IDEX Corporation (IEX) Earnings Call Transcript & Summary

Good morning, everybody. This is Nathan Jones from Stifel. We're here for the IDEX fireside chat. I'd like to welcome Eric Ashleman, Chief Operating Officer; and Bill Grogan, Chief Financial Officer from IDEX. Guys, thanks for your participation and your availability today. We appreciate you being here. For those listening on the line, there is a chat box at the bottom of the webcast where you can submit questions. If you put questions in there, I'll ask them ask we go along. So I'll get started here.

You guys have a number of really short-cycle book-and-ship-type businesses, and I'm sure everyone is very interested in hearing about what you're seeing in those businesses as economies have begun to reopen, perhaps more successfully than I think people were thinking a month ago. To the extent you're willing, can you talk about the daily order rates you've seen in May? Were trends in May any better than they were in April? And were they in line with your expectations when you reported a month or so ago?

Sure. Sure. Thanks, Nathan, and thanks, everyone. This is Eric from IDEX leading off. So look, I think going into this, like a lot of companies, we're all dealing with a pattern that we've not seen before. And Nathan, as you said, I mean, we're a very short-cycle business. So all of it's, frankly, pretty interesting as we go through it. I would say we probably weren't going to plunge business by business into rates. And honestly, I don't know what all of them would say at this point anyways. But we're generally kind of in that range, and we put that sort of wider bounded range out there at the beginning, recognizing we had certain things in backlog, we knew certain things would continue on, we kind of know our industries pretty well. And I think we've generally hung around in that zone. That being said, June is a pretty important month. We still have a few weeks left here. It's always an important month for us as we kind of go into the summer. And I think maybe more important now as things are starting to open up, as you said, and relax a bit. So kind of watching behavior here, I think, is going to be pretty critical. All the major operating regions where we do business, sort of all the way from China right through Europe into the Northern Hemisphere, they're all kind of in a similar place now where they've all had their share of the outbreaks in an acute phase and we're sort of in this flattened curve near normal, if you will, where things are indeed opening up. But for any of us to really call what we're seeing as a pattern in some ways, we think might actually continue even to next week, is pretty hard to do, and I'd hate to be misleading there. I would say in terms of the pattern we expected in a broad sense, it's largely following the way we would have thought. So there's more industrial businesses, things that are pointed a little bit more to oil and gas, as you'd suspect, are certainly feeling a little bit more pressure in headwinds. I'm sure somewhere in the chat here, we'll talk about a few things that are pretty exciting on the health science front that are all about trying to combat this virus, and that's on the positive side. The municipal, as kind of always, is in the middle, right down the fairway. It stays pretty consistent throughout, and there are certain things that are driving that one way or the other. But I really do think that all of us are going to have to kind of see how the next few weeks shake out leading into the third quarter. The summer is always an interesting one to call. And then, look, the virus is really sort of -- it's calling the day here for us. Bill, anything on your end?

Only thing I'd add is, obviously, the FMT is the hardest hit segment relative to what we called, HST is going to outperform relative to their exposures there, and FSD somewhat in the middle is how we thought about it going into the quarter. I think that ratio is maintained here as we've -- are 2/3 of the way through.

Is there any reason to think that June wouldn't be better than May given the relatively successful reopening of economies that we've seen, both in North America, Europe starting to pick up a little bit and all reports are that China is kind of operating at pre-pandemic levels. Would there be any reason for people to think that your business being short-cycle shouldn't improve in June over May levels?

Well, I think at a high level, that's a reasonable guess. I mean there's more cars on the road, there's more people back to work. Keep in mind, the environments where we play, our own factories were generally always in the essential category -- essential business category, and a lot of the people we supply were in that category as well. So I wouldn't say that unlike, let's say, an auto-intensive company, we're moving out of a period where nobody was working in to one where they are. But absolutely true that there's generally more activity, more people driving around, more shifts being extended in the factories. And so how that manifests itself in the order pattern, I think that's a reasonable expectation, but we'll need to see it play out.

Fair enough. The slope of the recovery was probably even more uncertain in April when you guys were reporting than it is now. You've had a few more weeks of orders under your books here. Has it changed your view of how, I guess, the bounds of potential outcomes here, maybe the floor and the ceiling of what you were thinking in terms of a slope of recovery, has that band shifted at all? Or have we just maybe shifted within the band?

