MSA Safety Incorporated (MSA) Earnings Call Transcript & Summary

Thank you all for joining us here today. My name is Stanley Elliott. I work on Stifel's equity research team, covering a mix of industrials, building products, some construction material company. We're very happy to have a company that fits squarely in between all of these sorts of end markets with MSA Safety. From the company, we have the CEO, Nish Vartanian; and then also Lee McChesney, the CFO. Gentlemen, thank you very much for joining us.

Thank you.

I guess maybe kind of starting off high level for people who may not be familiar with the MSA story, kind of a high level overview a great place to start.

Great, Stanley. And thanks for having us here today, and thanks, everybody, for your interest in MSA. I just want to begin by saying MSA is a mission-based company. Everything we do is around protecting workers in our environment. And that's been our mission for 108 years. We recruit, retain and motivate our workforce around protecting workers. So when we get up in the morning, our feet hit the ground, that's what we're thinking about is how do we better protect workers of the world and some of the most dangerous environments known to man and how do we get them home safely and how we protect the environment. So there's one thing I do want you to take home with you today, and that is that we believe we've reshaped this portfolio to be very resilient through economic cycles. And I'll talk a bit more about that later. So our beginnings came from the mining industry. 2 mine rescue engineers were just hired the death and destruction with underground mine explosions and the thousands of lives lost. And they convinced Thomas Edison to create first product, which was a flameless lamp. So back in 1914, to connect a bulb to a battery and put it on the miner was cutting-edge technology. So leveraging technology to protect workers. And over the next 25 years, deaths in mines went down by 75%. And we go by that philosophy today. We try to leverage technology the best we can to protect workers around the world, whether it's firefighters or industrial workers, oil and gas workers, construction workers across our broad product portfolio. So the way we look at our portfolio is fire service represents 40% of our business. And that's where we get resiliency in our business through these economic cycles. Fire service is funded through municipal funding and federal funding. That funding remains very stable through you're typical economic recessions. That represents 40% of our business. Our products in that areas were #1 in the world, protecting the firefighter from head to toe, firefighting helmet, turnout gear, breathing apparatus, thermal imaging cameras and, of course, gas detection. So when you think about market penetration, just when you think about the North American market, we estimate that 95% of the fire departments use at least one of our products. That provides us real good access to those fire departments where we can expand our product offering within those departments. And some recent wins that point to that, LA City, LA County Fire Departments, they were users of our turnout gear. When they went to buy breathing apparatus, we were fortunate enough to win that business. And so that's our strategy, not just here in North America, but around the world to develop relationships with fire departments throughout the world and expand the usage. So another example of that was London Fire Brigade. We didn't sell any breathing apparatus whatsoever in the U.K., but we leverage our relationship with our turnout gear with London Fire brigade to win that business and now we're starting to win the business within the U.K. and other parts of the world due to London converting over to MSA breathing apparatus. Second part of our business is gas detection. Gas detection represents about 30% of our business. So that's both portable gas detection that you would hang on an individual worker or fixed gas and flame detection that are installed to protect infrastructure. So whether it's a refinery, power plant, pipelines, they're using a broad range of application. And technology in those areas really revolve around quick response time of sensors, longer-life sensors. And the beauty in some of these areas is the replacement cycle on our sensors is -- about every 3 to 5 years, you're replacing the sensors on those detectors. So you would install fixed gas device, it hangs on the wall for about 15 years and you're calibrating that device and you're replacing sensors, which is nice razor blade business in that category. So that's -- those products are used to kind of very broad range of product -- market applications. And then the last category is our PPE industrial, personal protective industrial equipment. That's head protection, fall protection, air purifying respirators. That represents about 30% of our business. And you would see that across industrial applications. Oil and gas industry, construction industry, utility industry, wastewater, you would see those products using those categories. We advertise ourselves, so to speak, as a mid-single-digit grower, where we get 30% to 40% incremental margins. Trailing adjusted op margin is about 19.8%. That's nice growth from 2016 when we were around 15% op margin. We continue to see good margin as we go forward. And use of our capital across the portfolio, we'll diversify nicely and that we spend about $70 million in R&D. We'll make some acquisitions. We made 4 acquisitions in the past 5 years that brought in about $250 million of revenue. All that revenue is incremental to our margin business. And we've paid a continuous dividend, an increasing dividend for over 50 years for the business. So it's been a good resilient business over time. And with that, Stanley, I'll turn things over to you.

