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

All right. Good morning, everybody. Welcome back. We're going to keep it rolling here with from Ingersoll Rand on stage, I'm joined by almost the full crew here. I have Chairman and CEO, Vicente Reynal; Chief Financial Officer; and a few other hats that I don't think we have appropriately represented here, Vikram Kini; and Mike Weatherred, Head, Senior Vice President of IRX Strategy and Business Development. So thanks, guys, for joining us. Just before we get started here, I do have to remind everybody for questions about our research disclosures, please visit the research disclosure website or reach out to your salesperson. But then they maybe just start us off here with what you guys are seeing, what you're focused on what's going on in Ingersoll Rand these days, and we'll dive into Q&A after that.

Yes. Josh, thank you, and thank you for inviting us. Great conference for location, so I appreciate for that. What we're seeing, I'd like to base describe it as we continue to see pretty good demand, solid across broad based, as we said, even not too long ago on our earnings call, and I know we'll talk more about that kind of demand trends and things like that and kind of what's unique to us. And what I would like to maybe highlight here is that what is unique to us, if you think about 3 things that are kind of core to create this competitive advantage that we have and differentiation, I'll say, number one, it starts with the culture that we're creating. And when you think about the culture that we have at Ingersoll Rand, it's one of these broad-based ownership where all 16,000 employees have skin in the game. They have equity and they know what it means to have equity. And we tell them that they have to act and think like owners. And that means cash conversion cycles, investments and things like that. And that is creating a very unique high level of engagement across the entire organization. And one example of that, I can tell you, Josh, is that 3 weeks ago, I was in Brazil and doing a townhall meeting in [indiscernible], which is like 2.5 hours west of Sao Paulo. So it's not remote, but it's kind of far away from the metropolitan city. In the townhall meeting, one of the first questions that I got is, "Vicente, why is our stock at that level? And what can we do to make it up?" So when you get that level of engagement on the employee, workforce, it is kind of unique because they want to make sure that they continue to generate and be very well aligned with our company purpose, which is making life better for the employees, the customers, the planet and the shareholders, which by the way they are. I'll say the second unique point of differentiation for us is how over the past few years, we have really created these great pure play in what I call mission-critical flow creation. And the best way I can define that is that all the products that you see across our portfolio now, they're at the heart of the process in any process in any industry across the world. So that gives us an advantage of being very pointed to a specific end market that we want to play and create the application to be also pronounce that. And that's exactly what we've been doing. The teams have been kind of gravitating towards more sustainable, high-growth end markets, and that is giving us that ability to grow at a much higher pace than the GDP. And the third piece that I think is unique to us as well is that we talk a lot about the self-help commercial excellence and particularly around demand generation and one that is so unique to us because when you think about it, we have the capability of generating thousands of qualified leads every single week. And this is not sporadic. It's like every week, we generate thousands of qualified leads. How we reach to this highly fragmented customer base with our product technologies with this unique culture of ownership, it just creates a great differentiated company that ultimately, our employees like to say that they work in a 160-year-old startup company because the level of agility, nimbleness, is kind of unique. And at the same time, we like high performance. And I know startup just love that. But we have the backing of 160 years of history.

Right. So I suspect there might be a person or 2 in the audience or on the line that is curious about how things are going in Europe for you guys. So maybe just spend a moment on what you guys are seeing out there in the macro, particularly in Europe, given all kind of the geopolitical challenges?

Yes. And I say the best way to describe it is continued sustainable momentum, Josh. And it's not -- I mean we're not immune to what's going on out there. But again, if you think about what I just talked about, about the uniqueness, we're highly focused on energy efficiency. All of our products, compressors, blowers, vacuums, pumps, they save energy. And so we're leveraging our demand generation engine to reeducate customers on the very short payback that are now based on energy efficiency. So we're seeing a good movement on that. We're seeing a good movement around kind of the reshoring that happens in terms of countries trying to become less dependent on global supply chain that -- we see that happening globally. And we can talk about examples whether in India or other locations that is happening. And the third is that sustainability for that many companies, they spoke about the 2030 targets, and they're making the investments to get to those points. So again, it's definitely a lot going on in Europe, but I think our teams are being pretty agile to find the good pockets of growth to really put the effort and emphasis on those areas and then overdrive the revenue on the momentum.

