Otis Worldwide Corporation (NYSE:OTIS) Q1 2024 Earnings Call Transcript

Otis Worldwide Corporation (NYSE:OTIS) Q1 2024 Earnings Call Transcript April 24, 2024

Otis Worldwide Corporation beats earnings expectations. Reported EPS is $0.88, expectations were $0.87. OTIS isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning and welcome to Otis’ First Quarter 2024 Earnings Conference Call. This call is being carried live on the internet and recorded for replay. Presentation materials are available for download from Otis’ website at www.otis.com. I’ll now turn it over to Michael Rednor, Vice President of Investor Relations. Please go ahead.

Michael Rednor : Thank you, Sarah. Welcome to Otis’ First Quarter 2024 Earnings Conference Call. On the call with me today are Judy Marks, Chair, CEO, and President; and Anurag Maheshwari, Executive Vice President and CFO. Please note, except where otherwise noted, the company will speak to results from continuing operations excluding restructuring and significant non-recurring items. A reconciliation of these measures can be found in the appendix of the webcast. We also remind listeners that the presentation contains forward-looking statements which are subject to risks and uncertainties. Otis’ SEC filings, including our Form 10-K and Quarterly Reports on Form 10-Q, provide details on important factors that could cause actual results to differ materially. Now I’d like to turn the call over to Judy.

Judy Marks : Thank you, Mike, and good morning, afternoon, and evening, everyone. Thank you for joining us. Starting on slide 3, Otis started the year off with a solid first quarter, again confirming and demonstrating the continued strength of our service-driven business model, as we outlined during our Investor Day in February. Through the hard work and commitment of our colleagues across the globe, we achieved mid-single-digit organic sales growth driven by our Service business. We expanded adjusting operating margins by 80 basis points with both Service and New Equipment operating profit margins expanding 70 basis points and 20 basis points respectively. With another quarter of maintenance portfolio growth above 4% and solid modernization sales we delivered 6.5% Service organic sales growth.

Mod orders increased 12.9% in the first quarter with growth across all regions, while challenging market conditions and New Equipment continue, delivering operational excellence across the organization drove 10% adjusted EPS growth. This quarter, we executed our capital strategy with excellence. We continued to work to repatriate cash from overseas and use it for the benefit of our shareholders. As such, we were able to repurchase $300 million of shares in the quarter. Additionally yesterday, we announced a 14.7% increase to our quarterly dividend. We have nearly doubled our dividends since spin, emphasizing the importance we place on delivering shareholder value. We also made important progress towards our environmental goals. Earlier this month, the science-based targets initiative approved our near-term science-based greenhouse gas emissions reduction targets.

This is a meaningful step on our sustainability journey, and our steady progress meeting our commitments will be shared in our next DSG report expected to be published later this year. Turning to our orders performance on Slide 4. New Equipment orders were down 10% in the first quarter as anticipated, due to the tough compare versus the prior year. Double digit growth in EMEA and mid-single digit growth in Asia-Pacific were more than offset by a double-digit decline in the Americas and high-teens decline in China. Nevertheless, our New Equipment backlog at constant currency was roughly flat versus the prior year and up slightly versus the prior quarter. Service segment, we continued to deliver consistent solid performance with another quarter portfolio growth above 4% and demonstrating the value of modernization as a new strategic imperative, 13% orders growth and 15% backlog growth at constant currency, setting us up well for modernization sales through the rest of the year and into 2025.

Reflecting the hard work of our colleagues around the world, let me highlight a few orders we received during the quarter. In China, Otis Electric will provide 46 escalators and nine elevators for an expansion of the Shenzhen Metro Line 5. The elevators and escalators will be installed at three new stations connecting to the city’s Grand Theater where passengers can transfer to two other metro lines. In Canada, Otis will provide 19 elevators at the South Niagara Hospital, a 12-story facility that will consolidate and expand acute care services in the region. It’s designed to meet the Canada Green Building Council’s lead silver standards and is an important step towards becoming the first well-certified hospital in Canada. These elevators will be equipped with Otis ONE, EMS Panorama, and autonomous mobile robot system integration.

In Japan, Otis is modernizing six elevators and six escalators at the Hamamatsu Act Tower in Hamamatsu City. We look forward to continuing to service the 212 meter tall tower, as we’ve done for nearly three decades. And in the United Kingdom, the National Health Service of Wales has been an Otis customer since 2018 and has recently renewed their service contract covering 450 elevators across many health facilities in the country for an additional five years. Building upon our trusted relationship, we will now modernize 19 elevators at the University Hospital of Wales in Cardiff. Turning to Q1 results on Slide 5, we delivered net sales of $3.4 billion in the first quarter with organic sales up 3.8%. Despite dynamic market conditions, we have delivered organic growth every quarter since the end of 2020.

