Crane Co. (NYSE:CR)
8th Annual US Small/Mid Cap Conference
November 15, 2011 11:05 AM ET
Andrew Krawitt – VP, Treasurer and Principal Financial Officer
Unidentified Company Representative
Senior analyst covering the multi industry and electrical equipment group and Citi and we're delighted for you to join us and also our webcast listeners, we are kicking off the Citi Smith Cap Conference with Crane. Today from the company we have Andrew Krawitt who is the Principal Financial Officer and the Treasurer of Crane and has been the company since 2006 and previously he was the Director of Financial Planning at Analysis at Pepsi Co. Also here is Dick Koch, the Head of Investor Relations with Crane and let me hand the floor over to Andrew. Thank you.
Thanks Dean. Good morning. Crane is a diversified manufacturer of engineered industrial products and we tend to have a substantial presence in focus niche markets and by niche markets we mean markets that are typically less than 1 billion or 1.5 billion or so in size.
These businesses tend to have high returns and excess cash flow and we have a very disciplined process to redeploy that cash flow back into the businesses. Above all we want to conduct our business with integrity and honest dealings. This is a principal that dates back to our founder R.T. Crane in 1855. A lot of companies pay lip service to this but it really is in our culture at Crane.
We have become a much more integrated operating company from what historically was a holding company structure and in large part that's been facilitated by something we call the Crane business system and I'll talk about that a little bit later.
We make acquisitions to strengthen our existing businesses and in fact if you look at the company today revenues from businesses that we've acquired in the past dozen or so years make up about 45% of the company. We're focused on niche markets. So what are some examples of the niche markets that we are focused on? On the upper left you can see that in our aerospace business we serve a market of about $1 billion and that's across four solution sets there.
Another example is an engineering materials in the upper right, about a $700 million market that we serve and that's making fiber glass reinforced plastic panels. On the bottom you can see global payment solutions where we do coin and bill validation. That's about a $700 million market. And even in fluid handling which in total is a much larger market there are sub segments which have market sizes of a few hundred million dollars.
So it's not good enough to just have a focus in niche markets. We want to have a leading market share in those markets and some examples here, we're number one in Brake Controls in Aerospace & Electronics. We have the number one position supplying fiber glass reinforced plastic to the recreational vehicle industry and Merchandising Systems we're number one in vending in North America and we are the number two for payment solutions globally.
Fluid handling we have significant positions in the free plugged market and Europe for example (inaudible) and a number of other areas. So how do we have a leading market share in these focused niche markets? Well that's because of something we call proprietary technology. So for example for the 787 we developed a wireless electric brake control for the Boeing 787. This is something that had not been done before. Its technology that takes years and dollars to design and it creates a wide mode for competitors to try to get across.
From Payment Solutions perspective we have the ability to instantaneously validate whether a bill is a good bill or a bad bill, a coin is good coin or a bad coin and a hundred different currencies, something that is particularly important in say like Las Vegas for example. And we're on a number of different AML, Approved Manufactured Lists where customers know that we have the ability to provide high quality highly engineered products for their manufacturing facilities.
Two main parts of the Crane core strategy. First we want to grow profits from existing operations and that's in the context of an integrated operating company. So we want to leverage our intellectual capital across our business units. From a customer perspective we are aligned against our customers in terms of our vertical market focus and we're very interested in collection voice of the customer and doing what we need to do to address customer' needs.
Operational excellence is a key part of our culture. We have a systematic strategy deployment process. We do about 800 (inaudible) a year and we're passionate about standard work. In fact if you were to go to our facilities around the world you would see that our manufacturing cells are set up in very similar fashion.
In terms of strategic linkages we will take action if we look at our portfolio and something doesn’t seem to fit with what we want to do longer term. We'll take steps to trim that portfolio and we also do what we call internal mergers where it makes sense to put businesses together where we can better address customer needs or have cost advantages. We will do that as well.
So first we want to grow profits from existing operations and secondly we want to redeploy our cash flow to make acquisitions but we only want to make acquisitions that strengthen our existing businesses. So we're not interested in adding another leg to the stool and we have a very rigorous process to do this. We'll often times spend a lot of time looking at acquisitions which we may think is a good fit but if the value isn’t there we'll walk away from it.
