Carrier Global Corporation (NYSE:CARR) Q4 2022 Earnings Call Transcript

Carrier Global Corporation (NYSE:CARR) Q4 2022 Earnings Call Transcript February 7, 2023

Operator: Good morning, ladies and gentlemen, and welcome to Carrier’s Fourth Quarter 2022 Earnings Conference Call. I would like to introduce your host for today’s conference, Sam Pearlstein, Vice President of Investor Relations. Please go ahead, sir.

Samuel Pearlstein: Thank you, and good morning, and welcome to Carrier’s Fourth Quarter 2022 Earnings Conference Call. With me here today are David Gitlin, Chairman and Chief Executive Officer; and Patrick Goris, Chief Financial Officer. We will be discussing certain non-GAAP measures on this call; which management believes are relevant in assessing the financial performance of the business. These non-GAAP measures are reconciled to GAAP figures in our earnings presentation, which is available to download from Carrier’s website at ir.carrier.com. The company reminds listeners that the sales, earnings and cash flow expectations and any other forward-looking statements provided during the call are subject to risks and uncertainties.

Carrier’s SEC filings, including Forms 10-K, 10-Q and 8-K, provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements. . With that, I’d like to turn the call over to our Chairman and CEO, Dave Gitlin.

David Gitlin: Thank you, Sam, and good morning, everyone. Our Q4 results for sales, earnings and cash flow were all in line with our expectations, as you can see starting on Slide 2. We delivered organic sales growth of 5%, supported by another quarter of double-digit growth in light commercial and commercial HVAC, global truck and trailer and aftermarket. Pricing remained strong and our realization continued to offset inflationary headwinds. Supply chain improvements continued, allowing for a reduction of our past due shipments with further improvements anticipated in 2023. Our backlog, which ended up mid-single digits year-over-year, up 40% on a two-year stack and up 2x from 2019 remains at very healthy levels. Adjusted operating margins of 10.1% were flattish compared to last year, despite a 70-basis point impact from the consolidation of the Toshiba joint venture.

We made great progress on our productivity initiatives in the quarter and achieved our full year target of $300 million in savings. Adjusted EPS was $0.40 in the quarter at the high end of our guidance range. We generated about $1 billion of free cash flow in the quarter ending 2022 with $3.5 billion of cash, allowing us to continue to play offense with capital deployment as we head into 2023. Moving to Slide 3. I am proud of our team’s accomplishments last year. We delivered on our full year outlook for sales, adjusted operating margin and adjusted EPS while significantly advancing our strategic priorities. We drove 8% organic sales growth, adjusted operating margin expansion of 60 basis points and adjusted EPS growth of about 15%, when we exclude the impact of the Chubb divestiture.

Though we did fall short of our original $1.65 billion free cash flow guide, we discussed in October, resulting from supply chain and related inventory challenges we did deliver on our revised guidance of $1.4 billion as a result of our strong Q4 performance. So, our track record of delivering results without surprises continues, and our team is poised to continue to deliver in 2023, in part because of key secular trends that drive demand, as you can see on Slide 4. Our customers continue to look to us for healthy and sustainable solutions, and we have differentiated offerings that meet their needs, particularly in the fast-growing heat pump space. Our North America residential heat pump sales grew 35% in the quarter to a European commercial heat pump sales were up 30%.

We expect those areas to only grow stronger as the inflation Reduction Act and the RePower EU initiative propel increased adoption. Additionally, Toshiba’s innovative and leading inverter technology continues to impress. When combined with our multi rotary compressors, heat pump efficiency and capacity dramatically improve. Toshiba’s technology and expertise are also helping us penetrate the attractive and growing residential heat pump market in Europe. Our position in transport electrification is also market-leading. We have units operating in 15 countries and plan to ramp significantly with more than half of refrigerated transport units sold to be electric by 2030. The healthy building trends continued to be a positive in the quarter as orders were up over 80% and our pipeline increased to over $1 billion.