Adjusted operating profit, excluding a $7 million foreign exchange headwind, was up $50 million with both segments contributing. Adjusted EPS grew 10% or $0.08 in the quarter, driven by strong operational performance. Improvement in the tax rate, early results from uplift, and the benefit of a lower share count offset headwinds from foreign exchange translation and increased interest expense. With that, I’ll turn it over to Anurag to walk through our results in more detail.

Anurag Maheshwari : Thank you Judy. Starting with segment sales performance on Slide 6. Otis new equipment organic sales were roughly flat in the first quarter when compared to the prior year. America’s grew mid-teens on solid backlog conversion. EMEA and Asia Pacific both grew low-single digits driven by growth in key markets, and China experienced a double-digit decline due to the lower backlog and weaker market conditions that Judy mentioned. New Equipment pricing was strong in the Americas, EMEA, and Asia Pacific in the first quarter, up low to mid-single digits. In China, while the pricing environment remains challenging, we continue to drive productivity and capitalize on lower commodity prices. Service sales were $2.2 billion in the first quarter, with organic sales growth of 6.5%, reflecting growth across all regions and in all lines of business, and marking the 12th consecutive quarter of mid-single digit or greater organic sales growth.

Maintenance and repair continues to perform well, up 5.8% from portfolio growth, robust repair volumes and maintenance pricing which was up more than 3 points excluding the impact of mix and churn. On modernization, double digit growth in China and Asia Pacific drove organic sales up approximately 10% in the quarter. Turning to segment operating performance on Slide 7. First quarter New Equipment operating profit of $71 million was up $6 million at constant currency. Favorable pricing, productivity, and commodity tailwinds more than offset mixed headwinds and drove 20 basis points of margin expansion. Service operating profit of $523 million was up $47 million at constant currency as drop through on higher volume, favorable pricing, and productivity more than offset annual wage inflation.

This led to margin expansion of 70 basis points for the segment. Additionally, the ramp of uplift initiatives, alongside cost controls improved our SG&A as a percent of sales by 50 basis points year-over-year. All in all, we expanded overall adjusted margins by 80 basis points and grew EPS 10%. Shifting to cash we generated $155 million of adjusted free cash flow in the first quarter, reflecting a build in working capital, falling a snap back from a strong Q4 and the timing of buildings in the quarter. We are off to a good start. The strength of our Service business, including the execution of a modernization strategy combined with productivity efforts and the uplift program more than offset the subdued New Equipment markets. As a result, and with good line of sight through the rest of the year, we are raising a profit guidance.

I’ll turn it back to Judy to discuss our 2024 outlook.

Judy Marks : Now on Slide 8. Before I discuss our updated 2024 financial outlook, let me briefly update you on our global market outlook. For the New Equipment market, our expectations for the Americas and EMEA remain unchanged, down low-single digit in units. We now expect Asia to be down mid-single digits in units versus the prior outlook of down low to mid-single digits, due to weakness in China. There is no change to our outlook for Asia-Pacific as India, Southeast Asia, and the major infrastructure pipeline remain strong. We’re revising China to be down high single digits to down 10%, as activity remains sluggish. Although New Equipment markets remain challenging, Service market strength continues. With low single digit growth in the Americas and EMEA and mid-single-digit growth in Asia driven by China, installed base growth is driven by units that were booked roughly two years ago, installed over the past year or so, and are now starting to roll off their warranty period.

Therefore, we still anticipate the global install base to add roughly a million units, a growth rate of mid-single digits. Turning to Otis’ 2024 financial outlook. We expect net sales in the range of $14.5 billion to $14.8 billion, with organic sales growth of 3% to 5%. Overall unchanged versus the prior outlook, although we made some modest changes within the segments, which Anurag will discuss in a moment. Adjusted operating profit is expected to be up $135 million to $175 million at actual currency and up $160 million to $190 million at constant currency, up $10 million from the low-end of the prior outlook. Adjusted EPS is now expected in the range of $3.83 to $3.90, up 8% to 10%, with $0.03 improvement versus the low-end of the prior guide.

