ITT Inc. (ITT) Earnings Call Transcript & Summary

Good morning, everybody. Thanks for joining us. On day 3 of Citi's Global Industrial Tech and Mobility Conference. We're very excited to have ITT here with us today. We've got Luca Savi, CEO, who's been with the company since 2011 and been CEO since 2019. And we also have Emmanuel Caprais, CFO of ITT, who's been with the company since 2012 and CFO since 2020. Thanks for joining us.

Thank you, Vlad.

So I'll turn it over to you guys for some initial comments, and then we'll jump into Q&A.

Yes. So I'll just mention forward-looking statements. So 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 in that light. We encourage you to review the latest risks and uncertainties in our Form 10-K and other SEC filings available on our website. With that, we can start. Okay.

Perfect. Good morning, everybody, and thanks, Vlad, for having ITT here. We will spend a couple of minutes to tell you a little bit about ITT, 2023 capital deployment and what we are seeing for 2024. So what ITT does. We are an engineering and manufacturing company, making components for harsh environment that works in energy, in rail, in automotive, in aero, defense and general industrial. We are roughly $3.3 billion revenue, $10 billion of market cap and more than 11,000 people and global companies spread around the world. So when we look at 2023, it was a strong year. We had good growth in terms of orders, 7% organic, revenue organic plus 8%. Our margin expanded by more than 100 basis points. Our EPS grew by 17%, and our free cash flow margin was roughly 13%. Beyond these numbers was a strong execution. Those numbers were just the result of a very strong execution, which enabled us to win market share across all the different segments that we're in. A couple of examples specifically is in rail, where we won several awards across all the different regions, China, Asia Pac, Europe and North America, both in freight and passenger, automotive, where we won several awards in electrified vehicle platforms, more than 150 platforms. And when we talk about electrified, which means electric vehicles as well as hybrid. And all the -- those awards enabled us to outperform the market by more than 500 basis points in 2023 as well as a green project awards, if it was for carbon capture or stop flaring or also the award that we won with ExxonMobil, which will represent roughly $80 million in the next 3 years. We deployed more than $700 million of capital. First, organically, this is where the money goes first, but then also in share repurchases as well as in M&A. When it comes to capital deployment, Emmanuel, you want to add?

Sure. So what you see here, a organic investments are driving really -- are made to support really organic growth, organic growth that we get in, with a lot of share gains. A lot of our organic investments go to Motion Technologies. The majority of it, as we have been outperforming the market by a significant amount, I think, in 2013 -- 2023, we were above 700 basis points of market outperformance. And then the second aspect is productivity that really we invest to continue to expand margin. We see that we have a lot of self-help opportunities in MT, but also in IP and CCT. From an M&A standpoint, as you can see, we've deployed almost $1 billion of -- a little bit more than $1 billion of capital. We really worked hard in 2021 to clean our balance sheet from the asbestos liability. And then that allowed us to really concentrate on bringing targets that are fitting our business model and strengthening our competitive advantages. So you can see, in 2022, we acquired Habonim, a valves manufacturer, very present in all the process industry end markets, but also everything that is cryogenic applications. Micro-Mode, a connector company, and then Svanehøj that we closed finally at the beginning of January, where they make a lot of cryogenic pumps, marine cryogenic pumps, and then we'll talk about it a little bit later. And then shareholder return. Obviously, we're focused on growing the dividend, growing the dividend pretty much in line with our EPS growth. We announced that we were increasing our dividend by 10% this year. And then share repurchases really, we really drive share repurchases when we don't have as much visibility or ability to close a lot of M&A. So to constantly and efficiently deploy capital. If we go to the next slide, just very briefly talk about Svanehøj. So what we like about Svanehøj is that it has leadership position in 3 out of 4 markets that it plays in, marine, cryogenic pumps for both fuel and cargo applications. And hopefully, one of the opportunities that we have is to take that cryogenic technology and be able to apply it on inland pumps as well. And then a really good management team that we think is able to execute. That's going to deliver double digit, low double-digit growth in terms of revenue over the next 5 years and a very good price, as you can see, less than 12x EBITDA planned.

