Allegion plc (NYSE:ALLE) Q4 2023 Earnings Call Transcript

Allegion plc (NYSE:ALLE) Q4 2023 Earnings Call Transcript February 20, 2024

Allegion plc beats earnings expectations. Reported EPS is $1.68, expectations were $1.57. Allegion plc 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 the Allegion Fourth Quarter 2023 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Josh Pokrzywinski, Vice President of Investor Relations. Please go ahead.

Josh Pokrzywinski: Thank you, Drew. Good morning, everyone. Thank you for joining us for Allegion’s fourth quarter and full year 2023 earnings call. With me today are John Stone, President and Chief Executive Officer; and Mike Wagnes, Senior Vice President and Chief Financial Officer of Allegion. Our earnings release, which was issued earlier this morning, and the presentation, which we will refer to in today’s call, are available on our website at investor.allegion.com. This call will be recorded and archived on our website. Please go to Slide 2. Statements made in today’s call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law.

Please see our most recent SEC filings for a description of some of the factors that may cause actual results to differ materially from our projections. The company assumes no obligation to update these forward-looking statements. Today’s presentation and commentary include non-GAAP financial measures. Please refer to the reconciliation in the financial tables of our press release for further details. Please go to Slide 3, and I’ll turn the call over to John.

John Stone: Thanks, Josh. Good morning, everyone, and thanks for joining us. I’d like to start today by recognizing that 2023 was a year of strong execution by the entire Allegion team. This performance reflects the value we add for our customers, the strength of our distribution partners, as well as the quality of our brands and the capabilities and expertise of our employees. Let’s walk through some highlights of the quarter and the year. After celebrating our 10th anniversary as a standalone company in December, we closed the year with record revenue, adjusted operating income, and adjusted EPS. Reinforcing the thesis behind our seamless access strategy, electronics demand remained strong. We delivered approximately 20% organic growth in electronics for the year as supply chains normalized, and that’s on top of mid-teens organic growth in the prior year.

We sustained a high operating cadence and expanded our industry leading margins in the quarter. And for the full year, our adjusted operating margin performance was 22.1%, up 160 basis points. Simply stated, the Allegion team delivered on price and productivity, bringing margins back to pre-pandemic levels, with room to expand further in 2024 and beyond. Our balance sheet and cash flow generation are strong. We ended the year under 2 times net debt to EBITDA, which sets up a 2024 return to the balanced capital deployment you’ve come to expect from Allegion. When you look at our past decade, this team has delivered solid results and executed well through a variety of macroeconomic backdrops. We’ve built on the strength of 100 year old brands, consistently meeting customer needs and meeting our commitments to shareholders.

We’ve operated with excellence, sustained the highest margins in the industry, and are still pioneering safety, better securing people and their property where they live, learn, work, and connect. Driven by our vision of enabling seamless access and a safer world, we’re proud of this track record, we’re proud of what we delivered in 2023, and we’re excited about the momentum we’re carrying into 2024. Please go to Slide 4, and let’s talk about our capital allocation strategy in action. Reflecting on Allegion’s first 10 years, we’ve had a roughly even split between inorganic growth and the return of capital to shareholders through dividends and share repurchases. We remain committed to balanced, consistent capital allocation, and having quickly delevered from the Access Technologies acquisition, our balance sheet supports this strategy.

As we move into 2024, we will continue investing for organic growth, prioritizing projects and solution that drive seamless access forward. One recent example in new product development is Schlage’s next generation of innovative electronic locks, the XE360. This is the latest wireless lock family from Schlage, designed with flexibility and interoperability in mind. With solutions for perimeter and interior doors, this series has the security and access features most looked for by multifamily and light commercial properties at attractive price points. It leads with open architecture, supports the latest credentialed technologies, and integrates with the Allegion and our partner systems. In addition, Schlage’s innovative FleX Module allows the XE360 series to be easily upgraded in the field to allow migration from an offline to a network solution and to adapt to emerging trends in security and connectivity down the road.

