Vontier Corporation (VNT) Earnings Call Transcript & Summary

So why don't we get started? Quickly, I'm [ Will Dodson ] of Morgan Stanley's Investment Banking division. I'm delighted to be joined today by Mark Morelli, CEO of Vontier; as well as Ryan Edelman, who's the VP of Investor Relations. I need to quickly read a disclosure statement, and then we'll get started. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com research disclosures. If you have any questions, please reach out to your Morgan Stanley representative. All right. Mark, why don't we start with a couple of minutes of opening remarks?

Yes. Thank you, Will. So for those of you that don't know the story of Vontier, we spun from Fortive about 2 years ago. We have a portfolio of market-leading brands and a deep installed base, global scale, industrial technology leader. We're about $3 billion in revenue, about 70% of that coming from North America, about 10% from Europe. Dividing the 2 platforms, a Mobility Technologies platform and a Diagnostic and Repair Technologies platform, about 25% of our revenue is recurring revenue. When you look at the markets that we serve, it's a very attractive about a $28 billion market linked to the Mobility ecosystem. It's got low cyclicality, and the business is -- that are in there, the market segments that are in there are global retail, global fueling, automotive service and repair solutions, carwash solutions and fleet solutions as well as some electric charging is embedded into that as well. At the same time, if you step back and think about this market, it's got some really strong secular drivers. They're trying to tie to increasing productivity, increasing consumer efficiency. There is a strong linkage to regulatory drivers around payments and also environmental regulation and also infrastructure build-out. So with that, we also had a strong top-tier financial profile, excellent free cash flow, about 100% on a normal basis and about 15% of sales. At the same time, the business has a deep, rich, proud heritage in our business system. It's called the Vontier Business System. It's a direct outgrowth of the Danaher business system and the Fortive business system. And since then, it's helped us improve margins as well as our organic growth profile, particularly on non-EMV growth and our profitable growth initiatives. And then a -- linkage to that, that I think is also really important to highlight is that part of that is the deployment of capital. And so we've got a good basis and a good history and a disciplined strategy-led deployment of capital since [ spin ]. We've deployed about $1.5 billion in capital at a really strong return of double-digit returns in about 3 years. And then there's a linkage there, too, to -- I think the final thing I'd like to say, Will, is about the portfolio transformation. This is a multiyear portfolio transformation. We're planning and opportunity, both investing in the existing infrastructure, which a lot of that might be tied to ICE, or internal combustion engine, and the alternative energy changeout, which is electrification, hydrogen, CNG. So our portfolio has a lot of opportunities for us to exercise both acquisitions and divestitures. We've acquired DRB and [ Evenco ] quite recently as well as we've announced the divestitures of GTT and Hennessy. And on the electrification front, we've made acquisitions in [ Driivz ]. We're making organic investments in hydrogen, and we're growing our CNG business as well. Keep in mind, our business is tied to the car park or the age of the car park, which changes a lot more slowly than just what you read in terms of electric vehicle ads on TV. So we think that there's a great opportunity for us to move up the tech stack to be focused on customer high-value problems with workflows, and I think you're going to see our -- we're well underway of our portfolio transitions, and we're building a growth year, high-margin portfolio that I think we're going to find a very attractive return to shareholders.

Great. Well, there's a bunch there we should dig into. But why don't we start a bit more tactical front and talk a little bit about the third quarter, what you're seeing, how is demand shaping up? Talk about supply chain, inflation impacts, all of those topics that ever we will be eager to hear about for the third quarter.

