ITT Inc. (ITT) Earnings Call Transcript & Summary

All right. I think we're ready to get going with our next presentation. We're excited to have ITT with us here today. We've got Emmanuel Caprais, the CFO; as well as Mark Macaluso, Head of Investor Relations. I know that, Emmanuel, you've got some prepared comments, so why don't I turn it over to you, and we'll get to Q&A after.

Yes. Real quick on the safe harbor, just a reminder that, Emmanuel, my comments may contain some forward-looking statements, which are based on our best view of the businesses in the world today. And you can look at all the risks and uncertainty in our Form 10-K and other recent SEC filings on our website. So with that, I will turn it over to Emmanuel.

Thank you, Mark. So good morning, everyone. So first, I wanted to run through a couple of slides, referring to what we presented during our Q1 earnings. And so what we see out there was a really strong and supporting demand environment. And that we've been -- on top of that, our businesses have been outperforming versus those markets, specifically in the auto sector, in the connected sector and also in the industrial with pumps and valves, industrial process. The conditions are difficult. Conditions are difficult. We saw that in the first quarter, in the first big part of the quarter, we had significant labor shortage issues. Those have improved along the quarter and now almost back to normal. We are facing some issues especially in China, but it's more our customers rather than us. And then obviously, supply chain. Supply chain has not improved during the quarter and it's still not improving in Q2. So this is obviously a difficult environment. And for us, the focus is to execute on our playbook. We have also accelerated capital deployment. We've done almost $200 million of share repurchases. We purchased Habonim for $140 million. Habonim is a specialty valve supplier, very complementary to what we're doing in our industrial process valve segment. And we have a lot of activity. We have a new Head of M&A, and we have a lot of activity for the rest of the year. And then finally, we're maintaining our guidance. Obviously, it's a little bit more challenging on the margin rather than on the revenue side. But for the moment, there is a path to the midpoint, even though we're saying that we're -- most likely, we're going to trend more towards the lower end of the EPS guidance. So if we look at the demand, as I mentioned, really strong, especially in IP and CCT. And IP is our pumps and valves business, very strong on projects and very strong on the short cycle. So everything that is baseline, everything that is service, aftermarket really, really strong. Obviously, we're benefiting also from the price increases that we passed in 2021 plus a second price increase we passed in January and then one that's going to come in April as well. In terms of CCT, the aerospace is starting to recover, which is very positive. Connector is a super strong business. It's been very strong across 2021, continues to build on that strong performance. We are gaining back share also in terms of our connected business. And in Motion Technologies. Motion Technologies continues to outperform the market, albeit in a situation that's pretty difficult because of the supply chain issues with the chip shortage. And now the China situation where I mentioned that our customers are having some difficulties. We're able to operate through that environment, but it's on the demand side that is more weak. And then we continue to gain a lot of market share with electric vehicles. We won 15 new platforms in Q1, and that's building on an already very strong 2021 performance. So I'm not going to go through all this, but I want to just talk a little bit about capital deployment. I mentioned that we purchased Habonim, which is a great valves -- specialty valve supplier. They have a very unique proposal where they've been able to really standardize the core of their product and then do a late-stage customization for their customers, which allows them to simplify a lot of their supply chain and simplify a lot of their production process while responding to the customers' requirements. They have patented and proprietary technology called Total HermetiX, which guarantees no fugitive emissions from their valves. So given that they play in the cryogenic -- the hydrogen field, that's obviously a differentiator for them. We did significant repurchases, almost $200 million in Q1, and we have plans to do more also. So overall, I would say Q1, we came in, in line with our expectations. We continue to see super, super strong demand for our products in Connect and Control Technologies with the return of aerospace; in IP also, pumps and valves. And we continue to outperform with Motion Technologies. We're focusing on driving fundamentals because this is what has made the success of ITT. And so we're very focused on making sure that we drive a lot of price recovery because it's going to be -- it's key for our long-term profitability. And we're making some good progress. So yes a challenging environment, but I think what's going to differentiate for us is the execution.

That makes a lot of sense, Emmanuel, lots of jumping off points there. So you mentioned supply chain not really getting much better in 2Q, but I really kind of want to focus your commentary on China, right? And specifically, how that's impacting your business. I think for auto production, specifically, I think you guys have talked about a market forecast of down low single digits. And so provide some broader commentary on what's happening in China for you. And then also how that's impacting your friction business.

