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

Great. I want to pivot to China a little bit. So that has been a drag on ITS margins recently because inflation has been difficult to recover through pricing. Why has pricing been more difficult in China than rest of the world?

Sure. Yes, maybe maybe I'll start there. Maybe give a little bit of color here. So as far as the margin profile, and I'll kind of [indiscernible] with the pricing question. I think historically speaking, if you were to go back 2, 3, 4, 5 years ago, China or Asia Pacific as a percentage of our overall revenue was closer to 20%. China was about 15% of that 20%. So it was the lion's share of our Asia Pacific portfolio. For the factors that Vicente mentioned back into kind of really exiting the '23-'24 time frame, the big run-up you've seen in things like EV batteries kind of came back down. And then, frankly, just the overall China market reset that you've seen. China is now closer to about 10% of our revenue profile, whereas Asia Pacific is about 15%. So obviously, China has kind of reset for a lack of a better way to say this, within the overall kind of portfolio. And so a couple of things that you've seen over the last few years. One, obviously, as you've seen that reset, first and foremost, our Asia Pacific business is a profitable region. And obviously, when you've seen that kind of volume reset, you have seen some headwinds on the margin front compared to where we were a few years ago, largely attributable to that kind of volume kind of component. As far as the pricing side of the equation is concerned, a couple of comments. We did indicate that in Q2, you saw China was about a negative low single-digit headwind to pricing. So total ITS is delivering between 1% to 2% price with that negative low single digit from China. Now if you go back in time, China really never has played at the same levels of pricing as North America or Western Europe. Think of it as being more flattish. So yes, maybe there's a couple of hundred basis point headwind to that, which I think is just a reflection of kind of the overall market, some of the overcapacitization you've seen in the overall environment, not necessarily just our equipment, but kind of broader -- broader speaking. And so from our perspective here, what's encouraging is starting to see some of that China volume starting to come back, right? So even in Q2, we indicated that China was actually up low double digits, inclusive of that pricing headwind, which means volume was probably more like mid-teens. So I think as we continue to see, I'd say, better stability and traction in China, more medium term, we would expect to see pricing get nominally a little bit better. We're not expecting China pricing to get positive necessarily or back to the levels of of North America or Europe, but closer to that flattish realm over the medium term, I think, is more the expectation. It's just going to take a little bit of time.

And what needs to happen there because you said volume is already coming back where pricing hasn't, what else needs to happen besides volumes and pricing to normalize?

Yes, I think it's just a little bit of just time and normalization, right? We've been through a couple of years of that entire market getting reset. So 1 quarter or 2 quarters is not going to necessarily be the inflection point. It's going to take a little bit more time for stabilization. But I think to your point, the good news is we see encouraging trends, at least just in terms of how some of the broader market dynamics are playing out there than we saw in Q2. And I think the other piece here is if you look kind of under the covers of our China business, again, not all products are necessarily made equal in the context of pricing, right? We are seeing positive pricing in certain areas like aftermarket and maybe some of the more differentiated newer products that we've brought to that market over the course of the last few years, like blower and vacuum and air treatment as well as some of the localized product that we bought from some of the bolt-on acquisitions. So again, I think we're going to continue to obviously manage it in a kind of a portfolio-wide approach, but it's just going to take time, is kind of the base.

And if we get a few more quarters of China volumes increasing, do you have a sense for how long it usually takes for that price environment to normalize? Is it a 12-month [indiscernible]?

Yes. Tough to say exactly the right time frame here, but I think your point is valid here. If we continue to see better traction on the volume side, we would expect things will start to settle down a little bit and then we can start kind of closing some of that narrowing some of that gap we see on the pricing side between where we are today and more of that flattish level.

And would you ever choose to exit kind of lower differentiation in product categories where pricing is structurally unattractive rather than just chasing the volume that comes with it?