We anticipate adjusted free cash flow to come in at approximately $1.6 billion. In addition to returning nearly all free cash flow generated to shareholders, we’re also performing well on our cash repatriation programs. And we are raising our target share repurchases to approximately $1 billion for 2024. In addition, we are acquiring the remaining minority interest in Nippon Otis in Japan for approximately $70 million with cash. This will be about $0.01 accretive to EPS in 2024 and another $0.01 in 2025. With that, let me hand it back to Anurag to outline the 2024 segment outlook in more detail.

Anurag Maheshwari : Taking a more detailed look at our outlook and starting with sales on Slide 9. We expect total organic sales to remain consistent with our prior outlook. For New Equipment organic sales, we still expect to be roughly flat with no change to our outlook in EMEA up low-single digits. However, driven by a weaker market, we now expect China New Equipment sales to be down approximately 10%, offset by better than expected backlog conversion in the Americas and Asia Pacific. For service in-line with our prior guide, overall organic sales are anticipated to grow 6% to 7% including maintenance and repair within a range of 5.5% to 6.5%. For modernization, we anticipate organic sales growth of 8% to 9%, an increase versus the prior outlook of approximately 8%, as we continue to execute on the expanding backlog.

Turning to Slide 10. At constant currency operating profit should grow $160 million to $190 million, an increase of $5 million at the midpoint versus prior expectations due to continued strong contributions from service. On Service, we now expect operating profit margin at the high end of the prior guide up approximately 50 basis points for the year due to solid first quarter performance. For New Equipment, net of the previously noted puts and takes, we still anticipate adjusted operating profit margin to be flat to up 10 basis points. Better flow through of pricing from the backlog is offsetting the added mix impact from the weaker China outlook. We expect overall adjusted operating profit margin expansion of 50 basis points, as a result of service volume, productivity, and pricing tailwinds alongside ramping UpLift benefits.

Turning to cash flow, there is no change to our outlook and we expect to achieve adjusted free cash flow of $1.6 billion largely driven by net income growth. In addition, our continued efforts in cash repatriation gives us confidence to repurchase $1 billion in shares up from $800 million previously. This combined with the recently announced increase in our dividend, allow us to return approximately $1.6 billion of cash to shareholders up from $1.35 billion in our prior outlook. Moving to the 2024 EPS bridge on Slide 11. We have raised the low end of our guidance for adjusted EPS by $0.03 to a range of $3.83 to $3.90. That is over $0.30 of EPS growth at the midpoint driven almost entirely by growth in operating profit. Before we turn to questions, let me provide some more color on the second quarter.

Starting with orders, we expect New Equipment to be down mid to high single digits, reflecting the more challenged market conditions, though with backlog holding steady sequentially. Within service, maintenance portfolio growth should remain above 4% and modernization growth or orders growth should remain above 10%. For sales, we expect New Equipment to be down roughly mid-single digits organically due to China headwinds and a tough compare with approximately 10% growth in the prior year. Service should continue at roughly the same organic growth rate as Q1, netting to low single-digit overall organic growth for the quarter. Based on the recent deterioration in FX rates, we anticipate a headwind when compared to the prior quarter, netting to roughly flat sales versus the prior year.

Turning to profit, new equipment margins are anticipated to come in right around 7%, while Service margins are anticipated to be roughly the same as Q1 or slightly higher. Below the line, due to the timing of certain tax benefits, the tax rate is expected to come in around 20% and this benefit in combination with a slower share count will more than offset the headwind from higher interest costs. Absent further ForEx volatility, this should lead to approximately $0.10 of EPS growth or another quarter up 10% or greater. This implies first half EPS growth of roughly $0.20. And when adjusted for the tax rate impact, EPS growth should be fairly level loaded between the first and second halves of the year, largely driven by operating profit growth.

In closing, first quarter results further demonstrate our ability to execute a strategy to create momentum to perform for the remainder of the year. Growing our portfolio, leveraging our steady New Equipment and expanding mod backlog, and ramping on the UpLift program alongside continued operational performance set us up well to achieve a financial outlook and return $1.6 billion cash back to shareholders. With that, Sarah, please open the line for questions.

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Q&A Session

Operator: Thank you. The floor is now open for questions. [Operator Instructions] Your first question comes from the line of Rob Wertheimer with Melius Research. Your line is open.

Rob Wertheimer: Thank you, good morning everybody. Happy to be here.

Judy Marks: Good morning Rob.

