ITT Inc. (ITT) Earnings Call Transcript & Summary

Are we signed [indiscernible]

You're good. You're good. You're going to sign up for how many years.

Years to come.

Years to come. Okay. So -- but for those that aren't as familiar with the journey, maybe just talk through what's allowed you to grow as much above market as you have and what's going to allow you to continue to grow at 400 to 500 basis points above market share forward.

The demand is really -- as Emmanuel was saying, we're able to differentiate there in the market. So think about it, how. First of all, is our cost base. If you look at our competition to make the same number of brake pads, they have 15 plants in the world. We have 5. Now think about the efficiency you have, if you have to run only 5 plants versus 15, so cost advantage. That is one component. Performance in terms of quality. Why? Because all our processes are the same around the world, every single plant has got the same process and highly automated, which means that the level of quality you are delivering, it's less than 1 PPM. So less than 1 parts per million that we deliver to the customer has got the defect. And it's not a functional defect. It might be that the white bar in the barcode is not perfectly white, okay? So all of this enables us to differentiate from the competition and has allowed us to gain share. So we expanded, we started up a plant in China. In 20 -- we opened it in 2014, and we went from low single-digit market share to almost 28% market share in 2022. In North America, we opened a plant in Silao in the state of Guanajuato in 2018, and we went from low single digit to almost 25% market share in 2022. And now the way that it works in the automotive is that we win an award today for a platform that will have the SOP, the start of production, 2 or 3 years from now. So when we're saying we see this outperformance staying for 400, 500 basis points in the years to come is because we know the words that we want -- we know when they're starting, and we know the ramp up of production, which means that we can easily simulate what our market share will be in the next 4, 5 years.

That makes a lot of sense. I'll turn it over to the audience in a minute, but I do want to touch on the -- at the quarter, you mentioned that you signed an agreement -- a 10-year agreement with Continental for the aftermarket business in Europe. I think there was some confusion on the call regarding what that agreement potentially meant for trying to grow your aftermarket either in the U.S. or in China. So maybe just a -- clarify that for us.

The agreement that we have with Continental is a 10-year agreement, it would be roughly $1 billion for the 10 years and is for Europe, only Europe. We specified that because the agreement that we had before was covering also China, and we want China to be out of the way because we want the flexibility in China. We do not know how the China aftermarket will play, if it's going to be more the European style, more the North American way. And therefore, we want to try different things. This is the reason why we wanted to have flexibility in China to play in the way that we see fit. When it comes to agreement with Continental is the team has been able to negotiate a better agreement that we've done in the past. So for example, instead of price efficiency year-over-year, we have volume incentives. So this means that Continental is incentivized to sell more. And on top of that, you're not touching the price of the pad. So overall, a very good achievement that the [indiscernible] and the team have achieved.

Yes. Look, it's been a great relationship for you in Europe. I'm curious -- at what point do you make the investment? And what kind of investment would you have to make to really grow out your distribution, let's say, in China?

Okay. So first of all, if you think about every year, we strategically discussed why we do not enter North America or what we have to do to enter North America now because we do not play the aftermarket in North America. So this is something that strategic we discuss every year. When it comes to China, I think about it is, first of all, it's good that we are winning market share, today is 28%. Because when you have the market share means that you've got your SKU, you have the tools that die to make those parts. If your market share is very low, then you will have a huge investment to make. So when we are in the 30%, 35% market share, then you have a very good base to start with, and the investment that you will have to make is not that huge. So I would say that will be, I would say, a gate item.

Interesting. Okay. Great. So I'll turn it over to any questions from the audience. So I'm happy to keep going. All right. Got it. We get that question here. Okay. Right here up front.

Yes. I mean it's been an exceptional period for the profitability for the automakers globally for all sorts of different reasons. And maybe your thoughts on longer term, what that means for pricing for you in the EV space and traditional area as well.