Yes. So China, for us from the beginning, has been more of a demand challenge rather than an internal organization challenge with one of our sites in Shenzhen was down for 1 day, and we got the authorization to open back up the next day. And our Wuxi business, our Friction business has not been down. What we're seeing is that our customers, and we have a lot of customers that are in the Shanghai area. So if you think about SAIC, if you think about Shanghai Volkswagen, all those guys, they have difficulties ramping back up, opening up for production. And so we're seeing that they have trouble maintaining the level of production they had that has hit us in April. I would say it's pretty much in line with what we were expecting. But I think that for me, we're seeing a little bit of an improvement, but we're now back to where we were prior to lockdowns. What we focused on, again, was to make sure that we provide the logistical support to our people so we can maintain a closed-loop organization where they don't get in touch with external parties to -- and put them at risk of being infected. So we're able to continuously produce. Our customers, obviously, they're much bigger entities, organizations and so it's more difficult for them. And so they have trouble maintaining that. That's why you see a lot of touch and go. So a lot of -- they start back up and then they lock back down. So we're focusing on supplying our customers. So far, we've been very successful. I think we're very attentive to our employees and, hence, providing them logistical solutions is part of our model to make sure that we continue to see supply here.

That makes sense. And I guess, just maybe more specifics around that, Emmanuel. Like how -- what was your China auto business, up or down in the first quarter?

So our China business was up roughly in the low single digits. And so for the first quarter -- I would say, for the full year expectation that China, as you mentioned, is going to be down low single digits, mid-single digits. And then we're going to be up similar to what we've done in Q1, where we were high -- up mid-single digits, low single digit.

Okay. And then look, the China story for you guys has been such a good story, right, where you basically were 0 less than 10 years ago, and it's -- you now have about north of 20% of the market share.

29%

29%, okay. So look, you have very good visibility into your platform. So this is more just a transitory issue at this point, like -- and there shouldn't be a lot of concern beyond once when things open up, correct?

Yes, that's right. So we've been focusing a lot on gaining market share, and so it shows. We've gained, I think in the past 2 years, we probably gained 10 percentage points of market share in China. And that has been on the back of all those awards, including electric vehicle awards that we've gained and that are now starting in production. Actually, we were looking at the -- what the customers are forecasting in terms of the start of production for this year. And they are actually ahead of schedule, which is different from what we've seen in the past where, in China perennially, those people were pretty much late to what they were expecting. So this -- China is very strong for us. This is a market that we've been performing really well. We are focusing on what makes a difference, which is EV, and also premium applications where we can really make a difference. We don't play too much in the small delivery vehicles that they have -- they produce a lot in China. And I think that customers recognize the value we provide. We even started to get interest for our products from an aftermarket standpoint. And so this is something that we're looking at because China historically has been an OE business, original equipment. And so being able to develop that second leg, that aftermarket leg for us would be really interesting, especially given the fact that it's coming directly from an interest from the customer.

I want to come back to the EV aftermarket story in a little bit. Just to be -- just to wrap, put a bow on China for a second. So the facility in Shenzhen, I believe, is a connector facility just outside of like the Friction business today, you're not seeing much disruption across.

No, no.

Okay. And then Russia has been a moving target.

Yes.

So maybe discuss a little bit how Russia is impacting your business, where it's impacting your business and whether you feel confident in the new -- I think it's $60 million to $85 million, if I remember it correctly, the revenue.

That's right. That's right. Yes. So Russia has been a developing situation. So it's been tough for us to kind of quantify what has been Russia, especially because we've seen really 3 impacts. The first one is what we deliver directly to Russia. And so here, we have the IP business, which is our pumps, mostly from the oil and gas business. Then we have our Axtone business, which delivers a rail, rail parts for mostly freight in Russia. So that was one impact and it was a direct impact. There was 2 indirect impacts. The first one is what we supply to customers in Western Europe who then supply to Russia. And then so this, we had a little less visibility on this. And so it was really tough to quantify because, to some extent, we don't necessarily know where our customers are sending our products. And so that has proven to be an impact. And then the last portion that we really didn't see coming was the fact that there was a bunch of suppliers, OE suppliers located in Ukraine and Russia, shipping their products into Western Europe for Western Europe production. And that production has been severely impacted because, you all know about the Ukrainian wire harness supplier. Ukraine also produces 20% of the world neon production, which is used in electronics. We knew that. We didn't -- so that has impacted our customers. And so if they don't have a wire harness to produce a car, for instance, they don't need to break that either. And so I think that this is not lost production, but that has impacted us. And then you know the validation times for -- in the auto, it takes several months. So before they find a new source for those wire harness or other components, it's going to take a little time.

