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Watts Water Technologies Inc (NYSE:WTS)
Q4 2020 Earnings Call
Feb 11, 2021, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Watts Water Technologies Fourth Quarter 2020 Earnings Conference Call. [Operator Instructions]

I would now like to turn the conference over to your speaker today, Timothy MacPhee, Treasurer and Vice President, Investor Relations. Thank you. Please go ahead.

Timothy MacPhee -- Treasurer and Vice President, Investor Relations

Thank you, and good morning, everyone. Welcome to our fourth quarter and full year 2020 Earnings Conference Call. Joining me today are Bob Pagano, President and CEO, and Shashank Patel, our CFO. Bob will provide an overview of the past year, review our 2021 priorities as well as update you on our market expectations for this year. Shashank will provide a detailed analysis of our fourth quarter and full year financial results and discuss our outlook for 2021. Following our prepared remarks, we will address questions related to the information covered during the call. Today's webcast is accompanied by a slide presentation, which can be found in the Investor section of our website. We will refer to these slides throughout our prepared remarks. Any reference to non-GAAP financial information is reconciled to the relevant GAAP measure in the appendix to the presentation.

Before we begin, I'd like to remind everyone that during the course of this call, we may be making certain comments that constitute forward-looking statements. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially. For information concerning these risks, see our publicly available filings with the SEC. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. With that, I will turn the call over to Bob.

Robert J. Pagano -- Chief Executive Officer and President

Thank you, Tim, and good morning, everyone. Please turn to Slide three in the earnings presentation, and I'll offer some reflections on 2020 and provide our updated thoughts on 2021. I want to start out by expressing my deepest gratitude to our employees around the world. Their dedication since the start of the pandemic has been unwavering to ensure our customers' needs were being met and our business continued to move forward. This past year has tested everyone's endurance and patience. I'm so grateful to our experienced team that was able to nimbly adapt to the dynamics of this constantly changing global environment, and I'm confident the team will continue to proactively manage our business to meet our customer expectations in 2021 and accelerate Watts' strategy.

I'm also pleased to report that we continue to make progress in our environmental, social and governance efforts and in diversity, equity and inclusion initiatives this past year. Our sustainability performance improved following evaluations from several leading ESG rating agencies, and we supported our customers and local communities that were impacted by the pandemic. As you know, our product portfolio is aligned with three macro themes. Safety & Regulation, Energy Efficiency and Water Conservation. We believe this focus dovetails well with the ESG framework.

In 2020, we launched our first diversity, equity and inclusion survey, which identified key focus areas, and we formed working groups to lead our global diversity initiatives. We've also deployed employee training and development programs relevant to this effort. As a company, we enacted a comprehensive response to COVID-19 challenges. First, employee safety was and remains our priority. Through our COVID-19 taskforce, we emphasized safety protocols in the workplace that met or exceeded CDC and other country-specific requirements. Secondly, given we are an essential business, we maintained a customer focus. We set up a hotline very early in the pandemic to aid healthcare customers with any urgent requirements. We expanded our library of online learning tools to offer training and to stay in touch with our customers, which has provided us with great insights into customer focus areas and usage. And we continue to invest in new product development to address our customers' needs.

Regarding our 2020 performance, we proactively took very aggressive cost actions starting late in the first quarter of 2020. These address long-term structural as well as short-term discretionary costs. The totality of these actions was a positive impact of $55 million to our operating income in 2020. Clearly, some of the short-term actions are a headwind in 2021. The cost actions helped us maintain our operating margin at 2019 levels despite the top line headwinds. We also invested in strategic new product development and in our Smart & Connected strategy. We increased free cash flow over 2019 levels by 14%, and we strengthened our balance sheet by paying down debt, putting the company on solid footing as the pandemic subsides. We prioritized liquidity by managing working capital, extending our financing agreements, and aggressively paying down existing debt through repatriation and operating cash flow. We continued our balanced capital allocation strategy. We invested 50% more than 2019 in capital spending to fund growth and productivity. We continue to invest in new product development, and we made two small bolt-on acquisitions. We acquired the Australian Valve Group in Q3 and The Detection Group, or TDG in the fourth quarter, which I'll discuss momentarily. Finally, we sustained our dividends and share repurchase programs. Given the circumstances and challenges we faced, 2020 was a successful year for our company.

Next, I'll review our key priorities for 2021. As I previously mentioned, employee safety is our #1 priority. We'll continue to promote proper hygiene and safe social distancing practices. In 2020, we delivered over 100,000 training sessions, both online and through virtual Lunch & Learn meetings. This represented a 70% increase in training sessions over 2019. In 2021, we'll continue to enhance our training programs for customers, reps, engineers and contractors in order to drive further customer connectivity. We'll continue to elicit customer feedback to drive new product introductions and solutions, including expanding our Smart & Connected portfolio. We'll look for opportunities to expand geographically into new regions, either organically or through acquisition. Productivity will continue to expand through our One Watts performance initiative and is expected to help fund incremental 2021 long-term investments.

