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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning. Thanks for joining us. My name is Nigel Coe from Wolfe Research, and I welcome you to our 14th Global Transports and Industrials Conference. It's my pleasure to welcome Carrier Corporation to the conference. And I'd like to be hosting CFO, Patrick Goris. I almost said Rockwell to them, by the way, it's incredible to have [field lined] up to Rockwell; and Head of IR, Sam Pearlstein as well. So gentlemen, thank you for joining us this morning. We've got a fair amount to get through so we will dive into it as soon as possible. But I do want to highlight this is an interactive forum. If you got questions from the audience, please feel free to type those into the box, and I'll start talking through it, if there's any questions in the queue.
So with that said, Patrick, I don't know, if you want to start off with any opening comments? Otherwise, we'll just get into Q&A.
No. Good to be here, Nigel, and we can go straight to Q&A.
Okay. Great. So I think it's fair to say that when you moved from Rockwell to Carrier, I was surprised, I think many were surprised. I'm curious if you can maybe talk about what the attraction was moving to Carrier, a new challenge? And then we'd go from there.
Sure. So leaving a company like Rockwell after 14 years is never easy. It's a great company, as you probably all know. Carrier is a special company. It's not every day that you can join a company of this size and complexity that has been part of a conglomerate for about 40 years and is there to plot its own course. And in my role, I can be a big player in plotting that course. We have tremendous amount of opportunity. I was told that before I joined. It's absolutely true. A tremendous amount of opportunity whether it’s from a commercial point of view, whether it is from an internal complexity reduction point of view, whether it is from a capital deployment point of view. And frankly, I'm going to do things here that probably I wouldn't be doing at Rockwell and that includes the whole portfolio opportunity. So in short, very excited to be here. Lots of work, but a tremendous amount of opportunity for share owners and for all our employees.
Florida doesn't -- Florida is not too bad either. There's a place to be headquartered as well. So we’ll definitely talk about portfolio. That's 1 of my topics towards the end here. But I wonder to maybe get the ball rolling with just a state of the union on the end markets, what you're seeing through the second quarter. Last time you reported results, we had very strong residential, up more than 40%, commercial up mid-teens and transportation, too. Maybe just talk us through what you're seeing through second quarter so far?
Yes. So during our first quarter call, we raised our full year outlook for all of our segments, except Fire & Security. We exited the quarter pretty strongly, especially March was strong. That momentum has continued across all our segments in the third -- in the second quarter. In the second quarter, we expect our organic growth to be 20%, probably a little bit better than that. If I look at that within or by segments, within HVAC, continued strong resi growth, not the same growth rate we saw in Q1. Q1 was a little less than -- it was about 40-plus percent. We expect it to be less this quarter, but we expect to rebound in light commercial. And that will, I think, be probably the bigger change within our HVAC segment. Light commercial has still been down. We expect it to rebound, a strong sequential improvement.
Commercial HVAC, you mentioned, we expect another quarter about mid-teens organic growth in that segment. It was primarily driven by China in Q1. We see opportunity for higher growth throughout the other areas of the world as well in commercial HVAC, and we expect that to last. So strong momentum there.
Within Refrigeration, we do believe that, that will be the fastest growth segment in the quarter. And this will be helped in the quarter by a pickup in North America truck and trailer rates. As I mentioned, I think at the end of the first quarter, North America truck and trailer was up a little less than 10%. We expect that to pick up significantly in Q2, which in turn should help our conversion and segment margin performance in that area.
Fire & Security will be much stronger we expect in Q2 than in Q1, obviously, easy comps particularly in Chubb, but that segment has been on an improving trend. March was really strong there. And there, again, we expect a good second quarter.
For the full year, we still expect the second half to be about flattish compared to the prior year, and that's really all driven by the very strong resi growth we had last year. So I'd summarize, Nigel, by saying the momentum has continued into the second quarter, and we expect broad-based growth across our segments in Q2.
So pretty much what, as you planned it, not a whole lot has changed versus end of April, you’re comfortable there.
Pretty much .
Residential is obviously the big swing factor here. And I think you mentioned your sales in the channel, mid-40s in 1Q, the sell-through roughly 20%, 25%, if I remember. How are inventories right now? What's your perspective on inventory levels? Is that sell-in versus sell-out starting to normalize and equalize into the channel?