Yes. I think Q3 is shaping up a lot like Q2. There's no question that the macro and the supply chain is getting better. At the same time, there's quite acute issues in the supply chain at times we even work daily. As a consequence, I think that we'll be in this kind of environment well into 2023, working through those type of issues that are very prevalent in the marketplace. And in terms of the demand environment, similar to what we said in Q2, pretty solid demand. Particularly in areas of our business that are tied to non-EMV, we're seeing good growth, similar as GVR parts business, our Environmental Solutions, which is Veeder-Root as well as alternative energy, we're doing well. DRB, a recent acquisition, about a year into that, is posting outstanding growth, and we're booking well into 2023 on that business. At the same time, automotive aftermarket, where I think the backdrop on it with service technicians continues to be strong, we're working through some headwinds on converting the backlog that we currently have as we announced in our last earnings call. So that's clearly a work-in-progress. And so we still have a couple of more weeks to go in September, and we're just working in accordingly. I'm really proud of the team's efforts here. We've performed [ admirably ] well in the face of a lot of headwinds. So...

Okay. Great. I think it's a great overview. And if there are questions, please just raise your hand and we can go to those. Otherwise, I have a handful of things that I want to cover, based on your opening comments. You talked strategically about opportunities in convenience store, retail. Maybe you want to elaborate a bit on those and dive a little bit deeper to make that more tangible.

Yes. The convenience store is a place where -- obviously, we do business from a fueling infrastructure perspective, but we're also the #2 seller point-of-sale systems in the United States inside the convenience store. And if you look at the longer-term growth of this business, even since 2005, it's grown on average 5% CAGR since then and has done also relatively well in down markets. 95% of Americans live within 10 minutes of a convenience store. It's part of our local fabric, our own local stop on the highway. And while many of you may not stop there, I would guarantee that contractors that come into your neighborhood absolutely do, and they access that format quite frequently. If you look at how that is building out, it's providing not only energy but also alternative energy in the future, we think more so, as well as other type venues such as food service venues, fresh food services and other services that can occur there. So we believe that, that is part of the Mobility ecosystem as re-vibrant offers a lot of growth opportunities that we have a right to play and win in.

One of the comments you made upfront and certainly something that will be talked a lot about at this conference and be interested in your views on this is the car park EV adoption. What's your take on that? And then probably more pertinently, how does that affect Vontier?

So I think we're very much convinced that alternative energy is an opportunity for us because we have a right to play and win in the existing infrastructure, and we're making important strides into alternative energy many times with some of the same or similar type customers in the Mobility ecosystem. Keep in mind that a lot of what we read, and I'm very bullish on electric vehicles, on one, obviously, we're seeing a lot that goes on in that, but it changes -- the car park change is a lot slower. Just as an example, out of our roughly $1.2 billion car park by 2030, even on a more aggressive case is that people might be adopting your still 85% internal combustion engines. So for the next decade or 2, there's going to be a strong prevalence of the internal combustion engine. Why is that relevant to us? Because we serve the fleet, we serve the automotive aftermarket repair, and that infrastructure in place is going to require a lot of investment, whether it be secular drivers related to regulation or security of payment or vapor recovery or environmental regulation, there's a lot of drivers there that drive our business that will generate strong profits and cash flow for the time to come. And that's really important because we take that business and we deploy those cash flows into the growthier parts of the ecosystem longer term. And we will certainly diminish our presence of internal combustion engine, or ICE, over time. But we've got plenty of time with our portfolio to make really disciplined smart moves on how we deploy that capital.

Well, maybe talk about some of the investments you're making in EV.

Yes. Will do, we've made really interesting acquisition of a company called Driivz. And we've studied the EV charging infrastructure market quite a bit. As you know, there's a lot of money going into that part of the infrastructure. And the place that we've decided to play is not only, I think, a great opportunity for organic or revenue growth but also real strong operating profit and margin potential. And specifically, this is around how the operating system for electric chargers are being managed. This is through [ SaaS ] software, where you have to manage your fleet of electric chargers, both from its operating performance as well as roaming, tolling, payment, access to the grid and consumer applications like how do you -- how do consumers actually know about that infrastructure and access it. And we're seeing a lot of uptake because we believe that people are going to adopt this solution. And while we've owned this asset only since the beginning of this year, there's a tremendous amount of customer demand for this. And I recently come back from the Nordics, where we're very highly penetrated in all of the electric charging infrastructure for high-speed charging with our software.

