ITT Inc. (NYSE:ITT) Q4 2022 Earnings Call Transcript

ITT Inc. (NYSE:ITT) Q4 2022 Earnings Call Transcript February 9, 2023

Operator: Welcome to ITT’s 2022 Fourth Quarter and 2023 Outlook Conference Call. Today is Thursday, February 9, 2023. This call is being recorded and will be available for replay beginning at 12 PM ET. . It is now my pleasure to turn the floor over to Mark Macaluso, Vice President of Investor Relations. You may now begin.

Mark Macaluso: Thank you, Candice, and good morning. Joining me here 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 3- and 12-month periods ending December 31, 2022, which we announced this morning. Before we begin, please refer to Slide 2 of today’s presentation, 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 a number of risks and uncertainties including those described in our 2021 annual report on Form 10-K and other recent SEC filings. Except for otherwise noted, the fourth quarter and full year results we present this morning will be compared to the fourth quarter and full year 2021 and include 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. This morning, we will begin with an overview of results and our outlook for the year. Emmanuel will then review the fourth quarter results before we close the book on 2022. Luca will discuss some key commercial achievements and our 2023 guidance, and we’ll have plenty of time for your questions at the end. Please note there is additional information on the quarter and full year results as well as planning assumptions for 2023 in the supplemental data to our presentation, which I encourage you to review. With that, it’s now my pleasure to turn the call over to Luca, who will begin on Slide number 4.

Luca Savi: Thank you, Mark, and good morning. Before we discuss ITT’s results, I would like to start by thanking our shareholders for their investment in ITT, our customers, we always keep at the center of everything we do, and our employees for their ongoing commitment to ITT. This quarter, more than ever, I was humbled by the efforts and resilience of all our ITTiers. First, in Wuxi, China, our employees delivered the highest production quarter ever despite COVID infection rate of more than 75% in December. Our China team’s performance was the highlight of the quarter. Next, across all our factories. We navigated supply chain disruptions and ensure on-time delivery to our customers. And in Europe, our teams worked through the energy crisis, the impact of the war in Ukraine and an updating inflation.

I am grateful for the resilience you demonstrated this quarter and throughout 2022. It was your efforts that drove the record performance we are presenting today, including 12% organic orders growth following 13% growth in Q3, over 17% organic revenue growth in all businesses delivering double-digit growth, a record segment margin of 18.6%, 22% EPS growth after 21% in Q3 and over $130 million of free cash flow up 58% versus prior year. In many regards, ITT’s fourth quarter was another step-up in performance. Now to the details. Our seventh consecutive quarter of double-digit organic orders growth resulted in an ending backlog of more than $1.1 billion, up 22% versus prior year. Higher volumes and price recovery drove the strong organic revenue growth led by industrial process at 27%.

This year, we drove over $170 million of price recovery with MT at the forefront. Execution momentum in IP continued across projects, baseline pumps and aftermarket resulting in 27% organic revenue growth in Q4. CCT grew sales by 16%, boosted by share gains in connectors and strong demand for aerospace components. And in MT, the outperformance continues in every region. For the full year, we surpassed global automotive market growth by roughly 400 basis points. Our price recovery, volume growth and productivity led to a record segment margin in Q4, overcoming cost inflation impact of roughly $50 million for all of ITT, a truly remarkable accomplishment indeed. And on cash, after a tough few quarters, we generated strong free cash flow with 17% free cash flow margin in the quarter by far the best performance of the year.

The common thread that underpinned these achievements was our people and their commitment to deliver for our customers. I was fortunate to experience this in Saudi Arabia, where Halid and the local IP team performed flawlessly and achieved 100% on-time performance for our customers in 2022. In the flow industry, this is a differentiator. And given this performance, we are investing in new testing capabilities to grow our presence in the region. This has already helped us win more than $20 million in incremental project orders. Or in like — or like in South Korea, which has become our new center of excellence for vertical pumps, also here, we continue to invest in more technology, engineering resources and lean. Speaking of lean, we are working now on our next transformation of the plant layout in Seneca Falls, to optimize material flows and efficiency.

We are already realizing the benefits of IP’s lean efforts with more than 40% incremental margin in Q4 and for the full year. This relentless focus on excellence, continuous improvement and commitment to quality enabled us to deliver on our original revenue and adjusted earnings per share guidance in 2022 despite numerous unanticipated macro headwinds. On capital deployment, we deployed more than $600 million in 2022 or 3.5x our adjusted free cash flow. CapEx increased 18% to support the growth of in electrified vehicles and productivity. On M&A, Habani was a strategic acquisition and a great deal. It expanded IP’s valves business by more than 50% and was accretive to ITT’s earnings. And with this strong performance, our effective purchase multiple is now 8 to 9x and dropping versus approximately 12x at the date of acquisition.

