nVent Electric PLC

NYSE:NVT

Earnings Call Analysis

nVent Adjusts Sales Forecast, Raises EPS Guidance

nVent had an exceptional quarter with record sales surging by 15% and organic sales growing slightly, supported by strategic expansions and acquisitions. The company's adjusted EPS soared by 27%, and free cash flow strengthened, up by 8%. Despite a mixed market environment, nVent updated their full-year reported sales growth to 12-13%, slightly lower than the prior 13-15% guidance, with organic sales projected at 3-4%, revised down from 4-6%. Meanwhile, adjusted EPS guidance was raised to $3.01-$3.03 from the previous $2.85-$2.91, reflecting strong execution and better acquisition performance.

Strong Q3 Performance with Record Sales and Adjusted EPS Growth

nVent delivered a robust financial performance in the third quarter, with a record increase in sales of 15%. This impressive growth was fueled by the strategic acquisitions of ECM and TEXA Industries, playing a significant role by contributing 14 percentage points to the overall sales uplift. The company also saw a remarkable rise in its adjusted earnings per share (EPS), which went up by 27%, indicating strong profitability and efficient execution despite facing a challenging environment.

Innovative Product Launches and Targeted Acquisitions Drive Sales

The company's foresight in launching new products and pursuing targeted acquisitions has paid dividends; new offerings contributed about 2 percentage points to sales growth. The nVent team seamlessly integrated ECM and TEXA, outperforming expectations and fulfilling the objective to globalize ECM's portfolio and reposition TEXA's industrial cooling offerings.

Mixed Vertical Performance with Focus on Sustainable Growth

The vertical analysis of sales portrayed a mixed picture, with certain sectors like industrial and commercial residential showing modest single-digit growth while infrastructure saw a slight dip in sales due to inventory adjustments. Nevertheless, nVent maintains a resolute stance on growing sustainable and digital solutions, underlined by the performance of their Data Solutions which continued to grow in double-digits, illustrating the company's adaptability and focus on future-driven segments.

Updated Guidance Reflects Confidence in Continued Growth

Despite a varied business environment, nVent has upgraded its full-year adjusted EPS guidance, demonstrating confidence in its operational capabilities and the value of its acquisitions. The company expects a reported sales growth range of 12% to 13%, with organic growth between 1% to 2%, and an increased adjusted EPS guidance range of $3.30 to $3.35, highlighting its sound execution and positive acquisition outcomes.

Segment Income and Return on Sales Indicate Strong Margin Expansion

The third quarter exhibited a significant surge in segment income by 40% and a notable improvement in return on sales adding 420 basis points over the previous year. The Enclosures segment, in particular, displayed vigorous growth with a 6% sales increase and an impressive 24% rise in segment income, demonstrating the company's ability to enhance profitability.

Robust Free Cash Flow and Strategic Capital Allocation

nVent's financial health remains strong with a substantial free cash flow increase of 8%, amounting to $136 million. This robust cash generation facilitates strategic investments, share repurchases, and dividends, reflecting a balance between growth investments and shareholder returns.

Anticipation of Future Growth Leveraging Market Trends and Acquisitions

Looking ahead, nVent is well-positioned to capitalize on electrification, sustainability, and digitalization trends, with an expected influx of legislative funding potentially adding significant sales over the next five years. With an active pipeline for acquisitions and a strategic emphasis on high growth verticals, nVent anticipates synergies from its acquisitions to enhance its market position and drive continuous sales and EPS growth in 2024 and beyond.

Earnings Call Transcript 2023-Q3

[Operator]

Hello, and welcome to the nVent Electric Third Quarter 2023 Earnings Call. [Operator Instructions] Please note, today's event is being recorded. I would now like to turn the conference over to Tony Riter, Vice President of Investor Relations. Please go ahead, sir.

[Tony Riter, executive]

Thank you, and welcome to nVent's Third Quarter 2023 Earnings Call. On the call with me are Beth Wozniak, our Chair and Chief Executive Officer; and Sara Zawoyski, our Chief Financial Officer. Today provides details on our third quarter performance, provide an outlook for the fourth quarter and an update to our full year 2023 outlook.

Before we begin, let remind you that any statements made about the company's anticipated financial results are forward-looking statements subject to future risks and uncertainties such as the risks outlined in today's press release and nVent's filings with the Securities and Exchange Commission.

Forward-looking statements are made as of today, and the company undertakes no obligation to update publicly such statements to reflect subsequent events or circumstances. Actual results could differ materially from anticipated results.

Today's webcast is accompanied by a presentation, which you can find in the Investors section of nVent's website. References to non-GAAP financials are reconciled in the appendix of the presentation. We'll have time for questions after our prepared remarks. With that, please turn to Slide 3, and I'll now turn the call over to Beth.

