nVent Electric plc (NVT) Earnings Call Transcript & Summary

All right. Good morning, everyone. Next up on stage. We have the team from nVent, Chief Financial Officer, Sara Zawoyski; Tony Riter, Investor Relations. Team, thanks for joining us. A lot of exciting things going on in your end markets. I hear this data center stuff is pretty cool. So we'll touch on that.

But maybe, Sarah, just to start us off here, what do you guys focused on? What are you seeing out there? And then we'll dive into some questions if that works.

Yes. Thank you, Josh. Thanks for having us, and good morning, everyone. I'll just maybe start with a couple of highlights for nVent. NVent, we're a leader in the connection and protection in the electrical space. We're fast approaching $3 billion in sales, and we've had a very positive earnings trajectory. When you think about the secular trends around sustainability, digitation and some of the infrastructure investments, we see that all driving demand for our products. And when you think about our growth strategy, that has been consistent since we spun back in April of 2018, really centered around increasing those high-growth verticals, increasing new products, global growth as well as M&A. And there's some exciting things happening there on the M&A front in high-growth verticals, infrastructure specifically because of data solutions and the massive amount of growth we've seen there since spin, that now accounts for over 25% of nVent sales where that was back in the teens as we spun. I think the second thing maybe to point out is the M&A. We've acquired and just kind of wrapped up and be closed out our sixth acquisition since spin. And we've done 2 completed 2 in the last 4 months. And 1 of those has been our largest acquisition with ECM Industries. So we think with the combination of that strong execution on that organic growth side of the house as well as the strong execution on M&A, it really is changing that growth projectile for nVent. So we believe we're well positioned as it relates to these macro trends around sustainability, digitalization as well as the infrastructure investment. So with that, I'll pass it back to you, Josh for the Q&A.

Yes. Maybe just to start off on the macro side. Obviously, dynamic environment, certainly some regional color in places like Europe and Asia. Inventory levels are moving around for some folks. Anything that you would point out that stands out and you're particularly focused on in terms of, call it, near-term demand trends or customer behavior?

Yes. So I'll start out with maybe just kind of painting the picture from the vertical side of the house. So when we think about infrastructure, like I said, that's now over 25% of our sales in data solutions, that actually grew infrastructure grew 10% for us Q2. So strong double-digit growth. And when we think about data solutions for us, that really revolves around being a systems provider to data centers. So it's the enclosures, it's the cooling, it's the power and really focused on liquid cooling. And so that's where we're seeing that exponential growth. When we think about industrial, that's roughly 40% of our sales. And we see strong underlying secular trends there whether it be industrial automation as well as onshoring, reshoring, as well as the manufacturing construction that's sitting here in North America to meet those Build America Buy America requirements. So strong growth underlying there as well. Commercial resi, a little bit different. We did say coming into this year that we expect that to be softer. That's roughly 30% of our sales. But if you break that apart, there's an element of that commercial and resi infrastructure, particularly in the Electrical & Fastening Solutions business that is driven by power and data infrastructure. So when you think of anything that has to be digitized, whether it's in a building, in a material handling center, whether it's in retail, office, as things are upgraded, building solutions are upgraded, the computer programming is updated. You're putting in more cables and more infrastructure that needs to be managed, and that's driving demand for our products. And I think the last thing I would touch upon is the energy. It's a smaller piece for us here at nVent, but excited about that energy transition and what that means in terms of opportunity for our heat tracing. The one thing I would call out, and we talked a little bit about this on our Q1 call and our Q2 call, and that is the inventory level adjustments that we're seeing with our distributors. So 2/3 of nVent revenues go through distribution. And so with that, as that supply chain and lead times improved, and I like to use the example of our nVent products. There are some cases where typically, our lead time to our customers was 2 days, but it was 12 weeks. And that's much, much improved as that supply chain normalized. And so with that, we expected coming into this year, as that supply chain improved -- so would that show up in that ordering patterns of our distributors. And so we are seeing some of that as we came into Q2. We saw it a little bit in Q1 in commercial resi. We saw a bit more of it in industrial and commercial resi here in Q2, and we expect that to continue here in Q3.