Next, Allegion will continue to be a dividend-paying stock. You can expect our dividends to grow commensurate with earnings over the long term, and we’ve just announced our 10th consecutive annual increase. We also expect to grow through acquisitions. Bolt-on acquisitions that fill portfolio gaps in the hardware space and high margin, recurring revenue business in the access solutions space will remain priorities. Larger deals like Access Technologies may be more episodic, but we will be disciplined and have demonstrated the ability to quickly delever. Boss Door Controls, which we closed this month, is a classic bolt-on that both complements and expands how we go-to-market in the UK. This acquisition bolsters our local business with a strong architectural channel, flexible supply chain, and also positions us to increase our spec-driven business there in the future.

Lastly, with regards to share repurchases, as we’ve said, at a minimum, we will continue to offset incentive compensation. And as you saw in the fourth quarter, we will make additional share repurchases as appropriate. Mike will now walk you through fourth quarter financial results, and I’ll be back to discuss our full year 2024 outlook.

Mike Wagnes: Thanks, John, and good morning, everyone. Thank you for joining today’s call. Please go to Slide number 5. As John shared, Allegion continued to execute at a high level and delivered another solid quarter. Revenue for the fourth quarter was $897.4 million, an increase of 4.2% compared to 2022. Organic growth of 2.6% was driven by our Americas non-residential and Access Technologies businesses, offset by declines in residential and international. Adjusted operating margin and adjusted EBITDA margin increased by 130 basis points and 120 basis points, respectively, in the fourth quarter, driven by price and productivity in excess of inflation and investment. I am pleased with the margin performance as we have recaptured the margin loss during the supply chain disruptions experienced in late 2021 and early 2022.

Our operating model and strong execution have positioned us well for future margin expansion. Adjusted earnings per share of $1.68 decreased $0.01, or approximately 0.6% versus the prior year. Operational performance drove growth of $0.17 per share, with the offset coming from tax, driven by the timing of discrete items versus the prior year. John will cover the outlook later in the presentation, however, I want to note that our tax rate will migrate to between 18% and 19% in 2024, inclusive of the implementation of global minimum tax. We expect Allegion’s structural tax rate will be in the high-teens over the planning horizon we laid out at our Investor Day in May. Finally, full year available cash flow for 2023 was $516.4 million, a 30.6% increase versus last year, driven by higher earnings and improved working capital performance.

I will provide more details on cash flow and balance sheet a little later in the presentation. Please go to Slide number 6. This slide provides an overview of our quarterly and full year revenue. I will review our enterprise results here before turning to our respective regions. Organic growth in the quarter was 2.6%, a strong price realization offset pressure on volumes. Currency and acquisitions drove additional favorability in the quarter, bringing the total reported growth to 4.2%. On a full year basis, organic revenue growth was 5.2% overall, with Americas at 7.4%. Our international business was down 2.5% for the year. Our full year organic growth was led by our electronics and software solutions, which grew globally by approximately 20% in 2023, with both regions in double-digits.

Please go to Slide number 7. Our Americas segment continues to deliver strong operating results in the fourth quarter. Revenue of $704.6 million was up 3.7% on both a reported and organic basis as favorable pricing offset lower volumes. Our Americas non-residential business was up mid-single digits against a prior-year comp that grew in the mid-20%’s. On a full year basis, this business had double-digit organic growth in 2023. Residential markets are soft, with our business down low-single digits in the quarter and for the full year, as higher interest rates continue to impact new and existing home sales. Our Access Technologies business delivered organic growth of mid-single digits in Q4. Americas electronics growth remained strong on a multi-year basis, with mid-single digit growth in the quarter on top of the nearly 50% comparison in Q4 2022.