I mentioned earlier the Crane business system has enabled for us to become the integrated operating company that we are and the Crane business is a set of common business processes which drives our integrated operating culture as you can see on the slide.
It's easy to think Crane business system and other companies have similar business systems as well as just being manufacturing oriented or on the shop floor but Crane is really much broader than that. In addition to productivity tools we have very specific tools around growth, sales process methodology for example and we also use Crane business system to drive the strategy and to manage our intellectual capital across the company.
The transition to an operating company is a journey. It's still in process. In some cases we're pretty much there, Aerospace & Engineering Materials, we're about complete there and in some of the other segments we're still making that journey but the benefits to us are clear in terms of having a smaller number of larger units where we can have stronger and deeper management teams which allow us to prioritize our growth opportunities and of course reduce cost.
An example of the transition from more of a holding company mindset to an operating company mindset is this slide where you can see back in 2006 our fluid handling segment was about 10 different business units which was still largely independently run and so in 2007 we really moved to a much more vertically oriented focus where we have a smaller number of larger business units, for example KemPharma and Energy and this vertical focus really drives our ability to address customer needs.
We're disciplined about tripping the portfolio where it doesn’t make sense for us and you can see that we've trimmed about $200 million worth of sales of the past 10 years or so. We make acquisitions that strengthen our existing business. The green on this chart represents businesses that we've acquired in the past dozen or so years. So a couple of key things to take off of this chart.
One is the green part of this chart represents about 45% of the revenues of our company. So that's what's been acquired since 1998. Secondly we've only made acquisitions in areas where we already had a presence. So we've only made acquisitions where we're strengthening our existing businesses.
We believe we have a very balanced capital deployment strategy. First and foremost we want to make internal investments to guard those. That's sales and marketing, research and development, new product, capital expenditures to improve machine incapability, ERP systems, all the kinds of things that you want to do to make sure that we are establishing our company for growth going forward.
What we find is that because of the significant free cash flow that we generate we have more than we need to meet those needs. So a key priority for the company as we've talked about a little bit so far is to make acquisitions that strengthen our existing business.
From a dividend perspective we like to have a dividend yield that's attractive relative to up here. Our share repurchase program tends to just offset the impact of stock option dilutions and were responsible in terms of making pension contributions to meet our commitments. So overall we feel this is a very balanced capital deployment strategy.
In understanding Crane it's important to know that we do have an asbestos liability. The company manufactured asbestos but asbestos gas has previously been used for some of our products and as a result we have a liability. So the net after insurance, after tax asbestos payment from a cash flow perspective have been about $40 million a year for the past few years. What this chart shows is that even after making those payments we have significant cash flow to be able to fund the growth that we want to fund as a company. So the asbestos is only a small part of our overall free cash flow and we have ample cash flow to fund our growth going forward.
It seems like we're already late in 2011. So going back to 2010 seems like old news but it’s worth I think just taking a couple of steps back to set the stage for how we feel we're doing today. And really to talk about 2010 you almost have to go back to 2009. When the world changed at the end of 2008 we had liquidity. We were able to stay in office and that's what we did. We maintained our customer facing activities and we continue to stay on offence and get in front of the customer and make sure we were front and center. At the same time we took actions to significantly reduce our cost. That was starting in 2009.
Well of course in 2010 the world stabilized. So even though our sales were only up about 2% 2010 because of the significant amount of costs that we took out our operating profit was up 19%. So in 2010 we went from an EPS of $2.15 to $2.59 in large part because of the cost that we took out.
And again just to set up the stage for 2011 a little bit, coming out of 2010 we felt and we still feel that we emerged from the downturn tested and stronger. We stayed on offence, we gained market share and at the same time we continue and we still continue to focus on our cost reduction efforts.
So coming into 2011 we felt good about our backlog. You can see that’s on the chart on the left and how that has improved from 2009. And we also had momentum in core growth. So you can see the last three bars in this chart, the green bars where in the second quarter it was 1%, in the third quarter 4%, in the fourth quarter 9%. So good momentum going into 2011.
