ITT Inc. (ITT) Earnings Call Transcript & Summary

All right. Good morning, everyone. So continuing with Day 3 of the conference. My name is Brad Hewitt from the multi-industry team here at Wolfe. Next step, we have ITT to start the day, Thursday. Very pleased to have President and CEO, Luca Savi, and also Mark Macaluso from the IR team. Thanks for joining us.

Thank you.

Thanks, Brad. Just really quick, I'll turn it over to Luca. A reminder on Page 2 of our safe harbor. The presentation and comments that Luca and I make will contain forward-looking statements, which are based on our best view of the world and of 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. So with that, thanks again, and I will turn it over to Luca.

Thank you, Mark. So just a few minutes presentation before we get to Q&A. ITT. ITT is an engineering manufacturing company, designing engineering components for harsh environment that works across different industries. So you're talking brake pads for automotive, shock absorbers for high-speed trains for the rail industry or for defense vehicles, pumps and valves across different sectors from chemical, mining, oil and gas, traditional energy, energy transition as well as components and connectors that go in aero and defense. Geographically is quite well spread with more than 40% here in the North America and our strategy has always been to be in the region for the region. You see here our results for the last 3 years. So I'm not going to take you through those, but we generated a lot of value in the last 6 years, organic value creation through organic revenue growth and margin expansion. When you look at our Q1, Q1 was resilient. It was a good quarter and preparing for a stronger Q2. The highlights of Q1, I would say, really the orders more than $1 billion orders. This is the first time for ITT in a quarter as well as capital deployment. We repurchased $100 million share in Q1 and then when there was a little bit of mess in the market, we decided to pre-release our results and to go out in the market and to reaffirm our trough in the long-term future of ITT. So year-to-date, we repurchased $500 million of shares. Now if last week, we had our Capital Markets Day, and during our Capital Markets Day, the last one was in 2022 when we shared the long-term targets. We surpassed the long-term targets 2 years ahead of plan. So we decided to do another Investor Day last week, and we shared how we're going to create value in the future, both organic because that part is still there. We are not even close to be done as well as combining with M&A and we shared how we're going to do it through differentiation in execution as well as innovation. And we shared also our long-term targets by 2030, which is organic revenue growth of more than 5%, total growth of 10% and adjusted operating margin roughly of 23% or an EBITDA above 25%, EPS of $11 from an organic basis of more than [ 12% ] if you consider total with the M&A and the free cash flow margin between 14% and 15%. So with that, we can move to Q&A.

Thanks, Luca. So maybe starting with the M&A growth outlook. So the greater than 5% organic growth target through 2030, that would be targeting 5% to 7% in IP, 2% to 4% in MT and then 7% to 9% in CCT. So just curious if you could walk through kind of some of the moving pieces on the long-term growth outlook there?

Sure. As you see, our portfolio is shifting towards more flow as well as more on connect so higher growth and higher margins. So you see that in those growth there is, for sure, some market growth when you think about the flow as well as connectors, but there is a lot of outperformance. So we've been able through execution and innovation to outperform the markets that we were in. If you look at the ITT overall, was more than 9% organic in the last 3 years. So I would say the same outperformance will happen in flow and this is because of the way that we are executing on time for our customer in a consistent manner, good quality products across all the different regions particularly well in the Middle East. I would say outperformance on the connector side of the business, where we are exposed to air and Defense, we differentiate here through a very fast customization of our connectors. So we develop and we customize the connector very quickly. prototyping very quickly and this is how we get specified in programs as well as an outperformance in auto and rail. Traditionally, we outperform more than 700 basis points every year in the automotive market, and we have committed in '25 and in the next few years to outperform between 300 and 500 basis points.

Okay. Great. Then maybe in terms of that consolidated greater than 5% organic growth outlook, how do you think about what you're embedding there for the market growth versus innovation versus execution and kind of outgrowth versus...

