for the first 2 quarters of this year, some tailwind from that price cost. I also think that that's really been allowing us to overcome some of the inefficiencies that are persisting. You're probably sick of hearing us whine about all this stuff, but the labor in consistency is still not smoothed out. Components, chips are not readily available. And so there are still inefficiencies in the operating side. And I think we're pretty happy that. We've been able to, in the second quarter ship out more units than the first, that probably to everyone sounds like a normal situation of seasonality. But in fact, first quarter, we were going with the backlog we had and -- some of the ship dates pushed out, we're actually going as hard as we could. So for the second quarter for us to ship more units was a sign that, that execution, we were actually increasing capacity. So those trends that are all in place really persisted through July and August. The volume was there, I'd say as expected. I know you and I were talking a little bit last night, any signs of slowdown, and we just haven't seen that. I think what was better than we expected was the price/cost equation on the cost side, some improvement there that actually result in our margins being better than we were anticipating. And I think as that indicates to us, I think, Josh, that the guidance that we put out in July for the full year is going to prove to be conservative, and that we've got better performance than we're anticipating as we go forward. So maybe I'll just give those comments as backdrop, and happy to have you lead the questions.

Excellent. So good to hear things that are going well. And I know you guys have put in a lot of effort to make that the case. This is another thing. I know you and I talked about last night, and we've kind of heard from a few folks here, although not everybody. How do you see kind of the contingency planning around this environment? Everyone has elevated backlog, demand looks strong. The indicators mostly look good, but it's hard not to notice what's going off to the side. How do you see kind of the lesser evil of trying to maybe build in a little cushion or work down inventory versus say, look, like let's get this out and make hay while the sun shines, how does that look for Hubbell?

Yes. I mean I think you're trying to get at a little bit how much of the demand might be unsustainable. How much of the orders are really around whether they're called a panic buy or whether they're reacting to the lead times being longer than they're expected. One of the things as we try to evaluate your question, we have a number of vendor managed inventory programs with our customers. And so we actually have some imperfect, but in those cases, very good point-of-sale data. And from what we can tell, what we're shipping is getting sold. So we worry about buildup of inventory at our level but also in the channel. And it feels to us like for our goods, what they're asking us is actually moving. I think on the other end, it's been some very significant changes in our customer relationships. I think over the years that we've talked, I would have described us very much as a book-and-bill business. We take an order and we ship it in 6 weeks and it has -- I would say to you, always had sort of a current measure of the barometer of the market. And I think we're just starting to have much more granular forward conversations with end users and customers, people talking about projects in '24 already in places like utilities and renewables. And I think that's super constructive to navigate the kind of environment that you're describing when demand maybe starts to normalize, and what we're trying to plan for as you ask that. Trying to make sure we got enough backlog relative to where demand is to be able to sort of maintain kind of the operations of the factories and keep satisfying that customer demand as opposed to having some stops and fits and starts there. So that's how we're trying to do it. And I know as you and I were talking last night, maybe a little bit easier said than done, but that's certainly how we're looking at it.

Got it. And then you mentioned price cost. I know this has been topical for you guys for, gosh, almost 2 years now. How do you think about kind of the current environment? You guys are you're on LIFO. So you've seen some of these benefits from steel deflation, maybe a little sooner than others. But if you think about kind of the balance of inputs or the forward curves you're seeing. How do you think about maybe the cost side and then we can talk about the price side may be separate, but just start off with what you're seeing on the inputs.

Yes. So I think on the cost side, we saw a significant downward pressure on things like steel, copper and aluminum. So actually feels like some of that may be bottomed and is inching upward again, but not any -- not relative to where it was, just sort of maybe flattening, let's say, rather than on a continued downward slide. The resins and the oil derivatives were kind of out of sync with that for a while. So it's been interesting really in the last month to see some of those resins and oil prices react. So it feels to us like those costs are going to be lower as we roll forward and think about '23. What's the most interesting part of that is in ordinary times, you and I would talk about that being the catalyst to drive price downward in sympathy with that. And I think what's really interesting right now is it feels like capacity constraint and scarcity of capacity is what's driving price more than the cost of the inputs. And so I think we're anticipating being able to hold price, while capacity is short, which it is right now, and that it will be when capacity catches up rather than maybe reacting to what the Chicago Merck says about steel prices. So it feels like a different set of drivers for price cost than is normal. And frankly, probably more constructive for us.

Got it. And if I think across the businesses, if I'm remembering right, a lot of those discussions around modulating price with the input seem to happen more on the utility side. Is that still the way you would see it today. So when you talk about that relative firmness around capacity, is it a utility comment or your kind of pan portfolio?

I would say pan portfolio -- but certainly, there's pronounced dimension of it on the utility side for sure.

Got it. And then -- maybe just pivoting over to the growth side of the equation. I mean a lot of very exciting things going to happen for Hubbell and the rest of the electrical industry over a very short period of time there. Maybe talk about electrification as a whole? I mean, it might be a little over used, I might be a little to blame that for that. But where do you guys see it in your portfolio? It's sort of you've palpable in the utility piece, you can see the growth kind of as a before and after. But across the rest of it, it's diverse enough to maybe be harder to trace. I guess, first, where do you guys see it? And second, where are you kind of focusing on either commercially or product wise?