So if we look at 2024, okay? We enter 2024 with a very good momentum and with the largest backlog that we ever had. We -- our -- we have target roughly 10% in terms of total revenue, and we are expected to improve our margin by more than 100 basis points, excluding Svanehøj. If you look at how January and February look like, they were probably better than what we were expecting in terms of we had the good awards on Rail. We had good awards on Auto. We continue to outperform Auto and Auto has got good orders in the first couple of months for us. And also the industrial connectors where we saw some weakness last year because of the destocking actually, we had good growth in these 2 months, both on the OEM side of the orders as well as in distribution, both in North America as well as in Europe. On the M&A, you've seen the M&A is accelerating. The pipeline is rich and active. And so hopefully, we will continue to accelerate on the M&A front. So we are progressing versus our long-term targets. Over to you.

Great. That was a great overview and a lot to dig into. Maybe just starting with where you ended, momentum into '24. Given where you ended with the backlog and what you're seeing in orders so far, how would you talk about visibility to the outlook for this year?

Sure. There is a good visibility when it comes to 2024 and think about the business that we are in, right? If you're talking about Rail, that is a great business because we've got a very good visibility. We've got a very good backlog, there is a good aftermarket. So they're very good on that front. Auto, I think, is the same. And in Auto, probably the market will be flattish when it comes to 2024, but we count to outperform this market by roughly 400, 600 basis points, which is what we've done for the last 10 years, roughly. And we are saying this not because we are arrogant or cocky but just because we won the awards in the last couple of years, and we see those awards will have the SoP, the start of production, either last year and ramping up or this year and ramping up. So we saw that. And then when it comes to IP, the largest backlog ever. So this is really good. And despite the fact that we won many orders, and therefore, we got a lot of backlog, the funnel of opportunities that we are porting is the largest has ever been. We closed the year 2023. The backlog of opportunities was 26% higher than the year before and also grew sequentially to the previous quarter. Connectors we won a lot of OEM orders, which has got visibility for many years to come. And for this first couple of months, distribution and OEMs orders have been pretty good.

Good. That's helpful color. Maybe, just following up on that, you obviously have a very diversified portfolio. You're also a very global company. So can you talk about in that positive outlook you have for the year are you seeing any meaningful differences amongst the regions? Or how would you characterize trends amongst your regions globally?

Sure. Listen, we are, when you look at ITT, it's very diversified. But geographically, is very well balanced between the -- between Asia Pacific region, Europe and North America. And if you look at our business by business, I would say the Rail business has been growing, and there is good opportunities from a market perspective, both in Europe as well as in Asia Pac, China as well as in North America. Automotive. We are outperforming the market in, across all the 3 geographies. And we will say, when you look at the market, probably you have a China flat in 2024, Europe, down a little bit and North America flat to up a little bit. But once again, we think that we're going to outperform all 3 markets. And then when you look at IP, all the 3 regions have been growing in orders in 2023. And all the 3 regions have a rich funnel of opportunities. So cautiously optimistic, I would say.

Great. And then maybe just digging in on to the growth outlook a little more. You mentioned your track record of market outgrowth within Motion Tech and your Friction business in particular. Can you talk a little more about how you've been able to sustain that outgrowth? And where you see Friction OE market share headed over the next few years?

Sure. When you look at the market share in the different regions, we are talking about a very nice healthy market share in Europe. The market share in China that went from 0 in 2013 to almost 30% in 2023 last year and a market share in North America that went from 0 in 2017 to roughly 26%, 27% in 2023. So we outperformed the market. Now this outperformance comes from a variety of reasons. There is no one silver bullet, but let me give you a couple of them. First of all, we have a cost advantage compared to the competition. Our manufacturing footprint is very concentrated. We've got 5 plants, the competition to make the same number of paths. It's got 3x as many think about how difficult it is to run, keep efficient, 15 plants versus 5. So there is a cost competitiveness that we have compared to the competition. Second is the performance. If you look at our quality performance with our customers, we measure in PPB, Parts Per Billion. So it's less than 1 part per million as a defect. And defect, it's not that the brake pad doesn't work, is that maybe the camera, the customer doesn't, is not able to read that bar code, okay? No competitor is able to match this level of quality. And when you look at the on-time delivery in the last couple of years was -- has been 99.95%. Now we all know they s*** show of the supply chain in the last couple of years, and this delivery of 99.95% is simply outstanding. So you combine the cost advantage with this level of performance, OTD and quality and that you understand why we continue to conquer business. And we keep on investing in innovation, process and product, and this is what enables us to stay ahead of the competition.