In February, back in February on Investor Day in this year we showed this chart which first of all shows that about 50% of our businesses within Crane are late type businesses and in February we indicated that some of our businesses had yet to really return to growth. Some of them had, the shorter cycle businesses had returned to growth but the longer later cycle business, particularly KemPharma and Energy had not quite returned to growth but as we stand here today those differences have returned to growth.
So moving into 2011 we recently reported third quarter results where our sales were up 18% and that was a combination of core growth of 11% and then 3% each roughly from acquisitions and the impact of currency. Our operating profit margin improved to 12.5% and our EPS improved from $0.70 to $0.89 or 27%. So we had improved sales, operating margins and earnings at the time. When we reported the earnings at the end of October we raised the lower end of our EPS guidance by a nickel and we also updated our guidance in terms of how we're thinking about our shorter cycle business or engineering materials and merchandising systems and our longer cycle businesses of primarily Aerospace & Electronics and Fluid Handling.
So for our shorter cycle businesses Engineering Materials, Merchandising Systems, we feel that we're generally tracking to the guidance that provided back in February. Our longer later cycle of businesses at the Aerospace, Electronics and Fluid Handling have generally exceeded our expectations as we've come through the year and we now expect Aerospace group sales to exceed $400 million and that's versus an Investor Day guidance of $365 million and Fluid Handling has also done better than our expectations on a year-to-date basis and we now expect operating margin there to exceed 13% versus the February guidance of 12.7% and we feel comfortable about the backlog in both of those business. On a year-to-date basis our sales are up 16%, operating profit is up 29% and our operating margin 12.3% and EPS up 33% on a year-to-date basis.
This is a chart we looked at just a little bit earlier where it was a snapshot of what we were looking at going into 2011 and this update is just for three more quarters so where we sit today we continue to have a solid backlog and the core growth that we saw earlier which at the momentum 1%, 4%, 9% we have now have three more quarters of double digit core growth in the first segment of third quarters of this year. So we continue to have the kind of momentum that we had going into the year and we continue to feel comfortable about our backlog.
Our full year guidance for 2011 we now expect sales to be between15 and sales growth to be up between 15% and 16%. Operating cost between $310 million and $320 million. EPS we raised the lower end of the range by a nickel versus our previous guidance so it's now a range of $3.35 to $3.45 and free cash flow we maintained a $140 to $165.
So I will just hit on this theme you know again I have kind of touched on couple of times earlier. We are really positioning ourselves for growth, when we went through the downturn we stayed on offense, we took cost out of the business and over the past few years we have taken significant steps to increase sales and marketing and Aerospace for example. Our Fluid Handling sales effort is much expanded, we have a global sales force, we are effective at funneling products and we also have increased our presence in emerging markets, the middle-east, China, India for example. We have increased our capital expenditures to support this growth. We are maintaining our new product development efforts and we really feel that the Crane business is some has matured over the past several years to really position us to grow going forward.
A key investment piece is that we have been talking about probably for the last couple of years or so is represented by these slides, if you look at the left side of the slide it show sales and you can see that we were a $2.6 billion company back in 2007 and 2008 and when the world changed we reset that with $2.2 billion sales level. The right side of the chart is operating profit and you can see that back in 2007 and 2008, our operating margin was between 10% and 11%. So what we said was that when core sales returned to the $2.6 billion we didn’t say when we thought that would actually happen but when core sales returned to $2.6 billion level that our operating profit margin we felt very confident would be 13% which would be a full 2% higher than it was at the last time that our sales rose this level.
And further translating that kind of operating profit would be an EPS of between $3.50 and $3.75 per share. So we’re tracking towards this goal that we laid out and feel very confident about our progress. The other thing I will note on this from a capacity perspective when you look across our facilities we are still only operating at 50% capacity. So there is ample capacity in the systems field to support increased sales growth.