For the full year, healthy building orders were up about 50%. K-12 also remains encouraging with our pipeline up about 60% year-over-year, and with almost two-thirds of the federal government’s ESR funds yet to be allocated, we expect further acceleration into 2023. As we continue to distinguish ourselves as a climate systems and solutions company, we remain focused not only on achieving our own ESG goals, but also helping our customers achieve theirs as well. We recently increased our previous aggressive 2030 net-zero targets, committing to set greenhouse gas emission reduction targets in line with the science-based target initiative criteria. Additionally, Carrier continues to be recognized in the ESG space, including distinguished recognition in London, where our customers’ heating network will provide a 50% reduction in carbon emissions to network participants.

We also continued to perform on our aftermarket growth objectives, as you can see on Slide 5. When we became a stand-alone public company in early 2020, we emphasize increasing aftermarket growth rates from historical low single-digit levels. And last year, we produced another year of double-digit aftermarket growth. Our focus remains on providing differentiated digital solutions through our Abound and Lynx platforms and connecting not only our new products, but also our significant installed base. Our Abound technology now monitors over 1 billion square feet, and we recently onboarded over 100 commercial office sites for a key large-scale customer. We recently released the Abound Net Zero management, which provides customers with an easy way to view, track and analyze energy usage and emissions data across their global footprint and proactively identify conservation measures.

We’ve made similar progress with our innovative Lynx platform and launched several new capabilities in the quarter. We expanded our reefer health capabilities to include early refrigerant leak detection, and launched a managed services linked fleet offering for a major grocery retail chain in the U.S. We achieved our goal of having 70,000 chillers under long-term agreements by the end of 2022 and expect to increase that by another 10,000 in 2023. Importantly, we also achieved our objective of having 20,000 connected chillers and plan to connect another 10,000 this year. We recently announced a strategic collaboration agreement with Amazon Web Services, to jointly build, market and sell Carrier’s digital solutions. Not only are we delivering on our financial and strategic imperatives, we are also making great progress on our portfolio optimization and executing on our capital deployment priorities as you can see on Slide 6.

You’ll recall that at the time of our spin, we carried approximately $11 billion of debt on our balance sheet and cash of about $1 billion. Over the course of just 2.5 years, we have reduced our net debt levels nearly in half from that $10 billion level to $5.3 billion while increasing our strategic organic growth investments by over $300 million. We have also completed a number of compelling acquisitions highlighted by the consolidation of Toshiba Carrier. All acquisitions have been strategic and core to our business focused on enhancing sustainability leadership, accelerating aftermarket growth, driving digital and technology differentiation and expanding adjacencies and geographic coverage. We’ve also been disciplined in evaluating our existing portfolio to ensure each business is core and that we are the best owner.

As a result, we optimized our portfolio by completing the sale of Chubb and our shares — completing the sale of Chubb and our shares in Bayer while also reducing our minority joint venture count from 41 to 29 since spin. In addition to our portfolio moves, we’ve been disciplined and proactive with our other capital deployment actions. We have steadily and consistently increased our dividend and have completed about $2 billion in share repurchases since spin. All of this to say, we have made great progress over the last few years, but that does not mean that we are done. We are always evaluating acquisitions in our current portfolio for potential opportunities for simplification and value creation. We will remain steadfast in our commitment to keep evaluating our portfolio as we enter 2023 and beyond.

Patrick will cover our 2023 guidance in more detail, but I will emphasize a few highlights on Slide 7. Focus remains very thematic for us. All of our 52,000 team members are aligned on our key priorities, and those priorities remain consistent. Carrier 2.0 is a term that we have been using internally, which represents a very purposeful shift from a primary focus on selling equipment to now using digital and innovation to provide our customers with sustainable and healthy outcomes throughout the life cycle of our product and service offerings. The result will be our continued pursuit of higher margin, high aftermarket growth rates. We remain focused on reducing costs and expect to get another $300 million in productivity in 2023. We are clear-eyed about the broader economic challenges and uncertainty in 2023 and have done our best to calibrate macro factors in our guidance that you see along the left of this slide.

We expect to deliver solid organic growth, strong margin expansion, excluding TCC and high single-digit to low double-digit adjusted EPS growth. Strong free cash flow and a very healthy balance sheet enable us to play offense on capital deployment. With that, let me turn it over to Patrick. Patrick?

