ITT Inc. (ITT) Earnings Call Transcript & Summary

Good morning. Thank you, everyone, for joining us today. I'm Matt Summerville, senior research analyst with D.A. Davidson, here to host a fireside chat discussion with leadership from ITT. With us today, to my left, we have Luca Savi, the company's CEO and President; and to his left, Emmanuel Caprais, SVP and CFO. With that brief introduction, I'm going to turn it over to Emmanuel, who's going to go through the safe harbor statement and then hand it over to Luca for some prepared remarks, and then we'll jump into Q&A. Thank you.

Thanks, Matt, and good morning. So our presentation this morning 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. Thank you.

Perfect. Good morning. We're going to spend just a couple of minutes with a few remarks and then when we jump in Q&A. So ITT. ITT is a manufacturing engineering company, making components and they stress component for -- good start, for harsh environment in many industries, is energy, is auto, is rail, connectors, aero and defense. You see the numbers over there. We are very well geographically spread across all the different regions, Asia, Europe and North America. You see the results over there. Now what you will see in the last 5 years, our market cap grew from less than $4 billion to what it is today between $11 billion and $12 billion. And when you look at the value creation that has happened is mainly because of organic growth and margin expansion. And this remains our priority. But on top of that, what I would like to stress in the last couple of years, we're building the -- I've been building the muscle for M&A. We bought Habonim, a valves company; we bought Micro-Mode, a RF connectors company; Svanehøj, cryogenic pumps in Denmark. And the last acquisition that we closed just 1 week -- a couple of weeks ago is actually kSARIA. kSARIA is in the CCT business. So it's a fiber cable and cabling for aero and defense. And this is an area where we want to keep on growing organically and inorganically together with flow. We will probably talk more about this acquisition, but we wanted to stress that we are becoming more and more active on the M&A front. You've seen it in the last couple of years and the funnel is also rich of opportunities. With that, let me pass it over to Emmanuel for some more comments.

Thank you. Thank you, Luca. So a quick update on Q3. So from an order standpoint, we're going to -- we expect to report significant growth. And this is coming from pump projects, short-cycle flow and Connectors, specifically in IP, we expect pump projects orders to be up in the high double digits. So really large increase. And this is driven by share gains, especially in the Middle East. In IP short cycle, we're still seeing some really good and very healthy demand, and we expect to be up in the mid-single digits, both on parts and pumps. So both aftermarket and OEM. From a connector order standpoint, we expect it to be up in the mid in Q3, and this is driven both by OEM with a lot of defense business that we were able to acquire as well as distribution. So really healthy also outlook from a connector standpoint. And then there's really a good positive order dynamic because we're seeing a sequential improvement also versus Q2 in orders. On top of all that, Svanehøj is expected to be up in the double digits. So really strong order performance here. From a revenue standpoint, Friction continued to outperform the market and it actually bucking the auto production declines trend that we've been seeing. CCT is expected to grow in the mid- to high single digits organically, obviously. And keep in mind that on top of that, we have 2 weeks of kSARIA that we acquired just a week ago. IP is focused on executing on the large backlog that we have and trying to overcome supply chain challenges as we know, that are impacting the industry. From a margin standpoint, so we expect margin pretty much in line with Q2, but continued sequential expansion at Motion Technologies. Here, a couple of things to keep in mind. So KONI, which is our shock absorber business with Motion Technologies is expected to be at 20% margin for the first time. So really strong performance, and that will help solidify the 18-plus percent margin performance of Motion Technologies. We continue to make progress on pricing in Friction, which is -- it's a tough environment. So this is all the more an impressive performance. And from an IP standpoint, we expect to be above 20% again this quarter, despite the dilution from the temporary intangible from Svanehøj, which take away more or less 300 basis points of margin. And then keep in mind that for CCT, we expect a sequential decline in the margin versus Q2 because we're going to have the impact of kSARIA, which is going to be dilutive. kSARIA still going to produce income in Q3 and in Q4, but it's going to be dilutive from a margin standpoint to CCT. So all in, we expect EPS to grow in Q3 despite the divestiture of Wolverine and despite also the M&A costs linked to kSARIA. So a really good dynamic here. And I would say, finally, as Luca mentioned, the M&A funnel continues to be very healthy. So we continue to cultivate targets and probably for 2025 at this point. And we're really focused on delivering the synergies and the committed returns for Svanehøj and kSARIA.

