Carrier Global Corporation (NYSE:CARR) Q1 2023 Earnings Call Transcript

Carrier Global Corporation (NYSE:CARR) Q1 2023 Earnings Call Transcript April 27, 2023

Operator: Good morning and welcome to Carrier’s First Quarter 2023 Earnings and Strategic Update Conference Call. I would like to introduce your host for today’s conference, Sam Pearlstein, Vice President of Investor Relations. Please, go ahead, sir.

Sam Pearlstein: Thank you and good morning and welcome to Carrier’s conference call to discuss the transactions we announced last night along with first quarter 2023 earnings. With me here today are David Gitlin, Chairman and Chief Executive Officer; and Patrick Goris, Chief Financial Officer. We will be discussing certain non-GAAP measures on this call which management believes are relevant in assessing the financial performance of the business. These non-GAAP measures are reconciled to GAAP figures in our earnings presentation, which is available to download from Carrier’s website at ir.carrier.com. There are two presentations available there, one for the strategic actions, and one for the first quarter 2023 results. The company reminds listeners that the sales earnings and cash flow expectations and any other forward-looking statements provided during the call are subject to risks and uncertainties.

Carrier’s SEC filings including Forms 10-K, 10-Q and 8-K provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements. Once the call is open for questions, we ask that you limit yourself to one question and follow-up to give everyone the opportunity to participate. With that, I’d like to turn the call over to our Chairman and CEO, Dave Gitlin.

David Gitlin: Well, thank you, Sam, and good morning, everyone. A big day for us and we appreciate your flexibility joining us this morning on short notice. Today we are announcing a new Carrier, a new direction and an exciting transformation, a game-changing opportunity to acquire Europe’s premier company in the most attractive market in our space, allowing us to capitalize on the energy transition in Europe. Combined with the planned exits that we are also announcing, Carrier will become a simpler, focused, pure-play leader in intelligent climate and energy solutions that generates higher growth and superior shareholder returns. Before we discuss this transformation in more detail, we will cover the highlights of our Q1 results on slide two.

In short, good news, the team executed very well. We beat our forecast on the top line with 4% organic growth with double-digit growth in aftermarket controls commercial and light commercial HVAC and global truck trailer. Orders were modestly positive in the quarter with year-over-year orders performance improving as the year progressed. Adjusted EPS of $0.52 exceeded our projections and we generated significantly more free cash flow year-over-year. Based on our strong Q1 results, we now have confidence in the high end of our full year adjusted EPS guidance range. Before we discuss our exciting announcement about our future, let me take a brief look back on how far we’ve come already on slide three. I am so proud of our team’s accomplishments since spin.

In short, we do what we say we’re going to do. Our commitments were to drive sustained growth, improved margins through rigorous cost reduction, increased aftermarket revenues, deliver strong free cash flow, innovate and ensure customer loyalty, energize our teams and culture and strengthen our portfolio and balance sheet. We have grown sales at an 8% CAGR since 2020. And since 2021, we have expanded margins by 150 basis points and have driven an adjusted EPS CAGR of 19%. We have effectively driven significant productivity, growing our aftermarket double digits annually and have introduced over 400 new products over the past three years. We launched important new platforms for our building and cold chain ecosystems Abound and Lynx, with both getting superb traction with our customers.

We dramatically improved our portfolio, positioning ourselves in the fast-growing VRF market with the acquisition of Toshiba’s HVAC business and Giwee, while completing the sale of Chubb and our bearer shares. We improved our balance sheet, reducing our net debt by 50% from $10 billion to $5 billion all while doing $2 billion of share buyback and increasing our dividend payout ratio from 17% in 2020 to a targeted 30% this year. This outstanding performance has been made possible by our world-class workforce and agile new stand-alone culture. As a result of all of that, Carrier stock price has appreciated 229% since our spin date compared to 66% appreciation for the S&P 500. So with our foundation firmly in place and a track record of execution, we are now announcing a purposeful shift in our strategy, which is what you see on slide four.

We have a very clear and compelling vision, to be the world leader in intelligent climate and energy solutions. Strategically, we are positioning ourselves in the fastest-growing geographies, with highly differentiated channel access and the most comprehensive and differentiated suite of sustainable technology and services. Digitally enabled life cycle solutions will increase aftermarket and recurring revenues. Our energized team will continue to drive unparalleled customer loyalty and superior shareholder returns. This strategic shift in our vision has led us to the decision to further focus our portfolio and align it with faster-growing end markets, which leads to the announcement that we’re making today on slide five. The first is the acquisition of Viessmann Group’s Climate Solutions business, the premier company in the highest growth segment in the heat pump and energy transition markets.

