ITT Inc. (ITT) Earnings Call Transcript & Summary

Okay. Good morning. Thanks, everyone, for joining here with the ITT fireside chat. With us today are Emmanuel Caprais, CFO; and Mark Macaluso, Director of Investor Relations. Maybe just to start here, Emmanuel, walk through how you got to where you are within ITT and maybe just some of your high-level priorities here as you've taken over as CFO.

Yes, good morning, Jeff, and good morning, everyone. So my career at ITT started in 2012. I was Segment CFO for our Motion Technologies business, and this is where I worked really closely with Luca as Luca was President of that segment. And we worked really hard on improving financial performance of this segment by driving operational efficiency and also really commercial acumen. And so that segment was already very profitable. And we worked really on strengthening the fundamentals and make it even more profitable. As -- when I started, Motion Technologies was around 12% to 13% segment margin, and now it's more in the 20s. And obviously, a lot of work has been done. I then -- based on that success and the hard work, I was asked to come to Corporate in the FP&A role, where I was tasked to replicate that approach, that business approach to all the other segments. On the way of doing that, in 2017, I took over also for a little less than a year, the IP CFO segment position and really position IP for -- tried to position IP for the growth that we've been seeing and the improvement in terms of profitability. And then after that, came back to my regular job with -- including Investor Relations, where you and I met. And then since then, we announced early in 2020, the transition for the CFO role, and I've been in this role since October of 2020. So really recent appointment. And then since I've been in that job, I would say that I had the privilege to start that job in pandemic, which doesn't probably happen a lot in a lot of CFO's careers. And so what I focused on was really to make sure that we manage the crisis appropriately. So we took a lot of cost actions from the beginning. We worked really hard to preserve and grow our liquidity position, which we did very successfully. And then so as we have been exiting the pandemic probably in the second half of last year, we've been putting a focus on investing in our businesses so that we could be ready in the recovery. And I think this is what we're demonstrating in Motion Technologies that -- which has constantly outperforming markets. In IP, as we continue to grow profitability and we reach almost 16% in Q1 of this year. And in CCT, where we are -- despite a significant blow due to the aerospace -- to the aerospace market, we have been able to really recover from a profitability standpoint and be a little bit lower than where we were in Q1 pre-pandemic. So overall, ITT has made a lot of progress from a profitability standpoint. And we are investing so that we can take full advantage of the recovery when it comes. Mostly, I would say that applies to IP and CCT.

Great. And then just before I go back into questions, one, I wanted to remind everyone, at the bottom of your screen, if you do want to ask a question, go ahead and send that in and I'll filter that into the Q&A. And I think Mark wanted to do some forward-looking statements.

Yes. Thanks, Jeff. Just really quick. Just a reminder to everyone, this presentation and Emmanuel and my comments this morning will contain forward-looking statements that are subject to certain risks and uncertainties, including, but not limited to impacts from the COVID-19 pandemic. All such statements should be evaluated together with the safe harbor disclosures and the risks and other uncertainties that affect our business, including those discussed in our Form 10-K and other SEC filings. So I'll turn it back over to you, Jeff. Thanks.

Okay. Great. So obviously, we've talked to most companies around 1Q, and you guys, and inflation, supply chain, labor availability are all kind of major issues. Certainly, a good part of demand recovering here. But I just want to really dig in on like what really worries you most around those headwinds? And where do you think things can get worse? And where do you see things getting better where maybe some of those risks start to abate?

Yes. I would say commodity inflation is what is the major concern for us. And I would say even if we -- there are some signs that it could be short-lived. We are absolutely taking action to mitigate and compensate this negative impact. And as a reminder, we discussed during our Q1 earnings call is that there was a gross impact of $0.25 to $0.30 and that is coming mostly from MT, probably -- would say probably something like 80% coming from MT and that's steel and copper, and then some other impacts in IP and CCT, but minimal compared to MT. And we're working really hard on this because we want to make sure that we preserve all the progress and the profitability that we have achieved. And so if you look at IP and CCT, for instance, those are areas where we have large opportunities to transfer that inflation into prices. Same thing for the real segment within Motion Technologies. And then in terms of auto, we're working hard, but we have to be much more surgical because we can't go and blanket -- into a blanket price increase to all our customers. We want to preserve our competitive position. And we want to use this also to continue to gain market share, which we've been doing so far pretty successfully.

Okay. And then just to clarify, so how -- I think you said the gross impact $0.25 to $0.30. Can you just talk about what you get in terms of material price formulas and what you're doing pricing elsewhere? And kind of how to think about a net number?

Yes. So as I mentioned, $0.25 to $0.30 is the gross impact coming from steel and copper. We -- and so what we're seeing, we're seeing that starting off in Q2. Because in Q1, we had hedging contracts, and we booked the prices, steel mainly, towards -- until -- for 6 months until the end of Q1. So this is really hitting us in Q2. We think it will continue to hit us in Q3 as well and maybe subside a little bit in Q4, hopefully. And from a pricing standpoint, in terms of IP specifically, we're increasing the price of our short-cycle businesses mostly. And so that's baseline pumps, that's parts, things where we have a significant leeway in terms of increasing prices. From a project standpoint, not that project activity is really strong, but from a project standpoint, we are -- we don't have delivery to really increase prices because it's such a competitive environment, and you have -- and you either get to the price or not and it doesn't really matter what your cost base is. From a CCT standpoint, we have pretty good agreement, both on the short cycle and a little bit on the longer cycle also in aerospace. We have some pretty good agreements. So we feel pretty confident also that we can increase prices. From rail, same thing. We've seen customers even if they're not happy, they agree to price increases. And in auto, we're playing on different ways. The first way that we play in is, "Okay, so if you don't want a price increase, what can we do to offset?" And so usually, some customers would be willing to give you more business to offset the fact that we have a heavier cost structure. There's another distinction where you go into aftermarket first and then OE last. And then some items -- some opportunities where you have escalated contracts also with your OE customers and as a result, you're able to -- that's part of the price -- that's part of the agreement and that's kind of mechanical. The question here is a question of timing. Can you get it right now? Or do you have to wait 3 months, do you have to wait 6 months? But at some point in time, it's going to come. And then the last option we have also is, instead of giving your regular 3% year-over-year, which, for us, is never really 3%. It's something around more 2%. The option is to say, "Okay, so instead of giving you that 2% that's in a contract, can we give you less and recover some of that raw material increase that we're facing?"

