ITT Inc. (ITT) Earnings Call Transcript & Summary

Good morning, and this is day 2. I'm Andrew Obin, Bank of America's Multi-Industrial Analyst. And I'm absolutely delighted to have with us management team from ITT with Luca Savi, President and CEO of the company; and Emmanuel Caprais, Senior Vice President and CFO. We also have the IR team in the audience. And look, I think what really differentiates ITT from peers, if you just go back over the past 2 years and see whatever operating KPIs you want to pick, margin, revenue, cost takeout, ITT consistently came out on top in a very competitive sector with terrific management team. This team has really shined over the past 2 years. And as I said, it's an absolute delight to have Luca and Emmanuel here. And I think Luca is going to present some slides and I think Emmanuel is going to read a disclosure, and then we're going to go to a fireside chat. Thank you.

Thank you, Andrew. And so first, let me remind everyone that our presentation and comments may contain forward-looking statements, which are based on our best view of the world and our businesses as we see them today. These assumptions and expectations can change, and we ask that you view them with that in mind. We encourage you to look at our latest risk and uncertainties in our Form 10-K. Thank you.

Thank you, Emmanuel. So good morning, everybody. And let me start telling you a little bit about ITT. So ITT is an engineering and technology company. It's a manufacturer of components, components not systems that work in harsh environment in transportation, being auto, rail or aero in the energy sectors or in the broad industrial sectors. So let me give you a couple of examples. So if this morning, you were driving to London on the M4 and when you were using your brakes, chances are that those brakes were ITT brake pads. If your daughter or your son this morning had some slice of bread with Nutella, chances are that, that Nutella was pumped with our twin-screw pump technology from our Bornemann pumps. Or when you looked at your -- at the image of your unborn child, chances are that, that connector is an ITT Cannon connector. So what you see is that ITT touches people's lives in many different ways behind the scenes. And we do that every day and creating value for our shareholders. So we are well spread across different geographies, as you can see from the slide, more than 30% in the aftermarket, more than 35% in emerging markets. We were talking about creating value. So let me share with you some of key highlights for 2021. I will now go through the slides. But I think that the bottom line that also Andrew was explaining is the strong execution. The strong execution which is the base of everything. And if you look at 2021, for example, we surpassed 2019 pre-pandemic level when you look at EPS or when you look at operating margin. And if you think that our -- the sectors that we'll be working in, which is automotive or aero or energy, are sectors that have been impacted in the last couple of years. And that now they are at the start of the growth cycle. And you see -- because you see it in the orders. The orders in 2021, the strong demand being in auto or in aero catching up or in connectors or also for our pumps and valves. So a couple of things to share about the -- what is happening in terms of -- what is going to happen in terms of 2022 growth priorities. Of course, it's the electric vehicles and our win rate in the electric vehicles market. I'm sure that we're going to cover that later, but not only electric vehicles but also the internal combustion engine. We outperformed the market for the last 9 years by an average of 900 basis points. At the base of everything that we do, there is, of course, execution, but also innovation. So if you think about an example, all the value analysis, value engineering activities that we're doing in our pumps and valves business as well as in the connectors, this is the base -- one of the base of the rejuvenation of all our product portfolio in those 2 businesses. And of course, the deployment of capital. In 2021, we deployed more than twice our free cash flow. And we were able to transfer all our legacy asbestos liabilities to a subsidiary of Delticus. And this has probably been one of the most strategic deployment of capital of ITT. So with that out of the way, now we can really focus our capital, not only on organic but also in inorganic opportunities. So we were talking about innovation. So let's talk about -- give some examples. We talk about electric vehicles. Every time there is a technology change going on in the market, we're able to capture market share. And this is what is happening in electric vehicles. As I said, probably we will talk more in detail later. In our pumps and valves business is the i-ALERT. This is taking advantage of the digitization that is happening in this market. And with our tool and more than 13,000 rules, we are able to facilitate the diagnostic and remote diagnostic for our customers. And then electric vehicles again for what it comes with the connectors, if you think about all the infrastructure that is going to be built. And we are working with many companies on the connector side for electric vehicles, too. Emmanuel, I'll pass it over to you.