Sure. Sure. I would say, if you look at that property, the outperformance overall in the market is anything between the 300 to 400 basis points and this is really related to the execution and innovation.

Okay. Great. And then maybe switching over to the margin side of things. So you're talking about 500 basis points of margin expansion in 2030 versus 2024. Maybe just walk through some of the moving pieces on how we get there.

Sure. When you look at -- the margin has been a great story in terms of the last few years and has generated a lot of value. But as I said before, we are not even close to get it done. So if you come to our plans and you walk the shop floor, you will be able to see a lot of efficiency, a lot of things that are super lean. But at the same time, we'll be able to share with you and pointed out the area for improvement. So our factories in a process, in flow pumps and valves are working well, but there is still a lot of progress that we can do in lean and productivity, a lot of automation that can happen there. The same is when it comes to connectors and controls, a lot of lean, a lot of automation that will make our factory more productive. And then even when it comes to the gem in terms of productivity, which is our automotive and rail business, there is still room to improve that in terms of continuous improvement. So productivity is a big chunk of that. I would say, in terms of supply chain we have pocket of excellence, but there is still improvement that needs to be made on that front. And then in some of the sectors like flow and controls, I think that we will also have more price power. So there is definitely room to get those 500 basis points.

Okay. And one of the interesting slides from the Capital Markets Day, you had a slide about an opportunity to expand margins by 400 basis points from getting some of the underperforming sites up to the ITT level. Maybe just walk through what are the biggest steps you're taking to get there? What are the characteristics of those sites that are underperforming on margins?

Sure. A framework that we are operating in when it comes to our client, our businesses, SQDC, safety, quality, delivery and cost. And these are really the fundamentals of the businesses. And there is a very good correlation. If you look at the best-performing site or the site that got the best track record on safety, best record on quality. So working on continuously improving those fundamentals is really key. So focus on that one and guess what, the financials will just happen as a consequence. Now the other thing is ensuring that we cross-fertilize the talent. So we have a size where we have developed the best performing site is also where we have the best talent and therefore, moving those talents across the organization from Saudi, which is an incredible pool of talented individual, moving them to sites, either in Europe as well as in North America. We facilitate also the gain of the 500 basis points you're talking about.

Okay. Maybe sticking along that topic, it seems like IP and Saudi has been one of the -- one of the really good success stories for you guys in terms of the margin expansion. I guess curious how replicable you think that level of performance can be kind of across other regions?

It is, definitely, it is. And using the framework and the processes that we develop with SQDC as well as some of the talent that we had in Saudi, I think that, that will make that improvement right across the board. And just to share, there are talents. For instance, Hamdy Salem went to Saudi in 2018, 2019. It turned around that operation. He was responsible, but then of the European operation, now responsible of goods pumps of all our pumps around the world and therefore, is facilitating the implementation of all those process and those frameworks around the world for sure.

Maybe sticking with the execution topic, but switching over to MT, your Motion Technologies segment, the brake pad is the biggest business there. Your execution there has been vastly better than peers. I guess maybe talk about how much further room for improvement you see in that particular segment, given where you already are in terms of quality, speed of launches, customer experience?

Definitely, of course, the profitability of -- and the journey, the journey of friction of our brake pad business has been incredible. But as I said, we are not even close to that. And that's the beauty of the culture that you have in this team. Let me give you an example on a quality from a quality point of view, they are performing in PPBs, in parts per billion. So there is nobody in the market, no competitor that is at that level. So they closed 2024 at 400 PPB -- 400 parts per billion. And when they set their own targets for 2025, they didn't go for 10%, 20% or 30% improvement. They just said, okay, we are fit to 200 PPB. They don't need it. The market -- I mean, the competitors are not even close to that. And by the way, they will not hit it but they simply do not care. They know that if they stress themselves that we go for absolutely the best results that they can get. And they will be read every single month of the year. But they know that at the end of the year, they will achieve the best result. That approach in terms of quality is the same when it comes to the productivity of a press or oven or a finishing line. And therefore, the lines that today are operating at more than 90% efficiency is certain target even higher than that. So there is still a room that they can work on.