Perfect. Thank you, guys. I think first off, I want to talk about portfolio management a little bit, which is pretty topical given some of your remarks. ITT recently announced selling Wolverine, a business that was acquired to my recollection around the time you were running the MT segment. What changed why now? And is there more portfolio optimization to be had by ITT? And has this been informed by an 80-20 like approach to running the business.

Sure. Thanks, Matt. You're right, Wolverine was acquired in 2015 at the time when I was head in Motion Technologies. Now when we look at the two things, look at the enterprise and at the company. When we look at the enterprise in our portfolio, I mean, the focus is more shifting towards higher growth and higher-margin business. So the focus on the M&A is really on the floor as well as on the Connector business, and this is where our attention is. So we are rebalancing the portfolio towards those two areas. Now when you look at also from a company point of view, when we bought Wolverine in 2015, it was a different world. And Wolverine was a very concentrated manufacturing footprint, one plant in the U.S. So the way that it worked and we really liked it, we were importing cheap and high-quality steel from Europe, making shims and gasket and exported all over the world. Fast forward to today, we need to buy steel from the U.S., which is not as the European steel and therefore, generates a lot of rework and scrap. And on top, when you're exporting to China and to Europe, tariffs. So either we would have to invest hundreds of millions of dollars to make a plant in Europe and the plant in the U.S. and reduce the efficiency of our plant in China and reduce efficiency of the plant in the U.S. or decided to change, and this is what we decided.

Very good. Sticking just with that transaction, how accretive will that be to MT profitability? And Emmanuel, you mentioned that business generating an 18% operating margin this year, I think -- or this segment, excuse me, I think you've established a target to get to 20%. What does it take to get this business to 20% margins or better, and over what time frame?

So you're right, Matt. We were very happy this year because we were anticipating to finish the year around 18%, and we started the year super strong with already 18% in Q1 -- more than 18% in Q1 and more than 18% in Q2 as well. In order to continue this dynamic, there are several things that are working already today and are helping the recovery from a margin standpoint compared to when we were hit by the cost inflation. So a few things. First, volume. I mentioned we continue to outperform in our Friction business. And this continues, and this continues despite the fact that the market is going down and we continue to grow. We are also doing really well from a price/cost standpoint. So you remember that we had said that even if we didn't get full compensation in '22 and '23 from our customers, we will work over the years, over the long term to obtain the full compensation. And so as the commodity prices are going down, we are negotiating with our customers in order to recover what they didn't pay us of cost inflation for '22 and '23. So pricing is contributing meaningfully, I would say, to the Motion Technology story. And then the last point, which is -- has been always the key success driver for Motion Technologies is productivity. So productivity, it's happening both from a supply chain standpoint, so purchasing as well as from an operation standpoint. We continue to improve the efficiency within our plants. We find ways to reduce waste. And you just need a few cents because since you sell million of brake pads, a few cents add up to a lot of money. So we're looking after material cost reduction. So from a bill of material standpoint, simplifying the bill of material for new products. We're also working on our equipment to automate it further. And then -- so all of this is contributing to a good productivity performance.

Perfect. Just sticking with MT, the share capture story has been a really attractive and a hallmark to your ability to execute in that business. Can you review where your market share position was across the 3 regions, maybe 3 to 5 years ago, where it is today? And ultimately, whether you can surpass your stated target of 37% global Friction share?