Now let's briefly talk about how we see the market-shaping up in 2021. We gave some preliminary views on this year's markets during our November earnings call. Since then, we have finalized our internal operating plans and updated industry data has been published. Also, two important macro unknowns have been crystallized, namely the US elections are behind us, and effective vaccines have been approved and the deployment process has begun. What is still uncertain is when we can effectively reach herd immunity, which in turn depends on how quickly the vaccine can be disseminated to the broader population and how many people opt to take the vaccine. From a macro perspective, GDP forecasts in all our major regions are expected to grow from 2020's depressed levels, with most of our key countries expanding at 3% or higher. In the Americas, our market expectations for new construction in both the commercial and residential markets are still mixed and vary by submarkets. New residential single-family construction in general looks to be steady with persistently low interest rates, higher housing starts, expected job and income growth and positive demographics, driving anticipated mid to high-single-digit growth in single-family housing starts in 2021. And the LIRA index is anticipating the growth rate of homeowner spend on repair and replacement projects to continue into 2021, with spending increasing approximately 4%. However, multifamily starts are expected to decline mid-single digits in 2021.

In nonresidential, we anticipate that overall growth will be challenged. We still see divergent growth prospects dependent on the end market. The latest industry indicators, including the ABI, construction market data and construction industry confidence indexes are all portending a decline in nonresidential construction in 2021. The AIA recently released its semiannual Consensus Construction Outlook, which expects new non-resi construction spend in the US to decrease by about 6% in 2021. Also, AGC recently released survey results based on over 1,300 contractors that concluded 2021 will be a very difficult year for many construction firms in their markets. Given the various industry indicators and feedback we are getting from the channels, we are anticipating air pocket in activity impacting us starting in the second quarter of this year due to the reduction in non-residential and multifamily new construction starts during the pandemic. Existing funded projects continue and are being finished, but we expect new construction projects starting in the second quarter and through yearend may be down significantly.

In Europe, the markets are also mixed. In our Drains business, the Commercial Marine segment is expected to continue to be challenged. Project markets are lumpy and homebuilding is flat. Government-sponsored home energy subsidies in Germany should continue to provide support, and we see more wholesaler activity in France, at least in the near-term as we enter 2021. In Italy, there are concerns with government programs protecting employment that expire in March, which could impact unemployment and recovery there. In the Asia Pacific region, the overall economy is expected to grow with GDP up in all regions. China is forecasted to grow over 8% in 2021. Finally, Middle East GDP is expected to grow in the 3% range, so a little slower than other regions and likely being more influenced by adverse geopolitical issues and energy demand.

Now I'd like to provide an update on our Smart & Connected product initiatives. Please turn to slide four. When we started evaluating the potential for transforming our portfolio to be Smart & Connected in 2015, we realized we had deep capabilities and competencies in our Watts Electronics and Tekmar businesses, but little in the way of a development pipeline or strategic plan. Today, each of our business units has clear strategic goals to digitally transform their product portfolio where possible. Additionally, we have created and deployed a dedicated team that has a mandate for ensuring that our connections are robust, scalable with our businesses, and most importantly, secure. With these added resources, we have more than 85 people working exclusively on Smart & Connected products globally, a 55% increase in resources over 2019. Cumulatively, we have exceeded 70,000 connected devices shipped since we started selling Smart & Connected products. The primary goal of our Smart & Connected initiative is to enhance the value our products provide to customers. We are focusing our efforts on the following key areas. Safety and regulation, like our IntelliStation digital mixing products. Water hygiene, like our HF Scientific instruments. Energy efficiency in products like our AERCO boilers and PVI water heaters. Leak detection systems like the Century Plus backflow discharge system. These systems will ultimately provide us with the meaningful data that we can begin leveraging to further enhance our product performance, customer service levels and our own operational activities.

In addition, we see pathways toward subscription services. In 2020, our Smart & Connected solutions continued to represent a larger share of our sales and were in the mid-teens of total Watts sales. We're still focused on achieving our goal of 25% Smart & Connected product sales by 2023.

On slide five, let me highlight two Smart & Connected product solutions. As I mentioned previously, we made a small acquisition in the fourth quarter, a company called The Detection Group, or TDG. TDG provides factory mutual approved wireless leak detection products and notification services for commercial and multifamily buildings. Sales approximate $4 million annually. We were interested in TDG as another offering to bundle into our overall Smart & Connected suite of products. Their products are addressing a key pain point for commercial and multifamily building owners, that being rising insurance costs due to water leaks. We welcome the TDG team to Watts.

On the right side of the slide, you will see an in-house developed solution that leverages multiple Watts brands to provide a single connected user experience. The Dormont FloPro-MD combines our Dormont gas connector manufacturing with our Tekmar Electronics expertise on a single Bluetooth-enabled device and is utilized by service technicians and gas equipment installers to read and document consumption, pressure and flow of gas via a proprietary mobile app. This allows installers to quickly identify and report if a problem may be related to equipment or to disturbances in the gas line. This reduces the need for return service calls and increases efficiency during initial start-up or repair and maintenance procedures. FloPro-MD is another good example of how far we can combine our capabilities to create solutions that address everyday customer challenges. We remain excited about the future of Smart & Connected systems and what it's bringing to Watts and the industry.

