Crane Company
Q4 2020 Earnings Call Transcript

Published: 26 Jan 2021

[Operator:]

Greetings, and welcome to the Crane Co., Fourth Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation . And as a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jason Feldman, Vice President of Investor Relations. Thank you, sir. You may begin.

[Jason Feldman:]

Thank you, operator, and good day, everyone. Welcome to our fourth quarter 2020 earnings release conference call. I'm Jason Feldman, Vice President of Investor Relations. On our call this morning, we have Max Mitchell, our President and Chief Executive Officer and Rich Maue, our Senior Vice President and Chief Financial Officer. We will start up our call with a few prepared remarks, after which we will respond to questions.

[Max Mitchell:]

Thank you, Jason. Well, what a year. Just advanced warning to our investors listening today, I want to take a little more time today. Rich and I are going to cover a lot of ground, so well take some time to have us through our prepared remarks before we take Q&A, but we've got a lot of great information this year. As outlined in our press release last night, we reported full year adjusted EPS of $3.84 compared to $6.02 in 2019, with the decline reflecting the impact of COVID-19. For the fourth quarter, EPS excluding special items, was $1, compared to $1.58 in the fourth quarter of last year. Fourth quarter adjusted EPS was about $0.06 below what we expected as of early December. At year end, we saw a number of sporadic and isolated disruptions globally, clearly tied to the rising COVID infection rates in all countries that resulted in a number of small shipment delays due to everything from minor absenteeism, shipping constraints, route changes, delayed supply receipts, to delayed customer inspections. This impact was entirely timing related, we believe transients and shifted to the first quarter of 2021. Before I turn to our outlook, there are a few key messages I want to convey about our performance in 2020. While all businesses globally were challenged in this unprecedented environment, we executed extremely well. There are many examples I could highlight but that execution was most evident in our deleverage rates and free cash generation. Excluding the impact of acquisitions with special items, our overall deleverage rate in 2020 was 35%. Maintaining that type of deleverage rate on a modest normal decline in sales could be expected but 2020 was different, because of the magnitude of the sales decline and because of the substantial negative mix we experienced. The rate of sales decline was most significant at our two highest margin businesses, commercial aerospace and crane payment innovations. We were able to accomplish this solid performance in part because of our thoughtful and decisive action on cost reduction measures, but it also reflects years of work operationally to ensure that our footprint is appropriately sized and flexible enough to quickly adapt to sharp changes in demand.

[Rich Maue:]

Thank you, Max, and good morning, everyone. As usual, I'll be providing segment comments that will compare the fourth quarter of 2020 to 2019, excluding special items as outlined in our press release and slide presentation. Fluid Handling sales of $258 million declined 7%, driven by a 14% decline in core sales, partially offset by a 5% acquisition benefit and 2% of favorable foreign exchange. Fluid Handling operating profit declined 26% to $28 million with operating margins of 10.7%, 280 basis points lower than last year, reflecting lower volumes, partially offset by productivity and cost reduction measures.

[Max Mitchell:]

Well, that was quite a bit this quarter, but we felt we had a lot to cover. We hope that helps put things in perspective. Thanks, Rich. I would really encourage all of you to join virtually for our February 25 Investor Day event as well as our May 26th Aerospace Electronics Investor Day, where we will share our thoughts on the ongoing evolution of our portfolio as well as additional details and progress on our strategic growth initiatives. We have an exciting story. Over more than a decade, we have proven that the strength of our execution as a differentiating factor. Increasingly, over the last several years, we have a demonstrated sustainable and structurally improved free cash conversion in line with best-in-class industrials, and we have consistently invested in organic growth, demonstrated how we are positioned for above-market sales growth, and accelerating inorganic opportunities. Overall, it's a compelling story. We look forward to sharing more with you next month. Let's now open it up for questions. Operator, we're now ready to take our first question.

[Operator:]

Our first question is coming from the line of Damian Karas with UBS.

[DamianKaras:]

So first, I wanted to ask you about the guidance for 2021. The EPS range it seem a little tight considering the level of uncertainty that you're still talking about . Max, I think you made a comment that you could see some upside to that guidance range. I mean, in your mind, what are the key drivers that would lead to such a scenario?