Patrick Goris: Thank you, Dave, and good morning, everyone. Please turn to Slide 8. In short, Q4 was very much in line with our expectations and the guide we provided. Reported sales were $5.1 billion, with 5% organic sales growth driven by about 8% price with volume down a couple of points. I’ll provide a bit more detail on a future slide, but in essence, we saw continued strong organic growth in HVAC, Fire & Security and global truck and trailer, which was partially offset by a very weak quarter in container and to a lesser extent, commercial refrigeration. The Chubb divestiture reduced sales by 10% in acquisitions, substantially all Toshiba Carrier increased sales by 8%. Currency translation was a headwind of 4%. All segments were price/cost positive or neutral in the quarter.

Q4 adjusted operating margin was about flat compared to last year, driven by a 70-bps margin headwind related to the TCC acquisition. Strong productivity almost completely offset the margin headwinds related to the lower volume and the TCC acquisition. Adjusted EPS of $0.40 was consistent with the upper end of our full year guidance range. For your reference, we have included the year-over-year Q4 adjusted EPS bridge in the appendix on Slide 20. $1 billion of free cash flow in the quarter was also as expected, and we generated about $1.4 billion for the full year. Moving on to the segments, starting on Slide 9. HVAC reported sales included a 16% benefit from the TCC acquisition. HVAC organic sales were up 9%, driven by low single-digit growth in residential, over 40% growth in light commercial and mid-teens growth in commercial HVAC.

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Sales growth was driven by both price and volume. Residential movement was down about 10% in the fourth quarter and quarter end field inventory levels ended up higher than the flat year-over-year levels we targeted. Residential HVAC growth was driven by price as volume was down mid-single digits. Commercial HVAC had another very strong quarter with double-digit sales growth in applied equipment, aftermarket and controls. All regions grew double digits. Adjusted operating margin was up 60 bps with volume, price/cost and productivity more than offsetting a 100 bps margin headwind related to TCC. Full year operating margin for this segment was 15.2%, in line with the guide we provided post the TCC acquisition, which had about a 70 bps dilutive impact on 2022 for this segment.

Transitioning to refrigeration on Slide 10. Organic sales were down 7% and currency translation was also a 7% headwind. Within transport refrigeration, North America Truck/Trailer sales were up low teens and European Truck/Trailer was up high teens. This continued strong performance was more than offset container, which was down about 50% year-over-year driven by demand softness as well as a tough comp in the prior year. This is the second competitive down quarter for the container business and historical down cycles for this business have lasted about four quarters. Commercial refrigeration was down high single digits year-over-year, as our European food retail customers continue to be pressured by inflation and energy prices. Adjusted operating margins for this segment were up 60 bps compared to last year despite lower sales with the margin headwind of lower volume, more than offset by productivity and price cost.

Full year operating margin of 12.8% was slightly ahead of our 12.5% guide and expanded over 70 bps compared to 2021, despite lower sales as our refrigeration team managed price costs and delivered strong full year productivity to offset the impact of lower volume. Moving on to Fire & Security on Slide 11. As expected, the Chubb divestiture had a significant impact on reported sales. Organic sales growth was 6%, driven by price with volume down low single digits. Operating margin was short of our expectations for this segment due to continued high supply chain and logistics costs and operational performance challenges. As a result, full year operating margin of 15.2% for this segment was short of our 16% operating margin guide. Slide 12 provides more details on backlog and orders performance.

As our backlogs normalize in some of our shorter-cycle businesses, such as residential HVAC, we expect order trends to adjust accordingly. We have seen that trend over the last few quarters and in Q4, particularly. As you can see on the left side, total company organic orders were down roughly 10% for the quarter and up compared to 2019 and 2020. Backlog ended the year up mid-single digits compared to last year, with backlog growth in HVAC and Fire & Security, partially offset by backlog reduction in refrigeration. As expected, Residential HVAC orders were down in Q4. Light commercial demand remains robust as orders were up mid-teens in the quarter. The backlog is up well over 2x for that business. Commercial HVAC saw double-digit orders growth for the eighth consecutive quarter.

