ITT Inc. (ITT) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome to the 18th Annual OpCo Industrial Growth Conference. Next up, we have the ITT team. Very happy to have CEO, Luca Savi; CFO, Emmanuel Caprais; And VP of IR, Mark Macaluso, with us today. Welcome, Guys.

Thank you for having us.

Thanks, Bryan.

We have 35 minutes allotted, which is a really, really short period of time to discuss your story. So I want to jump right in. I think for those a little less familiar with the ITT story or at least modern ITT, you could offer a quick background of your history post-spin, overview of your current operations and probably most importantly, what you think really differentiates ITT.

Sure. Thanks, Bryan. Well, when you look at ITT, we are an engineering and technology company. We are making components for harsh environment that are working in the transportation industry, in automotive, in energy, in aero, defense and general industrial. And when you look at really what differentiates ITT in the market, I would say, is really the way that we manage the business in ITT, which lead to a superior execution. If you think about Motion Technologies with 99.5%, 99.9% on-time delivery in the last couple of years when the supply chain was quite challenged, our quality with less than 1 ppm and the same will be on the pump side. So execution is really what differentiates us in the market. And of course, each business then will have some key elements that will have differentiated from the competition. And we can go deeper when we talk about some of these businesses, Bryan.

Excellent. So with that segment. With Motion probably your best known, business. Friction, in particular. What you were instrumental in scaling fine-tuning the platform? What are the key steps along the way strategic transitions made? What continues to differentiate Motion Tech and what gives you confidence in continued outgrowth into the future?

Sure. Motion Tech is really where me and Emmanuel came from. Emmanuel and I worked very closely together in turning and making Motion Technologies what it is today. I would say in terms of what have been some of the things that have helped us in building Motion Tech, the way this is today is the continuous investment in the business. I remember some of the discussions that we were having with corporate many years ago on the capital investment because we wanted to keep on investing organically in this business, which was the right thing to do strategically, was the right thing to do financially, because the return on this business are incredible. So the continued investment in this business, the continuous investment in R&D and innovation has been critical. And then, of course, the expansion that we went with is expansion in China in 2013, 2014. We opened officially our plant in China in 2013, 2014. And we went to China for the local market. We didn't go to China for cheap labor. And then the opening of our Mexican plant for the North American business, in Mexico in 2018. So the geographic expansion, the strategy to go in the region for the region, and also the strategy to go with the same level of technology, the same level of automation that is really differentiating ourselves as from the competition, both in China as well as in Mexico. I would say on top of that, it might be something really simple, but it's really sticking to what our strengths are and to make sound business decision, Bryan. And I think that this is what differentiated us from the competition. I think that this differentiation is also sustainable. Sustainable because it kept being fed by continuous investment for growth or for productivity, differentiation in R&D in product that the competition do not have and in intellectual property that the competition does not have.

That's very helpful. Given the auto-centric nature of the platform, it'd be great to hear how you heard teams thinking about auto production trends, the outlook for 2023 likely outgrowth of the ITT team in each of your key regions? And then preliminary look to 2024. Is there anything in terms of your win rate, the backlog, what's in the pipeline, assuming that platform production plans are reasonably is currently set? Anything looking to next year that would allow for accelerated outgrowth relative to this year?

