Ingersoll Rand Inc. (IR) Earnings Call Transcript & Summary

Thanks for joining us for day 3 of our 19th Annual Laguna Conference virtual this year, but we're on the beach next year. You have my word on that. Joining me this morning for our next fireside chat, we have the team from Ingersoll Rand, including CEO of Vicente Reynal, CFO, Vik Kini; and also the SVP of IRX, Ingersoll Rand's business excellence program, Mike Weatherred. Guys, thanks for joining us this morning. Before we dive into it, I do have a quick disclaimer I need to rattle off. So for any questions about our research disclosures, please see the Morgan Stanley disclosure website at morganstanley.com/researchdisclosures. And for all other questions, please reach out to your Morgan Stanley sales team. Guys, thanks for joining us. Good to see you as always, even if it is virtual. Vicente, maybe if you wouldn't mind to spend a couple of minutes here telling the folks what you guys are focused on and what you're seeing out there in the world.

Yes. Thank you, Josh, and thanks for the invitation to your conference. Excited to be here, although we're doing it here from Davidson, North Carolina, and expecting we'll join you there live in Laguna next year. I think, Josh, I think we're incredibly focused on our portfolio optimization. You saw earlier in the year divesting 2 other businesses, and you saw how we have redeployed some of that cash already into some great companies, companies like Seepex and Maximus and a few others that are in our portfolio, too, as well that we haven't announced what had been actually good acquisitions that kind of come into the Ingersoll Rand family. And our M&A funnel continues to be a high level of priority in the sense that we still see tremendous momentum in our funnel. I think we mentioned before that we see about $1 billion of deployment here over the next 12 months, and we still see line of sight to that, and doing it in a very prudent and disciplined way. We know that some of the prices out there are high, but we are always finding these kind of great technology companies that we believe are increasing the total portfolio of Ingersoll Rand. And so we feel that the M&A pace that we have, combined with our organic investments and combined with our employee ownership mindset, is just kind of creating a very unique recipe for just kind of long-term shareholder value creation and that we feel that we're still at the early stages of our life cycle here. So we kind of reinvent ourselves into who we are today, and this redeployment of the cash into some of these kind of great companies that we're finding out there are going to be -- continue building that strong foundation for us for long-term value creation.

Excellent. So I definitely want to get into the portfolio story there. It's obviously an important part of what you guys are working on today. Maybe just to kind of address the biggest topic and certainly one we've spent a lot of time on all week with this overlay of the strong demand environment and maybe the ugly side of that equation, the more challenged supply chain. You guys have sort of been on the right side of that equation year-to-date on things like price cost and bottlenecks to the system. How has that played out over the last, call it, 60, 90 days as we've seen some others out there become more challenged in that regard?

Yes, Josh, I'll say that we continue to be very, very proactive. We said all along that, from a cost equation, we were really early on in terms of seeing some of the red signals and actively -- proactively -- working proactively on that with price increases even late last year and continuing this year and kind of continuing to readjust that. Same thing with the logistics. So I think although I will say that we're definitely not immune, I mean -- because, I mean, we're a global company and we have global supply chains, I think our teams have done a phenomenal job based on the utilization of IRX as a tool to proactively every time we see a problem kind of work very quickly in terms of the execution and finding ways on how we solve that. And the beauty of that is that I think IRX has always given us that ability to see the leading indicators that help us be able to achieve those better results by being able to proactively work as soon as we see a leading indicator that is kind of going the wrong way. So I think, yes, it's not immune to what we have seen in the market but our teams have done a phenomenal job coming out of it very well, and we'll continue to work through it. And I think we'll be successful to be able to meet the expectations that we have.

Got it. Is there anything about the structure of the business -- because this has been several years in the making and even some of the kind of premerger organizations as well never really struggled with price cost or procurement kind of in an externally visible way. But if I just look at the M&A strategy, sourcing is a big part, so you guys are clearing and buying a lot of stuff. I've seen a compressor in the flesh, and I always give the disclaimer. I'm not an engineer, but gosh, it looks like there's some electronics on there. And certainly, there's a lot of metal involved. So is there something about the way these businesses procure equipment or procure components or the supply chains that lands this to being an easier price/cost management or procurement cycle? Or are you guys just rolling up your sleeves as soon as the camera turns off and getting back to it?