Nish, that's a great way to start. I'd love to talk a little bit about what you guys are seeing in the demand environment, right? You have a very balanced portfolio, some longer cycle, some shorter cycle. We've seen PMI sub-50. Is that translating into what you guys are seeing in your order book? The Q1 numbers were certainly very strong, right? But just love to get an update on what you're seeing from a demand standpoint?

Lee, why don't you take that?

Sure. So we guided to end the year like remain be cautious just given the macro environment. So -- but when we did that, Stan, we said, hey, there could be some opportunities out there. So just broadly, first of all, we weren't counting on the supply chain to get better. We weren't counting on our backlog to improve. If those things happen, if the markets just pay us well as we want to, we could obviously fall back on that. But what's played out so far year-to-date is the fire business that Nish talked about has remained as resilient as normal. It's growing quite well. The fixed gas business is doing quite well. And then you get into the shorter cycle things like the portables, the head protection, fall protection, it's still doing quite well. You think about industrial employment levels, you think about backlog of commercial construction projects. So instead of it being maybe a little bit of something it would mix this down in terms of growth, it's actually turned out to actually be even a strength for us. So in the first quarter, we delivered 20% growth, half of that was units, half of that was price. We think for the second quarter, just the way things are trending, there's a lot of similarities to that. And we quite -- won't quite be at that level, but more in the mid-teens. And then what we're doing for the back half is just still staying with kind of our mid-single-digit growth. But again, you still have that same opportunity. There's some different comps and things like that. Price will do perform a little bit differently. But we'll have to see. Again, could these short cycle businesses turned out to be a little bit better? Maybe. Could the supply chain and could our backlog also help us? So we like to say we're responsibly optimistic for the second half of the year. And so far as we gone through the second quarter, we remain that way.

A lot of investors are concerned about where we are from the demand cycle perspective. And I get it. We've also talked a lot today with other companies about mega projects and the level of government moneys, also corporate moneys reshoring in trends. Along those lines, are you hearing that from your customers? I mean you would have so many different touch points. And then also, I guess the second point is should we potentially think about like a nonresidential construction cycle maybe differently than maybe what we would have in the past because of some of these different sort of drivers?

So when we look at the business overall, as I mentioned earlier, the fire service business is pretty resilient through cycles, right? So you have 40% of the business is fire service. 20% of the business is what we call fixed gas and flame detection, and that's very late cycle product. So that goes in at the end of projects. Those projects are typically brought to completion through economic downturns. So that 60% of our business we look as being very resilient as we go through this cycle. And then when you look at the other categories of our product, you have the utility markets, that should be resilient through this cycle, and that's another 5% of our business. So we have about 35% of our business that should be very resilient. When we look at that PPE Industrial segment, that short-cycle product could be impacted. But thinking that through, we have the infrastructure spend that's coming. That infrastructure spend could be a tailwind for us when it comes to that short-cycle product of head protection, fall protection, portable gas detection because you don't build bridges, tunnels, and roads without hard hats, fall protection and gas detection. So we could get some benefit and tailwind in that area. And then if you believe that there's going to be some reshoring of industry through the construction phase of that, we could see some benefit in health. So there is some upside potential as we go through this cycle, very different from the '15, '16 industrial downturn that we saw. We could see some benefit here, especially with the reshaping that we done with our portfolio.

And how do you all think about managing pricing cost, right? And may think about kind of how did you manage it last year, when COVID started? Maybe is it some of the things that you're doing differently? And potentially, how should we'd even think about that on a go-forward basis?