This will also expand our capabilities as a one-stop shop for renewable and climate management solutions. We are also announcing that we are initiating the process of exiting our fire and security and commercial refrigeration businesses. The former decision was easy, combining with the best asset in the best market could not be more compelling and exciting. The latter decision was tough. We love these businesses and our people in them. We have tremendous brands, gross margins, market positions and customer stickiness. But we saw the benefit of focus as we spun from UTC and we are confident that further focus will create additional tremendous value. The result will be a new Carrier, with higher revenue and EBITDA growth profiles, leading market positions globally with a portfolio unlike any other company in the world.

So let me start with an overview of Viessmann Climate Solutions business on slide six. Viessmann Climate Solutions with 11,000 team members as part of the family-owned Viessmann Group, who have established market leadership over its 106-year-old history. The company has made a purposeful shift from fossil fuel boilers, such that now 70% of its portfolio consists of premier heat pumps, digitally enabled services, solar PV and battery offerings. It also has highly differentiated boiler business that includes state-of-the-art hydrogen-ready offerings. About 40% of its sales are in Germany, with very strong positions in France, Poland and Italy. Those four countries make up more than 50% of the heat pump installed base in Europe with 20% annual heat pump growth rates.

The combination of Carrier and Viessmann’s Climate Solutions creates a tremendous game-changing opportunity. And as a result, the Viessmann founding family is showing great confidence in the combined entity, taking 20% of the purchase price and equity which has been fixed at signing. And we look forward to Max Viessmann joining our Board of Directors. Furthermore, we are excited to welcome the tremendous Viessmann team to the Carrier family to help us realize our shared vision. Carrier and Viessmann share a very similar journey as you see on slide seven. A phrase that we have used a lot to describe Carrier is a 100-year-old startup. Interestingly, Viessmann is very much the same. Both companies had visionary founders, who largely created and shaped the markets that we’re in and both of our businesses have evolved into agile, rapid innovation, climate-focused, digital industrial leaders.

Together, we are establishing a new global climate champion and that is one of the many reasons why Viessmann Climate Solutions just fits like a glove, as you see on slide eight. Thanks to the generations that came before as a Carrier, we have established market-leading positions globally. But when we spun, we had two strategic gaps, BRF, which we have now addressed with the acquisitions of Toshiba and Giwee and European residential light commercial heating, which we are now addressing with the premier asset in the space. These transformative moves position Carrier with market-leading positions now globally. So as we look at slide nine, you see the three primary rationales for this tremendously exciting acquisition. First, it is the most attractive market in our space globally.

Second, Viessmann Climate Solutions is the premier asset in that market. And third, it positions our portfolio to expand into integrated renewable offerings in a unique and differentiated way. So I’ll address each of these three elements starting on slide 10, explaining why the market itself is so attractive. The megatrends that you see here are reshaping our industry. Climate change and sustainability, energy, security and the rapid adoption of green energy solutions accelerated by government, regulations and incentives. These secular trends are indeed global but are clearly most acute in Europe. Europe has long been out in front on sustainability. The Paris Agreement and the European Green deal set a target for a 55% reduction in greenhouse gas emissions by 2030.

Fit for 55, targeted 40% renewable energy in Europe by 2030, which was recently raised to 45%, when the EU passed REPowerEU following the Russian invasion of Ukraine. REPowerEU also aims to double the current rate of individual heat pumps to reach 10 million additional units over the next five years. Likewise, 17 European countries have announced or implemented bans on newly installed fossil fuel heating systems for homes, which has been supported by government subsidies. The result is the massive growth that you see on Slide 11. There are 8.5 million heat pumps in European homes, which is expected to increase 25% annually to 40 million by 2030. Residential battery sales are also projected to increase over 20% annually during this time frame with a double-digit annual increase in residential solar PV sales as well.