Yes. So maybe a couple of comments here. One, We continue to see strong performance in resi. Having product availability and a good position in new construction is certainly helping us there as well as the dealer conversions we've done. In Q1, and we said this on the call, we believe that we may have seen some earlier-than-expected seasonal inventory build in the channel. Q1 inventory was up about 30% year-over-year. We expect movement in Q2 to drive field inventories up to being about 10%, 15% higher at the end of Q2 versus what it was in 2019. And if you look at what the market has done from '19 till now, we think that's pretty much aligned with the market.
It's still early in the quarter, but I would say that April was a very strong month from a movement perspective. And that gives us confidence, at least for now that those inventory balances will be up in about that 10, 15 percentage range versus 2019. It may vary a bit, but the movement we've seen in April certainly seems to support that.
And you mentioned product availability is a key factor. We know there's been 1 or 2 players that haven't had the same level of availability in the market. And this obviously comes into the whole supply chain issue as well. So maybe just talk about supply chains and whether you're seeing some market share movements related to some supply chain pressures with some of your competitors?
Yes. So from a supply chain perspective and maybe not a surprise, but currently, they're clearly tighter than usual. Actually, at the end of 2020, we deliberately increased some of our inventory levels as we prepared for a rebound. And certainly, that seems to have helped us in the early part of this year. If I look at where the shortages are, it's generally it’s components that includes electric components as well. It's impacting us from an efficiency point of view. So it impacts us from a factory efficiency point of view, for example, think of shorter production runs. But at the end of the day, we continue to meet customer demand. And just we're incurring some higher costs of doing so, including incremental logistics and freight charges, and those are embedded in our April guide for the year.
Yes. Okay. Thanks, Patrick.
And I would just call out our supply chain and business teams because they've -- they're doing tremendous work in addressing the challenges while meeting demand.
Yes. I can imagine it's quite stressful right now. And you gave very specific guidance on price and input cost inflation in April. I think $70 million of incremental price much by the inflationary pressures. Maybe just talk about what you've done in terms of going out to the market with additional price increases and whether that's tracking to your plan?
Yes. So we're actually -- and this is, frankly, a daily activity rather than a weekly or a monthly to see what's happening with input costs trying and be proactive about this. And throughout our businesses, we are proactively increasing prices. And so we've already announced and implemented additional price increases in our Refrigeration segment, in our HVAC segment. Fire & Security is looking at that as well. And frankly, I would not be surprised that in the current environment, there would be additional price increases implemented throughout the fiscal year to protect us for this year but also for next year.
Is that different to what you said in April? I mean, are you seeing a bit more cost inflation versus back then, to justify…?
What I would say is that the -- nothing has materially changed, except that it's a day-to-day activity. And every day, something news comes up where you need to address it either through cost or looking at pricing.
Okay. And then maybe a few more before we move on to some of the more longer-term strategic issues here. Watsco, I mean, it feels like you're working better with Watsco. The relationship seems to be working really well at this point. Maybe just talk about what's changed for Carrier as independent company versus Carrier as a UTX company in your relationship with Watsco?
So I'm -- I would say that there's a thing that has changed, I think, is that we have a better relationship with Watsco today than what we had before. And I think that Dave, our CEO and the Watsco leadership team have had some open and frank discussions on how we can both do better to drive benefits for both companies. And I see the benefits of that. And I think that an overall better relationship between the 2 companies and where both companies have been clear as to what we can do better but also what we expect Watsco to do better. And that can be from product capabilities, product availability to how many feet we have on the ground. I think it has benefited both companies. And I think there is much more to be seen there.
Okay. Great. And then maybe one more point on the -- on sort of the guidance framework. You talked about incremental margins improving from 1Q probably the balance of the year to about 30% or greater margins in 2Q to 4Q. And that's kind of higher if we take out the buyer lost income. Are we still on track with that? And how do we think about 2Q specifically, given that 2Q, we've got, I seen a big step-up in inflation pressures and perhaps the price might not turn -- anything to think about the 2Q specifically?
Yes. So maybe first for the full year, our April guide, I should say, continues to target 30% core incrementals for the full year 2021. On a reported basis, it's going to be closer to 25% core, as I say, we're operational close to 30%. And that's really 2 main items there. One is we exclude FX, and then, of course, the buyer income. That's the full year per the April guide. For Q2, and I think that's what you were referring to is we expect that for Q2, it will be the most difficult quarter from a price/cost point of view. And so we've announced some additional price increases by the time those take full effect versus when the inflation hits, Q2 is probably the quarter where we have more of a gap, but at the same time, for the full year, continuing to expect and target to be neutral for the year.
