ITT Inc. (NYSE:ITT) Q3 2023 Earnings Call Transcript

ITT Inc. (NYSE:ITT) Q3 2023 Earnings Call Transcript November 2, 2023

ITT Inc. beats earnings expectations. Reported EPS is $1.37, expectations were $1.27.

Operator: Welcome to ITT’s 2023 Third Quarter Conference Call. Today is Thursday, November 2, 2023. Today’s call is being recorded and will be available for replay beginning at 12 p.m. Eastern Time. At this time, all participants are placed in a listen-only mode and the floor will be open to your question following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Mark Macaluso, Vice President, Investor Relations and Global Communications. You may begin.

Mark Macaluso: Thank you, Lisa, and good morning. Joining me in Stamford this morning are Luca Savi, ITT’s Chief Executive Officer and President; and Emmanuel Caprais, Chief Financial Officer. Today’s call will cover ITT’s financial results for the three-month period ending September 30, 2023, which we announced this morning. Before we begin, please refer to Slide 2 of the presentation available on our website, where we note that today’s comments will include forward-looking statements that are based on our current expectations. Actual results may differ materially due to several risks and uncertainties, including those described in our 2022 annual report on Form 10-K and other recent SEC filings. Except where otherwise noted, the third quarter results we present this morning will be compared to the third quarter of 2022 and include certain non-GAAP financial measures.

The reconciliation of such measures to the most comparable GAAP figures are detailed in our press release and in the appendix of our presentation, both of which are available on our website. With that, it’s now my pleasure to turn the call over to Luca, who will begin on Slide 3.

Luca Savi: Thank you, Mark, and good morning. Before we begin, I would like to share how shocked we all are at ITT about the terrorist attack in Israel on October 7. We strongly condemn these terrorist attacks. Israel is a special place to us given the presence of our colleagues working at our Habonim valves business headquartered in the northeast part of the country. I was fortunate to spend time with Ilan and the team in August, and I was humbled by their capabilities, their strong work ethic and their commitment to ITT and their customers. Obviously, all their lives were impacted by these tragic events. We’ll stay in close contact with our Israeli colleagues there as the safety of our people and their families is always our primary concern.

It is our hope that peace is restored in the region. Now to our latest results. The main theme of this call is a step up in performance, a step up in execution and a step up in capital deployment. We’re converting ITT’s $1.2 billion backlog. At 19.4%, we are making significant progress towards our 20% long-term segment margin target. We are delivering new levels of earnings with a record EPS this quarter and expected for the full year. Last but not least, we expect over $400 million of free cash flow. And on capital deployment, we are accelerating. Yesterday, we announced the signing of a $400 million strategic acquisition in flow with the addition of Svanehøj. Now let’s get into the details. On execution, in Industrial Process, we continue to see strength in projects and aftermarket.

Our pump projects, parts and service businesses all grew revenue double digits organically in the third quarter, demonstrating our prowess in gaining share and emerging as a leader in profitability in flow. Still, there are many more opportunities for growth. For example, this quarter, together with IP’s President Fernando, I went to Brazil and Peru. He’s intimately familiar with the region coming from Brazil. There, we spent time with our local teams to review our outstanding performance in the region and the new growth initiatives. The talented local ITT team gave us a greater understanding about the growth actions they are working on to capture share in mining, process and energy. In Connect and Control Technologies, our aerospace and defense components business grew revenue nearly 30% and 6% sequentially, which drove 8% organic growth in CCT.

The growth in our connector OE business more than offset the continued distribution destocking impact in Europe. Just to step back for a moment. As you have heard us talk about, we have been managing through the destocking in connector distribution in Europe for the past three to four quarters. And whilst we still see weakness in Europe, our North American team had been able to offset the European weakness with actions in OEM and distribution. Well done, Art and team. Finally, in Motion Technologies. We again won share in the electrified vehicle market with 30 new platform wins this quarter and over 130 awards year-to-date at a win rate that is well above our current market share. Frictional e-outperformance continued to improve sequentially in Q3, thanks in particular to our China business, which grew sales roughly 25%, driving 20% growth year-to-date.

Also in MT, the friction team won new awards in the high-performance vehicle market ahead of the recently announced Termoli plant expansion, where the new line will be up and running in Q4 2024. And the progress did not stop here. Both KONI and Axtone grew double digits on the strength of share gains, new product innovations and pricing actions in rail. In Axtone specifically, we have won many new orders this year. And as a result, we expect our orders to be up nearly 10% for the full year versus a record year in 2019, when we were still operating in Russia. Continuing with execution. At 19.4% this quarter, we again made considerable progress towards our 20% long-term segment margin target. Industrial Process eclipsed 21% for the fifth straight quarter, up 220 basis points year-over-year and 40 basis points sequentially with an incremental margin above 40% as our operational drive continues.