I think there's a lot of what you said, at the end, I mean we -- we're hands on onto the game, clearly. But I will say that structurally, even years ago, if you remember, we always spoke through the Gardner Denver days that we were in region for the region, and that basically gives us the ability to kind of localize and control our supply chain locally much better. Obviously, we're global. So we're still going to be doing a lot of globalness from a supply chain perspective. But it's just basically a lot of a lot of good work that the teams are doing to really execute flawlessly as long as we continue to set up ourselves with this kind of in region for region. And in terms of the price equation, the beauty of our products is that we are -- whether it's a compressor, a vacuum, a blower, the pumps, we're basically the heart of the process. I mean we're -- we are that machine that basically generates the flow of the air, the water, the matter, and -- but we're very low cost relative to the overall system. And customers are looking for premium brands, highly recognized. And look at the companies that we have, I mean over 160 years of history in the making, highly known for reliability and great quality. And so we're able to command a premium price. And even in these situations, we take, obviously, the prudent advantage of being able to allocate that appropriately so that we can be price/cost positive.

What would you say in a typical year, understanding maybe '21 is atypical for a number of reasons, you are able to drop through to the bottom line on that price equation? Because it seems like you're usually positive. But if I look around some of the other folks in the pump and dispensing and compressor space, everyone seems to have a good pricing envelope. You guys certainly included. Is part of the margin story, just, "Hey, we're able to drop a lot of that price to the bottom line at the end of the day?"

Yes. Josh, I think that's exactly right. We've stated pretty explicitly year in, year out our expectation is being able to deliver about 1% to 2% net price to the organization. So part of that kind of organic growth equation, 1% to 2%, net price is generally our expectation. Obviously, this year, it's clearly been on the higher -- it's been, frankly, higher than that. Third -- second quarter, you saw that due to a lot of the actions that Vicente spoke to, the proactive nature and, frankly, the content been getting ahead of this really in the back half of last year, and we started to see some of the early indicators on the inflationary side as well as, frankly, just some of the opportunities we saw. As we brought the Gardner Denver and IR portfolio together, we've been delivering 30%-plus net price on the ITS side, a little bit lower on the PST side, but still quite positive. So I think the thought process, even if we look at 2022, obviously, we haven't given guidance, but the expectation of being able to deliver in that 1% to 2% net price and maybe even a little bit higher depending on the different product lines, I don't think anything changes in terms of that expectation. And obviously, to your point, yes, we've been able to manage on the procurement side. Clearly, we have a bit of a unique nuance compared to others that we're still very much in the integration of the GD and IR portfolios. And we've been very explicit that procurement, whether it be classical direct material procurement or the Innovate 2 Value initiative and being able to redesign products and take cost out, that's been a meaningful part of that $300 million kind of synergy number that we continue to say -- continue to be able to execute to. So I think we've found kind of 2 ways to help mitigate the [ environmental stuff ] and, to your point, still runway as we think about going forward.

Got it. So I want to spend a few questions here on kind of the demand environment because you guys play across a variety of end markets with a variety of different, I'll say, cycle positions, early, mid, late, aftermarket, new replacement, et cetera. How would you just characterize the IT&S portfolio thus far in terms of that recovery? I mean the aftermarket probably came on pretty quickly. Are you seeing more kind of greenfield activity, as what you can tell, be a driver of that today? Or is that still something that's emerging as your customer set up CapEx budgets?

Yes. I think, Josh, we're definitely seeing this kind of very solid broad base. I'll say early on, some pent-up demand may perhaps on the aftermarket kind of recurring side as factories during the COVID times were maybe minimizing the -- how people get into the factories. But right now, we're seeing a lot of the original equipment kind of moving in and very strong kind of numbers. And the way I will characterize our ITS business, I'll say that we have this kind of 40% of the business that is short cycle perhaps, which is maybe kind of small to medium-sized compressors. We have the medium cycle, which is another 40%, which is kind of the medium-sized compressors. And then we have this long cycle, which is 20%, and that is some very large kind of project and kind of large compressors that go multistage centrifugal compression devices. And to your point, early on, we saw obviously good momentum on the mid-cycle that kind of continued. But we're seeing some acceleration on the CapEx on kind of this long cycle, and some of that has to do with some onshoring and localization of supply chains, semiconductor being one of those. And although we're not a player on the back-end side, we're a strong player on the oil-free compressor side. And we're seeing that our teams are able to capture some good share on that side of the market. So I think it's one example that we'll see on how CapEx, combined with onshoring or a specific kind of end market, is we're seeing the benefit of that.