Right. Great. That's what I expect to see, by the way. Moving on to Healthy Buildings, IAQ and stimulus, huge topic of interest for you and your competitors. I think you called out a pipeline of $500 million of kind of healthy building opportunities, of which you got $70 million in 1Q. The good news is that we're starting to kind of make progress with vaccines and the pandemic, et cetera. Are you still seeing a strong pipeline building in IAQ, Healthy Buildings? And how the order rate is tracking versus that $70 million?
Yes. So the numbers you refer to, obviously, are accurate. We shared them on the call. This pipeline continues to grow. And I would say that we believe that not only Healthy Buildings is a secular trend that will benefit us for many years to come, but the whole sustainability is a big play as well. And so with Healthy Building sustainability, huge opportunities for us. And as we also mentioned on the call, and this is new to us in the last few months, we have a dedicated team now focused on this opportunity under a seasoned leader. And so it means more focus on this opportunity. And if you look at some of the capabilities we have launched, whether it's, for example, Abound, Abound this is for us just another opportunity, an important opportunity to differentiate us and go after this multiyear opportunity.
Yes. And I think you launched Abound in April, if I'm not mistaken.
That's correct. It's still the early days. Launch customer is very excited. We're working with them to expand our capabilities, of course. And it's -- as we talk about investment dollars, it's clearly it's one of the areas where we're putting some investments down because as I mentioned, this is an area where we see long-term opportunity, whether it's healthy, whether it's sustainability, and we have an opportunity to differentiate there.
Yes. Okay, great. And then stimulus. We're seeing some pretty big numbers, not on the proposed stimulus package, but the -- whatever it was, the last big package that was announced, coming with a name now. But there was a big drop of money for education, which is a big vertical for you and your competitors. We're entering the seasonally strong season for education upgrades. Are we seeing any momentum in those end markets, education markets right now?
Yes. What I would say, Nigel, is that what we hear from our people is that we've clearly seen an uptick in K-12 activity. And so that is certainly something we've seen. I would also say that this is not only an opportunity just for our HVAC segment, but also for our Fire & Security segment. So it's not just about IAQ, but also about sustainability and safety. And so think about access, think about alarms, evacuation. And so that's where more than 1 segment comes into play. And so yes, you mentioned there's a lot of money, big sums being mentioned. We believe we're very well positioned for this. Again, an opportunity, K-12 that we think will be an opportunity for us for multiple years. And there is a lot of focus on it. We have targeted kit offerings, dedicated sales team. We provide webinars to the school districts doing direct outreach. And I would also say that an important role that we play is to also help the school districts to find the funds, obtain them and then how to best invest the funds because often some of the school districts may not know how to get to the funds and then where to take it from there. And so we see an opportunity there to help school districts and that's exactly what we're doing.
Right. But you think it's probably too early for this year. This is more of a 2022 and beyond tailwind, do you think?
Well, if you think about -- first of all, we're clearly seeing an uptick in K-12 activity. Some of these, and you know that's primarily in our North America applied and light commercial exposure and as well in Fire & Security. Some of that have some lead times that are longer than just book and bill. And so would I expect to see some of that later this fiscal year? Maybe. But certainly, over the next several years, that should be a benefit.
Yes. Okay. I see the lights went out there. I'll try and get more…
It was not related to your question.
Maybe, I’ll ask -- yes, clearly. I'll see if I can ask some more questions get before in there. You mentioned Fire & Security. And this is a good opportunity to talk about kind of what's changing in the Fire & Security opportunity sets post-COVID. We've got social distancing in the office. We've got contactless access, et cetera. I'm just wondering if there's kind of a better opportunity set for Fire & Security post-COVID than there was pre-COVID and any thoughts there?
Where we see a, call it, a convergence or some synergies related to some of our sensors that we sell within Fire & Security. And so for example, we have smoke detectors, other types of detectors within that segment. And there is an opportunity to link that to what we do within HVAC. And so think about it as there is no reason why some of these sensors could not be sensors for air quality or to measure presence in a room. And depending on that presence in the room, what do you tell the HVAC system to do and create that loop.
And so I would say that clearly, within parts of our Fire & Security segment, the whole COVID has actually highlighted the opportunity to drive some synergies between the segments that before may have been a little bit more questionable or I should say less clear. And I'd say that's a part of our Fire & Security segment, of course.
