MSA Safety Incorporated (MSA) Earnings Call Transcript & Summary

Good afternoon. I'm Brendan Popson with CJS Securities. Our next presentation today is MSA Safety. It is my pleasure to introduce Ken Krause, Chief Financial Officer; and Elyse Lorenzato, Director of Investor Relations. We'll start with some high-level comments from the company. Following that, I'll host a Q&A session. Feel free to submit any questions you may have via the web portal any time, and we'll do our best to make sure it is covered. With that, Ken and Elyse, thank you for taking the time to join us today.

Certainly.

Thanks, Brendan. So we'll just start here with the safe harbor on Slide 2 before I hand it over to Ken. Please make note of that safe harbor, and we'll flip to Slide 3, where Ken will take us through the presentation.

Thanks, Elyse. I appreciate that. Thanks, Brendan, for having MSA today here at the conference. It's always great to attend and to share the MSA story. And for those of you that don't know MSA Safety, we're roughly a $1.3 billion company that designs and manufacture safety products and solutions across a diverse range of end markets and geographies. We've got about 55% of our business here in the U.S. and the remaining 45% is in areas including Europe, Latin America, the Middle East and China. Our largest single end market is firefighter safety, and we also play in more industrial-oriented markets, with our industrial PPE and gas detection product sets. About 10% of our business is from what we call air-purifying respirators, APR, for sure. We've been executing on our mission of protecting the health and safety of workers for more than 105 years. Every day, our products protect tens of millions of workers around the world. And I can't think of a time where our mission has been more relevant than in 2020. It was a challenging year, certainly, but also remarkable to see how our people have gone above and beyond to respond to our customers. We continue to work through our year-end closing process. We spoke on our October earnings call about incoming order pace strengthening in September and October. That strength continued in November and gained even more momentum into December. With much of the upside from fire service, a defensive business for us, business we've talked about as being such an important market and very resilient. We all know that things can certainly change in a dime based on the macro environment over the past 12 months, but it is certainly encouraging to see our business continuing to recover here in the fourth quarter. Our culture was really, when I look at it, our culture was certainly a really big differentiator for us in 2020. Our people executed strongly despite hurdles that we all faced. That's a good example of how our past focus on ESG has contributed to being a better business and better business outcomes. Our talent was certainly on display in 2020, and we continue to focus on our ESG programs as we look to the next several years. As we transition here to slide, I believe, Slide 4, MSA has an ESG-oriented mission. As we're making products and platforms that protect people's lives, social responsibility is deeply embedded in our culture and values as an organization. We've recently been focused on highlighting that in our disclosures more pointedly. In fact, we published our first ever stand-alone sustainability report in 2020. The report includes enhanced disclosures around our environmental metrics and goals, workforce demographics and community partnerships. In 2020, we continue to focus on these areas, and we're also an active contributor to the COVID response around the world with mass donations and multimillion-dollar investments to enhance our respirator manufacturing capabilities. We'll publish another sustainability report this spring. Our approach to ESG centers around continuous improvement, very much mirroring the approach we take in the rest of our business with the MSA operating system. And I'm proud of what the team has accomplished from an ESG standpoint and excited as we continue to progress towards our longer-term goals. Looking at some of the secular drivers of our business. There's certainly a tremendous amount of secular drivers in safety. And we've got exposure to key global trends. Here on the slide 5, you can see a number of those trends highlighted. But our growth profile is unique because we are a pure-play safety company in a highly attractive area of the market. When you think about it, as more and more companies place greater focus on social responsibility and enhancing the ESG reporting, safety has never been more important. There are a number of secular trends that drive our business, including firefighter health and wellness, the growing use of the Internet of Things in industrial settings and a high cost of noncompliance to safety standards, especially in the fall protection area. Looking at closer -- more closer in our positions in these attractive markets, while we expect changes in the world as the new normal is established after COVID, we are confident that safety has never been more important among our customers and potential customers. And at MSA, it all starts with our R&D investments in our leading market positions across firefighter safety, gas detection and industrial PPE, which includes the hard hat here you see and the fall protection device. About 35% of our revenue is from new products, and we play in an $8 billion to $9 billion addressable market, which we've expanded over the years through M&A and organic R&D investments. Our market positions reflect a very large installed base. Our strategy has been to seed the market heavily with MSA hardware and then layer on bolt-on technologies and software solutions. What we're doing with the G1 and LUNAR is a really good example of that or the ALTAIR 4XR and Safety io. We've continued to invest about 4% of revenue in R&D, which sustains our market positions and healthy gross margins of about 45%. Looking closer at the innovations here on the next slide, you can see from PPE to gas detection to connected products like LUNAR and ALTAIR io360 and the associated software platforms, we often talk about the competitive moats in safety and significant IP in our product portfolio as being a key driver of defensive -- of our defensive market position. We have nearly 900 patents and operate in a highly regulated industry, which naturally creates high barriers. And in addition to investing in R&D and all the innovation, we've got a pretty strong track record of execution, whether it be the organic side, with all the products we continue to launch here on the acquisitions, most recently with Sierra Monitors, Globe and Latchways. We continue to really drive nice growth and improvements in market share as we grow the business and invest. As you can see here in the last 5 or so years, our revenue CAGR has been about 7%. And our earnings CAGR has far outpaced that at about 15% and is being driven by that strong incremental margin profile that we have consistently talked about. In addition to the investments we're making to grow the business and improve profitability, we continue to be very well positioned to go after and maintain a -- go after acquisitions and maintain a very balanced approach to our capital allocation. You can see here, we've generated significant amounts of cash flow over the last 5 years. And have shared that cash flow with our shareholders through the use of an increasing dividend. Turning to page here on to the next slide and looking at our operating margin profile, you can see improvements over time and -- which is reflective of our competitive moats and all the technology as well as our continuous focus on efficiency and productivity in our business. If you go back to 2015, our operating margin was just below 13%. And through the first 9 months of 2020, we're running at just over 18%. We've executed a number of restructuring programs over this time to drive productivity in our factories and streamline our footprint in back-office areas. In 2020, we announced an additional global restructuring program designed to take additional costs out of the business in 2021 and 2022 and beyond. So we have a great portfolio of margin expansion programs that we're working on across the P&L and reporting segments should continue to drive improvements in margin going forward. When we look at the balance sheet, we again continue to be very well positioned, here on Slide 10. As you can see here over time, we've used the balance sheet, and we've continued to bring on additional accretive acquisitions. In addition to the organic R&D investments we've discussed, supplementing that with strategic acquisitions is an area where we've been successful in the past. And it's an area where we continue to focus and continue to pursue. Our balance sheet is very strong, and we think that executing acquisitions is an important opportunity for MSA over the next several years. As you see here, we've used the balance sheet many times over the past decade. We've levered up and quickly delevered, all while maintaining a very balanced approach to capital allocation. About 50% of our cash flow we've generated over the last 5 years has been invested in acquisitions while continuing to pay an increasing dividend each and every year. These acquisitions we've made have bolstered our positions in existing markets and expanded our addressable market. Looking at the pipeline of the future opportunities we are working on, we're working on with a number of strategic targets and we continue to execute and work on a number of strategic targets across fire service, industrial PPE, gas detection and additional interesting technologies. We will continue to invest in R&D, but we'll also focus on supplementing that with acquisitions, strategic acquisitions that will make a lot of sense to you. So in closing, as we look at some of the reasons and rationale why to own MSA, there's really clearly uncertainty in a number of near-term -- in the near term based on the macro environment. But we are really confident in MSA's long-term outlook and our algorithm for growth for several reasons. First, the secular trend of safety has only improved. I've said it a few times today. It continues to gain importance and improve with our customers around the world. Second, we are investing in our R&D and organic growth. And we have a very full pipeline for M&A, and our balance sheet with leverage below 1x positions us very well. Third, we have a number of programs in place to drive productivity and continuous improvement in our cost structure and our business model. And fourth, our culture and caliber of talent has never been better, and we place a lot of focus on engaging and motivating the team to drive results. We have a great business, and these focus areas will position MSA as an even stronger company as we navigate and emerge from the economic recession. Brendan, we'll hand it back over to you to lead the fireside chat and any Q&A you might have as well as any questions that might come in from the audience.