Makes sense. And then maybe can you just touch on the opportunity and Friction for EVs for your business. And as we've seen maybe EV adoption slower than some expected, how you think about that impacting your outgrowth potential going forward?

Yes. So obviously, we've really been able to exacerbate our competitive advantages in the EV market. The EV, the requirements for EV brake pads are much tougher in terms of vibration, in terms of noise because there's no engine to cover all those items. And so this is where really our technology called prowess, our advantage is playing a big part in us gaining market share. So if you look at our EV volumes, they've skyrocketed. When we were, when we presented it in 2021, our market -- the portion of EV revenues was around 20% of total OE revenue. It's now more than 30%. So we've grown significantly between the -- in these 2 years lapse, because we're able to really differentiate and offer customers solutions that solve their problem from a noise, from a vibration standpoint. I think as the EV production is slowing down, obviously, the hybrid continues to be pretty strong, and then I see declines less. But for us, it doesn't really matter because we are as comfortable in selling and producing ICE brake pad, hybrid brake pads or EV brake pads. So just what we, what the market doesn't provide from a growth standpoint in terms of EV, just fall back on ICE or hybrid. So I think that the growth prospects to be really strong in Friction because of that.

If I can bid on that one, if you think about 2023, for example, the internal combustion engine production declined. But the brake pads that we produce, shipped and deliver to the customer for ICE grew by 7%. So we were able to outperform the market on ICE substantially and growing that market as a matter of fact.

Right. That makes sense. And then I'm sure we could probably spend all day talking about Friction, because there's a lot in there. But you have, obviously, any other things in the portfolio. I wanted to ask you a little about Rail, which is also in the Motion Tech segment. Obviously, a smaller piece of the segment. You've seen, you talked about some of the share gains through wins last year, and you've seen pretty enthusiastic about the opportunities in Rail. So can you just talk about the growth potential you see in Rail and, how are you thinking about the potential for that to become, scale that business over time?

So when you think about Rail, why do we like Rail. First of all, you have a great visibility when you win a platform for, with the OEM, you have visibility for the next 30, 40 years. So this is, and when you are in there, you're in there for the OE and also for the aftermarket, which is good, so visibility. Second, we like the market because if you think about the macro trend, the green and the environment will keep on pushing the investment in Rail, and you have seen it across the board. And there are several initiatives that are going to push investment in Rail. So all of that we like it. On top of that, we have a unique and differentiated position when it comes to energy absorption. So we're talking about what we are making is shock absorbers, crash buffers. And we are the leader in many markets in many applications on that front. So, because of all of that, I think that we like Rail. We are looking also on the M&A front for Rail. But I would say when you look at the funnel of opportunities in M&A is much richer on the Connectors and the Flow side than in Rail.

Okay. Makes sense. So, maybe just shifting to IP, which has been another well-performing, strong growth, strong profitability, and obviously, you've guided to mid-single to high single-digit revenue growth in that business this year. You talked about some of the backlog you have coming into the year. Can you talk about what's been driving that outperformance in IP and the sustainability of the momentum that you've built in that business?

