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

Welcome back, everyone, for the ultimate session of the conference. My pleasure to have -- starting off Ingersoll Rand CEO, Vicente Reynal; Vik Kini, CFO; and Mike Weatherred from the excellence -- the business excellence part of the company. We spent some time together last summer on the road. So welcome, all 3 of you.

Thank you, Julian.

Maybe just sort of first off, obviously, you had your results just a couple of days ago. Help us understand sort of how you're thinking about the volume growth outlook for the year? I think it's fairly prudent, cautious, conservative, whatever you'd like to describe it. I think there's a dichotomy of some companies saying we've got a good backlog, so we're going to grow volume from that. Others may be a more cautious view, like, yes, the backlog is good, but don't put too much store in that. So just help us understand what sort of assumptions top-down wise are in a sort of volume guide?

Yes, sure, Julian. So I'll start and Vik can add more here. So first of all, very excited in terms of how the quarter and the year ended last year. The total year, double-digit order kind of growth momentum. So -- and we continue to see that over the past 7 quarters, double-digit orders and revenue kind of outperforming here in terms of what we have seen. So as we go into 2023, what we said is that organically, 3% to 5% kind of is what we're saying. What we said to as well is that our backlog is pretty robust over $2 billion, which is something that we never had before. And what we said is that as we -- in our guidance what we're assuming is that basically the backlog stays fairly constant point-to-point and we say that because of a couple of things that we continue to see. One, we have said before that MQLs, the marketing qualified leads. It's a very good indicator that we tend to use internally to know how economically we are doing against the market because that's -- we get over 5,000 leads every week, and that gives us a very good indication as to orders that we're going to see here 6 to 8 weeks down the road. And that tends to be fairly stable if nothing kind of continue to move in the right direction. So that's a bit of a self-help from us as we continue to take share in the market. The other indicator that I think we like that we think is a good tailwind. And we spoke a lot about that during the earnings call is the long cycle CapEx. So we're seeing CapEx getting released for these kinds of mega projects or projects that are related to sustainability, projects that are related to onshoring, not only onshoring in the U.S., but things that are happening in India, China and even in some countries in Europe. So net-net, what we said is that, okay, let's just view the total backlog kind of fairly stable or constant as we go point-to-point from now to the end of the year. And that assumes a prudent view of what will be in the second half of the year. And prudent because, obviously, even though we have all these indicators, we still -- there's just a lot of kind of noise, I would say, out in the market, and we just wanted to put more of a prudent view. We also said that if there's any upside that clearly that organic volume should rise in the second half. But at this point in time, just based on the visibility that we see -- that we have, we want to have more of a prudent view as we go into the 2023.

And when you look at that backlog and the health of it, kind of how do you gauge the resiliency of it, how valid and none of it is in terms of pace that it can be pulled down into sales? I suppose you look at things like cancellation rates and that type of thing. But how would you describe sort of the health of that? And do you think that easing supply chains everywhere will put pressure on the backlog or not necessarily?

I'll say not necessarily, at least what we put in our guidance too as well, and we said this also 2 days ago and the guidance is that we see supply chain not -- I mean, clearly, year-over-year improvement. But we said not going to dramatically improve and driven by potentially the reopening of China, a lot of these kinds of CapEx investments that we're seeing an acceleration of that CapEx cycle. And we said, let's just have a prudent view that supply chain, although kind of better year-over-year probably stays a big constant, mainly driven by a lot of these other indicators that we're seeing out there in the market.

And when you look at, I guess, a couple of the shorter-term questions that keep coming up for every company. I think one is around inventory levels, OEM customers, distributors, that type of thing. If every company is trying to bring down its own inventory, aren't their customers doing the same to them and that leads to a destock. So any perspectives on that? And then also China, we touched on, just give us some insight as to sort of how you managed to get those results that you did last year and how this year is sort of in your plan for China?

