Watts Water Technologies Inc. Q1 2023 Earnings Call
Core volume and incremental investments.
As a result of our strong earnings and expected cash flows for the remainder of 2023, we announced a 20% dividend increase starting with our payment in June our balance.
Sheet remains strong and provides ample capacity to afford us flexibility in our capital allocation strategy.
From an operations perspective, we acquired the assets and where Australia in an all cash transaction that closed at the beginning of the second quarter.
<unk> is a leading supplier of specialty plumbing and safety equipment with annual sales of approximately $30 million, primarily within the Australian institutional and commercial market.
This acquisition broadens, our product offering and channel access in a region with well established and tightly enforced plumbing codes a criteria that is well aligned with our strategy.
We welcome our new and where colleagues to what's the integration process has started and is progressing well.
And where will be reported in the <unk> segment.
On the inflation front, we continue to see cost increases across material labor overhead and other fixed costs, while the inflation rate has moderated from 2022 levels. It is still above normal historical levels and commodities are again beginning to rise.
As a result, we continue to assess our price cost relationship and rolled out additional price increases late in the first quarter.
I also want to mention that we'll be issuing our annual sustainability report during the second quarter.
Our teams have made tremendous progress advancing our ESG strategy and initiatives and we're looking forward to sharing this with you so stay tuned.
Next I'd like to provide an update on our end markets from a macro perspective global GDP, which is a proxy for our repair and replacement business is lower than last year, but remains positive and our key markets.
Europe has remained more resilient than we had anticipated as the energy subsidies continue to support our business in Germany, and Italy. However, new building permits have been trending downwards, and we're monitoring that closely.
In the Americas as expected new residential single family construction has been weak with single family starts down double digits.
<unk> family construction is up from the annual pace in 2022, but showed a sequential decline in March which may be an early indication of slowing in the multifamily market.
In the Americas nonresidential, new construction indicators are mixed despite the March reading slightly above 50. The Abi has been below 50 for several quarters portending, a slowing towards the end of 2023.
However, the Dodge momentum index continues to be in expansion territory, suggesting growth in nonresidential projects will continue throughout 2023.
Certain sectors have been stronger, including institutional which encompasses healthcare and education as well as data center projects in food and beverage.
In the Asia Pacific Region, China end markets were resilient in the first quarter with data center demand remaining strong and offsetting the slowing in residential new construction and our under floor heating business we.
We're seeing improving markets in the middle East due to continued higher oil prices. However, the rising interest rates have begun to impact new construction in Australia, and New Zealand.
Now an update on our outlook for the second quarter and the remainder of the year.
We expect our year over year second quarter topline organic growth to be muted due to the very strong second quarter. We had in 2022 with double digit growth. We also anticipate declining operating margins due to the reduced volume incremental investments and the onetime benefit of approximately $7 million, we secured in the second.
<unk> 2022 from our proactive investment in inventory at lower cost combined with higher price.
Due to our Q1 performance and our expectations for Q2, we are increasing our full year outlook for operating margin expansion.
The solid first quarter margin performance, plus favorable price and mix should mitigate expected second half market headwinds.
We are maintaining our full year organic sales growth outlook consistent with our guidance in February we remain cautious on the second half of 2023 due to the potential impact of rising interest rates lending tightening on new construction and persistent inflation.
We expect and where to add approximately $20 million of sales in 2023 with very little contribution to operating margin as we work on integration and adjusting the cost structure.
With that let me turn the call over to Shashank, who will address our first quarter results and our second quarter and our revised full year outlook Shashank.
Thanks, Bob and good morning, everyone. Please turn to slide four and I will review the first quarter's consolidated results.
Sales of $472 million were up 2% on a reported basis and up 4% organically.
As Bob mentioned, we drove growth in all regions. Despite the tough comparison.
Very strong first quarter in 2022.
Foreign exchange, primarily driven by a weaker euro reduced sales by approximately $9 million.
Four 2% versus 2022.
Adjusted operating profit was $84 million up 16% compared to last year and adjusted earnings per share were up 18% to $1 92.
Adjusted operating margin of 17, 9% was up 220 basis points as price mix and productivity more than offset inflation lower volume and incremental investments.
Adjusted effective tax rate was 22, 5% 40 basis points higher than the first quarter of 2022, the slight increase relates primarily to the changes in worldwide earnings mix.
Our free cash flow for the quarter was $28 million as compared to negative cash flow of $8 million in the first quarter of last year.
The cash flow increase was primarily due to higher net income and lower investment in inventory.