So we built that muscle. We did a nice job of building our pricing muscle around the tariffs. So when President Trump implemented tariffs in '16, '17, whatever the time frame was, we knew we had a pretty good pricing muscle here in the Americas, but not quite as strong internationally and we proved out to be true. So we work hard to improve ourselves when it came to pricing from an International standpoint to make sure that the pricing stuck. We drove that down through the organization through our product marketing group. And when we came -- hit the inflation period here, we acted fast. We had 3 price increases in '21, 2 price increases in '22. And when you look at our gross profit, our gross profit first quarter this year was 47%. So we typically run around 45%. So we've been positive on the price equation and that pricing sticks. When you think about personal protective equipment or protecting infrastructure, somebody's not going to save $1 on a hard hat or $10 on a portable gas detector, especially in this environment where you're looking for workers. You have workers who might be using our product. People have been wearing our V-Gard hard hat. That's a product that's 50 years old or our Skullgard hard that's used for bridging and steel work. Those products -- that product is from the 1930s. Steel workers, you won't see them in anything other than the Skullgard hard hat. And the V-Gard, you drive around the country and you see construction workers with the molded V in the top of the hard hat. That's our trademark. Safety managers are not going to swap those products out to save $0.50 or $1 on a hard hat. So we have real strong market share there and our price tends to be very sticky. And we've done a nice job of managing that, not just here in North America but around the world.

I think another reason why pricing had generally been sticky, you guys have spent a lot of time and energy on new product development. Maybe talk about some of the things that -- how that's been a key to success, where are the areas of kind of the new product development, where are you focusing on that NPD spectrum right now?

So when we look at our capital deployment, we spend about $70 million a year on NPD. Revenue is about $1.7 billion. So around 4% of our revenue is NPD. New product vitality runs around 35%. And those new products that we bring to the market are typically improve our market position. We get better pricing, better margins and they're better solutions for our customers in protecting life. So we've done a really nice job in bringing some new products to market to really hit some of the pain point that our customers have with product. So we talk about gas detection, both portable and fixed gas detection. They're looking for those sensors, which we manufacture ourselves to sensors to have quicker response times. So they react and alarm quicker to protect the worker and then also lower cost of ownership in use and lower maintenance. So the io 4, which is a new 4 gas detector that we've introduced does a lot of things to solve some of the problems and the pain points that our customers had with that type of product. When you go to a major refinery or chemical plant, you'll -- when you have a turnaround, you might see 45 or 50 workers lined up to sign out their portable gas detector and get that assigned to them. And that's all was typically done on a manual basis with our products and our competitors' products. So with the io 4, we have it designed to where you can tap it to the workers ID badge, tap it to their main system and it's logged that quickly. So there's no longer a line waiting for a product. When they're done using the product, they stick it back in the charging station, charging station automatically recharges it, calibrates it, that's ready to go for the next shift. So it's a real-time benefit and lower cost of ownership for the customer because it goes through the self-calibration mode. And obviously, productivity wise for the worker is much better. And that's also a connected device. So it's a connected device to wear. It's sold on a subscription basis where all that data that gas detector sees is uploaded to the cloud. We can work out charts and graphs for the employer, so they can see exactly what that gas detector had seen, and it makes all the documentation, much easier for the safety manager on site. So those are the type of things that we do to try to find competitive advantages in the marketplace for our customers.

And you mentioned the connected work, I mean you're doing it both on the industrial side as well as on the firefighter side. Kind of how are you trying to position this portfolio and maybe some of the things you're doing on the R&D side to continue to drive this connected worker within the space?

So we continue to work on the software side with the connected firefighter. So firefighter location is obviously critical. When you hear of some of these tragic loss of life for firefighters, and a lot of times, firefighters will go into a warehouse fire or another structural fire and they'll become disoriented and lost in that structure. . So we are developing technology to track the firefighter so that they can be easily found or they can talk them back out of the situation that they're in. And so we do that through LUNAR. It's a new device that we've introduced the industry that has GPS location tied to it, along with thermal imaging camera and then also connecting back to the station so that they can communicate back and forth through the LUNAR device. So the connected firefighter platform is starting to take [indiscernible] and be successful where we have some good penetration in some of departments.

And this is evolving. I mean, it's fairly recent, but it seems like it's more of a kind of an extension on a platform basically that you could offer as subscription services and things along those lines down the road.

That's correct.

And that would be both on -- for the firefighter as well as for the gas detection?

Yes. And also working on the same type applications around the fixed gas and flame detection products.

Can you talk about what's happening, like the competitive landscape that you're seeing out there? What are your peers doing in terms of investments, given that everything that you are doing right now?

