nVent Electric plc (NVT) Earnings Call Transcript & Summary

Michael Halloran here with Baird. We're pleased to welcome nVent with us, Beth, the CEO. So she's going to give some prepared remarks here. And then we're going to dive into Q&A. So if you've got any questions, let me know. Happy to make sure we funnel them forward. Many of you probably know the stock a little better than I do since I don't cover it, but I do know it well enough to be prepared enough to have a huge amount of questions. But we still want to make sure everything that you want to have answered gets answered. So anything you need funnel on our way. With that, Beth?

Thank you. All right. So nVent, we spun out from Pentair 4.5 years ago, but yet our brand's been around a long time. And what I'm excited about is we're around connection and protection. And as the world is becoming more electrified, we're really in a great position. And if you look at last year, as we rebounded from the pandemic, we had terrific growth, but that has not stopped. We've had our sixth consecutive quarter of 20% organic growth. But I saw a report out today, our stack of 2-year growth is over 40%. So to me, that's an indication of where the trends are headed. Last year, our earnings per share grew at about 31%, and our latest guidance that we gave in Q3 indicates we're going to have double-digit earnings per share growth again this year and typically really strong cash flow. One thing I would point out is when we look at -- we have 3 segments and when you look at the verticals where we play -- when we spun as a new company, we were in infrastructure, and that was teens. And in third quarter of this year, it was about 25% of our growth. And why is that important? Because we've consciously looked to grow in high-growth verticals. And when we think about electrical infrastructure, it's data centers, it's utilities, it's renewables, it's energy storage. There's a lot of growth there to come. So overall, a very strong healthy portfolio. When we launched, we had a strategy and that really was how do we scale what we do as an electrical company by really bringing all of our products through the electrical distribution channel as one company. And we typically are a top 10 supplier through the electrical distributors in North America. But most importantly is when we think about growth, we think about high-growth verticals, where do we see secular trends that are going to grow faster than GDP. Launching with new products, really important. And for us, as a company, for the last couple of years, we've launched over 50 new products. New products last quarter accounted for 3 points of growth. So it's showing the impact that we're having and growing globally and with acquisitions, and I'll talk about that. And then just like everyone, transforming with digital and working capital, and we think velocity and productivity are really key. So we think about building a more sustainable and electrified world. And if you look at the macro trends, there's a lot of investment in this energy transition. In fact, those investments in the U.S. are still yet to come. We don't even expect that tailwind to occur until 2023 and beyond. And it's true also for Europe as well. For us, we have very strong value propositions. What we do around enclosures, fastening solutions and thermal management is we drive energy efficiency, we drive electrical resiliency. We make things safer and we also drive labor and time savings. And those things are really important. And as you look at a couple of the examples here, one of our unique positions is around liquid cooling and data centers, where you can save up to 30% on energy efficiency. And this is a growing area. Today, data center is less than 5% are liquid cooled and the heat and the chips that are more powerful are requiring this type of cooling. And with energy costs rising, this is a whole growing area with data centers where we believe we have a great position. Similarly, with some of our electrical connection systems, we're able to drive a 50% savings in terms of the installation time and labor savings as well as cost savings. So just to give you an idea of where we're uniquely differentiated. And it's also important that as we launch our own products, we think about sustainability. And the last point I want to make on here is acquisitions. So since being a new company 4 years, we've done 4 acquisitions. Those acquisitions this year grew at 30%. Now we grew at 20%, our core growth, those acquisitions grew at 30%. They passed our hurdle mark faster than we expected, but they've positioned us to grow in data centers, to grow with renewables and grow with industrial automation. And our space is so fragmented. I mentioned that we're one of the top 10 suppliers in North America, top 20 in Europe. The electrical industry is so highly fragmented where we play, it's a $60 billion space, and we're just under a $3 billion company. When we find products that are focused on high-growth verticals that we can scale through our distribution, we've really seen that growth and hence, 30% growth that we've seen with those acquisitions. So in closing, we're on a great run in terms of our growth. We believe that our future is bright, given the trends [ towards ] sustainability and electrification. We're deploying capital to drive growth and attractive returns, and our balance sheet is very healthy. And we believe that there's more that we can do in terms of -- as we look forward, just thinking about this electrical trends, sustainability that we're going to outperform GDP as we go forward. So that's my short interim.