Got it. And then just maybe thinking more structurally on the demand equation, demand generation, and you guys have talked a lot about that increase in the qualified leads over the last few years. I think 3 years ago, you outlined that, as a strategy, the qualified leads are up 3x over that time frame. Maybe spend a minute talking about how that funnel conversion has gone. And what did the state before look like? Are these customers picking up the phone? Are they going to competitors? Or are they calling a number on the back of the unit? What's sort of the before and after? And what's the metric on the other side that you guys point to?

Yes, Josh, if you think about it, we started this journey not too long ago. Kind of in 2016 is when we kind of started creating the team -- the demand generation team. And we have come a long way to where we are today. And before, it was all about kind of waiting for the customer to call, as you said, or going to a trade show. And what we said is we want to kind of completely change that to instigate the demand, to basically go proactively to this highly fragmented customer base that we have in a very highly cost-effective way. And we said that the only way that you can do that is by applying direct-to-consumer marketing tools in a B2B environment that we play in. So today, fast forward to today, we have a team that is almost 100-people team dedicated every day to generate qualified leads, and now we're generating thousands of leads every week. And the goal that we want to be able to achieve is that we're generating at least a point of growth just purely on these kind of marketing qualified leads. So we generate the lead, it gets qualified. It gets put into the sales guy. It adds up to the funnel, and it generates this incremental value, incremental revenue growth onto our business. So I think it's just one of those very successful ways on a new process that we're launching and kind of getting executed with the use of the IRX tools that we have. And I think that we still see ways of continuing to reinvent how we do this because now we're combining the demand gen with the price with other tools that we're launching here that will give us better acceleration on margin, not only the growth but also margin performance.

Got it. And maybe pivoting over to another structural item that you guys have had a lot of success with on I2V, Innovate 2 Value. And maybe, Mike, an opportunity for you to weigh in on your experience with this as well. But is the starting point here, portfolio, there's a lot of rotating equipment, therefore, a lot of common parts that everyone with common -- with rotating equipment should be doing? What do you think sort of like kicked off this process where you guys seem to have had a good deal of success?

Yes. I think it's a great question. And I think a little bit to push up on the demand gen answer, the great thing about the utilization of IRX is it's not fits and starts and it's not one team taking it on and implementing it away. There's a very prescriptive, very much 100-day process-bound process that the team follows. And Josh, the answer to your second question there is it all looks different, right? So I2V for a specific PST brand is going to look much different than it might for an ITS large compressor brand. That's why it's not the tool as much as it is the process of identifying the opportunity, setting aggressive goals, going after it in 100-day increments with leading activity-based processes that are measurable during that first 3, 4, 5 weeks. And then about that 5- or 6-week time frame, the teams kind of light up. The process becomes less intimidating. It becomes more opportunistic around problem solving, where they're getting stuck. The other thing that I would say, and again, this is also pushing off of the demand gen, is a lot of companies would think about demand gen as a marketing challenge or I2V as an engineering challenge. And what we find in both of these and several others we could give examples of is cross-functional expertise or cross-functional engagement from finance to ops to procurement to engineering to commercial to marketing to customer input, customer input being a huge part of I2V. And you get that cross-functional team, we call that a self-directed work team. We call those people Board of Directors of that task, and they get after it.

Got it. That's helpful. Maybe pivoting over to the portfolio story, the M&A pipeline here. You guys had the update call a few weeks ago. You're kind of reprioritizing with the update on SPX FLOW. It seems like the funnel is extremely active without having to compromise valuation and I think in an environment where many folks are. What about your end markets, your products as sort of lent itself to pretty reasonably priced assets that seem like they still come in with decent growth outlook, certainly not GDP-, and a decent margin outlook? Like it seems sort of the goldilocks scenario. Like why are these assets still around?