So you touched on a few things there I'd like to double-click on. I guess, first, sort of that balance of kind of underlying demand maybe versus this energy efficiency story that is more kind of categorically important for your products. I mean, is that allowing a product category like compressor that's a big energy user to outgrow the macro? Like is that -- you think that's a differentiating point -- a bit like or is that -- or is the underlying still holding up well -- as well?

We think that is created definitely a good tailwind. I mean the underline seems to be holding. But in addition, it seems to be like a really great tailwind around these energy efficiency and the stories that we can kind of create to the customer around the energy efficiency and how that energy efficiency kind of translate into CO2 emission reductions as well. So I think it's a holistic story. But yes, we definitely believe it's a good tailwind at this point in time.

And then I guess if the manufacturer was thinking more tactically about how they need to manage their own backlog and production with maybe the looming threat later on of energy shortages or curtailments, do you see signs of that of folks just saying, we need to get this out the door now while we can run effectively before there's interruption? Is there sort of like an imperative for that?

I don't think so, Josh. I mean maybe in some places could be some of that. I mean, difficult to quantify at all. But I can tell you that, I mean, even in our case, for example, I mean, look at our backlog, I mean, 40% bigger backlog than last year, and we cannot ship at all. I mean, so we had an imperative to even accelerate everything. It's difficult because you're constrained in terms of labor, capacity utilization, supply chain. So I think we don't see that happening or be the case at this point.

Got it. And then I want to spend a little bit of time on margins here. I mean those have been a pretty impressive story over the past few years. But -- as I remind Vic Daily from -- or whenever we -- every time we catch up from being kind of the older guard for Gardner Denver, I mean I remember when the margins for the industrial business were half. And the ambition was like a couple of hundred basis points higher with like a very proud chest. If you maybe just break down how we got to where we are now in terms of four-wall productivity or sourcing or price, like there's kind of a rich mix of inputs there that are probably all contributed. But how would you sort of kind of lay out the importance of those drivers or maybe where the opportunity still exists?

Just I'll say here a few things and Vik can also add on. But if you think about the great margin expansion that we had over the past couple of years, even through the pandemic, if you think about it from the end of 2020 to expect that by the end of this year, almost 300 basis points margin expansion, even with everything going on in this kind of global macro environment with inflation and logistics and everything else. So it's a great story in terms of the team being able to utilize IRX and the execution of that. But if I were to think about kind of a couple of buckets. I'll say, first, price/cost. Again, we spoke a lot about how every single quarter, we have been price/cost positive. And as we kind of go here into the second half of the year, even price/cost margin accretive. So that has been a great story. So if you think about the 300 basis points roughly over those 2 years, you can think about 300 basis points is on that price/cost. Then in addition to that, synergistically, I mean, the combination of the merger but also optimization, productivity, the application of lean, the utilization of IRX, think about another 350 basis points on the positive side. And what we have been very prudent about doing is reinvesting back in the business. So you saw in the second quarter earnings call, we spoke about Ion Solutions which is really cold plasma generation solution that has a lot of our components inside that is really unique and differentiated. That's an example of a core organic investment. So think about investments being another kind of negative 300 basis points, right because we're investing. So 300 in price/cost, 350 of this kind of synergy perspective, [indiscernible] sourcing productivity, I2V and then offset with some investments to give us roughly a 300 basis point expansion. So again, it's been a story of great exciting movement in terms of execution, but at the same time, really heavy investments happening.

And if I think about the price/cost element, I mean, on one hand, I think I could bang a ranch and hear the sound of metal and most of your products. On the other hand, you're buying a lot of components, right? So you're not indexed to like loss yield copper, aluminum, stuff like that, where I think other folks who have talked constructively about price/cost have that tailwind what is driving the price/cost? Because it doesn't seem like any component is really coming down. Is it just that being able to price better or price for value that's really kind of establishing that?