Sure. So when you look at -- there's probably going to be pressure from -- you're talking about on the OEM side. Having said that, I'm not so sure that the pressure that you will see is going to be substantially different than the pressure that you've seen before in the ICE. There was a level of high competitiveness in also the internal combustion engine and that we experienced, we were able to win in that game. So when it comes to the EV, I would expect that the competitive pressure will increase, absolutely. Not so sure it's going to be substantially different than what it was in the past. And when it comes to the EV for the reason that Emmanuel was talking before, we're still able to differentiate from the competition. Why? Because some of the challenges from a breaking perspective you have on the EV are difficult to solve, are different what you had in the past, noise. If you drive an EV, you want your braking noise to be 0. If your disk is going to be more rusted because you're not using the break all the time, which means that you need to find a way [ where the material having ] to clean it. So because of those specific problems, hard problem to solve, you might have a chance to solve them faster and with that be able to differentiate yourself from the competition and get maybe some premium.

Any other questions from the audience? All right. Let's turn to IP. It's been -- what a great story. This has been, right? From a margin perspective over time. I mean, it's really incredible. You posted 21% margins each of the last 3 quarters. Just talk through the evolution of this business and why you've been able to achieve what many of your competitors have not come close to achieving from a margin perspective on this business? And is 20-plus percent now the kind of the new standard for this business going forward?

Sure. There is no one single bullet, but many, many things that have been done. And I've been lucky to work with Emmanuel and the team in this journey. It has been a transformation of the business, starting in discipline. Discipline in the way that you price, discipline in the way that you're pricing for the projects, discipline in the way they're executing the project. So we went from a situation in 2016 where our project business, you're talking about projects that go from a few million dollars to $30 million, $40 million project in the last 2 years, that were losing money or breakeven. Today, it's a very profitable business, granted not as profit or the short cycle, but it's a double-digit profitability. So that is one part. Then is the lean transformation on the shop floor. I mean you were going to get down in 2017, you will go down on the shop floor where we're making pumps, you will not be able to understand how they make the parts. Now I don't necessarily think that we are Albert Einstein, but we're not that stupid either. So I think that today, you go down on the shop floor and you see these pumps made in one single piece flow, the standard pump, the ANSI pumps. You will be able to see exactly if there is a problem or not. The problem is going to side, you go tackle and then back in. So the lean transformation. VAVE, value analysis, value engineering. That is something that a man responsor from the very beginning to transform many of the portfolio of pumps that we have to make them more competitive, to reduce the [ metals ] but improve the hydraulic performance of the pumps. The footprint, the closing of a plant in Brazil or a plant in U.K., flawless execution of those closures, the closing of the foundry that we have in upstate New York, that closing, we announced it a couple of years ago. It's going to be done by March 2024. You might argue why it takes so long? Well, if you don't want to mess around with your customer, you need to develop your supply chain properly, it takes time. So all of this has really helped in generating the level of performance that we are able to post. So we're really proud of that, and there is no really finished line yet.

And because we've been able to deliver -- to improve the customer experience, that is through quality, through delivery that has allowed us to really drive up price also, which has been a big part of the story, especially in 2022, probably in the second half of 2022, where we started seeing major headway in terms of increasing prices on our standard pumps, on our spare parts. And we saw that realization really starting at the end of the second quarter, which now is carrying over into 2024. And we are going after now different type of pricing. While in 2022, we were more focused on getting offset for the cost inflation. In 2023, now we're going after value-based pricing. So we're identifying what are the areas where we're still not capturing the entire value. We have an entire team that's dedicated to this, and we're making some great progress.

Yes. What's somewhat amazing to me is that your project business has been really growing as well and the order growth was up tremendously, and you're still seeing this type of expansion. Typically, historically, the project business not necessarily just for ITT, but across the industry, it was more kind of like a breakeven type business. But it sounds to me that even on the go forward with the mix changing in your business, it seems like you're expected to get leverage.

Absolutely. I mean the project is a headwind in terms of profitability. But absolutely, it's something which we completely strongly disagree with. And today, the entire IP disagree with the project business is profitable, should be profitable. And today, the backlog that we have in projects is the highest profitability that we've ever seen.