Yes. Thank you, Luca. So looking at Q1, what we're seeing today. So demand for our product is strong. We continue to see pump project growth in the high double digits. And obviously, we intend to take full advantage of this dynamic in order to capture more value on those pump projects. Short cycle is also strong. Today, we're seeing growth in the mid-teens versus 2021, and this is driven mostly by aftermarket. Our connector demand is especially robust across the board, and we're seeing really strong gains in OEM in Europe and in North America as well as in distribution. Aerospace orders are also accelerating versus prior year, and we're seeing delivery dates that are now in 2022. So orders for 2022 with delivery days in 2020. Auto production globally is down in the mid-single digits. This is in line with our expectations. And this is mostly driven by Europe and North America, which are still recovering and are still impacted by the chip shortage, but we continue to outperform the global auto production, especially in North America. Pricing recovery is very difficult. Although we made significant progress, it is taking longer than expected. And this is mainly in our Friction business. We're focusing on 2 to 3 OEMs, and we're trying to get them to recognize inflation that is not just the steel inflation we've been talking about, but also labor, energy and freight inflation, and it's taking longer than expected. It doesn't help also that the raw material prices are highly volatile in order to establish productive negotiations with our customers. And then finally, from a business update, the dollar has been strengthening significantly versus the euro. And obviously, this is stronger than our assumption. Our assumption for the euro to dollars was 1.13. Today, it's around 1.09. And so that negatively impacts our MT business from a translation standpoint. If we move to the macroeconomic situation, unfortunately, it's not trending in the right direction. We're facing the same difficulties than a lot of the different companies that are in the same business as us. We have closed down our business operations in Russia temporarily and we estimate that the impact of disclosure from a revenue standpoint is around for the -- on a full year basis around $55 million to $75 million. This is higher than what we discussed last month. But at the time, we focused on Russian operations. This number now includes all the sales that we are making to Russia even coming from outside of Russia. The war in Ukraine continues to have many implications that are not obviously fully developed yet. And supply chain could be further impacted as we've seen in the auto business, for instance, where the auto production was impacted by components coming from Ukraine. The supply chain, overall, the situation is not really improving, especially for our Industrial and Connector business. But we are working really hard to make sure that we focus on what we can control. So for instance, in some of our industrial facilities, we stopped some unnecessary activities in pumps. We were -- we continue to pay stainless steel components. We got rid of that so we can accelerate our internal processing time. We redesigned also some of our assembly processes to cut on the cycle time. And also, we moved some of our production from make to -- order to make to stock so that we can further reduce the lead times. But this is an uphill battle, for sure, compared to the supply chain challenges we are facing. So another thing that we are focusing on what we can control is capital deployment. So we've been repurchasing shares very aggressively in this environment, especially given our valuation. And we're very confident that we will execute one or more deals in 2022 from an M&A standpoint. So with that, let me pass it back to Andrew for Q&A.

Yes. So thanks so much. And for everybody in the room, feel free to ask questions. And also folks online, feel free to ask questions on Veracast. So let's just sort of focus on longer term. Over the next 3 to 5 years, what do you think are the platforms that will drive market outgrowth for ITT? What do you see as structural trends that are positive for ITT's end markets?

So if we look at the next 3, 5 years, I would say, if you look at the industry, the sectors we are working in, we are early in the cycle. So think about aerospace. Emmanuel was just talking right now about what we are seeing in 2022, and those will keep on happening, will keep on growing in the next few years. This is -- therefore, that is on the positive side. If we think about our pumps and valves, we all love to talk about the energy transition, but energy transition is going to take some time. So I think that the business of the pumps and valves in the energy sector, I think that will be positive for the next few years. We were talking about the LNG investment and our engineering on the orders that we can't bring in the last couple of years, all those orders will come to fruition. And then rail. Rail, we believe in rail. We have a good platform in rail. Rail is a push by the macro trend, so being passengers of freight. And last but not least, also automotive. Automotive is early in the cycle. If you look at the last 4 years, the automotive production went down from 92 million to 75 million vehicles produced every year. So roughly 20% down. Now what is amazing is that in those 4 years, our automotive business actually went up 21%, going back to the outperformance early in the cycle as well. So all of those sectors will be positive for the next 3 years.

