Crane Company (NYSE:CR) Q3 2023 Earnings Call Transcript

Crane Company (NYSE:CR) Q3 2023 Earnings Call Transcript October 24, 2023

Operator: Greetings. Welcome to Crane Company’s Third Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. At this time, I will now turn the conference over to Jason Feldman, Vice President of Treasury and Investor Relations. Mr. Feldman, you may now begin.

Jason Feldman: Thank you, operator, and good day, everyone. Welcome to our third quarter 2023 earnings release conference call. I’m Jason Feldman, Vice President of Treasury and Investor Relations. On our call this morning, we have Max Mitchell, our President and Chief Executive Officer; and Rich Maue, our Executive Vice President and Chief Financial Officer. We’ll start off our call with a few prepared remarks, after which we will respond to questions. Just a reminder that the comments we make on this call may include some forward-looking statements. We refer you to the cautionary language at the bottom of our earnings release and also in our annual report, 10-K and subsequent filings pertaining to forward-looking statements.

Also during the call, we will be using some non-GAAP numbers, which are reconciled to the comparable GAAP numbers in tables at the end of our press release and accompanying slide presentation, both of which are available on our website at www.craneco.com in the Investor Relations section. Now let me turn the call over to Max.

Max Mitchell: Thank you, Jason, and good morning, everyone. Thanks for joining the call today. Well, we delivered another impressive quarter with results again outperforming expectations. We delivered core sales growth of 9% with a 42% increase in adjusted operating profit and adjusted EPS of $1.03, with strong performance across all of our businesses. Our performance year-to-date along with our market outlook gives us confidence to narrow our guidance range with a midpoint $0.175 higher than our prior guidance updated in July. Our revised adjusted EPS guidance range is $4.05 to $4.20. While the comparison to last year’s EPS isn’t meaningful, given the recent separation, on an operational basis, our revised full year guidance reflects 7% core sales growth driving a 24% increase in adjusted segment profit.

Strong core growth, along with very impressive execution on productivity and pricing initiatives deliver more than 50% operating leverage with operating profit increasing more than three times the rate of core sales growth. Hey, I want to start off with an update on the M&A front. Since our separation announcement, we have described how we expect acquisitions to be a meaningful contributor to our growth story as we move forward as we have an extremely strong balance sheet, providing us significant acquisition capacity. We have a proven track record of successfully integrating acquisitions and over delivering on synergies. We operate in markets with numerous potential small and midsized targets as well as a smaller number of large potential acquisitions.

And our current structure, we are entirely focused on our two global strategic growth platforms, aerospace and electronics and process flow technologies. All factors that set us up to be a consistent serial acquirer moving forward, adding value above and beyond our organic growth investments and opportunities and strengthening our business to further accelerate growth. Last quarter, I mentioned three specific transactions we were actively working on each with enterprise values in the $75 million to $200 million range. Of those three transactions, we closed on one acquisition a few weeks ago, I’ll address shortly. A second in aerospace is still in progress. And while the outcome isn’t yet certain, we are cautiously optimistic about our prospects.

And on one pharmaceutical asset, we lost to another bidder, unfortunate because it was a great asset, but a reminder about how we will remain fiscally disciplined and not chase assets when the pricing is inconsistent with our financial criteria. With that, I’m pleased to announce the successful acquisition of Baum Lined Piping Gmbh. This is a business we have respected and followed for many years and is a perfect fit with our existing business. Baum significantly increases our scale, installed base, geographic coverage and breadth of product offerings in the specialized fluoropolymer lined pipe business, where we already are one of the leaders today for highly erosive and corrosive flow handling. Approximately 40% of sales are in the chemical space, a little under 10% to pharmaceutical, about 7% for hydrogen applications with the rest sold for a wide range of general industrial uses with a particular strength in high-purity applications, including those used in high-tech manufacturing, all perfectly aligned with this segment’s targeted higher growth end markets.