Yes. So let's comment real quick on the utility side. As you mentioned, again, as you and I have talked over the years, that's really felt like it had sort of a GDP level of demand to it. And I think the predominance of our volume was really MRO. And so it was economic life that was determining when something would get reordered. We've seen a shift from any GDP levels towards mid-single digits. And I think that's been a function of some catch-up on the aging, but also the fact that the infrastructure and the grid is getting more complex and sophisticated. It's not just replacing, but investing in new that can be smarter and do some more things. I think on the Electrical side of our business, on the behind the meter, we just see some verticals that are reacting pretty strongly. So data centers is an example of something that's quite obvious. So as the word electrification and people are demanding more and more data as part of that electrification, we see just almost insatiable demand for that data, which then drives need for mega buildings, which has been inside of those buildings. There's just an awful lot of electrical component content that's good for us. The renewable areas, maybe another 1 that I would point to in your electrification theme, where making sure that's not coal or even natural gas, but a renewable source between energy and wind -- I mean, sorry, between solar and wind. It feels like the near-term opportunities are probably in the solar. But some of the dynamics of wind blowing at night has some, I think, reasons that maybe in the medium term, the wind will be there. But the renewables side showing just really, really strong growth. Speaking this morning with some of our managers selling into that end market, and they talk about dialogue with customers years ahead of getting ahead of capacity. We heard anecdotes of this project has been on the -- it's been talked about for years and years and years, and all of a sudden, now is the time in renewables. So I just think a really big growth in some of those electrification themes that you're talking about.

If I had to think about that from a utility perspective, I mean, there's a baseball analogy to be had here. We're probably not in the first inning, but probably not too far away from it because we've had a few years of this accelerated growth. Is there some sort of either percentage of the market that has been modernized or kind of a total TAM that you guys think about to gauge where we are in that journey or how long this could last? Because it seems big, but it's also extremely hard to track.

I think it's hard to track, and I don't have a satisfying answer with significant digits to it. But I'd give you a couple of -- I mean, -- it does feel to us like a lot of the construction, you sort of have eyes and how your grid installation. The life of those products is 20 years, 30 years typically up on a pole. And so I would argue you're talking about maybe 40 years of underinvestment and maybe 5 years of sort of higher spending so far. So maybe -- So maybe in the second inning -- that using that. I think also if we were to pull our utility sales team, they would say that years ago maybe 70%, 75% of the sales were this MRO just replacing into life, and now it's maybe down around 60%, 65%. And so you can even see that's just the replacement piece. And so I say that because it means that there's more project value add going on too. So it's not just to kind of catch up replacement, there's also new spending for better applications. So anyway, I think the drivers are really solid there and feel multiyear at least, yes.

And then from a catalyst perspective, I mean, you get a lot of attention grabbing headlines about things that happen in places like Texas or here in California. How much of that growth is sort of determined by events versus those events being just sort of an awareness raising like, oh my god, the cost of failure on something that's really not that expensive is high. We need to replace it versus you have a snowstorm in Texas or something and that really moves the needle on any given quarter.

Yes. I think it's more the former. The awareness is a really big deal. I think politically, 1 of the scarier words out there right now is rolling blackouts. I think if you're an elected official and you're running on, we're going to have rolling blackouts. That's not going to give you a successful platform. So to your point, to think about the amount of capital relative to avoiding that kind of outcome to your word, the raised awareness of that is really, I think, really profound.

Got it. And then just on the Aclara side, maybe some different market drivers. There's certainly a growth of your business, and that was why it was brought in the portfolio. But I think the AMR market is probably on a different cycle maybe than some of this other stuff. The technology isn't super new kind of definitionally, but there's been evolution. How are we in upgrade cycles or penetration? Like how would you define that market today and what you're seeing out there?

Yes. So Aclara for us, just to remind everybody, a couple of different product lines there. One is the meter. And the other, as Josh refers to is the AMI, which is the comms in the meter. And I would describe it, Josh, just having an 08-ish mid-2000s, heavy bit of installation where the application was meter reading. So rather than having to have a van drive by and someone stop and read it, it was automated meter reading. And again, I think you should think of maybe 12- to 15-year typical life of that technology. And so we're at the point where it feels to me like there should be a 2.0 refresh on some of that. And what's very exciting for us is that the application is advancing much beyond meter reading. So it's getting into the control and safety and monitoring of the hardware. And what's interesting about that is it has a different demand on the AMI technology. So the old technology and what's predominated has a reasonably high latency, you need to read it once a month. Some of these newer things where you're really monitoring, you want to maybe figure out if something needs maintenance and see if it's heating up or performing differently than it usually does, that actually needs to be pulsed a lot more frequently. And that's where our technology, we feel is actually much better than the old technology. And so we feel we've got a lower latency solution. And so we're really looking for it. And I agree with you, the drivers are different. So those RFPs for that next wave are still sort of just in front of us. You start to see some big IOUs asking for beta test, starting to talk about when they might have their RFP out. And so it will be really, really interesting for us to see because our Aclara product historically, has been sold more in rural applications, Josh, with co-ops and munis. And we're really excited about it is to get it into the larger electrical IOUs. And I think that's just in front of us now over the next couple of few years.