Yes, sure. So I mean, Josh, I'll start with -- yes, obviously, we say we kind of talked a little bit broader about capital allocation. And yes, M&A really kind of more bolt-on medium-sized is still -- is, without question, the focal point. And I think, first and foremost, take a step backwards here, obviously divested 2 components of the business earlier in the year in terms of our HPS segment and Club Car. And we always said from day 1 that those are probably assets that, longer term, probably wouldn't be part of the portfolio. And part of it was, obviously, let's focus on more sustainable, higher growth markets because ultimately, over time, we want to be able to drive outsized organic growth, not GDP-, GDP+ or GDP++. And obviously, HPS, Club Car, good businesses, but they had a degree of cyclicality that we just thought was probably better sort of not being part of the portfolio. In terms of the actual M&A process, the funnel, first and foremost, not to go back to IRX, but no secret, we use IRX to kind of run every facet of the organization in terms of the process. M&A is no different. And so a lot of it is, frankly, very prudent cultivation of a funnel. We have said very explicitly that if you even go back to Gardner Denver days, I mean 90% of every deal we've done have all been privately sourced, not really banker-driven processes. We're not waiting the book to show up -- to show us assets, no. We have a BD -- we have a corporate BD team, but really the extension sits within the organization because, ultimately speaking, they're competing against those players in the market day in day out for years, so no better utilization of the team to be able to cultivate the funnel. And a lot of that funnel is privately sourced internally, multiple-year cultivation funnel or cultivation process. And as such, we're building that rapport with those prospective prospects. And frankly, now as we've built a multiyear kind of cadence here, yes, we've been very prudent in terms of the technology. The criteria we're looking at, we outlined that a couple of weeks ago, both qualitatively and quantitatively. But another thing that I think is quite unique is that now we're starting to kind of get that track record here. And a lot of these privately held companies want to see a continuity of their brand, the continuity of their company they've spent decades building. I think Ingersoll Rand, we're now starting to create that with the employee ownership, the employee engagement, how we will treat, obviously, those employees as we onboard them into the company, how we utilize tools like IRX. We do impact daily management to those IDMs. We start those probably 2 to 3 months before we actually even close a deal. So by the time we get to a closure of a deal, we have literally onboarded, for lack of a better way to say that, those companies from an integration process. And literally, they're running the IDM within 1 week, 2 weeks, 3 weeks post acquisition. And that's how we get this cadence, how we're able to deliver results pretty quickly. But I would also say, listen, there's a part of it that's just blocking and tackling. We talked pretty explicitly in the context of our Q2 earnings call and even 2 weeks ago that we walked away from 30-plus deals in the context of Q2, and a lot of that was, frankly, valuation. You're right, valuations, they are pretty lofty right now, and we're not averse to saying, "Hey, if it doesn't make sense from the criteria we laid out, particularly on the financial side," we're not adverse to saying, "Hey, we're going to take a pass." We've got a very healthy funnel, and we know we have a lot of other assets that we could focus on. So I'd say it's a good mix of blocking and tackling process. And then now we've really kind of got this -- I'd say, this engine running here in a couple of years now with a good track record. And Vicente said before we see the ability to be able to employ $1 billion to M&A over the next 12 months. There's no reason given the funnel and how we're seeing it unfold that we shouldn't be able to see that kind of unfold in the next 12 months.

So if I think beyond kind of that 12-month period, obviously, the cash flow engine here is pretty strong. So once you get through that $1 billion, there'll still be kind of the annual opportunity to deploy. How would you size, kind of over the next maybe 3 to 5 years, what that annual component could look like? And then do you think the funnel or maybe just even stuff outside the funnel, the broader TAM for acquisitions is big enough to support being able to do that on a fairly regular basis?

Yes. Josh. So one of the ways that we look at it is that we say that, organically, we want to grow anywhere between 200 to 400 basis points higher than what might be that GDP blended in terms of where we play organically, and then inorganically, we want to kind of double that. So think about 400 to 500 basis points of inorganic kind of growth. And if you put in perspective this year with the acquisitions that we have done, we're definitely being able to achieve that already. So if we put it in that perspective, then we work backwards. We say, okay, how much of -- based on the close rate that we have in this funnel of M&A, why do we have this funnel, what do we need the funnel to be in order to get to that point and level, always thinking in mind of the quality of the businesses that we have internally. And the same thing we do it organically, and this is where demand generation plays to as well. We say, "Okay, we want to grow that much organically. What do we need that leads to be generated every week because of the close rate to be able to get to that growth number?" So again, it's just kind of part of that thoughtful way that we're doing it. And the other thing that we do is that we continue to increase the aperture of our addressable market in a logical way. And one example of this is Seepex. I mean when we acquired Seepex, it gave us a new technology, progressive cavity pump technology. It gave us a $2 billion addressable market that we were not participant before. Maximus, same thing. Maximus, gave us a controller in the agritech market, an IoT system for agritech, indoor farming. And it gives, again, a $1.7 billion addressable market expansion to what we already have. So those 2 acquisitions already $4 billion-plus incremental addressable market, one where we currently have roughly a $40 billion. So with those 2 acquisitions, we already increased our addressable market by roughly 10%. So I think that is the exciting of this kind of engine that is going to be able to kind of create that compounding effect.