Understood. That's a helpful update. Maybe diving right into the need of it on the data center side, obviously, very topical at multiple levels of the market. But maybe distinguish if you can, how your offerings in liquid cooling maybe differ from some of the other opportunities out there or other solutions providers. We've had a lot of the HVAC guys on stage everyone seems delighted with the opportunities in front of them. It's not apparent that all these things are necessarily competing with each other, maybe just filling different roles. But anything that you would point out in terms of where you're focused in the data center or technology milestones. It's sort of deliberately open-ended. But how do you see this ecosystem evolving as you talk to presumably or like NVIDIA?

Yes. Maybe I'll start out by saying that we've been focused on this liquid cooling space for decades. First, in the industrial space. It was really prespin where we took that liquid cooling expertise and really looked at the data centers. And with that, we began to work with the hyperscalers on 1 of their most difficult problems that is cooling within the data centers. And so from there, it's been our Data Solutions business was roughly $100 million. Last year, it was $375 million. Some of that through inorganic, but a lot of that through that steady double-digit organic growth. And when we look at that $375 million, roughly 40% of that is in that liquid cooling and power space, and that's growing 3x that of the market. And when we think about liquid cooling and what nVent does and what makes us different is, one, it's that technical and application expertise. In many cases, these systems that we provided, that's the enclosures, the rack, the cooling distribution unit as well as whatever cooling continuum that hyperscaler wants, you have to have the technical and application expertise to be able to put that system together. And in many cases, that prototyping and that testing happen over a course of a year or 2. So it's a long cycle working directly with that hyperscaler. The other thing I would mention, too, that is really important is a lot of the liquid cooling technology are start-ups, and they don't necessarily have the scale to manufacture nor put the complete system together. And I think that's something that uniquely nVent can bring to the table. We talked a little bit about this on our Q2 call that we're also excited about the generative AI and what that's doing in terms of accelerating and incrementally increasing the data center growth and particularly focus on liquid cooling because we like to share that in this data center space, still 95% of it is air cooled today. Only 5% is liquid cooling. That liquid cooling is growing exponentially faster than the air. And that's because in this newer space around generative AI and the new chips, it requires the liquid cooling in terms of the density that it is and the inefficiency that it provides.

Understanding it's just building off of what you said in terms of a lot of the other folks in the space are more startups may not have the real manufacturing capability, certainly not the scale I'm assuming that it provides you a huge advantage just to lead out in front and say, hey, we can deliver this. But are there also technology milestones that yourselves, other folks out there need to meet to sort of rise to what generative AI needs. Like is the technology available today? Or is there still some iteration that need to take place?

Well, I think the technology is going to continue to develop on liquid cooling. I mean right now, there's various aspects of what that cooling looks like, whether it's direct to chip, whether it's immersion, whether it's rear door cooling, and I think those various cooling options are going to continue to evolve. And we think about it from an nVent perspective and really looking to drive -- provide the full system solution for the hyperscalers or multi-tenants, et cetera, we're looking to be an expert of regardless of what that cooling technology looks like, providing that cooling distribution unit, which is kind of controlling all of those cooling elements and putting it into that system solution for that hyperscaler and then scaling with that hyperscaler as they grow.

Is there an opportunity for consolidation there? Or would consolidation be healthy in that space where -- maybe there's still some, I don't know, road technologies that could be brought in the fold or improved upon for folks that are either capital constrained or just don't have the expertise to ramp. Is that a role that nVent could play, should play?

I think into the future, you could see that there would be more consolidation of vertical integration. At this stage, I think, we are focused on being able to be experts across that cooling continuum and providing that technical expertise working directly with those hyperscalers on solving their cooling problems and then being able to provide that full system solution for them.

