ITT Inc. (ITT) Earnings Call Transcript & Summary

Okay. Next up we have ITT. ITT is a diversified manufacturer of highly engineered critical components and customized technology solutions for the transportation, industrial and oil and gas markets. The company's portfolio includes brake pads, shock absorbers, pumps, valves, electrical connectors and aerospace and defense components. Joining us today from ITT are CEO, Luca Savi; CFO, Emmanuel Caprais; and Vice President of Investor Relations, Mark Macaluso. Luca was named CEO of ITT in January 2019 after previously serving as COO. He first joined the company in November 2011 as President of Motion Technologies segment, where in 6 years, he drove an approximately doubling of segment revenue and 400 basis points of segment EBITDA margin expansion. Emmanuel was named CFO of ITT effective October 2020, first joined the company in 2012 as segment CFO of Motion Technologies, working alongside Luca, later added responsibilities as CFO of the Industrial Process segment. Mark joined ITT in January 2021 as Vice President of Investor Relations after more than 12 years at Honeywell in financial leadership positions, including Vice President of Financial Planning and Analysis for one of Honeywell's 4 strategic business groups. ITT has 83 million shares outstanding. The stock trades around $91, $7.5 billion market cap, $103 million of net cash, $7.4 billion total enterprise value. Luca, Emmanuel and Mark, thanks so much for joining us today. I can turn it over to you for any introductory remarks, so we can launch right into the fireside chat.

Good afternoon, Brett. We can go straight into Q&A, if that's okay with you.

Excellent. So since we're at the pump, valve and water system symposium, why don't you start with your pumps and ballast business, your Industrial Process segment? We've seen your pump business on the project side really accelerate, 74% growth in Q4. Can you talk about some of the end markets, both in the U.S. and internationally that ITT is capturing that growth in?

Sure. So when you look at our pumps portfolio and our pumps business, we are playing across the board. And what we have seen in the last few years is us capturing shares across the board if it is in general industrial, if it is in the chemicals and petrochemicals and oil and gas. And this is true across different regions. So if it's North America, Middle East or Asia Pac. So that is across the board, right.

Yes. And also with the industrial process, Luca, the margin improvement there has really been dramatic. Since you guys turned your operational focus to that segment. Segment operating margins up over 300 basis points last year. Is the profitability momentum sustainable now that projects are starting to become a larger portion of that business? And if so, what initiatives have you undertaken on that side of the portfolio?

Yes. We think it is. So we communicated at our Investor Day that our long-term target in terms of profitability for this business is 20%. And this is independent from the mix. So it's true that when you look at 2023, probably the mix will change because the projects are expanding, and we have a very good mix of opportunities in there. Having said that, if the mix may reflect a headwind, we have plenty of opportunities to offset this headwind and overcome this headwind. Let me give you a couple of examples. One is our product development vis-a-vis that we do on the products is the leaning of our factory -- major factory, Seneca Falls. And let me give specific examples on that. Last year, we communicated the closing of the foundry in Seneca Falls. This is a process that if you want to do it properly without impacting the market and the customers, it's taking a couple of years. So we will end the closing of the foundry in Q1 2024 or by the end of this year, and that will benefit immediately our cost competitiveness in this business. So we will keep the momentum. We will keep on improving towards the 20% EBIT margin.

Great. And maybe discussing the valves portion of the portfolio, it's smaller but growing nicely. Can you talk about the key end markets that ITT is exposed to there both, I guess, legacy ITT and then through the recent acquisition of Habonim?

Sure. When you look at the legacy valves business, that is roughly $100 million business. And the big market for us in valves is the pharmaceutical and the biopharma. This is an area where we have some strength. We have a very good customer intimacy. We have some unique products and some intellectual property, some IP, and we're able to differentiate ourselves from the competition. Now when you look at recent acquisition Habonim, a valves company based in Israel, they are playing across different markets in terms of if it is on the energy side, if it is on the chemical side, is on the hydrogen. And this is one of the areas where that we really like about this valve business. And I must say it's been a great acquisition because we bought that company at a 12% -- 12-12 multiple. And when you look at the actual of 2022, the multiple is something between 8% and 9%. It has been positive both in terms of orders, revenue, operating income, cash. It has performed better than what we expected.

Excellent. And maybe moving over to Motion Technologies, the largest segment of the company today. Can you talk about the 78 new electrified vehicle platform awards you won last year? Where ITT sits in terms of market share in that part of the business today and where that could trend over the next several years as these platforms ramp up?