Sure. So the -- let's start with the number of 2023. We closed the year in 2023 with roughly 29% market share in China. Remind you, we opened the plant in 2014, and the market share then was approximately 0. North America, our market share last year was around 26%, 27%. We opened the plant in Silao, Mexico, in 2018. Our market share then was roughly few -- low single digit. And our market share in Europe is very healthy and is more than 50%. So we think that we will continue to grow our market share and to outperform the market in the next few years. And the reason why we're saying that is because we know the awards that we won in the last couple of years. We know the awards that we won this year. And those awards will start production 24, 28 months after has been given the award. So we see exactly the platform that we will ramp up and what our market share will be in the next few years. So yes, that target is absolutely achievable and beatable.

When you look at the transition, albeit the slope maybe changing a little bit, when you think about the ICE to EV transition, how does ITT win in that transition?

Sure. Let me start saying that we are completely agnostic. If you're driving internal combustion engine, we would be happy to provide you the brake pads and hybrid or EV, the same. So as an example, in 2023, the internal combustion engine production was flat to minus 1%. We grew between 6% and 7%. So we were able to outperform on the internal combustion engine as well, as well as EV as well as hybrids. When it comes to EV and hybrids, the challenge is a little bit different. The way that their brakes perform, the tribology between the brake pad and the rotor is completely different. Your brake pad is cold because you don't use it all the time. And therefore, the material performs completely different. You need to come up with a new recipes. So this is where R&D really play a role. The EV is completely silent, which means that from a demand point of view, your customer and the end user want a perfect silent breaking. And the demand on the NVH on the noise is absolutely very demanding, which means that, once again, is R&D. So because the demand on R&D is so high and R&D is a key differentiator between us and the competition, this help us to win market share on EV. And actually, our win rate for electric vehicles and hybrid has been incredibly high.

When you look over the last few years, what's defined your ability to capture share? You have gone through a supply chain crisis, logistical challenges, COVID impacts. Talk about some of the KPIs that you often use as selling points with your customers to help gain market share?

Sure. There is a clear differentiation between us and our competition. And it's not just in the financial performance, it's not that we outgrow and they're declining. You look at our margin, where they're barely breakeven or making low single-digit EBIT. The reason of this differentiation are multiple, it's not just one. It starts with performance. So if you look at all these 5 years despite all the things that you said, our on-time performance has been between 99.95% and 100% for all our customers across all the regions. When you look at the quality, we measure the quality in PPB, parts per billion. So few years ago, we were at 1 PPM, 1 parts per million defective, which by the way, it's not that it doesn't work, maybe it's the barcode that, that machine is not able to read the barcode of our brake pad at the customer side. Today [ it's 0.2 PPM, 200 PPBs. ] When I meet with the customers, and they got this very simple but effective metrics 2 x 2 in terms of number of pads delivered and quality delivered, we're also on the top to the left in terms of the highest provider of pads and the best quality in terms of PPB. That is a key differentiator. Second is the R&D. When you look at our R&D is second to none. We are faster in finding the solution for the customer at every single platform and therefore, that's a differentiator. But then also other things like our cost structure. If you look at our footprint, it's very concentrated. We have 5 manufacturing plants around the world, one in China for China and Asia, a few in Europe for Europe, one in Mexico for North America. To make the same number of brake pads, our competition will have more than 10 plants. So you can see the difference of keeping, few plants efficient versus many plants. And then it's the standardization. You come to all our plants around the world. They are the same. The process is the same. The machines are the same. So when the customer comes to China, BMW comes to China that we see the same line that they saw in Europe, highly automated, same machines. This not only increase the customer confidence in what we're doing, but also standardization, copy and paste and efficiency.

Perfect. I have more I want to talk about with MT, but maybe let's pivot over to IP for a couple of minutes. Emmanuel, in your remarks, you talked about the project side of the business being -- sounded extremely strong, at least from an inbound order standpoint. I would think there's no way the market is growing that fast. So maybe can you highlight what's enabling you to deliver the market outgrowth you're delivering? And can you touch on, do a little bit of a deeper dive just from an end market standpoint, talk about chemical, oil and gas, mining, general industrial and if you're able to take that a step further with a little bit of a geographic overlay, that would be helpful.