[Beth Wozniak, executive]

Thank you, Tony, and good morning, everyone. It's great to be with you today to share our record third quarter results. I'm very pleased with our execution in the quarter. We had exceptionally strong income growth, ROS expansion and robust free cash flow. We continue to execute on our strategy, focused on high-growth verticals, new products, acquisitions and geographic expansion. We believe we are well positioned with the electrification of everything.

In the third quarter, we had record sales up 15% with the addition of ECM and TEXA Industries. Adjusted EPS was up an impressive 27%. The acquisitions performed well and are great additions to nVent. Overall, we are very pleased with our Q3 performance, we had strong execution despite a mixed environment, which I will [ come on ] shortly.

Now on to Slide 4 for a summary of our third quarter performance. Organic sales in the quarter were up slightly on top of 20% a year ago. We continue to see channel inventory adjustments resulting in lower-than-expected organic sales. Organic orders were positive in the quarter, growing low single digits.

Segment income was up 40% year-over-year, and return on sales up an impressive 420 basis points. Adjusted EPS grew 27% on top of 25% a year ago, and we generated $136 million of free cash flow, up 8%. Let me touch on a few highlights for the quarter. New products contributed approximately 2 points to sales growth, and we are well ahead of our goal of launching over 50 new products for the year.

Turning to acquisitions. We're excited to have the ECM and TEXA team as part of nVent. These acquisitions have strong product portfolios which we believe further position us with the electrification of everything in high-growth verticals globally. In Q3, they added 14 points to sales and delivered better-than-expected income.

With ECM, we are executing on our plan to globalize its portfolio. In particular, we are working on the certifications to expand the [ ILSCO ] power connection offering for Europe and Asia Pacific. We are making progress with our distribution partners to expand coverage. In addition, we are working on pulling our nVent products through some of the ECM channels.

With TEXA, we are executing on our plan to position its industrial cooling portfolio alongside our enclosures through our European distribution channels. Similarly, we are executing on a product road map to expand the portfolio to North America. We believe there is significant potential for global growth and expansion with both acquisitions starting next year.

We would also like to share a couple of awards that we recently received. nVent was named as one of Fortune's best workplaces in manufacturing and production. We were also named as one of Newsweek's America's Greenest companies. Finally, we were awarded the IMARK Supplier of the Year for ILSCO, part of ECM which highlights the strength of that product portfolio.

Looking at our vertical performance in the quarter. Overall, we saw a mixed environment. Organic sales were led by industrial and commercial resi each growing low single digits in the quarter. While industrial is growing, the rate of growth is slowing. In commercial, we saw pockets of growth.

Infrastructure declined low single digits, largely in electrical and fastening solutions due to customers and channel partners adjusting their inventories as our supply chain improved. Data Solutions continued to grow double digits. We are making good progress on expanding our footprint and capacity to meet growing demand for liquid cooling driven by the acceleration of AI.

We remain confident in the growth of the infrastructure vertical with the electrification of everything and legislative funding expected to ramp in 2024. Finally, energy was flat in the quarter, but with the energy transition, we are seeing positive order trends.

Turning to organic sales by geography. We continue to see growth led by North America, up low single digits. Europe declined low single digits, primarily due to our wind down in Russia and Asia Pacific declined primarily due to China. Looking ahead, we are updating our sales expectations and raising our full year adjusted EPS guidance. This reflects our view on a continued mix environment.

Importantly, it also reflects our confidence in our ability to execute, either acquisitions, new products, pricing, productivity and cash, we believe are all strengths for us. We expect electrification, sustainability and digitalization to continue to drive demand. Specifically, we expect strength in infrastructure in data solutions in industrial with the trends of automation and onshoring and in energy with the energy transition. We continue to expect the commercial resi vertical to have pockets of strength.

Overall, I'm very proud of our event team and our execution. I will now turn the call over to Sara for some detail on our third quarter results and our updated outlook for 2023. Sara, please go ahead.

[Sara Zawoyski, executive]

Thank you, Beth. We had a solid quarter with robust margin expansion and free cash flow. Let's turn to Slide 5 to review our third quarter results. Sales of $859 million were up 15% relative to last year. Organically, sales were up slightly with price contributing 4 points to growth and volumes down 3 points.

Acquisitions added a meaningful $104 million in sales or 14 points to growth. Third quarter segment income was $202 million, up 40%.

Return on sales was an impressive 23.5%, up 420 basis points year-over-year. Our strong performance was driven by continued productivity improvements and accretive return on sales from the ECM acquisition. In addition, price more than offset the impact from inflation of just over $20 million.

Q3 adjusted EPS was $0.84, and up 27% and above the high end of the guidance range. This included a better-than-expected $0.08 contribution from the ECM acquisition.

We generated robust free cash flow in the quarter of $136 million, up 8%. This included higher CapEx investments for growth and capacity.

Now please turn to Slide 6 for a discussion of our third quarter segment performance. Starting with Enclosures, sales of $413 million increased 6%. The TEXA acquisition contributed 1.5 points to sales. Organically, sales were up 4% with solid price and volumes slightly down.