So when you look at the production, the production of vehicles in 2020 was roughly 82.5 million vehicles. IHS is forecasting a mid-single-digit growth to 85 million, 85.5 million. We tend to be more conservative. We like to plan that way. So when we look at market growth, we think that probably is low single-digit growth, flattish in Europe and in China and probably mid-single-digit growth in North America, but that is the market. And then we expect to outperform the market by roughly 400, 500 basis points in 2023. Now when it comes to 2024 and the years to come, we are expecting the market to continue to grow. Think about it in 2017, in 2018, the vehicle produced were more than roughly 91 million, 92 million vehicles. And so the market is expected to keep on growing and be at this level in the late 20s. But think about it. We actually were above the 2019 level already in 2021. So while the market declined, Friction OE were able to grew -- were able to grow. And we expect outperformance to continue in the years to come. The reason why we expect outperformance to continue is because our win rate in electric vehicle platform and electrified vehicle platforms, so hybrid is substantially higher than our current market share in production today. So because of that, I believe that, that we keep on feeding our performance. So once again, if you think about the auto market, it will keep on growing. It's going to take a few years to go back to the pre-pandemic level, but it will keep on growing. On top of that, you've got electric vehicles where the growth is much higher, and compounding on that is our market -- our win rate in this electrified platform, which is substantially higher. So this is why I like to say always electrification is good for ITT.

Understood. And I wanted to put some more numbers to that in terms of the win rate that you have, the current EV mix for Friction revenue and where that's expected to go over the coming years? And in turn, we've historically thought of Friction's pretty consistently outgrowing more like 800 to 900 basis points per year. As you continue to increase share, you're obviously kind of a victim of your own success in terms of lapping figures. That's understandable. But as the EV production ramps and you are taking more and more of that share, could we see you get back to that kind of range?

Fair point, Bryan. I would say our, we said just because our market share gains -- think about it from 0 to 28% in China in 6, 7 years. I would say, from 0, from low single digits to more than 25% market share in North America. So as we grow market share, obviously, the outperformance is more difficult to achieve level like 800, 900 basis points that we've done in the last 10 years in the last 4 years. You rightly point out that actually electrification is something that can be a tailwind to that outperformance just because of the amount of platforms that we're winning today in the market. So we might exceed that number because of the electrification. But at this point in time, we were saying probably 2023 and 2024, will probably be an outperformance of 400, 500 basis points from what we see today.

Okay. Understood. Last MT specific question. Run rate margins are a bit lower than investors have come to expect from the segment. Can you detail the cost headwinds that you've faced? What led to that? What is, in essence, locked in for part of the year and how we should think about margin progression Q2 into the back half and perhaps resetting to what we think of is more of that normalized high teens plus range going forward?

Bryan. Let me address that. So in -- starting with the most recent stuff, in Q2, we expect Motion Technologies margin to improve versus what we've seen in Q1 and here, what is that work is better price recovery, especially in Friction as well as starting to see an improvement from a commodity standpoint. So we have booked steel, copper, a lot of our commodities ahead of time. And because we have done that, we have -- we are not benefiting immediately from the cost reductions or the -- let's say, the lower prices of those commodities as they're happening now. We expect that to build in Q2 and then Q3 and Q4. So there really -- there's a couple of things that you think about Motion Technologies in terms of the margin progression. The first thing is that Motion Technologies is a very commodity-centric business. So as a result, when steel, when copper, when tin, when all those materials have gone up in terms of price, that has impacted us significantly. And unfortunately, in this business, we haven't been able to get 100% coverage from our customers. We did get the majority of our cost covered but not 100%. And so that's a big headwind from a margin standpoint. And we're progressing on this because this year, for instance, will increase our percentage of recovery of cost inflation compared to where we were last year. I think when you think about the -- when are we going back to this 18% level of margin in Motion Technologies, I think we -- as we mentioned, 2024 seems to us like a good time for us to be back at those levels of margin. We see really good volume growth based on both the recovery of the industry, the auto industry, but also the outperformance that we talked about. We also have new generation of brakes for new platforms that are entering into production in the next few years. So that is going to -- and these platforms have been -- are including this new level of cost that we've seen for the past 1.5 years. So much less -- much more favorable from a margin standpoint. And then productivity. Productivity is very key to Motion Technologies. And so we continue to improve from a productivity standpoint, and we expect this to really keep on going in the next -- as long as we can, we have many opportunities across the board and also in Motion Technologies. So that should help us with margin recovery also.