Sure. The market share is different for the different regions. We have a very high market share, very healthy in Europe. The market share in China and in North America, where we made investment in new plants, respectively, in 2014 and in 2018, is approaching now 30%, the high-20s. So because of that, of course, our outperformance of the market would probably be a little bit less than what we have been accustomed to for the last 10 years. But a possible tailwind to this outperformance is exactly your saying electric vehicles, not just EV but also hybrids, what we call electrified platforms. When we look at the 78 platforms that we won is substantially higher than what we won in 2021. And another key indicator, important number is that our win rate in electrified platforms is today much higher than the current market share that we have. So this may represent a tailwind to that outperformance. And this is also why we say that electrification is good for ITT. It's good because our electrification is accelerating. And therefore, there is a high growth in automotive electrified platforms. And on top of that compounding that is our win rate, as said, is substantially higher. So for that reason, we are confident to say that we will keep on outperforming in the next few years, the market.

Great. And maybe along those lines, can you help us think about how the characteristics of electrified vehicle platforms tie into the brake pad product with those vehicles being heavier, potentially the brakes wearing out more rapidly and how that could impact the aftermarket portion of your business and generally kind of the aftermarket outlook in the 3 major regions that piece of the portfolio operates in?

When you look at the impact of electric vehicles to electrified vehicles, hybrid, there is no such a big impact when you talk about the OEMs in terms of the OE platforms. But you might have a negative impact on the aftermarket because even though the vehicle is heavier, as you rightly said, Brett, it's also true that in an electric vehicle, you're using the brake as much less as you are using regenerative braking. So here you have -- when you're talking to the OEMs, you've got 2 different schools of thought. You have a Tesla, who really have 0 service business today and therefore, decided to add brake pads for life or you may have a German OEM who has a very healthy and profitable service business, replacement business and might want to keep it. And therefore, may decide that, okay, those breaks pads that we make them half thin, much thinner, half thick what they are today so that they keep their service business. So I would say exactly how it's going to work in the aftermarket, it's too early to tell, and maybe it's going to be a mix of both. It's fair to say though that for this dynamic to impact the car park that is out there today, the aftermarket, it will take quite a few years, more than 10, 15 years. So the aftermarket, we will see in 15 years, the impact more or less. When it comes to the OE, I would say the only thing is that probably because the vehicle is heavier, then the brake pad is has to be a little bit larger, bigger to have a larger breaking friction surface. And this will require more material. And therefore, the price of a brake pad might be a little bit higher on an EV or electrified platform.

Great. Maybe rounding out with the smaller part of Motion Technologies, your rail platform overcame some headwinds last year with the exit from Russia. Can you talk about your outlook for your rail business this year? And what role acquisitions could play in growing that piece of the portfolio going forward?

Sure. The rail business in Motion Technologies is really made of 2 companies. It's KONI making shock absorbers and Axtone acquisition we made in 2017 that make crush buffers and that works both across passengers and freight. Now our KONI business is a very nice profitable business. It's growing nicely and is in high teens in terms of EBIT profitability. When you look at Axtone, this is a business that suffered the most because 25% of our Axtone business was actually our Russia business. We have a very nice profitable business in Russia that we suspend completely and that impacted that heavily. Despite all of that, the team, our leadership was able to shift and to recover some of this 25% business in Russia with more passengers business in the rest of the world. So that the decline of Axtone in revenue was only 12%, 13%, same in orders, and we're able to close the year still profitable, even though less than the year before. Now we have opportunity to grow organically because of our products and differentiation that we have with intellectual property as well as our performance in terms of on-time delivery and quality. And because this is quite fragmented industry, we are still looking at acquisitions in the rail portion, always close to the bogey, always close to the energy absorption, always close to what we know and know well.

Terrific. And moving to your third segment, Connect and Control Technologies, which is about half aerospace and defense. Can you help us think about the major platforms you're on from a commercial aerospace and military standpoint and kind of the growth outlook for those pieces of the business going forward?

Sure. So if you look at the platform in Aero, we are on the 737 MAX. We are also on the wide bodies. It's fair to say that probably a lot of our products are in the wide body. And therefore, this is the reason why we see the growth in our aerospace business to come a little bit later with some lag in terms of time. We are in -- we are working also with Bell and Sikorsky for their FLRAA program. So we had a solution for Bell, a different solution for Sikorsky. So we know that one way or another we will be on that platform. And one thing I would say is that if you look at the performance of CCT, is quite good if you see the profitability and the recovery, if you think that we are still probably 20% below the pre-COVID level when it comes to aero and defense.

Great. And the last piece of CCT, the electrical connectors. Can you talk about how you guys have gone about developing the EV charging connectors business and the outlook for that product line going forward?

