ITT Inc. (ITT) Earnings Call Transcript & Summary

Hi, everybody. This is Mike Halloran with Baird. Thanks again for joining us at our 51st Annual Industrial Conference. We really appreciate it. This presentation is obviously with the ITT team. We have Luca Savi, CEO and President; Emmanuel Caprais, CFO; and you can't see him, but he'll be talking to us. And we also have Mark, who heads up IR and helps with a bunch of stuff there as well. This will be mostly a fireside chat. Luca is going to do some prepared remarks after I get to this opening here. If you have questions for the fireside chat, either use this chat format and they'll come to me, or just e-mail me directly at [email protected]. With that, Luca, floor -- no. With that, Mark, the floor is yours, and then we'll hand it over to Luca. I think -- maybe we can...

Mark, you might be on mute.

Yes. Well, what...

I'm sorry, Mike. I'm here. Can you hear me now?

Yes, we got you, buddy. All yours.

All right. Really great. Sorry about that. Today's remarks may contain forward-looking statements that are subject to certain risks and uncertainties, including comments related to company performance, strategic priorities, business mix, market conditions, the effects of COVID-19 and ITT. These statements are not a guarantee of future performance or events and are based on management's current expectations. Actual results may vary materially due to, among other items, the factors described in our 2020 annual report on Form 10-K and other recent SEC filings. ITT is not under any and expressly disclaims any obligation to update forward-looking statements whether as a result of new information, future events or otherwise. And with that, I will turn it over to Luca.

Okay. Thanks, Mark, and thanks, Mike, for having us. Let me start with a brief -- very brief introduction about ITT. So ITT is a diversified engineering and manufacturing company, making a component for niche and, many times, harsh environment applications. We supply critical components to industrial, transportation and the energy market. When you look at ITT, you see the spread, the geographical spread, and we will look at the numbers for Q3 in a second. But let me tell you what ITT does because all of our lives are touched directly or indirectly by one of ITT's product. I always like describing this part of ITT because it makes you really touch who ITT is. So for instance, when you're spreading Nutella on a slice of bread to give to your son or to your daughter, and your daughter gives you that chocolate filled toothy smile, chances are that, that Nutella was moved with our Bornemann twin screw pump technology. Or when you're looking in awe at your unborn child's image, chances are that the connector transferring the data is an ITT Cannon connector. Or when you're driving on the I-95 or on the highway or on Autobahn in Germany and you need to brake suddenly, chances are that it's ITT brake pad that are keeping you safe. So as you can see, ITT enables everyday's life in unexpected ways, and we do this while driving outstanding value for our shareholders. So let me quickly share some hard facts on Q3. If we move to the next slide, please. So what you see is organic revenue growth, 16% organic revenue growth, 20% in Motion Technologies working in automotive and rail, 70% revenue growth in connectors. And with our Friction brake pad business outperforming the market by more than 1,000 basis points, and this has been the case for the last 9 years. Adjusted segment operating margin of 16.8%, plus 20 basis points versus 2019. And then the adjusted full year EPS guidance between $4.01 and $4.06, which is once again 6% above 2019 at the midpoint. And this despite all the headwinds. If you're talking about the unprecedented mess that the supply chain is in our industries today, and -- but the most important thing that I would like to highlight is really the 27% organic orders growth, and that strength is across the board, if you're talking about our connector business, if you're talking about our Motion Technologies, you talk about rail, automotive, or if you're talking about our short-cycle business in our pumps and valves or in projects. If we can move 2 slides down, Alex, please. I would like to spend the last minute to talk about capital deployment. So regarding our capital deployment philosophy, the first way that we deploy our capital is really inorganic, organic investment. This is where we have the best return. This is the safest way, and this is where the money goes first. Second is in M&A, and that we'll cover in a second where are we focusing on M&A. And here, we have a very rigorous process, both strategic rigor as well as financial rigor to ensure that whatever acquisition we are making, we are creating value for our shareholders. And last is dividend and share repurchases. What you see here is a $620 million deployed year-to-date in 2021. You see the share repurchases, you see the dividend that was increased 30% in 2021. Share repurchases was more than $100 million year-to-date. You see the CapEx. And what is relevant to know in 2021 is the divestment that we were able to do of all ITT legacies asbestos obligations and with an indemnify for all pending and future legacies liabilities. So now with this behind us and with a strong balance sheet, we can really drive M&A activity. We recruited the Bartek Makowiecki as the Senior Vice President, Strategy and Business Development, and we are definitely driving M&A, driving the funnel, driving the cultivation, the expansion of the targets to close the M&A, which is our focus in the next few years. And with that, I will stop here and pass it over to you, Mike, for Q&A.