Yes. I don't know that either one of us would say, hey, we've got a startlingly different view of this. And I really think this is one where we just have to recognize that the medical issue is leading the way, and the information on that changes pretty rapidly. There's new stuff now out there about transmission for asymptomatic carriers and whether or not that actually happens. And we've spent so much time, frankly, just trying to keep our people safe and businesses open and supply chains flowing and learning as we go, just like everybody else. So I think, in general, I would say, look, I always bet on the innovation in human ingenuity and I think that will hold up over time. But there could be bends and peaks and valleys here. And I think we should be prepared for that. That's what we're planning for.

Yes. I think as we look at the data, our inbound order trends across the businesses that we leverage as indicators, right, there's going to have to be consistent time period where either sustained at a certain level or starts to increase before we start to say that there's going to be a much different change in how we thought the recovery is going to be. I don't think we've said, hey, it's going to take significantly longer or much faster than what we talked about after the first quarter.

Okay. Fair enough. I think I've prodded you enough on near-term trends, so I'll move on from that. You guys did note on your second quarter summary looking to balance additional restructuring actions with optimizing the ability to respond to the recovery. With another month under your belt there, has that shifted one way or the other? Or are you still in that position?

Look, I mean, I think if you go back even before the year and before this event, we had done some things to mitigate costs heading into the year because we thought even then it was going to be a more challenging flattish kind of year. So we have those in place. Then is -- of course as this event kind of fell over the top of us, I mean, you get some pretty natural mitigation just from nobody moving around, no trade shows, not a lot of intensive marketing. And then we did some other things on the other side of that. Those other discretionary items that we control, we hit those hard as well. And so I think we've been in good shape overall. Now as we sort of go into the end of Q2, obviously, for us, we've got so many different businesses. They're in different markets. We do this organically from the bottom up. And so there's no doubt, we're looking at certain businesses, and we're asking, hey, scenario planning, what if this were to happen, what if that were to happen. And as many of you know, we're pretty good operators. We always have a series of contingency plans on the shelf for different eventualities. I think one of the things we said all along even before the pandemic is we want to be really careful here, though, that we don't lose sight of the long term. The long-term health of incredible franchises. Product cycles being what they are, things like IoT and transformations that we want to do, we don't want to check down on all of those investments and lose something in the long term for some short-term gains. So we're trying to balance all of that. But really, at this point, it's a discussion and it's one business at a time.

Yes. I think you guys have proven that over the years. One here but probably for Bill. You guys issued $500 million of debt recently. I think that's probably at least partially to repay $300 million that you've got due in December, and there's another $350 million due in 2021. Was that just part of your typical refinancing activities and taking advantage of what were very low interest rates, and still are very low interest rates, available at that time? Or is there anything else behind that?

No. That was the primary reason. Obviously, the $300 million we had due in December, relative to the market conditions, the volatility and some concerns around liquidity but then also, obviously, the extremely low interest rate that we were able to capture a 3% coupon. First is to refinance that component and take out some additional capital relative to the favorable interest rates and hopefully leverage that as part of our normal capital deployment strategy. To your point, interest rates still remain extremely low. We're monitoring the debt capital markets to see if there's an opportune time to pull in the 2021s as well. But right now, I think the balance sheet is in great position, right? We've got access to over $1 billion of capital between cash on hand and availability on our revolver. So we're well positioned to support any capital needs we have over the next 12 to 18 months.

Okay. I know you guys have spent a lot of time cultivating the acquisition pipeline over the last few years. It's been tough to get a lot over the finish line, particularly compared to the amount of cash that the portfolio throws off. Can you talk about your expectations? This recession might provide you with more opportunities to get deals across the finish line versus potential targets may be holding on through the downturn and hoping for better prices on the other side.