Yes, I think -- and then even to build on what Vicente said, I think the one thing on the margin expansion story is we've done a lot here in the last 2, 2.5 years. But as we laid out at our Investor Day in November, we see a path to being able to deliver about 100 basis points per year platform-wide as we land on our targets for 2025. So we frankly feel like we've done a lot, but there's still a lot more ahead of us here as we think forward, specifically on the price cost. Yes, you're absolutely right. I mean we've been on the forefront of pricing in our space. We have been very quality of earnings focused. We've been very transparent about that. And we've taken what we think to be requisite pricing actions in the market, frankly, independent of what competition has done. Now we do feel like competition has largely kind of been in line with us. But we didn't wait to kind of see what everyone else was doing. So you've heard us talking about it. We've probably done upwards of 4 to 5 price increases across every part of the business over the last 12 months. We've continued to take, I'd say, targeted pricing actions. We've been over the last 60 days in areas of the business that we saw -- we thought was required. And as such, you've seen a lot of that pricing, frankly, going to orders and backlog. You actually haven't even seen that hit the P&L yet and that will be a catalyst for why we expect second half margin expansion to actually be even a little bit better on the price/cost side than what you've seen in the second quarter, we're at [ percentage ] point. We've been price/cost dollar positive every quarter. Second quarter, we turned margin positive as well, largely driven by ITS. Our expectation in the second half, you're going to continue that momentum, but be actually price cost dollar and margin accretive in both segments.

Got it. And can you remind us -- probably maybe specific on the top of your head, what prices and kind of the order book versus what you guys have shared your sales?

Yes. So in the second quarter, we did about 8.3% in ITS, 6.7% in PST. So let's call that a blended average of a little over 7%. We don't disclose price on bookings, but suffice it to say, it's been healthier than those levels, and that's obviously what's sitting in the backlog. The great news here is that second half margin expansion when it comes to that price/cost, it's really just a matter of shipping that backlog through. So it's really execution. It's not necessarily waiting to see what may happen. It's really just let's execute on what we know we have line of sight to.

Got it. And I want to spend a few minutes here on kind of the demand and growth drivers. You guys have done a good job on taking share, and you've talked a lot about the demand generation. I guess first, how do you track it, sort of underlying versus outgrowth? And how do you see where you're winning? I mean the market has some fragmentation, certainly beyond the top 2 players and a lot of fragmentation markets within that. So where do you see yourselves winning? How do you track it? And then where do you think you've had the most success within that ?

Yes. I think maybe this is something that we'll let Mike talk about the demand generation and the MQLs and how we track it for you, Mike.

Yes. I think one of the things that a big mantra at our place these days is control what you can control. So when you think about the macro environment and you think about the last 30 months of evolution of our company, so we got 2 big companies coming together and then the world changed. And we haven't let off the gas pedal on growth at all. And I think that's because of exceptional commercial execution in the region. So we have exceptional commercial teams in all parts of the world. And then on top of that, at the global level, we've got this demand generation machine. So that machine is very, very good at looking around with input from those regions at targeted micro parts of the vertical markets and trying to give them exactly the information they need at exactly the point in the buying cycle that they're at. In response to that, we call it marketing qualified lead. And to Vicente's point, we look at those marketing qualified leads across every region, every product, every sales organization every week. And you can see the way that, that thing is ticking. And so recently, in Europe, as you teed off with your second question there around the Europe macro environment change, that marketing generation machine changed its lens and focused on executing in things that we could control the outcome.

Got it. And how do you guys source those marketing qualified leads? And I guess maybe how does that differ from where you were a few years ago before this was a bigger part of the organization.

I think it's a maturity curve. So I think the sourcing -- sourcing is sourcing. I mean I think it's outbound campaigns. The database continues to grow at a really accelerated rate. So there's millions of people in that database. Every time we make an acquisition, we clean and enrich that database. That database can be cut by vertical market. But I think the real answer to your question is it may have been North American-centric and pockets of Europe, I would say now it's pretty equally layered across the organization globally by business. We don't really have a weak point in that go-to-market at this point.