Great. So you did highlight in your presentation EVs. So could you talk about the structural trends in ITT's own strategy to drive electric vehicle growth? And how is the per vehicle content different from the traditional internal combustion engine platform? And maybe I think there's always confusion as to why you have been able to outgrow, it's been like this non-controversy, controversy about your ability to absolutely crush your market share, for lack of a better term, in brakes. So maybe first, you can explain to people what it is you're doing different from your competition and why you're running circles around them? And second, if you could talk about what differentiates EV technology from internal combustion engine and what opportunities it creates for ITT?

Okay. All right. It's going to be a long answer. So try to shut me up, okay? So first of all, how we -- why we differentiate, why we are winning, why we are outperforming, it's not just one thing. It's not just 1 silver bullet, there are many, many aspects. So there is a cost element to it. If you look at our competition to make the same number of brake pads, they might have, let's say, 15 plants. To make the same number of brake pads, we have 5 plants around the world. Now think about the cost structure, the efficiency that you can run it if you only have 5 plants versus 15. So that is one on the cost element. The other element is that when you go to our plants, 5 plants around the world, China, Mexico, Europe, it's the same technology. It doesn't matter if you're in China or Mexico where the cost of labor is lower, we went with the same level of automation, with the same technology. So when you have to transfer something, it's going to be easier. It's a copy and paste almost. When you're bringing a BMW customer to Europe and then it comes to the plant in Wuxi, China and he or she sees the same technology, you can see them relax, okay? So this helps you winning. We were talking about the level of automation. The level of automation, you go to our plants, you see in Barge, the bottom of the Alps in Italy, you will see probably 500 robots and 120 people. So level of automation, which means better quality helps winning. So all of these, we have created reinforcing loop. And because we are able to be success also financially, we will keep on reinvesting in the business, in R&D. And R&D is also another strength in terms of the material science, the tribology that happens between the material of the brake and the rotor when it breaks. So all of this is the reason that have helped us outperform the market consistently and win against the competition. Building on the EV. We are really excited about the EV and I would say, electrified vehicles. It's not just the electric vehicles, but also the hybrid and because it's going to be good for us. It's going to be good for ITT. First of all, we're talking about automotive is in the early phase of this growth cycle. Then what you have is that EVs will grow even faster. And then our market share in EV in terms of awards won is much higher than our market share today that we have in the market. So we're going to have a compounding effect, and this is why we are confident that we are going to keep on outperforming the market for the next 3 to 5 years.

And is content different or what?

Yes. So -- and content is not exactly different. But I think the value proposition is different and this is where -- which is why we're able to win. If you look at an EV, it's heavier compared to an ICE vehicle. It also uses the brake pad less, so the rotor gets rusted, so their dynamics with excessive vibration. And I think our ability to propose a solution that addresses those characteristics that are linked to the EV, while maintaining the level of performance that we have on the other platforms, is what makes us more successful every time there's a technological change. We lived through this with a copper-free brake pad, where we're able to significantly increase our market share, and we're doing the same thing with the electric vehicle.

Got you. No, that's a great answer. Thank you. So maybe we can switch to oil and gas. And has your outlook for oil and gas CapEx spending shifted given the ongoing Ukraine/Russia conflict? We did sort of talked a little bit about LNG, which was coming back actually. We had a dinner back in December and even then we started seeing green shoots on the LNG side. But just based on your conversations, what type of project spending are O&G customers making? Have you seen an increased focus on brownfield projects around emissions reduction related to issues of sustainability commitments, increased productivity, so near term and longer term?