Our Americas adjusted operating income of $188.4 million increased 10.8% versus the prior year period, while adjusted operating margins and adjusted EBITDA margins for the quarter were up 170 basis points and 190 basis points, respectively. The team executed well. We are performing more efficiently, driving price and productivity, and we delivered margin expansion every quarter in 2023. Please go to Slide 8. Our International segment continues to execute well in a challenging macroeconomic environment. Revenue of $192.8 million was up 5.9% on a reported basis and down 1.3% organically. Price realization was more than offset by lower volumes associated with soft end market demand. Currency and acquisitions were a tailwind this quarter, positively impacted reported revenues by 4.4% and 2.8%, respectively.

International adjusted operating income of $32.3 million increased nearly 13% versus the prior year period. We also saw improvement in adjusted operating margins and adjusted EBITDA margins of 110 basis points and 100 basis points, respectively. The team delivered margin expansion for Q4 and the full year despite a challenging topline, highlighting the healthier, more resilient business portfolio we have within our International segment. The acquisition growth I mentioned earlier is primarily driven by our plano business, a tuck-in software-as-a-service business we acquired early 2023, which is accretive to both growth rates and margins. Please go to Slide number 9. As I mentioned earlier, year-to-date available cash flow came in at $516.4 million, up nearly $121 million versus the prior year.

This increase is driven by higher earnings and working capital improvements, partially offset by higher capital expenditures. You can look for Allegion to continue to invest in our business and convert earnings to cash. Next, working capital as a percent of revenue improved versus the prior year, driven by higher inventory turns as supply chains normalized. Finally, our net debt to adjusted EBITDA is down to 1.9 times as we successfully delevered following the Access Technologies acquisition. We are now back to historical leverage levels, which demonstrates our proven track record of effectively deploying capital, while maintaining both our leverage profile and our investment grade credit rating. Our business continues to generate strong cash flow and our balance sheet continues to be in a healthy position.

I will now hand the call back over to John for our 2024 Outlook.

John Stone: Thanks, Mike. Please go to Slide 10. And before we get to guidance, I want to spend a moment on what we see as a couple of key drivers for 2024, including macroeconomic inputs that inform our outlook. We’re expecting more modest inflation in 2024, enabling normal levels of margin expansion from net price and productivity. We report these to you as aggregate price, productivity, inflation, and investments shown in the left-hand chart. Since the beginning of 2019, we’ve averaged approximately 60 basis points of margin contribution annually from net price and productivity. This has been a hallmark of the business over time and it’s a key driver of our 2024 outlook. We’re expecting a stable non-residential environment, underpinned by healthy institutional markets.

You can see Dodge starts for institutional have shown steady growth in the past few years, contrasting the higher volatility in commercial leaning verticals. As you all know, Allegion is a late-cycle business, and starts can lead our business by a year or more. We’re not expecting many market tailwinds, however, we believe the visibility and stability of late-cycle institutional verticals, as well as our large installed base, will allow us to deliver organic growth. Please go to Slide 11, and let’s walk through the outlook for 2024. We expect total and organic revenue growth in the Americas to be 1.5% to 3.5%. This is led by our non-residential business, forecast to grow low to mid-single digits organically. Please note, the non-residential business is inclusive of Access Technologies, starting this year.

The residential business is expected to be flat to down slightly on an organic basis. Overall, for the Americas, we are expecting more normal seasonality with tough comps in the first quarter. For Allegion International, we expect total revenue to be up 1.5% to 3.5% and minus 1% to up 1% on an organic basis. Inorganic growth includes the recently announced acquisition of Boss Door Controls. While mechanical markets remain sluggish in international, I’m pleased with how the team executed to close out the year. We have a high quality portfolio and continue to see good growth potential in our international electronics and software solutions businesses. All in, for the company, we are projecting total revenue growth of 1.5% to 3.5%, with organic revenue growth of 1% to 3%.