The business adds about $55 million of sales to our process flow technologies business with growth rates nicely above our segment average. Margins are currently slightly below the segment average, but together with expected synergies should be margin accretive within a few years. The purchase price was approximately $91 million, which is about 10 times expected 2023 EBITDA. We expect this acquisition will hit 10.5% ROIC with approximately 15% EPS accretion, excluding amortization by year three. A small acquisition, but it couldn’t be a better fit. And we continue to work on our funnel where we expect additional opportunities to become actionable over the next several quarters. My personal thanks to Mr. Markus Baum for entrusting Crane as the stewards of this outstanding second-generation family business to our care and the outstanding Baum team now part of Crane.

I’d like to share a few success stories in the quarter as well on core growth and share gains. Within Aerospace & Electronics. In the electric vertical takeoff and landing space, we secured contracts on two new platforms. One was a power conversion application using our DC to DC converters for a demonstrator program and another for proximity switches on the landing gear of another demonstrator. We continue to secure additional content on a number of six-gen fighter demonstrated programs, including solutions from our fluid, landing solutions and sensing solutions, with additional proposals recently submitted and pending. We secured key wins in our thermal management business with coolant pumps for two classified programs and activity remains robust with proposals in process or submitted for additional content on a number of programs across a wide range of our solutions, from power conversion and thermal management to proximity switches and antiskid brake control systems.

At Process Flow Technologies, we had a number of notable developments as well. Over the last two quarters, I highlighted the progress we are making with our new hydrogen initiative where we have qualified a new cryogenic valve for liquid hydrogen applications with a major OEM to be followed by five additional new product lines over the next 12 months, all targeting a market that is growing at more than 15% annually. We have now secured orders for new applications with two OEM customers. And before year-end, we expect to secure our first approval from at least one of the gas majors, which will position us to accelerate order intake, as we enter 2024. In the chemical space, we just had our best quarter for orders to date for our FK-TrieX product line with the value proposition of this recent product introduction resonating very well in certain markets, particularly for Chlor-Alkali.

Elsewhere in the chemical space, while new project activity has slowed, we were very successful in the quarter, winning a few larger project orders, and we continue to see pockets of active projects, particularly those expanding chemical capacity in the United States and product localization programs in China. In the wastewater space, earlier this month at the WEFTEC tradeshow, we probably introduced the latest extension of our premium efficient motor platform used in our wastewater pumps called brand named Envie. Since it was introduced in 2021, the Envie motor platform has seen explosive growth, and we are on track for a 300% growth in 2023. This latest extension, which increased our horsepower range from 75 to 125 horsepower will drive further growth in 2024, and we are actively working additional extension projects that will continue the momentum in 2025 or beyond.

My thanks to our global teams for all the hard work and effort and success both with our recent acquisition as well as on daily execution and our array of growth initiatives. Overall to-date, it’s been a year of great performance across our business, and we are increasingly turning our focus and attention to 2024 and beyond. And we remain confident in our ability to execute on the strategy and vision we laid out at our March Investor Day event. A 4% to 6% long-term core sales growth rate from resilient and durable businesses that derive about 40% of strategic growth platform sales from the aftermarket, with substantial operating leverage on top of already solid margins today. That should lead to double-digit average annual core profit growth with potential upside from capital deployment and with virtually no debt, the capital deployment opportunity is significant.

And a five-year vision to double revenues and get to a scale with $2 billion in sales at each of our strategic growth platforms with adjusted EBITDA margins above 20%, giving us the optionality for future strategic portfolio decisions. Now let me turn the call over to Rich for some more specifics on the quarter.

Rich Maue: Thank you, Max, and good morning, everyone. Another outstanding quarter with 9% core sales growth, driving 42% adjusted operating profit growth and driven by excellent performance across all businesses despite some end market and continued supply chain challenges. We are confident in both our outlook for 2023 and in our ability to drive significant growth in 2024 and beyond. Getting into the details, I will start off with segment comments that will compare the third quarter of 2023 to 2022, excluding special items, as outlined in our press release and slide presentation. Starting with Aerospace & Electronics, end market conditions remain robust, and that’s reflected in both our growth rate in the quarter and on a year-to-date basis.