Well, let's talk about software for one second and then I'll pause for any questions. Another topic that will definitely get discussed across the venue will be digital transformation drives. You mentioned in the comments the other investments in software. Talk about what digital transformation means at Vontier and what's the role of software in the broader Mobility ecosystem as you see it?

So we believe that software really complements that we also have on an embedded connected hardware business. A great example of that is our DRB business. It is growing about 25% and more than 30% margins. Because we have a deeply embedded point-of-sale system, which is a combination of connected hardware with workflow software that's on top of that. And that -- the workflow software solve high-value problems around the operating efficiency of carwashes as an example. And so these are great solutions for us as we move up the tech stack. We believe that these are growthier margin-enhancing businesses that we have a [ world right ] to be in and a right to play. And I think you see that we're demonstrating our ability to execute around this and build out the portfolio. So we think that these integrated workflow solutions are a big part of where we're going to grow in the future. And they're also growing faster and more margin accretive than the EMV roll-off, which is a pretty significant roll-off for us next year that we've talked about and announced. But if you see some of the growth initiatives we have in place around that, we think this is an important part of the value proposition.

Great. Let me pause there for a second and see if there are any questions from the group that we can take. Otherwise, we can continue to work through a couple of other topics. Why don't we talk about capital allocation? You mentioned the capital deployed to date. Additionally, as you look out over the next couple of years, I think you're going to have a significant amount of cash flow to deploy. Talk about the framework that you're using internally for thinking about that. You've touched on a handful of acquisitions. What role do they play? What role does return of capital play? Provide some perspective there.

A great attribute of these assets is that they do throw off strong cash, and we're going to have a lot of cash coming back to us to redeploy. And the way we think about this is, first and foremost, it's discipline and its strategy led. How does it fit, where we see and have a vision on the mobility ecosystem to develop a strong return on capital? I think you see us doing this in the DRB acquisition is, I think, showing up already, and we've also done the [ Evenco ] acquisition. I think the [ Evenco ] in particular, is a prime example of a bolt-on, which I think fares quite prominently, where we're looking at good returns, where we have a unique ability to bring that into our assets, take out some costs as well as push out a new software platform for convenience retailing, that is based on what's called micro services in a general retailing sense, which enables a customer to have a choice with the different applications that they bring to market. So it's a very contemporary software platform. So a great example of a bolt-on with good returns there or solid returns. We're seeing 20% in 3 years. So I think these are examples of how we think about that in terms of looking forward. I think you should expect more disciplined approach around bolt-on acquisitions, as well as we've had a pension for stock buybacks. Given some of the prices of the stock, we think that generates a really strong return as well. And since spin, we've deployed $1.5 billion of capital, about $300 million in stock buybacks and another $100 million to go this year. And we think the combination of that, we are able to deliver a very solid double-digit return in 3 years. So in maybe early innings, for most of you with this story, we hope to continue this strong track record and this really disciplined approach that we have around capital allocation.

Yes. So say, another word on capital allocation around M&A. You talked about one of the deals you've recently done. What are the general criteria that you're thinking about? How does the process work when you get from idea to execution?

So a big part of our process is cultivation of assets that's a takeover from the Vontier Business System, really helps drive not only the strategy but also the responsibility of our operating companies to cultivate assets over a longer period of time. DRB is a prime example of that, that came out of the work that's been done prior, and we were able to refresh that and act very quickly when that asset came to market. [ Evenco ], same way. So I think that's one part of the asset -- one part of the equation. The other part of the equation is just, once again, being strategy-led and very disciplined in terms of our deployment of capital and making sure that we feel that it's going to get a really solid return. So we say no quite a bit in our process. We're very selective in terms of how we deploy capital and very disciplined in that approach.