Sure, Matt. So you're right, I think that we are outperforming the markets in IP as well, especially in projects, where we're having record -- we're going to have a record quarter here. So if you look at the dynamic from a market standpoint, the funnel is very healthy because a lot of projects have been awarded, but the funnel keeps on growing. It's not growing as fast as it used to, but it's still growing. So that means that the rate of replacement of those projects is very good. So that's one thing. We expect to show significant growth in projects in Q3, as I mentioned, as well as in Q4. So from an energy standpoint, you may remember that in Q2 -- Q1 and Q2, we were down, and this was because of tough compares. We had 2 large decarbonization projects in Q1 and in Q2 of last year that we were unable to repeat. And as well in Q2, we had mentioned we had some delays from a project acquisition standpoint. These projects, as we were predicting have come in. And so as a result, we'll have a really good Q3 quarter. If you look at from an energy standpoint, this is mainly coming from the Middle East. In the Middle East, we're gaining share left and right. And this is very, very positive. And this is really thanks to the work that has been done to really improve our project management performance, make sure that we clarify with the customer upfront what are the requirements. We work with them to develop the pump, as the pump progresses. And then at the end, we really work until we fully deliver the project to them, including documentation, so they feel that they can use our product really well. So that has been a transformational for our project business. If you look at from a chemical and general industrial standpoint, we have grown so far in the mid-single digits, and that what we expect for the rest of the year. I think this is very tied to U.S. GDP. We see good demand here. And then from a mining standpoint, we have seen some declines. We believe that this is tied to the EV pull back. We think it's temporary. I think the fundamentals are strong over the long term, and we're going to continue to see, I think, once we over the hump of the -- regarding the EV situation, we're going to continue to see growth from a mining standpoint, especially in South America.

With respect to decarbonization, you mentioned that, how big is your decarbonation driven business today? What's your technology differentiation? And maybe just to switch gears to Svanehøj, which you mentioned in your prepared remarks, what did that acquisition bring to the table for you guys that's differentiated?

So our legacy decarbonization business is probably a little lower than $100 million today. It's difficult to say it's a run rate because, first, it's growing really fast. So we have growth in the double digits, in the high double digits. And second, it's also very lumpy. But I think that here, we're doing really well. Svanehøj obviously adds a lot because most of them is -- most of their products is used for -- LNG as a transition fuel and also carbon capture. So this is a really good business from that point of view. I think the -- when you think about the differentiation, what we've been able to do, is we've been able to repurpose some of our pumps, some of our existing applications, into decarbonization applications. So for instance, our Bornemann Pump, which is a multi-phase pumping that is able to pump at the same time gas, oil and sludge because it's not a centrifugal pump, it's a perfect application for carbon capture. Because for carbon capture, you're basically mixing CO2 with water and you inject it downhole. And so this is perfect for that application. And so we've been really looking at our portfolio and trying to see which pumps we could use for those green projects, and we have been successful so far.

So another application of the Bornemann Pump would be in stop flaring. So some major energy company is using our technology to stop flaring, which is something that they committed to by 2030. And it's also something that are forced to, depending on the country that they're extracting oil. And going back to Svanehøj to give a couple of examples, the first vessels that will use as a second fuel ammonia in addition to the normal fuel will have this Svanehøj fuel pumps, and we are the only one who got that reference. And then if you look at the other carbon capture plant that is going to be in Europe and Northern Lights, where practically there are ships transporting capture CO2 to a port in Norway and then put it down under the North Sea. Those vessels transporting capture CO2, will -- are using Svanehøj pumps as well. So Svanehøj is playing a big role in the energy transition with LNG that Emmanuel was talking about and also in -- for the green.

Perfect. Sticking with IP. Across the broader industrial space, we've seen capital investments being laid deferred as a function of -- I mean, you can name 10 different things, but supply chain constraints, macro geopolitical, political, how might we expect this to play out in IP's order entry over both the shorter and longer cycle businesses over the next couple of quarters?