I think in our view, we -- when you think about our products, I mean, we tend to be highly differentiated and which is the reason why we continue to maintain a pretty high level of margin and the ability to be able to get that 1% to 2% of price every single year regardless of the market. So I'll say that, on purpose, we want to take technologies that are differentiated. When you think about it, I mean, we play -- we're $8 billion roughly revenue company. We play in a $75 billion addressable market. So plenty of opportunity for us to be selective on technologies that we want to continue to acquire, plenty of opportunities for us to be selective in the end markets that we want to play. And we believe that we can only win as long as we really deliver that total cost of ownership with a differentiated solution.

And then broadening out from China, you gave the July update on the quarterly call. But as you look across the rest of the world, how would you characterize the underlying demand environment today?

Yes, sure. I'll just keep it relatively simple here. I think North America, obviously has been seeing the best kind of improvement here. We talked about it in Q2, high single-digit kind of orders improvement. So continuing to encourage what we're seeing in North America, particularly after kind of the last 2 years that have been a little bit more [indiscernible]. We talked pretty extensively about China and Asia Pacific just now. Obviously, Europe is the piece or we run it as EMEA, Europe, Middle East, India, Africa. To Vicente's point from earlier, it's been the most stable region over the last few years. I think right now, it's kind of relatively neutral, not all parts of EMEA are kind of made equal for lack of better way to say that. I think India, for example, has been our best growing region for probably the last number of years. Clearly, right now, Middle East, obviously seen some of the challenges, Central Europe, comparable areas like Italy, Spain, have been seeing some pockets of opportunities. So some puts and takes within I'd say the broader EMEA expansion, but when you put it all together, relatively neutral. And then areas like we mentioned India, areas like Latin America, areas like Southeast Asia. We've kind of highlighted those as probably 3 of the 4 kind of major areas of, we'd say, potential outsized growth as you think more medium to longer term. And a lot of that is just because of we have good presence there. We've been making structural investments, whether it be commercial investments or I think Vicente has mentioned here, we've put 2 new manufacturing plants into operation over the course of last year, one in Latin America for localized compressor manufacturing, a second manufacturing plant in India for compressors because we frankly had run out of capacity in our first one. So those are areas that we see, I'd say, maybe slightly outsized opportunity just because of maybe our historical presence, our share there is not at the same level as you see in areas like North America and Western Europe. And so again, continue to be optimistic there in terms of the long-term growth. But I'd say that's kind of how we're seeing the expense from North America to Europe to APAC.

Great. And then getting more specific on ITS. We saw organic growth grow 4%-ish in Q2, but EBITDA margins declined year-over-year. You highlighted China price cost as being a pressure there, but also investments that you're making in new technologies and commercial operations and higher corporate costs. Which one of those are versus the fastest and which one is more of a structural phenomenon?

I'll tell you the first is going to be the price cost situation and we spoke about how as we were into last year because of tariff situation, we were going to do price cost neutral, meaning that increasing on the price to cover the tariff, but not to kind of get the margin or benefit of that price on that side. As we kind of move here into the second half, I mean, we're comping some of that. And in addition to that, we have done also incremental pricing that we typically do here in the first half of the year. And so that's going to prove to kind of deliver some better improvement on the price cost equation. The second piece is that we -- as we tend to always optimize the business, we did some restructuring kind of second -- end of Q4, kind of early Q1 roughly. And some of that, kind of, we'll see some of the fruit to as well as we kind of come into the second half.

Then you see the long-term ITS earnings power there approaching 30% EBITDA margins, what needed to happen operationally for the segment to get there?

I think when I say that it's a segment that we see structurally nothing different than -- I mean, it can definitely continue to achieve or we'll get to that 30%. So structurally nothing that has dramatically changed, except obviously the tariff situation, there has been this kind of price cost neutral that really affects the margin. So I think -- and also in addition to that, you saw the negative organic volume that clearly that created the headwinds. I mean despite that, I mean, the segment still trade -- or still runs at high 20s. I mean, 26%, 27% EBITDA margins. So we're in that kind of closing to the line that as we continue to now get the price cost equation improvement and as we start to see in the volume, the organic volume, that's going to be the main -- those are going to be the main drivers to kind of get back to those levels.