Now, Shashank will review our results for the fourth quarter and full year and offer our outlook for 2021. Shashank?

Shashank Patel -- Chief Financial Officer

Thank you, Bob, and good morning, everyone. Please turn to slide six, which highlights our fourth quarter results. Reported sales of $403 million were up 1% year-over-year. Organic sales were down 2%, but were more than offset by net acquired sales and a foreign exchange tailwind. While each region experienced lower organic sales, America and Europe sales were better than anticipated. Acquired sales, net of divestiture, approximated $1 million in the quarter. I will review regional performances momentarily. Adjusted operating profit of $55 million, a 10% increase, translated into an adjusted operating margin of 13.6%, up 110 basis points versus last year. Benefits from cost actions, including restructuring and productivity savings, more than offset lower volume and incremental growth and productivity investments. Investments totaled $3 million in the quarter. Adjusted earnings per share of $1.15 increased 15% versus last year. EPS growth was driven by $0.08 from operations and $0.07 primarily from a lower adjusted effective tax rate and positive foreign currency translation. The adjusted effective tax rate in the quarter was 24.6%. The rate declined as compared to last year as new regulations provided an opportunity to benefit from a favorable tax election, and we received tax benefits related to foreign exchange on cash repatriation.

GAAP reporting included a net tax charge of $9.7 million or $0.29 a share, primarily driven by increased income tax expense resulting from recently issued final tax regulations which reduced the realizability of foreign tax credits. In summary, aggressive cost controls and a higher American and European topline drove the better-than-anticipated operating results.

Moving to the regional results, please turn to slide seven. In the Americas, reported sales decreased by approximately 1% to $264 million. Organically, sales were down by approximately 2%, with growth in certain plumbing and electronic products being more than offset by reductions in heating and hot water, water quality, drains, and HVAC product sales. Together, positive foreign exchange movements in the Canadian dollar and the TDG acquisition added 1% to sales year-over-year. Americas adjusted operating profit for the quarter increased 1% to $46 million. Adjusted operating margin expanded 40 basis points to 17.4%. The margin increase was driven by cost savings and productivity, which more than offset the volume reduction and incremental investments. We made approximately $2 million more in investments than the previous year. Overall, Americas sales were slightly better than anticipated, with cost actions driving the positive bottom line.

Turning to Europe, sales of $120 million were up 6% on a reported basis, driven mainly by a stronger euro as foreign exchange increased sales by 8% year-over-year. Organically, sales were down 2%, which was better than we had expected. From a platform perspective, we saw growth in fluid solutions from higher plumbing and HVAC sales being more than offset by continued drain softness, especially sales into the commercial marine market. By region, we saw growth in Italy with France flat and Germany and Scandinavia both down. Italy saw strength in the plumbing, wholesale, electronics and OEM markets. France saw growth in the wholesale and OEM markets being offset by drains. In Germany, the sales decline was driven by reduced drain sales into commercial marine applications and in electronics, partially offset by continued strong sales into OEMs that are supporting government subsidized energy savings programs. Scandinavia was down with softness in drains and the wholesale market. Adjusted operating profit in Europe was approximately $17 million, a 25% increase over last year. Adjusted operating margin of 14% increased 220 basis points, primarily due to cost actions and productivity, including restructuring savings which more than offset lower volume and investments. In summary, Europe's top line performed better-than-expected and along with restructuring benefits delivered a solid operating performance in the quarter.

Now let's review APMEA's fourth quarter results. Sales approximated $19 million, up 1% on a reported basis, with favorable foreign exchange movements of 5% probably in China and net acquired sales growth of 4%, more than offsetting an organic decline of 8%. We saw double-digit organic growth within China, where commercial valve sales into datacenters continued to be strong. Outside China, double-digit organic sales declines in the Middle East and Australia offset nominal growth in New Zealand. Adjusted operating profit of $3.4 million was up 13% versus last year with adjusted operating margin up 170 basis points driven by cost controls, productivity and high intercompany volume, partially offset by lower third-party volume and investments. So APMEA saw continued China growth, while other regions are still dealing with the impacts of COVID.

On slide eight, let me speak to the full year results. For 2020, reported sales were $1.5 billion, down 6% on a reported basis. The decrease was primarily driven by an organic sales decline of 7%, attributable to the effect of COVID-19. Foreign exchange and acquisitions had a 1% positive effect on sales year-over-year. Adjusted operating margin was 12.9% in 2020, flat with 2019 and a good result factoring in lower volume. A decremental decline in adjusted operating profit was 13% for the year. We were able to mitigate the impact of the volume decline through aggressive cost actions which totaled $55 million in 2020. It is important to note that we maintained our adjusted operating margin while still funding incremental investments of roughly $9 million during the year. Adjusted full year earnings per share of $3.88 declined 5% versus the prior year. There was a decrease from operations due to the pandemic related sales decline, but this was partially offset by lower adjusted effective tax rate and favorable foreign currency translation. Free cash flow for the full year was $187 million, an increase of 14% over 2019 driven by better working capital management, especially in accounts receivable. Free cash flow conversion was 164%. We increased free cash flow while still investing 50% more in key projects over 2019. These investments were specifically in new product development, capacity expansion and factory productivity. In total, we invested $44 million in 2020, which equates to 140% reinvestment ratio. In 2020, we returned $60 million to shareholders in the form of dividends and share repurchases, an 18% increase over 2019. During 2020, we also paid down debt by $110 million. Our net debt to capitalization ratio is now negative at 2% at yearend as compared to a positive 8.4% in the prior year. We used cash from repatriations and operations to pay down debt.