So what we shared also during Q2, we share some delay that we discussed in Q2 on the orders. And we share what we said is that, listen, these are delays just because of the negotiation in terms of those that are happening. And this is actually what has happened. You will see it in the order that Emmanuel talked about for Q3, and we will outperform. We will grow for the full year on the project side by mid- to high single-digit year-over-year. So I think that our view, our outlook for 2024 is positive on orders for projects. And when it comes to the short cycle, it still stays at a very robust level. And like Emmanuel share the numbers for Q3.

Perfect. Maybe moving over to CCT here. Can you talk about how ITT is positioned relative to the commercial aerospace? Obviously, we're seeing some challenges from an OEM standpoint. Supply chain constraints had been topical. Now what's maybe more topical is the Boeing strike. Should we expect that to impact your business over maybe the next 3 months? And if it goes beyond that, how should we be thinking about that?

Sure. When you look at CCT, you have 2 businesses in there. The connector side of the business that have done extremely well and it's growing in a very highly profitable. And then CCT, the component side, aero and defense. And this is where probably the only area where ITT has underperformed the market. And the reason for that is because when you look at the business, we tend to be more exposed to the wide bodies than the narrow bodies. And the wide bodies have not yet fully recovered if you look at the pre-COVID. So I will say this is the area where we expect to keep recovering in the next couple of years as the wide bodies recover. Now when you look at the situation on the supply chain, it has been pretty tough for everybody, including ourselves. And I would say, it's slowly improving, but I wouldn't say substantially different. And then when you look specifically at the situation of Boeing and the strike, we are working with Boeing. We are supporting Boeing as a reliable supplier, like always in terms of delivery and quality. Now if the impact is going to be practically 0, when it comes to Q3. And when it comes to Q4, if the situation really doesn't improve in any case, it will be an impact from a revenue point of view, which is going to be less than $10 million for CCT and ITT.

Perfect. If I recollect properly, you have a major multiyear OEM contract that's up for renegotiation, which you're contemplating some pretty notable price capture. Is there any update you can provide as to how those negotiations have been progressing?

Sure. Listen, we are negotiating, and we are working together with our customer being Tier 1 or OEM to ensure that we get a fair and just price reflecting our good performance in on-time delivery and our good performance in terms of quality. So I think that this contract has been a challenge for the last 10 years. So when it comes to January 2025, it would be refreshing to see the proper price for the components that we're delivering, and the performance that we are providing to our customers. So I'm looking forward to January 1, 2025.

Let's stick with CCT. So speak to ITT's core defense-related business and the relative positioning here, growth outlook into '25, but also very importantly, how kSARIA, which you now just acquired fits into that framework?

Sure. So defense has been a market of ours, particularly on the CCT a little bit also in Motion Technologies because we do shock absorber for the [indiscernible] for other vehicles. So we got a tailwind there as well. But when it comes to CCT, you're talking about the KC-46, the refueling plane. That valve transport, allowing the fuel to go from the big plane to the small plane has been designed and manufactured and delivered by CCT, by ITT. So when it comes to the Connector business, this is where we are really strong. The Connector business, ITT Canon is really strong in aero and defense. And our ability to provide the customer with what they need fast. I mean, meeting the customer, designing together with them back-of-the-envelope, the connectors they need coming back 24 hours, provide a prototype, delivering and then you get [ spec-ed ]. So this is where we are really delivering value to our customers. We had various wins on the Connector business. We are winning market share on that front. And when it comes to kSARIA, whose main focus is really defense, we see a lot of revenue synergies there. Think about it. In many cases, we receive from the customer request for fiber cable assembled with our connector. And we don't have those companies, we are not able to provide that. So we have to reject those requests. And now today, with the capability of kSARIA, we'll be able to address that. And on top, there are a lot of synergy when it comes to programs between kSARIA and ITT Cannon and also between customers. So that is a market that has been focused for connectors, growing and will grow even more in the near future.