And maybe on the innovation side of things, curious if you could talk about kind of the pace of innovation at the total company level? And maybe is there a way to translate that into a new product vitality metric?

Sure. The way we do, and we have metrics internally, the way that we classify our innovation is in now, new and next. So now all the VA/VE, the value analysis, value engineering project that we get going to continuously improve the competitiveness and the performance of the product that we do have. And as you can imagine, plenty of projects in there. And this is where the success rate is the highest. Then you have the new. The new is practically is the same product but it's really new. It could be a new mix. It could be a new product for us that has got an indication in mind that we didn't have before. And therefore, we've got less project on that one and good success rate, but less than the now. And then we've got the next. The next is really where you have the revolutionary product. It could be a smart, a brake pad that is intelligent and that gives that data for autonomous driving or it could be VIDAR, a new motor, new to the world and new to us. And in those cases, our fewer projects, but also the success rate is a little bit lower just because they're completely new. So -- but we keep on feeding. We tend to invest more than 4% of our revenue in R&D and it's one way that we differentiate.

Maybe in terms of capital allocation. So M&A was also a big focal point at the Capital Markets Day. Can you talk about some of the criteria? And how do you think about what are the nice-to-have criteria versus the must-have criteria for M&A?

Sure. M&A is a muscle that we are building. So as I said before, a lot of value is created organically. But in the last couple of years, we started deploying capital also on the M&A front. We bought Habonim, a vast company out of Israel that works a lot on the LNG hydrogen. We bought Micro-Mode, RF connectors in aero and defense. And then Habonim cryogenic pump for -- in the marine industry for LNG, LPG, ammonia. And then last but not least, kSARIA last September for interconnect solution for aero and defense. So the best -- those are all working very well. And I would say and criteria are, a, working for the high-growth and high-margin businesses. So you see it cryogenic energy transition you look at aero and defense, so high growth, high-margin business. Companies that have a leading position in their market. Svanehoj is a leader in 3 of the 4 sectors that are operating in and then strong management teams. And this has been the case for Habonim, has been the case for Svanehoj, has been the case of kSARIA to the point that the management team of these 3 companies, they are all 100% still with us within ITT. So these are really the criteria that we are looking for.

So it sounds like both Svanehoj and kSARIA are both very good templates in terms of what to expect for future acquisitions. But I guess curious, is there anything that could lead you to do a meaningfully larger size deal?

Sure. I think those are -- if you look at the kSARIA and the Svanehoj is really the sweet spot. And if I look at the funnel of opportunities, the majority of the opportunities in the funnel of M&A are really that kind of size. So you're talking about anything between $400 million to $700 million in terms of capital deployment and revenue between $200 million and $300 million. Sure, there are some larger deals in the funnel, but the majority is really that in that range.

Maybe on free cash flow. So the -- you raised the free cash flow margin guidance, long-term guidance, 14% to 15% at the previous Capital Markets Day, it was 11% to 13%. So a nice step up there. Maybe how much -- curious how much of that is coming from working capital?

A lot of that is coming from working capital. So when you look at our portfolio, you have our Motion Technologies business. The working capital Motion Technologies is roughly 15% is the best performing as a value center. And we still have some room for improvement on that front. If you think about it, we were discussing with the Board there past due as a percentage of all receivables is less than 4%. So great, great performance. And if you think about it, a big chunk is also European business where it operates differently. So great on that respect. But when you look at IP and CCT, the working capital leaves a lot to be improved. So they are in the 20s, low 20s or in the case of CCT, you're in the higher 20s. So a lot has to be done on the working capital and particularly on the inventory side. If you look at Svanehoj which is marine industry projects from their working capital is single digit. So there is a lot that we can learn in IP from the way that Svanehoj is managing the working capital.