Great, Luca. Thanks a ton for that overview here. That's actually a good dovetail on where I want to start anyways. You hired Bartek, you got rid of your asbestos liability. That really does free you up from a risk profile perspective to be able to go after some of these targeted initiatives. We'll talk about the organic next because I have a couple of questions there. But from an M&A side, does the philosophy change from here? Are you willing to be a little bit more aggressive than history because the asbestos is no longer there, balance sheet in a good spot? And how should we think about what those targets might look like?

Sure. No, if -- to be honest, Mike, I would say that when you look at M&A, we have been slower than we anticipated. Now this is why we invested in Bartek. We brought in the capabilities to really focus more on the cultivation, on the targets. And therefore, now we are going to be even more focused with this more investment in M&A. I would say the rigor is going to be exactly the same. The rigor, both strategically and from a financial point of view, that will have to stay, would always have to stay. But we definitely have a different momentum, different energies and different capabilities. Now when we look at where we are going to deploy our capital from an M&A perspective, I would say rail is something that we've always discussed. We like rail. We think that with everything that is happening from an environmental perspective, rail will benefit. So the macro trends are behind. Rail has also got a 60% -- between 50% and 60% of the business in aftermarket. So it's a good mix. So here, we have a platform of roughly $200 million that we want to expand to $600 million, $700 million, working on components on the bogey on the energy absorption. So rail will be a good business for ITT and a place where we're going to invest money organically and inorganically. That is also on the pumps and valves. Here, we are not planning. I always say we're not planning to be a big consolidator. But this market is very fragmented. There are many good companies out there that could be part of the ITT family. And therefore, here, we are modeling more, adding small- to medium-sized company in valves and pumps that will enable us to keep on creating value in our pumps and valves business. And last but not least, CCT, where we're making components in aerospace and connectors. So this is a business where if you look at connectors, we had -- we are already performing very well. We're already better than pre-pandemic level from a profitability point of view and also from a growth point of view. But this is a business that can gain from scale and from enlarging our product portfolio and technologies. So connectors is an area where we will invest inorganically. And interesting enough, our corporate venture connectors is the first area where actually, we made our first investment.

And when you think about the valves and pump side, is the idea to diversify away from some of the traditional markets, obviously, versus some of the public peers, you have more chemical and industrial of a base, and that's really where you've had your best profitability? Do you see yourself moving more in that direction, maybe towards life science, some of these other applications, different sizes than you currently have? I mean what's the vision as you think about building that out?

So when we talk -- when we look at pumps and valves, we're already in valves, already well exposed to the bio pharma and therefore, that will keep on expanding. It could be organic and inorganic, absolutely right, Mike. Now when you look at the pumps side of the business, obviously, we are working in terms of expanding our product and looking also inorganically at everything that is going to happen from an environmental point of view, if you think about hydrogen and all the investments that are happening in there. But let's not forget that it will be quite a lot of the investment happening also, we believe, on the oil and gas in terms of we will be at the beginning of the growth cycle if you think about LNG, for example. We won many engineering-only orders in 2020 for LNG programs. This was the strategy we adopted in 2020. So when many of these projects were practically frozen, our strategy is, well, let's win the engineering-only orders so that we have better chances when this program will come live to win these programs. And therefore, there will be investment happening in there, and we're well positioned to take advantage of this growth side.