This morning, we announced a dividend increase of 10% after increases of 30% and 20% in 2021 and 2022, respectively, and we repurchased over $250 million of ITT shares, lowering our share count by 3%. Finally, on our 2026 long-term targets, we are making significant progress. A few highlights. Our relentless focus on safety drove reductions in both injury frequency and severity rates, leading to a 32% decline in the number of incidents in 2022 to a much improved incident frequency rate of 0.55. On sustainability, we are reducing our greenhouse gas emissions, increasing revenues from green products and advancing our diversity, equity and inclusion efforts. And our financial performance, organic revenue and adjusted EPS growth in 2022 were in line with our long-term growth target.

We are proud of what we accomplished in 2022 but never satisfied. And that is why we’re encouraged by the opportunities we see in 2023. With that, let me turn the call over to Emmanuel to discuss our fourth quarter and full year results.

Emmanuel Caprais: Thank you, Luca, and good morning. Let’s begin on Slide 5. Revenue growth of over 17% was driven by double-digit growth in all businesses. In IP, projects increased over 70% organically. Here, we continue to benefit from share gains in large capital CapEx spend and near-shoring activities that are ramping up. Short-cycle revenue increased on a year-over-year basis across baseline pumps parts and service aided by pricing capture. The strength of the commercial aerospace recovery and accelerating demand for defense applications drove strong growth in CCT as well. Our aero components business grew 26%. However, we remain somewhat capacity constrained due to continued supply chain issues. Connectors grew 13% driven by market share gains as the benefit of new product innovations, particularly in defense, began to materialize.

In MT, friction OE share gains in all regions and price recovery drove 12% organic growth. Friction’s on-time performance was 99% again this quarter despite rising COVID infection rates in China, order volatility and unplanned customer shutdowns. Our rail business grew 10% organically and orders were up 35%, with strength mainly in Europe. On profitability, volume and price added 800 basis points of margin expansion, which more than offset 650 basis points of cost inflation and roughly 100 basis points of FX. We’re continuing the push on shop floor improvements as demonstrated by IP’s margin of 22.9%, up 700 basis points year-over-year, even excluding roughly 120 basis points of onetime items, IP’s margin was still above 21%. This is quite an improvement from what was an 8% margin business in 2016.

Next, CCT’s margin grew 80 basis points to 19.2%, driven by higher volume and price recovery. For the year, CCT’s margin ended at around 18%, up 270 basis points. Finally, in MT, margins declined 500 basis points to 14.7%. This was driven by a combination of higher material, labor and energy costs and unfavorable mix stemming from auto aftermarket declines in Europe. We also had a tough compare this quarter given the gain on asset sale realized in Q4 2021. This margin performance was clearly below our expectations, but we expect that MT’s margin will return to its previous level as cost inflation subsides and we sustain pricing benefits. On EPS this quarter, we overcame $0.48 of cost inflation, $0.15 of negative FX, $0.03 for the loss of business in Russia and $0.03 from higher interest expense.

On cash, we improved significantly in the fourth quarter, exceeding our last forecast on the strength of AR collections. We’re seeing the benefits of our daily collection efforts and expect further improvements as supply chain disruptions is. Let’s move to Slide 6. I want to make a few additional points on this page. First, price recovery again exceeded cost inflation in Q4. This is a testament to the differentiation we provide compared to the competition. Second, foreign currency was a significant headwind given the strengthening of the U.S. dollar. Third, with interest rates rising throughout the year, our interest expense was $3 million this quarter. We expect it will remain at this level throughout 2023. Finally, despite the long list of challenges we encountered this year, we didn’t lose sight of the long term and continue to invest in new product development, redesign and innovation.

Let’s turn to Slide 7 to discuss ITT’s growth momentum. Friction continued to win content on new EV platforms. We’re making progress in our — on our 2025 EV market share target of 37%. Further, in 2022, our total electrified vehicle revenue was over $100 million. We’re also beginning to see investments in rail infrastructure materialize. Even with the significant loss of business in Russia in 2022, rare orders were approximately flat for the full year. IP is seeing strong growth in project that will drive future revenue outperformance, enlarge our installed base and drive aftermarket demand. In CCT, we saw another strong quarter with commercial aerospace demand continuing to ramp. And we also drove significant orders in EV connectors. This business has grown organically to almost $40 million in orders in 2022.