And then just a -- well, so we tend to focus on Friction with Motion Tech, it is the core driver of the [indiscernible]. But the non Friction businesses, if we think about the market expansion over the coming quarters and then resetting just on a go-forward basis, is the recovery weighted to non Friction businesses? We know KONI [indiscernible] borrowing that was unavoidable for a period of time. And there have been cost related matters and kind of extended catch-up process with some of the assets that...

Yes. So I think you're right, Bryan. We have Axtone and Wolverine, which have been double-digit businesses in terms of margin. And today, they're low to mid-single digits. And it is disproportionately impacted by commodity price increase, but also in the case of Axtone by the disappearance of the business in Russia. Since then, we're seeing obviously a reduction in cost of the commodities, but also from Axtone, really an improvement in terms of the order rate and we have been able to really compensate all the Russia business that we have lost as of March 2022 with more passenger business out of Europe, outside of Russia. So the volume headwind in Axtone is disappearing with our orders as early as Q4 of last year and Q1 of this year, which are in excess of the Russia business that we lost. The commodities are going down. And at the same time, we have stepped up our ability to get pricing. So I think that, as you rightly said, we have a lot of opportunities with those 2 businesses who today are in mid-single digits to bring them back to double-digit margins and contribute to the greater MT performance.

Thanks for the detail. Now moving to industrial process, IP has been a fantastic story for your team. Look, I recall talking pre-pandemic and very clear about creating the Motion Tech of the flow. Well, it seems like maybe your team is well on its way. In the last couple of quarters have been quite exceptional. What are the next steps on that journey? You put in the script for the Q1 call, continuous improvement journey, there's no end in sight. So what are the near-term actions underway? What's the progress that we can look for the remainder of '23 into '24? How does that business continue to get there?

Sure. Thanks, Bryan. Yes, it's been a wonderful journey in IP. I think -- let me share a couple of things that are undergoing that happening right now that will consolidate the performance and will continue to improve. Our major site is Seneca Falls in Upstate, New York. In that side, we, believe it or not, we still have a foundry. A foundry that is not the most the efficient and not the best foundry in the world that produce casting. Today making casting ourselves is not strategic. There is a supplier base worldwide as well as regionally, that will be able to provide casting in a much more competitive manner and with better quality. So what is in the process, Bryan, today is the closing of the foundry, which is something that we've worked for the last couple of years, and it's going to be closed by the end of Q1 2024. It takes some time because you do not want to screw up your operations while you're doing that. You want your customer not to be impacted, affected by something like this. So that closing will enable us to be more cost competitive as well as reduce partially our footprint in Seneca Fall. That will translate in cost competitiveness. VAVE, value analysis, value engineering. We have started this process in 2017. I remember Emmanuel and I having meetings where they say, okay, what can we do to improve the cost competitiveness of each of our products and how can we make our product better from a technological point of view. Probably we've gone through 30% of our products and our families of pumps and therefore, it's going to take the next probably 7, 8 years to finish the complete portfolio and then guess what? We start over again. So VAVE is something that's happening right now. The complete relay out of the factory in Seneca Falls, where each as we mentioned in the remarks in the script, is at the end of Q3. Each and every single plan that we are making in Seneca Falls will be made in one piece flow. So you will be able to be on the shop floor and see actually how you are making this pump, the productivity, the efficiency, and see the problem, attack the problems and that not only will improve the productivity efficiency, but the speed that this factory is operating at. So all of these are the things that are happening as well as the development of new products, unique products that the competition does not have that will help keep on differentiating ourselves from -- in the market. So those are a few examples that we continue to consolidate our results today, with 3 quarters in a row at 21% operating margin and continuously improve in the future.

I appreciate the detail. It's all very exciting. Since we're discussing IP, maybe offer a quick update. Any perspective your team -- you may have on just the run rate and market trends? So chemical, industrial, oil and gas, green energy, broadly speaking, has been a nice tailwind for you guys, just any insight you can offer on general and [indiscernible]