The commercial backlog is now up 35% compared to last year and extends well into 2023. Refrigeration orders were down roughly 10% in the quarter, driven by market weakness in container and commercial refrigeration that was only partially offset by Global Truck and Trailer. North America Truck and Trailer continued to have strong orders in the quarter, up over 100% compared to last year. Global Truck and Trailer backlog is up high single digits as the strength in North America offset order weakness in Europe. Container orders were down about 50% compared to a very strong fourth quarter last year. Commercial refrigeration orders remain weak and reflect market softness. Finally, demand for our fire & Security products was mix. Orders were positive in roughly half of the businesses, including residential fire and access solutions.

Fire & Security Products backlog is up almost 30% year-over-year with double-digit growth in all the businesses, except residential fire in the Americas. Overall, we entered 2023 with strong backlogs and continued strong order trends in commercial and light commercial HVAC and North American Truck and Trailer. Businesses experiencing softer order intake include container, commercial refrigerating and residential HVAC. Now moving on to our ’23 guidance on Slide 13. We expect reported sales of about $22 billion, including organic sales growth of low to mid-single digits. Almost all the organic growth will be priced as we expect volume growth to be flattish. We expect currency translation to be about one-point headwind on while acquisitions, primarily the impact of Toshiba Carrier will contribute about 6% to the growth.

Adjusted operating profit is expected to be up compared to 2022 with operating margin at about 14%, including a 50 bps dilutive impact from Toshiba Carrier. We expect high single-digit to low double-digit adjusted EPS growth in 2023. I’ll provide more color on that on the next slide. We expect a 23% adjusted effective tax rate and full year free cash flow of about $1.9 billion or about 100% of net income. Our free cash flow guidance assumes approximately $75 million of cash restructuring payments and about $100 million tax headwind, since Congress has not renewed the full expensing of R&D. As shown on the right side of the slide, we expect mid-single-digit organic growth in HVAC as continued strong growth in light commercial, commercial HVAC and aftermarket are more than offset flat residential.

Reported HVAC sales growth should be in the low teens — in the low double digits, given the additional contribution from seven more months of consolidating Toshiba Carrier. In Refrigeration, we expect flattish organic sales as continued strong growth in Global Truck and Trailer is offset by container and commercial refrigeration. For Fire & Security, we expect low single-digit organic growth. We expect the HVAC segment operating margin to be similar in 2022 despite absorbing about 100 bps of pressure from the consolidation of Toshiba, and expect operating margin expansion in Refrigeration and Fire & Security. Let’s move to Slide 14, adjusted 2023 EPS bridge at our guidance midpoint. Our operating profit is expected to be up about $200 million, despite flattish volume growth.

Price cost and gross productivity combined or an expected operating profit tailwind of $500 million, with $200 million coming from price cost and $300 million coming from gross productivity. Annual merit adjustments and investments amounts to about $200 million in total, and we expect about a $50 million additional headwind of TCC integration costs. There are some other minor smaller moving pieces, but that all adds up to roughly $200 million in increased adjusted operating profit. Core earnings conversion, which excludes the impact of acquisitions, divestitures and FX is about 35% at the guidance midpoint. Moving to the right on the bridge, some modest savings on net interest expense and a lower share count offset the expected higher tax rate and currency translation headwinds.

That gets us to our midpoint of about $255 million for next year or 9% growth compared to 2022. As usual, we provide estimates of other items in the appendix on Slide 19. On Slide 15, you’ll see that our capital allocation priorities remain the same. In 2023, we expect about $400 million in capital expenditures. We recently announced another significant dividend increase and our dividend payout ratio is about 30%. Finally, we target $1.5 billion to $2 billion in share repurchases in 2023. Before I turn it over to Dave, let me provide some additional color on the first quarter. We expect a $0.06 headwind from a higher effective tax rate of about 25% compared to 16% last year. In addition, we expect our first quarter to be the weakest quarter from an organic revenue growth perspective with organic sales growth flat and volumes down.