[MaxMitchell:]

I think Damian, it's all around any assumptions you might have on COVID vaccines recovery, broader economic recovery. We debated the range extensively when we dialed into a $5 midpoint. And I think the thing I would leave investors with is our confidence of that range, given our current assumptions, which is a flat to Q4 second half 2021 first half with continued improvement into Q3 and Q4. If an investor believes that -- now, we don't believe it's going to be significantly worse than that, but there's still a tremendous amount of uncertainty out there. I mean, I think we should -- once again, we were one of the few that gave guidance and fairly accurate guidance in an unprecedented time where many were criticized for even giving guidance. I think we're close to our businesses. I think we understand the range of potential outcomes. I think it's measured and balanced in our view. We have high confidence but it's the uncertainty around the recovery that leads us to keep a tighter range quite honestly and uncertain in terms of the improvement.

[RichMaue:]

Damian, just to add a couple of things there, just to make sure balancing some of that more measured recovery, and I would say some of our shorter cycle businesses earlier on, because we do expect earnings to be more level loaded overall. There's not a hockey stick, in other words, in our overall performance. But some of our businesses, like I said, like Max just said, clearly are pacing at more of a measured flatter in the first first few months, four, five months of the year.

[DamianKaras:]

And Rich you had talked a little bit about the cadence and mentioned currency kind of front-loading in the year. For P&C segment, could you maybe just elaborate a little bit on your expectations for the various pieces of the business? And what the cadence looks like kind of across the board? And I'm just curious on currency, specifically, what are you assuming relative to that BEP order for fiscal '21? Are you kind of -- because it was a very wide band, what's your assumption for your business this year relative to that?

[RichMaue:]

Yes. So really, with my comment with respect to currency, it just gets to the order profile and delivery profile of certain of our customer base, particularly across the board but notably, we see that in the international side of the business. So we've had really, really nice momentum in currency all through 2020. I mean, exceptional performance. And it wasn't just USG, I think we talked about this in the third quarter as well. Very good strong performance through the year, and that momentum continued with a nice order profile exiting. But the timing of our shipments sometimes can be different. So in currency, in particular, for example, we would expect a stronger first half than a stronger second half at this point. Our assumptions right now, stronger in the first half of currency and a little bit -- I don't want to even say weak or just not as strong in the second half. CPI, I would tell you is the opposite case, where we're going to start to see things come back a little bit more towards the second half, as markets recover as the vaccine gets distributed and so forth. So I think at a high level, that's what I would say.

[MaxMitchell:]

On the BEP order specifically, in addition, we assume the low end of that range, which is I think is good planning because of some of the constraints we're seeing from the BEP's end as well. But if there's upside from the BEP, we'll be prepared to produce as well.

[Operator:]

Our next question comes from the line of Ken Herbert with Canaccord Genuity.

[KenHerbert:]

Max, I just wanted to start off. I mean, you opened up with some pretty bullish comments on order trends through the fourth quarter. I mean we're almost at the end of January. Can you just comment on if you've seen that strength continue past the new year and to the start of this year?

[MaxMitchell:]

Consistent with what we would expect, Ken. So I feel fine with how things are progressing to our guidance in my comments.

[KenHerbert:]

And I think you also mentioned there was some timing issues around just site disruptions at the end of the fourth quarter with some shipping. Can you sort of quantify what that impact was? And how much of the benefit that could be in the first quarter?

[RichMaue:]

We're looking at that is roughly $0.06 overall. We would expect all of that, frankly, to hit in Q1.

[MaxMitchell:]

Now if there's other disruptions, Ken, I mean, this is where there's just some knits and gnats. You're seeing this, whether it's automotive, whether it's electronics, whether it's shipping, whether it's constraints, it was a little -- we didn't anticipate it. It was a little surprising, but it was nothing major. It was just a number of very small disruptions around the world, random could be a supply chain disruption and absenteeism problem.

[RichMaue:]

So I think we're going to see that continue to improve. So I would expect it to read through all in Q1. Again, it's all around the assumptions of COVID. I think we all believe it's peaking, spiking as the spring and summer comes, it should do nothing but improve as vaccine continues to get distributed as well.

[KenHerbert:]

And I guess if I interpret those comments, it sounds like the way to think about that is maybe a series of one offs, but nothing from a disruption standpoint that you would say is a longer term risk, I guess, or a risk to the full year beyond what you've identified already?