The orders growth in our ending backlog give us good visibility into the revenue conversion through at least the first half of 2023. Let’s turn to Slide 8 to wrap up the 2022 discussion. Here, I’d like to quickly recap ITT’s 2022 performance. The headwinds on this chart for cost inflation, foreign currency and the lost Russia business amounted to over $2.30 of impact, which was well above our expectations when we issued our guidance early last year. As Luca mentioned, execution was the differentiator, our commercial teams sprang into action to execute pricing negotiations. We ramped our effort on productivity to address rising costs, and we completed the acquisition and integration of Habonim. While we’re incredibly proud of this performance and humbled by the team’s achievements, there is still much more that we can and will do.

We’re driving improvements in our on-time performance in IP and CCT further expanding our value-based pricing strategy and increasing our cash generation to execute more strategic M&A, all of which will drive long-term value creation. With that, let me turn the call back to Luca on Slide 10.

Luca Savi: Thanks, Emmanuel. Before we cover our 2023 outlook, I’d like to share some examples of how performance and innovation are driving customer wins and market share gains across friction, pumps and connectors. As we discussed during Investor Day, Motion Technologies is strengthening its leading position by taking full advantage of the EV transition. This year, we won content on 78 new electrified vehicle platforms, with awards from leading global automotive OEMs, including Tesla, BYD, Rivian, Poster and Neo among others. Our best-in-class quality with defects below 1 part million and outperformance at 99% on-time delivery helped us win the front and rear axle pass on a premium German electrified platform that we launch in 2024.

Electrification is also good for our connectors business. We developed and investing in an EV connectors portfolio catering to regional charging infrastructures, and we are seeing orders surge. Customers are choosing our connectors because of our engineering capabilities and responsiveness. In industrial process, we are capturing share in a market that’s rebounding from 2 years of supply chain disruptions and component shortages. Over the next 2 years, will deliver pump systems to an independent oil company in Nigeria using our Bornemann twin screw technology. This unique offering will stop flaring at site and eliminate roughly 1,000 tons of CO2 per day. Orders for green projects increased 50% in 2022 compared to prior year. We are winning on near-shoring opportunities including a hazardous waste treatment system for a new semiconductor plant in Arizona and for a commercial EV battery recycling facility in Upstate New York.

Finally, we are making progress on the embedded motor drive technology, or EMD, that we displayed at Investor Day. Initial testing showed that our Gen 2 prototypes exceeded expectations in energy efficiency, operating temperature and vibration. We are currently in initial discussion and field trials with 10 customers across various industries to demonstrate EMD’s capabilities. In Connect and Control Technologies, we are qualifying new vibration isolation technology that reduces motor induced vibration for military applications with leading helicopter OEMs. We with custom designing to develop our Cannon connectors together with our customers to withstand the most harsh environment. And this quarter, we are launching a new family of soldier war connectors.

We’re also qualifying ruckedized connectors for the net warrior wearable Mission Command system. So clearly a lot of exciting innovations that you will hear more about throughout 2023. Let’s now turn to Slide 11 to discuss the growth outlook in each business in 2023. Starting with Motion Technologies, we expect friction to outperform the market as global production continues to recover to prepandemic levels. We foresee auto production to be flat to up low single digits in 2023 and are planning for a slowdown in demand, particularly in Europe in the second half. On the auto aftermarket, we think the weakness we saw in 2022 will persist through Q1 and then begin to improve from there. On the rate portion of MT, after a long year of declines stemming from the war in Ukraine, we exited Q4 with strong orders in both KONI and Axtone.

Passengers rail is ramping up and with our 2022 awards, we think 2023 will be a strong year despite a potential slowdown in freight activity in the second half. Longer term, this market will be strengthened further by the public investments in rate infrastructure in the U.S. and in Europe. Moving to industrial process. We are entering 2023 with a healthy backlog. The project activity in this segment should continue to ramp with investments to support infrastructure, near shoring and clean energy. Parts and service demand, the aftermarket in AP has been strong and this trend continued into January. On the other hand, baseline pump activity slowed in Q3 and Q4. So we are monitoring industrial orders closely. Moving to Connect and Control Technologies.

In the Industrial Components segment, the outlook is mixed. In Q4, we saw sequential low in the short-cycle industrial connectors business but encouraging demand in the EV and medical connectors space is providing a partial offset. In aerospace, there is no change to our positive outlook. Build rates are improving and air travel is accelerating amidst the commercial aerospace recovery. In defense, demand remains robust given the current geopolitical conflicts and heightened level of military preparedness around the globe. Let’s now talk about our 2023 guidance. We expect organic revenue growth of 7% at the midpoint. This is due to a combination of share gains and conversion of our backlog, tempered by slowing short-cycle demand, primarily in the industrial markets.