Our balance sheet continues to be in excellent shape and provides substantial flexibility to address our capital allocation priorities. Given the many operating and personal challenges we faced with COVID in 2020, our ability to proactively manage costs, maintain margins in a down environment and strengthen our balance sheet was noteworthy. Bob characterized the year as successful, and I would agree.

Now on slide nine, let's discuss the general framework we considered in preparing our 2021 outlook. First, let's look at expected headwinds. COVID-19 will continue to be a focal point and the evolution of the pandemic could provide potential headwind until we reach herd immunity. We mentioned the non-residential and multifamily air pocket that could affect new construction and discretionary repair/replace. Its timing and length will determine the impact on our business. We presently believe that this air pocket will impact us starting in the second quarter of 2021. Consistent with our ongoing strategy, we are going to incrementally reinvest for the long-term growth of the business, especially in investments to drive our Smart & Connected strategy. Of the $55 million of cost actions we took in 2020, we expect that approximately $15 million of these costs will return in 2021. These costs include pay reductions, government incentives, travel and MARCOM. In the middle column are themes that we'll continue to monitor. There are several geopolitical concerns that could impact Asia Pacific and the Middle East as well as Europe. With the US election results behind us and a new administration in place, the transition and new policy proposals will take time to sort out, especially regarding further fiscal stimulus and future potential tax increases. Commodity inflation, especially in copper and steel, have been significant. We have also experienced substantial cost increases in logistics, packaging and insurance. We have announced price increases to help mitigate the current cost increases.

Now looking at anticipated tailwinds, residential single-family construction should continue to grow in 2021. We expect to benefit from new product introductions, including additional Smart & Connected products. We intend to drive continuous improvement through our One Watts performance efforts with additional productivity initiatives within our factory walls as well as in the SGA function. And we should benefit from incremental savings on cost actions taken last year. As discussed, our balance sheet is exceptionally strong coming into 2021. We have the flexibility to pursue inorganic growth opportunities to augment the business, assuming a transaction meets our strategic and financial criteria. Lastly, global economies are expected to continue to recover in 2021 from the lows of the COVID induced recession of 2020.

With that backdrop, let's review our outlook for the full year 2021. On slide 10, we have provided our major assumptions. We estimate that organically, Americas sales may range from down 5% to flat in 2021. We expect adjusted operating margin in the Americas may be down compared to 2020, with incremental cost savings and productivity initiatives offsetting increased costs that were suspended last year. Sales should increase by about $4 million with the addition of the TDG acquisition. For Europe, we are also forecasting organic sales to be down 5% to flat. Adjusted operating margin may decline for similar reasons as the Americas. In APMEA, we expect organic sales may grow from 2% to 6% for the year. Sales should also increase by approximately $6 million from the AVG acquisition. We anticipate adjusted operating margin may decline against 2020 as some level of expenses get reintroduced and intercompany volume is expected to decline year-over-year.

Overall, on a consolidated basis, we anticipate Watts organic sales to range from down 5% to flat in 2021. Organically, we expect that first half sales may be better than the second half from a year-over-year perspective. We have an easier second quarter comp due to the major COVID impact last year. Also, the second half will be challenged as we anticipate nonresidential and multifamily new construction markets will slow due to the air pocket we've mentioned. We estimate our adjusted operating margins may be down 50 to 90 basis points. This is primarily driven by the 2021 time/cost headwinds of $15 million, decremental lower volume, incremental investments of $13 million, and general cost inflation, which are being partially offset by $14 million of incremental restructuring savings, along with price and productivity actions.

Now a few other key inputs to consider for 2021. We expect corporate costs to be about $40 million for the year. Interest expense should be roughly $10 million. Our adjusted effective tax rate for 2021 should approximate 27%. Capital spending is expected to be in the $40 million range as we will continue to reinvest in our manufacturing facilities, systems and new product development, which will support future growth and productivity. Depreciation and amortization should be approximately $46 million for the year. We expect to continue to drive free cash flow conversion equal to or greater than 100% of net income. We are assuming a 1.22 euro-US dollar foreign exchange rate for the full year versus the average rate of 1.12 in 2020. Please recall that for every $0.01 movement up or down in the euro-dollar exchange rate, our European annual sales are impacted by approximately $4 million, and our annual EPS is impacted by $0.01. We expect our share count should approximate $34 million for the year.