So we are comfortable of the business that we have and we continue to expect increased sales, operating profit and margins in 2011 versus 2010. I think I will take a few minutes to just quickly go through some of our segments and then we can move to some questions. So first Aerospace & Electronics, our Aerospace & Electronics segments is 60% Aerospace and 40% Electronics. Now the 60% that’s aerospace is 80% commercial business and 20% defense business. The 40% that’s the electronic space is about 2/3rds defense related and 1/3 commercial.
The solution sets that we serve in aerospace includes landing systems primarily brake control systems, sensing and utility systems, proximity sensing and things like that. Fluid Management, moving scavenge funds for example and cabin and you can see that we have a high market share and each of the solution sets by that we serve. I will just pause for a minute. We will see a number of slides that look like this, to the extent that there is a 2011 estimate comp, this is what is left over from our February investor day guidance. So for and in some cases it's outdated guidance but as a matter of fact we have not updated it. So, back for example, back on investor day we expected aerospace sales to $365 million and see in the bottom of the space we now expect aerospace sales to exceed $400 million.
So we have a strong third quarter in aerospace and electronics broad based strength across our OEM and our aftermarket in aerospace, a traditional aftermarket sales were up 16%. Our outlook from an aerospace perspective for full year 2011 we now expect OEM sales to be up 13% and our aftermarket to be up 19% much of that is driven by modernization upgrade program we happen to see 130 occur a brake upgrade.
Just for a perspective, our commercial aerospace market is about 50%, our commercial aerospace sales are about 50% directed at large transports and then the balance is right across business ships, regional and cabin business. To give a sense for what we are thinking about going forward, we are quite optimistic about prospects in the aerospace industry for large transports for expecting a &% CAGR between 2011 and 2014, for regional jets we are expecting a 11% CAGR and for business jets we are expecting a 10% CAGR.
An important of our aerospace story is to understand that back in 2008 and 2009 we spent a significant amount of money on research and development primarily to support the brake control system for the 787 as well as for the A400F. We have sent broad based level of our R&D spending down we are now in a much more normal range of 10% to 12% of sales that we expect to maintain going forward. This is a slide we showed at investor day that we have a number of new products that we have developed over the past several years and we expect these to contribute to our sales growth going forward.
Electronics consist of three solution sets, power, microwave, and a small micro-electronics business, important to understand here that 2/3rds of the business is defense related, 1/3rd is commercial and at investor day we indicated that we thought electronics would be up about 10% for the year. We have since updated that given strong performance in the first part of the year that we think electronic sales will increase at least 10% over 2010 and just to kind of give a little more detail on that we expect, we said that we expected both commercial and defense sales to increase 10% in 2011. A lot of this is driven by a solid backlog at the end of 2010 going into 2011 and that we had successfully transitioned 12 development programs from development into production driving that sales force.
Engineer materials, is the next segment I will talk about 40, this is we manufacture fiber glass reinforced plastic panels and we sell it into the recreational vehicles industry as well building products and transportation primarily refrigerated trailers. So we have provided guidance back at investor day of $230 million and we think we are generally tracking to the guidance that we provided on investor day in the third quarter. Our sales were down a bit and our profits were down a bit and our profits were down a bit. The RV industry has slowed somewhat and we are also seeing the impact of higher raw material costs throughout 2011 in this business. Merchandise to this some of this is really two different businesses that on the left you can see payment solutions this is the coin and bill validation business, this is not just serving but also retail, transportation, gaming applications as well. It's our high growth, high margin, global business that we are now the number two global provider and then the little more than half the businesses are traditional vending business where we consulted the market back in 2006 in the U.S. and we further consolidated two plants into one to be able to effectively meet market needs in a cost effective manner. So back on our investor day we indicated that we would expect to about $375 million of sales. A lot of that is driven by the an acquisition that we made, money controls which were made in December 2010 which contributes about $60 million worth or so of sales and again we expect that, we continue to expect that we are tracking towards the guidance that we gave on investor day. And finally I will talk a little bit about the Fluid Handling about three quarters of Fluid Handling is Dow and that’s KemPharma pointed at the KemPharma and Energy segment.
Little less than 20% of our business is a pipe valve fitting distribution business that we have up in Canada it's called Crane Supply and we have a small pumps business. So in the third quarter we had a very strong growth, our revenues were up 19% and that was 11% core growth, we had a 6% impact from acquisitions and then we recently acquired WTA which added 2% in the quarter.