Okay. Great. And maybe moving on to the Motion Technologies segment. So as we think about your Friction OE business, you guys are embedding kind of 400 to 500 basis points of outgrowth for 2025 and over the long-term. I guess curious if you could talk about your confidence level in that level of outgrowth. And historically, you guys have outgrown by more like 800 basis points. So what can cause that outgrowth to reaccelerate?

Sure. I think that it's true. If you look at the last 10 years on average and even in the last 5, 6 years, despite COVID and all what was happened in supply chain or et cetera, we outperform as an average by 700, 800 basis points. I would say, we committed to 400 to 500 basis points also because as your market share is growing, the amount of outperformance becomes more and more challenging. We have a very healthy market share in Europe. China went from low single digit in 2014, 2015 to more than 30% market share last year. If you look at North America, went from 0 in 2017 to 26%, 27% market share last year. So as we've gained all this market share, the outperformance becomes a little bit more challenging. But -- so this is why we went to 400 to 500 basis points. Now in terms of confidence in meeting the outperformance, we are pretty confident because think about it, you win an award in automotive. And SOP, the start of production in the Western world is 2 years after the award. So the award that we won in '23 are going to start in '25. The award that we won in '24 going to start in '26. So -- and the award that we are winning now they're going to start in '27. So we have the visibility in terms of the platform that we want and that will start. So this is why we were not being arrogant. We're just -- we know we have the visibility, and therefore, we know that, that market share has already been won is an award, it will just begin to be executed and just making the breakouts.

Okay. Great. Let me pause for a moment and see if there's any questions from the audience. All right. We'll keep going then. So maybe in terms of MT margins, so you're talking about around 20% margins this year, long-term target for 2030 is around 23%. So curious if you could talk about kind of the path to get there?

Sure. I would say one part is linked to the business within MT. We have friction, the brake pad business, which is the biggest chunk, 70% of the business and highly good profitability. And as we said, continuous improvement in the productivity in the plant, in the machinery in reducing the waste that continuous improvement. We keep on feeding the growth in terms of margin. Our rail business is today is accretive actually to MT. If you look at the KONI business, and there is still productivity improvement, a little bit of price as well that can be -- can have on that front. And then we have another business, Axtone in rail, where we make crush buffers. That business is today in the low teens. That was a business that was impacted by the war in Ukraine, and therefore, that is in a path to get to the 20s as well. So all of those are levers for us to get to the new target.

Great. And maybe switching over to the IP segment. So in terms of Svanehoj, one of your recent acquisitions, book-to-bill was 1.3 in 2024 and then 2.0 in the first quarter. I guess, curious if you could talk about what's driving the strength of the orders there? And do you expect that level of strength book-to-bill to contribute?

Sure. So there is a component of that, which for sure is the market. If you think about the marine industry, they are all moving to cleaner fluid and that energy transition to LNG to LNG now and then to ammonia, probably in the next 10, 15 years is what is feeding the growth of Svanehoj. So there is a big chunk which is the market. And on top of that, a nice top-up is the outperformance simply because their quality is second to none, their on-time delivery is good that they got great credibility and great loyalty from their customer. Now do I think that the book-to-bill will stay no, but the book-to-bill will higher than 1 will be consistently higher than 1 in the years to come as well. And when you look at Svanehoj, we are comfortable in saying that Svanehoj will grow double digit for the next few years for sure.

And as we think about the margins of Svanehoj away, I think it's currently high teens EBITDA margins. I mean as we think over the next 5 years, could that be a 25% EBITDA margin business?

I think there is no reason why not. I was on a call with Soren, the leader of Svanehoj, this morning. And they had a management meeting there, and we were talking about the area for improvements. And this is definitely one opportunity for Svanehoj for us for sure.