Sure. Well, I mean, obviously, the uncertainty that we're talking about here doesn't help either side of those kind of transactions. So there's been -- at least early on, there was a pens down, let's wait and see how this goes. I will say, look, we have some things that we were working on before this happened, and we have restarted some engagements and discussions with businesses that were on the docket before. We're actually being pretty creative about how you do that. It's not easy. You can't -- it's not easy to get on a plane and cross international borders, but we're leveraging all of the sites that we have, the talent that we have in different areas, professional services. So I would say that we're back to work. That being said, I think you could recognize if there are concentric circles around us, we're probably less likely to go 3 or 4 circles out in a time with this much uncertainty where it's this hard to do the work. But on those near-term targets, there's long been something that we've thought about. There's -- we think of those as value-creating over a long time horizon. They're quality businesses, and they're the kind of things that are going to hold up pretty well on the other side of this as well. So I don't know that the set of things we're considering is radically different here. There's no doubt some temporary issues in front of us that make it a little bit more challenging. But maybe for that reason as well, when we start thinking of valuation, we also don't anticipate that what we're going to see is massive pandemic discounts on the kind of properties that we really like, that we think are the kind of businesses we'd like to own for the long term. I think a lot of folks are going to view if they're selling, saying, hey, look, this is a -- it's been good for 30 or 40 years, and it's likely to be good for 30 or 40 more, and we'll have some conversations about what the near term will do. But -- so I don't know that this has actually changed a lot other than we've got this period here with a lot of uncertainty, hard to do the work. But that being said, we're being pretty ingenious about how we actually go about it.

Do you think that there are certain areas -- I'm sure you guys have been looking at a broad swath of businesses across the entire portfolio that have those IDEX-like characteristics. Are there certain areas where maybe that forward look, that long-term value creation that you're looking for, where that's fundamentally changed in some of those businesses, where maybe the aperture is closed a little bit, you have to pause for a bit longer on certain types of businesses that you might otherwise have been looking to acquire?

No, I don't think so. I think from an end market perspective, obviously, the things that are harder hit relative to oil and gas, some of the things that are energy exposed, I think those are the areas you might see more discounted prices in the short term as they've been harder hit and the recovery is going to be a bit longer. But most of the things that hit our funnel that are attractive to us to have are solid competition from a filter perspective, you're not going to see massive decreases in multiples here in the short term. Obviously, high-quality businesses -- obviously, U.S. equity markets have rebounded extremely quickly. I think the private market is calibrating around that to their valuation expectations. So I don't think there's going to be a significant disconnect on the lower multiples here as we go in a lot of the end markets, with the exception of some that are probably more exposed on the energy side or maybe automotive.

Fair enough. So with interest rates back down to basically nothing, making debt extremely cheap again, which I think has been one of the problems that you guys have run into over the last several years. It makes the economics a lot more attractive for your competition, primarily private equity, that will use much higher leverage than you guys will and makes the multiple they can pay higher because you can still generate those cash and cash returns. Do you expect that to make it more difficult going forward or at least as difficult as it has been to compete for these kinds of deals?

No, I don't think so. I would say, hey, historically, private equity is the most disciplined, right? They have the math that they use on what they're going to lever up to, what they can lever up to on a business. So it kind of caps out the multiple that they're able to pay for most of these acquisitions. It's really been the strategics that have driven the prices up on these assets. And I think, obviously, lower interest rates will help continue to foster that behavior as a lot of the folks do leverage their cost of debt versus their cost of equity as the evaluation for a deal. Obviously, the folks on this phone want a return relative to how we're investing and deploying our capital. So we obviously don't have that thought process as we evaluate our valuations. We do consider a fully burdened weighted average cost of capital as our hurdle rate. So I think the private equity guys, interest rates will help them but only to a certain extent in which they'll lever up to. It will still be the -- how disciplined are the other strategics as we go into these bidding processes. Obviously, to Eric's earlier point, we're working on some transactions that are proprietary, and in those, maybe you get a slight discount to what you'd see in an auction process.

Okay. So even after you guys did the $109 million of share repurchase in the first quarter, the balance sheet is still only just over 0.5 turn in net debt on it. If it does remain as difficult as it has been to find appropriate places to put that capital in the M&A market, what are your other options here? Do you need to start looking at different kinds of businesses potentially outside of that IDEX-like definition, potentially increase the dividend payout ratio, more consistent and larger share repurchases, special dividends? Any color you can give us on how that capital allocation might cascade down?