We expect to drive margin expansion consistent with our historical framework. We’re confident in the execution playbook we have for 2024, given cost actions taken in ’23 and a more modest inflation environment. Based on our strong operating momentum, prior cost actions, and more normalized inflation, we are projecting an adjusted EPS outlook in the range of $7 and $7.15. This represents growth of approximately 1% to 3% over the prior year period, inclusive of a $0.37 headwind from tax. Lastly, we expect our outlook on available cash flow to be in the range of $540 million to $570 million. While we are committed to balanced and consistent capital deployment, this guidance does not include future capital deployment beyond the recent acquisition of Boss Door Controls.

Please go to Slide 12. Bottom line, I am very proud of the entire Allegion team’s 2023 performance and grateful for the strong distribution partners and loyal customers we have. As we look ahead to 2024, we will continue to build on the Allegion legacy and deliver new value in access. Our team is focused on relentless execution of our strategy and balanced capital deployment against what we expect to be a stable market backdrop. We remain committed to putting our customers first and delivering our vision of enabling seamless access and a safer world. I look forward to updating you more in the future as we work to achieve another record year for Allegion and propel our company into its next decade of growth. With that, let’s turn to Q&A.

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Joe O’Dea with Wells Fargo. Please go ahead.

Joe O’Dea: Hi. Good morning.

John Stone: Good morning, Joe.

Mike Wagnes: Good morning, Joe.

Joe O’Dea: Wanted to start on op margin in ’24. It looks like year-over-year margin expansion maybe in the 60 bps kind of range. So it would fit within the 50 bps to 100 bps, I think, medium-term target, but also comes off a pretty tough comp where you just did 160 and so, I think maybe a little bit better than anticipated. Can you just talk about the drivers of that year-over-year expansion that’s embedded in terms of price, productivity, inflation, sort of how much of that is driven by it? And then also how much is already kind of in there in terms of carryover price, price that you’ve announced, cost actions that you’ve taken versus how much you still have to go get?

Mike Wagnes: Yes. Thanks for the question, Joe. You’re correct in that. If you look at margin expansion, a big driver of that is the price productivity in excess of inflation and investments. As you look at our topline guide, our pricing is going to be a driver of growth. If you think about midpoint, it’s going to be the biggest driver of growth. As a result, you will get margin expansion when you think about the ’24 year. And in addition, when you think about the actions we’ve taken, biggest driver of price for us is our non-residential business in the Americas. Those pricing actions are — have already been announced and in the marketplace. And then from cost actions, we’ve taken some cost actions in the fourth quarter of ’23. As a result, we’re positioned nicely. You should see an acceleration of productivity in 2024. So, when you think about our margin outlook, the actions have been taken and we’re positioned well in order to achieve that outlook.

Joe O’Dea: That’s really helpful. And then in terms of non-res and the growth outlook in Americas, can you unpack a little — that a little bit by vertical then to talk about sort of electronics versus mechanical, but then institutional versus commercial, I think a lot of focus on sort of office and headwinds out there. But what you see on kind of new versus renovation, just trying to understand some of the moving pieces within that growth in non-res.

John Stone: Yes, Joe. This is John. I appreciate the question. I think as we showed, the institutional verticals, they’re less volatile than the commercial leaning verticals and have still been flashing some positive data on starch. So we — and our businesses, as you know, is a little bit heavily tilted to those vertical. So we feel good about that space. It’s stable. The commercial, that’s a wide basket of end users. So it’s everything from data centers to retail to office to multifamily. We put that in the commercial bucket as well. And certainly, commercial office on the new construction side is soft and has been for quite some time. We think that will continue. Multifamily has been slowing as well. So we’re not counting on a dramatic snap back there.

