nVent Electric plc (NVT) Earnings Call Transcript & Summary

The CFO; Tony Ritter, VP of IR. So I'm going to give a couple of prepared remarks, and we're going to dive into Q&A. I don't follow the company, so all the help you all can give me would be great and have an awesome questions. So I have the iPad right here. So you can use the placards in front of you or the cards in front of you, send me a question, and we'll make sure everything gets incorporated. So with that, please, Sara?

Thank you, Mike, and good afternoon, everyone. Thanks, Mike, for having us here, regardless of whether you cover us or not.

I let myself that I can update for that.

You did. So I'll just jump right in before we get into the Q&A side of this and just share with you a little bit about nVent for a couple of minutes here. So nVent, we're a leader in connection and protection, and we help build a more sustainable and electrified world. We have 3 different segments with strong brands and leading positions, particularly in North America. We have very strong margins that convert over into a strong free cash flow conversion. If you look off to the right here, those are our 2022 financials, a little bit dated, but what I will say is that we're having a little bit of a mic issue. All right. I will speak into this mic. And so from a financial statements for 2022, you see there, a strong organic growth along with strong earnings. And for 2023, we expect to deliver double-digit sales, including the impact of ECM acquisition as well as TEXA acquisition, along with another year of strong double-digit earnings growth. And so our strategy has been consistent since we spun roughly over 5 years ago, just executing on different elements of our strategy with really a 4-pronged growth pillar approach. One would be really laser-focused on increasing the mix of high-growth verticals. The second thing being new products. Our vitality when we spun was in the mid-teens and now it sits at 20% with new products contributing meaningfully to the top line global growth. As you saw previously in the chart, we're still predominantly a North America business, but we see significant growth opportunities, particularly in Europe as we expand that product portfolio offering. And last but certainly not least is acquisitions. Since we spent a little bit over 5 years ago, we've completed 6 acquisitions to date with our largest acquisition that we just completed here in May with ECM Industries. And so as it relates to electrification of everything, this has really been something that we've been talking about for several years now. And if we start with what we see from a macro and secular trend standpoint, we're really excited about what it means from an infrastructure standpoint. If you saw on the first slide, infrastructure overall now sits at roughly 25% of our sales. That was in the teens when we spun. And when we think about the $1.3 trillion of legislation funding that is combined with U.S. and Europe and translate that to what we believe that means for higher demand for our products in nVent, we see potential sales opportunities of roughly $250 million to $500 million over a 5-year plus time horizon. And then if you look at what AI is driving demand more and more for our data solutions business, along with energy transition, there's a lot of positive momentum when we think about these secular trends. If you think about percentage of our overall revenue, we estimate that greater than 60% of our overall revenue is exposed to these secular trends around digitalization, sustainability, electrification and more specifically, under that infrastructure vertical is data solutions that have grown consistently double digits since then, and we believe we're well on track to hit $500 million of sales in 2024. And then maybe just a point on acquisitions. I talked about completing now 6 acquisitions since spin. We participate in a large space, $75 billion. It's very fragmented. So when we think about the runway and opportunity we have for future M&A, it's significant and more specifically for 2023 with the 2 acquisitions that we completed here in Q2, we believe that, that will contribute a meaningful 9 points to sales in 2023 with meaningful carryover into 2024. So to wrap it up, maybe a couple of things I would leave you here with before getting into the Q&A. One is while we would characterize the environment overall as mixed. We are executing well within our strategy. And so when you think about the contribution of revenue from new products being 3 points year-to-date. When you think about the acquisitions that we completed, contributing meaningfully to the top line, executing well on price as well as productivity to drive margin expansion this year. We think that's all culminating into another year of strong overall top line growth. as well as double-digit earnings growth and believe that we're well positioned with the electrification, sustainability and digitalization trends into the future. And so with that as a quick overview, I'll hand it over to Mike, and I'm not sure how we're going to do the mic thing here.