Finally, a few items to consider for Q1. For Q1 organically, we see sales down 3% to up 1%, with Americas and Europe sales slightly negative and APMEA likely experiencing organic growth in line with the full year range due to easier comps from Q1 COVID impact last year. We estimate our Q1 operating margin will be flattish in the first quarter as compared to Q1 last year. Acquired sales should approximate $2.5 million in Q1, $1 million in the Americas and $1.5 million in APMEA. We expect incremental investments of $2 million to $3 million in Q1. The investments will be offset by about $5 million of incremental restructuring savings. The adjusted effective tax rate should approximate 26%. We anticipate foreign exchange would be a tailwind in Q1, given current rates as compared to the first quarter of 2020.

So overall, we see 2021 as a transition year for the company. During this time, we expect many of our end markets may be adversely affected, putting pressure on our organic growth and margin expansion opportunities, but we are taking this opportunity to continue to invest for the future, deepen our customer relationships, and empower our people to drive us forward.

With that, I'll turn the call back over to Bob to summarize our discussion before moving to Q&A. Bob?

Robert J. Pagano -- Chief Executive Officer and President

Thanks, Shashank. Please turn to slide 11 and let me summarize our discussion. The team successfully navigated through a very trying year. We were able to adapt to the many challenges caused by the COVOD pandemic, delivering strong results by controlling what we could, given the economic environment. Our market outlook for 2021 remains guarded. Timing for broad dissemination of the vaccine is critical to reduce uncertainty and restore some normalcy to the markets. We see a challenging year starting in the second quarter, given current industry indicators and the lack of new nonresidential and multifamily construction starts in 2020.

Smart & Connected products continue to gain momentum, and we expect they should continue to grow in 2021. Productivity and efficiencies gained through the One Watch performance system will continue and help fund investments. We plan to deliver strong free cash flow. As always, we'll remain disciplined in our capital deployment, prioritizing reinvestment in bolt-on acquisitions that strengthen our core, further expand our geographic reach and add technology to build scale. We'll be closely monitoring how the COVID vaccination process develops and how that affects customer sentiment and the construction markets. Given our 2020 performance, I'm very confident in our experienced team will work through the near-term COVID issues and execute on what we can control in 2021, while still focusing on our long-term growth strategy.

With that, operator, please open the line for questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Your first question comes from Nathan Jones with Stifel. Your line is open.

Nathan Jones -- Stifel -- Analyst

Good morning, everyone.

Robert J. Pagano -- Chief Executive Officer and President

Good morning, Nathan.

Shashank Patel -- Chief Financial Officer

Hi, Nathan.

Nathan Jones -- Stifel -- Analyst

Thanks very much for all of the color on your end market expectations there, Bob, that's very helpful. Maybe just a few questions on the cost side to start with. Shashank, you made a couple of comments during your remarks, $15 million of costs returning in 2021, $14 million incremental cost savings in 2021. Can you talk just in a little bit more detail about what the level of temporary costs that you took out in 2020 that are returning versus carryover savings from structural elections, just to put a finer point on that? And then given the expectations that revenue are going to be net down low to mid-single digits here in 2021, whether you need to take more cost actions or more planning to maintain capabilities for a potential rebound in 2022?

Shashank Patel -- Chief Financial Officer

So on the cost actions that are coming back, it's about $15 million of headwind, primarily starting from May onwards. And what that $15 million is made up of is there was temporary pay cuts we had from the April through September time period, which is about $3 million. We got government subsidies, primarily in Europe and in China, which is about $3 million, which again were one-time. Travel and MARCOM is about another $6 million, and that's the one we're going to meter. Obviously, in the first six months, it's going to be light again because of COVID. But in the second six months, once things hopefully open up, those costs will be coming back and we'll be metering that based on what the top line is. And then there are some miscellaneous other costs of $3 million, and that's the $15 million of cost headwind that we've kind of included in the budget. And obviously, we'll be metering the variable pieces of that like travel and MARCOM. On the restructuring side, of the $55 million cost out in 2020, about $14 million were restructuring savings. Now -- and that was partially a restructuring savings. So the actions we took saved us $14 million last year, and then there's another incremental roughly $14 million, $15 million that we get in 2021 on top of the $14 million that we had.

Nathan Jones -- Stifel -- Analyst

Okay. So net temporary versus restructuring, you're about even in 2021?

Shashank Patel -- Chief Financial Officer

That's a fair statement, yes.

Nathan Jones -- Stifel -- Analyst

Just one more on the repair and replace side of this, Bob. I know you talked last quarter about not seeing the typical correlation between GDP recovery, repair and replace and there was some concern there that potentially customers' balance sheets were a bit wounded, and maybe you wouldn't see that typical correlation. Any updated thoughts with another three months under your belt there?

Robert J. Pagano -- Chief Executive Officer and President

Yes. I think the troubled markets, which are really the hotels and restaurant side of the business, I think their occupancy is 10% in some of the hotels, etc. So I think they're continuing to defer as much maintenance as they can. Certainly, the break/fix side of that is happening, but overall, they're cash constrained, and I think that continued in the quarter. Overall, we saw positive residential side. And everybody is trying to complete their existing projects that they started because builders want to get paid and get going. So I think we're seeing that continuing as expected. And our biggest concern is really in the -- primarily in the second half of the year given the starts, the lack of starts in the multifamily and nonresidential part of our business.