One of the other things of note, and Ryan is a perfect example of this, has been sort of an influx of talent in the last -- at least in my mind, the last 3 quarters, but certainly even in the last quarter. Talk about some of the management changes, people that you've brought on board and what you think it means for Vontier?

Yes, I think we're continuing to build out our management team, and I'm very pleased with the management team we have in place to meet the challenges of our portfolio transformation. We've, I think, done a very good job at operating these assets since spin. I think we've been able to demonstrate that. That's a function of the management team in place. And then as we're executing through this portfolio transformation, a couple of areas stick out. We have a new leader that's just joining us from Honeywell on the -- in our Retail Solutions business, which is going to be a new position we're creating to lead all of our assets there. We also have a new Chief Technology Officer, who comes with a strong background in the Mobility ecosystem, specifically on the software side, joined us from 7-Eleven. In the finance group, we're doing a fair amount of build-out in team and capability there, in strategic finance roles, FP&A, Head of IR. So I think -- new CFO. So I think making our really good strides there as well as changing out a couple of the operating company leaders. Many of you may know that we're getting good traction on our Teletrac Navman business. I think a lot of that is because of the management changes we've done there, brought in some excellent talent from Trimble into that business. As you know, that's been a multiyear turnaround on Fortive, and I think we've demonstrated really strong traction in that business. So I'm super happy with the talent that we've put in place. And -- and it's a big focus of mine and the rest of the management team to continue to nurture the talent that we have and identify any other gaps that might exist and continue down that path.

Great. We talked about EVs penetration, maybe just a -- stepping back and broadening it out a little bit. Talk about ESG generally and Vontier's commitments there. We'll certainly get a lot of discussion here for lots of focus. What's your perspective? And what are you guys doing?

Yes. I think we've come out of the gates, making some pretty strong statements around ESG and our commitments that are being put out here, and this is our first year of really coming out, reporting and documenting those on the science-based initiatives. And so I feel like the team internally is very committed and passionate about this. Part of the reasons why is that we have a lot of conviction that the existing retailing fuel -- excuse me, retail fueling infrastructure can be built out much more environmentally sound and -- as well as some of the alternative energy opportunities that we have in front of us. And so it's just something that resonates a lot internally, and we've staffed and fully embraced that. So I think the targets you see we're putting out there are very much factual-based targets. And I think we'll establish a leadership position here.

Great. You can't get out of here without a discussion around EMV. So you mentioned it upfront. Talk a little bit about the $300 million to $350 million, your confidence level. What sort of guidelines do you want to put around that?

We have no sort of further update on that. That's the $300 million to $350 million roll-off of EMV next year. As you know, we worked through this problem quite regularly. And this year, the compare to last is an unfavorable compare in the second half. But we still have a significant backlog there that we're serving. Part of what we do is we work with the customer base. And one of those customers is the small network retailers or SNRs, these are the smaller sort of mom-and-pop parts of the industry that are still adopting EMV and into next year. And some of the risks that are associated with that or some of the headwinds are their access to capital. So we're obviously working to find ways to help that. And with higher fuel cost than their capital is tied up also in fuel. And -- so there is some headwinds at those SNRs folks that are working through. But at the same time, I think if you look at what we've done here, we've done a very good job in serving that market. I think, over time, evolved, gained share in the EMV part of the business. And I think that sets us up well also for aftermarket and selling a lot of parts into that installed base over a long period of time.

And talk about some of the offsets in '23 traction you feel like you're getting there?