Commercial resi was up low double digits with strength in North America. Infrastructure and Industrial were each up with continued strength in data solutions and positive growth in industrial automation. Geographically, North America led up mid-single digits, while Europe was flat and China was down.

Enclosures, third quarter segment income was $89 million, up 24% and Return on sales of 21.7% increased 320 basis points year-over-year, driven by price cost and productivity. This includes our increased investments in our data solutions business and expect this to ramp in Q4 and into 2024.

Moving to Electrical & Fastening. Sales of $302 million increased 45%. The ECM acquisition contributed 47 points to sales growth further scaling our highest margin segment. Organic growth declined 4%, mainly driven by infrastructure that stemmed from channel and customer inventory reductions. This was partially offset by low single-digit organic growth in commercial resi, which has grown each quarter this year.

Geographically, sales growth declined low single digits in North America and mid-single digits in Europe. Notably, orders were up low single digits.

Electrical & Fastening segment income was $98 million, up 61%. Return on sales was a notable 32.3%, up 320 basis points relative to last year, on solid price/cost, favorable mix and productivity.

Turning to Thermal Management. Sales of $144 million were down 3% organically. Price contributed 3 points to growth, while volumes were negative. The decline was driven by commercial resi down low double digits, partially offset by energy.

Industrial MRO demand remained solid. Geographically, North America was up low single digits, China grew double digits, while Europe declined, including our wind down in Russia. Notably, orders were up mid-teens, driven by energy transition projects and backlog grew year-over-year and sequentially.

The Thermal Management segment income of $35 million was down 3%. Return on sales of 24.2% was flat year-over-year due to lower volumes and mix.

On Slide 7, titled Balance Sheet and Cash Flow. We ended the quarter with $113 million of cash on hand and $600 million available on our revolver. We believe our healthy balance sheet provides us with ample capacity to invest in the business and execute on our growth strategy. As you can see on the slide, we have invested nearly $50 million in CapEx year-to-date, up nearly 60% versus a year ago.

Turning to Slide 8, where we outline our capital allocation priorities. We believe our robust balance sheet and cash generation puts us in a strong position to continue to invest in growth, return cash to shareholders and deliver great returns.

We had a strong free cash flow in the quarter and year-to-date, growing 46% compared to a year ago. We exited Q3 with a net debt to adjusted EBITDA ratio of 2.4x, back within our targeted range of 2 to 2.5x, well ahead of our expectations after the ECM acquisition. This is a testament to our strong cash flow generation and ECM performance. Year-to-date, we have returned $103 million to shareholders, including dividends and share repurchases.

Moving to Slide 9 for our updated full year outlook. We are updating our reported and organic sales forecast to reflect the mixed environment and expected channel inventory adjustment. Reported sales growth is now expected to be in the range of 12% to 13% and versus our prior guidance of 13% to 15%. This reflects full year organic growth of 3% to 4% versus our prior guidance of 4% to 6%.

We continue to expect acquisitions to contribute approximately 9 points to sales growth. We are raising our adjusted EPS guidance to a range of $3.01 to $3.03, up 25% to 26% versus our prior guidance of $2.85 to $2.91. This new guidance reflects our year-to-date performance, continued strong execution and better acquisition performance. We now expect acquisitions to contribute approximately $0.15 to adjusted EPS versus our previous expectation of $0.08 to $0.10.

Looking at our fourth quarter outlook on Slide 10, we expect reported sales to grow 15% to 17% with acquisitions contributing approximately 13 points to sales. Organic sales were expected to be up 1% to 3%. We expect adjusted EPS to be between $0.73 and $0.75 which, at the midpoint, reflects 12% growth relative to last year.

Wrapping up, we delivered another quarter of robust margin expansion and cash flow and are well positioned for another great year. This concludes my remarks, and I will now turn the call back over to Beth.

[Beth Wozniak, executive]

Thank you, Sarah. Please turn to Slide 11. At events, we are building a more sustainable and electrified world. The trends in electrification, digitalization and sustainability are driving secular demand for our products and solutions. I'm confident about the future, given the macro trends and our strategy with our focus on high-growth verticals, new products and acquisitions.

Starting with macro trends, we believe the $1.3 trillion in U.S. and European legislative funding for infrastructure has the potential to add between $250 million to $500 million in nVent sales over the next 5-plus years. Looking at the trend of digitalization, artificial intelligence is driving demand for our liquid cooling solutions, leading us to increase investments to expand our product portfolio and capacity to drive future growth.

Looking at sustainability, we are seeing the energy transition gain traction. Notably, our third quarter project orders were up double digits in our Thermal Management segment.

Next is our focus on high-growth verticals and new products. As we shared at our Investor Day, more than 60% of our sales are exposed to secular trends. Some of the high-growth verticals we are focused on include industrial automation, data solutions, power utilities, renewables and the energy transition.

For example, we expect our Data Solutions business to continue to grow double digits and reach over $500 million in sales next year. By the way, we look forward to hosting investors at the Supercompute trade show in Denver next month, where we will showcase our innovative portfolio, including our liquid cooling solutions.