We expect sequential improvement in our free cash flow and our full year goal is to achieve free cash flow conversion of 100% or more of net income as previously communicated.
During the quarter, we repurchased approximately 22000 shares of <unk>.
Our common stock for $4 million and as Bob mentioned announced a 20% increase in our dividend starting in June .
Please turn to slide five let me provide a few comments on the regional results.
The Americas had a solid quarter with organic sales up approximately 3% despite a tough prior year comparison.
The growth was primarily driven by price realization across the majority of our platforms and channels.
As expected, we did see softening in our residential end markets, which mainly impacted our OEM and specialty channels.
Adjusted operating profit increased by 25% and adjusted operating margin increased by 400 basis points.
The margin expansion was driven by price mix and productivity, which more than offset volume declines inflation and incremental investments.
Europe demonstrated resiliency with organic sales up approximately 4%.
Reported sales were negatively impacted by 5% from unfavorable foreign exchange movements.
Growth was primarily due to price with growth in Germany, and Italy, driven by our OEM business and in France, and Benelux through solid wholesale activity.
As a reminder, we stopped our direct shipments to Russia in April 2022, and we estimate the impact of that to be approximately $2 million in the first quarter.
Operating margin declined by 250 basis points as price and productivity or unable to fully offset inflation and volume deleverage.
<unk> also had a solid quarter delivering 11% organic growth.
Reported sales growth of 4% was negatively impacted by 7% from unfavorable foreign exchange movements.
China's organic sales grew double digits, primarily from commercial valves sold into data centers.
Organic sales outside China were up by high single digits with growth in Australia and in the Middle East, partially offset by a decline in New Zealand due to historic flooding.
Adjusted operating margin increased by 490 basis points due to higher third party sales volume affiliate volume price and productivity, which more than offset inflation.
Slide six provides our assumptions about our second quarter and full year operating outlook.
First let's cover the second quarter outlook.
As Bob mentioned, we have a very tough comparison to a strong second quarter in 2022.
We estimate consolidated organic sales may be flat to down 4% with low single digit declines in the Americas, and Europe , offset partly by low single digit growth in apnea.
In addition, we expect approximately $7 million of sales from the acquisition of <unk>.
We estimate our adjusted operating margin could range from 17, two to 17, 8% for the second quarter down 70 basis points to 130 basis points versus prior year.
The decline is due to the reduced volume incremental investments of approximately $5 million and the one time benefit of $7 million. We spoke about in the second quarter of 2022 from a proactive investment in inventory at lower cost combined with higher price.
In addition, we expect <unk> acquisition to be dilutive to operating margin as we work to rightsize the cost structure.
Corporate costs should be approximately $13 million and interest expense should be approximately $2 million in the second quarter.
The adjusted effective tax rate should be approximately 25%.
We are now assuming a 1.09 average euro U S dollar FX rates for Q2 versus the average rate of Euro 1.07 in Q2 2022.
This implies an increase of 2% year over year in Q2, which equates to an increase of approximately $2 million.
In Europe sales and <unk> a share in EPS versus prior year.
Now, let's cover the full year outlook.
For the full year 2023, we are maintaining our prior outlook of minus 5% to plus 2% consolidated organic growth.
We believe that a better than expected start in the first quarter, we will be able to offset potential weakening in multifamily and nonresidential new construction.
In addition, we expect approximately $20 million of sales from the acquisition of <unk>.
While we are maintaining our organic top line outlook, we are increasing our full year adjusted operating margin contraction to a range of minus 70 to minus 10 basis points.
Third to our previous outlook of minus 102 minus 40 basis points.
We now expect our adjusted operating margins to be between $15, seven and 16, 3%.
We expect our solid first quarter plus price and productivity.
Offset potential further weakness in the second half and the dilutive impact of the <unk> acquisition.
Our free cash flow expectations are anticipated to be in line with our previous outlook from February and should meet or exceed 100% of net income.
We are now assuming a 1.09 average euro U S dollar FX rate for the full year versus the average rate of Euro 1.05 in 2022.
This would imply an increase of 4% in sales year over year and equates to an increase of $12 million in Europe sales and four a share in EPS for the full year versus prior year.
And regarding other key inputs for the full year.
We expect corporate cost to be approximately $52 million for the full year.
Interest expense should be roughly $8 million for the full year our.
Our estimated adjusted effective tax rate for 2023 should be approximately 25% cap.
Capital spending is expected to be in the $42 million range.