Understood. Maybe pivoting to some of the other pieces of the business. You talked about some of the distinguishing kind of demand between the industrial markets versus the commercial and resi. On the sort of traditional CRE side, are you seeing that slowdown show up in the business? Or are there other things on the right retrofit? Obviously, there are certain verticals like data centers that are stronger. Any verticals that we should be particularly mindful of as just being particularly important to nVent?

Yes. I mean -- I think the infrastructure continues to be 1 of the key verticals that we focus on. And I'll go back to maybe our growth strategy, where we're focused on high-growth verticals, new products, global growth and M&A. And a big part of where we're focused is improving the growth trajectory of nVent and you see that over the last 3 or 4 years, growing 18%, 20%. Now part of that is price, but a lot of that is volume as well. And that's really that focus on -- focusing on these entire growth verticals. When you think about Enclosures, it's ubiquitous. -- anything that's electric or electronics needs to be enclosed. But where we're focusing those capital allocation dollars as well as business development dollars, R&D are in these higher growth verticals like infrastructure, so some of the areas that we're really focused on is going to be data solutions that we've talked about. Power utilities, that's another place where it's roughly $100 million of sales for us, but growing in the strong double-digits that also sits in infrastructure. And on the industrial side, it really is focusing on the industrial automation. We often like to say that our product is lower on that overall bill of material, but importantly, provides an outsized value to that un-customer -- so if you think about an automation line, with all those electronics and electrical equipment that needs to be protected, we're low on that value, but the value that we provide to that end customer in terms of protecting hundreds of millions of of process dollars that flow through, I think that's an important aspect when you think about the nVent products and the value that we provide to those customers.

Right. Cost of failure just being way higher than the cost of the product. maybe going across either the key end markets or geographies. However, it sort of fits best. But if I think about nVent having done really well versus most industrial peers over the last, call it, 18, 24 months. I think supply chain is something you navigated better in particular. Obviously, a lot of price in the business, similar to some of your peers. Are there areas that if I were to just isolate volume and look back to, say, prepandemic, where things are still depressed, still have an opportunity to kind of ramp up? And maybe how would you characterize volume levels cyclically right now, just given that price has been such a needle mover?

Yes. We still believe there's plenty of volume there to be had because of these secular trends and how nVent is positioned. I would say, if you look at Q2, it was more price than it was volume. And I think that really is more reflective of what we view as to be temporary on these inventory level adjustments. But when we think about where that volume opportunity sits, I would say, first and foremost, in that infrastructure space as well as in industrial. And what I would also tell you that we're sort of constrained as we sit here today. While we've been investing in supply chain, and I do believe we've done a really good job over the last couple of years, delivering for our customers and delivering volume in '21 and '22. It really is about as we look out ahead over the next 12, 24 months, investing in further capacity around data solutions. We're really -- we talked about that a lot on our Q2 call that with this acceleration of AI, we're finding that we need to build these units faster for our hyperscaler customers as well as new customers that are coming on board and really focused on that, and that's kind of showing up on the OpEx side and the CapEx side, building out that capacity for further growth.

Understood. Maybe pivoting over to another mega trend that I know you participate in with electrification. How do you see that manifesting itself across the business? Where is that most powerful? Is policy a meaningful driver of that from your perspective? And anything out there that you're paying close attention to?