How do you guys prioritize end markets? I would imagine that upstream oil and gas, just take it through to the Board very often. But on the other end of the spectrum, some of the growth of your stuff around medical or water is more interesting but also you pay for it. And in some cases, the juice may not be worth the squeeze in terms of what the growth and margin profile is at the other side. So what do you think is kind of the sweet spot end market-wise? And what are the markets that you guys are kind of most focused on in the medium term here?

Just we like to say that everything is really well aligned with our purpose of the company, which our purpose is making life better. So we want to be very participant in those technologies and markets that are making life better. So I mean medical is definitely one. You just got to be very specific into which of the life in that end markets -- subsegments you want to be a participant. And so we have selected some that are kind of very unique. Agritech is definitely one end market that we have chosen to as well that we want to have a good play. Something related to renewable energy is also important as we go through the -- maybe some of the energy transition into hydrogen and things like that, all along the lines of how can we leverage our products to make life better for the end customer but also the environment and the community. So there's a big participant here in terms of what we do around our environmental and social aspect to as well that it is very well aligned. And I think this is what our employees are liking a lot is that alignment that everything that we're doing day in and day out is very related to our purpose as a company. And so I think we call it life-plus markets, which is basically markets that are helping make life better but that they're also growing at a much higher growth rate than the typical average industrial market. So I think that's something unique from our kind of successful recipe that we're doing here, and it's kind of proven to be a great economic engine for us.

Got it. So just based on the synergies that you guys have been able to realize, especially out of these kind of small and midsized deal where the sourcing takes out several terms at the multiple pretty early on, you've demonstrated that a few times, how do you distinguish the diamond in the rough and the quality company that's maybe underearning from something that's sort of structurally more challenged? I mean if I look at my screen over time, about half the companies have had a pump business that had varying degrees of success. I mean I remember having to look at the commercial marine industry and all sorts of byzantine chemical markets where they had, like you said, a progressive cavity pump, in some cases, that the technology itself may be 100 years old. How do you identify what's good versus maybe some of the commoditized stuff others have struggled with?

Yes. I think, Josh, obviously, there's a lot of criteria to look at. But I think one thing that we definitely put a lot of focus on to really kind of identify quality is we look at the gross margin profile of every deal we look at. And by and large, the screening is we want to see things that are 40% or better such that one indicative of a good quality business, one that we can probably help improve over time. And even if that maybe EBITDA profile is maybe a little bit lagging, a lot of it might be in some of the G&A and some of the kind of -- some of the back office and some of the areas that we can probably help improve. So I think for us, absolutely. We're looking for good quality assets. We use gross margin, obviously, as a meaningful indicator there. And then obviously, we do a lot of diligence in the context of the assets we're buying, whether it be the MD-Kinney assets, for example. Seepex is a great example. Seepex, business we just purchased; fantastic technology; top 2 in the markets that serve us from a progressive cavity pump perspective; 50% roughly speaking gross margins; today an EBITDA margin profile that's not at the segment profile. But we know that with exactly a lot of the areas that you've mentioned as well as plugging it into a larger infrastructure from a commercial reach perspective, we absolutely see ways that we can rightsize the cost structure, leverage the cost structure and get that up to PST segment profile. But we want to make sure that we're not buying, let's call it, underperforming or structurally, from a gross margin perspective, challenged businesses because, quite frankly, that's not what's going to fit with the portfolio as we're looking to kind of transform it here over time.

Got it. And you guys have obviously been active managers on both sides of the equation, including some of the bigger sales. And I think you've also identified tools as maybe an area that may not be core longer term. Is there anything in the legacy portfolio outside of those 3 assets, I think you were very clear early on that might not be core, that maybe they look like core on the surface but something has changed about the end market, the technology, the competitive set where the product's fine but it might not be a good fit anymore? Are there sort of 80-20 kind of cut-the-tail opportunities? Or are you guys generally happy with what you have for the most part?

I'd say we're generally happy for the most part. Well, there be maybe 1 or 2 small here and there, as you said, as kind of some of the end market dynamic changes, that we deem that might be better to have it in other places. Potentially, yes. And we continue to evaluate that on an ongoing basis. But generally, we're very happy after those assets that you mentioned that, long term, we don't see the path.

Got it. Well, I see we're at time. I thank you guys for joining us this morning. Always good to see you. I promise we'll do it on a beach with a cocktail next year. But in the meantime, be well, and again, thanks for joining.

Thank you, Josh. Appreciate it.

Thank you, Josh.

Thank you.