We do see strength like everybody has been talking about in data centers, that’s a highly spec application of our high end electronic products. And I’d say on balance, you add all that up, the puts and the takes, and complement that with — again, if you think of Allegion has about 50-50 new construction to aftermarket exposure. The aftermarket is quite stable across all verticals, break fix, repair and maintenance, even some tenant turnover here in commercial office. So the aftermarket is still, I think, pretty stable and underpins the overall portfolio, that’s what leads us to come up to low to mid-single digits for growth in non-res. The only other item to mention since we do include Access Technologies and non-res for this year and going forward is big retail chains with store renovations and things like that also makes for a rather stable outlook on the Access Tech, the automatic doors business, that’s kind of how we would see the whole basket.

Joe O’Dea: I appreciate the details. Thanks.

John Stone: Thank you.

Operator: The next question comes from Joe Ritchie with Goldman Sachs. Please go ahead.

Vivek Srivastava: Hi. This is Vivek Srivastava on for Joe. Thanks for the question. My first question is just on the cadence of organic growth. It just looks like in first quarter ’23, you had a big backlog burn, so that will be a tougher comp. Is it fair to say, you probably have a slightly negative organic growth in first quarter and then it ramps up to maybe closer to mid-single digit level in the second half?

Mike Wagnes: Yeah. Thanks for the question. Clearly, Q1 is going to be our most challenging comp when you think about the ’24 year. We don’t give quarterly guidance. But if you recall, we burned through that backlog Q1 of ’23. So when you think about our cadence for top line, ‘23 was not a normal year, right? When we think about ’24, I think there’s more normal seasonality. So we’re a little more back half loaded than first half loaded from a top line. Don’t want to get individual quarter forecasting. As you know, we don’t give quarterly guidance. But just remember, a little more back half than first half from the top line as a company and that we do have that really challenging comp in the first quarter when you model year-over-year.

Vivek Srivastava: Thanks. That’s helpful. And then just a follow-up on the International segment margins. It was impressive to see that in fourth quarter despite negative organic growth, you expanded over 100 basis points of margin. Could you talk about what drove that strong margin expansion in fourth quarter and then just expectations in that segment for margins in 2024?

Mike Wagnes: Yeah. Super pleased about our international business when you think about the margin performance. If you look at our 10-year history, that business is breakeven when we spun out a decade ago. Now we’re driving good healthy margin expansion. It’s a much healthier portfolio. When you think about that electronics and software businesses, we’ve been talking about the last few years, strong – stronger businesses from a margin perspective and top line. So really doing some good work to drive productivity in the region, pricing excellence. Tim, he took the excellence we had in the Americas and brought that to International as well. So a lot of things favorable for International as we think about the business for ‘23 and more importantly, moving forward.

Vivek Srivastava: Great. Thanks.

Operator: The next question comes from Jeff Sprague with Vertical Research Partners. Please go ahead.

Jeffrey Sprague: Hi. Thank you. Good morning, everyone. Just coming back to just the seasonality comment. I know you don’t do want to get into quarters, but are you comfortable with us kind of assuming kind of the pre-COVID period, call it, 2014 to 2019 is what you mean by normal seasonality as we look into Q1?

Mike Wagnes: Yeah, Jeff. If you look at half, I’d like to talk about it in halves. I think that ’14 to ’19 is kind of a normal seasonality when you look at the half years. And we expect to be more in line with that a little more back half weighted than first half.

Jeffrey Sprague: Okay. Great. You just give us a little more color on Boss to size the profitability, what impact, if any, it has on international margins?

Mike Wagnes: Yeah. Jeff, if you think about that business, organic — I’m sorry, inorganic growth for International, you would assume — about half of that inorganic growth we’ve highlighted in the outlook is coming from the Boss Door acquisition, the other half coming from currency. So you could see it’s a pretty — it’s a smaller acquisition. It’s not a massive size. So from a price now on the top line, you have an idea that it’s not a huge acquisition, but it’s a nice complement to our business. We’re really strong at writing specifications in North America. This is bringing that spec writing capability to a large country in Europe like the U.K.

Jeffrey Sprague: Great. And then, hey, John, earlier in your opening remarks, you mentioned this new Schlage electronic product. Can you just maybe provide a little bit more color overall on what you’re expecting for electronics growth in 2024? Is there a measurable impact on your investment levels to drive that, etc.?