Okay. So I think that when you look at the projects and when you look at the oil and gas, I think that we start seeing the activity picking up as we were discussing already towards the end of last year. Now I wouldn't say that because of the conflict unfortunately that's happening over here in Europe that I've seen things accelerating, but I would expect so. Because some of these projects, of course, are long in the making. It's going to take time. What we have seen is that some of the big projects being the LNG, et cetera, we are talking more about those, that the funnel of opportunities is larger. But some of these big projects have not been awarded yet. So they will be awarded probably in the next 3 to 9 months. And now there has been more talking about the flaring and our twin-screw pump technology, which is good for Nutella, it's also good for eliminating flaring, because it's multiphase pumping. So when you have a well and we have an agreement with an oil producer, instead of having the well, extracting the oil, separate water, oil and gas and you flare the gas, which is bad. Actually with our multiphase pumping, you can pump oil, water and gas together for the next 50 or 60 miles to a station where you separate and then you recover the gas. So this is going to be good for the world. It's going to be good for ITT.

And just a question, as you have -- this is a bit of a debate we're having internally, when you talk to your customers in oil and gas industry for the next 3 to 5 years, do you see some thinking about CapEx differently, maybe thinking more about efficiency versus just growth, right? Is there a change in thinking? Or we're still, look, we have the CapEx budget, right? Because you will think between ESG, between sort of increased focus on return on capital in the industry and energy transition, you would think they would think about sort of sweating the existing assets harder, but I'm not sure if you would see that in real conversations yet.

Yes. So I would say from my experience, it depends on the region. So it depends in some countries in North Africa or in the Middle East versus the U.S. And therefore, you have different conversation if you're getting the asset, et cetera, that's one thing. And I will expect with the macro environment that, that might also shift, what's happening might shift a little bit.

But I would say, Andrew, it's fair to say that we've had more than in the past conversations with customers that are asking us if our technology can help in mature fields already because you face a decremental pressure, right, in the well. And our technology, especially the Bornemann technology is able to address this and to prolong the life of existing wells.

Got you. That was great. So next is aerospace recovery. What's your base case assumption now for the aerospace recovery? What will be the mix benefit to CCT when aerospace fully recovers? And I think one other question was, can you keep up with what Airbus and Boeing want to do?

So our expectation is that we're going to see a full recovery towards the end of 2024. We're seeing some green shoots in 2022. We think it's going to take some time to go back to pre-pandemic levels. But by the end of probably 2024, we should be in that situation. For CCT, it's going to be extremely positive. CCT has -- is the business that has the highest incremental margins of our 3 businesses. And aerospace within CCT is also the segment that has the highest incremental margins on CCT. So I would say that it's going to be very beneficial. I think in terms of capacity, we invested in the capacity in our plants. And so we still have the capacity of pre-pandemic levels. We will need to ramp up the level of staffing in order to operate those equipment. But I would say that we feel we are well prepared to handle the demand -- the incremental demand that is coming our way.

That's great. So maybe Industrial Process. So the Industrial Process backlog was up 21% year-over-year at the end of '21. What are the type of long-cycle projects being booked in the backlog? And how do you expect backlog conversion to play out in '22 given extended lead times? And always a question on double ordering and cancellations.

Okay. So when you look at the projects business, in 2021, the short cycle business was strong. So if you look at the backlog that we had in our short cycle business probably has been the highest that has been for the last 6 or 7 years. So this, I would expect all of that backlog to be converted into revenue usually to happen in the next 3 to 6, 7 months. Now projects started to come back towards the end of last year and therefore we start seeing the backlog of projects increasing again. And that is, I would say, across the board. We saw it in industrial, we saw it on the pulp and paper, we saw it in the chemical and in the oil and gas. So now going back to your -- the second part of the question, which is the supply chain, it's really a mess out there. And I think that when you look at IP, it's probably the business that has been impacted the most by the supply chain mess worldwide that you have. Why? Because if you're buying casting, for instance, out of India or out of China, well, you will have to face the challenges of -- that it might have because of labor shortage or because of the COVID situation. When you sort that out, then you need to find a container that is the next bottleneck. And then when you sort out the container, then it's the ship that is stopped on the -- before unloading. And then it's the truck drivers. So what you have is IP. You've got all these bottlenecks on the chain that you have to overcome. So the lead times have been extended by some of our suppliers. And I would say that we are monitoring the aging of our backlog. And so far, I can tell you that we've been able to manage the critical projects, the critical delivery and the critical customer so far so good.