Turning to new products, we have seen significant growth. We have improved our new product introduction process, increasing velocity and time to revenue. Year-to-date, new products have contributed 3 points to sales growth, and we have launched 64 new products way ahead of our expectations.

Lastly on acquisitions. We play in a highly fragmented $75 billion space. We see tremendous opportunities to continue to grow and expand with our acquisition framework. Recall, we look for differentiated product portfolios in high-growth verticals that we can invest in and scale to strengthen our position with the electrification of everything. This year, we expect the ECM and TEXA acquisitions to add approximately 9 points to sales. We have a strong track record of deals exceeding our weighted average cost of capital in 2 to 3 years.

In summary, we expect to continue to execute on value-creating deals with our active funnel and strong balance sheet. We are excited about the electrification of everything.

Wrapping up on Slide 12. We had a strong quarter with record sales and adjusted EPS. We expect 2023 to be another year of double-digit sales and adjusted EPS growth. While the current environment is mixed, our execution has been strong. We are driving growth with new products. We are executing well on acquisitions. We are expanding margins with price and productivity and we are delivering robust cash flow. We are within our target leverage ratio in less than 2 quarters after completing our largest acquisition ever.

The ECM and TEXA acquisitions have been meaningful additions to invent and are performing well. We are excited about the growth and scale of our combined portfolios. I'm very proud of how well our team is performing.

Looking ahead to 2024, we believe we are well positioned with the electrification, sustainability and digitalization trends. We believe the legislative funding and investments in infrastructure will start to [indiscernible]. We expect to see the continued acceleration of artificial intelligence and the energy transition, and we expect the sales synergies from our acquisitions to begin to layer in. We are excited for our future, our future is bright.

With that, I will now turn the call over to the operator to start Q&A.

[Operator]

[Operator Instructions] Today's first question comes from Jeff Sprague with Vertical Research.

[Jeffrey Sprague, analyst]

Could we just kind of touch on the channels a little bit more detail that you gave on the call. So we're kind of a year into kind of channel inventory liquidations at this point, right? And just kind of wondering your confidence in kind of parsing what actually is normalization versus maybe just kind of eroding fundamentals underneath the surface kind of deteriorating here as we go.

[Beth Wozniak, executive]

I think as we started to see some of this activity taking place earlier in the year as supply chains improved. And that continued, and we expected it to continue in Q3. And I would say some of our channel partners have done that and some are still continuing, so it's somewhat mixed.

And I think early on, we saw some of the slowness in commercial resi and so we saw some of that activity taking place there. Then we've started to see industrial slowing. I would say sell-through has been slowing as well.

But I think it is some end markets are choppy, so we're seeing some slowness there. But then we also see some positive in some of the -- we've seen commercial in some places to be very positive. Our event [ caddy ] portfolio has seen some nice growth over the last several quarters. I think it's really mixed, Jeff, and what we're seeing. And I do think with supply chain is improving, that's been one of the big drivers of the adjustment.

[Jeffrey Sprague, analyst]

And you did note orders were positive in EFS and thermal. How did they perform in Enclosures? And is there a particular additional inventory issue that you're working through there?

[Beth Wozniak, executive]

Yes. On the enclosure side, it's -- they were down, and some of that is what we saw in industrial slowing. But again, puts and takes there, infrastructure data solutions was very strong. So some of it is inventory adjustments and some of it is some industrial areas starting to slow.

[Jeffrey Sprague, analyst]

And maybe just last one. Just your confidence on the continued ability to kind of price in a kind of what was called a flat volume environment.

[Beth Wozniak, executive]

Well, I think you've seen every quarter that we've had strong price, although we said it was going to slow as we progress through the year just because of how we started to lap some of our price increases. We're continuing to do some price increases where we think that makes sense. For example, we've had some price increases in Europe. And I think as we look into next year, we still expect that we will be positive when it comes to price.

[Operator]

The next question comes from Nigel Coe with Wolf Research.

[Nigel Coe, analyst]

I'm going to start off with a question you're probably not going to answer it, but I just appreciate your thinking about the '24 environment. We've got channel adjustments, some maybe getting stronger, some weakening, but we're certainly quite deep into that process right now. So perhaps you've got some favorable comps coming up on the channel into '24. But I'm [ interested ] actually in this backlog build of [ TM ] and obviously, the data center -- data solutions tailwind, how are you thinking about the growth setup for next year? I mean are you confident, obviously, you're investing in [indiscernible] business, but what kind of environment do you plan for in '24?

[Beth Wozniak, executive]

Well, look, we're confident in 2024 being a solid growth year for us. And when we think about -- as I was saying in some of my concluding remarks, first, you have some of this infrastructure spending starting to actually ramp in 2024. And we can see that because of some things that we're quoting on, so we know that, that money will start to flow and have an impact into 2024.