Makes sense. Let's shift a little bit towards margins and how you think those track over time? I suppose I'm going to take this in 2 tranches. One, I think there's the idea that over time here, you expect some significant margin improvement across the portfolio. Why don't we start there? How far in this journey do you think you are? Because it's been going out for a period of time here. You've been -- you've had elevated CapEx to drive both growth, but also a much better operational footprint, operational flow, et cetera, organizationally. So maybe frame up those investments and what it means on a forward and how much is left in that journey and kind of ignore the short-term supply chain inflation type pressures, and we'll talk about those second?

Sure. Well, one element of our culture, and it's funny that you mentioned this, Mike, because we had our townhall after our Q3 earnings call with our 10,000 employees in the last couple of days, last night to cover Asia and this morning to cover the rest of the world. And one way to look at our strategic priorities, our results, is one dimension of our performance culture, which is proud and never satisfied. And therefore, I think that when you look at the results, you're right, Mike. I mean we made a lot of improvement that if you think about our margins in IP. We started in 2017, which was in the mid-single digit, and we set a target of 15% plus. For the last 4 quarters, we've been able to achieve that, right? And therefore, this is something that we need to celebrate and recognize. The margins in Motion Technologies as well in the automotive business are unique, okay? Very difficult to find that level of profitability and unique value creation. And then you think about connectors, our level of profitability is comparable to some of our largest competitors, and this is after the pandemic. So definitely a lot of progress. But the one thing I can tell you is that every time Emmanuel or me visit the business, go to the shop floor or participate with key sales review, we came out halfway happy about all the improvements that we have made. And there is the other half of us, which is really eager and to drive the improvement that we see, the opportunity that we still see in that shop floor, in that program, in that project, in the way that we are executing that R&D program for reasons. So definitely, there is -- there are opportunities out there across the board. If it is in rail, if it is in automotive, if it is in connectors with more automation in the Nogales side, for example, under the component side and also pumps and valves. Emmanuel, do you want to add anything to that?

Yes, I think that we have had over the years a very detailed road map of what it takes for us to improve margins. And I think that here, what you hear is that we've been disciplined during the past 3 to 4 years in implementing this, whether it is in material cost reductions, in VA/VE, in footprint optimization or in basic cost control. And I think today, ITT is today, as Luca mentioned, is very different from where it was in 2017. We have a CCT business that has per quarter $20 million less dollars in terms of revenue, mostly aerospace, and it is already very close to pre-pandemic level at 17%. And so when you think about it, in 2023 and 2024, when aerospace come back, that margin is going to be benefiting very positively from that aerospace revenue. We have a Motion Technology business that today, as you mentioned, is hedged by raw material price increases. But I don't think that over the long term, this is an impediment for further progress from a margin standpoint. And then you have an IP business, which has been solidly around the 15-plus percent operating margin. And as we have explained, there are many opportunities, whether it is VA/VE, whether it is footprint optimization to continue to drive the progress we make. So we are very optimistic in the margin outlook for our businesses.

Yes. One thing that my team and I struggle with a fair amount of this whole balance between -- we think there's a healthy cycle ahead of us. But the last 10 years really weren't a particularly good industrial cycle. It was far more of a cost-centric cycle. And so there's going to be a lot of companies that probably need to figure out how to balance funding growth and funding capacity and making all those decisions while still managing that margin profile effectively. I look at ITT, and I think you guys have basically been doing that for the last, what, 5, 7 years. And so you're going to be uniquely positioned here, I think, once we can get past some of the short-term stuff to be able to both see margin expansion while still being able to fund those things appropriately because certainly feels to me you have a little bit more muscle memory associated with that than a lot of other companies.

Yes.

Yes. That's fair, Mike. And if I think about a couple of examples on that one, making a little bit more tangible. I would say if you look at Motion Technologies, 10 years ago, 9 years ago, it was just a European business. So in 2014, 2015, we opened China, and our market share there was 0. And today, it's above 25% in just a few years. So we invested in the growth, the new plant, new lines, et cetera. And then in 2018, 2019, we invested in North America, where our market share was a single digit, low single digit, in a new plant in Silao, we invested for the growth, we captured the way at the right time. The time was very well chosen. And our market share today in North America is around 25%. So we were able to feed that growth. And the same is with the DAV investment that we had in IP.