Carrier does not offer solar PV and home battery solutions today. So Viessmann Climate Solutions offering provide Carrier the perfect opportunity to pursue an incremental fast-growing annual TAM of $35 billion. The shift to heat pumps is unique and compelling given the mix-up opportunity that you see on Slide 12. First is the rapid adoption of heat pumps, from selling about one million per year, going up to 10 million per year in 2030. Now factor in the positive mix impact with heat pump selling for as much as 4x per unit compared to boilers. The result of that combination is that the EU residential heat pump market is expected to grow revenues 25% annually for the coming years. The opportunity is tremendous. So turning to Slide 13. Let me provide some additional color on why Viessmann Climate Solutions is the premier company in this space.

Thanks to Professor Dr. Martin Viessmann, who represents the third generation of the founding family and his courageous move 30 years ago. Viessmann Climate Solutions is one of the very few companies in Europe that primarily sells directly to installers. 75,000 of them, with whom they have deep, long-standing relationships. This highly differentiated channel allows for best-in-class customer intimacy, rapid innovation in response to the customer desires and digital connectivity. Likewise, the Viessmann brand is iconic and highly trusted across Europe. It has often been compared to as the Mercedes of residential heating brands. During German Chancellor Olaf Scholz’s most recent New Year’s address, he singled out Viessmann as a shining example of the innovative side of Germany.

It has the highest ranked heating and energy brand in Germany and has been the most trusted OEM for almost two decades. The result, thousands of customers recognize and demand Viessmann climate solutions and are willing to pay a premium for it. Its excellent reputation is largely driven by its track record of product leadership and premier innovation as you see on Slide 14. Viessmann Climate Solutions has leaned in to the use of natural refrigerants and as heat pumps require 50% less floor space and installation time. They also developed a new integrated heating solution called Viessmann Invisible, a patented concept which optimizes space and aesthetics by integrating the heat pump, air handler, water tank and accessories into a decorative indoor panel.

They are at the digital forefront providing innovative heating as a service offerings and generating subscription-based recurring revenues. The result, outside top and bottom line growth as you see on Slide 15. We expect approximately €700 million of EBITDA on €4 billion of sales in 2023. Fast forward to 2025, we expect those numbers to increase to over €900 million and €5 billion respectively. That’s double-digit top and bottom line growth and it’s nothing new for them. They’ve done it in the last few years and we expect it to continue going forward. So best asset in the best market. What’s equally exciting is that the combination positions Carrier to enter an entirely new market, given that Viessmann Climate Solutions has effectively established and ecosystem approach as you see on Slide 16.

Viessmann has done a masterful job of creating common and distinctive designs across its product portfolio, that all interact seamlessly with one another so the consumer becomes attached to its ecosystem with multiple interoperable products, digital and value-added services. Max Viessmann and his team have effectively implemented this strategy. Its solar PV battery, and heat pump systems can all be installed at different times, but are then seamlessly interconnected and interoperable, all underpinned by their common digital platform one base. One base gives the customer an easy, reliable and quick way to operate their energy system via an app. The platform bundles devices and electronic applications, into one single climate and energy solution for the home.

The beauty as you see on Slide 17, is that Viessmann Climate Solutions is the only company in the industry with such a comprehensive solution level offering. When you combine Viessmann Climate Solutions unique market position and breadth of offerings, with Carrier’s technology and global channels, the opportunity for us to create unique value to our homeowner and other customers and importantly the planet is truly differentiated. Homeowners in Germany with boilers spend on average €2,200 per year, on gas heating. Switching to an electric key pump, can reduce the owner’s cost by over 20% to €1,700 per year. If those same homeowners implemented a complete renewable solution, with solar PV, battery storage, heat pumps and an energy management solution with effective grid management and controls, they could — annual heating bills by 60% to 80% to about €700 per year.

Those same owners same homeowners would also reduce their individual carbon footprint by about 50%. So the world continues to be more electrified, integrated solutions provide a step change in customer value and benefit to our planet. This broad suite of offerings, introduces a new addressable market to Carrier, as you see on Slide 18. Heat pump sells for about 4x the price of a boiler. When you add solar PV, battery and accessories and services, the installed price can be as high as 15 to 20x the installed price of a stand-alone boiler. The result is Carrier’s ability to now pursue a 35 billion fast-growing market opportunity. The key to success is effectively integrating and coming together as one team. We have done it so effectively before, and I have no doubt that we’ll continue to do it again, as we see here on Slide 19.