Motion Technologies reached 17% margin in Q3, improving 100 basis points sequentially as we anticipated with incrementals of 40%. Notably, we saw a strong improvement in both Wolverine and Axtone due largely to pricing actions, and we expect both businesses to be back to double-digit profitability in Q4. This is quite an accomplishment considering the challenges our teams confronted from high-cost steel inflation and the war in Ukraine. Moving to capital deployment. We are accelerating. In October, we announced a new $1 billion share repurchase program with an indefinite term that we will strategically implement at the completion of the current $500 million plan. But more importantly, yesterday, we entered into a definitive agreement to acquire Svanehøj, a Denmark-based supplier of cryogenic marine pumps and aftermarket services for liquefied gas.

The Company operates in attractive industries tied to long-term trends, including decarbonization, energy transition and growth in marine transportation. I will share more about this exciting acquisition momentarily. Coming back to our full year results. We are raising our 2023 outlook once again across all metrics. At the midpoint, we now expect nearly 8% organic revenue growth, 140 basis points of margin expansion, nearly 17% earnings growth and over $400 million of free cash flow generation. These set us up for a record year, and I’m really proud of what our teams all over the world are accomplishing. Now let’s turn to Slide 4 to talk about our pending acquisition, Svanehøj. Yesterday, we announced our intent to acquire Svanehøj, a leading cryogenic marine pump supplier, for approximately $400 million.

The purchase price multiple equates to less than 12x estimated 2023 EBITDA, and the deal is expected to close in the first quarter of 2024. Svanehøj has leading positions in cryogenic applications for the marine sector, including deep well gas cargo, fuel and energy pumps, which have the technology to process all future energy transition fuels. Like IP, the Company has a large installed base of pumps and a sticky profitable aftermarket business, thanks to its differentiated service model with global reach. The regulatory nature of vessels service allows Svanehøj to benefit from recurring aftermarket revenue with sole-sourced positions. Its products and services are also widely regarded as the highest quality in the industry, which drives customer loyalty.

Stepping back, there is a lot to love about this business, which adds cryogenic pumps to our flow portfolio. First, the Company has a strong management team that has a deep knowledge of their markets and a clear focus on driving performance. Next, we have good line of sight to future revenue growth coming from decarbonization and energy transition, where Svanehøj has leading positions in three out of four verticals in which it operates. Shipowners are required to service and upgrade their fleet, which we expect will drive recurring demand for Svanehøj’s products and aftermarket services. And the shift to more environmental-friendly propulsion technology, coupled with growing ocean cargo activity, will increase demand for new marine vessel build.

With all of this, we expect Svanehøj to lead in the global energy transition across most verticals with a multiyear outgrowth supported by their backlog, by their differentiated technology and predictable aftermarket revenue. I would like to welcome Søren and the entire Svanehøj team to ITT. I also want to tell you that our M&A pipeline remains active. In Q3, the business, Emmanuel and I continued to invest a significant amount of time visiting potential target operations as we work further to further enhance our acquisitions pipeline. Let me now turn the call over to Emmanuel for more details on the quarter.

Emmanuel Caprais: Thank you, Luca, and good morning. Starting with revenue. Industrial Process once again led the way this quarter with 11% growth on the strength of the aftermarket, driven by both volume and price and project shipments. IP is also growing its backlog, which is up 18% year-to-date, with project orders up 29%, including green projects which are already up 160% versus all of 2022. CCT growth was primarily driven by a more than 20% increase in aerospace components and defense, underpinned by macro trends in these markets. Notably, we also generated 9% sequential growth in Connectors due to share gains in OE and SKU expansion with distributors in the U.S., more than offsetting weaker European distribution. Motion Technologies’ growth was driven by friction OE at 7% and higher pricing in KONI, Axtone and Wolverine.

This was mostly offset by timing in the friction aftermarket driven by distribution inventory reduction. Looking ahead, we expect our auto aftermarket business to be flat in Q4 and to start growing again in 2024. Rounding out the ITT top line. Core volume growth contributed 300 basis points, while pricing actions contributed 200 basis points. The pricing was most prominent in the IP aftermarket and aero in CCT. Aero OE contracts is an area where we are dedicating more energy as more long-term agreements are coming up for renewal in 2024. Moving to margin. We improved in Q3 due to a combination of profitable growth and pricing actions. Volume and price contributed over 200 basis points, while our net productivity actions drove 150 basis points of expansion, more than offsetting the impact of foreign exchange and investments.

Specifically, we continue to invest in sales and operations planning to augment the Lean improvements in IP and CCT. The impact of stronger organic growth and improved margins drove 14% earnings per share growth, which includes the benefit of a 1% share count reduction. Last but certainly not least, our teams delivered another impressive cash performance, with nearly $150 million of free cash flow or roughly $300 million for the year-to-date. This amounted to over 7x more free cash flow compared to the same period in 2022. Our free cash flow margin this quarter was 18%, driven by stronger collections and higher net income. Cash is improving, but working capital was still a use of cash year-to-date mainly due to inventory. We expect this dynamic to reverse in 2024 with improved inventory management.