Yes. Yes. Thanks, Brett. So I think the -- we were early in the game and we had a whole range between AC and also high-power charging. And so we developed, over the years, a lot of really good relationships with those EPCs in charge of installing those charging stations. And then a couple of years ago, we invested heavily in renewing our product portfolio for those EV connectors, including super high, high charging connectors. And so right now, we're rolling out our third generation for those products, AC and hypercharging -- high power charging. And so as a result, we're getting a lot of customers, for sure, a lot of volume because this is a segment that is really growing exponentially. And in fact, we grew orders in 2022 by 100%.

Excellent. And Luca, you touched on the resiliency of CCT margins. Can you talk about some of the structural and process-related operational improvements you've had underway there and kind of the runway for profitability in that segment?

Sure. It's interesting because it was in our Nogales factory in terms of connectors a few weeks ago. And one strategic thing that we are doing connectors and we've done some in Nogales is really to look strategically at our make and buy. If you look at the connector business, what is strategic for us to make and when you decided to make it, where you're going to make that. And believe it or not, but in the past, ITT made a decision that we were not going to make -- we're going to outsource contracts. Well, guess what? If you are in the connector business, contacts are strategic. So it's important for you to have it in-house, at least 70%, 75% of your production. So we are doing more in-sourced and buy machines to making the contents, which will reduce the lead time, will make us more cost competitive. And the same is on plating. And in Nogales, Mexico, we had a new plating line that we opened a couple of years ago that we are running with very good quality, reducing the lead time to the market, but also improving the quality and our cost competitiveness. Those are a couple of examples that are in action now. Another thing that we are working hard is to automate, to increase the level of automation that we have on the assembly of these connectors because we have a very good performing factory in Nogales. And -- but traditionally, probably the company went in Nogales because of cheap labor. Now I think that for quality reasons and also to put through the factory much more volume, much more connectors, we are investing in automation on the assembly line, and this will generate more throughput to the factory and better profitability as well.

Great. And Emmanuel, you've spoken about the significant opportunity ITT has on working capital this year, the potential to nearly double cash flow in 2023. Can you help us think about what the main drivers of that will be?

Yes, you're right, Brett. So if you think about working capital, we already made a significant improvement in Q4 and mostly around collections. And we're going to continue that effort. And so we keep a lot of focus on that with the teams, making sure that our customers are paying us on time and making sure that we avoid in future value. Inventory is a big brand for us. We increased inventory by $100 million in 2022. And some of it is because we wanted to protect our customers. Some of it is because we had supply chain issues like a lot of people. And some of it is because our supply chain performance was not good. And so we're going after very methodically. We're going after all these elements of the inventory in order to improve our working capital. And we feel that in 2023, we could be able to generate a little less than $400 million of free cash flow.

Excellent. You all started to deploy more of that cash flow, $420 million deployed on bolt-on M&A and share repurchases last year and still coming into this year with an excellent net cash balance sheet. I guess can you talk about your focus areas for any additional acquisition activity, how the landscape looks in terms of sellers' expectations and deal availability?

Sure. So when you look at our -- at ITT, I think that we have demonstrated the ability to execute to grow organically. And one area probably where we could be more active than M&A. Now to contextualize thing, what was important for us to do is to transfer all our legacy vessels liabilities, something that we did in 2021. And now with this behind us, I would say we can focus more on the M&A front. Habonim has been a great acquisition, as I said before, exceeding all our targets. Now where we are active in cultivating across mainly 3 aspects. One is the connector side of the business that we covered before, and the second one is pumps and valves. Like Dave said, our IP leaders say, we love pumps. And so pumps and valves is an area that we are really paying attention to from an inorganic perspective. When it comes to the second part of your question, expectation from the seller, I would say, yes, they are adjusting a little bit, but I would say a little bit. So we have to be very, very rigorous, not only on the strategic portion of the fit, but also on the financial aspect to ensure that we create value at the end of the day.

Okay. And on the organic new product development front, any update you can provide on ITT's unique smart pad technology where -- in terms of where that is in commercialization?

Sure. So what -- with the arrival of Bartek Makowiecki, the new Head of Business Development and M&A, we have started a kind of venture initiative, both venture capital external to invest in some venture external to ITT, but also to run internal ventures on some key innovations like the Smart Pad or the EMD, the Embedded Motor Drive in IP. So we have a restructuring -- not restructure, reorganized in a way that these are run outside of the business. We have a product on the Smart Pad. We have 2 projects going on currently with different players in automotive and not only in automotive. And I would say, in the next 2, 3 years, we will be able to see if this is able to take off. The EMD, the Embedded Motor Drive is a new technology and intellectual property that we have developed together with the University of Nottingham is proprietary to ITT. And this as well is a venture. We have prototypes. We are installing these prototypes in Q2 with our customer, with 10 of our customers. And hopefully, these will be launching in 2025.