Well, maybe we'll both take a shot of pieces of this. In terms of kind of widening the aperture of different kinds of properties and looking in different fields, our aperture is pretty wide now. I'd say, several years ago, we took hard to look at the filters that we use around what makes a great IDEX business and recognize that in some ways, those attributes could be found in different markets that might not have historically been part of IDEX. So I think of the things we've been looking at over the last few years, I would say that net is pretty wide now. Now that being said, we still have a pretty disciplined view of what it takes to be an IDEX business. So you can think of this like a broader playing field, but it's still relatively narrow in terms of fitting kind of how we do things. So I really wouldn't see a widening into other kinds of businesses that are even now not on our list because I think, again, those left and right boundaries are pretty broad as it is.

And then for other changes in our capital deployment relative to dividend and share repurchases, from a dividend perspective, no, I think relative to a 30% to 35% payout ratio, we're at the upper bounds of that right now. I think that will be consistent over time. We're not going to make short-term deviations relative to market conditions that maybe prevent us from deploying a significant amount of capital in M&A. And special dividends, we would probably avoid that, too. Ultimately, we think, over a period of time, we're going to be able to deploy a meaningful amount of capital in the M&A space and then continue our share repurchase program as we have historically. When there's a disconnect, obviously, which we saw in the first quarter, we were able to buy a significant amount of shares back, average price of $125. So we'll continue on with our current strategy relative to capital deployment and hopefully get some deals over the finish line here over the coming quarters.

I've talked to you guys about this before, but you guys have had a very disciplined process within the businesses over the last several years driven by 80-20 of -- you have your fixed bucket that businesses can make their way into, make their way out of if they're no longer IDEX-like businesses or you're not the best owner. Having been through that with your portfolio, would that give you the confidence to buy maybe a larger collection of businesses where there are IDEX-like businesses and not IDEX-like businesses within the portfolio, and then kind of run that same process through that portfolio as you run through your own portfolio over the years to keep the good parts and get rid of the not-so-good parts, but maybe that would allow you to deploy bigger chunks of capital and then whittle that portfolio down to the businesses that you wanted to keep?

Yes. Well, I mean, that's an absolute scenario that we do look at from time to time. Because I mean, look, there's -- we're a pretty unique kind of company. The kind of companies that are like us, they're not everywhere. They're often embedded as parts of other things. So when you start to scale them up, it's not uncommon to find, hey, there's 3/4 of this looks exactly like us, and then there's 25% that doesn't. So to the point of your question, I mean, we've run this play on our own enterprise now over the years, it's worked. We know how to do it and would not hesitate to do it on something outside. You'd have to model it in. I mean you've got some choices you make on the beginning end, they pay off on the end as you redeploy resources. And so the financial modeling looks a little different than your classic synergistic out-of-the-gate kind of deal. But we're -- we practice that quite a bit. We take a look at it, would be perfectly willing to go down that road if we could find the right collection of assets. But it's probably got -- there's a certain threshold where -- because that's pretty hard work. So you -- the prize has got to be worth it. And so we have a mind of what that cutoff is, and it usually comes down to bandwidth and resources. How many people are going to be -- have to be dispatched on a part of business that otherwise we don't find all that attractive, that can only go so high. But it's absolutely a play that we've trained for and are prepared to do.

Makes sense. Okay. So a few more pandemic-related questions. IDEX has a lot of different businesses with a lot of different end market exposures. Some of those end markets are likely to see structural changes in a post-COVID world. Some of your businesses are likely to benefit and some of them are likely to be hurt. Can you talk about the businesses you think are most likely to benefit from any structural changes in the economy post COVID-19?