Sure. That makes sense. And then like the $60 million to $85 million, you feel like it's pretty well ring-fenced at this point? Or...

We feel that, that it is. I wouldn't guarantee it, but I think that this is the best estimate that we will come up with.

That makes sense. I have to talk about price cost. So inflation exceeded pricing by, I think, $0.29 this quarter. And it seems like you're baking in, call it, roughly $50 million or so in inflation for the rest of the year. But the price/cost equation, if I calculated it correctly, it seems like you're pretty neutral throughout the year. So help us just maybe kind of understand, number one, am I -- do I understand it correctly from Q2 to Q4? And then the second question is clearly like the confidence in the $160 million to $180 million in price that you discussed?

So for Q1, we had a little bit more than 150 basis points of margin impact between price inflation and productivity on our margin, negative impact. If we look at the second quarter, we expect that it's going to be more or less flat. So we're going to be able to compensate with price and productivity the cost inflation we're seeing. And then in the third and fourth quarter, this is where we're also going to be able to compensate, maybe catch up a little bit of what we didn't -- weren't able to get in Q1 and in 2021 as well. So when you think about the cost inflation impact, it's a little bit more than $50 million more or less per quarter year-over-year. And then with the $160 million to $180 million that we're planning to get from customers, we would more or less cover that inflation. We will be still a little bit down. But I think the expectation is that the second half for sure is going to be stronger in terms of price recovery than what we've seen in the first half.

Yes. And so going back to the -- what -- some of the math I did, like it seems like you got about $65 million or so in -- of the $160 million to $180 million, so call it like you have $100 million left to get. Talk a little bit about the conversations you're having with your customers. I know they haven't been the easiest customers to negotiate with. So whatever visibility you can provide us, that would be great.

Yes. So I would say, in general, customers are never happy to get price increases, but the OE customers in auto are really against that. I think what we're seeing is that our OE customers have been able to increase prices in 2021. They've been able to get nice margins out of that. And so now they're really focused on preserving those margins. And so they want -- they are rejecting a lot of the claims for cost inflation. So what we're focusing on is really making sure that they understand the value that we provide. And we believe that we're very much differentiated compared to the competition. We offer near perfect quality. Our quality record is 1 defect per million. So every 1 million part we ship, we ship 1 that is defective. And I don't -- and no other competitor in the BRICS segment can do that. We have 99% to 100% on-time delivery performance. And so we think that those are really -- and we provide innovation also. We provide products that have better performance. We provide -- we solve our customers more pressing issues. And so that has to go. And so we're very focused on making sure that they understand the differentiation that we provide. And then also, we're very transparent on our cost inflation that we're seeing. And we're not looking to make money out of this. What we're looking for is a share compensation forecast. And so customers have varying degrees of dealing with those issues. Some of them are very collaborative. Some others are -- I would say, they do not welcome these types of discussions. But I think that we have good arguments. And I think that right now, they may not have all agreed to price increases, but they are all at the table discussing. And so that's really important because in the beginning, in 2021 and also at the beginning of Q1, some customers didn't want to talk to us. And so we made sure that they understood that it was important for us to have those discussions.

I'm envisioning like a lot of email traffic back and forth.

Yes. A lot of Zoom conferences also. And so it's a challenge because we're a small supplier to them. And so sometimes they know us, but we're not on their -- very present on their mind. And so it's important for us to make them understand that we sell a product that is based on steel, copper and tin, which are the commodities that are -- that have seen significant inflation. And so they forget over time. They think that we're kind of immune. And so it's our job to remind them and to make sure that they understand.

Got it. That makes sense. I want to turn the conversation over to just guidance, to some degree. So you mentioned in your prepared comments that the midpoint of the guide for the year is still achievable, but that you're probably trending more towards the lower end. I guess just as you kind of think about it as the CFO and your approach to the guidance, I'm curious like why not just cut the guide at this point if the high end is probably unlikely?

So we see a path. We see a path to -- definitely to our midpoint. There's a lot of things that need to happen. Number one is price, we talked about this. Second one, we expect that supply chain and commodity inflation will start to moderate. So for instance, all the teams are very focused on delivering their budgets, which in the end, will allow us to deliver our guidance. So as long as we see a path, we feel that there's no reason to move to change the guidance. We're very much focused on delivering those numbers. it's going to require a lot of efforts, but I think that the team have delivered in the past and have proven that they can deliver. And then so it's no different. It's no different. The conditions are a little bit more difficult, but we still have a lot of confidence in our team and their ability to deliver our commitments.