Second, we look at some of the order rates that we have in Data Solutions, which has given us the confidence, right? To make those significant investments and build out more capacity. So in that case, we've got good visibility, especially with some of the hyperscale and where we're involved with this AI, which is driving the demand for liquid cooling.

Third, when you take a look at our Thermal Management business, we see those orders increasing. So we talked about double-digit orders growth and in particular, around that energy transition. And we've seen some nice wins whether it's on renewables or carbon capture. So we're seeing funding going into that energy transition.

So I think the channel inventory adjustments this year have been one of those things a little bit out of our control, but everything that we've been working on, new products, we will have more new products this year than we've had in the last couple, and that's always been a great driver for growth for us. And I just want to add, of course, we have the two acquisitions and those sales synergies that we've been working on will start to begin in 2024. So all of that, I believe, sets us up for a solid growth year next year.

[Sara Zawoyski, executive]

And maybe one other thing, Nigel, just to add from a modeling standpoint too. This year, at an nVent level, the impact of our wind down of the Russia business was roughly 1 point of headwind on the top line. And while we'll see a little bit of a rollover in that in Q1 in thermal, it will have a negligible impact from a year-over-year perspective going into next year. So we won't have that headwind either.

[Nigel Coe, analyst]

So obviously, 4Q embeds a pretty significant step down in margin. So I hope we get into that on the call, but I just want to just dig into the M&A contribution of $0.15 for the year because that's obviously a nice pickup. $0.08 in the quarter, I think it implies maybe 5% in the fourth quarter. You're pointing to some integration and investment spending in the back half of the year. Just wondering maybe some of that pushing out on the right -- I guess the question is, what's driving the upside to the M&A [ attrition ]?

[Sara Zawoyski, executive]

Yes. I mean, I think it's a couple of things. One, as we bring that ECM into the nVent fold here, I think the team is executing very well from a price cost perspective. I also think that they're executing well from an overall productivity and cost control measures. So I think it's just --

I think the other point I would make too, Nigel, is we also have some mix benefit there. As you look at that business, if you remember, it's largely through distribution, but we also have OEM and retail e-commerce that distribution business is actually growing and growing nicely. So we're getting some positive mix contribution there as well.

But as we look in Q4 from Q3, there's a couple of things to keep in mind is there. You have some normal seasonality in that business, very similar to the EFS business. And we will begin to ramp on the investment side to be in a good position for those sales synergies that Beth talked about. And that's going to take the form of some digital investments, sales and marketing, engineering investments, et cetera. And we're really excited about what that holds for us next year.

[Operator]

The next question comes from Deane Dray with RBC Capital Markets.

[Deane Dray, analyst]

I would like to talk a bit here about data solutions investment that you're making. You talked about it last quarter. I was hoping you could size for us, I think you've told us the CapEx, but how much capacity are you adding in liquid cooling and when does that come online? And we'll probably hear more about this at super compute. But just give us a sense of your customer concentration. It looks like all the hyperscale guys [ have once have ] moved the fastest into this space. How broadly do you think the customer base extends and what time frame?

[Beth Wozniak, executive]

Okay. So this has been -- we've been adding capacity. First, opening a new plant in Mexico, so we could expand capacity within our Minnesota campus, if you will, for more liquid cooling. And then we realized that wasn't enough. So we're moving distribution out of that location to a new center to extend more capacity.

And I think we're going to double our capacity. Maybe it's more than that. But I mean, that's how we're thinking about it when we look at liquid cooling.

And a couple of things that we've been doing in addition to the hyperscale accounts, we've also been creating some more standard offerings that we can take through some of our distribution channels as well as serve say, maybe enterprise accounts where they're looking for maybe not a custom solution, but for something ready to go and off the shelf. These are some of the products we'll actually have on display at the supercompute trade show. So we can give a -- we can overview for those in attendance just all the different breadth of our capability there.

So we've often talked about, takes a couple of years to work with an account to get these systems certified. We've been doing that for several years now. So we believe these new customers are starting to come online. That's also part of what's accelerating our growth into next year. And we just see a long runway here that, liquid cooling, just because of the types of chips that are being used and even some of the energy efficiency play there that, that will be the future.

[Deane Dray, analyst]

Let me go back to a couple of points that Nigel was asking about on ECM. Can you separate for us how much of the cost synergies you've captured so far? And it sounds like most of the revenue synergies are still in front that certification to take the products into Europe and Asia that still happens. But it's unlike some of these enclosures business might be selling some of ECM as well, maybe that time frame is earlier. So where do you stand on cost synergies and time frame for revenue?

[Sara Zawoyski, executive]

Well, I'll start with the cost synergies. So I would say, Deane, we're off to a great start from a cost synergy standpoint. If you recall, we estimated roughly $10 million to $15 million by year 3 and some of that execution in the quarter is really a faster-than-expected realization of some of those cost synergies, whether it's looking at some of our freight parcel rates combining kind of the overall insurance programs, I think the team is doing a nice job of finding those synergies early. And so we're well on track to achieve that $10 million to $15 million of cost synergies.