Yes. I mean, maybe I'll start on the policy side. As we looked at what's happening on the government infrastructure spend flow, it's roughly $1.3 trillion. But if you look at those categories and match that up to where nVent plays today, we believe there's roughly $250 million to $500 million of opportunity there, based on that fund flow and based on the categories for which we play. Now that's over a 5- to 10-year period. We do believe that by the end of this year, we'll be starting to see that in earnest. Our customers are coming to us and saying, okay, how does this meet these requirements and where do you manufacture and how can we capture this growth? -- that we see from an end market standpoint. So that's something that we're excited about. And I don't even think that's really yet we've seen it in earnest that's still largely in front of us, and that has a long tail to that. When you talk about electrification and digitalization, maybe let me give you a couple of examples here where this plays for nVent. With more and more of the world being electrified, that is requiring a better, more resilient grid. And so that's creating demand for our grounding and bonding products in Electrical & Fastening. And when you think of this world being more and more digital, and you think about the infrastructure that's required, we've talked about data centers and you need cooling and more liquid cooling and that -- at more advanced chip scenario. But then you also need it from the standpoint of infrastructure that we talked about a bit in terms of you need more cables and then you need more power and data infrastructure, and that requires and drive demand for Electrical and Fastening products.

Sort of the last mile kind of stuff.

Yes.

Understood. You touched on this a little bit, but I'm wondering if there's a way to characterize a lot of folks up on the stage and certainly for most of 2023, you've talked about this big pipeline of mega projects that have kicked off or should kick off shortly. I would imagine in a lot of cases, maybe some what in EFS is maybe earlier, but most of the business is not day 1 of that mega project, not when the shovel hits the dirt. How long around in a process or a project does and then start to show up, get the visibility, bid on jobs to the extent that they're bidding involved. How does that process work for you?

Yes. I think it's going to vary over time. But as I think about projects maybe on the manufacturing construction or commercial construction side or probably more so in Thermal Management when you think about the energy transition and what's happening there in regards to the capacity that's being built or retrofitted for carbon catcher, biofuels, hydrogen, et cetera, that can take up to 3 to 4 quarters-ish in terms of depending on the project, when that project comes into the pipeline and then ultimately, maybe when that order hits nVent because where they're at in that overall cycle. I would say we don't necessarily have a lot of what I would call mega projects in nVent. And so I'd maybe characterize them by more of projects and build-outs, and that's probably more relevant to that thermal management business. and specifically energy transition. So I think we're beginning to see that order flow from an energy transition standpoint, and we're really excited about that because when you think about heat tracing cables and the viscosity and the temperature range that's required within those processes. That's a perfect application for our heat tracing cables and expertise there. But that takes time in terms of ultimately when that shows up in the order book and then ultimately, when it shows up on the revenue side.

Understood. I guess maybe more near term than that then would be the pace of finalizing inventory destocking. You mentioned a little bit in your remarks upfront. But when do you think we get back to normal on inventory? And any sense for what the wraparound or easy comp for that means when we're selling back to underlying demand?

Yes. And I would just start by saying this is something we anticipated and we were talking about really even as we exited last year that this concept of orders growing 20% to 30% because the lead time was so long -- would not last. And frankly, it's a good thing when you think about it from a supply chain normalization on the productivity side, so as these lead times, and we're working this even in-house with us, right, from a supply standpoint as well as with our distributors that as that lead times come to more normalized levels. And we're not normalized everywhere. There's still positive opportunity that we still have, and we see more broadly within the marketplace. But as that normalizes, so with those orders, and again, as I said earlier, it's -- we saw that beginning in Q1. We saw it more in Q2 and expect that to continue here in Q3. I think the only other thing I would say is that is something that is a dynamic of this, we believe that supply chain normalization, where we're really focused on -- over here, beyond kind of the visibility and importantly, I would add the positive sell-through that we're seeing through our distributors -- is really focused on secular trend infrastructure growth. And I think the only other thing I would add that we really haven't talked about is the M&A acquisition. So we said that, that would add 9 points of growth for nVent here in the current year, and that's really accounting May and July completed acquisition, and we're really excited about the sales synergies opportunities. From an M&A standpoint, we do deals because of the commercial opportunities that we see and the growth trajectory of those businesses.

Understood. Maybe sticking with where you left off there on the M&A front. ECM, Texa, I think, suggests there's still a lot of opportunity to consolidate in that space around electrification, digitization, what do you consider sort of the focus niches for nVent within that? Or any obvious gaps that you see that you'd like to fill in?