Nathan Jones -- Stifel -- Analyst

Do you believe this might create some pent-up demand? Or does this just permanently shift that demand curve to the right?

Robert J. Pagano -- Chief Executive Officer and President

Yes, it's tough to tell on that. That's a great question because I think in some parts, there'll be pent-up demand that's willing to be spent. But others, and again, those troubled markets, I think it is just going to be pushed to the right until they get their cash flow back. So I think, again, that's mixed.

Nathan Jones -- Stifel -- Analyst

Thanks very much. I'll pass it on.

Robert J. Pagano -- Chief Executive Officer and President

Thanks.

Shashank Patel -- Chief Financial Officer

Thanks.

Operator

Your next question comes from Jeff Hammond with KeyBanc Capital. Please go ahead.

Jeff Hammond -- KeyBanc Capital -- Analyst

Hey, good morning guys.

Shashank Patel -- Chief Financial Officer

Good morning, Jeff.

Robert J. Pagano -- Chief Executive Officer and President

Good morning, Jeff.

Jeff Hammond -- KeyBanc Capital -- Analyst

So just a clarification on multifamily. What are you looking at, or what are you assuming for multifamily? I know it's not going to be as robust certainly as single-family, but I thought it would be fairly stable.

Robert J. Pagano -- Chief Executive Officer and President

Well, multifamily, overall construction, as I said in my prepared comments, is going to be -- they're forecasting to be down 6%. What we're most concerned about is when we look at loan originations, and I'm looking at a Q3 document that basically said the origination volume index for multifamily is down 31%. And that was in Q3, expecting similar in Q4. So again, everybody is completing, Jeff, what they started, but new construction is really slow at this point in time. Permits are down. You see the ABI, the Dodge Momentum index, all those are portending a softness in that air pocket that we're talking about. Talking to channel partners, they're also discussing that they're seeing some air pockets, and for the first time in a while, there's some trades, plumbers, etc., unionized labor that's sitting on the bench and not employed right now, in particular in New York City. So those are the things that we're most concerned about. A lot of stuff that started is being finished. And I think that's mixed up into that overall minus 6%. But I think the second half of the year in particular is going to be really challenged.

Jeff Hammond -- KeyBanc Capital -- Analyst

Okay. And then so if I look at your bridge, it seems like at the midpoint of guidance, EBIT is down $13 million. And you've got $28 million of headwind from investments and temp costs coming back, $15 million of structural savings. And then I guess you had some volume baked in. So I don't know if I'm missing something else in the bridge, other savings or favorable mix or --

Shashank Patel -- Chief Financial Officer

Yes. So Jeff, mix is not -- it's insignificant. The other big piece is inflation, right? So we talked about inflation from commodities and freight and packaging and all sorts of stuff. So inflation is a significant headwind this year. Now obviously, we got some price to try to combat that, so that's the other piece of it. But the point you made, which is the margins, the 50 to 90 basis points of margin degradation is probably driven by the decrements on the volume.

Jeff Hammond -- KeyBanc Capital -- Analyst

Okay. And then in an inflationary year like this, what kind of price do you typically realize?

Robert J. Pagano -- Chief Executive Officer and President

We implemented price increases of 3% to 5% in January. And we plan on realizing 1% to 2%, and we're pushing the team to get even more aggressive on that. So that's an area that we're pushing hard, and that's what we're looking at.

Jeff Hammond -- KeyBanc Capital -- Analyst

Okay. And then last one on connected products. It looks like if I take your 15% now to 25% and put a little growth on the total business, you are kind of high teens to the 20% kind of growth CAGR. How are you thinking about that in terms of organic versus these kind of bolt-on technology acquisitions?

Robert J. Pagano -- Chief Executive Officer and President

I think it's going to be a combination of both. We're first focused on organically transforming our products. And again, that will cannibalize existing products. But the whole digitization strategy has become more and more important. So we'll do small bolt-ons right now, but I think the majority of it is our focus and what's driving our significant investment is to take our existing products and electronify them.

Jeff Hammond -- KeyBanc Capital -- Analyst

Okay. Thanks a lot.

Robert J. Pagano -- Chief Executive Officer and President

Thanks.

Operator

Your next question comes from Bryan Blair with Oppenheimer. Please go ahead.

Bryan Blair -- Oppenheimer -- Analyst

Thanks. Good morning, guys.

Robert J. Pagano -- Chief Executive Officer and President

Good morning, Bryan.

Shashank Patel -- Chief Financial Officer

Good morning, Bryan.

Bryan Blair -- Oppenheimer -- Analyst

You've given a lot of color on expectations in terms of the moving parts and then what's billing to impact the margins throughout the year. Is that level set on quarterly or first versus second half progression and thinking about the down 50 to 90 basis points for the year?