So when you think of the competitive landscape, 2 large competitors we have in the market space that compete not across the entire portfolio, but part of the portfolio, 3M and Honeywell. So there are 2 large competitors. So when you think specifically to the fire service, we've had 3 of the competitors drop out of the market because the barriers of entry to meeting industry standards are pretty high. So it's a significant investment. Our G1 breathing apparatus, for instance, is a new product that we introduced in 2014. And that was a 5-year $50 million investment for an entirely new platform to introduce the fire service. And 1 out of every 2 of our orders that we received on that product are competitive conversions. So we've taken some significant share to the point where a couple of our competitors just decided not to go in for approvals on next standard cycles and have dropped out of the market. So you have 2 large competitors left in that space in North America, and that's MSA and 3M. So that's one competitor. We haven't seen any significant investments in that space from 3M over the last several years. I'm not quite sure what they have for the future. Turnout gear. Honeywell was a large competitor there, and we haven't seen any new innovation from them. Lion Apparel is another one that's a privately held company. And then on the gas detection side, the #1 player, we're #2 is Honeywell. And that's -- they do make some investment in that area. I think that, that core to what they're doing as they go forward. Head protection is a real small category. We compete against Honeywell and 3M in that space, but we continue to do quite well. We've introduced a couple of new products. One is our C1 helmet, which -- inside the helmet, we reduced the temperature by 20 degrees from the external temperature. And what you'll see in normal hard hats and then a climbing-style helmet which is a little different style how both of those products get a nice price premium and also additional margin.

In addition to kind of the NPD and kind of focus on organic growth, you had a very active M&A platform for the past number of years. What are your thoughts on M&A right now? What do the multiples look like? What are you guys eyeballing? How is that coming together?

So I think it's evolving nicely. I may just go back to the coordination. We're focused on safety. If you think about all things [indiscernible] we want to continue to extend this journey. We -- a number of years ago, we said we're going to focus in these 3 categories. So we haven't stopped engaging a market looking for natural bolt-on acquisitions, but they would, Stanley, be very much in these 3 lanes we've spoken about. I think if we think about where we are today versus the beginning of the year, the bid and ask is getting closer, you are starting to see a little bit of activity. For us, think about it from a capital allocation perspective, we're going to fund organic growth. We're going to pay our dividend. And for this year, we also are focused on getting our debt to EBITDA to below 2x. So we've already moved it from 2.4x to 2x as of the end of the first quarter. So we'll get it below 2x and hopefully get into the mid-single digits, and that would be a nice time to do an acquisition again. So could that play out this year? Certainly, but I think it'll be more later this year or early next year. But we have a history of doing acquisition about everywhere 1 year or 2 years. We're very disciplined on what we buy, the returns we're looking for, and to your point earlier, the bar is a little bit higher because of the cost. But honestly, we're going to do things in a very clear lane of what fits the MSA mission.

I think back a couple of years ago, you did Bacharach deal, right? And it was basically played into your core competencies on the fixed gas side and the sensors and the technology around that moved it into an adjacent market that arguably would be a little less cyclical than oil and gas. Maybe talk about that business, how it fits in the portfolio and then also kind of the success of the results that you've seen so far?

So previous to the Bacharach acquisition, the HVAC refrigeration market represented about $10 million to $15 million of our fixed gas and flame detection portfolio. So it was fairly small. And our attitude was we either need to invest in it or exit the space. And so the Bacharach product became available as an acquisition target for us. And they did a nice job in carving out a nice niche within the HVAC refrigeration market. So we made that acquisition about -- about $75 million of revenue. So again, that's where we were able to further diversify our business away from oil and gas and heavy industry into the refrigeration space. So when you think of Whole Foods or Walmart or areas where you have a lot of refrigeration. That's where we're doing a lot of monitoring for those refrigerants, whether it's freon ammonia because, obviously, the users of those, they don't want to have leaks for 2 reasons. Number one, they're bad for the environment. And number two, they're really expensive today to replace. So you could have a Walmart location or other location that is that large that could be losing up to $80,000 a year in product into the atmosphere, which is bad for the atmosphere and also expensive for them. So there's some nice opportunities for us to continue to expand and use our monitors within the refrigeration space and also HVAC environment. So a lot of the technology is similar to what we do. It's how they package those products and then how they market them. So we have some success and really optimistic about that business as we go forward.