Excellent. So maybe we can pivot a little bit. You did provide an update on your supply chains and COVID and China. But maybe how do you think about -- it was very interesting that you guys provided an update on sort of Russia impact. And what was interesting to me is that for those who know, you guys are as much in the weeds of your business as any management team out there. And it's interesting that you guys like had to provide an update on your Russia exposure, which probably means everybody else has to take a second look at their books. But how do you think about second and third order impacts of what's happening in Russia and Ukraine? And not necessarily direct exposure, but second and third tier suppliers impacting supply chain, this is sort of cascading and trying to assess what this means a couple of months out?

Yes. So the impact that Emmanuel was sharing is, I wouldn't say it's easier to figure it out, but it's your Russian business. Your Russian operation, when you are selling in Russia from different countries. And as we have suspended temporary our operations, we know how much that is going to hurt us. Now everything that you're saying is unfolding right now and it's much more difficult to really grasp in its entirety, okay? So we'll start seeing the volatility. Why? Because if one of your OEMs, being Volkswagen or Daimler or Renault decided that because of that, I want to -- I need to reschedule because I'm not selling or because I'm not getting the electric -- the harness from Ukraine, you start seeing these kind of things unfolding right now. I think it's too early to really understand exactly the full impact of this. Sorry, I don't...

No, thank you. No, no, no, but...

But I think, if I can just provide an example, like, for instance, you've all heard the -- this wire harness supplier in Ukraine that is putting at risk the entire supply chain in Europe. And so when we look at our demand, we look at it every day. And then all of a sudden, one week for the other, we lost $8 million of revenue in our friction business. So not everything is an impact for us because we have contingencies, we look at different plans. And that business has been shifted to June so far. So our customers are telling us, we don't need it right now. We're probably going to need it in June. But it's so volatile that it's very difficult for us to manage our operations because we are in the business of mass producing brake pads. And every time there's such a big change -- we're not used to week-over-week changes. And every time there's a big change, we have to reschedule completely our production. And this is a lot of inefficiencies.

No, it's fascinating to me because as I said, you are relatively small. And any management team I look at, you guys are really down at the factory level. So the fact that you're figuring it out is -- still figuring it out is very telling that I think the industry is just not there yet. It's just my personal rant. But so maybe we can talk about a supply chain strategy. Given what's happening in the world and maybe COVID, but now with Russia, how has your supply chain strategy evolved given the new operating environment? Are there opportunities to flex your cost structure, use old source suppliers? And how has in-region supply chain manufacturing helped or hurt you? And where is it going longer term?

Okay. So what we have been trying to do is, of course, trying to solve one bottleneck at a time, being very much in the weeds that you were saying, but also look at strategically in terms of, "When I solve this bottleneck, what is going to be the next one, right?" So of course, we have a global supply chain, and we are working trying to make it a little bit more resilient. What does it mean? It means that if you're buying your casting, as I said, from China and India, then you need to strengthen also your relationship maybe with those 1 or 2 strategic foundries that you have also in North America, in Mexico or states so that you have almost like a backup plan, right? So I think that some of the globalization, the global supply chain in our view is there to stay because it's more efficient in that way. Having said that, counting only exclusively 100% on that, I think this is what is changing. And therefore, having more of a resilient and some backup option at home closer to where you're producing is something that we are working on.

