Ingersoll Rand Continues To Drive Margin Expansion Through Synergies and Productivity Initiatives

Equity Analyst

Krzysztof Smalec

In February 2020, Gardner Denver acquired the former Ingersoll Rand’s industrial business in a transformative reverse Morris trust transaction. The combined entity took on the Ingersoll Rand name and stock ticker.

Following the merger, Ingersoll Rand is a leading mission-critical flow creation and industrial technology company. The combined entity operates under two reportable segments: industrial technologies and services; and precision and science technologies (including Gardner Denver's medical business). The combined business will benefit from a more comprehensive portfolio of products and services. Ingersoll Rand’s large installed base of equipment generates a relatively stable stream of aftermarket and service revenue, which accounts for roughly 36% of combined pro forma sales.

Management is confident it can deliver approximately $300 million in cost synergies by the third year, which we view as realistic. Ingersoll Rand expects to spend about $100 million on separation costs and $280 million to achieve the target synergies, and we expect that the integration efforts will be management's focus in the near term. Longer term, we believe that Ingersoll Rand has attractive portfolio optionality, with both acquisition opportunities in its core mission-critical flow creation business as well as potential divestments of noncore businesses.

In 2021, Ingersoll Rand sold a majority interest in its high-pressure solutions segment. The divestment has reduced the firm’s direct exposure to the upstream oil and gas end market to less than 2%, thereby reducing overall portfolio volatility. Ingersoll Rand also sold its specialty vehicle technologies business in 2021. We think both divestments make sense from a strategic perspective, as they have helped Ingersoll Rand simplify its portfolio and focus on its core business. Furthermore, the cash proceeds have helped significantly lower the firm’s leverage, which we believe will give Ingersoll Rand more flexibility to pursue growth through acquisitions.

Business Strategy & Outlook

We believe that new Ingersoll Rand, formed through the merger of Gardner Denver and Ingersoll Rand’s industrial segment, merits a narrow moat rating based on intangible assets and customer switching costs. Both businesses were founded over a century ago and have established a reputation for quality and reliability. Each company has also built a large installed base of equipment that continues to generate aftermarket revenue, which we estimate accounts for roughly 36% of the combined firm’s sales. We think the combined business will benefit from a broader portfolio of complementary products, larger scale, and cost synergies from the merger, and we believe that Ingersoll Rand’s narrow moat will help the firm generate returns on invested capital exceeding its weighted average cost of capital throughout the next decade.

The cornerstone of Ingersoll Rand’s moat is its large installed base of equipment. The firm specializes in manufacturing mission-critical equipment that typically accounts for a relatively small fraction of the cost of an overall system but performs a vital function. Furthermore, Ingersoll Rand differentiates itself by offering equipment that reduces a client’s total cost of ownership by improving energy efficiency and offering superior reliability. Given the high cost of failure, this creates customer switching costs, as end users are reluctant to switch vendors given that the potential cost of unscheduled downtime and safety considerations. For instance, the firm manufactures blowers used to purify water at wastewater treatment facilities, and a product failure could result in the facility being shut down. Other examples include air compressors at factories and frac pumps, which typically account for less than 10% of the overall capital outlay, but any product failures could disrupt a customer’s operations.

As Ingersoll Rand’s products perform a critical function and are closely integrated within a customer’s production process, customers tend to replace components like-for-like. Therefore, the firm’s large installed base of equipment generates a relatively steady stream of recurring service and aftermarket revenue, which we estimate accounts for roughly 40% of the combined company’s sales following the merger.

Within its industrial and energy segments, many of Ingersoll Rand’s products are designed to work in harsh conditions, which leads to significant wear and tear. For example, fluid ends used in hydraulic fracturing pumps need to be replaced frequently due to their exposure to corrosive fluids and abrasive proppants. This leads to a substantial recurring revenue opportunity, as the total aftermarket sales throughout a product’s life span can represent a multiple of the initial cost outlay. Furthermore, aftermarket margins are typically higher compared with original equipment sales (roughly 500 basis points higher in Gardner Denver’s industrial segment before the merger). Ingersoll Rand further differentiates itself from competitors by its customer service. Given the mission-critical nature of its products, customers value the availability of replacement parts and the quality of a vendor’s repair service. As Ingersoll Rand has established a strong reputation for quality and reliability, we think it would be challenging for competitors to encroach on the firm’s installed base.