And you talked about this business in kind of a mid-single-digit kind of revenue organic grower. Maybe help us with kind of the buildup of how all that kind of comes together? And then also kind of how you think about the 30% to 40% incremental margins, what are the key drivers to kind of keep those dynamics in play?

Yes. So broadly, we'd like to say, hey, we're a mid-single-digit growth grower. We used to be low single-digit growth. Some of these acquisitions, some of these things that have changed that. So certainly, the fixed and portable gas business are going to grow on average above that. That's a faster-growing market. There's some nice industry dynamics going to play out there. Buyer has actually been actually right in that lane as we've expanded what we do in that space, in the U.S., for example, the number of firefighters isn't changing, but we're selling more, we're having more market share, and there's obviously a big global opportunity. And then the wild card becomes what happens with the short-cycle thing. Some of these businesses could be up 10%. It could also be down 10%. Things like the hard hats, the portable and the fall protection. So that's what makes it up. And then a nice complement, which has been consistent is these bolt-on acquisitions, and you bring those in, we've kind of averaged a CAGR more in the upper single digit, Stanley. Now organically, it's obviously -- we're consistently going to have a price element. So that's going to be a couple of points. Obviously, there's some GDP and then we're doing things to take share. That's what makes it up. When we're doing a better job, it goes higher like you've seen in the last year, where you see both a higher price number and a higher unit number. But as you look forward and then particularly this macro environment is challenged, we still feel comfortable that mid-single-digit growth. That's what we can do because, again, we have this resiliency, that's been there if you go back and look at COVID times, you go back and look at a Great Recession, we did well in those times. We actually still grew. And I would argue today, we're even more prepared for that. And so it's an optimistic outlook in a macro environment, it's a bit challenged.

And in terms of the margin profile, so if we kind of stick on the 35% incremental. Have you talked about kind of an upper bound of where you think margins could end up going?

Yes. So we like to talk about 30% to 40% incrementals. We've done a nice job of delivering in that range. To Nish's point earlier, we moved from an operating margin that was more in the mid-teens to now approaching 20%, which is one of our goals. And it's been a nice evolution in both, the Americas business and International. As we look forward here, we like to cross that 20% threshold and get into the low 20s, that certainly, I think, out there. So in terms of what the driver would be there, things like our business system, which really look at the entire business. So again, we've had really good momentum with SGA in the past. There's still more opportunities there, but you're also seeing some nice evolution in gross margin over the last couple of years. You didn't see it all during COVID because you have broker buys and airfreight, things like that, but you'll see the nice evolution where, again, there's probably an opportunity to 30 to 50 basis points of operating margin, and you'll see a little bit of a contribution from both elements. And that really is bringing our business system, [indiscernible] to life over the next several years.

And that would be both for the International business as well as the North American business continued to drive business higher?

It's interesting to today, all the businesses are on a good momentum. If you actually into get the question well, what's going on in the Latin America? Latin America is very much aligned with what goes on in the rest of Americas. In International, growing in Asia, we're actually growing at above line average there. So Europe becomes our opportunity. You get things -- there's a scale opportunity in Europe. So when you get the London Fire Brigade and you get some of these other campaigns that are going to come along, you're going to change that scale, and that's going to help with kind of these other base initiatives going on across MSA.

And we're coming close to being out of time, but I'll turn it over to you guys. Is there anything you feel maybe is underappreciated about the MSA story or maybe anything else you want to leave us with this investor audience?

It's a great long-term investment. If you go back to MSA, I've been here 38 years. If you go back to '95, that's 2 predecessors ago, started his role as CEO and Chairman of the company, the stock -- split-adjusted stock price was $4. In 2000, it was $7. 2010, $25. Today, it's $140. We've paid a continuous dividend for over 50 years. So that's over 3 different CEOs, 3 different management teams. It's just the consistent delivery of value for our customers, our shareholders and our community. It's a good resilient business to be in.

Great guys. With that, thank you very much. I appreciate your time.

Thanks.

Thank you.