Yes. So I think I would say that when you think about inventory for us, maybe view it in 2 kind of buckets. One, when you look at the ITS segment, we have a multichannel model where we go direct, but we also go through distribution. In terms of distribution, it's really a lot of the small, I'll say, entrepreneurs, mom-and-pop kind of regionally, locally in cities, but they're very loyal to the brand. In this case, Gardner Denver brand and some Ingersoll Rand too as well. And they don't tend to load because they're just also cash constrained, right? I mean, meaning they're not going to load up on inventory because it will be difficult for them to guess what type of compressor they're going to be putting an order. On the PST side, I'll say maybe roughly 20% of the business, 20%, 30%, about 1/3 of the business goes through more kind of national distribution. And for those, we actually have a pretty good process where we track sell-in and sell-out. So we can see the net of whether inventory is building or not. And our teams know very well that we don't want to build inventory in the channel. Because typically, when you build that inventory, you do it by providing discounts and you know how disciplined we have been with the pricing that we do. So I think it's just one of those at least right now at this point in time, we see a very good balance between the selling and sell-out and not leading to any potential kind of destocking that maybe others could have seen. And in relation to the China question, I mean, I think China and we said on the call, I mean, Q4, even during this COVID, you can see the numbers. I mean we talk about China being up double digit and seeing very good momentum. Even today now, when we spoke about the first 5 weeks of Q1 here into 2023, China continues to do fairly well. And I think it's unique from the perspective of maybe 2 things that we can try to classify. One is a lot of these self-help commercial initiatives that we're driving. Again, we talked a lot about the demand generation. But also in China specifically, if you remember, historically, we always said that Gardner Denver was underpenetrated while Ingersoll Rand had a really great solid commercial footprint. What the team in China has done is they have taken the Garnet Denver brand and products and relaunched that into the market, leveraging the commercial footprint that they have in China. And in addition, what they have done is they have taken like blowers and vacuums from the Gardner Denver side to as well and repositioning that through their commercial channel. So we view it as it's being basically a market share taking. It's not that we're saying that the market is growing and stable, and it's just basically market share takes that we have been doing there. So again, these self-help initiatives. And the other big bucket is our area of outperformance, it's really, Julian, everything that we have been saying about this ownership mindset and how 16,000 employees across Ingersoll Rand are owners in the company. And it is really, really unique situation here in China where the China team for them is a very proud sense of ownership to be able to have a piece of ownership of a multinational company that trades in the U.S., and they put a big effort to ensure that they work every day like an entrepreneur or owning the company.

That's good color. And maybe a thematic point away from the cyclical stuff. The energy efficiency element in compressors. It's a topic that gets a lot of airtime in the last sort of 18 months or so. Help us understand sort of how much of a tailwind do you think that is, someone might say well, volumes are not growing much. So does that mean there's less of a tailwind? Or how would you sort of explain it to someone like the power of that as a driver for compressors?

So I would say that -- so think about -- at least the back compressors, in particular, roughly, they consume 30% to 40% of the energy consumption at an average facility. And that could vary -- it could be up to maybe 60% if it's a brewery or a food or beverage facility could be less, if it's a smaller location. And it is known and we have put a lot of data on how -- there's just a lot of losses of energy because of leakage of air in many cases or misuse of the compressors. So we have been doing a lot of things around air audits where we go to a facility, we do an air audit. And then we come up with a game plan on how we can reduce the energy. And we're seeing clearly, in Europe, when invasion in Ukraine happened and energy costs rise, a big ramp-up in terms of conversations with customers around energy efficiency and how paybacks back then became less than a year. So clearly, very easy for a customer to see how can they actually save energy with a very quick payback. And we saw good momentum on that. I think what we're seeing very different right now is that whereas before, a lot of the conversations were happening at the plant manager level, at the customer level, conversations are now happening more at the C-suite with large customers. So for example, last week, I was in conversations with a global operations leader for a very large food company. And what they're looking for is basically someone like us, they can partner with that could go across all their facilities and understand how can they obtain these energy efficiencies. And I think it's more and more of those examples that we're seeing in better conversations that we think, it's a good tailwind. Specifically, how much of that tailwind is going to create? I mean difficult to pinpoint exactly. So at least we're seeing that there's just a lot more conversations at a higher level to be able to deploy it more effectively across.

And then another point, I think, where there's been a lot of discussion broadly is around sort of reassuring if you like, Ingersoll Rand has a very global footprint. So I just wondered, your benefit from that with -- in industrial, in particular in territory PST. But do you see a real change in that reissuing appetite among customers? Are you doing anything yourself 3 years now since COVID? Or you think it's sort of things are settling down to business as usual as it was 4 years ago?