Yes. So I think that when you think about IP. What we try to do is we try to replicate the Motion Technologies playbook. And a lot of that comes from the strength in operational excellence. So safety, quality, delivery and cost. And so what has been working really well in Motion Technologies, we adapt it to IP because they are different performance drivers. But we really worked on improving the quality for our customers. We really work on improving the delivery. Our Saudi site, for instance, as for 2 years in a row, be hovering around 100% in terms of on-time delivery. And obviously, as you work on improving your quality, improving your delivery, the cost is a logical consequence of this, and we've been able to really significantly improve the cost position in industrial process. So that's one side. Our customers are happy because, we provide them with better quality. We provide them with better delivery. From a project management standpoint, we've applied the same principles and making sure that through the life of the project, we would deliver to our customers the best-in-class performance, and so that comes from really well defining the expectations from the customer at the beginning, managing the development of the project and then excelling the delivery, including, for instance, documentation, which is sometimes overlooked. And so as we are able to really replicate the playbook, the Motion Technology playbook, customers are trusting us. We're generating significant goodwill from our customers. And so they're willing to give us -- to give us more of their businesses, modern business. We have specific cases where we've been able to switch customers from competition to an ITT account. Luca was talking about, the Exxon Award. This is an award that's really important because we used to have almost 0 market share with Exxon. They gave us basically all the brownfield pump demand for the next 3 years. So a lot of is based on strong execution. Providing what the customer wants, investing in technology so that we're able to drive those share gains.

And then given the growth you've seen in IP and the continued momentum there, can you talk a little about where you are in terms of capacity and whether you see the need to invest significant capital for more capacity over time?

The capacity is not an issue when it comes to IP. We do not necessarily need to invest on that front. I think what we might want to invest is maybe in some of the facility in terms of be able to test bigger pumps or bigger projects in some of the high-growth areas where it may be India or might be Saudi. But I would say, in terms of capacity, that's not an issue that we have today.

Okay. Great. And then maybe just shifting to CCT. CCT little bit of noise in '23 around some destock in parts of the business. So maybe if you could just give us an update on how you're thinking about that outlook for growth there, what you're seeing in terms of channel inventory?

Sure. So when we look at the CCT, what we have in CCT is the control side of the business, the valves and that we -- the equipment that goes in the area of platforms and the Connectors side of the business. The Connectors side of the business in 2023 had a very good OEM orders. But OEM orders are strategic for the long term, but they are not really show signs in terms of not generating a lot of revenue in the short term. And therefore, what we suffered in 2023 was really the destocking and distribution, particularly on the industrial side of the Connectors. And when we started the year we thought that this destocking will probably continue for the first half of 2024. Now when it comes to January and February, what we start seeing is very good orders on that side as well, not only good orders on the OEMs, but good orders also in distribution, like I said at the beginning, both in North America as well as in Europe, which was better than expected. So we would, it's only 2 months, so we would see. Nice start.

Nice start. We'll see where it goes.

Indeed.

So one thing I wanted to follow up on CCT. You talked at, on your earnings call at 4Q, you had highlighted some of the new product innovations in the business. Could you talk a little bit more about how new products are impacting growth at CCT and how you're thinking about the runway for further new product innovation in that business?

Okay. So when you look at the new product, in CCT where one typical example is the ESS, is Energy Storage. This is a product that is the consequence of our investment in our Shenzhen facility. So it's our strategy to be in the market for the market. So we have a facility, Connector facilities in Shenzhen, China. We invest in engineering. The team in China developed this product at China speed and was able to commercialize this product once again at a China speed and therefore, they've opened a market where we were not present at all. These happen there in China, but we're going to use this product as well in North America as well as in Europe. I think that this is an area where Connectors can really play to differentiate ourselves from the competition. This is how we win some of the orders in working very closely and codeveloping together with the customer. How do we win some of these OEM project is really visiting the customer, the co-designing, co-developing together with them, the Connector that will go in that platform, in that project. Coming back, prototyping in a highly, at the China speed, the prototype, ship it to the customer, get it approved, get it tested and then you're specified in the program. And this is really how we win in Connectors, in CCT.

That's helpful. I did want to shift and ask about profitability and Op margins. Op margin expansion has been a focus for ITT. You've laid out some longer-term targets for the businesses. Now IP, for instance, is already above your longer-term target. So maybe just generally, if I take a step back, could you talk about where you see yourself versus your longer-term targets and how we should expect margins to...