Okay. So just maybe switching gears here. Luca took over, you talked about war chest of opportunities. It really shown up in the results resonated with investors, the stocks performed well. If I think of your -- some of your industrial peers that you aspire to in terms of performance and valuation, they tend to have a strong operating acumen, which you guys have illustrated, but also active capital redeployment, M&A activity. So just wanted to -- just trying to get a sense of what it takes here to see more momentum here. Where are you going to be focused within the businesses? I know there's some areas where you're going to be wanting to acquire somewhere, maybe you just grow it organically. And then what would it take for you guys to kind of take action to simplify the portfolio, split up the businesses or do something more creative from a portfolio standpoint as we're seeing a lot of industrial companies kind of go through portfolio simplification?

Yes, Jeff. As a reminder, we -- our priorities from capital deployment are always organic because this is where we get the highest return and the lower level of risk. So we have -- we were very happy to announce that we are increasing significantly our CapEx -- organic investment by more than 50%. It will be a little bit more than $100 million this year. We're also -- we have also highlighted inorganic M&A, as you were mentioning. And then we've done a lot of work on -- or we've announced a lot of really good actions on dividends and repurchases. We increased dividends by 30% in 2021 after increasing by 15% in 2020. And we also did $50 million of repurchases. And what's great about ITT, Jeff, is that we are able to do everything. We don't -- it's not like we have to choose. We can still do acquisitions and still increase dividend by 30%. We've seen -- in terms of acquisitions, we've seen that the M&A market continues to be pretty difficult from a valuation standpoint. But we continue to look at our targets in a very disciplined fashion. For us, it's critical that to -- in the targets that we look at, it's critical that they fit ITT from an end market product standpoint so that we know what we're dealing with, and we're not discovering new businesses as we acquire a company. And also, it's really important that there is a clear value creation path, which is underpinned by strong competitive advantages, whether it is product or process. So right now, I would say that we are cultivating very aggressively. We have made some good progress. We have increased the frequency of deals review. We are -- right now, because of what we're seeing, we're focusing on probably smaller deals. Typically, we will be looking at companies that are between $20 million to $200 million in terms of incremental revenue for ITT. We're seeing more companies towards the lower end of this. But I think that we are -- by focusing on North America, focusing in Europe in terms of region, by focusing on the end markets that we know, so aerospace, rail, that we want to grow to a $500 million platform organically and inorganically, and also material science for Motion Tech, we feel that we have the areas of interest covered -- well covered. And we'll continue to be very disciplined because when you can really do on-site due diligence, when your revenue, your profitability as a target has been impacted by -- severely by COVID, it is -- it puts a lot of stress on the return equation. And so we want to make sure that we don't take any risks, and we approach those business in a very disciplined fashion. So we're not rushing to do anything, but we are certainly very aggressive in increasing the cultivation of those targets.

Okay. And how about just the portfolio simplification?

Not really. We're really happy with what we have today. And especially because we see a lot of potential IP, we've been improving the profitability very aggressively. And even -- despite all the progress we've made, we continue to see a lot of opportunity, a lot of runway to further improve margins. And in CCT, this is a business that has been hit really hard, but we continue to see a lot of opportunities there, whether it is in terms of sourcing and footprint, in terms of manufacturing productivity, in terms of improving plant operations, we're just at the beginning here. And so because we feel there's a lot of runway because we feel we have the cards well in our hands for the moment, we don't see a meaningful opportunity in terms of simplification of any of our businesses.

Okay. Great. Let's just move to the businesses and talk about Motion. Just thinking of the cadence of the year, very high level demand in 4Q, 1Q. Should we think about -- I'm just trying to -- I'm struggling with the degree of step down from 1Q to 2Q, and kind of how you see some of these auto headwinds and semi-shortages kind of impacting as you move into the second half?

Yes. So in terms of Q2, probably Q2 and Q3 mostly, we expect probably Motion Tech to be down from a profitability standpoint by roughly 100 to 150 basis points in terms of margins sequentially. And this is really due to the -- the commodity inflation as well as lower volumes, as you were mentioning, chip shortage. The chip shortage issue is significantly impacting automakers in North America, but also in Europe. And so hopefully, in terms of chip shortage, we should see an improvement towards the end of Q3, maybe in Q4. But keep in mind that before we declare a win and assign a really outsized growth in Q4, keep in mind that Q4, in Motion Tech, as you mentioned, was also very strong. So even if things go back to more normal situation in Q4 of this year, we'll still have to overcome a very strong Q4 in 2020. In terms of revenue, we expect to continue to see significant growth in Q2. But here, we talked about the easy compares because of the pandemic. And so we're talking about something around 60% probably. And then strong growth in Q3 and in Q4, on average. The full year will probably be in the low high teens in the -- sorry, in the high teens kind of growth profile.