I think the other thing I would just point out, too, we talked about this, and it shows up really in our cash flow numbers is we are also on track and seeing the cash tax synergies as well of roughly $6 million to $8 million per year across that 10- to 15-year kind of amortization period. So the cost and the tax synergy is well on track.

And on the revenue synergies, I would say they're still in front of us, but what we've been working on, we said we're going to expand the ECM products through our distribution channels. And so we've been engaged in those discussions. I mentioned that, and I think we'll start to see that layer in as we go next year.

Similarly, we've been looking at some of the unique channels that ECM had and what products from our portfolio can we bring through their channels. So again, those discussions are overweight. And I think where we're trying to certify the product, obviously, for global distribution. That takes a little bit longer because you've got to get those certifications. And there are some different modifications we make to the product. So I think going into 2024 is when we start to see those synergies start to layer in.

[Operator]

The next question comes from Julian Mitchell with Barclays.

[Julian Mitchell, analyst]

Maybe just a margin question, first off. So it looks like the fourth quarter guide, you're embedding, I think, sort of flattish revenue sequentially at sort of [ 860-ish ] or something. But the operating margin is down 250 to 300 basis points. So I just wondered if that was roughly correct and I understood you often have seasonally down margins in Q4 sequentially, but if there was any particular aspect driving them this time or it's just conservatism?

[Sara Zawoyski, executive]

If you recall, Julian, there's a seasonality to that Q3 to Q4 margin that has consistently played out historically. So when you think about it, some of it is just going to be the mix of the business in terms of Enclosures and EFS versus thermal. And I think the other piece I would point to is just the acceleration on the investment front from an EPS perspective. So we talked about that in our prepared remarks. A big piece of that is going to be on the data solutions investment side of things. So nothing in there beyond really that historical seasonal EPS pattern as well.

I think the other thing I would point to, just from an EPS perspective, it doesn't necessarily show up on the [ rock ] side of the equation because that's overall accretive, it's just going to be ECM. We do believe that ECM will have less of a contribution, still stronger than what we expected initially. But again, that's just that added seasonality element to it.

[Julian Mitchell, analyst]

And then just a second question around the top line. Should we assume that, that orders improvement in EFS translates into sales quickly, say, in Q4, sales growing again in EFS. And more broadly, I heard the comments around destocking, are you seeing any kind of project delays in commercial or industrial and then that's feeding through to distributors selling into those projects starting to pull back on their orders to suppliers such as yourself?

[Beth Wozniak, executive]

Well, maybe one area that I would point to is -- I'll just give you an example, [ ground rods ] are used in utilities and telecommunications and construction, et cetera. This was an area where we had really long lead times over the last couple of years, like months. And then we're now in stock, and it's down to like weeks. And so what we saw there was that there was inventory that had been built up at our channel partners and then there was inventory even at end customers. And so that's one of the impacts, as I characterized that we saw for EFS occurring even though we know the future with everything electrifying, this is a category that is going to continue to grow.

And when we tried to understand where the inventory is at, we have -- we know in some accounts, there are some end customers that perhaps they're waiting for other components beyond ground rods that we don't make that have slowed some of those projects. That's one area, but -- that's just one example. But I would say generally, it's just inventory adjustment is mainly what we're seeing. And go ahead, Sara.

[Sara Zawoyski, executive]

Yes. And then just from a Q4 sales perspective, we do expect to see modest growth in EFS in Q4. So if you just take a step back and look at that organic growth of 1% to 3%, we expect enclosures to lead -- expect modest growth in EFS and then expect thermal to continue to be down with some of those trends continuing on commercial resi and that Russia impact. And just to characterize that a little bit, that Russia impact specifically on that thermal management business is roughly 5 points in Q4.

[Operator]

Your next question comes from Joe Ritchie with Goldman Sachs.

[Joseph Ritchie, analyst]

Just maybe can we just start on EFS margins? I know that you've got the acquisition going through there as well. If you kind of think about negative organic growth, the EBITDA margin now north of 30%, north of 32%. How do we think about the trajectory of these margins from here? Fully recognizing that I think is there to step down expected in 4Q.

[Sara Zawoyski, executive]

Yes. I think -- here's what I would say is, one, I think the team has done an incredible job of managing that price cost equation. I think we're beginning to see that productivity ramp within the 4 walls as we would have expected kind of heading [ icker ] into the back half.

I think the other piece that's really showing up in that Q3 number is the mix that I referred to in Riter's prepared remarks. And we just had sort of an uneven mix of revenue, if you will, commensurate with what that typically looks like and that's driving some of that [ $32 plus ] return on sales for that quarter.

But if we look -- just going ahead in electrical and fasting, and I would argue that this is cut across enclosures as well, we continue to see strong underlying margin expansion opportunities. And it goes back to with volume in new products. Those new products tend to have higher margins because of the value that we're providing to our customers. The supply chain excellence, while we're improving productivity, improving productivity within the 4 walls, we're still not at our normalized levels of productivity, if you will. So there's still plenty of runway there to go. We're also doing things like transportation optimization, lean, automation, simplification of product family. So there's a lot going on there as well, along with just general functional excellence that you do see the leverage we're getting from an SG&A perspective.