I think the best example here is that what we're doing even ourselves internally. And last year, we spoke about the reopening of our Buffalo facility, and we did that as to be able to produce our multistage centrifugal oil-free compressor to be able to make compressors in the U.S. for the U.S. market. And immediately as soon as we did that, capacity count gets sold in less than 9 months, and now we're continuing to expand capacity. In addition, you saw how last -- on the earnings call, we announced how we're doubling our footprint in India. This is on top of the 4 facilities that we have in India. We're expanding our footprint again because of the demand that we're seeing in India for made-in-India product. And also later this year, we'll be opening our new rooftop in Brazil. Again, same thing about -- there's a lot of in Brazil or in Latin Brazil for Latin America kind of -- so when you put that into perspective, that's exactly what we see from our customers. Our customers are looking at production expansions as well as relocalizing themselves to be more in local and in region for the region.

Got it. And I suppose, product-wise, I think people are kind of interesting to look at the IIoT-enabled product showing it's up to almost 20% now. I guess 2 questions on that. One is the fact that it's IIoT capable. I guess, how much is actually being used of that capability by the customer? How are you driving that usage? And then how does Ingersoll itself benefit from them using that IIoT capability?

Yes, Julian, I'll say maybe a couple of things. We're still at the very early stages of being able to generate the revenue that we can generate from these remotely connected machines. Even though during the Investor Day, we spoke about already having roughly about $100 million revenue stream that is getting generated from these kinds of service agreements and packages that we create as we connect more machines and that continues to accelerate. We decided that to talk about this leading indicator that for us is a percentage of revenue of equipment that we're shipping already IIoT-enabled. And because we think that, that's a leading indicator of what we're putting in the market that later, obviously, through demand generation and through our sales guys. We're able to then connect the machine and offer services. And here, we're offering services multiyear service agreements where we can guarantee uptime where we can guarantee or kind of work with energy savings and kind of remotely fine-tune a lot of the compressors or devices that we have to be able to provide that. So I'll say early stages, but we're seeing some very good momentum on accelerating that, which is part of our long-term strategy on increase in our active market and recurring revenue because this becomes a real kind of recurring revenue on these multiyear agreements that we get paid on a multi basis.

And on ITS is got a very well-developed sort of aftermarket model now, particularly in the compressor piece. PST aftermarket is a long way behind. There's a share of revenue. How quickly are you driving that up? And I guess, why is that starting point kind of so low there?

Happy take that one, Julian. So in the context of classical aftermarket, you're right, the way we measure it and define it. So ITS closer to 40%, things like service, parts, labor, consumables. The PST side, just given some of the nature of the products, for example, a little bit more of OEM installed parts and things of that nature, they tend to have a little bit less of those classical consumable parts and whatnot. But in the context of recurring revenue, meaning, for example, you have a pump that reaches end of life and it's replaced like-for-like, there's actually a much stronger correlation to the percentages that look more like ITS. So classical aftermarket as we've done on ITS, screens a little bit lower. But like-for-like replacement and as such, that stickiness component that resembles the aftermarket having ITS, PST actually looks fairly comparable in that respect. But that being said, I do think that there is a big push to continue, particularly in businesses like ARO and Tuthill Pumps and assets that have those consumables pumps that are very similar in nature to ITS, you are continuing to see a lot of the same momentum initiatives IIoT aftermarket being deployed there as well.

And within PST, I suppose there's a very -- there's a fragmented market. There are a lot of different niches. You've gone after some of those niches with organic growth, inorganic. How satisfied are you with your range across different pump technologies now? What are some of the technologies that you're looking at getting into? And is there any sort of or much of a synergy across the different pump niches?

Yes, Julian, so we said that there's definitely positive displacement pump technologies. And we have roughly 3/4 or 2/3 of all technologies that are available in the market. So there's still a possibility to keep expanding on new technologies that we don't have. And so how satisfied are we? I mean, we're very proactive with our M&A, and you can see that not only looking at new of these kinds of pump technologies but also kind of incremental add-ons to the technologies that we have. What you have seen that we have done here over the past year is really acquiring technologies that are going to be complementary to the ecosystem. And by that, I mean is that technology that can actually make that pump smarter. And then we can actually generate more recurring revenue. So to give you an example, we have a business called YZ. And YZ is the market leader in odorizing natural gas, which is when you think about natural gas, it doesn't have any smell and you have to odorize that. We're the market leader for odorizing natural gas. Important to know that as you into -- as we go into hydrogen, you have to -- you're going to have to odorizing hydrogen. So we believe that this technology can actually be very well applicable to that. It's a very mission-critical technology. So you don't want -- you want to provide the proper amount of chemical to be available to odorize. Otherwise, it becomes very expensive, or if you provide too much, it becomes dangerous to the population. So very critical. So we acquired a company called Westwood, and Westwood offers low radio frequency WiFi systems that now we're going to be able to go into a network of utility companies and provide connected multiple locations at the same time via WiFi systems that can go and expand up to 10 miles. So now that's a technology that not only is going to be beneficial for YZ systems, but we're going to take that and utilize that into our compressor system. So again, this is just one example that value-additive solutions on controlling that ecosystem that is going to give us more better penetration into our customers. Same thing we did with Maximus. Maximus was a way to control the ecosystem for our Dosatron pumps in vertical farming solutions or cannabis solutions and things like that of that nature. So we've been putting a lot of attention on that ecosystem controllers so that we're able to have better recurring aftermarket services solutions.