And I would say, Mike, this is a very deliberate approach. When we look at the results on a monthly basis, on a quarterly basis, obviously, we're very happy with the progress that we've done. But we always are looking out for us to be able to continue to invest to generate future longer-term growth. And so this is an emphasis that Luca is putting a lot with our teams, not only to look at the current performance, but also prepare for the future.

That's helpful. Let's turn just into the shorter-term conversation there. I mean I've covered you guys a long time. So I remember when you guys went to China for the first time with the brakes business. And in my -- I mean, I guess I was covering before ITT split up into 3 pieces. In my tenure, I don't remember you guys have a good price on the Motion or the Friction side of the business. There's a little bit of a new paradigm because of how sharp the inflation has been here. So maybe help walk through how you're thinking about the balancing of that, right? Obviously, everyone's feeling supply chain inflation here in the short term. It's going to certainly linger through the fourth quarter. How do you guys see that balancing out for your portfolio? When do you start getting back to that normal ITT type parity? Is this a 1Q, 2Q type timeframe? Or do you think it extends a little bit further?

So let me frame it, and maybe, Emmanuel, you add to that later. So first of all, when you look at the 3 different businesses, you have a business in IP, pumps and valves and the CCT connectors, where you have distribution, short cycle, et cetera. And in these 2 businesses, we do have pricing power. And for 2 of the 3 businesses, you have the pricing power, we can act on that and this is good, and we see it. Now you have some pricing power also when you're talking about, for instance, the rail business, too. The biggest challenge from a pricing power is, as you rightly said, Mike, is on the automotive business. And this is true. I mean if you look -- this is a paradigm, our salespeople, the automotive salespeople, our sales, our entire automotive organization for the last 20 years have known only one way, which was a work on efficiency every year and give price every year. And now you have to shift the approach. And this is something that we discuss in the townhall today. This is something that we're discussing regularly with the team every day, and we have seen some improvements on this one. So for instance, Q2 Motion to prior is automotive, Motion Technology was already price neutral. In Q3, we were -- our price was positive by more than 100 basis points. This is the first time ever in the history of Motion Technologies. And we expect that to be better in Q4. Now still, I would say, when you look at Motion Technologies, is not with cost and price, we are not neutral. We are not still today getting everything that we should get. And therefore, this is a journey, a journey where you are educating your organization and your sales force and you're also working with the customers to shift their mindset too. Okay. So we believe that this is a world that needs to continue to happen in Q4 and is a world that needs to continue to happen and continuously improve also in 2022. At least for the next few years, I think if the world is going to be an inflationary world, this is the way that we need to work, and we will continuously improve quarter after quarter. The supply chain is a completely different discussion, I will say.

Yes. Anyone who tells you they know when the supply chain is going to get figured out or if somebody is probably making a guess more than anything, it's going to take time, right? I mean, you underinvest in it for 10 years and you try to get as efficient as humanly possible over that timeframe. You're going to have these periods of absorption that you're seeing right now, and it's been magnified by everything else. So let's stay on the Motion side and specifically on the Friction piece. The out-performance lately has been absolutely tremendous. And it's been broad-based, right? It's in the traditional side, but it's also in some of the emerging areas within the auto landscape. So let's start by just talking about how you think these wins inform the out-performance potential over the next chunk of years here? Because it certainly seems like you're building with all the wins, a nice, consistent paradigm for market out-performance for a very long time.