Great. That's a great overview. And just starting off today, you did touch this in the presentation, but if you want to provide a little bit more detail, talking about ESG, which is certainly a theme that we're talking about a lot at this conference. And just briefly highlight key actions you've taken or anything that you have -- didn't cover there? And then -- and then even more importantly, I guess, how are you thinking about this over the next few years and any actions you might take?

Sure. ESG, as I said a few times, is incredibly important to us. When we think about ESG, we think about what's material to our business and what's material to the world with respect to our business. That is how we set our ESG strategy. For MSA, our mission and the overall product development process serves a critical ESG function because our products protect the lives of millions of workers each and every day. We help our customers achieve their safety goals. And as you well know, we're very focused on advancing safety technology to make the workplace safer for all. One of the key supporting pillars behind it is attracting and retaining talent. I've talked about our talent a number of times. And we continue to focus there and invest in our key talent, which is really a differentiator for us. We're also very involved in giving back to our communities where we live and work. We support STEM initiatives in our local school districts in colleges and COVID relief, we were on the front line with donating respirators to support local healthcare institutions and their response to the unfortunate situation. In other local causes, really, we're really involved with our customers, with our communities where we work and live each and every day. We're also focused on the environment. We focus on energy consumption and carbon emissions and things like that. We -- the ESG, we view it really as a pillar within our operational excellence aspirations. And we integrated it into key business processes. We put it to work each and every day. It's just not something we talk about, but it's something we're focused on executing around.