So there's lots of things that we're doing to drive that ongoing future margin improvement within Electrical & Fastening Solutions as well as the broader segments as well Enclosure and thermal. The only other thing I would make is, is that Q3 to Q4 to does include the incremental investments we plan on making within the ECM acquisition as well that will really begin to ramp here in Q4 and into next year.

[Joseph Ritchie, analyst]

Got it. That's helpful, Sarah. And I guess maybe piggybacking on Julian's question around commercial. It's interesting. I mean if you take a look at the start data, it's been pretty tough over the last several months. And then you look at the performance of each of your different businesses and depending on the business, commercial resi has been growing or not growing. I'm just -- it's kind of hard to square it all. And so maybe just kind of like give us a little bit more insight as to why potentially commercial resi might be holding up a little bit better in EFS than in thermal, if there's anything you could add there?

[Beth Wozniak, executive]

Yes. I think it has to do with our product portfolio. So if you think of what we do with our nVent CADDY brand, which is all around supporting power and data infrastructure, and you think about it's really applicable to any type of construction or remodel. And we just think everything is getting smarter and there's more power and data reward in a building, in a hospital whether it's industrial, construction, new plants, et cetera. And we've done a lot to invest in new products in that product line.

So our new product vitality there is approaching 20%. And when we acquired EFS, it was single digits, so seismic, just different things that we're doing that I think that portfolio, ubiquitous and where we are.

Our commercial portfolio in thermal is not as ubiquitous just because we're doing freeze protection or we're doing underfloor heating or we're doing maintaining hot water heat tracing within a building so it just -- the applications are a little bit different. And I think that's one of the things that we're seeing, the difference there.

[Sara Zawoyski, executive]

And maybe one other thing to add here too, the Thermal Management business has more of the resi as well. Impacting that from a growth rate perspective.

[Joseph Ritchie, analyst]

Yes. I guess maybe that's very helpful, and I appreciated all that detail. Maybe the follow-up there is, I mean, is there -- should we be reading into the commercial starts data and ultimately, what that means for your business?

[Beth Wozniak, executive]

Well, this is one where we've got pockets of growth. And I think one thing we're seeing is just construction in general, right, which tends to be a little bit more and then industrial construction is driving growth for some of our products. There's a lot of investment in new battery plants and other things. And sometimes those products with CADDY, we can't tell, but because it may look more commercial even though it's headed to industrial construction, I think that is another area that's driving growth for us.

[Operator]

The next question comes from Vlad Bystricky with Citi Group.

[Vladimir Bystricky, analyst]

So just stepping back, I wanted to ask you, as we've seen increased pressure on interest rates recently. Just what are you hearing from your channel partners in terms of how increased cost of funding their own inventory is influencing sort of how they're approaching this destock cycle and whether you see some risk that destock could be they could swing further in the other direction versus recent cycles just given their increased cost of financing.

[Beth Wozniak, executive]

Well, they don't really -- they're not really that explicit in sharing with us how they're thinking about it. But we know that's certainly one of those considerations. And we think that's what's played out over the course of this year that they've looked at their cost of capital and inventory. And with supply chain improving, it's a multitude of factors, but we certainly think that's what's played out here in 2023.

[Vladimir Bystricky, analyst]

And then just maybe, you mentioned, I think, in thermal, China, low double digits growth. So can you just talk about specifically what's driving that in China versus not a great overall backdrop in the region? And how you're thinking about sort of sustainability of good growth in China for thermal?

[Beth Wozniak, executive]

Well, one of the things I would say with our business in China, we've got a lot of project type based business. And so some of that could be on the chemical side or on the energy side. And that's where, over the last little while, we've been working on projects and orders and started to see some of that growth there on that industrial side for us.

[Operator]

The next question comes from Jeff Hammond with Keyport Capital Markets.

[Jeffrey Hammond, analyst]

Maybe just to go at the organic growth in a different way. It looks like you lowered your guide from [ 4% to 6% to 3% to 4% ]. And I'm just wondering if that's simply kind of the destocking effects or if there's anything else that's driving that change?

[Beth Wozniak, executive]

That's basically it. As we've noted, some of our channel partners, we think, are through that inventory adjustments and then some have indicated they're going to continue that through Q4. So just in light of that and it's sort of being choppy, we just -- that was our view that we would see improvement from Q3 to Q4, but we did lower it just because that inventory adjustment is going to continue into that fourth quarter.

[Jeffrey Hammond, analyst]

Okay. Great. And then just on liquid cooling. It seems like a lot of other companies are talking about liquid cooling and maybe just update us on competitive landscape, emerging competitors? I don't know if these products are maybe complementary or different or if you're seeing kind of new competition and new capacity investments?