And it sounds a lot like we have good data on our installed base, and we just use that.

Installed base, but also aimed at growth. So one of the things we're talking about in the last several months is what's new. So how -- what's the new acquisition, new customer acquisition as a result of demand generation. And so it's not just kind of pruning the existing garden. It's getting out and getting new customers and new verticals.

And comparatively, I mean, harder to speak for your competitors, but are they steering in a phone waiting for it to ring? Or what do you like, what is the common industry practice to compare that against.

I don't know. I mean I think it's probably solid sales, commercial execution. We don't really -- I think what we're doing is so different, especially globally than the competitors, we're not really benchmarking anybody.

Got it. And if I had to think kind of more broadly about the environment we're in around CapEx. I mean kind of talked about a CapEx super cycle, super cycle is probably overused as a term even though I use it myself too much. What do you guys see in the business because you touch a lot of different end markets and a lot of capital equipment at the end of the day. Where do you see sort of kind of a new environment that would be differentiated versus other cycles?

Yes. So we see -- this is not a time where we're starting to see this, and we kind of -- we work with the teams, and we were expecting to see it, and we're seeing it now, which is a release of these kind of more longer cycle projects. And longer-cycle projects, meaning large projects for plant capacity expansions, more reshoring could be and where we are working with, let's say, an EPC company to deliver a solution, not just a component, but a solution set, we call it engineered to order solutions. And so we're seeing that a lot of that is getting released and getting action now. And in many cases, these are customers that working with the EPC. They're releasing the purchase orders, obviously, it takes us, call it, longer cycles. It takes, call it, 12 months to deliver to the solution to the customer, to the end user. And then obviously, it takes even more time. So we're hearing that customers are getting ready even also now talking about the next upswing economical growth and they just want to be ready.

And this is a capacity comment, a productivity comment? Like how would you characterize? I know it's sort of hard...

That's right. Yes. I would say, for sure, capacity expansion as people are looking to the [ reshoring ] side, but it's also a lot around sustainability and whether, obviously, things with the hydrogen expansion or it could be the LNG or things of that nature that more countries are looking to get to that renewable energy independence.

And if I sort of turn that lens around and focus it back on your business, how do you guys think about your own sourcing practices. I think you're mostly kind of in region -- for region on the manufacturing side. But are you thinking differently about what parts of the process you want to control? And where do you want to source from?

Absolutely. We -- as we said, I mean we have close to 70 manufacturing sites globally. So we have been very precise about wanting to be in region for region and supply chain closer to our factories. So yes, we continue to go to that strategic imperative of how do we get closer to the customer and how do we hit the supply chain closer to the factory.

Got it. And maybe just shifting over to M&A. This has been a big part of the story, and I guess a question for all of you. The market seems like it's full of these rich opportunities where valuation is pretty undemanding. Clearly, there's a lot of synergy there. I guess what is -- what changed in terms of your perspective or maybe the industry that has kind of allowed this now to be more actionable. I think M&A was a little bit more sporadic before.

In our case, I would say, the best way I can describe it is that we have been, as you know, Josh, very, very proactive on doing a lot of sole source of the transaction. So when you think about all the acquisitions that we have done over the past 2 years, 90% of them being sole source. The 3 that we announced during the Q2 earnings and the 2 that we just press released a couple of days ago, sole-source again. So speak to our process, which, again, it kind of goes back to the uniqueness of being very sustainable process of being able to achieve what we committed during our Investor Day of that 400 to 500 basis points of annualized growth acquired in year and that we still see great line of sight to get that done this year. Even though Q1, it was a slow start and then now we're ramping up. I would say that in our case, the activity ramping up -- it's just mainly driven that for us, Q1, it was a slow start due to some of the COVID spikes that were happening in January and February, and that kind of put a little bit behind or pushed out. In terms of what we see in the environment, I would say that in our case, companies are thinking about at least the ones that we deal with, which are privately owned family companies, they are thinking about transition times. They're thinking that the past 2, 3 years have been just full of sporadic global changes, pandemic, war, logistics, inflation and what's about to come, they get worried. And we think it's a good time for them to transition them to us. And I think that has worked really well. And again, this broad-based ownership and how we treat employees, employee engagement is very unique approach and they -- a lot of these family-owned companies, they just like that.