That's great. LNG is a big opportunity that folks have been -- that folks are excited about and excited about for good reason. Are you starting to see some of those awards materialize for you at this point?

Absolutely. We had a great relation with some of the more strategic and best EPC in the world, and we have seen some very nice order in LNG. Some of those orders were actually orders that we won as engineering only during COVID. During COVID, when all these investments was frozen, we adopt a strategy to go to the customer and win engineering-only orders. So instead of committing about $20 million of order is a few hundred thousand dollars of doing all engineering. So that was good because you got the foot in the door. But it's not just LNG. It's all the decarbonization project that we're going to have. We share the capital we won for an American oil company. One is in Africa to stop flaring and one is in Australia to really own carbon capture. So what we have here is the differentiation from a product point of view. Our Bornemann Pumps twin screw pumps are able to do multi-phase pumping. So you are able to pump water and liquid and gas together. So the Australian job that we won, what you have is the production of gas offshore together with CO2. They go through a separator where they separated the CO2 from the gas. And then our pumps take the CO2 mixed with water and push it down 2 kilometers underground. We're working with this oil company to really standardize the solution with our technology. And there are only 2 or 3 companies in the world that we have the technology, we'll be able to do that in this way.

So that all sounds great. So look, I just gave you a lot of props for how your margin stack in IP relative to peers. The Connectors business in CCT has really transformed as well, but your margins are still below some of the peers out there...

At the CCT level.

At the CCT level. Okay. Good, good. So talk about the margin runway on the CCT business.

Yes. So I think when you -- the CCT is composed of connectors and components. The connected business is doing great. In fact, it's in line with the margins of [indiscernible], which are much bigger than us. And here, the great thing is that not only we saw a significant improvement compared to where we were in 2015, 2016, but also there's still more runway to go after. We are -- we see a lot of manual operations that we have to automate in this -- across the [ Boeing ] plants. We are selling right now product portfolio gaps with either new applications or trying to catch up to the competition because in the past, we haven't invested as much as we should have. And so -- and then also here, there's a pricing component where we're able to really identify being sole-sourced on a lot of defense platforms. We are able to identify where we have opportunities. So Connectors is doing great. We are facing right now a destocking situation with our distributor customers, mostly for the industrial markets. And we think it's going to play out until probably the end of the year, and we'll be fine. On the Controls business, this is a business that is mostly aerospace and defense. And this is a business that has -- that is facing the same difficulties than a lot of our peers, which is a lot of supply chain issues. So -- and an accelerating demand from the part of our aerospace customers. So we are doing everything that we can to make sure that we stabilize this business from a delivery standpoint. We continue to work and invest on improving the fundamentals safety, quality, delivery costs. And we think there's a lot of good run work for this business as well.

That was a great clarification. I appreciate that. I didn't fully appreciate the Connectors as all the way there. Is the -- and I just want to understand the supply chain commentary, is the Controls business, the aerospace controls business, is that -- does that margin -- does that have the same entitlement of the Connectors business?

I think, yes. I think over the medium term, absolutely. What we're seeing in terms of the supply chain difficulties is that our customer base is struggling like a lot of the customers in aerospace. And also ourselves, we're struggling to get labor for machining and labor for assembly also. And so that's penalizing us in our ability to ship the expected demand. But we're going to work. This year, we are working to solve those issues.

So last question for me. Balance sheet is really never been in a better position than it is today. You've earned the right, I think, across our portfolio to invest if you want to inorganically, what are you looking at today? What's the pipeline look like?

So we made a very good acquisition in 2022 of Habonim valves. We purchased at 12 multiple, and looking at the actual is less than [ 8% ]. So that's very good. We made an acquisition of Micro-Mode in the connector, defense and space. So we are looking at the funnel opportunity, which is larger today than it's ever been. Thanks also to the business development, M&A department we put in place. We are really looking at flow, pumps, valves and the connector side of the business. So I think that we're working, and we hope to add more and more happening in Micro-Mode in the family.

Great. Luca, Emmanuel, thanks so much for spending time with us today.

Thanks.