Great. And then looking at the effects of the pandemic on your business, if you want to talk about longer-term implications, and it might be helpful to talk about it by your end market, you're looking at fire safety and then industrial and then maybe fixed gas and flame. And just what you're seeing in terms of recovery and any other business model changes brought about because of that?

Yes, certainly. It's a bit of challenge -- 2020 was certainly a challenging year for everybody standing out there and executing on a daily basis. We had a number of headwinds, things that didn't go in our favor, employment-related industrial PPE, energy-related product areas. Really hard to -- even though safety products are essential, sometimes selling safety products is not essential. And so it was really tough to get in front of customers during the summer months when COVID resurged in the Gulf Coast. Really a tough time, which really played out in a really challenging third quarter. But when we look at some of the things that maybe we're more optimistic about, APR, the things we did on APR and responding to the customer. The focus on the CARES Act and the funding that's coming into fire service is providing a sense of optimism. Our fire service position. It's never been any better. And whether it be the SCBA or the turnout year with Globe or some of the technologies, we really feel like we're really well positioned and seeing some nice benefits in that market. In addition, not surprisingly, we took action. We took action in the pandemic to reduce our cost structure. And that action has paid off for us. If I look at the first 9 months of the year, our international margins and what our associates are doing in the international segment of our business can't be understated. I mean it's -- the work is tremendous and seeing several hundred basis points, 200-plus basis points of improvement in a challenging growth environment is certainly good to see. The other thing, I think that as I look back through the rearview mirror and I assess was I'm glad we didn't take short-term measures. A lot of people were cutting pay and doing things like that. We took a longer-term view. And we looked at our business and asked ourselves what can we do with this business over the next several years? And what do we need to be doing today to be an even better company in 1 to 2 years down the road. And so we started that action more robust restructuring programs as opposed to short-term cost levers. And so that's kind of a lay of the land in how we responded to COVID, but I feel like we're positioned now to continue to see improvements.

Yes. And then on the -- alluding to your international margin, if you walk us through some of the progress you made there in 2020? And then also any plans in 2021?

Yes. I mean, talking about margins in International, I'd tell you what, we came into the recession with a full pipeline of opportunities that we were executing on. And I think it's important, no matter where you are in a business cycle to have a portfolio of opportunities that you can action when necessary. You may not need to action them today because you're -- you need to be more in an investment mode at one point in the cycle or the other. But I think having a portfolio of restructuring opportunities is really important. And I think as we think about international, we've been talking about that segment and the improvements in profitability for some time. And I think what you saw this year was a lot of those actions being realized. And it's great to see Bob and the team over there really seeing nice performance through the first 9 months of the year and actioning a number of those initiatives. I feel like we've got other things ahead of us. We're not done. We certainly have another number of opportunities ahead of us as we go forward. But it's good to see that we're coming and the results coming to fruition.

Yes. Great. And then looking at fall protection. I'd like to talk about before the pandemic, it certainly was something that you felt like you had a -- at MSA a very small slice of a larger and very quickly growing pie and somewhere where you saw a long ramp of opportunity. Certainly, it's been a difficult year for that just with the unemployment for the workers who would need equipment like that. What are you seeing in terms of that business? And I mean, when do you think that can return to one of your strongest growing product types? And then what -- is there anything that has changed with your strategy there?

Yes. Unfortunately, falls remain the #1 cause of death on construction sites and many of those falls involved individuals who were wearing fall protection equipment, but they're just not tied off to an anchor point. To help customers address that issue, we recently launched a smart, what we call a smart hook connector. It uses our RFID technology. It alerts the wearers when they're not using it. And so fall protection remains a really important business segment and product segment for us. We -- And I think we have got a lot of room to run, a lot of room to grow. It's the largest overall market at just about $2 billion market size. And it's the only core product area where we do not have a #1 or a #2 market position. So -- and there's some nice opportunity there. As you saw with the growth over the last couple of years in fall protection before COVID. It's difficult to say exactly when fall protection will snap back relative to the rest of the portfolio, but it does depend on the employment levels just like head protection. But when fall protection snaps back, it comes back pretty quickly. I mean we're pretty -- we're bullish about the business longer term. We feel good about the business, and we feel like it's an area that we will continue to invest in.

Okay. And on that, looking at the -- your long term -- your goals, mid-single-digit organic growth. Has your formula as to how you get to that based on the various businesses you're in, has that formula changed based on -- is there certain products or end markets you see as even more attractive or maybe not quite as attractive now that we're through 2020? Or is that about the same long-term expectation?