Shashank Patel -- Chief Financial Officer

Yes. I think -- so Brian, a lot of the cost actions we took obviously started -- we actually got early, so we started March, but the bulk of them happened in the second half. So therefore, when you think about margin degradation, not expansion, a lot of that is in the second half. The first quarter, and that's why when we gave the first quarter guidance, we kind of said flattish from an operating margin standpoint, because we're still getting the benefit of the actions we took in Q1, and we didn't have the benefit of that last year in Q1. So to your point, the second half is going to be more weighted around -- with lower operating margins versus 2020.

Bryan Blair -- Oppenheimer -- Analyst

Got it. Appreciate the color. Anything more you can offer on AERCO and PVI trends through the fourth quarter and into early 2021? And I guess given current visibility in market reads, what's your base case expectation for boiler sales this year?

Robert J. Pagano -- Chief Executive Officer and President

Well, our complete HHWS platform, which is boilers and water heaters, they were down mid to high-single digits in the quarter, and we see similar as we're coming into the first quarter of this year. So that's an area they were most hit by restaurants, hotels, etc. That was their strength. And if you recall last year, in the first quarter we saw a lot of education spending in the first quarter last year, which surprised us. There was some pent-up demand. So we've got a tougher comp in particular in our AERCO boiler side in the first quarter.

Bryan Blair -- Oppenheimer -- Analyst

Got it. And you have US government transition/policies in the monitoring section of 2021 planning framework. Outside of tax policy, which I assume is more of a 2022 watch item, what's on the team's radar there?

Robert J. Pagano -- Chief Executive Officer and President

Well, we're certainly watching the stimulus proposal and what happens on that, especially if there's energy efficiency type discussions with that on infrastructure. So that's a key area. I mean, again, it's an unknown right now at this point in time, but a lot of talk on roads and bridges. And certainly, we would rather have social infrastructure, really focused on healthcare, education and airports, but they're not talking about that. Obviously, that's an area we, with other industry participants, are focused on pushing where we can. But that's an area we're hopeful. But right now, I think there's a lot of talk, and we haven't seen much action at this point in time.

Bryan Blair -- Oppenheimer -- Analyst

That definitely makes sense. If in an optimistic case scenario, we do have a package come through over the near term, is there the potential that that could meaningfully lift your back half expectations? Or should we assume that the spending would take place into 2022 and reset our thinking in that direction?

Robert J. Pagano -- Chief Executive Officer and President

I would think it'd be very late in the year and then definitely more into 2022. But again, I don't think it's significant at this point in time.

Bryan Blair -- Oppenheimer -- Analyst

Okay. Thank you.

Robert J. Pagano -- Chief Executive Officer and President

Thanks.

Operator

Your next question comes from Brian Lee with Goldman Sachs. Please go ahead.

Brian Lee -- Goldman Sachs -- Analyst

Hey guys. Good morning. Thanks for taking the questions. Maybe just a follow-up from an earlier one around price actions. Just as you think about the base case for 2021, price/cost dynamics, you're out to the market with 3% to 5%, you're maybe targeting 1% to 2%. If you base case the 1% to 2%, is it sort of net neutral price/cost for the balance of 2011? Or are you actually able to get a point or two? Just trying to understand what's baked into your model for price cost.

Shashank Patel -- Chief Financial Officer

Yes. So look, with the price and productivity, we offset inflation. That's usually the way we go at it. And that's the way we're thinking about this one. Obviously, on the inflation side though, because it's commodities and we have locks in place as you guys know, and those take us through the end of June, depending on how commodities progress through the rest of the year, we might be looking at price again. But for now, it's that 3% to 5% that Bob mentioned, with a 1% to 2% realization rate.

Brian Lee -- Goldman Sachs -- Analyst

Okay. And then that gets you to net neutral on the price/cost dynamic?

Shashank Patel -- Chief Financial Officer

Collectively, yes.

Brian Lee -- Goldman Sachs -- Analyst

Fair enough. All right, that's helpful. And then I guess maybe a bit more color on the air pocket. You guys have been pretty detailed around the drivers here and sort of the timeframe, but can you give us a sense of what percent exposure you have to multifamily and non-res new construction? And then in terms of timing, you're calling out Q2 and a weaker back half, but any visibility as we stand here today as to kind of how that air pocket might normalize as you move through 2021? Or is this -- are you kind of even shelving that for a 2022 discussion at this point?

Shashank Patel -- Chief Financial Officer

So taking your second question first, right, on the length of the air pocket, if you go back to ABI, Dodge momentum, all these indices, they started turning negative in the second quarter. And usually, they have a nine to 12-month lag. So if you take that point, that's where we come up with our second quarter, and we expect that to continue throughout 2021. As to when that turns in 2022, we don't know yet. We'll just have to see how those indices progress through the rest of this year. But we have factored in that we'll have that air pocket through 2021. As to the challenged markets, when we look at all of our challenging markets, right, so residential, multifamily, office buildings, stores, lodging, food services, recreation, commercial and marine, that represents approximately 20% of our total Watts business, and that's what we say will be impacted by the air pocket that we expect in the Americas.