Yes. Well, this is an interesting question because when we think of growth and outperformance and any of you that have been talking to us for a while now, we do that at actually a pretty discrete level. We make very, very focused bets on pieces of businesses and application sets that we think have got a lot of tailwinds behind them. And that same play is -- frankly, we're running it now. We're running it in this context to COVID-19. And so we've actually pulled some resources here and taken a hard look, and we call it an essential products group. And we're looking at sort of dynamics over time that are being shaped because COVID-19 has landed on top of us. And what's interesting is there's some that are no doubt immediate right out of the gate. And I'll give you -- the best example I can think of is hand sanitizer. Almost anything to do with hand sanitizer was a -- on the first day, how do we get more of it. And we have some products that play in that area, and we rallied the troops there and put our best foot forward and captured some business. But that doesn't go on forever. Eventually, the liquor companies go back to making intoxicants. Then there's a second wave that I would say sort of you can think of is duration of the event. And so it probably runs -- if we're assuming we're a couple of years of coexisting with this virus, there's a series of things you need to do that -- some are in the life sciences category. Some are actually in the chemical category in terms of things that are being used to sanitize. And so we thought of those a slightly different way, and we're tuning some solutions that we have to that area. And then I think there's the last category, maybe it's the most important that says, what changes forever because this has happened. And it's probably smaller than we think. I know it always seems like when you're in one of these things that the world will be fundamentally altered and will never come back. And yet, every time one of these things has happened, it comes back pretty close to where it was before with subtle differences. And so we're doing some work within businesses. We're doing it above to talk about those longer-term trends, some of which Nate, frankly, we talked about yesterday, in the panel you asked me to join, around IoT and the pace of digital transformation. So I'd argue maybe that's ratcheted up a little bit as we think of growing the company. So in terms of business types, obviously, some of the things going on in the health science world are very, very important to help respond to this across the world. Anything to do with -- we have a few businesses that touch on vaccine production and helping to make that work better. We have some other things in the general pharma area. That's probably got some short-term and long-term legs as people think about where they want that to be in the world. And then we even got some things, point-of-care testing, microfluidics, things that are pretty interesting there as well. So we're making sure those are fully resourced and everybody's got the best shot to put our best foot forward, both for the business and, frankly, for society. But I would leave this category with an important point that it's very easy to take a broad masthead and call it either petrochem or energy and think of a condition that applies to everything that's underneath it. And that actually is often not the case in our world. You can get down to something that looks classically industrial and yet very low in it, find an application set that's actually being redirected to do some great work in this way. So we're probably being more careful than most around subdividing, segmenting our business and understanding where is the switch moving off temporarily, where is it turning on and how do we move resources and attention between the 2.

Interesting. Are there any businesses where you think that there could be structural impairment to the end market, structural impairment to the businesses where you might have to take more significant action or maybe put that into fixed bucket and see what you can do with it?

I would argue, we could see some things move up and some things move down in terms of those classifications that we use. Remember, even in the case of energy, it's relatively -- it's single-digit exposure for us. The job we do there is not out close to the wellhead. It's very important custody transfer, much of which exists whether -- as long as the pump is on somewhere. Volume matters, CapEx is impacted there. So I'm not going to keep it out of that category. But even there, our diversity helps us -- frankly, the job we do, the criticality of it helps us. And where we finally have to take some actions, then we think of things like scale, structure, things that we can do to become more -- better positioned as well as -- financially as well as competitively. We'll always do that.

Okay. Fair enough. Last 5 minutes here. I did want to ask about strategic priorities. Someone jumped on to that question. How, if at all, has the situation we find ourselves in changed the strategic priorities of management at IDEX? Have there been things that have moved higher up the priority list or things that have been put on hold for a period of time?

I would say, I mean, there are course corrections that we've already talked about that are shifts to the -- a couple of degrees to the right or the left but not massive pivots here. And it's really because -- and it's why I took the time on that other question related to how do you grow in the context of a COVID environment because it often maps out. If you want to be very, very thoughtful and careful, especially given that we're kind of a component business, by and large, and so we often have to kind of map, hey, the product we make, what does it actually do again? Where does it go? And very -- and just given the nature of a good IDEX business, we often find it in mission-critical solutions that don't necessarily fall off the planet as easily as some commoditized things. So that doesn't mean you stand back and just let it all be as it was before, but it does suggest that a company like ours is less likely to make massive pivots, one segment over another. It's more likely to make actually surgical choices within those segments with the recognition that, hey, if I was going to come up high and you force this, I would say, health, life science, some of the things that are going on in there no doubt are front and center and there's dollars available and investments there. Municipal businesses, government budgets, we'll have to watch that, and we'll see where they go, but hey, we have a global dispersion there and we've got some great technology, so we'll continue to invest. And on the industrial side, there's probably inherently more pressure, but even there, there's such quality things -- applications that we have that I think tuning those, there's always that ability. So we think about this as outperforming in any cycle, even this one, and that's really the mandate. That's the effort. And I don't think it requires a massive pivot here for us.