Yes, sure. This is key, Mike. I think that you hit the nail on the head. And this was actually one of the very first shift that we did in ITT 10 years ago. And everybody was focusing on the revenue metrics, on the financial metrics, et cetera, when the key is really the award. This is really what you need to work on, is the award. Even if the award that you win today is going to be an order in 2 or 3 years from now, because this is when you really start the production. The SOP, the start of the production of the platform is 2 years, 2 to 3 years after the award. And this focus of the award is really what is feeding the market share gain. So the one beautiful aspect of the Motion Technology of the Friction automotive business is the visibility that you do have because the award that we win this year give us the visibility of the production of our share, market share gains that 2 or 3 years from now. And this is why we can comfortably say that we foresee us continuously outperforming the market in the next few years because we have seen all our rewins, the platform that we were in, that we rewon. We saw that we conquer new platform, where we weren't present, and we conquer also a platform where the competition was in. So this will keep on feeding our market, our growth of the market, our outperformance. Fair to say that when you look at 2021, our outperformance has been simply outstanding. There are 2 components to that, Mike. I mean one is pure market share gain, and this is credit to the team, credit to the friction team who really won well and delivered perfectly. There is another component, which is the mix. And on this one, let's face it, maybe on this one, we got a little bit more lucky because as the OEM have shifted production more to their more profitable model, these are where we have our higher market share gains, where we have better presence. And therefore, we've got a double benefit. But let me elaborate why we are so confident on the outperformance in the future is the EV. Electrification, I call it during the earnings call, is our springboard for our future growth in Motion Tech and Friction. Exactly like the copper-free brake pads has been a way for us to differentiate and win further market share, EV is going to be the same. Why? How is going to work? First of all, our win rate on EV award is considerably higher than our market share in industrial combustion engine.

I think you went on mute there, Luca.

Can you hear me now?

Yes. We got -- the last thing we heard was industrial combustion engine, and we probably missed about 10 words, so pick up where we left off.

Okay. Okay. Sorry about that. It's the connection. So what you have is that, first of all, our win rate in EV is much higher than our market share that we have today. So we are going to grow faster. But then it's the EV and the hybrid adoption. If you think about in 2021, of the 75 million vehicle produced, 20% are hybrid or EV. It's going to be more than 30% probably in a couple of years. It's going to be more than 40% in 5 -- in 2025. So you see that the segment of hybrid and EV is getting larger and larger, and it's almost like a compounding effect for ITT. So the segment that is going to go the fastest is the one where we've got the highest win rate. So this growth will really compound, and this is what we see the outperformance growth in the next few years.

Makes sense. And then how do you think the auto market then plays out here over the next period of time and specifically going into next year? Obviously, you've got a lot of supply chain challenges that are impacting that industry. You guys have done very well relative to it. My suspicion is it might take a little more time for that industry to really get back to full run rate than maybe some people are thinking, but I'd love your thoughts. You're always very on top of these things.

Sure, sure. So what you have today is a market which is really at the bottom. If you think about it, in 2017, 95 million vehicles were produced in the world, and that market dropped to 21% to 75 million vehicles in 2020 and probably is going to be roughly flat in 2021. So we believe that we are at the beginning of the growth cycle. It's going to take a few years to go back to pre-pandemic level. But look, when you look at the Friction business, our business is higher than the 2019 pre-pandemic level this year in 2021, while the market will get to that level in 2023 or 2024. So once again, we -- when you look at the market, we are at the bottom, and we believe there is -- we are at the beginning of a growth cycle, which is going to be good for us and EV is going to grow even faster. And then despite the decline, we are already at a pre-pandemic level, and we are beating that in 2021. So our performance is the key.

Well, great. Well, we really appreciate it, Luca, Emmanuel, Mark from -- even though I know you're not on the screen. We're unfortunately out of time, and we leave applause for you over here. Hopefully, next weekend, personally, you get some real-life applause. So -- but either way, I appreciate it, gentlemen. Very, very well done. Presenting next here, Session 1, IDEX Corp; presenting on Session 2 is American Woodmark; Session 3, ATS; Session 4, Silgan; Session 5, Trinity Holdings -- I'm sorry, Trinity Industry; Session 6, Diversey; and Session 7, TuSimple. Thanks, guys. Appreciate it.

Ciao, Mike. Bye, everybody.

Thanks, Mike. Appreciate it.