This one's on. So what we're going to do is, one, compliment you on the nice adjustment to the mic change there and then also put it on my hand, so the arthritis doesn't kick in. I'm getting old. All right. Let's just -- you touched on it a little bit at the end there, mixed macro environment. Maybe talk about what you mean by that, where are the strengths, where the weaknesses and kind of puts and takes as we head into next year?

Yes. So maybe I'll start off with the strengths and what we're seeing from a secular trend standpoint. So I'll start with Industrial. It's our largest segment. It continued to grow in Q3. And we still see strong growth overall in terms of industrial automation, reshoring, onshoring. So we still see strength in the industrial setting. I think the one thing I would add to that, too, is in manufacturing, construction, which sits largely under that industrial vertical for us, but a little bit on the commercial side as well. So we see that overall as very strong. While infrastructure was down for us in the quarter, we still see continued strong growth from an outlook perspective. What we saw there was a little bit of that mixed environment that I referred to is one, data solutions continue to grow strong double digits in the quarter. But offsetting that was a bit of a dip, if you will, or a decline in infrastructure in our electrical and fastening solutions business. And this is where a bit more squarely under that utilities, and we saw that supply chain get healthier a little bit later than industrial as well as commercial resi we saw those channel level inventory adjustments in those customer inventory adjustments happening and impacting that. But nothing's changed in terms of our long-term view of infrastructure providing significant growth into the future. Commercial resi, it was up for us in the quarter. But again, I would say, mixed across the segments. So it was up strong double digits in enclosures. Up in Electrical & Fastening Solutions, which really speaks to the power and data infrastructure as well as the labor savings applications of those products within that electrical and fastening solutions business. So strong there. Where we saw declines and continuing really from the first half was in our thermal management commercial resi business. So this is a little bit less ubiquitous as some of what we see in Electrical & Fastening and enclosures, and more centered around underfloor heating, de-icing in the commercial setting or fire-rated wiring, which we're seeing some of that softness. Energy, I would say, was flat overall. But encouraging in the quarter, we saw thermal management orders up mid-teens in the quarter, really reflecting mainly the uptick we saw in orders around energy transition projects. So to summarize it, I would say, those secular trends, we still see well intact and strong, and some of those accelerating heading into 2024 around data solutions, AI as well as energy transition. And then we see some mixed elements around commercial resi, not all parts of that are growing as well as industrial growing but slowing from that first half, the growth rates that we saw.

Maybe you could talk a little bit on how the destocking side of things is there. Where is it most prevalent? Where are we in the destock journey? And then question came through of how are you able to distinguish between what's destocking versus maybe just incremental weakness from a demand perspective in some of those areas.

Yes. So let me start off with the channel inventory level adjustments. We expected that at some point as the supply chain improved we were going to see those inventory level adjustments in those buffer inventory requirements come down. And I would say that it improved a little bit quicker and faster than what we expected. We saw a little bit of that at the tail end of Q1, saw it in earnest in Q2 and expected that to continue here into Q3. And more generally speaking, we expect that to continue into Q4, but at a lesser rate of what we saw in Q3. Some of our distributors are saying, look, you're at the turn level where we want you to be and other distributors, it's taking them a little bit longer to work through their inventory. So that is impacting, I think, our overall volume levels in the current year. And it's to be expected because even as we look at our own lead times for our products, I'll give you 1 example, more specifically that we had a 26-week lead time, for example, for our ground rods, and now it's back to next day. And so as you move those lead times materially in that form, you're going to have an adjustment, if you will, to that ordering and those inventory level adjustments. In terms of your question, Mike, in terms of how can we tell in terms of what's inventory level adjustments versus what's that end market demand. A couple of different things that we look at. One, I would say we're out there talking to our customers and talking to our contractors, and that's giving them some insights to what's working and what's not working. I think the second piece is looking at sell-through, through the channel. And what I would call that sell-through is while it was literally increasing here in the first half, it reflected a little bit more of that mixed environment. So not all elements or all end markets were up. So when I talked about a little bit more of that mixed environment by end market, commercial resi, industrial, we see that a little bit more through the sell-through of our distributors as well.