Perfect. Maybe just sticking with kSARIA. Can you just take a moment to remind investors the opportunities for synergies across kSARIA, the core CCT business, be it commercial, operational and the potential impact on ITT's financials with respect to accretion, et cetera.

Sure. Maybe talk about the synergies and for kSARIA, I'll pass it over to you, Emmanuel. I think that the synergies are mainly revenue. So there might be some cost synergies in terms of different -- as an example, we are making just a few million dollars of cabling in our Connector business, and that will make sense to have it in kSARIA. But the cost synergy are probably not really material. It's mainly revenue synergy coming from cross-fertilization through accounts as well as programs. So when it comes to the numbers...

Yes. So as we mentioned, kSARIA in 2023 had $175 million of sales. We expect to be in 2024, around $200 million. Obviously, we acquired them mid-September, so we're not benefiting entirely from this. But we expect high single-digit growth over the next few years. So a lot of it is coming obviously from defense spending, but also their ability to gain market share and even more so with ITT Connect -- with the partnership with ITT Connectors, the Cannon Connectors. If you think about Q3, we expect to be able to offset mainly the interest expense that we didn't plan -- we didn't put in our guidance. It's a couple of cents, a couple of million dollars that will impact our Q3 revenue -- our Q3 EPS that we're able to offset. From a Q4 standpoint, so first of all, I'll put a disclaimer. This is really early in the process. We acquired them last week. And so even though we have very precise plans, it's still very early to assess how they're going to perform in Q4. But nevertheless, we expect them to generate income. Obviously, we'll have the impact of the temporary intangible amortization. And then the big change, I think, compared to what we guided to was -- is the fact that we're going to have significant interest expense. So if you think about kSARIA linked interest expense increase, it's around $0.07 to -- that's going to impact Q4.

Perfect. And then I think we just have about 2, maybe 3 minutes left. Just talking about capital deployment, you mentioned having a pretty good funnel. As it pertains to inorganic, talk a little bit more about the actionability, the depth of the funnel, how that's matured as you brought in additional M&A resources over the last few years? And how ITT thinks about M&A versus repurchases, noting you have $1 billion or so authorization out there?

Sure. So in -- what you have seen in the last couple of years is step-by-step building, what I said before, building the muscle. This has been planned and executed in a very rigorous way. So once we got rid of the U.S. pension, when we got rid of all the ITT legacies, asbestos liability in 2021, then we recruited our Head of M&A, business development, Bartek Makowiecki. Together with Bartek, we developed the team and we start developing a funnel. A funnel that today is very active. It's rich. And once again, let me reiterate, it's focused on flow. So we're talking about mainly pumps and valves and on the connector side of the business. Connectors, mainly on the aero and defense. So this is where the focus is. The funnel is rich and there are active opportunities. As Emmanuel said, probably at this point in time, the calendar might happen at the beginning of 2025. Now when you look at the capital allocation prioritization is always organic investment first. This is where the money will go first. This is where we have the best knowledge, there is less risk, the best return. So when I talked about value creation that we had in the last 5 years through margin expansion and organic sales growth that will keep on happening. We know that we continue to grow, continue to win market share. We know that we can continue to expand our margins. So that will continue. M&A second, share repurchases as well. I think that you have seen in the years that we had the ability to do all 3, both organic, inorganic as well as buying shares. So year-to-date, I think that we were in the region of $70 million of share repurchases year-to-date. So that option is always there, also because M&A, we are not in control of it. So in the case that doesn't work out, more share repurchases will happen.

And as an example of what Luca was saying, so we closed the acquisition of kSARIA mid-September, but we also went back in the market for some buyback also in September at the same time. So our financial position is giving us significant flexibility as well.

Perfect. With that, I think that's a good stopping point. I believe we're out of time, if I'm not mistaken. So thank you again, Luca, Emmanuel, really appreciate it.

Thank you, Matt.

Thank you, Matt.