Viessmann Climate Solutions is a highly integrated successful well-run business. It has tremendous people, one ERP system, one brand, a deep well-established channel and a strong operations and innovation. We have been very impressed with Thomas Heim, Viessmann Climate Solutions CEO and his leadership team. Thomas will lead Carrier and Viessmann Climate Solutions, Center of Excellence for our combined residential and light commercial European business, which will continue to be headquartered in Allendorf, Germany. After completing the acquisition and business exits, the vast majority of our business will be HVAC. As a result, Chris Nelson and I have collaboratively agreed to streamline the organization. Our superb HVAC business leaders, will now report directly to me and Chris will be departing Carrier next month.

He has served the company for 19 years, so well, and we wish him nothing but the best. Another reason for confidence in the integration is how well our cultures align as you see on Slide 20. A passion for customers and results, unwavering commitment to our people values and purpose, innovation, community and a deep passion for the environment. Together, we will achieve important and compelling sustainability targets. We are aligned and cannot wait to move forward together as one team. Our base business case, includes the cost synergies that you see on Slide 21. We have identified €200 million of cost synergies the vast majority of which will be achieved by year three and we have a track record of over achieving our projections. On Toshiba, we committed to 100 million of synergies and we are tracking to do meaningfully better than that.

Viessmann Climate Solutions is a rapidly growing business, so this is not about employment reductions. Rather about 85% of the cost synergies are driven by procurement and in-sourcing. For example, we anticipate in-sourcing differentiated inverter drives from Toshiba, heat exchangers from our facilities in Spain and Poland as well as other components like rotary compressors and vents. Cost synergies are expected to increase Viessmann Climate Solutions margins by over 200 basis points within three years. There were also revenue synergy opportunities, which we have not included in our base estimates, such as introducing multi-tier offerings into Viessmann Climate Solutions channel and leveraging its digital ecosystem offerings and technologies more broadly across Carrier’s channel.

Now I will turn it over to Patrick to take you through the transaction itself on Slide 22.

Patrick Goris: Thank you Dave. The enterprise value is €12 billion, which is about 13 times forecasted 2023 EBITDA assuming €200 million of run rate synergies. We are very pleased that the Viessmann founding family elected to take 20% of the transaction value in Carrier equity and that the family is making a long-term holding commitment. They share our excitement about the future — the future value we believe this transaction will provide to our stakeholders. The number of shares are based on a VWAP prior to signing and are those fixed. The balance of the purchase price €9.6 billion will be funded through a combination of cash on hand and debt. With respect to cash we have $3.3 billion at the end of Q1 and we expect that to grow to about $4.5 billion by year-end excluding the impact of the acquisition since we paused share repurchases.

We have fully committed financing in place for about €7 billion and have hedged the cash portion of the euro-based purchase price. Given Viessmann Climate Solutions growth profile, the acquisition is expected to add over 100 basis points to Carrier’s overall revenue and EBITDA growth profile. We expect a high single-digit free cash flow yield starting in year five. While the acquisition is expected to be adjusted net income accretive in 2024, we expect the acquisition to be adjusted EPS accretive starting in 2025, because of the additional shares outstanding. Retaining solid investment-grade credit ratings is very important to us. Yesterday Moody’s, S&P and Fitch have reaffirmed our current investment-grade ratings following the announcement of this transaction.

Excluding proceeds from the business exits, we plan on deleveraging quickly following the transaction returning to about 2x net leverage in 2025 after which we expect to resume share repurchases. The timing and net proceeds of the business exits may of course accelerate the timing of both the deleveraging and the resumption of share repurchases. We expect to repurchase the equivalent number of shares issued to the Viessmann founding family as soon as we reach our target leverage. This could happen as soon as 2024. Finally, we remain committed to a sustainable and growing dividend and expect the transaction to close around the end of 2023.

David Gitlin: Well, thank you Patrick. So the $1.1 billion business that we are exiting at high single-digit EBITDA margins last year, we have invested significantly in restructuring and improving the margins of the business, which will significantly benefit the business going forward. We expect to exit this business over the course of 2024. To be clear, we are retaining our cold chain solutions and transport refrigeration business which includes truck, trailer, container, Sensitech sensors and our Lynx platform and all the related aftermarket and digital offerings. So in summary on slide 25. These moves position us as a higher top and bottom line growth company. Had we made these transformational moves three years ago, Carrier’s revenue CAGR would have been 2x the rate that we indeed achieved, mid-teens rather than 8%, thus giving us confidence that we are transforming into a sustained higher growth profile company.