So how do repricing into that conversation? A couple of questions came through here about how are you managing the price and what is the mix environment? How do you feel about price? Anything competitively that we should be worried about, not worried about? Maybe just run through some of those dynamics.

Yes. I mean I would start by saying, I think we've done across our 3 businesses, an excellent job of managing that price cost equation. Clearly, we saw some meaningful inflation over the last couple of years. And across all 3 segments, we've managed that price cost equation well. And I think there's a couple of different things. One, I think it begins with having really strong brands and leading positions. Two, we prioritize servicing our customers because it's one thing to published list price increases, but it's another thing to realize that, and it does take a focus on the customer service level to help make that happen. I think the other thing I would point to is the level of innovation. Even as things were challenging in COVID, we stuck to our CapEx and stuck to our R&D budgets and making sure that we are prioritizing that new product and innovation. I think all of those elements help ensure that we can manage that price cost equation well and realize that. Clearly, as inflation eases, we wouldn't expect that level of pricing or the number of price increases to duplicate going forward as we've seen over the last 2 or 3 years, but we're going to continue to need to be vigilant from managing that price cost equation because we do continue to see it as an inflationary year even into 2024, mainly related to wage and labor inflation that's driving that. I think the last point I would make, while productivity, frankly, in the prior several years, has been more of a headwind for us, we see that turning to a tailwind in the current year as that supply chain challenges begin to ease and things improve. With that being said, I do continue to see and expect productivity to play a larger part in our overall margin expansion heading into next year. And sometimes I get the question, well, where are you at in terms of getting back to pre-COVID productivity levels, and I would still submit that we've got plenty of runway to go. Because if you look at what's driving a lot of that productivity improvements this year, in part, it's not duplicating some of the challenges in logistics costs and inefficiencies that we had last year, but we still have room to go in terms of getting 4-wall kind of earned our productivity and efficiencies within our overall productivity within our plants and logistics and DCs.

So if you look pre-COVID and you think about what next year brings, most people are talking about something around the level of normalized pricing, right? What would you guys have called normalized pricing historical, 1 to 2 points per year pull a little bit to the bottom line, something more volatile year-to-year? I mean how would you typically think about what normal is?

Yes. I mean I think if you look back pre-COVID at the electrical businesses, kind of pricing normalized environment, what that looks like. I think it's fair to say and it's in that 1% to 2% range, depending on where that inflationary environment sits. And maybe one thing to add to that, Mike, too. We've always said, and it's an equation that every 1 of our businesses has to work towards is price cost productivity helps offset total inflation, including wage and labor inflation as well as fund investments to get to that margin expansion. And so that's where that productivity really ramping this year and heading into 2024, will play an increasing more role within that margin expansion.

And the last one that's loosely tied to pricing here. any formidable competitors coming out of China or other emerging markets that you guys are worried about?

Look, I would say that we've always got to be on our toes and vigilant from a competitive landscape. So I would say nothing new to point out from a competitive landscape. And I think it comes back to what differentiates nVent is we're leading in our categories, strong brands. And really, it's that quality and that outsized value that we believe we provide to our customers, really that mission-critical protection on the enclosure side, liquid cooling solutions and data centers and that labor savings kind of innovation that we bring to contractors on the commercial, just to give you some examples.

So a couple of questions here on this one. Maybe talk about what the liquid cooling solutions you have for data centers are, what the drivers and why you're so excited about it? I'll just start there, and then I'll lay on the second question, if it doesn't get covered in the first.