This reflects continued growth in the HVAC and Fire & Security segments and a decline in the Refrigeration segment driven by container and commercial refrigeration. We expect residential HVAC to be down mid-single digits in Q1. Recall that our Q1 ’22 residential HVAC sales were up an industry-leading 23%, so certainly a tough comp for that business. Overall, we expect revenues in Q1 to be a little over $5 billion and adjusted EPS to be between $0.45, $0.50. We expect first half adjusted EPS to be about $0.45 to $0.50 of full year earnings, the reverse of 2022. And as usual, free cash flow will be more weighted to the second half. We expect organic revenue growth to sequentially improve after Q1 with easier comps in the second half of 2023. With that, I’ll turn it back to Dave for Slide 16.

David Gitlin: Thanks, Patrick. We delivered strong performance in 2022, and we are targeting another strong year this year as we continue to execute and control the controllables. We continue to see opportunities to use our strong balance sheet to create value for our customers, shareholders and the planet for future generations to come. With that, we’ll open this up for questions.

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Q&A Session

Operator: And our first question coming from the line of Julian Mitchell with Barclays. Your line is open.

Julian Mitchell: Hi. Good morning. Just wanted to start with maybe start with the first quarter outlook there. So it sounds as if you’ve got maybe the operating margins firm-wide down perhaps sort of 200 to 300 points or so year-on-year. Just wanted to check if that’s the case. And is the bulk of that downdraft really coming in HVAC presumably? And if it is, kind of what’s the confidence that you can get back to full year margins in HVAC being flattish given the headwinds in resi for the year?

Patrick Goris: Julian, good morning. Patrick here. The margins in Q1, we expect them to be down about 200 basis points, and there really three elements to it: One, acquisitions, and that is HVAC specific, expected to add over $500 million of revenue, but with very little operating profit contribution. Two, volume mix, as I mentioned, is expected to be down in the first quarter. That’s not — that is really not just in residential HVAC, but is also impacting, of course, the refrigeration segment. That’s the secondary contribution to the 200 bps or so margin contraction in Q1. The third element is price cost. We expect price cost to be close to neutral in Q1, which actually is a headwind to margin — margins in the first quarter. And that is across the three segments. So that gets to about a 200 bps margin contraction in the first quarter. In the second quarter, we would expect to return to year-over-year EPS growth.

Julian Mitchell: That’s helpful. And maybe just following up, on the HVAC segment overall for the year. So I think you talked about a flattish margins there that sort of 15% plus in that business, and you’ve got organic sales guided up about mid-single digit for the year. Maybe just clarify for us what you’re expecting there on your residential volumes, perhaps within that guide? And then any sort of weighting on things like the productivity savings, just trying to understand where you get the offset in that HVAC margin, if there’s a mix headwind and a TCC margin headwind as well?

David Gitlin: Well, Julian, let me start with a little bit of color on kind of resi and what we’re seeing across the mix between resi, light commercial and commercial, and then Patrick can give a little bit of color on the margins themselves. We do expect for resi in 2023. We’re expecting flat sales, flattish sales, but we get there with volume being down potentially high single digits, offset by mix and price. So when you think about resi, we’re looking at new construction potentially down 20%, 25%. Now remember, that’s only about 20%, 25% of resi, but some of our customers are saying it could be much better than that, some were saying it’s in that range. So we’ll have to see as we get into the second half of the year, but we’ve calibrated residential new construction down 20%, 25% and replacement down mid-single digits.

We are seeing that offset that gets us the flattish sales for the year driven by mix and price. So we have some price carryover. We’ve just announced a new price increase of 6% that’s effective in March. We’re going to mix up this year, as you know, because of the new SEER units that are coming in and we are pricing 10% to 15% higher, and we’re also seeing a mix up as we transition to heat pumps. Also in the mix is that we do see a strong year for light commercial, which was, as Patrick said, up 40% in the fourth quarter, that continues to be very strong. And our backlogs in commercial with a nice mix with aftermarket of double digits, controls up double digits, helping that piece. Patrick, maybe comment on the full year.