Q&A. So thanks very much.
Yes, y ou bet. Thanks for hosting, Julian.
Of course.
It's really good timing for Allegion to be here. You know, we released Q4 and gave our 2024 guide just Tuesday of this week.
Very proud of what the team accomplished in 2023. It was a record year by almost every measure. Record revenues, record adjusted operating income, record EPS. So really proud of what the team put together, and as you heard on Tuesday, we think 2024 is gonna be better. You know, Allegion has a strong market position in a good industry, and in that good industry, we by far have the highest margins. We don't feel like we've hit a ceiling, as heard on the call.
The secular trends that are driving electronic hardware, connected hardware adoption, with the continued and increased use of digital identities and digital credentials, that's still underway. That's still driving growth Yeah -for Allegion, and then we feel very strongly that we're an innovation leader in that space. Cash flow was very strong this year. Gonna be better in 2024. As you saw on the earnings call, very balanced, very disciplined capital allocation, to profitably grow the business through acquisitions, as well as direct, return cash to shareholders. And I think it's very much within the realm of possibility to see more quarters like that from Allegion going forward. So we're excited about, what the future offers. You add all that up, I think we're one of the most compelling companies here.
Fantastic. Thanks so much, John. And maybe just start off with just, you know, organic growth outlook, let's say, for the year ahead. You know, I think you talked about sort of the Americas, let's start with that. You know, the residential market, sort of not much growth there, more on non-residential side. So maybe sort of far out in non-residential, kind of what you see are some of the, the headwinds and tailwinds. You've got a very strong market presence, so you have a good sort of feel of different verticals.
Yes, I think consistent with the call on Tuesday, when you roll it all up, now we see organic growth between 1.5% and 3.5%. As you disaggregate that, you're right. We don't see a lot of market tailwinds in the very near term, in residential. So we'd see that as flat-ish to maybe down a point. In the non-res side, we highlighted in the call, Dodge starts in the institutional segment are still positive. You know, starts can lead our business by a year or more in some cases.
So, you know, our demand generation model in this classic pull strategy we have through distribution means we have kind of a steady stream of business there through the aftermarket, through new construction and institutional. On the commercial side of non-res, that's where you've got more of a mixed bag, and so that's about 30% of our Americas business, and we tend to bucket that as like a third in multifamily, commercial office, and then everything else would be things like, retail data centers, warehouse, manufacturing, s ome strength and weakness in that other segment.
Multifamily and certainly commercial office, we've been talking about this several quarters in a row, is under some pressure. But don't forget, you know, half our business is aftermarket, which tends to be pretty stable as well. Yeah. We would see that continuing in 2024.
Perfect. When you think about the sort of multifamily and office piece, I know that's something that investors are always focused on, you know, with Allegion, for example, and some other companies. How well is that aftermarket holding up? How well has it held up, say, last year, when greenfield started to come under pressure, and you sort of think it carries on holding up well, from here?
I'd say aftermarket in general is less volatile than new construction t hat shouldn't be surprising. And I would say that holds true in multifamily and in office. So while you might not see a lot of new office towers being built in big cities, you do see tenant turnover from time to time and repurposing of space, and that's still a good business for us.
On the pricing side, I think you've always had very good pricing at Allegion in different environments of inflation, more or less. When you think about pricing in, you know, areas like mechanical, residential, and commercial, multifamily and office, do you see more pressure because of volume pressure in Greenfield or not necessarily? Like the degree of price pressure is no different.
Yes. I think certainly, and this would be consistent with past comments as well, our market position, our pricing power in the non-res s pace is stronger than it is in residential. So, you know, I think the fact that we're, you know, consulting on the design, we're in early on the design with the architect. We're, we're listening to the end user, understanding their requirements, and then specifying a solution set to the value that they need.
And then it's important to remember, in a building, our products is a relatively small piece of the total construction, total building cost, but it's also very critical to get your Certificate of Occupancy and meet your codes and standards.
And so it's not the place that your GCs are gonna try to value engineer you to something cheap, r ight. It's too risky there when you're ready to hand the keys over to the building. So that helps the pricing power as well. In general, this is a good industry. We price to value, we keep the product line fresh and the fact that there's only a few of us that can manage millions of SKUs in a made to order environment, I think helps reinforce that pricing power.
When you think about those cycles in, say, you know, multifamily and office, and then, you know, I assure you, I won't keep asking about those two verticals. Last one on those is around, when you look at the historical experience of those down cycles, you know, how long do those tend to last? Kinda when do you think those verticals may bottom out on your product, multifamily and office?
Yes. I'd say we watch the same indicators that you do, and as you disaggregate something like the ABI. You've seen, you know, multifamily, commercial office, below 50 for a while, w hich we never read too much into those indices, but you also don't ignore them, right?