Yes. So maybe I would start by -- we see it less as sort of a consolidation play and more about how do we add great products to the nVent portfolio, for which we can grow in these high-growth verticals and scale through distribution. And that M&A flywheel, if you will, has really enabled us in our past acquisitions to get to value faster. And importantly, exceed that weighted average cost of capital before that 2- to 3-year time horizon, for which -- that's one of our important financial metrics that we look at as we look at deals overall. So it's less about kind of the consolidation and really more looking at these great products in these high-growth verticals that we can scale overall. I think ECM industries, again, it's over $400 million of revenue. It's accretive to nVent margins, and not to EFS margins, but we think over time, we can get there and importantly, generates a lot of cash. And what it does from a sales perspective is a couple of different things. One, it does sort of round out our grounding and bonding offerings in that space. Importantly, it provides tools and test and measurement to our contractors, we already have a great suite of products and fastening with our CADDY business, and it just adds a whole another suite of products to service those contractors, and we're all about labor savings with our contractors. And I think the other piece, too, is we believe we can take that product, especially the ESCO brand more through distribution. Again, 2/3 of our revenue goes through distribution. We're already a top 10 supplier within that distribution space, especially here in North America. And we're great at adding more and offer more products to those distribution channel partners.

Understood. I'd like to pivot over to margins, if we can. How should we think about margin progression here and not to do the famous sell-side 14-part question. But there are a lot of moving pieces. There's investment in some of the areas for growth, M&A, which may have kind of short-term dilution, probably a lot more inflation in this next cycle than what we were used to in the last 10 years. But how should we think about -- especially in the context of price cost is really good last quarter what's the margin trend line from here? Where should we think about the potential for where the business can go?

Yes. I would just start by saying our margin performance has been very strong this year. We outlined our Investor Day earlier this year, our path to margin expansion, really three-pronged. One is growth in new products. We're really focused on providing that outsized value to customers, and that's reflective in that new product margin profile. Two, would be supply chain excellence. And this is something that, well, we've done an exceptional job delivering for our customers and really driving that volume growth over the last couple of years, it has cost us from an efficiency standpoint on that productivity line. And so we're really focused on turning that productivity positive. We began to see that in Q2, and we would expect that in the back half of the year going into next year. And the third piece is just functional excellence. We're doing a lot around automation and really streamlining our activities to make sure that we can get great leverage on that overall growth. So as we think about that kind of margin performance in the long term, we still believe there's margin expansion going forward as we focus on those 3 areas, I would just say that as we look at kind of what we outlined there in Investor Day, we're already making fantastic progress in a couple of our segments, especially Electrical Fastening and Enclosures. Maybe the one thing I would call out, as we look here in the back half, we would expect some of those margin performances to reflect some of the investments that we're making, especially in Enclosures that we talked about in our Q2 call, but we believe those have great medium- and longer-term returns as we look at the data solutions growth going forward.

Understood. How should we think structurally about just higher inflation for the business? And I guess the premise is this, nVents pricing power is far stickier than that of your inputs, things like steel can kind of go up and down and obviously have more commodity exposures. But I would imagine your price to customers and the value proposition sort of informed that, hey, a price is the price, we don't give that back overnight. Does that create a higher trend line for margins if we were just in higher inflation? Is that generally something you regard as good for the business?

Well, I would say maybe this way, our teams have done an excellent job of managing that price cost equation, especially in the last couple of years where we've seen significant inflation. And that's really across the board as I look at the 3 segments. And I do think, one, it's the execution that we have, 2/3 of our revenue going through distribution. So we've had some strong execution from a pricing standpoint. But I do think it goes back to the value proposition and the strength of our brands and the value we provide to our customers that allows us to manage that price cost equation very well.

Understood. I think we're coming up on time, Sara. I really appreciate the time. Great to see you enjoyed the discussion and best of luck from here.

Thank you, Josh.