On the commercial side of the business, aircraft retirements remained very low due to high demand and limitations on aircraft deliveries. This results in an aging fleet that requires more aftermarket parts and service and demand for new aircraft continues to exceed what the OEMs can deliver. And air traffic activity is also strong with global air traffic just a few points below pre-pandemic levels. In the United States, RPKs are 9% above 2019 levels with international travel recovering at a slightly more measured pace. Overall, just a great demand environment. For defense, RDT&E, or Research, Development, Test and Evaluation appropriations growth, along with procurement spending have been very strong over the last two quarters — sorry, last two years, and there is a growing sense of confidence in the industry that geopolitical issues will both result in the passing of the fiscal 2024 budget soon as well as resulting in additional investment reinforcing the broader defense industrial base.

And across both Commercial and Defense, we are positioned extremely well in many of the areas seeing the most significant interest and highest rates of growth. That strong demand was reflected in our third quarter growth rates with sales of $207 million, increasing 24% compared to last year, with some benefit from shipment timing as we did everything possible to accommodate our customers’ requirements and some linked quarter shipments that would otherwise have shipped early in the fourth quarter. Even with this high level of sales growth, backlog of $678 million increased 15% year-over-year, with a slight increase sequentially. In the quarter, total aftermarket sales increased 44% with commercial aftermarket sales up 39% and military aftermarket up 60%.

OE sales increased 16% in the quarter with 19% growth in Commercial and up 13% in Military. While the demand environment remains as strong as I can ever remember seeing it, our continued challenge is the supply chain. I would like to further expand on what I mean by the supply chain. This is not just related to on-time deliveries from suppliers. At the beginning of this year, we were one of the few that said, we did not expect significant improvements in the supply chain in 2023, but rather, we expected a more gradual recovery. Our position has not changed. Moreover, while demand is generally back to 2019 levels, the broader supply infrastructure is not spanning the gamut from raw materials, components and labor not only in terms of availability, but also experience levels.

Areas of specific shortages continue to shift and evolve. Over the last quarter, we have seen greater stability in the supply of Electronic Components. However, as we see improvements in one area, we are seeing new constraints in others like Machine Components, particularly from smaller suppliers. Our suppliers and sub-suppliers are also managing through shortages of skilled labor. While we have navigated these shortages extremely well, they do introduce added costs. For example, we have had increased costs relating to expediting shipments due to supply chain issues as well as costs associated with qualifying new suppliers and adding second sources. At Crane, we have always prioritized safety, quality, delivery before cost, and we did that in the quarter doing everything possible to accommodate our customers, as we believe that is the best approach to maximizing value overtime.

Segment margins of 19.4% increased significantly, up 250 basis points compared to last year, primarily reflecting leverage on the higher volumes and productivity. Regarding full year 2023 guidance, we raised the core sales outlook from 14% to 16%, reflecting the very strong third quarter. For the fourth quarter specifically, that implies sales down modestly compared to the third quarter, but still well ahead of the first half run rate due to the shipment timing I mentioned earlier. No change to our full year revised margin target of 20.3%, reflecting 200 basis points of improvement compared to last year and implying 33% leverage for the full year, even in the face of all the challenges the industry is facing. We will give detailed guidance when we report fourth quarter results in January.

However, based on what we can see today and assuming continued gradual improvement in the supply chain, we expect sales in 2024 to increase above our long-term 7% to 9% sales CAGR forecast with operating leverage in our targeted 35% to 40% range. In the near-term, we remain towards the lower end of that range as we expect these broad inefficiencies to persist into 2024, while continuing to improve gradually. However, we are confident that the actions we are taking today being appropriately assertive on pricing where we still have significant opportunities as we move forward, continuing to drive productivity, expediting and adjusting staffing in our factories to manage the supply chain, and continuing to make investments in new technology, position us very well for strong leverage and margin expansion in 2024 and beyond.