Okay. Maybe a little more tactically. With the diversity of businesses that you have, clearly, there's been some opportunities in HST. Maybe you could just talk about how you think about those tactical opportunities, how you look at committing resources to potentially take advantage of some kind of short-term demand trend. And is that something that you see value in? Or is it distracting, difficult to predict the returns and too risky to commit capital to those kinds of things?

Now this is absolutely something that -- this is what we spend our day doing because if you look at our organic outperformance over the last, let's say, 3 really good years, where I think we did well, this is how we did it. I mean we actually did it by taking small pockets of burst resources and capital, deploying them with a focused intensity and racking and stacking them at the top of the company. That -- our own history suggests that's how you drive growth outperformance. It actually comes from a fewer set of sources than a lot of people realize. It doesn't come from all businesses getting blanket incremental investment. It never has. And so in a time like this, we're very -- and we're doing this, we're looking at certain opportunities. We're saying, I'm going to take the 6 best people we have over there, they have a credible track record, this is your new job. 100%, this is what you have to do. We know -- let us know what you need from a capital perspective. Now we're going to -- we have -- we're only going to take so much of those. We manage risks as we go. But it's very easy for us to course correct in a way that I think is different than a lot of businesses. And we're doing that now in something called essential products. That's how we're thinking about it.

Yes. I think that nimbleness has shown itself out over the last few years. Just a couple on some more manufacturing questions. Most manufacturing facilities aren't really set up to maintain 6 feet of distance between employees. How have your manufacturing processes changed to adapt to that need? How has it impacted efficiency, throughput, costs or any of those other metrics that you track from that perspective?

Yes. Well, so look, we've worked really, really hard here, probably earlier than many, around addressing how we were going to set this up to be as safe as possible. We have a little bit of an advantage. I mean labor, generally, is a small percentage of our overall cost structure. We're not as vertically integrated as a lot of places. We do a lot of custom work and configured work, which means that you don't have those kind of 10 people in a row doing 1,000 parts an hour kind of environment. We absolutely have lean. And so lean, of course, you try to take advantage of proximity where you can. But when you separate it through social distancing, it's a barrier to overcome, but it's not massive 25% superimposed like you might see in some high-volume environments. We actually have -- if you were to go in an average place, what you'd see is you'd some places where we put some plexiglass in place, where we've moved people apart and they hand the part after they worked on it for a few minutes to their partner. That's not massively disruptive, some machining centers that are largely stand-alone anyway. So we've concentrated on things like foot traffic, where do people go, how does material get delivered. I'm not going to suggest it doesn't have -- it isn't a challenge to overcome, but it's not a massive part of our cost structure. And frankly, I've got a lot of confidence our team members will do everything they can to overcome it through other productivity elements.

With that in mind, I'd be interested in hearing how you think about optimizing under that structure. I mean if it's a pretty low impact to the business, do you look at optimizing the changes in structure that you've had to put in here on a potentially temporary basis? Do you -- is it not worth those resources, that they can be better deployed somewhere else and you just wait until we go back to the normal structure?

Sure. I'll give you one good permanent example of something that will change and can change and will make us better in I think any place. I've now gone 4 months somehow doing my job without printing a thing. Something I wouldn't have thought possible before. And if you look in our factories, when we've done this work and kind of mapped where people are connecting, it's often because they're connecting on pieces of paper and information, especially in our environment, more than they are in actually making something. And so that's an area where we've got a couple of businesses further out in front who have digitized their shop floor. That's something I could see absolutely happening everywhere. And when you do, it will not only be safer, honestly, it's more productive. You got a lot less walking around, a lot less potential for errors and information transfer. That's -- in our world, that's the one element that's popped out here that we need to fix, protect ourselves and it will make us a better factory going forward. We'll keep that.

That's an interesting point as somebody who is a -- has been a massive consumer of printed paper, I printed some of these questions off yesterday. It was the first thing I printed in over 3 months.

See?

So an interesting parallel there. Okay. I know we're at our time limit now. So I'd like to thank Eric and Bill for their time today. And I look forward to catching up with you guys as we go through the rest of the day. Thanks very much for your time.

Thank you very much.

Thank you.