Depreciation and amortization should also be approximately $42 million for the year.
Expect our share count to be approximately $33 5 million for the year.
Now, let me turn the call back over to Bob before we begin Q&A Bob.
Thanks for shrink on slide seven I'd like to summarize our discussion before we address your questions. The.
The first quarter was better than we anticipated with record first quarter sales operating margin and earnings per share supported by price some favorable mix.
While we expect muted top line growth in the second quarter due to challenging prior year comparisons we are increasing our full year operating margin expansion outlook and are maintaining our full year organic sales growth expectations.
We acquired and where Australia and are working on integration into the watch portfolio. We continue to stay on top of the price cost dynamic and adjust as needed.
<unk> the weakening macros will continue to make incremental investments in new product development and to drive our smart and connected strategy and in automation to drive productivity. We are also increasing our dividends by 20%.
We are well positioned financially operationally and commercially to take advantage of market opportunities as they arise and I'm confident in our team's ability to execute in this uncertain environment.
With that operator, please open the lines for questions.
At this time I would like to remind everyone in order to ask a question press star followed by the number one on your telephone keypad.
Your first question is from the line of Mike Halloran with Baird. Your line is open.
Hey, good morning, everyone.
Good morning.
So a couple of questions here first.
I certainly understand the leading indicators side of things, particularly for some of the multifamily API everything like that but when you look at the core business you have today, leaving aside the residential piece single family.
Are you seeing in North America.
Deterioration happening at this point in time or is it still perspective, and any any kind of channel oriented commentary would be great.
Yes, Mike I think we're really seeing in the residential single family side, that's where we're down we're seeing it in the Oems we saw more destocking in Q1 and expecting a little more OEM destocking in Q2, So that's where we're really seeing it I would say multifamily is holding up and.
Non <unk> is holding up also.
And any nuance on the non res side worth mentioning because non res is a.
Awfully big market with a ton of different constituents.
Again, our product doesn't really care what market. It goes into office buildings are down and institutional up it just shifts right. So with the labor shortages in the construction market right now the contractors are still busy and these jobs are continuing to happen, but like as you said, we are watching the leading indicators because we're a short.
Cycle business.
And then second one on the margins here.
Obviously, the really strong performance in the first quarter North America. In particular, you look back over the last four five quarters, frankly longer but last four five quarters you've been hovering.
Well in the low twenties on it all in here you look at how the guidance seems to cadence out diesel on the margins through the year could you just talk about the puts and takes it seems like that's just mostly tied to the volume side of things. Obviously, there is a <unk> <unk> year over year comp that you mentioned with the $7 million, but anything else.
I would point to the sell other than just caution about the environment or is there something else in that margin profile one worth mentioning.
Yes, so there's a couple of things right. So firstly, we did have some slightly favorable mix in the first quarter as we sell less and single family residential the module that tend to be lower so there is some mix favorability that helped Americas and then secondly on the price cost side. If you recall, we had price increases pretty much consistently every.
Quarter, we start lapping those starting in the second quarter. The first quarter, we still got benefit of most of the four increases we had last year. So that helped our margin profile and then finally on the on the cost side of the equation.
Certainly on the inflation as Bob as Bob noted inflation has moderated we saw that in Q1 beyond commodities and things like logistics costs et cetera, et cetera inflation was allowed to us.
Thanks, Jane Thanks, Bob I appreciate it thank.
Thank you.
Your next question comes from the line of Jeff Hammond with Keybanc. Your line is open.
Hey, good morning, guys.
Morning.
Can you just speak to what Youre seeing in the channel around any.
Destocking, maybe beyond residential just.
Fly change get better if youre seeing any of that in the channel.
Yes, I think.
Electronics is still spotty from a supply chain issue point of view I would say as I said earlier the destocking is more in the OEM residential side wholesale we're watching it we're seeing it.
It's harder for us to see because we don't have a lot of visibility into all the wholesale channel, but it seems like its stabilized we're still watching that very closely but in general.
It's more of the softness is on the residential side.
Okay, and then just back on the margins. It seems like <unk> is always a step up from one <unk> as you get the seasonal volume but.
Guide is kind of suggesting margins are kind of flat to down.
It seems like.
The price cost gap is getting wider and youre seeing some moderation in inflation and we've had a lot of companies talk about.
Just supply chain friction expedited freight.
Zero spot buys kind of normalize.
See some of that drop to the bottom line. So I just don't know if there is there something I'm missing there.
Yes, a couple of things. So obviously, we had a little bit.
