Lennox International, Inc. (LII)
Bank of America Merrill Lynch Global Industrials & Materials Conference Call
September 6, 2012 9:30 AM ET
Todd Bluedorn – Chairman and CEO
Previous Statements by LII
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So without further ado, I’ll hand over.
Great. Thanks. Why don’t we go ahead and get started. I’m going to make a few opening comments and then we’ll turn it over to Q&A. This is a chart I always like to lead with. For those of you who are new to the story; this talks about the investment thesis in the stock, really four points.
One is, we have and continue to reduce our cost structure. The last four or five years we’ve gone from 25 to 15 factories, have done significant material cost reduction as we’ve moved our component supply base from North America to Asia, significant reduction in SG&A. And as revenue flows back across our business, we’ll be able to leverage those cost reductions is SG&A. We’ve committed we’ll going to grow half the rate of revenue as our end markets and our revenue grow.
Second point is, even when we’ve been doing this aggressive cost reduction actions we’ve continued to invest in the business, research and development to differentiate our product, investments like our India Research Center. So continue to differentiate product, also making significant investments in our physical distribution, this is the business where having physical distribution on the ground, drives market share gains.
Some of you may have heard us talk about our residential distribution strategy where we’re increasing the number of physical distribution points doubling it over a three-year period. We ended the year at 75 of these. We’re going to end this year over 100 and we’ll be over 125 next year. Have a similar strategy on the commercial side of the business as we leverage the investments we’re making in residential to also grow physical distribution for our commercial business.
Third is, after four, five years of being in the absolute wrong place at the wrong time, being in North America, tied to housing is probably not a bad place to be. And so this pent-up demand that we talked about of people have been, on the replacement side of the business, have been repairing units rather than replacing them. We think that’s an opportunity going forward. We talked about macroeconomic conditions to support that unleashing in the pent-up demand as things like stabilization of existing home values, consumer confidence and unemployment.
I think home values have started to make the turn. The other two metrics, I think, are still flashing yellow, maybe red. First half of this year for the first time in a long time, we saw our equipment sales grow faster than our part sales. And we think that’s sort of positive sign, which is an early sign of sort of unwinding of some of this pent-up demand.
And then finally, we have been extremely disciplined with a focus on shareholder value and our free cash flow. We think about, one, investing in the business first to doing focused targeted M&A like we did with our Kysor/Warren deal, where we play in the businesses that we or spend in the businesses we know well. We’ll have dividends grow with earnings over time and then we give money back to shareholders with share buyback. Our target debt to EBITDA levels too and over the last five years, we’ve returned over $750 million to shareholders through share buyback.
Let me talk a little bit about the four businesses. This is a breakout in revenue and earnings of our four segments. Maybe let me talk a bit about each of them. First overall, we had a good first half of the year with revenue up 4% at constant FX, earnings up 11%. We also exited the Hearth business, which was a non-core business that we sold to private equity earlier in the year.
Our Residential business, revenue up 10% through the first half of the year, constant FX, earnings up 30%. We’re winning in the marketplace. Market’s not growing as fast as we are. I think that’s a couple things. One is we have more exposure to residential new construction than many of our peers. We have a strong share with the major homebuilders as well as regional homebuilders. And that segment of the market has grown faster than the replacement segment and so that sort of mix shift, if you will, has helped us.
The other is within each segment, both add-on and replacement and new construction, we think we’re winning in the marketplace. We think our investments that I talked about and our physical distribution parts plus, as well as our investments in a fuller product line, most namely a furnace line that we launched last year or finished last year, is helping us.
Mix has still been headwind this year for us. We talked last year a lot about a mix down that we saw last year and we said we’d have $15 million mix headwind this year. We still think that’s about right. In second quarter, we saw a continued trade down as customers are still buying more entry-level product, increasingly more entry-level product and premium product. But I think the one good sign that we saw through second quarter was R-22 as a percentage of our sales was flat where we thought it would be up year-over-year.