Yep.
And so I'd say, calling bottom, we're hesitant to do that on any particular segment at any given time. I think, you know, we're interested in always striking that balance between new construction and aftermarket, striking that balance with the conversion from mechanical to electronic systems which tends to reduce the overall volatility and buffer Allegion against any macroeconomic cycle. Over time, we've performed well, I think, against up and down cycles, and broad end market exposure. Broad portfolio helps us do that.
Fantastic. You know, more broadly across Allegion, you know, a lot of sort of ups and downs with inventory adjustments by your channel partners. So I guess a couple of things, you know, how satisfied are you about inventory levels now across the channel partners that you serve? And also, is there a way of getting, I don't know, more visibility into those channel partners, or it's just the last two years it was impossible 'cause they didn't have the visibility either on demand swinging around and supply chain moving up and down?
Yes, it's a good question. And I think it's hard to overstate the disruption that those supply chain problems had on our industry b ecause again, we're typically a book and ship, made to order business with, you know, order lead times in the two to four week range for most of our products. That got completely turned on its head in late 2021, early 2022 and was difficult for the entire industry to overcome.
You mentioned on the call, we do see that it's mostly in the rearview mirror at this point, g etting back to that book and ship business, public lead times have been normalized for several months now. Ordering behaviors with our channel have also rather normalized. Our own inventory performance is a lot better, and we see continued incremental improvements on inventory turns and working capital management. So I think it was a temporary phenomenon.
I think it was extraordinary for the industry, but I do feel like collectively, I would just say getting back to normal.
Yes. And I guess on the sort of stimulus front, you know, Allegion has been more prudent, perhaps, on sort of managing expectations around tailwinds from things like Inflation Reduction Act or IIJA the last couple of years. Have you seen much in the way of any effects on that, on your business? You know, do you expect much stimulus tailwind in the future? And, and, you know, there's two broad programs and then also the investor in education. You know, any thoughts around the scale of that help to your business, if any?
I think, of course, yes, to some extent. But you know, as we've shown, if you look at our Americas business, roughly 45% of that business is in the institutional segment. And then 30% commercial, and in that commercial space, you know, things like the Infrastructure and Jobs Act put $25 billion towards airport terminal refresh.
That's a good end user vertical for us. We've implemented end user standards for many, many airports. The addition of our automatic doors with Stanley Access Technologies even complements that portfolio, y ou know, I'd say within education, it's probably more closely related to just the ongoing turn of municipal bond offerings that, you know, 2022 was an all-time record. In 2023, the bond offerings were down 2%. So down 2% off of an all-time record is nothing to get too excited about.
I think, you know, the work that we do with end users and with architects and general contractors very early on in the project phase t ends to have, you know, our product spec'd in. Once you're spec'd in, people tend to respect the spec. So any of those stimulus dollars that come down and do get, you know, allocated to security and access, where we're a pure play c ertainly provides some tailwinds.
Fantastic. And then away from kind of the cycle aspects, you know, the electronics push, I think, you know, again, supply chain noise behind you now on that. So we saw kind of very, very strong growth the last two years, I think 20%+ growth in 2023 there in electronics. Now we've sort of calmed down on supply chain and so forth, what should investors expect that portion of Allegion to grow this year, for example, and next?
Yes, probably not gonna give a pinpoint number for you there.
Sure.
I would say, what we need to look at is, we feel this is, as we talked at Investor Day, over the medium and long term, t his is a high single to low double-digit growth driver for Allegion. We see some very interesting, bolt-on acquisition opportunities in the space as well. You know, the tailwinds are really driven by a couple of things. Mainly, it's the adoption of digital identity, digital credentials, mobile credentials- Mm-hmm. in your smartphone, driving adoption of electronic locks and electronic exit devices, and then complementing that, with other products that maybe we don't have in our portfolio today. I think we can capture even more of that growth.
It's also not surprising that an electronic lock will have a shorter life cycle than a mechanical lock, right? So the replacement cycle is shorter, instead of a mechanical lock that can conceivably last decades. The electronic components, either through the need to upgrade for better cybersecurity or upgrade to a Wi-Fi connected offering, or just the circuit board has burned out quicker than a mechanical assembly would. You've got a shorter life cycle, greater replacement cycle there. So also kind of a nice, nice tailwind in that space.
Within, you know, electronic security, I guess for 10+ years, people worried about a shift in where value goes in that chain. You know, maybe internet service providers seemed to take an interest 5-10 years ago. But it feels like the competitive dynamics are pretty stable on the whole, and you didn't see value move around much in the chain, even with the emergence of ISPs, for example, in home security or what have you. Is that kind of a fair assessment? And maybe, you know, how is your thinking on electronics adoption, pace of it, drivers, how has that evolved? How has Allegion's view of that evolved, let's say, in the last couple of years?