At Process Flow Technologies, as we have explained previously, we are extremely well-positioned to continue to outgrow our markets even though we have seen some signs of slowing demand as expected and messaging all year and consistent with our full year outlook provided in January. The softness remains largely confined to European chemical, non-residential construction, and industrial markets as well as some project pushouts in North America, though we did see some nice project wins in the quarter. As a reminder, if you look at prior cycles, given our specific product exposures, we typically see slowing activity a few quarters before many others playing in the broader process markets. But as displayed in 2021 in previous cycles, we also tend to recover a few quarters earlier.

We continue to focus on what’s in our control, namely gaining share to outgrow our end markets. Orders in the third quarter were better than expected and driven by key project wins rather than a fundamental change to our market outlook. We still expect negative orders in the last few months of 2023, and through most of 2024 before we see a positive inflection, likely late next year. In the quarter itself, we delivered sales of $267 million, up 7%, driven by 5% core sales growth and a 2% benefit from favorable foreign exchange. Adjusted operating margins of 19.2% increased 240 basis points from last year, primarily reflecting strong value pricing and productivity gains, partially offset by unfavorable mix. Compared to the prior year, core FX-neutral backlog decreased 2% and core FX-neutral orders increased slightly sequentially compared to the second quarter FX-neutral backlog increased 1% with FX-neutral orders up 7%.

Order rates and backlog levels are consistent with or slightly better than the trends we have talked about since the start of the year, reflecting some modest slowing in a few markets as well as the natural impact of shortening lead-times as the supply chain continues to improve. For the full year, we continue to expect 6% core sales growth with contribution from the Baum acquisition starting in the fourth quarter of about $12 million, adding about a point to the full year. We are raising our full year margin guidance by 90 basis points to 19.4%, more than 300 basis points above last year’s record 16.2%, reflecting continued execution on our stated goal of driving an average of 100 basis points of margin improvement per year. In 2019, just before COVID, margins were 13.6%, and when we hit our guidance this year, we will have far more than outpaced that 100 basis point average.

Reflecting on the full year guidance as a whole, our 6% core growth is driving an impressive 29% improvement in operating profit or 66% full year operating leverage. Remember that the operating leverage reflects a number of factors including strong operational execution, value pricing and continued structural change in the business. That structural change includes an ongoing mix shift where today nearly two-thirds of the business is positioned in our core target markets of chemical, pharmaceutical, water, wastewater and industrial automation. It’s those markets where we have the greatest differentiation and the best ability to create value for our customers. These are also the markets where boundline piping participates today, a perfect addition to the portfolio.

We also continue to invest for the future with new product introductions released at record pace and with structurally higher margins. New product vitality metrics continue to improve year-after-year, giving us high confidence in the 3% to 5% growth profile through the cycle and the substantial opportunity to further expand margins. For the fourth quarter, our guidance does imply a step down of margins consistent with our commentary throughout the year. We did outperform expectations in the third quarter driven by strong pricing net of inflation and productivity, along with more favorable mix than expected. In the fourth quarter, as we have discussed previously, we do expect a seasonal slowdown, less favorable mix, given the slowdown in our chemical market and some higher investment spending.

Remember that some of the significant factors that resulted in stronger first half margins relative to the second half were timing related. And when you think about margins for 2024, you should base them off our full-year margin guidance of 19.4%, not the fourth quarter rate as we exit the year. For 2024 specifically, we are just entering operating plan review process where we will refine our outlook. At this point for the segment, we expect core sales next year to be relatively flat, perhaps up or down a few points before reaccelerating in 2025. With that sales outlook, we would expect margins to be flat to up modestly next year. The Baum acquisition should contribute approximately $55 million of sales with no material impact on margins. At engineered materials, sales of $56 million decreased 11% compared to the prior year as expected.