So maybe just talking about the margins for a second. So I think your -- the margins are based on up 40 to up 130 basis points for the year. I think the first quarter was down about 150. Fully recognize the price/cost equation has to get better. But maybe just kind of provide a path what are Q2 margins supposed to look like on a year-over-year basis and then for the rest of the year? And how do we get there?

So let me get the good stuff out of the way, and I'll focus on. So IP and CCT, each of those business will sequentially improve. So Q2 over Q1, Q3 and Q4. Now we'll see significant improvement to the point that for the full year, IP and CCT will show margin expansion compared to 2020. A lot of things -- we're working on a lot of things. In IP, we're still working on improving the productivity. We have also launched 2 price increases, 1 in November of last year, 1 in January and then 1 in March. So several benefits. And so we should see a significant improvement starting in Q2 because we're going to get an improvement in terms of revenue. You remember that we mentioned that January was really terrible in terms of deliveries, a lot of impact due to the absenteeism. And that -- so that increased revenue in Q2 compared to Q1 should help us, and then we're going to continue to see build because revenue is going to get better in Q3 and then in Q4 as we are converting those strong orders that we have accumulated. And then in terms of CCT, strong productivity momentum and then aerospace demand is coming back up. And all the aerospace orders that we've been accumulating, we got a significant portion of them that are to be delivered in 2022. And that aerospace demand, when it comes, drops a really favorable, favorable incremental margins. So we're fairly confident in the margin profile of those 2 businesses. In MT, it's going to be a little bit of a step down in the second quarter, roughly 200, 250 basis points in Q2, less than Q1. And then we're going to go back up from that in Q3 and in Q4 as we're able to get price recovery. Q4 in MT is still going to be a challenge year-over-year because in last year in Q4, we really had strong margins. We had more than -- we had, I think, 19.7% or something in MT. So it's going to be difficult to overcome that. But I think there's a path as we recover price and we get -- you mentioned that $160 million, $180 million of price recovery, the majority is coming from MT. So as we recover these prices, we're going to see a nice margin ramp up in Q3 and in Q4 sequentially.

Makes sense. I'm going to open it up to the audience and see if there's any questions in a minute, but let's talk about EV for a minute.

Yes. There's not really a difference between our existing ICE business and then the EV margin profile, there's not really a difference. If you look at the ASP, it's a little higher than our ICE business. And the reason for this is because since EV are larger vehicles, heavier, the brake pads needs to be -- they need to be a lot bigger. So I think EV in general is very good for ITT, where I think we're handling the transition really well. We're facing the same competitors in the EV space as we're facing them in the ICE space. So there's no new competitor that are emerging. However, I think that the current situation is not helping our competitors. It's not helping us for sure. But I would say that given the difference we already had with our competitors where we're much more profitable than them, we're much better in terms of performance. The current environment is certainly not helping them. And so the step-up that is needed for EV, it requires a lot of investments. And then so we are obviously better positioned to make those investments because we remain still very profitable. Even though we have a lot of catch-up to do, we remain still very profitable. So we feel confident that we can negotiate that transition much better than the competition.

Makes a lot of sense. So I'm just going to open it up to the audience. If there are any questions from the audience, happy to keep going as well.

Could you just expand a little bit more on the nature of the supply chain constraints you're facing now and how that may have evolved versus 6 months across the business, right? Is it logistics? Is it shipping? Is it chips? Is it raw material availability, et cetera?

Yes. So it's everything, unfortunately. So transportation is difficult. So oceanic transportation is difficult. It's harder to find containers. It's also more expensive. And so this is a challenge that we have when we face for instance, when we have discussions with our customers, we're trying to negotiate freight surcharges with them because everything is more expensive. In our businesses, our motion tech business weathered the supply chain crisis better than other businesses. But we're now seeing -- we have been seeing in Q1 and also a little bit in Q2 some difficulties in terms of steel availability. And so steel, which was not so much of a headwind in 2021, has become harder to get. And then I would say from an IP business, IP is the one that has been impacted the most, industrial process. We missed more or less $30 million of revenue in Q1, and this was due to specific components. So motors, for instance, for our pumps. Seals for our pumps, they're hard to get. And so we're looking at ways for us to find other sources. It's not easy also to look at ways how we can standardize our motor offerings so that we don't have to go necessarily to customize motors, but see if we can offer our customers with a more standard version of motors that will ease the supply chain challenges that we're facing. So I would say that the supply chain issues have evolved. They were concentrated on IP in the beginning. MT, seeing some difficulties in getting steel, we're still negotiating -- we're still managing those challenges pretty well. And then now the challenge in supply chain is more acute on motors, on seals. So we're trying to be creative in order to make sure that we get those components so that we can supply to our customers. We've been very attentive to improve our lead times. And so the difficulties we've been facing with suppliers in getting the components, we try to offset them by accelerating the velocity within our plants. And so as a result, we worked on how can we do -- how can we get better? As soon as the components enter our facilities, how can we process them much faster so that the lead time to our customers is not impacted as much. And we've seen some pretty successful -- we've implemented some pretty successful strategies in order to get that.