Okay. Well, let me maybe step back and give. The bigger picture in terms of data solutions, right, of which liquid cooling solutions is part of. And we've characterized that just to frame it from a financial standpoint, that's roughly $375 million of sales in 2022. That started out at roughly $100 million when we spun back in 2018. And we think we're well on track for that data solutions business to be $500 million-plus in 2024. Now a big part that business and that growth because that's sort of consistently grown at double digits since spin, and we've been additive to that on an inorganic basis as well, has been the liquid cooling solutions. This goes back roughly a decade with several industrial liquid cooling solutions that we are working towards maybe a year or so prior to spin. We were looking at data centers specifically and how do we provide differentiated value in this space, and liquid cooling solutions is which when we began to work kind of in earnest, roughly 5 or 6 years ago with some of the hyperscalers. And so with that, liquid cooling solutions. We work across the cooling continuum. So whether it's cold plate, immersion, air to liquid, liquid to liquid, we work across that total continuum. And importantly, what we do is put that cooling solution together, design, develop and manufacture the manifolds, the cooling distributions and work with air to liquid, liquid to liquid cooling solutions and be able to solve for that particular hyperscalers needs from design to production. That life cycle, if you will, from design to production can take 1 to 2 years. So it's a process. And where we think we differentiate from that liquid cooling solution standpoint is really technology, expertise and ability to scale and manufacture. There are -- and it continues to be an ever-evolving environment. But in many cases, some companies don't have that scale and capacity that we're investing in and also that deep technology and application expertise.

So the follow-up then is, how do you think about the growth profile over the next 3 to 4 years? And what's the entitled margin target? Or how do you think about the margin progression?

On data sources, specifically?

On liquid cooling solution, specifically for data centers was that question was worded.

Okay. Well, I would say that data solutions in its totality has grown strong double digits organically since then. And we would expect that to continue and specifically with liquid cooling solutions, we see that accelerating with AI. And so what we talked about is we had plans to increase, conceive but those plans were probably a year or 2 out. with what's going on in AI, we're seeing an accelerated demand for our listed cooling solutions. And so with that, earlier, we talked about expanding production in Mexico. And that's allowing us to then increase the way we think about our liquid cooling solutions, transitioning out of a distribution center in our campus there in Minnesota, freeing up some space that allows us to roughly double our liquid cooling solutions capacity. So I think maybe to answer that more succinctly, is we expect that double-digit growth to continue, liquid cooling solutions to be a big part of that. And we do see that accelerating with what we're seeing in AI and that increasing demand for cooling and for an energy efficient means to cool and with that chip technology that goes alongside AI.

That makes a lot of sense. And one of the questions here also is talk about the secular drivers in the presentation, you talked about 60% plus of the organization tied to secular thematics, you just touched on the data center side. Maybe also give some similar thought on the factory automation piece. How you see underlying fundamentals today momentum? But then also, how do you play in that thematic over time?

Yes. So we continue to see that, what I'll call industrial automation, reshoring, onshoring continuing to be a positive tailwind for us and incorporated under that kind of secular trend of greater than 60% of our revenue exposed to that. We believe it's been a big part of our growth, especially from a manufacturing construction side, number one. And number two, as labor continues to be and we expect will continue to be just a general overall constraint, it increases the importance of continuing to move and invest in overall industrial automation. So we believe that's 1 big element of that overall secular trend. I think the other things I would point out, Mike, would be a couple of things. One is the data solutions, which we talked about. And then another piece would be on the energy transition. We haven't talked about that as much. We talked about that in our Investor Day earlier this year, but we hadn't necessarily see that come to fruition by way of the order intake. And in this last quarter, we began to see that with mid-teen orders year-over-year in our Thermal Management business, largely being driven by that energy transition in transition projects.

Makes sense. Maybe you can talk a little bit about capital allocation. Obviously, you're funding everything that's got that return profile internally, the right growth profile. Externally, you have done some transactions. How do you feel about what that landscape looks like today? How aggressive you're willing to go after the right targets? Just any context.