So when we had our Investor Day in 2022. We communicated a long-term target for IP of 20% for Motion Technologies, 20% and for CCT 22% and the time span that we gave was 3 to 5 Years. Now when you look at the different businesses, you have a business that some businesses they are going to get there faster or they already there, like IP, IP was 22% in last year. So super fast and beating. So we need to come up with a new target, I got that. And then there are other businesses like Motion Technologies that probably will get to the target of 20%, but towards the end of the time range. And so I think that the targets are absolutely achievable for all the 3 businesses. And the only thing is that different speed of how we got that. But if you think about IP, which closed 2023 at 22% and something, excluding the acquisition of Svanehøj, IP on a like-for-like basis in 2023 will be higher than 23%. So the continuous improvement journey continues.

That's helpful. You mentioned Motion Tech taking a little bit longer to get to its targets. You did guide to, I think, 100 bps of margin expansion this year. So can you talk about the margin expansion runway in the near term. How much of that is volume dependent versus how much is based on things within your control?

Yes, so I would say volume growth is within our control because we're driving that a lot with our share gains. But let me say that, let me start by saying that in 2023, we were able to really deliver solid margin expansion quarter after quarter to reach a little bit more than 17% by Q4. So we feel pretty confident that in the first half of this year, we'll be able to get at an 18% run rate and then grow from there. I think that the growth, the margin expansion engine in Motion Technologies is productivity and our ability to really deliver cost reduction, efficiencies within our factories. We've been able to do that in Friction. We have done this in KONI and KONI now is no longer dilutive to Motion Technologies margin. It's actually accretive. Our Axtone business, despite losing the Russia business is back to pre-war type of revenue with a margin expansion and a margin solidly into the double digits. So -- and in our Wolverine business, as we mentioned during earnings call, hit high teens in Q4. So all this is participating into the margin recovery at Motion Technologies. As I was saying initially, volume obviously, also plays a part of it. But for the volume, we are very much in control because all these awards that we have gotten in the past, in the past maybe 3 years are now converting into revenue all those awards. And so as a result, we expect, as Luca was saying, outperformance of the market of roughly 500 basis points in 2024. And it's going to continue in the future because we've accumulated that backlog of awards. So good line of sight from a productivity standpoint, really the engine of Motion Technologies. Volume also is going to participate. And our ability to really deliver that productivity is key to get that leverage on the higher volumes.

Makes sense. Then maybe I'll ask you a similar question on CCT, where I think the outlook is more for flattish year-over-year margins this year. So maybe if you could talk about what will it take to really get more op margin expansion underway in CCT? And how you're thinking about the path or the time line to your 22% margin target for that segment?

So let me start by saying that we closed 2023 for CCT at a record high in terms of margin. This is a business that has been, it has more than recovered from the pre-pandemic level in terms of revenue. So things are improving significantly in CCT. I think that the biggest opportunity that we have is self-help and the productivity that we need to generate through the system. So if you think about the Motion Technology playbook that I was talking to about earlier. Deploying that rigor, that operating excellence -- operational excellence in our businesses, I would say CCT is the one that is the most immature from that point of view. So there's a lot of work that needs to be done in terms of one piece flow in terms of leaning out the factories. And in terms of automation also. This is a business where if you look at our Connector facilities, there's a lot of automation opportunity that still is available for us. So productivity, the key productivity takes a while to get implemented and to show results. So that's why we think that over the next 2 years, we have a lot of benefits coming from that productivity that's going to allow us to really produce the volume that's coming in with a recovery, especially with the recovery in Aerospace and the share gains that we have that Luca was talking about in terms of OE Connectors.

Got it. Makes sense. And then I did want to ask about free cash. Free cash flow rebounded nicely last year after coming under some pressure. So can you just talk about the sustainability of the progress you've made on free cash flow?

Yes. So as you mentioned, we had $430 million of free cash flow generated in 2023. And despite the fact that this was largely above 2022, we still have a negative contribution from working capital. So working capital more or less absorbed cash or was a use of cash of $30 million. Within the working capital, inventory was the main contributor, the main negative contributor. We've been able to make progress in our inventory reduction in Motion Technologies. We have not made the same progress in IP and CCT. So really 2024 is focused on driving down inventory for IP and CCT, not only improving the percentage as a percent of sales and inventory but actually driving the value down, in order for us to absorb the increase in working capital that's going to come from the growth mainly in Motion Technologies and in IP. So I think that the key for us is to be able to reduce -- continue to optimize our working capital. And so as a result, that $400 million plus level of free cash flow is absolutely sustainable from a run rate pinpoint.