Okay. Yes. And of course, there's other parts that might not be quite strategic as well. And there's been some press stories. I know you can't comment on them but Chubb. We heard the UTX CEO, Greg Hayes talking about Chubb very publicly before the spin. There's been some headlines there. I want to comment this question a little bit sort of from a different angle. Given that you're focused on improving the service and field operations within the HVAC businesses, might Chubb not be more kind of strategic to the whole kind of strategy of Carrier going forward?
Yes. That is a -- that's a much bigger question that you asked there. And our view is at this point is that we are focused on improving the operating performance of Chubb just as like we're focused on improving the operating performance of every part of our company. But at the same time, that's where the portfolio comes in as we're taking overall look at simplifying our company. We're taking a look at what are parts of our company that are less strategic, where we have maybe less synergies with the rest of the company and where, frankly, we may not be the best owner. That's why we're looking at not only our JVs, but also at the parts of our portfolio that we own 100%. And it's a dispassionate look. We're assessing the entire portfolio and that includes Chubb, includes every part of the business.
Right. You mentioned the JVs. And I forget how many JVs you have, but I know it's north of 50 still.
Actually, we are on our way to get to the low 30s by the end of this year.
Those are of the...
Of the minority JVs. Yes. Thank you for clarifying that. Yes.
Is this something that could be reasonably material to cash flow and balance sheet? Or are these…
I do not believe, Nigel, that what's in the pipeline for further, call it, pruning this year would have a material impact on either equity income or cash proceeds. We don't have another dozen buyers out there, like the divestiture last year. Yes.
You do have some very valuable large JVs, Toshiba in China. Obviously, the WESCO JV as well. At this point, it sounds like there's nothing to do on those structures at this point. It seems that you focus more on the smaller minority positions?
I think that's probably a fair statement. And first of all, JV is not a bad thing. Minority JVs are not a bad thing. Actually, they help us significantly in parts of the world with presence that would be harder for us to do without them. But the ones that we are looking at, think of them as being the smaller ones rather than the larger ones, of course, that you just mentioned.
Right. Okay. Shifting gears to Carrier 700s. And maybe just talk about, Patrick, where -- what we've achieved so far, what's to achieve within that program. And maybe just talk about how you see that improving margins over the next several years?
Yes. So think of Carrier 700, it's a 3-year program started in 2020 to drive out costs that include supply chain costs, factory costs, utilization of our field resources and then, of course, G&A as well. Last year, we delivered $250 million. We increased last year the full program target to $700 million. And this year, we're targeting $225 million for the full year. Of course, given the inflationary headwinds, it's become more challenging to get to the $225 million, but that's very much our focus. And if there are additional headwinds, then we look for other ways to get cost out. And of course, as we mentioned, we're always looking at pricing as well to offset additional inflation headwinds. The 3-year target remains $700 million. And so that is absolutely the target. And that means for next year, it means another $225 million of savings of Carrier 700.
Okay. So the $225 million, you pulled forward some investment spending from 2022 into 2021. I think we're now at $150 million of investment spending for this year. How much investment spending do you think we should factor in for the next year at this point?
At this point, we're dialing in about $50 million. And so that's kind of the program we said over 3 years we would do, was about $300 million, $100 million in 2020, $150 million now in this year, another $50 million next year. And so think of another $50 million next year. But I will also tell you that if we see opportunities to continue to invest with returns that we like and the returns of which we like, then we may consider to do more. But at this point, the $50 million is what we're thinking about for next year. And again, the investments are primarily selling expenses but also research and development and increasing or enhancing our digital capabilities.
Yes. And of course, you should invest to grow, that's the key thing. Your margins, Carrier margins, if we adjust to your equity income, if you look at your operating income, ex equity income, you're about 11.5% in 2020. EBITDA margin is about 13.5%, well below where sort of best-in-class HVAC is. Do you think that -- is there any reason why Carrier can't be at those levels? I'm thinking here about portfolio mix, Fire & Security, et cetera, et cetera. Can Carrier be a mid-teens OEM company?
The short answer is absolutely yes. And I would say that I see several drivers that we have levers in our control that we can use to achieve that. And I'll mention, I think there are like 4 or 5 of them. One, accelerating our organic growth across our portfolio. That's why we're making some of the investments in sales resources in R&D to make that happen. Frankly, pricing is part of accelerating organic growth.
Second, you've heard us talk about our focus on the aftermarket. Aftermarket digital increasing recurring revenue and cash flow streams, those tend to be margin accretive. revenue across the life cycle, attaching services, having more sticky business. And frankly, the benefit of some of that, including the aftermarket is -- it's not that like we are bumping up against our big OEM competitors, it tends to be smaller regional firms.