Great. Thank you for that. So let's start high level here. The growth of previous few quarters here has been really strong, really for 6-plus quarters. Maybe just talk a little bit about what the drivers for growth are and then dovetail into why you think there's that outgrowth potential as we look forward relative to whatever those markets might look like?

Yes. So when I think about everything becoming electrified, so areas where we've had really strong growth. It starts with infrastructure and take data centers and data solutions. So I mentioned our liquid cooling capability. Again, that's a new technology shift that's going into data centers. Data center spend has been strong, but we've been even stronger in terms of our growth there because of the unique value proposition. When we think about infrastructure in our Electrical & Fastening Solutions business, we play in utilities. In Q3, we had 50% growth there. Everyone just thinks about that electrical infrastructure. And I think it really comes down to that focus on where are those end markets and verticals where the trends are there. Everything is electrifying. We need more electrical resiliency. I always say this with our Enclosures segment, everything that's electronic needs to be enclosed, right? You've got to protect it. And so we provide that value proposition and that security.

Makes sense. Maybe talk a little bit about what you're seeing from a macro perspective as we look into next year more in general and touch upon it by segment, if you mind.

Okay. Well, as we go into next year, we're at record backlog levels like a lot of other companies. And so I think we're going to continue to see this infrastructure build out. And so for us, with our 3 segments, I mean, that bears very well for us. So taking Enclosures, the 2 areas there that our strength is around industrial and everything getting industrial automation, needs an enclosure, data centers, we expect to see continued growth there and strength. When we think about our Electrical & Fastening business that plays in the electrification of everything. So if you think about the grid hardening of renewables or energy storage, we provide electrical resiliency, and we think that has some nice tailwinds going into next year. And our third segment, our Thermal Management business has a focus on industrial, on the energy markets, and we just know with energy independence that our MRO side of that business continues to grow and continues to build. And so we think, again, some nice tailwinds as we go into 2023.

So how would you handicap the risk to the markets that you serve as we sit here? And oh, by the way, the e-mail for the iPad is not pulling. So if you have questions, either e-mail me directly at [email protected] or just raise your hand. I'm happy to do it that way, too. So how do you think about the risk to the end markets you specifically serve?

Yes. So I think some of the risks that we see is just -- we're starting to see some things slow down, right? And I say that given we've had 20% growth for 6 quarters. So you would like to expect things that's a crazy pace. So I do think that we're going to see -- we see it in -- we don't really play in residential. It's a small piece of our portfolio, but certainly, you can look around resi markets are slowing. Commercial markets are expected to slow. So our view is that we're going to see things not at this crazy growth rate, and we've seen disruptions, which could continue, right? So it's still an inflationary environment. And what we're trying to do is just understand where we're going to see growth despite some of the slowdown because the investments are being made in automation, investments are still being made in data centers, maybe at a little bit lower pace. And so it's just positioning with those secular trends that we expect that we're going to have growth above GDP as we go forward.

Anything to think about regionally, obviously, everyone is super focused on Europe and the concern points in Europe more broadly. How does that fit into your profile? What's the concern level there? And any other geographic areas that you're particularly excited about, we're worried about as we think about things right now?

Yes. Well, I would start by saying our strongest growth area has been North America. And I think -- and we're mostly a North American business. In Europe, we had very solid growth through Q3. And I think what we're seeing in Europe is that we're going to see and we have seen energy prices increase, so it's going to be a higher cost area. But there is such a need to switch to electrical energy and other and electrification that, that actually is driving demand for our products as there's a real focus there to quickly move off of dependency upon Russia. The other area for us is China, and China is like mid-single digits for us. That's an area where it's been a little disruptive. So we talked about on our earnings call, just having one of our factories shut down with COVID in China. I expect that's going to improve as we get through Q4. But I think we just think it's a little bit more volatile, and we just need to watch that. We've been working for the last several years to really build stronger regional supply chains. And I think that served us really well in terms of our ability to respond to demand. So we're on a path there to really strengthen what we do in region for region.

So on the European side, the electrification side of things, is that being regulatory driven right now? Is that something you're tangential to? Maybe just help me understand what those product categories that are really tied to the electrification side that -- you're absolutely starting to see in Europe.