Yes. So I would start by saying our capital allocation priorities remain consistent. We continue to believe that growth is a great way to deliver strong returns to shareholders. So that continues to be our top priority, both organic and inorganic. So from an organic side, you see that by way of R&D being up 18% year-to-date, and we believe that that's providing good value by way of that new product revenue contribution of 3 points year-to-date. The second piece would just be capital expenditures, which in part is being driven up by way of the data solutions investments. And we're running year-to-date and kind of expect for the full year for that to be up roughly 50% to 60%. Now part of that is that ECM industry is rolling into that CapEx number, but the other part of it is data solutions. From an M&A standpoint, as I talked about, we just did 2 of our acquisitions this year, 1, our largest acquisition in May with ECM Industries, and continue to see and have a very active funnel of M&A opportunities. We always like to say that we're a $3 billion-plus company in a $75 billion space. So it's big, it's fragmented. And we believe we've proven with the 6 deals that we've done that it's really well aligned with our strategy, and we can create outsized value with that. Maybe the other thing I would point out is while ECM Industries was our largest acquisition, not even 5 months post completing that acquisition. We're back down from 2.8x upon acquiring that company to 2.4x in terms of leverage, net debt to EBITDA. So it just shows strength of the cash flow, strength of the EBITDA coming into the portfolio, and frankly, our ability to have further optionality as we look into the future.

Thank you for that. And I know you haven't given any guidance or anything in 2024, but maybe how are you thinking about your end market trends as you move into '24, your ability to grow and what you characterize as a mixed environment.

Yes. So it's early, but I would say just some early thoughts around 2024. One, I think we'll -- we expect that largely this channel level inventory adjustments would be behind us. But I think as we think about next year, some things that I would point out. One, that legislative funding that I talked about earlier. We're seeing that in pockets or examples of some wins that we can look at across our segments, but we believe that, that money really begins to flow in earnest in 2024. We've talked about infrastructure and data solutions specifically and some of the accelerating trends that we're seeing there, particularly with liquid cooling solutions. I would say, energy, while it's been kind of flattish for us this year. We believe that those energy transition trends are growing and increasing heading into next year. And I think the last thing I would point out is the sales synergies with the acquisitions that we've completed this year. ECM Industries in terms of annualized revenues that adds over $400 million of sales to nVent. So it's meaningful in sort of absolute dollars. But as we think about the power of the combination of our 2 portfolios, nVent and ECM industries, we get really excited about those sales synergies. One is taking their ILSCO electrical power connection, product portfolio and putting that more broadly through distribution. Two would be taking that portfolio and expanding it globally. Clearly, there's work we're working on and underway in regards to getting those certifications and those requirements. And the third would be even looking at some of the nVent product portfolio and putting that through some of the ECM channels that we're not as strong in today. So those are some of the positives. I think commercial resi, we'll see in terms of kind of where that heads. And again, it's a very mixed pluses and minuses for us across the various portfolio. But overall, we believe we'll have solid growth in 2024 because of some of these factors.

And then a follow-up question on data solutions from the audience. How do you look at the competitive dynamics within the data solutions side of things? Are there other large competitors? Are folks trying to enter the space? How do you think about those dynamics?

Look, I think it's a very high-growth, attractive space. So we're not suggesting for a moment that, that competitive environment is going to stand still. But as we think about where we're positioned, we think we're positioned very strongly because of those things that I talked about earlier. Our deep technical expertise, the application expertise in terms of just overall cooling as well as our ability to scale and have capacity. So we believe -- I think maybe the other thing I would add in that liquid cooling solution space, Mike, is as we think about solving the hyperscalers needs, we're also looking at how do we take that liquid cooling expertise and apply that in a more standardized way through channel as well as into industrial cooling and also thinking about how that transcends into things like enterprise, energy storage and edge computing, all things that are going to need different ways, more energy-efficient ways to cool as we increasingly have more data computing and high densities.

Great. Well, please join me in thanking the nVent team for their time today. Thanks, everybody.

Thanks, Mike.