Okay. Great. And then maybe on VIDAR, one of your new exciting product launches. I think you're getting first sales in July. You talked about the $6 billion addressable market. Targeting $150 million of revenue in 2030. Maybe just talk about that a little bit and then what drives that assumption of $150 million of revenue?

Sure. So when we're talking about innovation, we're talking about next. VIDAR is the best example. So if you think about it, the industry, pumps are the heart of the industry. When you think about your Amazon boxes, those that paper, everything, you use pumps to process fluid, et cetera. And these pumps have got the motor associated with that. And that motor runs 100% speed all the time. Even if you need half of the flow, et cetera, the motor can run only 100% speed. And therefore, you can imagine it's almost like you're driving your car with a foot full on the accelerator and then you manage your speed just using the brake. It doesn't make any sense. It's a lot of waste. The industry came to the solution with a variable speed drive. So these are big boxes with a lot of electronics in it that give the structure to the motor to run 50%, 70%, 40% depending on your need. But because variable speed drive, electronics, big, they need a lot of space. They need a clean room. So these variable speed drive are used only 15% of the cases. In 85% of the cases, you still have a motor running 100% of the speed, wasting a lot of energy. So -- and this is where VIDAR comes in. So what our team did working with the best university in the world, we invented an embedded motor drive. So practically, you can imagine, you get the motor, you reduce it and you insert it into the motor. The variable speed drive, you reduce it and you insert it into the motor. We had -- we invented this, we prototyped it. We tested in the last couple of years in different fields with different customers. And the results are incredible. And therefore, we launched it commercially in Q1. We already have orders and we start selling it in Q3. The return ROIC for the plant is less than 2 years, between 1 and 2 years. The energy savings is between 50% and 70% the noise level drops dramatically. You go from an incredible noise where you need to cover your ears to the noise of a [ Hoover ], right? So we are very excited about it. The opportunity is $6 billion in a market that -- where we do not play. We do not make motors. And by the way, we don't make the motor. We will contract manufacture the motor. This motor is contract manufactured and -- but all the intellectual property is ours, is our own sales team, and we are already selling it through our own distribution, new distribution of motors and also end users.

Maybe switching over to the CCT segment. So kSARIA, another one of your recent acquisitions. You talked about the high single-digit growth outlook for that business over the next 5 years. Maybe talk about just the confidence in that and then also the margin progression of that business as well.

Sure. kSARIA, high attractive market is aero and defense. They're very well known in terms of the quality, very good quality -- high-quality team in terms of execution and with a great customer loyalty. So there is -- the reason why we purchased this is one when we -- R&D connector business, in many cases, we were receiving from our customer request for potential for fiber cable with our connectors that we were not able to execute because we didn't have those competencies. So the acquisition of kSARIA was critical to expand our market. And also, there are nice revenue synergies there. If you think about kSARIA buys a lot of connectors, some of those connectors are ITT can, some of the connectors are our competitors. So there is an opportunity there for the programs where we are qualified sure to put our connectors in there. The growth is going there. We are in the major programs in terms of defense and therefore, we have that visibility. And now in being together connectors and kSARIA, we will have even more opportunity to win even more.

Okay. I guess we'll pause there and see any questions from the audience.

On the motor development, you mentioned that it's your own IP, are you worried that there's any risk for other competitors to develop anything similar to this or not at all because of that? Or are you one year ahead, 5 years ahead? Just curious there.

Sure. We -- I think that we are very comfortable in terms of having protected properly the intellectual property. We managed to go to the most expensive IP lawyers in the U.S., and we spend a considerable amount of time and brain and money to have an IP intellectual property strategy to cover. So we feel comfortable on that one to be the only one that in an industrial world, we'll be able to have this. I think that we are talking about probably a couple of years ahead that from the motor manufacturers when it comes to this technology.

All right. I think we're out of time, so we want to draw the line there. Thanks, Luca, so much for joining us.

Thank you, Brad. Thank you.