So I know you have a big TAM in terms of how you identify the market from an M&A perspective. I would imagine though that within kind of your lines of business, there's some either cyclicality line or asset quality or maybe even just something on consolidation that draws a line at some point that makes it a little harder. How would you sort of rate what's out there in the marketplace? Like is the quality level for stuff that you're looking at as high as what you've done? Or do you feel like you've kind of gone after the low-hanging fruit first in terms of quality or valuation?

No, no, not all. I mean, I think we think that, again, because we're being very proactive. I mean we're being very picky about what we go for. I mean a great example of the acquisition that we made in the fourth quarter, Air Dimensions. I mean that was a fantastic business, 50% EBITDA margins; today, 60% EBITDA margin. So I mean, we're finding these kind of great niche technologies that are highly complementary to what we do. That business was solely 100% U.S.-based. We're now expanding that to be kind of more pronounced in Europe and also Asia. So it's just a great, good quality, opportunity of businesses that's out there. Yes.

And if I think about kind of air and fluid handling in the aggregate, I mean, pretty significant number of companies here have pumps and some general like how do you view kind of what's a good adjacency versus what might be too far away. I mean you have kind of very narrow we define things, but you have product categories that are right around the corner like dispensing that could also have high margins and then what sort of fit like what you do, sort of where do you view as kind of those complementary areas?

We don't want to go too far away from that, as we described it before, the heart of the process, that flow creation device, and we wanted to get it close to any adjacency to be closely attached to it. So we can create that synergistic view. And the way we think about it is how we can continue to control that ecosystem. How do we -- how do you get better feedback loop on the quality of that flow? How do you get better control of that quality of that air or gas that you're generating -- and that's exactly what we saw -- what you saw in the second quarter earnings, right Holtec, which is a nitrogen generation, on-site nitrogen generation gets attached to the compressor and again, it helps the customer to create nitrogen on-site versus having to transport via truck. And those are the technology that we're looking for. We're looking for how can we be highly more complementary and provide a better total package solution to our customers.

And I think your big competitor has probably been a little bit more active in channel acquisition, doing distribution. I think you guys have done a little bit around that over time, but what's your view on that? Does that make sense to sort of roll up kind of that vertical market strategy?

The way we think about it is that we like these multichannel, multi-brand strategy that we have. As you remember, Gardner Denver in the U.S., call it, 70% through distribution. Ingersoll Rand was 70% direct and also had some distribution. And we have been able to make it work really well. And the ultimate purpose there is that how do we increase market coverage without dramatically disrupting the market. If there's pockets of channel that feel like strategic for us based on the end market or based on the application, yes, we'll definitely think about doing that. But we definitely want to have these multichannel, multi-brand strategy.

Got it. And then just shifting over to the product side. Oil-free is an area that you guys have had, kind of a lot of success, clearly, a big incumbent there. How do you think about the benchmarking there? And sort of what do you view as your entitlement over time?

Yes. I mean, I think the oil-free when we were with Gardner Denver, we were always talking a lot about how do we create massive differentiation to be able to enter that space. We launched a technology called Ultima oil-free compression. And that gave us a great access to start penetrating the market. And then obviously, with the acquisition with Ingersoll Rand, it was just a perfect fit -- because we had oil-free in what we call kind of a small compressors with great new technology like the Ultima whereas Ingersoll Rand had more on the medium to large oil-free. And now we have just basically created the entire spectrum of oil-free for brands for Gardner Denver and also Ingersoll Rand and in Europe compare. So I think now we have the full spectrum of technologies and it goes back to the execution. How do we continue to drive that differentiation. How do we continue to educate customers that we have more unique products how -- that we have higher efficiency that we have a better serviceability of the product. And we're driving our share -- market share taken based on those based on great solid commercial execution by communicating the great innovation that we have in our portfolio.