A third lever is the entire cost efficiencies across the company, whether it's Carrier 700 or just driving simplification throughout the company, tremendous amount of opportunity here. For example, we just started on our journey implementing shared services. Many companies have done that or have started doing that 10 years ago, but we see a significant opportunity to simplify what we do and basically make ourselves less complex and have more scalable infrastructure.
A fourth element I would mention with respect to margin, and I think you touched on that, Nigel, is portfolio. As we review the portfolio, of course, we're taking a close look at growth profile, free cash flow profile, margin profile, ROIC profile. And frankly, we can add by subtract and reinvest in higher growth, faster-growing margin-accretive businesses. That's absolutely something we're looking at.
And then another element, I would say, and that probably goes beyond just the margins, but there are opportunities for improved balance sheet efficiency, lower PPE, less of a footprint. And frankly, I see a lot of opportunities on the working capital as well. So in short, a little bit of a lengthy answer, but I see tremendous opportunities for margin expansion over the next several years in our business.
Patrick, thanks for that brief answer to that question. You talked about service attachment rates, and I think the target is to increase the applied service attachments from 50,000 to 60,000, 10,000. It seems like a pretty ambitious target. Maybe just talk about where we are in that initiative and so what that does to your service growth rates?
Yes. So first of all, it's still a significant minority of our assets that we have out in the market that are under contract with us. And so the 10,000 as we see as a first step to increase the assets -- our assets out there that we put under contract, we target ourselves to 10,000 more contracts this year. That's the path we're on. And frankly, it's another area where we're making some of the investments. People who know where those assets are or find those assets and then working with those customers to sell the value of having those assets under contract. The economics are really attractive. If you think about the -- the aftermarket tends to be more -- or margin accretive compared to just the first equipment sale within HVAC. And so there's a benefit there. There is a benefit of it being recurring revenue in nature as well.
And if you look over the life cycle of the product, the total aftermarket sales tend to be about 5x or more the value of the equipment, the initial equipment value. And so this focus is another way that we say, you know what, there's opportunity for us to drive long-term growth, to drive margin expansion, growing the aftermarket is absolutely part of the focus on enhancing market, enhancing our margin I should say. And again, this is something that will pay off over multiple years, but we're already seeing now that our aftermarket business is growing double-digits.
Right. Great. Thanks, Patrick. We're running a bit low on time here. So -- but I do want to squeeze in 2 quick ones here. One, on free cash conversion. Is there a path to 100% or maybe even better free cash conversion over the medium term? And then we talked a lot about portfolio subtraction. What about portfolio addition? We've just done the Chigo acquisition. How focused are you and the organization on acquisitions?
Yes. So maybe first on free cash flow. The answer to your question is, yes, I do see a path towards a 100% free cash flow conversion over time. I think it's well known that we have 2 headwinds to get to our free cash flow conversion. The one is our JV -- the dividends from our JVs is lower than our equity income from JVs. The other one is within Chubb we have non-cash pension income that's benefiting us. But I would say that even with that, I see opportunities to get us to a 100% or more free cash flow. Main driver clearly is improving working capital. We are looking through working capital now in a structured way throughout our segments. And I have to tell you, I'm very bullish on the opportunity to address working capital and drive efficiencies there, and therefore, increase our free cash flow conversion.
Great. And acquisitions?
The second part of your question was about acquisitions, being in a much better financial position than we were post spin, we really have the flexibility now to have a much more balanced capital deployment. And if I look at our priorities, it's organic and inorganic growth, then it's a growing dividend. And then, of course, it includes share repurchase as well, all within the context of a solid investment-grade credit rating.
And so on the acquisition side, we've made some changes. We actually hired a new lead, new corp dev leader, Jen Anderson. And there is a lot of focus on increasing our pipeline for acquisitions, aligned with our strategic priorities, being the leader in health safe and sustainable solutions, whether it's for the cold chain or for building. And so a big focus there. And my expectation is that you'll see more there. But I would also say that think of it more as being bolt-on acquisitions than elephants. And think of the range of maybe $100 million to maybe up to $1.5 billion. But given all the opportunity we have internally to improve our financial performance, I think bolt-ons is probably a smarter move now than going to bigger deals.
Yes. I agree with that. Well, Patrick, we're slightly overtime here. So we'll draw a line there. But thank you so much for your time, great discussion. Patrick, Sam, thank you very much.
Thank you.
Nigel, thank you.