On Slide 6, you can see we delivered a 14% EPS increase this quarter to $1.37, a new record for ITT. We also continue to invest in new product development, including for IP’s embedded motor drive, which is currently deployed in customer field trials, and undergoing reliability and certification testing. As you can see on Slide 7, today, we’re raising our full year outlook given the year-to-date growth in orders and robust backlog and higher revenue growth, segment margin expansion and strong free cash flow generation. This is a testament to the execution our teams have delivered throughout 2023. We are moving our revenue guide to the upper end of the range at 7% to 8% organic growth, which implies the following for Q4. We expect low single-digit organic revenue growth led by Motion Technologies.

CCT aero should continue its growth trajectory coinciding with increasing air traffic, and we also foresee a pickup in defense demand near and midterm. We also expect continued strength in the IP aftermarket based on strong daily order rates exiting Q3 as well as in October, offset by lower baseline and project shipments. On segment margin, we are increasing the midpoint of our margin range by 50 basis points to 18.6% and approaching 19% at the high end. Segment margin in Q4 should be roughly flat sequentially. These dynamics should drive low single-digit adjusted EPS growth year-over-year. Finally, cash performance is outstanding. More than a year ago, we made a conscious decision to invest in inventory to support our customer amidst significant supply chain challenges at the expense of our free cash flow.

As a result, we won new business, built a robust backlog and gained market share. Fast forward to today, we have a record backlog, up 13% versus the end of last year, profit is way up, and our collections and cash flow are improving every quarter. As a result, we are increasing our guidance to more than $400 million, and our free cash flow margin is already at 12%, double from last year. Before I turn the call back to Luca, I’d like to share some highlights from our — from ITT’s 2023 sustainability update released last Friday. Last year, we made considerable progress in our — on our sustainability journey, including: a 32% reduction in recordable safety incidents; a 7% reduction in greenhouse emissions and in water consumption; and a $25 million commitment to solar energy projects.

This year, we connected solar installations in Barge, Lancaster, Oud-Beijerland and Nogales. These installations, along with other pending projects, are expected to reduce our CO2 emissions by approximately 6%. Last year was a significant step on our sustainability journey, and we look forward to sharing more good news in the future. You can read more about our sustainability highlights in the appendix. Now back to Luca.

Luca Savi: Thanks, Emmanuel. Before we move to Q&A, I’d like to share a few closing thoughts about our execution and accelerated capital deployment. First, we continue to outperform in some of the world’s fastest-growing end markets, and we are finding new avenues to differentiate, whether with groundbreaking innovations or new areas for growth. Second, we are well on our way to reaching the 20% long-term segment margin target that we set just last year. Industrial Process led the charge beginning at the end of last year and eclipsed their long-term target for five straight quarters. Third, because of the momentum we’ve built, we raised our outlook for revenue, margin, earnings and free cash flow. And with a double-digit increase in our backlog expected by the end of this year, we are confident that ITT will continue to grow in 2024.

This is our third straight quarter of raising EPS guidance, and our progress towards our long-term margin target is accelerating. Finally, we are also accelerating capital deployment. We are acquiring Svanehøj to grow our flow portfolio, and we continue to evaluate other high-quality targets in flow and Connectors to put our strong balance sheet to use. Additionally, our new $1 billion share repurchase program gives us flexibility in allocating capital effectively. We have reached another new stepped-up level of performance for ITT. Thank you for joining us today and for your continued interest in ITT. Lisa, please open the line for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] And our first question will be coming from Michael Halloran of Baird.

Michael Halloran: So first, can we talk about the IP side of things, what you’re seeing from a fundamental order trajectory perspective? And maybe you could parse that out a little bit by the end-market applications here, energy, the short-cycle general industrial, chem businesses, mining and any of the other — or any other end markets you think I missed there?

Luca Savi: Sure. Let me start and then, Emmanuel, you can build on that one. So when we look at the orders, the orders in Q3 declined 2%. You have short cycle that was flat year-over-year, and the project, there was a decline. Now having said that, there was a lot of timing that shifted from the quarter to October. And what I can tell you, that looking at the orders in October, they are considerably strong year-over-year. The short-cycle orders in October are up, and our rate is higher than what has been in Q3. And the projects in October are more than 40% higher year-over-year because some of the projects shifted. So that is the picture on the orders, and the funnel is still very, very healthy.

Emmanuel Caprais: Yes. And by end market, just to add a little bit more color, we see a slowdown in chemical, but our general industrial markets are really strong. We continue to gain share there. And then if you look at the funnel, I would say the funnel is also very strong. As Luca was mentioning, year-over-year, our project funnel is up 16%. Versus the beginning of the year, it’s up almost 10%. And this is driven by really energy, chemical, general industrial. So pretty good picture from a project standpoint also.