Adjusted operating profit margins increased 290 basis points to a solid 13.7% with lower volumes heavily offset by lower inflation and strong productivity and reflecting another impressive deleverage rate. For the full year, we continue to expect a sales decline of 14%, but we now expect margins of 14%, up from the prior guidance of 12.2%, reflecting the team’s great execution. As a reminder, the fourth quarter is always seasonally softest of the year for this business given customer shutdowns between Thanksgiving and the New Year. Moving on to total company results. In the third quarter, adjusted free cash flow was $82 million. Total debt at the end of the third quarter was $250 million, with $274 million of cash on hand. At the beginning of October, after the end of the third quarter, we drew $100 million on our revolving credit facility to fund the Baum acquisition.

We also increased the size of our revolving credit facility to $800 million from $500 million with the same terms as the original credit facility. The higher limit will give us more flexibility for small to mid-sized acquisitions in the quarters and years ahead. We continue to have substantial financial flexibility with more than $1 billion in M&A capacity today, reaching and reaching as much as $4 billion by 2028. While this is more financial flexibility than we have historically had, our capital allocation strategy is unchanged. We will deploy our capital with the same strict financial and strategic discipline that we always have, prioritizing internal investments for growth, followed by M&A and returns to shareholders. Now turning to other elements of our guidance for 2023.

We increased and narrowed our adjusted EPS guidance range to $405 million to $420 million from the prior range of $3.80 to $4.10, with adjusted EBITDA guidance now at $366 million or 17.6%. While I have already discussed the segment details, the primary drivers of the increased guidance are higher core sales growth now in a range of 6% to 8%, up a point from prior guidance and adjusted operating margins of 15.7%, up 60 basis points from prior guidance. Those items are partially offset by higher non-operating expense, which is primarily interest, up $1 million to $16 million for the year, slightly higher corporate expenses of $72 million, reflecting higher compensation expense due to our outperformance year-to-date and a diluted count of $57.5 million in shares slightly above prior guidance.

So another great quarter following our separation and demonstrating that we can deliver in any environment and a very strong balance sheet and free cash generation to support value-creating capital deployment. Operator, we are now ready to take our first question.

See also 16 Best Places to Retire in Norway and 20 Biggest Countries With Mandatory Military Service.

Q&A Session

Operator: Thank you. [Operator Instructions] And our first question today is from the line of Scott Deuschle with Deutsche Bank. Please proceed with your questions.

Scott Deuschle: Hey, good morning.

Max Mitchell: Good morning, Scott.

Rich Maue: Good morning, Scott.

Scott Deuschle: Rich, why do A&E sales go down sequentially in the fourth quarter?

Rich Maue: A&E sales will be down modestly. To your point, it’s just largely timing associated with what we were able to deliver here in Q3. So we did have some accelerated shipments. So our expectation is that we won’t need to do that in Q4. So really, it was a little bit more than expected here in Q3 at the expense of Q4 slightly.

Scott Deuschle: Okay. And sorry, if I missed it, but can you say what the third quarter price realizations were at both A&E and PFT.

Rich Maue: Yeah, I didn’t mention it on the prepared remarks, but I would tell you that price cost was quite solid overall for the business. In A&E, I would say it was definitely accretive but not anywhere near as much as it had historically been in the first half of the year. So we did see some of that sort of close a little bit. It was still modestly accretive, but not as much as historical — historically in the first half. And then I would say at PFT, it was accretive to the overall margin profile.

Scott Deuschle: Okay. And then last question for Max. How would you characterize the ability of the company to benefit from these accelerated shop visits on GTF, I think you’ll have some engine content there. So curious how you’d frame the impact to aftermarket sales over the next few years as a result of those accelerated shop visits? Thank you.