Terrific. On the pricing front, within your Motion Technologies brake pad business operates in a sector not historically known for pricing power, can you talk about the approach you've taken with your customers to start seeing some realization there?

Well, it's an interesting question, yes, got just one answer because it has been different with different OEMs, has been different with different Tier 1s. I can tell you with some Tier 1s, some OEMs, just ensuring that you've got your facts, all your information, be very factual going there well prepared, enabled us to get to an agreement to a fair and square negotiation pretty quickly. There are some others where it took 8 or 9 months. It was almost like a birth. So in some of these negotiations, you really have to keep on pushing because you find some resistance on the other end, almost like dealing with an insurance, no, no, no, no, no, until you keep on pushing, you keep on motivating. And because of our performance, which has always been more than 99% on time deliver, even these despite the supply chain mess that we were facing. Our quality, which is less than 1 ppm. So less than 1 part per million defective at the customer side, we've been able to negotiate even in these long-term agreements, some recovery in terms of price. Having said that, 2022 was negative in terms of price/cost equation. But from what we learn and from what we see and the negotiation we are running now, we count on being price/cost positive in terms of dollars in 2023 in Motion Technologies.

Excellent. We talked about some of the investments you're making in Nogales, Mexico on the CCT side, helps address wage pressures. Can you help us think about other investments in automation you're making across the footprint today?

Sure. That is something that keeps on happening also in China. So both on the Motion Technologies front, but also in Shenzhen, our connector business. The aerospace and defense as well is an area where we're investing more in terms of automation. And also when you look at IP, in some cases, we're looking at some automation. But the efforts when it comes to IP and pumps is more on the lean of the [ shuffler ], lean in the factories, in the way that we are really making and assembling our pumps or our valves.

And so in terms of automation, if I can ask, it's -- obviously, a lot of it is going to create productivity, and we -- and that's going to help us offset some of the inflation and expand margins. But some of it we're doing also is to create capacity. For instance, on EV, we see such a huge increase in demand that we have -- we want to make sure that we are able to respond to that demand by increasing the capacity and automation is the good way to do this.

And Emmanuel is talking about the EV charger connector in this specific example.

Yes.

Terrific. You've also made some investments recently in -- to improve your environmental footprint. I think they also come with some cost advantages at a couple of your sites. Can you discuss some of those?

Sure. So we have worked really hard since probably 2017 to really streamline our footprint. A lot of it has happened in ITT. And recently, in IP, we closed a couple of sites. We consolidate one site in Brazil, for instance. And then also, we consolidate some of them in Europe. That has been really beneficiary for us. And so we go in IP that has been also one of the drivers of the margin expansion. Now if we look at MT, our Axtone business also had historically, this is a business that we purchased in 2017, a lot of German sites. And so what we've done is we -- in several steps, we closed one of our German sites and moved all the production to Poland, which has allowed us to expand margin, and that was before the conflict in Ukraine, which has really significantly impacted, as you know, the Brett our Axtone business. We do have further opportunities. And so we're constantly looking for ways to streamline our footprint.

Excellent. There's no other questions from the audience. I'll ask one more on the technology front. Your i-ALERT system continues to gain traction. Can you give us an update about how much of your installed base and competitors' installed base that is instrumented on and continued versions of that you're rolling out?

So what I can tell you is that the i-ALERT system that we're selling, so obviously we're selling those devices, and they go to a lot of different pumps. We had a really large contract with one customer to equip all the pumps that they have on their pipelines. And historically, we don't supply in our pipeline market. So those were all competitor pumps. And I think that from this point of view, it's going really well. We're also working with several large oil and gas customers. But I would say, for us, what's really exciting about the i-ALERT is the fact that we are able to sell subscription services, thanks to the predictive maintenance capability that we can offer to our customers. And so I think that customers really appreciate the fact that we can help them with machine uptime. We can help them with efficiently running their assets, and they don't have to go pump by pump to get the data because we are able to pull the data directly from the pumps and put them on the cloud, and they can have a dashboard in front of them of how all the pumps are going, how is the temperature, how is the vibration and as a result, with our predictive maintenance in our vibration engineers, we're able to help them avoid downtime.

Excellent. With that, I think we're bumping up against time. So Luca, Emmanuel, Mark, thanks so much for joining us. I know you're traveling. So really appreciate you being with us today.

Thank you.

Thank you.

Thanks, Brett. Thanks, everybody. Have a good day.