Yes. I think it's 2 things. It's the energy independence for one. And it's -- the second is around just sustainability. Certainly, it's had a lot bigger focus in Europe for a while. And so as you look to how do you electrify, whether it's your source of energy moving to electric vehicles, which requires all that infrastructure, renewables, energy storage, anything electric as I've said needs an enclosure. Our fastening solutions are all tied to power and data infrastructure. So that's -- those are the key things that are driving that. And even for our Thermal Management business, as we think about LNG investments, biofuels, clean fuels, it actually requires more content for what we do with our electric heat tracing capability and controls.

So that's a good segue here. Let maybe talk about some of the specific verticals that you touch that are really tied to some of this electrification movement. Maybe start on the Data Solutions side, the play, obviously, a lot of enclosures on that side, and I'm assuming some fasteners.

Yes.

So what does the customer conversation look like on the adoption side? Is it -- they're carrying you along? Are you pushing them in the specific direction? How does that conversation go? And how are you thinking about the resiliency there?

So I think let me start with what I described as the most exciting area there is around liquid cooling. Data centers, when you look at the energy utilization of a data center that's just to cool not just for the computational needs, it's a lot, right? They've often said, if you put data centers altogether, they would consume more power than some of the largest countries in the world. So it really starts with a conversation with the customer about we can help provide you energy savings as you're looking at more computational requirements. We can give you a retrofit solution, we can work with you on something new to drive performance from a cooling standpoint. And then here's all the other things that we can do from our racks and power management and cable solutions. So really, it's that technology conversion that we're working with them on and providing several different types of solutions around liquid cooling. When it comes to some of the other verticals, just take anything that's becoming more electrified. We have enclosures that are focused on solar applications. We have fastening solutions that are really a -- as the one example I showed where we have a very resilient both labor savings and a cost-effective connection solution that is more reliable that can connect inside panels, between panels, used in energy storage applications. So we're providing more electrical resiliency as a result, right? And everyone's -- our dependence upon the grid is to have something that's very durable, something that's very resilient. I mean we need everything to work. And then I would just say, as you think about how we all -- the move towards more electric vehicles and electric transportation is requiring charging stations, right? So we're working with charging manufacturers on different components that we provide there, working on electric transportation. All of those things are just requiring more content for what we do.

Would you say the same for the factory automation piece?

Yes. Because I think we've all had challenges over the course of the last year or so around labor. And it's been a real constraint. And so really, one of our -- and everyone is looking to have stronger manufacturing capability regionally and the most cost-effective way to do that is to drive automation or digitization. And again, that's driving more demand for products and solutions that we have.

I mean the demographic side alone is going to push that there. It's just a question of timing, right?

Oh yes, absolutely. And I think you can see some of that automation is very versatile and flexible and the paybacks are there.

And I know you've talked about smart buildings in the past. How quickly do you think adoption curves are happening with your type of content in this kind of smart building ecosystem that's building?

For us, where we play in smart buildings, again, are a lot of the components. But even if you take the hotel that we're in, a hotel room today versus what it was 10 years ago, there's a lot more outlets and there's a lot more charging for your phone or your smartwatch or whatever, all of the fastening solutions that are actually in the ceiling and in the walls are a lot of what we do. And I think with more power and data, there's just more connections being made and that drives more adoption of our products. But even more important, our whole value proposition in our Electric Home Fastening Solutions business has been around labor savings. We constantly innovate to find a way to install our products faster. And again, with labor shortages, right? And it's a low cost in the bill of material, it makes for really just a strong portfolio that's easily adopted and accepted by the contractors.

So how do you think about the pace of orders underneath the hood in the short term here and maybe put that in context with backlog trends you're seeing and what kind of visibility you have in the channel by the various pieces of your portfolio?

So when we look at our backlog, it's up, which gives us some -- a view and confidence into the quarter and going into next year. Orders, as we talked about on our Q3 earnings call were high single digits, so that's lower than where they had been. But keep in mind that was on a really strong orders growth a year ago, right? So the stack is pretty high. But we would expect that orders would get to a some more normalized level as supply chains start to normalize around the world. When we look at our distribution channel, the sellout is very strong for our products. But we do think that distributors have been carrying more inventory because the distributor that has the products has been able to service demand. But I think we're going to see with interest rates up that, that is -- and we talked about this on our earnings call that we do anticipate that distributors as supply chains will start to back off of some of the inventory that they have.