Max Mitchell: Yeah. So on the GTF, when the engines are taken off wing earlier than expected, our products tend to be serviced as well, right? So we are seeing a modest acceleration relative to what we would have originally expected. Relative to the overall business at this point, I wouldn’t say that it’s material. But it has been slightly helpful to aftermarket growth rates recently and would expect it to continue to be.

A – Max Mitchell: But we don’t see it, Scott, as a significant impact for us.

Scott Deuschle: Okay. Got it. Thank you.

Operator: Our next question is from the line of Damian Karas with UBS. Please proceed with your question.

A – Max Mitchell: Good morning, Damian

Damian Karas: Hi, good morning, guys. Congrats on the continued demand momentum you’re seeing. So I think the one thing that kind of look out was you saw this aftermarket surge, if you will, but yet you had that kind of some, I guess, lighter incremental margins, if you will, for A&E. Is the right way to interpret what you’ve said that you basically saw a step backwards in the supply chain conditions or something else to kind of factor in there? And Rich, you highlighted, right, your expectations that in 2024, you’ll see much stronger margin expansion. What kind of incrementals should we be thinking?

A – Rich Maue: In 2024?

Damian Karas: Yes.

A – Rich Maue: Yes. So — so I’ll answer that portion first. So in 2024, we would expect to see close to a couple of hundred basis points of margin improvement, which, on our guide on the top line would imply somewhere in that 35% to 40% range. We’re still got to go through our plan process as you know, Damian, but we would expect it to be somewhere in that range. And just given the supply chain itself, we’re thinking that it might be towards the lower end of that range, but in the range.

A – Max Mitchell: Damian, I wouldn’t suggest that the supply chain took a step backwards. I would say that we took a step forward in addressing some of the challenges we have to try to expedite material and delivery to our customers. I don’t know if you want to frame up a little bit how we’re thinking about

A – Rich Maue: Yes, I think it impact…

A – Max Mitchell: Quarter — Q3 to Q4

A – Rich Maue: Yes. I think that’s right, Damian, in the quarter. We certainly were doing all we could to make sure that we were delivering to our customers. And with that comes a bit more higher expedite charges you might have. We’ve done — I think we’ve done a fantastic job just generally with establishing second sources, which requires requalification costs and so forth. And frankly, those are going to be cost with a fantastic payback in the future as we’ll have a more, I guess, diverse supply base from which to satisfy our demand in the future. So we certainly had more of those costs in the third quarter, then I would say we did maybe in the first half Look, if I was to give you the overall from Q3 to Q4 in terms of what we would otherwise — what you would otherwise expect on the revenue growth because we did have the higher revenue growth.

We had some favorability in aftermarket. We would have expected or the math would simply suggest $5 million or $6 million more in OPay. And it really is a combination of what I just mentioned, that might be maybe half of maybe half of those costs that I just mentioned represent that half of that $5 million to $6 million or so. We also had higher material costs in the quarter. I would say maybe 20% of that $5 million to $6 million relates to price cost, getting a little bit at Scott’s question. It wasn’t as accretive as we saw at the beginning of the year. And then about 30% or so relates to higher program costs generally just because of all the recent program wins. But I would tell you, though, that these are costs that we largely expected.

There were some incremental, so that 5% to 6% is the simple math from Q3 to Q4. But if you step way back and look at your full year, the leverage rate that we expected to hit this year relative to our January guidance, we raised revenue $40 million since January, and we’ve raised OP guidance by $12 million, right? And so you do that math. And on a net basis, our total cost profile, you could argue, is up maybe $1.5 million, right? It’s a small amount. But to kind of explain that Q3 to Q4, those would be the elements.

Max Mitchell: Yes. And just remember that part of that is timing elements, right? So the requalification second sourcing has a payback the price cost, which was a little less favorable in the quarter, we got very good pricing have been in this business. It just comes with a little bit more of a lag than in process flow technologies, right? So these are not structural or permanent. This is a weather-specific transient issue.