We believe that the introduction of “Internet of Things” offerings that complement Ingersoll Rand’s installed base of equipment will reinforce customer switching costs. For example, several years ago the company launched iConn, a software platform that remotely connects to compressors and vacuums. Such Internet of Things offerings are beneficial for end users as iConn allows Ingersoll Rand to perform predictive analytics and ensure that the equipment is adequately serviced when necessary, which helps prevent disruptions in the customer’s operations. At the same time, the company can benefit from increased aftermarket sales, as Ingersoll Rand said that iConn has increased the aftermarket opportunity for connected compressors by as much as 25%. As such, we believe that not only will digital solutions increase the stickiness of the business by offering software that complements the large installed base of equipment, but they also have the potential to translate into a meaningfully larger recurring revenue stream.

Furthermore, we believe that Ingersoll Rand benefits from intangible assets, including brand names, patent portfolio, customer relationships, and its reputation for quality. Ingersoll Rand distinguishes itself by focusing on energy efficiency and cost savings, and highlights how its products can help lower operating costs and reduce a customer’s total cost of ownership. For example, the RunTech vacuum technology reduces energy consumption by over 50% and water consumption by over 90%. Before the merger, both businesses have done a solid job refreshing their product portfolios, and we believe that the combination will result in a broader portfolio of complementary products and solutions that will solidify Ingersoll Rand’s competitive position.

We note that aftermarket revenue accounts for a much smaller fraction of the mix in Ingersoll Rand’s medical business, where it accounts for roughly 3% of sales compared with around 36% for the company overall. That said, the business has long-standing customer relationships to supply components to original equipment manufacturers, and multiyear contracts to provide solutions to OEM end devices are a source of recurring revenue in the segment. The firm often works closely with OEMs and is often involved throughout a device’s entire life cycle starting with early design. Given the mission-critical nature of the end devices and the regulated nature of the medical market, Ingersoll Rand’s strong customer relationship are another moat source in its medical business.

Narrow

Economic Moat

Ingersoll-Rand

GHH RAND is a company that sells oil-free and oil-injected screw compressors for industrial applications as well as special markets such as air-starting / jet-starting or unloading of silo vehicles. The company is a wholly owned subsidiary of the American conglomerate Ingersoll Rand, which is also a wholly owned subsidiary of Ingersoll Rand. a. Products for refrigeration and air conditioning, compressor technology and safety systems manufactures.

GHH RAND

Club Car  is an American company that manufactures electric and gas-powered golf carts and UTVs for personal and commercial use. It is a business unit of the Ingersoll Rand corporation in its Industrial Technologies division. It is one of the largest employers in Columbia County, Georgia.

Club Car

Thermo King is an American manufacturer of transport temperature control systems for trucks, trailers, shipboard containers and railway cars as well as HVAC systems for bus, shuttle and passenger rail applications. Thermo King also manufactures the highly successful "TriPac" hybrid auxiliary idle reduction and temperature management system for truck cabs.

Thermo King

Ingersoll Rand, Inc. provides a broad range of mission critical air, fluid, energy, specialty vehicle and medical technologies, providing services and solutions to increase industrial productivity and efficiency. It operates through the following segments: Industrial Technologies and Services, Precision and Science Technologies, High Pressure Solutions, and Specialty Vehicle Technologies. The Industrial Technologies and Services segment designs, manufactures, markets and services a range of compression and vacuum equipment as well as fluid transfer equipment, loading systems, power tools and lifting equipment. The Precision and Science Technologies segment is involved in designing, manufacturing and marketing a range of positive displacement pumps, fluid management equipment and aftermarket parts for medical, laboratory, industrial manufacturing, water and wastewater, chemical processing, energy, food and beverage, agriculture and other markets. The High Pressure Solutions segment includes designing, manufacturing and marketing a diverse range of positive displacement pumps, integrated systems and associated aftermarket parts, consumables and services. The Specialty Vehicle Technologies segment focuses on designing, manufacturing and marketing Club Car golf, utility and consumer low-speed vehicles. The company was founded in 1872 and is headquartered in Davidson, NC.

Earnings data Q2 2023

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