Other questions from the audience? Perhaps while we wait, I've got another one on -- so interesting commentary earlier on aftermarket. And I'm just curious, like as you think about the aftermarket opportunity in China, I'm sure that setting up distribution in China is probably very different than in other areas of the world. So like how do you get after the aftermarket opportunity? And what type of investment is needed?

Yes. So we are -- one thing that has made us successful in our businesses is that we know where we're good at and we know what we don't know how to do. And so when it comes to aftermarket, we don't know how to market and we don't know how to distribute. So for us, what we do know is to produce really high-quality brake pads. And so what we've been focusing on is finding partners that can do the marketing and the distribution for us, and then we just have to produce those brake pads in large quantities and we just supply to them. This is something that we have done very successfully in Europe, where most of our aftermarket resides. We have an almost exclusive agreement with Continental, and we supply to them, I think, more than 90% of their brake pad needs for their aftermarket. They do all the marketing, they do all the distribution. And we're looking to replicate that in China. China is a much bigger market with really large production compared to even Europe and North America and probably growth rates in the long term that are going to be also higher than Europe and in North America. So it's important for us to find the right partner. But as long as we stick to what we know, I think we'll be successful.

Is there a margin differential in your European business on the OE side versus the aftermarket side?

So the aftermarket is more profitable, but the difference is not as high as you could think or as like in other businesses such as aerospace, where there's a major multiplier between OE and aftermarket. It's higher but not as much.

A couple of other quick ones from me. So Habonim, first time in a long time you guys can be as front-footed as you want to be, really, from a capital deployment standpoint. So just help us understand the strategic rationale behind Habonim and then also thoughts around additional M&A.

Yes. So Habonim is a company that we've cultivated for a long time. And then when the opportunity came, they came to us and they say, "Well, would you want to buy us?" And so we were able to negotiate an exclusive deal with them. They have a really strong track record for growth. Over the years, they've grown really fast. And they have really good profitability. And what they did, as I mentioned earlier, is that they worked on standardizing their product offering so that they don't have to buy so many different components and they don't have to organize the production of those different valves. And so as a result, they rely on very few versions of their valves from the core. So if you think about the valve, you have those maybe 4 or 5 components that are pretty standard and then you customize the rest. So you customize the end piping, you customize whatever the attachment and those type of things. And so they've been really successful at this. And so that was very clear for us from the beginning that this was a peer differentiator. And it was also an opportunity for us to reorganize our existing valves business, which is around $100 million without Habonim to develop the same characteristics that Habonim has. And so we're very excited with this because we think it's going to help us get better. They're playing also in markets that are really high growth. We mentioned cryogenics. We mentioned hydrogen. They're also -- in terms of end markets, they're in biopharma. So it's very, very interesting. And so we're confident that this is going to be -- they're very profitable. They're accretive in terms of EBITDA. They're accretive to our segment margin and to our overall -- to IP segment margin and to our overall segment margin. And so we think it's a really good addition, a little less than -- around 12x in terms of multiples, which is I think is very decent. So very good. And then for the future, what does it mean? We're looking at probably right now, seriously, we're looking at a dozen, dozen targets. And we have a specific plan. We have a new Head of M&A that came on board late last year, and he's doing -- he's implemented -- he has already recruited his team and has implemented his operating model, and it's working well. It's working really well.

That's great. One last one, and I don't want to steal all Mark's thunder, but Investor Day. First Investor Day in over a decade.

Yes. Oh, I know.

What can we expect next month?

I think it's going to be a lot of excitement. We're going to talk about technology. We're going to talk about our businesses and what's underpinning their success and their performance, and we're going to talk about financials.

Long-term targets?

We're probably going to talk about those, yes, even though I won't give any specifics, but I think that whoever wants to attend is welcome. And I think it's going to be very, very interesting and insightful.

Awesome. I look forward to it, and it was great seeing you guys again.

Thank you, Joe.

Thanks, Joe.