And on sort of PST end market-wise, it's got higher growth this year than the Industrial division. Maybe sort of clarify what's driving that? I think investors seem to have a good grasp of Industrial, but PST, there's always a sort of a hazier impression for people.

Yes. So PST has a really nice, I'd say, end market diversification and the context stuff. Yes, you do have some local core industrial. But then you supplemented that with, let's say, lab life science, water, some clean renewable energy type applications, Agritech, as Vicente just mentioned, which, on the whole, we do believe has obviously a slightly higher growth rate than ITS, which also has good end market diversification, but tends to be classified a little bit more as classical industry. So I think when we look at the multitude of different end markets there, we do see good growth opportunities on the whole. It's also worth noting that with a lot of the acquisitions that we've done as of late, whether that be Maximus, whether that be Seepex, whether be Air Dimensions, Tuthill Pumps, a lot of these are now being much further integrated into, I'd say, our core processes. And Mike can speak a lot to the demand gen side that we think is going to help grow and drive a little bit of disproportionate growth for some of these newer assets in the portfolio?

Yes. Maybe, Mike -- thanks, Vik. Mike, on that point, maybe help us get a clearer picture of sort of Seepex that the ramp inside the organization of margins, lead generation. It wasn't a bad business when you bought it...

No, no, no. Really, a great business, great technology, yes, great market. And Seepex is a little bit unusual because I think with Seepex, the path to profitability was a little more straightforward kind of block and tackling. And what I mean by that is Seepex had tremendous gross margin, barely mid-teens-type EBITDA, but we could see a cost structure and a price play and probably an I2V some innovative value to get the value out pretty quickly. And I think in Q4, it was roughly 25% EBITDA. So 1,000 basis point improvement there, which, again, pretty straightforward. Now I think there's another, I don't know, Vik, 500 basis points plus to go. And that's where I think some of the expertise of things like demand generation will come into play. And so we've talked to you about this, Julian. But I think we're unique in that. In an industrial space, we have about 150 people that work full time on customer insights and customer -- providing customers with information at the right time in a period where they're trying to make a decision that will ultimately lead to a purchase of a product that we have available. And easy to talk about, really hard to do the other benefit and uniqueness, I think, we have as an industrial company is this 150-person team has spent their whole careers, which, in some cases, are 10 years-ish when they spend it all in digital marketing. So they're not going up the learning curve of -- I used to do marketing in a classical way, knocking on doors and making phone calls. I just -- this is the only way I know. So with that, we get about 5,000 MQLs a week. And then within -- in some cases, 5 minutes, in worst case, 48 hours. We convert those into sales qualified leads or reject them. So SPX -- Seepex, most recently SPX, but those companies, they get the immediate benefit of that as soon as they come in. And so we would fully expect and certainly 2023 Seepex to be a major beneficiary of that. And again, we're not going to be creating demand and marketing on things that aren't of the highest margins. So there's also a good mix play there.

That makes sense. And on M&A, and like you just mentioned the FLOW deal that closed a month ago. How would you characterize the environment today? I think last year was obviously tough for global M&A activity. You managed to get a good amount done despite that. Do you think this year will be any easier for M&A? And then, I guess, on size of deal, I think investors seem to like bolt-ons for last 18 months. A lot of industrial companies have announced larger transactions and received a fairly clear negative reaction from investors pretty quickly. How are you thinking about like scale of deals?