So throughout the year and we have started off at investor day giving guidance of a $1.60 billion which is probably a big conservative in retrospect and throughout the year we have continued to do better than we thought and energy and KemPharma sales in orders have continued to exceed our expectations and so we are now and we have been saying that we expect to exceed our investor day guidance here and that margins will be in excess of 13%. It's really a story of gradual end market improvement, when we think back to last year we talked about how we felt that our later long cycle businesses were recovering but it continues to take just happened a little more slowly, a little more gradually and we expect it and then coming into this year we really saw an improvement particularly in energy and KemPharma in terms of sales and orders and markets around the world.
Just to kind of fill out the picture for Fluid Handling we have about 23% of our businesses in the KemPharma, roughly similar amount is energy, building services and general industry on utilities is the balance. We are very much an international business in KemPharma over almost three quarters of our sales, sold to customers outside of the United States and as I mentioned earlier as we moved into 2011 this is February 2011 snapshot some of our later longer cycles had yet businesses had yet to move into growth as we sit here today those longer later cycle businesses which represent about 70% of Fluid Handling sales have moved into growth and we are seeing improved results from them. So we are comfortable with our backlog and Fluid Handling, you can see the growth there and core growth we now have four quarters in a row of core growth the most recent core growth 11% of their core.
WTA (inaudible), I will touch on quickly, this is a manufacture of (inaudible) valve. It's a zero fugitive emission valve that fits in nicely to our portfolio. We completed that acquisition back in July and then I will just end on Fluid Handling in terms of this is a segment that a Dow happened to company, it's positioned for late cycle recovery. We are pointed at vertical markets, we have a global sales force that can take products and bundle those products and bundle those products and sell the customers at around the world. So we will feel very confident about our position there.
And with that I am happy to take any questions. Go ahead.
Well as I tried to mention a little bit earlier that it's easier to think about the Crane business as some as just been kind of manufacturing process oriented but we have really over the past year we have really stepped up our effort and applied this mentality to develop a sales development process and a customer relationship management system that we are now beginning to roll out across our business units to have it much more standardized and a systematic way to approach customers and to complete that selling process.
So we feel you know quite confident that going forward that it will have an impact on the sales side as much as on the cost side.
Well Dan I think you hit on the answers in your question it's really combination of all those things. We have moved to lower cost country sourcing, we have implemented very systemically Crane business system principals throughout the business and we used to show a chart that actually showed that growth from margin growth from the mid-single digit range to today and in fact in the first two quarters of 2008 we were at 15% margins and we think that is still a longer term goal for the business to be able to achieve that. We haven’t really put a time on that but we are at 13.5% now and I guess I would just echo your thoughts that it's really a combination of those things. We have stronger management teams; we have applied the Crane business system. We have moved low country cost country sourcing. I think that a key part of the growth story is that as we transition from this a larger number of smaller units to a smaller number of larger units heaving this vertical market focus and also building out our presence from a sales perspective in the Middle-East, in China, and India has allowed us to have a global sales force and then we make the acquisitions to kind of supplement the technology that we have to be able to really leverage those products through these global sales force and that’s been very powerful for us and we have success stories where just recently I heard about one where.
We literally are energy and our KemPharma are teaming up and to the extent 10 years ago would have made separate calls on a customer. We are going in and we are noticing that, is that a customer that we are about to make a sale on. Also needs eval from our sister unit and we are bundling the sale and we are winning, because that’s what customers want, they want to go to one source. So I think it's a combination of those things.
Yes, Dick is just reminding me that the foundries shut down, to the extent that we move to low cost country sourcing and in conjunction with that we shut down foundries here in the U.S.
With some of the slowing we've seen in Europe are you experiencing any slowdown in orders as far as you can tell?
Well there's a lot of stuff going on in Europe as we read the papers every day. It seems to dominate the stock market news. We, in general we're comfortable with our business trends. I think it's fair to say there are spots in Europe where there is some slowing but we're comfortable with our overall business trends.
Okay. Great. thank you very much.
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