[RichMaue:]

Nothing.

[KenHerbert:]

And just finally, if I could, I think great -- congratulations, great work on the cash. Again, I agree. I don't think it's something that people have paid as much attention to perhaps as it justified, especially considering the performance last year. But as you think about 2021 and you think about capital allocation, you called out you're active, obviously, looking I think you specifically said Fluid Handling and Aerospace & Electronics from an M&A standpoint. How should we think about capital allocation this year? And can you give any more color on timing or types of things you're looking at from an M&A standpoint, either in terms of size, markets? Just refresh us on your criteria there?

[MaxMitchell:]

I'd like to defer a little bit of this to the Investor Day as well as the May Investor Day, we're going to give a little more color and clarity. I would just say that Payment & Merchandising, we've had some major acquisitions to date, there's some significant opportunities just focusing on integration and execution. No problems, just continue to focus on the core. So you're going to hear a little bit more of -- as we look at 2021 holding on Payment & Merchandising, prioritizing, Fluid Handling and A&E.

[RichMaue:]

And just in terms of criteria and such, to be very clear, our disciplined approach continues, Ken. We'll continue to be mindful of all of our metrics. In terms of the capacity that I mentioned during the call as well, the cadence of that grows pretty progressively, as you might expect as we go through the year. So we ended the year at 4 times debt to EBITDA. We'll finish next year right around 3 times.

[Operator:]

Our next question is coming from the line of Brett Linzey with Vertical Research Partners.

[BrettLinzey:]

Just wanted to start with payments and the margin expectations for '21, a very robust rebound in '21 on margins and even more significant than the actual decline last year. I'm just trying to understand the various considerations, what are volume incrementals versus restructuring, versus simply just the mix of the businesses?

[RichMaue:]

Yes. I think you hit all three pieces, I would say, Brett. So there's a considerable amount that's reading through. Now this is one of the businesses, in particular, in CPI, as you know, currency really benefited. So the CPI or Crane Payment Innovations business had substantial cost out, unfortunately, given the challenging end markets in that space. And then as we think about 2021, we get the full read through on that. And then on top of that, the volume is coming back we can provide a little bit more at February. But there's a fairly, you might say, equal distribution among those three components, the third being mix, where we're seeing some continued strength, not only in currency but on that payment side, that contributes even more because of the mix of the profile of customers and business that we have in that space.

[BrettLinzey:]

And on the significant cost out, I mean, as volumes do return, you're talking about '22 really being the recovery. I mean, should we expect some of those favorable cost items this year to layer back in next year?

[RichMaue:]

Actually, no. And even the mix component, I'd be cautious about thinking that, that's temporary either, particularly on a total company Crane Co. Level. So Aerospace is still going to come back in a pretty strong way when you're thinking about '22 and forward. But yes, that's what I would say there, Brett.

[BrettLinzey:]

And then just one more on Aerospace & Electronics, you indicated you think you've reached a bottom. So that does imply that the rate of the year-over-year decline does begin to get better in Q1? And then just on the aftermarket side, spare parts and shop visits, clearly lower. But are you seeing any semblance of a bottom in aftermarket on the commercial side?

[RichMaue:]

So what I would say is to be cautious when I say trough more from a sequential point of view. The first quarter of last year for Aerospace was very strong, in particular, frankly, in the aftermarket side. But overall, we had a solid first quarter. And so my trough comment meant here in the fourth quarter relative to Q3 and Q2. So we expect things to improve from Q4 but on a year-over-year basis in Q1, will be down. From an aftermarket perspective, similarly, we expect really that to begin to return in a more meaningful way as passenger air travel recovers, which we really don't expect in a very meaningful way until the second half of the year. It starts to progressively improve but it really starts to improve in the second half of next year.

[BrettLinzey:]

And so when you say down, should we split the difference between Q3 and Q4, or is it more like Q4 in terms of year-over-year in Q1?

[RichMaue:]

I expect the profit improvement in the first quarter in that business relative to Q4.

[Operator:]

Our next question comes from Caitlin Dullanty with Bank of America.

[CaitlinDullanty:]

I have a few on A&E today, the first one is, it would be great if you could comment a little bit on what you're seeing in terms of channel inventory trends, destocking and any different dynamics that you might be observing in the various areas of aftermarket?