Great. And then following up on that, how are you thinking about priorities in terms of usage of that cash flow and where you see best opportunities for investment, either internal or external?

Sure. Well, when you look at capital deployment, where the money goes first is in organic investment. This is where you know it best, where we have the best return on invested capital. So you have seen it in the slide that Emmanuel was presenting. So if it is on the CapEx, if it's in, like, for example, the high-performance investment in brakes pads that we have in Europe. So this is where the money goes first. Second is on the M&A front. We are building ITT, and therefore, we are really cultivating the pipeline where in connectors, flow, mainly pumps and valves and a little bit distance in Rail. So this is where it goes. Second. And -- but last, we have a $1 billion repurchase program that has been approved by the Board last year, which give us the flexibility. In the case of M&A, we are not able to close the deal or it doesn't materialize, we have the flexibility to return capital to our shareholders, and this is really the flow.

Got it. And just digging in on that a little on the M&A front, you still have some would argue a relatively underlevered balance sheet. So how are you thinking about the potential -- Svanehøj was your largest transaction to date. How are you thinking about the potential for other larger-sized transactions like that? And then separately, given your margin profile, how do you think about potential acquisitions that may not be additive or maybe dilutive to margin?

Sure. So listen, I think that the most important thing is that we know that we need to grow and use our capital also inorganically. But even though the funnel is richer and there are more opportunities, you need to be very rigorous and disciplined and you need to know exactly that you're able to create value with the acquisition. So ensuring that the process is rigorous is key. And sure, there are also some larger deals that are moving in that funnel. But one thing that we need to say is really rigorous and disciplined in our process. Second, I would say is if you're looking at acquisition, some would be dilutive, yes, it could be. It depends if it's able to create value. So for example, if you look at Svanehøj. Svanehøj is a very well-run company. It's good profitability, good growth, and therefore, we decided to buy because of the leadership position in several markets. But if we look back, for instance, if you look at the Axtone business that we purchased in 2017, that was a turnaround. That business was a low single-digit margin business. We bought it. And now today, despite COVID, despite the war in Ukraine, is double and the closing of our Russian business over there is double-digit profitability business. So it depends and the most important thing is can we create value.

That's helpful. Do we have any questions from the audience? I forgot to open it up earlier. All right. We'll keep it between ourselves then. So one question that I did want to get to that we're asking every company, and I think I probably asked you last year as well is what are the top 2 or 3 innovations and structural changes affecting your company over the next 5 years? Are there any emerging industry trends that are maybe being overlooked in the current discourse?

So listen, there are many macro trends and technologies that are going to help ITT and there could be a tailwind for ITT. We talk about electrification. I keep on saying electrification is good for ITT's across the business on the Aerospace side, but it's on the Automotive side. If you look at Automotive, there is a lot of talking about "electrification is slowing down". True. First of all, when you talk about EV, we talk about electrified platform, which is electric and hybrid. Just to put things in context, when you look at that volume of vehicle produced, you're talking about probably around 24 million, 25 million vehicles produced. This is almost twice as much vehicles that are produced in North America. So in my, the growth might be slowing down, but the trend is there. So that is something that we should not underestimate. The decarbonization of the oil and gas industry. That is something that is going to be good for ITT, and it's going to be cyclical. So you've seen it in the Green Project orders that we won in 2023. Almost 30% of our projects were Green Projects to stop flaring or for carbon capture of the recycling of battery or some others. So I think that, that is another macro trend that is important. And then, on top of that, we are investing in some key technologies that will actually accelerate some of the strengths. So those are all good for ITT.

Great. Well, that's maybe a good stopping point. Thanks again for your time today, gentlemen. Thanks, everyone, for joining us.

Thank you, Vlad.

Thank you, Vlad.