And then on PST, that continues to be a bright spot, 31.5% margins in Q2, targeting around 32% plus in the second half on a path to mid-30s. What remains the largest lever from here to drive those margins up?

Yes. I think we're incredibly pleased with the momentum we've seen on the PFT side. Just to kind of give a bit of color here. You've got the 2 platforms within PST. You've got already rough numbers, roughly $1 billion, precision technology is kind of niche positive displacement pump business. You've got a $600 million, $700 million life sciences platform. I think you've seen a lot of efforts over the course of the last few years, particularly on the life sciences side to further integrate those assets. Obviously, a big piece of that equation is the ILC over assets that were acquired 2-plus years ago. I think you've seen a lot of the heavy blocking and tackling in terms of the integration, getting those P&L structure set up, managing that P&L and that business in a very comparable manner to how you see the rest of the enterprise getting things like IRX and I2V and a lot of the kind of internal kind of mechanisms and playbooks into that business. So at this point in time, to your point, you're seeing good growth across both the PT business tends to be a little bit shorter cycle in nature. So by definition, you've seen that card to come back a little bit sooner just based on some of the short to medium cycle momentum you're seeing broader speaking. And then obviously, the life sciences business has been, frankly, the best growth [indiscernible] business of the entire portfolio. But I think on the go-forward piece here, to your point, now you've seen EBITDA margin sustainably over that 30%, 31% level for approximately 4 quarters now. The content of getting to that mid-30s EBITDA margin profile, not that kind of far away. I think the single biggest catalyst, a number of the same blocking and tackling drivers you would expect to see across the portfolio. But obviously, I think the biggest area there continues to be just the growth side of the equation. This is a healthy margin business plays in the mid-40s gross margin profile. So just continuing to see I'd say the requisite growth on both the PT, but as well as the life sciences business, I think we'll continue to drive good momentum there.

Great. I want to shift a little more to pricing and margin recovery in the back half. How much confidence do you have that this price realization catches up with inflation without compromising order growth?

Yes. I think we've been very, I think, prudent and thoughtful about that in the context of making sure that, of course, we're taking the requisite pricing actions, as you would expect. We have 9 P&Ls that make up the entire portfolio. Each of our P&L does pricing on their own cadence based on the region, the product lines. In certain cases, there's multiple pricing actions taken through the year based on kind of what needs to be done. And as you can expect, there have been pricing actions that were taken both in the second quarter as well as actually actions that are taking on -- taking place as we speak here right now. So whether it be just normal course pricing -- to the question whether there will be some inflationary pressures where we may have to recalibrate a little bit? The teams have gotten pretty adept at having to kind of look at this and reanalyze on a fairly consistent basis just based on what you've seen over the last couple of years with supply chain disruption, tariffs, things of that nature. So I think that is what you should expect to continue to see. I think we're going to continue to remain very prudent and disciplined in the context of where we take price and how we kind of calibrate. To your point, the organic volume piece of the equation is very important. We've seen that coming back nicely here in the second quarter. We continue to expect that to kind of keep coming through in the back half of the year. So I think we want to be thoughtful about maintaining that price and volume kind of balance along with kind of just some of the other self-help to Vicente point, things like some of the restructuring actions we've taken, which should be a little bit more visible in the back half as well as just the direct material productivity equation. Obviously, when you think about the seasonality in ITS, typically speaking, Q1 is your kind of lightest quarter, Q4 is your heaviest with Q2, Q3 in between, and your direct material thought productivity follows your cost of goods sold. So inherently, as you have more of your shipments in the back half of the year, you typically tend to see that margin profile follow. So I don't think this year should be any different than that expectation in terms of just the sequential momentum you would see from first half into the back half.