[RichMaue:]

So on aftermarket, right now, the way we're thinking about aftermarket as it relates to 2021, is it's going to be a lagging improvement as passenger air miles grow, okay? Because there are inventory levels that are in the system without a doubt, that will be replenished, replenishing the demand initially, and hence, a good reason why we have more of our aftermarket improvement occurring in the second half of the year. So I think to answer your question, that would be, yes, there are inventory levels that are in the system that will be tapped into first and our assumptions in our operating plan -- in our plan and guidance reflect that.

[CaitlinDullanty:]

And then how large is Defense as a share of the A&E business today? And if you could share a little bit on how you're thinking about your Defense strategy over the next several years in terms of investment in organic growth, inorganic growth, maybe a target split between Aero and Defense? And anything you'd share on that or specific programs that you're pursuing?

[RichMaue:]

So today, as of the end of this year, it's roughly 50% of the business. Actually, I think it's 51% as we look at it today and would see a similar profile really next year. And that reflects the growth and strength that we've seen in this business over the last few years. If you were to take this business, our Defense portion of this business and compare it to 2018, we're up 10% if you compare it to 2018. If you compare it to 2017, we're up 22%. So we're seeing really, really nice strength and it's following all the technology investments that we've been making over the last several years. We're seeing a lot of that growth in radar applications, whether it’d be ground based radar, tactical vehicles, radar in aircraft and so forth. Just to give you a little bit of color in our microwave business, for example, we've historically had around three or four development programs ongoing at any point in time. Today, I can tell you, we have upwards of 20. So very exciting what we're seeing in the space. Our high power business in our Florida operations, same kind of thing. We're working on more development programs for future revenue streams than ever before. So we're excited about what the prospects are. It's going to be a tough comp next year, I would tell you, in 2021 relative to 2020, given all the growth that we've seen. We've had high double digit growth over the last couple of years. So it's going to be tough to see that happen again in 2021. But we are really, really encouraged about '22, '23, '24, '25 and so forth.

[MaxMitchell:]

And Caitlin, we're going to provide even more color on the May 26th aerospace dedicated day to really go through this, our core competencies, what the technology road maps have been, the programs that we're on, the programs that we're targeting and long term trends from power conversion, electrification, sensing, thermal management, as Rich talked about, moving up the curve from microwave components to integrated microwave assemblies. So it's a robust list and we look forward to sharing that with Investors, May 26th.

[Operator:]

Our next question comes from Matt Summerville with D.A. Davidson.

[MattSummerville:]

A couple of questions. I want to try and get back to a comment that Max and Rich, I think you both sort of touched on, which is kind of this cadence as we move into the first half '21 relative to the second half of '20. And I want to make sure if I'm understanding correctly. So you obviously have the tough comps in Commercial Aerospace, particularly in Q1. So that's sort of on the negative side. On the positive side, we've certainly talked about and you guys mentioned the tailwinds in the currency business. Then you have a little bit of timing that shifted from Q4 to Q1. If I throw that all together and kind of think about the puts and takes, how should we be thinking about Q1 revenue and earnings relative to the run rate you guys did in the back half of '20?

[RichMaue:]

It's going to be significantly better and it's going to be driven largely by your comment with respect to currency and the cost that we took out last year that we start to see the full impact of in the first half or first quarter of 2021.

[MattSummerville:]

And then maybe as my follow-up, if you could spend another minute. I know you touched on a couple of the end markets where you expect to see earlier recovery in Chem and Pharma, maybe a little bit in General Industrial. But could you do a little bit more of a deeper dive on end market trends as it pertains to the Processing Commercial Valve businesses with some sort of geographical overlay to it as well, please?

[RichMaue:]

So let's see, what I would say is from a chemical perspective, things are a little bit better than the others, for sure, in terms of performance, progression from Q2 to Q3, to Q4 and what we're seeing in terms of recovery into 2021. I would say we bottomed out in chemical in that June-July time frame and things have just been getting modestly better since. Obviously, oil and gas is not significant for us and the overall investment in that space not being strong, industrial production. Again, similar to chemical and that a bottom to that June-July time frame, so we're a bit more optimistic here. We started to build inventory levels in the fourth quarter. We took some decisions to actually go out and procure in anticipation of high runners being stocked out and those kinds of things. So we feel pretty good about industrial production. And I would say that's largely here in the US. From an MRO perspective, we feel pretty good in the Americas. We're a little bit cautious in Europe. China, not so great on MRO but a little bit better on projects. And the projects are really all brownfield and productivity improvements versus really any greenfield. There might be one greenfield, if I'm not mistaken, in China. But other than that, I hope that gives you a little bit of context.