And if I'm remembering it correctly, oil-free is a pretty rich mix product category. I think historically, it was part of that gap to Atlas Copco. As you hit sort of what you think your -- that right mix in the portfolio of oil-free looks like, I'm assuming that benefits margins anyway to sort of think conceptually around what sort of that calculus could be?

It could in the sense that oil-free comes in with a good service and aftermarket. And I think that definitely should help drive that perspective.

And the other side is the growth side where the oil-free markets are typically growing 1.5x, 2x, roughly speaking, of the -- what we'll call more legacy oil lubricated side. So as that mix continues to move in the right direction, it should be a benefit for growth with obviously a tailwind to margins as well. So obviously, a huge focus. And actually, that's why you hear us talk about it every quarter. We give you the view on oil-free versus oil lubricated. And I think at least 5 of the last 6 quarters, you've actually seen oil-free growth rate to outpace that of the broader compressor category.

Got it. And I would assume kind of a less cyclical market as well as like more [indiscernible] or something like that -- just shifting over to free cash flow and working capital. I mean, I've sort of mentioned this a few times this week, so people are probably tired of hearing me say it, but most companies here are probably behind on free cash generation relative they had hoped at the start of the year, just what working capital has done. Sort of how would you guys think about where we're at now? And then more broadly, what are the levers that need to be pulled between now and year-end to sort of rightsize that? And -- maybe just on the other side of that, if your customers have the same view, is that something that you could see in terms of like a cancellation of destock that might hurt the business?

Yes. Sure. I'll start, and I'll let Vicente as well. Let me just start by saying I think we would probably agree with a lot of the comments you made. That being said, we're actually pleased that we were cash flow positive, free cash flow positive in Q1 considerably better than that in Q2. So despite a lot of the known headwinds, we've continued to manage fairly well in this environment, continue to be free cash flow positive to the first half. Typically, seasonally stronger in the second half. We would obviously expect that to be the case. And to your point on the working capital side, yes, we've been very transparent that we had about a $200 million of inventory headwind through the first half of the year, largely just attributable to the supply chain. Worth noting that, that is not necessarily prebuying per se, it's really buying the right inventory to fulfill the backlog that we have line of sight to. So yes, the next 6 months, and frankly, probably even into the beginning into the early parts of 2023. There's going to be continued, I'd say, work in rightsizing that inventory level. I'd say that's probably the biggest -- not the only, but the biggest opportunity set as we think about free cash flow in the back half of the year. But we should also mention we're still only 2.5 years old as a new company. And as such, things around, let's just call it, the ETR, the tax rate, things around our debt structure and interest levels, those are going to continue to be, I'd say, ongoing tailwinds that we think out more than just the next 6 months as we think into the next year or 2. We said at our Investor Day in November, right around mid-teens free cash flow conversion. That's what we delivered in 2021. We have line of sight and a target to be at the higher teens, free cash flow conversion or free cash flow margin, I should say, by 2025, but let's be clear, that's not the stopping ground. Our aspiration is to be 20% or better, and it's just higher teens as we're kind of a step in the road here, but we have line of sight to that in the next 2 to 3 years.

Got it. And if your customers sort of prioritize their own cash, is that something that -- I know you guys don't have a lot of inventory in the channel, but is there anything you could flare up there?

No, we haven't seen that. And at least if you think about it, customers cancel, if they were to even cancel, I mean, then they get it back into the backlog and they have even longer lead times if they want to do something. In our case, a lot of the orders that we get -- think about it too as well. I mean our products are highly configurable. So it is -- they're not just doing it just to put in inventory so...

Understood. I see we're out of time. So Vicente, Vik, Mike, really appreciate the time. Thanks for joining us in person. And thank you everyone in the room for your attention.