Rob Wertheimer: So my question is just around Mods, where sales and orders are showing obviously healthy double-digit-ish growth. Would you talk a little bit about margin in those orders in the backlogs and the drivers of it? I know, you are working on standardizing production on the product and a bunch of stuff. [I don’t know] (ph) if price is a positive driver there in the backlog as well as you kind of continue on that journey to bring margins up and above. And I wonder if you could just talk a little bit about what the environment is out there for that product? Is there a lot of customer pull on it? Do you have solid demand where you can kind of embrace pricing maybe just the demand environment around that. Thank you.

Judy Marks: Sure. Thanks, Rob. Listen, Mod was up nicely in all regions. I think, our strategy is on track, our team is executing that strategy. And these are still early days in what will be probably more than a decade long Mod growth market. So we are really encouraged by what we are seeing. Orders up almost 13% in the quarter, backlog up 15%. So now we are just building on quarter-after-quarter of double-digit growth. The standouts, we really saw in the quarter from the demand side, Asia Pacific and Americas were up really nicely, but Asia Pacific was a standout and China did well too, double digit. So everyone, again all regions are up. We’re seeing a mix of major projects and just really good volume package demand by customers and we’re performing well.

In terms of the margin, I’ll turn it over to Anurag for help with the backlog, but — what I think is important, what we shared at Investor Day was that we would shortly be surpassing Mod margins would be surpassing New Equipment margins. I’m really pleased to share that in Q1, we saw that inflection point and Mod margins are now higher than new equipment margins. Anurag, I’ll let you add some color?

Anurag Maheshwari: Yes. Thanks. Just to add to that so a few quarters ago, we said that we should be higher than the new equipment margin. We are here right now modestly higher, as Judy said, one quarter does not make a trend, but we are very encouraged by what we are seeing in terms Mod margins. And as the year goes by, we should see more of the expansion on Mod margin and more differential between that and New Equipment. What’s driving the Mod margin expansion is more of us becoming more productive on the cost side, right? The initiatives that we mentioned around standardization, we’re across the supply chain, be at the factory, be the product and doing field installation at a lower cost, all of this is helping out and it is really driving the margin expansion. So it’s more on the productivity side that we control. But we’ve got to do a lot more than that and let’s see how the year plays out, but very encouraged.

Judy Marks: Yeah. The last thing I’ll add, Rob is that Mod market has potential of several million units in every of our regions. So this won’t be lopsided growth. We anticipate significant growth by all regions.

Rob Wertheimer: Perfect. Thank you.

Operator: Your next question comes from the line of Julian Mitchell with Barclays Capital. Your line is open.

Julian Mitchell: Hi, good morning. Just wondered when you are looking the overall sort of global picture on New Equipment. The backlog was flat at constant currency year-on-year, with TTM orders down. It seems like TTM orders should be down again in the second quarter. Just wondered how you are thinking about the year as a whole, if you could frame up sort of any expectations in New Equipment around, say book-to-bill and how we should think about the confidence in the New Equipment backlog not shrinking year-on-year over the balance of the year?

Anurag Maheshwari: Yes. Thanks, Julian for the question. Listen, as we said Mod was down about 10% in the first quarter, second quarter — sorry, New Equipment was down 10% in the first quarter, expected to be down mid-to-high single digit in the second quarter. So as the year kind of progresses, the compares do get better in the second half of the year because we started seeing the slowdown on the New Equipment side especially in Americas and EMEA, more towards starting from 2Q of last year. So let us see how that progresses, if we perform in-line with what the market does, the backlog of new equipment could be down a couple of points. If we do better than the market then it could be flattish. So there is a possibility that the New Equipment backlog, as we end this year could be flattish to down low-single digits.

And as we kind of mentioned at the Investor Day, if you look forward to the next few years, clearly we are expecting New Equipment to be flattish. But where we see a lot of growth coming in is on the Mod side. And the Mod backlogs are up 15%. We continue to perform well in the Mod, New Equipment and Mod as we end the year, that backlog should be up low-single digit, as we enter into 2025.

Julian Mitchell: That’s helpful. Thank you. And then just maybe, my second question on the Service margins, very good performance in the first quarter, up 70 bps year-on-year. Based on what you said about the second quarter could be up similarly year-on-year sort of 60 bps, 70 bps in Q2 and the first half. So that guide of plus 50 bps of margin for the year, is that just reflecting sort of it’s still only April a long way to go? Or is there anything specific happening with costs or technician wages or something in the back-half, maybe just any update around that wage inflation headwind.