John Stone: Yeah. It’s a good question, Jeff. And I think if listen to the prepared remarks in 2022, strong electronics growth, 2023, around 20% electronics growth. So I mean, over the long haul, long term, like we said at Investor Day back in May last year, think of our electronics performance of high-single, low double-digit growth driver for Allegion. We’ve definitely given backlog burn and things in 2023, we’ll have some tough electronics comps here and there. But demand is still strong. The secular trend still remains this migration to electronic access control for better security and better convenience is still moving and underway. We’re still investing there. XE360 is just on that was very timely to highlight for us given the flexibility and interoperability that, that brings to the market.

And also just to highlight the ease of upgrade of that in the field. We’re also pretty excited about that. I mean the flexibility that’s going to offer the end users is quite interesting and quite attractive for us. I think as you – as we move through 2024, you can continue to see, I think, an emphasis from us on things like product vitality, you’re going to see a steady stream of new product launches just like this, and we look forward to highlighting those for you.

Jeffrey Sprague: All right. Thank you.

Operator: The next question comes from Julian Mitchell with Barclays. Please go ahead.

Julian Mitchell: Hi. Good morning. Maybe just the first question. You talked about some of the color by end market vertical earlier. And maybe one, I guess I wanted a bit more color on was the education vertical. I think it’s one of your largest. So maybe any sense of kind of scale of how much of your business is education today and how do you see the outlook there? There have been some good tailwinds depending on product types from the education stimulus three years ago or maybe 70% of the way through that spend now. So how do you see that kind of tailing off and what does it mean for your education vertical growth rates from here?

John Stone: Yeah. I think, Julien, when you look at our Americas business, we would say we’re in the range around 45% of that business would be institutional. Institutional, of course, would be education, also health care, some government institutions in there. Education, K-12 and higher ed have been quite stable. I think when you see the things that Allegion invests, human capital as well as product investments and terms of helping drive safer schools. It’s one, it’s a really important mission. We’re very active in the partner alliance for safe schools, advocate for proper standards, make sure people are aware and educated on proper standards. And then yes, that is a substantial portion of our business. But 45% of Americas is institutional — it’s a stable vertical.

I think you can look around the country, you can see some big bond referendums lately. Those can lead sales by a year or two years or more in some cases. In any given year, certain portions of school budgets, of course, go to safety and security. And we want to make sure people understand proper standards and advocate for that. And if you recall, again, one of the products we highlighted at our Investor Day, these indication lots that just provide a visual indication of the lock status critically important. We’ve got a great portfolio there, and that’s continuing to drive value into that vertical. So I think stable would be the outlook that we would see kind of consistent with the Dodge starts — chart that we showed you. I think in that low to mid-single digit growth driver.

Julian Mitchell: That’s helpful. Thank you, John. And just my second one would be following up on the operating margin outlook. So I just wanted to check, is the right way to think about it that you referenced that kind of 60 bps average on Slide 10 from price productivity inflation investment net. Is that really sort of the — essentially the margin expansion guide for 2024 simplistically? And then we assume that things like mix and volume sort of netting off against each other? I just wanted to check that that’s the right assumption. And any color you could give on the corporate cost outlook for the year.

Mike Wagnes: Yeah. So as you know, Julian, we don’t guide margins per se. However, we do give top line, bottom line, other estimates. So you can back into a margin rate. I think one, Joe kind of talked to margin rates earlier in the call as well. From a business perspective, you can see corporate being flattish for us year-over-year. With that element, you can kind of back into the respective region margin rates. And the big driver to the expansion, like, I mentioned earlier, is that price productivity in excess of investments and inflation. Lastly, you asked about mix, historically, mix is not a huge mover of margin rates for us. They can move around a little, but it’s not something that drives significant changes in our margin profile for a full year.