With Viessmann Climate Solutions, we are now positioning ourselves to be the Global Climate Solutions Champion. We are buying the premier asset in the premier market. We are standing by our commitment with our portfolio to be clinical and dispassionate and though we are selling tremendous franchises, the result will be a focused differentiated carrier that drives higher growth and returns for our shareholders and value for our employees and customers. And with that, we’ll open this up for questions.

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Q&A Session

Operator: The first question comes from Julian Mitchell with Barclays. Your line is now open.

Julian Mitchell: Hi. Good morning and congratulations.

David Gitlin: Thanks, Julian. Good morning.

Julian Mitchell: Maybe just a first question around Viessmann itself. So, a couple of things. One was maybe if you could help us understand its market shares in the main businesses that you’re most attracted to in it for example heat pumps. I think it’s got close to maybe $1.5 billion $2 billion of sales and you talked about sort of a $5 billion TAM somewhere in the deck, but I’m not sure those are apples-to-apples. So maybe just help us understand the market share. And also, you talk about the appeal of it the uniqueness of the sort of one-stop shop aspect with the residential building. In the nonresidential world, the sort of the one-stop shop has been harder for equipment suppliers to get right. So maybe help us understand why in the residential world you’re confident of that one-stop shop approach is the one that will drive share gains and returns?

David Gitlin: Sure Julian. In terms of their positioning, what I’ll tell you is that they are the number one premium brand across Europe. So in the premium market with heat pumps they’re number one. Within Germany and heat pumps, they’re number one. And across Europe, air-to-water heat pumps they are in the top five. In terms of the latter question, what they’ve done that is incredibly impressive is that they’ve designed — you can think of it almost as the apple of their space because all of their products are seamlessly integrated into an ecosystem approach. So, if a homeowner can’t afford to buy solar PV, battery and a heat pump all at the same time, they pre-designed them so they’re all interoperable and interconnected at the time of installation.

So what really makes them unique is their ability. So if you only install the heat pump in the battery and a year later you install Solar PV, it’s been seamlessly integrated. So what they’ve done unique is have their products interoperable and it’s underpinned by a digital solution. So you have this one based system that can control all of the various products and also provide greater management. Because if you fast forward to the future, we’re all going to get to a point someday where you get home at the same time, you plug in your car, you turn on your heating system. You’re putting a lot of reliance on the grid all at the same time. So being able to do grid management and have their products interoperable is very, very unique and they’re the only one in the world that does it.

Julian Mitchell: That’s helpful. And then just my follow-up would be on the exit side of things Fire & Security and Commercial Refrigeration. Investors may be concerned that you’re buying Viessmann for sort of 17 times or so headline ex synergy EBITDA and worry about sort of the selling prices of F&S and commercial refrigeration versus that. So maybe help us understand kind of how you’re thinking about the exit route for those in terms of spins or outright divestment and how you’re confident that as we go through this process of sort of €4 billion of sales out €4 billion of sales in that the returns and sort of financial criteria looks okay?

David Gitlin: Well a few things Julian. First of all, we think of it as buying 13x the fully synergized number. Second, we are going to be bringing in just on a base level more EBITDA than we’re selling and then you add synergies to it and it’s even more. And the growth rate of Viessmann is far higher than anything else on a sustained basis that we have in the portfolio, including the businesses that we’re exiting. In terms of the price that, we’ll realize on these divestitures we’ll have to see. But what I’d remind folks is that when we sell Chubb we sold that for a 13x multiple. And as great as a business Chubb is with 240 branches, it’s largely an installation and services business. Here you’re dealing with especially on the fire and security side highly differentiated high gross margin businesses usually with three to five competitors in their spaces they’re going to be hugely sought after and we’re going to see how — as we go through the process what’s the best way to sell.

We may sell it its entirety. We may do a spin. We may sell it off in various pieces some quicker than others. So we’ll go through the process. But I think it would be very surprising for us to get anywhere close to — the multiple on Chubb are lower we would expect it to be materially higher.

Julian Mitchell: That’s great. Thank you.

David Gitlin: Thank you.

Operator: Please standby for our next question. The next question comes from Nigel Coe with Wolfe Research. Your line is now open.

Nigel Coe: Thanks. Good morning, and thanks for the questions.

David Gitlin: Good morning.