Got it. Inflation Reduction Act seems like it's sort of like a nice -- both direct and indirect beneficiary to some of your businesses. Maybe the ink is still a little too wet to put decimal point accuracy on it. But what are the big pieces in there that could be needle movers or you guys are thinking about in terms of how to prioritize opportunity or deploy resources?

Yes, without just focusing on the IRA, I think it's worth us mentioning the IIJA, too. I know maybe the ink is more dry, but that fiscal stimulus is a little more direct. I think that's going to be money that goes to states and then states would hand it out to the utility. We think that's really applicable to us. And some of what maybe you and I were talking about in a minute ago, big drivers of demand for utility infrastructure hardware. Maybe this is giving the utilities confidence that the funding is there. And we're not finding specific orders or projects necessarily have a little tag that say this is IIJA or not. But I think it's giving the buyers the confidence. And so I think the effect is already here in the sense that it's supporting more aggressive purchasing. We were talking about the need for the product, but now there's also the funding for the project. And interestingly, sort of switching the burden from the rate base to the tax base, which is sort of also or just sort of interesting policy-wise. And I think now as we shift to the IRA, a little bit less direct in the sense that you're talking about tax credits and incentives rather than maybe pure funding sources and how that sorts out will be interesting. But we think there's some really good benefits on the renewable side and in some of our Electrical applications. So yes, this fiscal stimulus, it seems maybe a little bit interestingly directionally opposite than monetary policy, which is trying to cool spending. This feels to us like it could be years and years of supporting demand for both utility and Electrical side for us. So it's really interesting legislation for us.

So if I think about everything that we just talked about in kind of these growth vectors and there's multifaceted right across the portfolio, is there anything from an M&A perspective without naming names or even kind of individual product lines, which is a non-engineer, would probably go over my head anyway, that you think Hubbell needs to sort of execute on to win in this? Or do you have the pieces that you'd like to have?

No, no. I think the M&A opportunities are really good -- we've identified some 6 specific verticals that we're really trying to be intentional about. And we benefit from the fact that the industrial organization has lots and lots and lots of smaller companies. Those companies might have a good brand. They might have a good product line. They might have a good technology, but what we're finding when we start talking to them and saying, hey, where would you be interested in selling to us. They realize how much better their company would be on our platform with the capital behind it and the sales force in front of it and really help. And so in areas like data centers where we just bought a really nice company called PCX in an area of utility where we just bought Ripley in July, which is in the tool side and which is also cutting into telecommunications, which is another vertical that's showing both with the 5G kind of build out, just lots and lots of spending that gives us really good runway at. So being able to go out and on orders of magnitude, be able to spend our operating cash flow. We certainly need some CapEx. We have dividends on there. We usually buy some shares every year, but you're talking about a few hundred million left after that, and I think we can put that to work in the M&A market in these high-growth areas and be very purposeful about taken our portfolio and making sure it's pointed in the higher growth, higher-margin areas. So I think that is just -- I see years and years and years of runway of that. I don't see that drying up and really good opportunities out there. I think the only downside I'd say is that multiple conversations seems to drift up over the last several years have felt like we could buy things at 8x and then that became 10x, and it feels like 12 is the new 10 and...

They know what they got.

So that's that part -- and yet, I think we can still add lots of value even at the valuations we're talking about.

Got it. That's help. And then maybe last question for me on the margin front. In terms of your own plans and kind of productivity and some of the repositioning that you guys are doing internally, the environment changed a lot over the last couple of years. And I know that there's been kind of this ongoing rationalization plan by the same token, you mentioned earlier, capacity constraint. Is there any kind of pivot that needs to take shape? Obviously, productivity and kind of roofline optimization are still in there, but how do you balance kind of those 2 factors?

Yes. So the pivot for us is kind of by segment. So the utility side is really taking CapEx for growth, adding capacity, footprint and PP&E inside the buildings. But I'd say the Electrical side, when Gerben, our CEO, ran Power Systems, he just had an awful lot of success taking a bunch of acquisitions and bringing them in to compete collectively as a Power Systems business. And so he's been very keen on getting that done on the Electrical side of our business and rather sort of compete desperately, trying to compete more collectively there. And we're finding as a result of that rather than having individual presidents but having a whole segment focused on behind the meter, that the opportunities are still there to consolidate in factories, share those factories because you're sharing across more lines of business that you can be more efficient. And also on the distribution center side, 1 Electrical business doesn't need its own DC network and the other need its. And so we've got still, I think, some really good consolidation and productivity opportunities on the Electrical side. And so it is a bit of a pivot that by segment, it has a different flavor. One is a little more towards the expansion, the other a little more towards efficiency.

Got it. I see we're out of time, Bill. I always appreciate your time. Thanks for making this out, and thanks for everyone's attention on the line in the room.

Thank you very much.