Yes. So I think, Julian, to the point of, are we seeing acceleration in terms of the company? You could say, yes. You can argue to say yes. And the proof point to that, in the prior Q3 earnings call, we talked about having 8 companies in [ LOI. ] We closed 2 of them, so call it down to 6. And now we announced that we have 11 under LOI. So that just shows the sequential acceleration that we saw in terms of companies moving to an LOI. And LOI for us is pretty close to high probability that we will close them. Again, 90% of these transactions have been sole sourced by us. We're talking to the family -- to the ownership family. So we know that unless something that we see that we don't like, we'll likely close the transaction. And this 11 LOI is very similar bolt-on in nature to -- similar to maybe what you saw was announced with Paragon Tank Truck. Very niche specialized technologies that complement very well to the portfolio of technologies that we have. So Paragon Tank Truck gives us an entry into the liquid tank aspects with a blower technology that we don't have in our portfolio. And believe it or not, they're the one of the top leaders on that kind of niche application, which when you think about food, beverage and pharma, you need to load and unload liquids from tanks. And so again, at this point in time, our funnel very sizable. We said it continues to be 5x what it was back in 2020. And one that it is very bolt-on in nature, where we'll continue to be very disciplined with the multiples on average, low teens or low 10, so between 11 to 12x with a post synergy that goes into the high single digits and generates the ROIC of mid-teens by year 3.

On that ROIC, we should expect that at Seepex and the FLOW deal, all of those. Is -- and sometimes people ask the types of acquisitions, they're hardware-centric, good cost synergy. Maybe the question might be around sort of long-term organic growth profile. Should you be trying to future proof of the company with more of the software or digitize M&A strategy? What would be your sort of response?

Yes. I think if you look at some of these acquisitions that we done, they're all not -- I mean they're not software -- pure software, but Aircom, a great way to transmit the data and obviously do a lot at the gateway point of transmitting the data. So there's a lot of software involved in that. Maximus is the controlling of the systems to be able to sell SaaS revenue. So they do have some Software-as-a-Service revenue already and one that we think we can continue to expand. And even someone like Seepex. Seepex great acquisition. It really came with a very strong IIoT platform that we're leveraging and utilizing across the entire PST segment and now even moving to the ITS segment. So I think when we make an acquisition, are we buying a pure-play software company? No, we have not done that historically. One of those just primarily just based on valuation points and being disciplined on how we do things. But at this point in time, we feel that by trying to manage that ecosystem, then we can actually apply better service revenue models that have that recurring revenue with a gross margin that is very similar to software in the high 70s or low 80s kind of gross margin revenue, and that's basically what we've been able to accomplish with these kinds of recurring service revenue models.

That's helpful. And maybe last question very quickly before we get to the audience response surveys around. You talked about going back to the sort of the cycle element sort of single-digit orders growth assumption for the year. Best case, do we assume that's fairly sort of linear as we go through the year?

Yes. I would say we feel it to be relatively consistent. The one thing to keep in mind, given that the ITS business is still roughly speaking, 80% of the revenue profile, there does tend to be a little bit of seasonality associated with the ITS business. As a reminder, it's one that typically has book-to-bill above one in the first half and slightly below one in the second half, and that's largely driven by the longer cycle project nature of the business, which still is around 20-ish percent or 20% to 25% of the revenue base. We've -- in Q4 was a great example. We tend to have a propensity of the booking in the first half and the shipments happen the second half, tend to be really more so Q4 weighted. And that's exactly what you saw in Q4 2022 where ITS book-to-bill was closer to a little bit above 0.9, but that was very consistent with typical seasonality that we see.

Fantastic. Thank you, Vik, for that. And so if we could quickly pivot to the audience response to the first question around sort of current ownership. [Voting]

Yes, no, it's about 70%, no. Second question is around sort of general sentiment or your own sentiment. [Voting]

So generally quite positive. Third, on -- this is sort of EPS growth. Again, the peer set here would be U.S. industrials or U.S. multi-industry, that's the reference point. [Voting]

So fairly above the average. Next question is around capital deployment. Obviously, the company history is more about 1, a little bit of 2. [Voting]

So we were very comfortable with bolt-ons. Next is around valuation. So what kind of through cycle, if you like, PE ratio to put on it. [Voting]

Okay. So 20x pretty much, 19 to 20x. The next question is sort of why is it that high teens or 20x, why not higher than that? What's the sort of single biggest concern? [Voting]

So, cool, growth, and that maybe goes to some of that acquisition type of asset point. And then lastly, a new question this year, and I'm sure the responses will evolve over time, but just sort of ESG and significance of that as an investment decision factor. [Voting]

So pretty typical. Mostly, it's about 25% answered 1 and then 75% answered 3. So with that, thank you so much...

Thank you much.

Thank you so much. We appreciate you. Thank you.