It's a great question. And again, it's one of the main secular drivers that we see as key for Allegion to continue to invest in, be an innovation leader and drive growth.
Yeah.
If you look at the, w e'll hit the competitive dynamics first. It's a great question. So you know the competitive dynamics in our space. There's literally two other companies that do what we do at scale. If you look at the space of access control software, y ou can go to our Investor Day deck from May in the appendix, and you'll s ee the myriad of companies that we are a hardware partner of choice for. So quite a fragmented space there. Then, you know, probably the next layer, if you will, in the the technology stack would be video surveillance and the AI on the back end to start to make security from reactive to proactive. And, you know, all that kind of interacting together, I'm talking the non-res space, not not residential.
As your overall solution set, depending on your needs. Allegion was positioned very well, I think, in terms of our hardware position I don't see software companies, ISPs. I don't see them trying to get into electronic hardware and compete with us. It's just too many, too much investment. The barriers are quite high. That also gives us distribution channel strength end user relationship strength, because we have these relationships for decades. We've helped design their entry, egress, advocate for proper safety standards. And as there are, new offerings l et's say, software offerings in the access solutions arena, so it could be access control, it could be something like visitor management, temporary credentials.
There is good potential. And, and I think, you know, for a company like Allegion, we would be looking at early-stage companies with good products, good management teams, and, you know, solutions that need distribution. And we can, we can help with distribution. These early-stage companies typically struggle with that. Early stage also means a company of Allegion's size likely can afford- Yeah -to make an acquisition or two, just like we did with Plano a year ago.
Great tuck-in. It was a bolt-on to our Interflex business in Germany. y ou know, Interflex provides readers access control, time and attendance, for hourly workforce, and then Plano is a workforce management, bolt-on to that. So just another module you can buy. It's a SaaS offering. It's accretive to Allegion's margins even though the size right now is, you know, relatively modest in terms of top line. But bolt-on acquisitions like that and high-margin software solutions that interact with our hardware, feels like a very good growth vector for Allegion to continue to invest in, in the electronics adoption space. Pace of adoption is still going.
You know, as we showed at Investor Day, I think low double-digit % adoption. We see that has the potential to 3 or 4x over the long term. It doesn't go to 100%, of course because you're not gonna electrify the door itself, right? So the key hardware items that can be electrified and connected.
Perfect.
Long-winded answer, probably.
No, that's-
It's an exciting space, and we've got a lot, a lot going there.
-the sort of, you know, Allegion historically, a lot of replacement work, as you said, 50% of sales, you know, subscription-type models, somewhat similar to that, but also a different business model. Kind of, how have you found running those subscription and SaaS offerings, and should investors think that you might do a larger acquisition there, or in general, because of valuations and just financial metrics, the sort of smaller stuff makes more sense?
Great question, and yes, to the second part of your point. I think if you look at Access Technologies, you know, Stanley Access Technologies that would be a large acquisition for Allegion. You know, it closed the week before I took the job. So it was quite interesting to integrate that very large acquisition and de-lever, and I think we've done a good job there. And the business is performing quite well. What that brought with it, though, was about 40% of that business is services. And now if you look at Allegion's portfolio and our 10-K, up from 29% in 2022 to 33% in 2023, is electronics, software and services.
We see that piece of the pie continuing to grow, but again, I want to frame everybody, the way we see this is where Allegion can play, add value, profitably grow, would be early-stage companies that, you know, smaller bolt-ons, something like Plano in the software space.
Okay.
Like we did with Boss Door Controls, and that was very much a channel strength play to get us into more spec-driven business, architect-driven business, but it was hardware . I think in our space, we see those types of acquisitions being a bit more actionable than they have been over the past 12 or 18 months. You know, I think it's most important to say what we always say in this part of the commentary, is we will be disciplined. You know, that means single to very low double-digit EBITDA multiple on a hardware- Yeah - bolt-on.
And, you know, an early-stage SaaS company like Plano, relatively speaking, the multiple will look high but in terms of affordability for a company like Allegion, quite reasonable.
With good returns?
With very good returns. Yes. If you look at these hardware tuck-ins that we look to do, and Boss in particular, I mean, double-digit ROIC right out of the gate, something that by year three is probably mid-teens. That, that's the kind of discipline that I think we will certainly keep.
Those return metrics, those can work for both the sort of hardware and the SaaS, or by year three to five-
Absolutely.
any transaction you need.