More volume leverage in Q1 versus Q2, because Q1, we grew the business at about 4% at the midpoint on the Grad Guide is about a 2% decline. So there is some volume deleverage in the second quarter and back to that pricing dynamic as I said earlier that we had the benefit of full prices has increased in Q1 that starts fading in the second.
Quarter, so in Q1.
Sterilization mid to high single digits will talk about the second quarter. When we closed out the second quarter, but our expectation is it'll be less so that impacts the margins.
Okay.
And then just.
Back on kind of non res maybe can you just speak to your lead indicator products remind us what those are and what youre seeing there that would maybe signal or not signal a slowdown in commercial construction.
Yes in general things are holding up we did see a slight decrease in some of our drains but that was based on some lumpy business project business in the prior year. So I think it's basically holding steady at this point, Mike I think Jeff what we're doing is continuing to talk to our channels are key.
Contractors', they continue to be busy they have a backlog of work. So that's how we're watching the leading indicators are longer term, but.
Feet on the street talking to what's happening out there is what we're really watching at this point in time and as I said earlier labor shortages are prolonging. This so there is a backlog of jobs I think as we said as we get into the second half, that's where we're being a little cautious at this point in time to watch that again, we're a book and ship business.
Okay. Thanks, so much thanks.
Thanks, Jeff.
Your next question comes from the line of Nathan Jones with Stifel. Your line is open.
Good morning, everyone.
Good morning.
Maybe a question on the <unk> acquisition, I mean that pretty soon.
Pretty significantly on a relative basis, I think to the business in Australia.
Can you talk about how you how you leverage that business to grow do you need to.
Make more acquisitions that build scale, what's the strategic plan with that.
Yes, so and we're looking at it's in Sydney designs engineers, and manufacturers specialty plumbing and safety equipment and it fits nicely, it's quite honestly a turnaround for us it's basically a breakeven business teams already at work integrating that and we like the channel access to bring our other products with it.
As well as they did a lot of what I call.
Sourcing locally and we will leverage our global sourcing.
Business, but overall it gives us scale as well as it gives us additional channel access for our existing products.
Hi.
Do you need to build further scale to really.
Leverage channels intuition.
And things like that like is that a strategic priority at respond I know you've looked to move into.
Developed markets that have strong plumbing codes.
<unk>.
Do you need to build more scale in Australia or wherever else you choose to go in order to leverage this business properly.
Yes in general I would say our whole apnea region, we want to continue to scale and leverage that so we're looking for quality acquisitions that give us channel access we've been building a nice position both in Australia, and New Zealand now accumulative three acquisitions Thats given us.
Some good numbers in total it's going to be probably more than half of our business now in apnea. When you add all this together so we've been building scale, we've been building capabilities and like you said, we want to be in co developed countries that.
Which is really important and the second part is that enforced codes. That's the important thing. So that's why we like that region of the world and again, it's more about focus.
That business, it's they've tried to be everything to everyone and were being 80 20 focused in.
Re evaluating the whole product portfolio and mix and sourcing capabilities in that organization.
You just let me know when you want to take me to say that business.
Yeah.
The question Thanks, Sean.
Okay.
Sure my inviting them now.
Just staying on the Europe margins.
Yes, we've got 200 bps year over year, but given the volume leverage in the high fixed cost base there I thought.
Pretty good performance out of Europe can you maybe provide some more color on on the margin profile of the contributing factors too.
Pretty decent margin performance, there and how we should think about that going forward.
Yes, if you recall last year in the first half we had very robust margins in Europe , leveraging the volume.
They dropped off pretty significantly in the second half as the volume came down and we had we had a high fixed cost base.
You recall, we took restructuring actions in Europe in Q4 and early on in January and that's certainly helping and thats, helping the margins in Q1 as well as the fact that the volumes came in better than we had anticipated in Europe , so less volume deleverage than we thought.
And that was obviously the strength in Italy, Germany, a little bit in France and Benelux.
Those regions came in better so there was less volume deleverage and that's why the margin profile is better.
Great. Thanks, very much for taking my questions. Thank.
Thank you.
Your next question is from the line of Michael Anastasio with TD Cowen Your line is open.
Hey, good morning, guys. Thanks for taking my question.
Good morning.
You had mentioned earlier prices about high single digit in the quarter can you just dive into sort of a price impact expected.
For the remainder of the year.
Yes. So we had said first quarter was mid to high single digit price realization.