So maybe I'll combine the sort of the price/cost question and self-help opportunities. How do you think about the levers that you can sort of pull internally in this environment? And -- so that's part one. Part two, how do you sort of lock in prices in a world where there's extreme volatility in commodity prices? So how can you control what you can control in this environment?

Yes. So the levers -- I mean, we're very much -- what's important and what Luca said is that we're obviously very interested in the specific micro dynamics but we'll also take the time to step back and to understand what are the more strategic implications. And so for us, while we're trying to solve one supply chain crisis after another, we're also very much focused on improving the fundamentals of our business. And for us, the fundamentals is how do we operate safely in our factories, how do we improve quality, how do we improve delivery. And as a result, how do we improve cost. And so what, right now, our efforts are both trying to get the casing from India that we're not able to get, but also how can we make sure that in our facilities, we continue to improve those metrics. And so how do we reduce cycle times to make sure that we improve the delivery of our customers. How do we solve the warranty issues that we got a couple of weeks ago from our customers and make sure that it doesn't happen again. So how do we look at root causes. And that has been really the work that we've been trying to do, being able to split our time between solving the crisis, but also making sure that the business for the long term, produce sustainable performance.

And going to your second point on the pricing, it's a challenge. Think about it, if you have sold -- if you work in automotive for the last 30 years, and you're dealing with your sales force, they've never been trained to get price, never in their entire working life. So what you have to do is on one side to be empathic, to understand the challenges they need to face in terms of they really need to change the way that they've been working. Coach them, give them the training, train them with -- the one thing that we did is with coach that was training the purchasing manager of the OEMs. And then at the same time, is breathing on their neck all the time because you need to ensure that, that negotiation is brought home. So trying to balance that is a challenge, and we're doing a relatively good job on that one. Now you raised another interesting point, which is in such a volatile environment, I mean, do you want to stick a price right now for the entire of 2022? No way. So you really need to close on it. That's the difficulty why it takes a little bit longer, because you want -- which is an oxymoron, you want to close the negotiation now with the customer for what it might be Q1 and Q2 maybe that you don't want to close it with the price of the H2 because we don't know what's going on. It's too volatile. So you need to put in place mechanism that are protecting you in the short, but they leave you the door open for the medium term.

And I guess in the remaining couple of minutes, you used to have the asbestos liability. It's no longer there. You have a clean balance sheet. You've sort of -- I think you've indicated you have $2 billion of opportunity. What are your capital allocation primaries and it's a good problem to have over the medium term? And what type of strategic acquisitions, if any, are you considering? Maybe you talk about the markets, regions and what are you seeing.

Sure. So yes, that asbestos is out of the way. So the priority in terms of capital allocation, of course, is organic investment. This is where we got the best return. It's less risky. We know exactly the business and we got wonderful returns. So this is where money goes first. Second is on the M&A front. And when you look at inorganic opportunities, the 3 sectors that maybe I'm sharing with you today are -- we talked about rail? As I said, we like rail. Macro environment will be good and a nice aftermarket visibility for the long term. So this is an area where we are planning to invest inorganically in the Industrial Process. In pumps and valves, it's another area where the market is fragmented, where we can replicate our playbook that we are doing with our Goulds Pumps with the acquisition. And also the Connectors business, this is a business that we really like where we are operating nicely and we can do even better. Now size, everything between $20 million, $30 million to even $300 million, $400 million of revenue. So the name of the game here is flexible. It might be a company that is a turnaround, and therefore, you need to use pure hard work to turn it around. And -- but you are creating value because of the turnaround, you're paying a little bit less, but you created value in the turnaround to a company that fits strategically, very well run. And therefore, you might end up paying a little bit more for that. So we are flexible on that front. But those are the sectors that is the size and very focused on that. Last but not least, is repurchasing shares that goes without saying.

I think this is a great way to end. Thanks so much for being here. I hope to have you back. This has been fantastic. Thanks so much.

Thank you.

Thank you, Andrew.

Thank you.