In 2023, we will drive further value-based pricing actions with a notable step-up in IP and CCT, following an absolutely stellar performance in MT in 2022. To put this guidance into perspective, we expect to deliver approximately $3.2 billion in sales in 2023. On profitability, our productivity journey continues. We still see many opportunities to improve our supply chain effectiveness. Our assumption is that supply chain and material constraints will continue to ease and higher raw material costs will subside in the second half. I do want to stress, however, that we are still largely in an inflationary environment even though it may be at a lower rate than last year. Our productivity actions net of inflation, will drive adjusted segment margin expansion of 50 basis points at the midpoint to 17.7%.

With the progress at IP and CCT and easing inflation at Motion Technologies, we are well on our way to the long-term margin target of 20%. The strong top line growth and margin expansion will drive adjusted EPS growth of 7% at the midpoint. On cash, improving our working capital will be a key priority in 2023. We expect to more than double our cash flow generation and drive free cash flow margin of 11% to 12%. On Slide 13, as you can see, our strong operational performance and pricing actions will outweigh cost inflation this year. However, we expect the other nonoperational headwinds related to foreign currency and interest will impact our results. Still, we anticipate a solid 7% growth in adjusted EPS. For the first quarter, we expect to deliver mid- to high single-digit organic growth led by industrial process followed by CCT, more than 100 basis points of margin expansion at the midpoint, led by IP and CCT with MT approximately in line with its Q4 2022 margin rate and adjusted EPS growth of over 15% year-over-year.

We expect EPS growth in the first half of 2023 to be stronger than in the second half. We are prudently taking a cautious output to Q3 and Q4 until we have more clarity on the economic situation. Now before we move to Q&A, please let me share a few final points. First, all year, we executed for our customers, gain market share and grew orders across all our businesses. The result is a strong, profitable backlog on which to execute and outgrow the competition in 2023. Second, we see positive signs in several markets, and we expect to perform well. The foundation for this performance has been laid over the past 5 years. And once again, we are executing. Still there are signs that growth will slow in the second half in some end markets and so we’re staying laser focused on what we can control.

Third, as I said in June at our Investor Day, electrification is good for ITT. Frictions flawless performance and many competitive advantages are amplified as the industry transitions to EVs, and we are well on our way to achieve our EV market share target. Lastly, once again, in 2023, execution will be the differentiator and that is ITT’s strength. I would like to thank all our stakeholders for their continued support of ITT. As always, it has been my pleasure speaking with you all this morning. Candice, please open the line for questions.

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Q&A Session

Operator: So our first question comes from the line of Nathan Jones of Stifel.

Nathan Jones : Congratulations on 2022. I think that’s a pretty phenomenal execution effort given all the incremental headwinds you had to deal with. A few questions on the guidance I’m going to go with. Just looking at the price versus cost inflation buckets in your 2023 bridge, I’m a bit surprised that they’re largely offsetting. You had about $0.38, I think, of headwind from price versus inflation in 2022, but you were positive in the second half, and I would have thought that would carry over and you would make some of that back up in 2023. Maybe you can just give us some more color on price versus cost and why that’s not reading through as more positive in 2023?

Luca Savi: Okay. So I would say when we look at 2023, we are getting roughly half the price that we got in 2022, and those are going to be incremental, right? So those are incremental to the price that we got in 2022. The other element that I would like to stress before maybe passing over to you, Emmanuel, is that when you look at 2023, we’re going to be slightly price positive across all the value centers, something that we couldn’t say in 2022. So it’s a substantial improvement and is a continuation of what we have achieved in Q3 and Q4.

Emmanuel Caprais: Yes. And Nathan, regarding the — we were pricing — price cost positive in Q3 and Q4. However, this wasn’t like a large beat. We were slightly price positive. And I think that we maintain that in 2023. Keep in mind, in 2023, that there is some headwinds from a commodity standpoint, notably chemicals in Motion Tech and also energy. And so we are going back to our customers for additional price increases to cover and compensate this commodity increase. Lastly, I would say, in the second half of 2023, we expect things to slow down also. And so we want to be mindful of that economic slowdown when we ask for price increase to our customers.

Nathan Jones : Okay. And then maybe the operational performance bucket that’s to . I think that implies an incremental margin of right about 30% which is kind of what I’d expect from the businesses in the absence of additional productivity, which you guys clearly over-delivered on in 2022, maybe talk about the expectations for productivity in 2023 and the potential for you to deliver better incrementals on that growth?

Luca Savi: I think that on the other side of that, Nathan, is that the — all the investment in strategic initiatives that we do have that we are working on. Let me give you a couple of examples, is investment in products like the EMD that we talked in the prepared remarks, this mass pad in Motion Technologies or also the digital automatic capital that we are developing for Axtone or the SFO next lean transformation. We are going through a complete relay out of SFO to take that plant to the next level. and also the lean activities that we started in CCT in places like Valence Califone. So — and that’s on top of all the initiatives to sustain our growth. So that is something that we take into consideration when you look at the incremental margin.