So modest destocking. It's sound like the end markets you serve right now are in excess, but it's more anticipatory relative to what you think the order trajectory might look like?

Yes, absolutely.

No. That makes sense here. I forgot to ask a thematic earlier. How are you guys looking at the reshoring or at least the regionalization of manufacturing thematic in the various regions you're in? How much of a benefit is that for you?

I think we see it in terms of -- it's hard for me to distinguish between -- it's all part of automation, right? So it really is, as we start to see a lot of the industrial automation occurring, I think that is tied to that reshoring as well as just labor shortages.

So on the R&D side, maybe help me understand what the philosophy behind the R&D spend looks like, how you allocate engineers? Just really a sense for what the internal effort is to push the R&D on the new product side? And then secondarily, talk about what the new product side is giving you and how you think about from a vitality contribution, mix, et cetera.

When we started, our R&D was low 2% range as a percent of sales. And our vitality was in the low teens. And we just said, look, at the core of what we do is we create products and solutions. So that's really core to nVent. And so we started to look at thinking about new products in terms of just platforms and markets that we serve and how do we differentiate and how do we really understand the voice of the customer. And over the last 4 years, we've seen where new products started as adding a point to growth to now we're running at 3 points of growth. And we look at can we reduce our cycle time. And we've done that by about 20% to 30% each year. We've reduced our cycle time to launch a new product, and we put a focus on how do we see time to revenue improve. So by the time -- when we launch, we launch a product through a channel with inventory, digital, et cetera, all of those things. So I look at that as a real success story that new products are -- we're investing more, we're market-backed thinking, we're launching products that really do scale. They're differentiated, and we're doing that with velocity.

What were the levers you pulled to have that success that quickly?

So it started with making sure that cross functionally, we really had a good market team working with our engineers focused on these verticals that we understand the voice of the customer or the contract or whoever it was, and that it really was making sure that we were using agile tools because agile is a way that you really can iterate and respond quickly using things like just making sure digital capabilities and 3D printing and a lot of things coming together. And I think it's really a success of a cross-functional team just focused on some key objectives and seeing the response by our customers that -- and that success creates success.

So let's talk a little bit about the inflationary environment, price cost environment. One, where are you seeing the inflation most severely? I certainly know you guys have been price/cost, done a good job managing it. But how are you thinking about what that spread looks like on a forward basis? How much more work is there to do or do you think you're in a good spot on a relative basis?

So we are price/cost positive, and you saw that in our results in Q3. I think, generally, we've done a good job and been out in front on the pricing side. As we go forward, we still see 2023 as an inflationary year. You look at labor inflation is still there. There's energy inflation. Even freight from the standpoint of fuels are still at a high level. I think we expect that certainly metals or copper or some of the materials we use, we'll start to ease up some of those higher levels. So we still think we're going to manage to be price/cost positive as we go into next year.

And I'm guessing you have some price carryover into next year at this point too?

We will, yes.

How do you think about the stickiness of the pricing that you've put into the marketplace today. You certainly did a good job given the puts and takes there, but you look back historically, is this a business model that has historically been able to maintain that pricing after a push through?

Yes. And I think part of that is because 2 reasons. One, we're typically a low cost in the bill of materials. And for the portfolio like our Electrical Fastening Solutions business, where it's all about labor savings, that trade-off just works. And I think we're still in an environment where there's a lot of demand and some constraints. And so servicing that demand, I think we're going to be able to manage that price cost equation effectively as we go forward.

So remind me again what your typical pricing cadencing looks like? Is it ad hoc based on need? Is it a little bit more structured annually? And talk about the need for whether you see the need for additional price increases from where we sit here today?

So we typically -- I mean, nothing is normal anymore, right? But I would say every quarter, we had done some price increases. And most of our products go through distribution. So you need to give 60 days notice. So it's a disciplined approach because you need to get notification. And as we sit here today, we've done -- already done some additional price increases that will carry us into 2023. And I suppose my thought there is we've shown that we can very effectively action pricing as we need to as the environment requires it.

In supply chain side, how has that tracked for you? Are you seeing easing at this point?

Getting better. I think electronics was one of the areas that had been a challenge and has improved. There's still always disruptions. I think the -- one of the biggest constraints still remains labor for our factories.