Michael Halloran: Great. Really appreciate that. And then follow-up is, maybe, Luca, you could give some thoughts on how you see the auto market tracking and any thoughts on the 2024 build rates on a global basis. You always give really good color there. Certainly appreciate Emmanuel’s comments on the sequential improvement on the aftermarket side going into next year, but any other color would be great.

Luca Savi: Sure. Thank you, Mike. When we look at the market, the market was up in Q3 a good 3.8%. The production was up in Europe, was up in North America despite the strike, whereas in Q3, it was flat in China. But then when you look — and this was after a first half which was already very good. So when you look at the full year for 2023, we expect the market to be up roughly 7%, so mid-single digit; Europe, up low double digit; North America, mid-single digit; and also China, mid-single digits. So China was able to surprise us in 2023 as we forecast it to be flat for the year. So — and on top of this market, as you know, we continue to outperform. The outperformance was very good. It was roughly 800 basis points in Q3 and accelerating.

So year-to-date, roughly 400 basis points of outperformance. When you look at that — so 2023, you are probably thinking about roughly 88 million vehicles produced when — 88 million, 89 million. When you look at 2024, it’s still a little bit too early to tell, but probably it’s going to be a low single-digit growth, what we are considering right now. The aftermarket, which was the second part of your question, it’s going to be flat in Q4 year-over-year. Q3 was a tough quarter in terms of comparison versus 2022. And we expect it to grow again, based on what the customers are telling us in Europe, in 2024.

Operator: And our next question today will be coming from Damian Karas of UBS.

Damian Karas: Congrats on the deal. So maybe a higher-level question on MT and friction because there has been a lot of noise out there in the automotive world. Obviously, the strikes in the U.S., pushing back of a lot of these EV production schedules; OEM price wars in China. I’m just curious, Luca, how are you seeing all of this affecting your business? And just on the MT margin front, is that path to 19-plus — 19%-plus, do you kind of see that sooner or later?

Luca Savi: Okay. So let me address the last part of the question first. The long-term target for Motion Technologies is 20%. This has not changed, and we have a clear path to get there. You can see our margin already up sequentially year-over-year to 17%. This will keep on improving. We will be able to eat 18% in — some time in 2024. Now going back to some of the dynamics that you shared, the strike. The strike was really immaterial for us. Probably what was the hit was a couple of million dollars in terms of revenue, so really immaterial. When you look at the EV production, sure, when you’re listening, particularly in the North American market, you may see some slowing down in terms of the adoption and maybe investment from the OEMs. But this is really, I would say, a North American dynamic.

The electrification is really going full speed when you look at Europe and North — and China. And by the way, Damian, we are really targeting all electrified vehicles. You’re talking about AV, you’re talking about hybrid, you’re talking about IC, and we are winning across the board. So we are also very successful in defending all our platforms that we are in, in the internal combustion engine. That is on the EV. When it comes to China, I’m glad that you are mentioning China because China is a great story for us. When you look at our China business, $300 million, 80% of that is friction. We are winning. It’s a great, good operation, good financially. Let me give you a couple of examples. When you’re talking about financially, this is a plant that is only producing OE, no aftermarket.

Still, it’s the most profitable plant for friction in the world. When you look at operations, in Q3, we had roughly 40 PV, 40 process validations every month. This is when you run your PPA for the SOP for the start of production. When you do that, you have a lot of interruption. You have a lot of disruption in production. Despite all of that, the fantastic Chinese team delivered 99.93% of on-time delivery. And this is why the Chinese keep on awarding us the platforms. Today, at the end of September, they’ve already reached 90% of their full year award target. And we are winning with the winners. More than 60% of what we are producing is for the Chinese OEM. So it’s a great story there, too.

Damian Karas: Great. And I know I’m going to botch the name of this, but on the Svanehøj deal, any color you can give on EPS accretion? And if my math is correct, it looks like it may be slightly dilutive to IP margins. Just curious if there’s any synergies with Habonim or the rest of the pumps business.

Emmanuel Caprais: Thanks, Damian. So yes, so we’re very happy with our ability to secure that deal with — to buy Svanehøj. It’s a great business, gives us entry into cryogenic technology. We’re very, very excited. If you think about accretion, from an EPS accretion standpoint, Svanehøj will be accretive in 2024. Keep in mind that this is a business that has a lot of long-term backlog. So there will be a negative impact on — in terms of intangible depreciation in 2024. But overall, very, very strong business. As Luca mentioned, a very strong management team. So we’re excited about that. In terms of margin, you’re right. It’s going to be — from an EBITDA margin standpoint, it’s going to be slightly dilutive to IP, but there are many opportunities.