We don't really comment on price until we close out the cost quarters, because now we're going onto to Es plus with price increases, but the expectation when we did our call about three months ago, we expected in the low single digits for the full year. So that does come down as we go through the year, just because we comp higher price realizations last year.
Okay.
Great. Thank you and then just on the.
General commercial side and kind of multifamily and stuff like that can you just comment on sort of the cadence throughout the quarter anything in particular that would be.
We're seeing there.
No I commented earlier that it's been holding up where we're seeing the softness.
Single family side of the business.
That's where most of the issues are at this point in time as well as the OEM Destocking that we're seeing.
Okay.
Okay.
Again, if you would like to ask a question press star followed by the number one on your telephone keypad.
Your next question is from the line of Walt Liptak with Seaport Global Your line is open.
Hi, good morning, everyone.
Well.
Hey, good morning, Shashank I'm ready to go to visit them were too. So just let me know.
[laughter].
Okay.
To ask a follow on to the Vmware question.
It sounds like with the turnaround loved to hear the 80 20 being talked about that's great.
Could you talk about what normal margins would look like for <unk>.
In the future and then how much how long does it take to get them there.
Well, we're expecting basically breakeven now and then we will continue to ramp up over the next three years to get it back in line with the over the overall Athenaeum type margin. So that's our goal. The teams are working aggressively and have already taken aggressive actions already so teams on the ground, making good strides.
Okay, Great and then on.
Just kind of M&A more generally it's good to see you guys get one done.
Here is.
The rising interest rate environment.
Seeing more deals come into the pipeline from private equity or whoever.
And are you seeing any changes in valuations.
I would say in general I mean, M&A activity is still out there.
It's hard to comment on it because it takes two people to get their minds around whether they want to sell or not but our pipelines full we look at small medium and large acquisitions.
We're I would say it's about the same we're continuing to monitor it but.
I don't think the environment has changed that substantially at this point in time.
Okay, Alright, great and then.
I don't think I've ever asked a question about this.
Of any company before but the dividend increase I think you said it was 20% is it.
Power for you guys or is there something that we should read through about the cash levels.
Our uses for cash.
Uh huh.
I Wonder if you could just comment on that.
Yes, we tend to drive to a median yield of about 0.9%, which is kind of in line with the median for the water space.
Back in the pandemic days of 2020, we didn't have any increase so we fell a little bit behind because of that as well as our EPS has obviously done well.
And our stock price has done well so in order to try to get back to that median level of 0.9%. That's why we had the 20% increase so beyond that there is no need to read anything else into that.
Okay, great. Okay. Thank you.
Thanks.
Your next question is from the line of Brian Lee with Goldman Sachs. Your line is open.
Hey, everyone. This is michelle on for Brian .
And you got a question.
Question, Hi, everyone. Just a follow up question on <unk> again, you said it would take about three years to sort of fully get it get that business up to the overall margin levels.
Could you just maybe talk through specifically what are the levers to get you there or do you need to grow that business to a certain scale is it a combination of that plus.
Integrating the operations working on cost structure, just any additional color that would be what would be great. Thanks.
Well it certainly all of the above but I would tell you. The first focus is on profitable growth, which you know our playbook. So if anything volume is going to go down in the short term.
Because we are in a rationalized products again, the 80 20 concept of making sure we're producing and manufacturing.
Products that make money and then the second thing it's about focus and the team is looking most of their product was sourced locally we're going to leverage our global sourcing capabilities around the world, including our global plants to optimize some of the production of that material. So it's about focus it's about right sizing the business.
And potentially decreasing the sales volume to get the profitability again similar to what we've done and what's here.
Great. That's helpful. And then just a quick follow on historically can you give a sense of.
Maybe how quickly that business had been growing in Australia, and then Youre talking about maybe right sizing in the near term so what does that look like.
In terms of the near term growth rate for that business then.
In general it's mid single digits.
But as I always tell anybody can give away products right and get the growth. So it's about leveraging.
Overall profitability, but our goal is to get that in the mid single digit growth.
Okay, great. Thanks, that's very clear I'll pass it on thank.
Thank you.
Again, if you would like to ask a question. Please press star followed by the number one on your telephone keypad.
There are no further questions at this time I will now turn the call back over to Mr. Bob Pagano.
Thank you for taking the time to join US today. We appreciate your continued interest in <unk> and look forward to speaking with you again at our second quarter earnings call in early August have a good day and stay safe.
Ladies and gentlemen. This concludes today's conference call you may now disconnect.
Okay.
Yeah.
Yeah.
Yeah.