We have a whole set of profitable growth initiatives and platform strategies that we've been talking about. I couldn't be more proud of the team driving some really strong not what we call non-EMV growth, based on these profitable growth initiatives. And we've said that it will continue to deliver strong organic growth. We continue to see that. A couple of examples of this is something we call the Focus and Prioritization Program inside the company or FPP, what we refer to it as. It's a simplification effort, where we figure out how we can drive more growth out of the existing businesses. High-growth markets are a part of that. They can be lumpy, which is not an attractive part of that, but we're a big believer in the long-term high-growth market build-out, particularly in markets like India, and we think that, that will continue to drive good growth. After market repair is also another area that's tied to the complexity of repair, and we think that having a high vitality of bringing new products to market through Matco can help drive longer-term growth there as well. Our Environmental Solutions, which is the Veeder-Root business, has been very good. And we're seeing strong growth out of that, as well as aftermarket parts, is another big initiative. Our platform strategies that are part of that is -- a great example is DRB, which is posting really strong growth, and we think we'll deliver strong growth in the next year. And we're very optimistic that [ Evenco ] as part of that platform strategy build out, will also give us a technology that's based in New Zealand pretty much, and we are adding a channel to market for them, where we can bring that into the United States. We bring that into high-growth markets with products that we don't have. And it fills some very significant gaps. And that technology as well gives us a couple of year head start over the competition and over where we'd have to be able to invest by bringing micro services into the convenience retail market. And this offers flexibility and agility for customers to make choice about how they're going to manage their software in a convenience store, so they can pick best-of-breed solutions, and they're not tied into a captive platform. So this is a great example of where we can get additional growth in our platform strategy. So I think our -- we're demonstrating our -- since been a really strong uptake and traction there. So I'm really proud of the team's efforts.

Great. I'm going to finish on capital allocation portfolio. But before I go to the last couple of questions, any questions from the group that people wanted to ask more? Yes, we've got one up here on the left. If you don't mind, just wait for the microphone, so we can -- thank you.

Appreciate it. So Mark, my question is -- when we look at the stock, right, so there's all the business decisions that you and the Board are making to create value over a 4- to 5-year time frame. But obviously, the stock is trading at a level that just doesn't make any sense on a multiple basis. So how do you and the Board balance M&A with not necessarily having a lot of currency at a fair value? And I guess where I'm going with this is, you look at this and say, look, there's an opportunity there, we need to be more aggressive on buybacks, which then if our currency goes up, that helps facilitate better M&A or more M&A. How do you and the Board -- like how do you look at that stock and balance M&A with buying your own stock today?

Well, I certainly share [indiscernible]. We think the stock is undervalued, based on its potential. And this is a conversation that we do have. We are -- we have announced another $100 million of stock buybacks. I think the part of the equation here that makes a lot of sense is that we will and we are committed to doing stock buybacks because we think that there is a strong return that can be had there. At the same time, when the right opportunity presents itself for M&A, then we are also committed multiyear to the portfolio of transformation that is also, we think, is important. And -- so I think the combination of the both. Of course, we're leaning heavily into stock buybacks right now. But we will also transform the portfolio over time, and we just have to think about as a time phase -- time-phase problem that we have to work through. But we are certainly committed. You saw us step in into the [ ASRs ] earlier in the year. And I think that shows our commitment at -- currently very low, what we believe are low stock price is to help support not only the stock but also deliver a strong return.

Any other questions from the group? If not, maybe I'll end with one. Just talk about portfolio. And you mentioned a couple of divestitures, couple of acquisitions. Talk about how you feel about the asset mix today. And as you look forward, what are your thoughts?

Well, I think what we're demonstrating that the portfolio is -- represents a lot of optionality to us. And I think you're seeing us exercise that. That's both through addition and subtraction of that portfolio. I think you can think about just longer term to be less ICE dependent. We're very committed that we think that the ICE infrastructure tied to the aging car park is going to be a 10-, 20-year strong set of growth drivers in that. But at the same time, we're going to be moving down our ICE dependency as a percentage of our portfolio to arrive in what we believe are more growthier, more higher recurring revenue, strong margin and strong cash flow portfolio. So a better, stronger portfolio mix over time. And I think you're seeing us exercise that in the early innings. More work to do, but we think we have the time and capability as well as cash flow and balance sheet to exercise that.

Great. Why don't I just do one last check for questions. And if there are none, I think that's a pretty good place to end up anyway.

Thank you, Will.

Thanks. Thanks for the discussion.