And that's probably not going to change anytime soon, particularly on the skilled labor side.

Yes. Well, even hourly labor, it's a challenge. And with some of the things that we're doing in our Enclosures business, we operate in Mexico, we're going to expand there just because we need some more capacity, whether it's our liquid cooling or some other capability that we're building.

What's the working -- go ahead.

[Technical Difficulty]

He just asked, Phil, is on the webcast to just dive into the liquid cooling market, specifically what the opportunity set is.

Yes. Let me just characterize it this way, that if you look at all of the data centers today, 95% of them are cooled by air, so the penetration is only 5% today. So there's a lot of opportunity for growth. And not only that, I would just say, as you look forward, these high-density electronics and the chips themselves are becoming so much more heat intensive that liquid cooling is the direction that -- it's where everything is moving. And it will expand beyond data centers over time, too.

The competitive situation within that business?

For liquid cooling, there's -- I think there's a lot of smaller competitors and players and startups and there's lots of different technologies. And I think you've got lots of different ways, whether it's at the chip level, whether it's immersion cooling, whether it's like a rear door, liquid to air cooling system. So there's various types of technologies. And I think there's plenty of runway for all of them at this point because they all serve and can serve a different need, whether it's retrofit or new.

So maybe talk about your -- the internal inventory, working capital situation, how you've been managing it and just thoughts on how you think the cash conversion tracks from here.

So our guidance in -- that we just gave out for the year is 90% conversion. We typically are a 100% cash conversion company. Like many others we've made some of those investments in inventory. But I would say starting towards the end of Q2 and as we got into Q3, where we had 100% cash conversion, we really started saying, look, there's areas where we still need to invest, but there's other areas that we can start to that we feel better about the supply chain. So full year, we're looking to drive about 90% cash conversion.

And I'm guessing then as you look to next year, the hope is that the conversion levels get better -- and then if there is a slowdown, probably accelerate the conversion just with some working capital.

Yes, I mean, that's typical, yes.

Yes. So let's talk then the usage of cash from here. Maybe just philosophically start with how you look at cash returns, obviously, internal investments first. What do you think about dividends, buybacks, M&A, how do you prioritize?

Yes, as we think about capital allocation, our first priority is always to invest in growth. And so that's new products and it's CapEx. And from there, we -- and we typically want to ensure that we're operating between 2x to 2.5x as our leverage ratio. And we're certainly there. We were at 1.7x exiting the quarter. As a minimum, we're always going to do share buybacks to offset dilution. And then we put a priority on M&A, and we've seen terrific returns from M&A. And I think we'll keep that in balance as we look -- as we go forward through into 2023.

So what's the M&A landscape look like from your perspective? You've seen a spike in interest rates, strategics, maybe counterintuitive some have gotten a little bit more competitive as a result because you have the synergy side on the back side. Has that funnel gotten a little bit wider for you at this point? How actionable do you look at the funnel as we sit here today?

Yes. I would say this, I think our funnel, it's been robust for a while. I always say, we're in a very fragmented space, and there's lots of smaller and medium-sized companies, and sometimes you don't quite control the timing, if they're privately held. And I think we remain very disciplined in how we think about our financial models and metrics that we want to meet. And we're also very strategic. And I'd like to think of how we've executed on those 4 deals with high-growth verticals and great product portfolios that we scale, that's the lens that we bring to it. So I think we'll continue to see M&A as a key part of our strategy, and we'll continue to remain disciplined and drive that execution.

Are there any particular focus points on the M&A side or is it just going to be about what opportunities roll up around the 3 different categories or the segments you serve?

Well, we think of it more from, first of all, our mission to protect and connect, and we always say that because that idea of protection just implies that it's huge value creation, right? So a lot of things to fit. And then we really look at these high-growth verticals because we know if we can find great product portfolios that are positioned for data centers or positioned for utilities or positioned for renewables or any of these electrification areas, they're going to have great growth trajectories. And the other thing with all 4 of those deals, we bought companies that just did not have a strong position through distribution. So our ability to scale them globally or through distribution, it's why we're seeing such strong growth there. So it starts with those great product portfolios in high-growth vertical areas.

Well, great. Unfortunately, we're out of time, but please join me in thanking the nVent team for their time today.