It's still intact. I think the long-term indication and expectations of mid-single-digit growth and the algorithm associated with that growth is still very much intact, low to mid -- low -- 1% to 2% sort of of market growth or low to mid-single-digit market growth, depending on where you are in the cycle. You've got some price realization of 1% to 2% and then some small market share gains. We've consistently done that. And I think over the long term, that's where we expect to be. I think M&A provides a little bit of upside to that as we go forward based upon our position. But we're going to be smart. We're not going to chase every acquisition. We're not going to overpay. We're going to do things the MSA way and the way that we've done for the last number of years here. And so -- but the growth algorithm, I think, is still very much intact. I think the thing about MSA is we've got a resilient business model and a very defensive business model. The unfortunate thing with that is not every one of the markets are always working in the same direction. But that also plays in our favor. When you might see energy contraction, you might see fire service doing well and doing better. And so we've got a nice portfolio, diversified portfolio that provides an opportunity for us to grow at that mid-single-digit kind of growth rate long term.

Great. And then in talking about M&A like you mentioned, how prioritized is M&A right now within your capital allocation framework? And I guess, what if anything can you say about what you're targeting right now for potential investments? And what markets feel attractive right now?

Yes. M&A is always a part of the equation. I wouldn't say it's at any one period ever any more important than any other period. We grow -- we've done a really good job growing the organic business, but we are very active at looking at M&A. Again, I'll reiterate, we won't chase things. We'll remain very disciplined and diligent. And we have high hurdles that we measure ourselves against so that we are going after and pursuing the right acquisition that we can create a better company -- where we can help create a better company. And so I think it's really important to remember that. But I think M&A is important. You know our leverage, it's just about 1x. So we feel like we're well positioned to go after and pursue additional growth that will make MSA a better business longer term. And that's what it's about. So I think that's -- we've got targets in fire service. We've got targets in fall protection. We've got targets in gas detection. And so you've got targets up and down the spectrum that we continue to look at and evaluate.

And looking at something like your LUNAR product, is that somewhere where you think is -- would be called, I guess, a priority if you're looking at these targets as connected safety equipment a primary theme? And can you talk to any developments there?

When we look at opportunities, technology, we look at a defensive mode, right? And just like many of you look at MSA or other businesses and evaluate the competitive mode around the business. Any time we can find an opportunity where there is some technology where there's recurring revenue, where there's things like that, we certainly are attracted. And so I think that those are things you call out that are important to us as we evaluate opportunities and what makes businesses more valuable.

Yes. And is there a range in terms of size of opportunity you might pursue with M&A?

No, I think using history as an example here, which is not always accurate, but using history. For General Monitors, we levered up to 3.5x. For Latchways and for Globe, I think we levered up to around 2.5x. And so we've got a past practice of using the balance sheet, but then also quickly delevering. We want to be an investment-grade company. And our focus is to buy businesses that make us better and allow us to hurdle our cost of capital by year 3. And so I think that using those metrics and principles, I think, will be what we continue to follow going forward.

Okay. And then lastly here, just looking at your -- what would you ultimately say, MSA primary competitive advantages and barriers to entry? What would set your business apart from others? And obviously, you have various business lines. But -- and also playing out with the M&A, what kind of barriers to entry and competitive advantages are you looking for there as well?

I think safety -- really, safety is important. So when we think about M&A, we think about MSA, safety is all we do. It's where all of our energy and focus is. And that creates really a unique bond with customers. It allows us to remain really agile on the R&D front, leveraging the technology across our portfolio. I think a key competitive advantage is our ability to partner with the customer to bring new innovations to market that provide a safer working environment for those that use it. It's a defensible market position with leading technologies, significant IP, strong brand equity, safety is highly regulated, and that creates natural barriers to entry. And so we really -- we don't compete on price. I've said a number of times, we compete on technology, comfort, delivery, brand equity and the total cost of ownership, to name a few. And so hopefully, that answers your question.

Yes. Great. And just before I end the call, I figured I'd turn it back over to you if you have any -- you've got a couple of minutes here. If you want any closing comments before we let you go.

No. The only thing I would say is just thanks to each and every one of you for your interest in MSA. We continue to execute on a long-term strategy that's focused on providing customers with the best products and the most reliable, best products, most advanced solutions to their situation. And we'll continue to do that while maintaining a very balanced approach in our capital allocation strategies. And so that probably summarizes it.

All right. Well, great. Well, thank you for coming to the conference. We appreciate you guys coming. And I hope everyone has a great rest of their day.

Thank you, Brendan. Appreciate your interest and talk to you soon.

Thanks.