Absolutely. I mean, look at, look at, Plano again. I think 1.5 to maybe 2 points of revenue for Allegion International, but accretive to Allegion's enterprise margins.
Yeah. Okay. And you don't need sort of a huge dollop of kind of investment to scale it. Like, it can run with good margins and decent growth from the beginning inside of it?
Yeah, I think that's the other attractive piece of these early-stage companies, that we can scale without the kind of incremental investment that the early-stage company would have to do on their own. We have 600 people out in the field for sales. We have decades-long distribution channel relationships and end user relationships to help with customer acquisition and profitable growth. The synergies are, in my opinion, quite strong, and it's very attractive growth potential for Allegion. But again, with discipline on the valuation and acquisition price.
Who do you sort of compete with to buy something like a, is it the traditional, you know, other big two, you know, the newer entrants, private equity-backed, roll up vehicles? Like, what's the sort of landscape of buying that versus, you know, the, the hardware acquisitions?
I think certainly it's a range of investors. Private equity plays a role there from time to time. Family investment funds play a role there from time to time. Sometimes it's just founder-led investment, you know, we're very choosy.
Yes.
As a pure play in security and access, we're not drifting out of that. We're staying in our sandbox because that's where we've got expertise and the ability to scale. And so, yes, typically venture-backed, private equity-backed, family fund-backed.
Sure. And, you know, that one-third of total Allegion revenue, that's electronic software and services now, you know, any sense of sort of how do we think about sort of margin rate of that versus the total company, operating leverage for that one-third of the company?
I would call it good.
That's yes.
On the upper end, let's just say...
On that point around, you know, people often ask, oh, your Americas operating margin is back to sort of very, very high-
Pre-pandemic.
- 20s
Yeah, pre-pandemic
- close to 30%. It's hit that number a few times, I guess, in the decades since spinning out. I think you've said it, that's not a ceiling. There's nothing magic about 29.5% or whatever as a ceiling. From here, when we think about main drivers, kind of volume leverage, you know, is there a mixed tailwind from that electronic software services piece as well? Any thoughts around that kind of operating leverage from here in the Americas?
Yeah. In aggregate, Julian, I would just go back to the 4Q call.
Yeah.
You know, it still comes back to price plus productivity and excess of inflation and investments.
Yes.
You know, we will maintain the pricing discipline to cover inflation as we experience that. We have good momentum, good muscle around just self-help productivity. We do run lean, and we see good potential for productivity gains in the very near term. We did take some cost actions, even in at the end of Q3, early Q4 of 2023. Yep. to help support that. And, this continual stream of new products with the added upside of disciplined and consistent capital deployment, that's, that's the recipe. I don't think it's anything different than you hear from a lot of other companies, but I think with our market position and our industry structure, we're in a very good position to deliver on it.
When we think about the two, you know, segments that you report and the operating margin expansion potential, are they sort of fairly similar to date, year-on-year margin expansion that we should expect between International versus Americas? Are they comparable increase over time?
I think you can look at the course of 2023. Y ou know, we do break that out and show margin expansion by the reporting divisions. Both divisions did very well in 2023, and we expect both divisions to deliver going forward.
In international, are you sort of satisfied there with the scale of it? Or do you think, you know, to get margins up, you got to do, you know, two, three counter acquisitions, and then your margin entitlement moves up to the twenties, let's say, once the scale is...
Yes. I would attribute it more to, and again, back to the call comments, a very disciplined focus on portfolio quality in international versus pure scale. I think, if you wind the clock back many years, Allegion International was probably too myopically focused just on scale and not enough on portfolio quality. So acquisitions like Boss Door Controls, g reat one, g reat tuck in, and again, good ROIC right out of the gate. Synergies are gonna start right away. And it was a channel strength play for a spec-driven, architect-driven business. Good portfolio quality is what we're after, not chunky acquisitions just to get bigger.
Yes. No, that's reassuring. And then I think we have to switch now to the audience response survey questions. So if you could grab those gray devices, please. And the first question should be around ownership. There we go. So do you currently own the stock? I'm suddenly very nervous. So that's a good, good thing. You know, a lot of opportunity there. Number two, question around sort of general predisposition towards Allegion at present. So fairly balanced, neutral on the whole. Number three is around kind of expected earnings growth against, say, the multi-industry average over time. So in line with, with peers overall. Next question is around excess cash usage. There's a broad list there. So generally, bolt-ons and, and buybacks. And I guess on that point-
I like this crowd.
All right. They're in sync.
Every company leads with internal investment as a key priority. I like this crowd.
Next question, the P/E multiple, you know, for Allegion.
The sort of high teens, 19, 20 times. And then the last question is really around sort of what's the reason people don't own more of Allegion shares today?