[Operator:]

Our next question comes from Nathan Jones with Stifel.

[NathanJones:]

I’m going to go back to Payment & Merchandising here a little bit. Revenue guidance for 2021 is a little lower than I was expecting. I think I have some idea where that's coming from. So I wanted to kind of target it on that. I was probably expecting Crane Payment Innovations to be better. It sounds like you guys are building in some conservatism for the COVID impact there. Obviously, CPI has had a lot of challenges with just access to customer sites and things like that. Can you talk about a little bit of what kind of impact you built into this outlook from COVID? Because it sounds like, at least for the first half of '21, you're not assuming that things get a whole lot better there, that maybe you are restricted from getting into customer sites for potentially a longer period of time than I think we were expecting?

[RichMaue:]

So I would say that our activity with customers is solid, strong. There's no customer issues per se, financial or otherwise, we feel pretty good about it. The activity that we saw coming out of the fourth quarter, in part, absolutely was Payment Innovation. So we are seeing that momentum. What I would say, Nathan, is we're being a bit cautious for sure, given the uncertainty in the spaces that we're in. But absolutely, we're seeing that momentum and expecting a better part of the recovery to come in that second half.

[NathanJones:]

It also sounds like, Rich, one of your comments there to another question where you weren't anticipating a lot of the costs that have been taken out of this business to come back as revenues ramp up. Do you think there's been a structural change in the incrementals that the Payment & Merchandising segment is going to be generating over the next few years?

[RichMaue:]

You know, what I would say, in our Crane Payment Innovations business, I would say, for the next couple, yes, we'll see how things form. What I would say is in Crane Currency, I would say, yes, to that. I really would. The amount of operational improvements that this business has been driving since we've acquired them has been exceptional. And a lot of the margin improvement that we're seeing is coming from not just volumes, but it's how we're running those volumes through the factory. So structurally, I would say, on the currency side even during COVID the amount of work that we've done to continue to improve that business has been substantial and it's reading through in the results. But again, on the CPI side of the payment innovation side, next couple of years, yes, and we'll see after that.

[NathanJones:]

And one last question I wanted to get in is on inflation. Clearly, a lot of steel inflation, a lot of the raw material inflation in the second half of 2020. You're still in a spot in the cycle here, we're at relatively low levels of demand, although they are improving. Can you talk about how that likely impacts your ability to pass through higher raw materials? And do you see any price cost headwinds coming through the businesses in 2021?

[RichMaue:]

So no, our price discipline has been pretty solid. Our strategic sourcing has been solid. We've seen this coming and been monitoring it, and our plans for 2021 incorporate the right level of pass through on price. Really, what we're seeing it's more about lead times across a couple of our businesses, and all of those extended lead times or challenges that we're seeing, we're dealing with and we've got plans in place, and again, are reflected in our guidance. So no headwind from a cost point of view.

[Operator:]

Thank you. It appears we have no additional questions at this time. So I'd like to pass the floor over to Max Mitchell for any additional concluding remarks.

[Max Mitchell:]

Thank you so much. Thank you for joining the call today. We hope you're all able to join our upcoming February 25th Investor Day event as well as our May 26th Aerospace & Electronics Investor Day. We have a lot to share. It's a compelling story. We look forward to sharing more with you next month. It's been an incredible period for all of us, and it's not over yet. My thanks to our global teams. I'm proud of how we reacted to the pandemic and how we led and worked together. In the words of the late great Sir Sean Connery, there's nothing like a challenge to bring out the best in people. As we have seen over the last year, we all grow through adversity and I remain proud of Crane's leadership and compassion in dealing with the pandemic, and I truly believe that we have been forged to do new levels of strength and determination through that process. Thank you for your interest in Crane, and have a great day.

[Operator:]

Ladies and gentlemen, this does conclude today's conference and webcast. Once again, we thank you for your participation, and you may disconnect your lines at this time.