[Beth Wozniak, executive]

Well, a couple of things. We've been at this for a long time, even free spend working with some of these big leading customers. And over the course of the last 5 years have developed some solutions that took a while to really optimize the manufacturing supply chain capability and they're really ramping.

So as I mentioned, it takes two years to test. So I think for some, it takes time and there are some start-ups and others, but it takes time to get to scale in manufacturing. So I think we're in a good position that we're accelerating. I think there's a lot of interest here, clearly with AI, and we're expanding from what have been more solutions for hyperscalers into solutions that we can sell through distribution channels or to enterprise accounts. And we think that's where over the next several years, we're really going to start to see more scale adoption.

So I feel from the standpoint that we have several partnerships. So whether it's -- we -- actually, from the -- whether it's a [ close late ] or immersion, we have the manifolds, we're doing the distribution units. We've got solutions that are liquid to air, liquids to liquid. I mean, we've got a variety in our portfolio. So I think it's going to be an area of strong growth, and I think we've got a good start on it.

[Jeffrey Hammond, analyst]

And then just last one on ECM. I think when you announced the deal, I think the margin structure was kind of in line with the overall invent maybe well below EFS. But it sounds like maybe it's coming in a lot higher and do we need to kind of adjust our expectations for kind of margin contribution from that [ business ]?

[Sara Zawoyski, executive]

Yes. So out of the gate, Jeff, we have said that ECM would be accretive to overall nVent. And just given the margin profile of would be a bit dilutive, they're out of the game. But I would say that -- I mean, I think that ECM margin profile is a couple of things. Like I said, it's the mix profile that we do believe that as that growth accelerates, it will probably revert back a little bit to the prior kind of margin profile. But two, we're going to continue to execute on our cost synergies, and that should accelerate over time.

And I think the third piece to keep in mind, too, is the investment. So I think what you're seeing right now is great execution by the team, very good price cost management and some early cost synergies. I think what you think -- something to think about as you think about Q4 and into next year is just the increased investment that we plan on making to really ramp the top line even more and capture some of those sales synergies.

[Operator]

The next question comes from Scott Graham with Seaport Research.

[Scott Graham, analyst]

So Beth, just to maybe ask you to elaborate your comment on '24, sorry. When you said growth, do you mean organic or earnings or both?

[Beth Wozniak, executive]

Well, I was specifically talking about our overall growth. But I mean both. We expect to grow organically, inorganically, obviously, with these acquisitions and to grow EPS.

[Scott Graham, analyst]

Very good. And one for you, Sara. The drop down in incremental margin in the fourth quarter from the third quarter, is that because the gap in positive price/cost peaks has peaked in the third quarter and kind of narrows a little bit in the fourth quarter?

[Sara Zawoyski, executive]

Well, here's what I would say. There's nothing different in terms of price cost on performance first half, second half. We came into the second half, expecting that to narrow. At the same time, though, Scott, I would say the productivity is ramping.

I think one thing to keep in mind is if you look at the cadence of last year, Q4 was our best return on sales expansion that we had last year, roughly 300 basis points, and that's when it began to kind of turn us on some of our pricing actions were coming into play. And so it's one of our most difficult comps, I think Enclosures expanded return on sales by like over 600 basis points in the quarter.

So I would just come back to, in Q4, if you look at it just from a year-over-year standpoint, despite the difficult comp, we're planning on growing organically. We've got a good line of sight to another quarter of margin expansion across nVent and then you roll in the positive impact of acquisitions, so it's summing up to a really nice kind of year-over-year earnings per share as we end the year.

[Scott Graham, analyst]

Last one, if you don't mind. Just wanted to understand your capital allocation thinking given the sort of the higher for longer mantra that we continue to hear from the Fed. Does that slow things down for you guys? I know you've got the great opportunity to understand that, get that. Just that are you thinking that maybe you have to pause a little bit here? Or does your criteria [indiscernible]? What's changing, if anything, in that environment?

[Beth Wozniak, executive]

Well, look, I think we've always fundamentally been very strategic and disciplined in how we look at our capital allocation. And we've always said, first, we want to support growth. And so you've seen that in the M&A that we've done and the investments in new products, digital expansion, right for data solutions, pay a competitive dividend and make sure we offset dilution and I think that still remains our position. And as we look at things like growth, we're always looking for good returns and that we can execute within our framework. So I don't think it's giving us any different perspective in how we think about our priorities.

[Operator]

Thank you and this concludes the question-and-answer session. And now I would like to return the call to Beth Wozniak for any closing comments.

[Beth Wozniak, executive]

Thank you for joining us today. I'm very pleased with our performance in Q3. We believe nVent is a top-tier high-performance of electrical company, well positioned for the electrification of everything, sustainability and digitalization trends. Thanks again for joining us. This concludes the call.

[Operator]

Thank you. Now as mentioned, the conference has now concluded. Thank you for attending today's presentation, and you may now disconnect your lines.