Makes sense. And you mentioned earlier that outside of China, pricing is relatively normal at 1% to 2%. Is that what we should think about as a through-cycle pricing contribution? Or is there anything that's changed in Ingersoll to make that higher?

Nothing has changed. I mean, clearly, we're going to try to hold exposure to be higher than that. But I think you can think about it always as a 1% to 2% of price in -- through the cycle in any environment.

Great. And the second half margin ramp depends on things we've talked about in terms of pricing, normalized corporate cost, productivity, which of those carries the greatest execution risk in your view?

Sure. I think if you -- let me just kind of state, you have improving volume. You've got some of the pricing actions that we've taken that should kind of materialize more in the back half of the year. We did talk about some of the outsized impact for some of those targeted wins that we had, for example, in China in Q2 that should repeat themselves to the same magnitude as well as some of the productivity factors. I think when we think about -- to your question, what carries the most risk? Listen, we feel good about the ability to execute across the balance. Obviously, there are some of those that are a little bit more within our control, some are a little bit more just execution based on the macro environment. But to that point, I think we feel pretty good about where we're continuing to see order trends and things like that. So inherently, obviously, some of the areas that are a little bit more market and execution driven probably carry a little bit more risk, but those are things that we feel like are manageable. And clearly, we're continuing to execute here as we exit through this Q3 and into the back half of the year.

Great. And then looking a little longer term, you've continued to reference roughly 30% ITS and mid-30s PST margin potential. What is the realistic time line for getting both of those businesses near those levels simultaneously?

Yes. Obviously, the timing here, let's just -- I think without putting an exact pin on it here, PST, to your point, we're approaching that 32% margin range. So I think the content of getting in the mid-30s, [indiscernible] is 33% or better. You're not that far removed to be honest. I think on the ITS side, listen, we've been close to that 30% level before. To your point, obviously, we're stabilizing now a little bit more in that 27%, 28% realm here as we exit the year. I think the concept of triple-digit margin expansion like you saw back in the days post the merger, I don't think that's the realistic expectation on a go forward. But I think getting back to some requisite amount of margin expansion here in the context of next year, assuming we kind of have a bit of a more normalized growth environment with contributions from both price and volume, I think getting back on track with some degree of margin expansion here in ITS, of course, is the expectation. And as such, more of a medium-term approach in terms of getting back to those levels. It's not going to happen overnight. But to Vicente point earlier, we don't see any reason why structurally we can't get back to those levels. It just going to take a little bit of time.

Great. And then thinking about the puts and takes as we start to look towards 2027 and beyond, you've highlighted July strong order growth, general activity going well, investments you're making into growth. Where do we see, in your view, the largest upside to the earnings equation over the next 12 to 18 months?

Sure. I think -- listen, I think what we see here is, clearly, as we sit here right now, we're coming off of a couple of years of lows [indiscernible] in North America and Asia Pacific, right? So I think, one, those obviously will kind of have hopefully the best ability to kind of rebound here after, obviously, North America is kind of seen in the order profile as we sit here right now. I think to Vicente's point, continuing to leverage some of those differentiated capabilities in terms of ETO and things like that, showcasing that, which has really become more of something we've been leaning into over the last year, leveraging this kind of one IR portfolio. So for example, we have a strong life sciences present, it's about 20%, roughly speaking, of our portfolio is life sciences oriented. But now we really have a true, I'd say, connectivity closer to -- with the IoT [indiscernible] acquisition to kind of the biopharma, the pharma producers. How can we leverage that to pull through more of the portfolio. So it's really starting to think about that in a little bit of a different manner as opposed to just compressor [indiscernible], how can we look at things in a much more systematic approach and then leveraging some of our ETO capabilities to really be able to provide differentiated systems and solutions. Obviously, the M&A piece will continue to be there. It's been there. It's going to continue. But I think continuing to think about how we can drive the entire portfolio in a little bit of a differentiated manner is something that we're really leaning into here.

Excellent. Well, thank you both for your time. Thank you for coming to the conference. Thank you.

Thank you.

Thank you.