Robert J. Pagano -- Chief Executive Officer and President

Yes. And that's on the new construction portion of that. Brian, one of the key things, and I think you guys have all heard me talk about this in the past, it's confidence, right? It's confidence from the builders to invest their cash at this point in time. So I think there's money on the sidelines just waiting for some stability in the markets. You're hearing shortages of supply chains with builders, lumber prices are up double. So I think we're looking -- they're just waiting for supply chains to normalize, vaccines to be rolled out. There's low interest rates, so at some point, this will be released. So the timing of this is it will be very interesting to watch. So we see things happening in the marketplace, a lot of discussions. But look, when you're not doing loans and you're not doing starts, obviously, at some point, that's going to catch up with us, and that's why we're talking about the air pocket the way we are.

Brian Lee -- Goldman Sachs -- Analyst

Thanks guys.

Operator

Your next question comes from Joe Giordano with Cowen. Please go ahead.

Joe Giordano -- Cowen -- Analyst

Hey guys, good morning.

Robert J. Pagano -- Chief Executive Officer and President

Good morning, Joe.

Joe Giordano -- Cowen -- Analyst

Can you talk about, as you continue on the Smart & Connected path here, what that means from a margin standpoint and like the uplift associated with the percentage ratcheting higher over the next couple of years?

Robert J. Pagano -- Chief Executive Officer and President

Yes. I mean, look, as we look at our Smart & Connected solutions, we continue to try to bundle a value proposition to our customer higher than our existing value proposition with our standard products. So in general, the standard margins tend to be higher. But as you know, we're investing significant amounts in SG&A and R&D right now as we scale up and build those capabilities. But at the standard margin, they tend to be higher given the value propositions we're offering to our customers.

Joe Giordano -- Cowen -- Analyst

And then as we think longer term, you've made big strides in Europe on the restructuring end, how should we think about the normalized margin potential of Europe versus Americas?

Robert J. Pagano -- Chief Executive Officer and President

I think, as we said, we have significant footprint inside of Europe. So I think structurally, margins are going to be lower there. We continue to take small restructuring actions. And we have headcount freezes in place and let turnover take its course. But it's very expensive, as you know, to take out a lot of people through social plans, etc. It's only gotten harder during the pandemic at this point in time. So we continue to monitor that, look at that. But in general, it will be structurally lower. And remember, there's a big, about 1/3 of our business or a little less than 1/3 of Europe business is OEM related. So that in general is lower-margin business.

Shashank Patel -- Chief Financial Officer

Joe, I would say that over the last 12, 18 months, the teams have done a nice job with the whole value proposition and driving price and that's helped on margins, and they're going to continue working on that.

Joe Giordano -- Cowen -- Analyst

Thanks a lot guys.

Shashank Patel -- Chief Financial Officer

Thanks, Joe.

Robert J. Pagano -- Chief Executive Officer and President

Thanks.

Operator

Your next question comes from Walter Liptak from Seaport. Please go ahead.

Walter Liptak -- Seaport -- Analyst

Hey, Thanks. Good morning guys.

Shashank Patel -- Chief Financial Officer

Good morning, Wal.

Robert J. Pagano -- Chief Executive Officer and President

Good morning, Wal.

Walter Liptak -- Seaport -- Analyst

I wanted to stick with the discussion of Europe and I just wanted to clarify that the air pocket that we're talking about is largely North America. And I wonder if you could talk a little bit more just about that growth rate in Europe and what could go well or are the headwinds to get to the low end of the range for 2021?

Robert J. Pagano -- Chief Executive Officer and President

Yes. The air pocket that we're talking about is in North America, so that's what we've been talking about. In Europe, I think Shashank talked about it, our commercial Marine business is what's challenging us. In general, Europe has been slow growth for us over this time. But our drains business, which is one of our more profitable businesses, is getting hurt abnormally hard at this point in time. So we always plan lower growth in Europe to keep our cost structure down, etc. But the team, as Shashank said, its done a nice job managing those costs and driving change. But low growth and offset by our drain business is why we're giving the guidance the way we are.

Walter Liptak -- Seaport -- Analyst

Okay. Got it. And I wanted to go back to the discussion of restructuring and productivity. Understanding the $15 million of savings comes to an end, is there another phase of restructuring that you can do? Or -- and I think my understanding was there was productivity going on, on the factory floor, with machinery. I wonder what kind of benefits you'll get in 2020 from productivity?

Robert J. Pagano -- Chief Executive Officer and President

Well, you know, we're always driving productivity in our factories, and that will continue. When we look at restructuring, our teams are always looking for opportunities for restructure. We went pretty hard in 2020 and went after it. Any other restructure is longer, more difficult, requires plans, etc. So we're always looking at that, we'll continue to look at that option, but we're in it for the long run here, right? We believe there will be a recovery coming back. We want to be ready to be able to capitalize on that and hit the ground running. That's why we're continuing our investments and the teams will continue to get leaner inside of our factories, but we've decided strategically to go after $13 million of incremental investments, primarily driving both productivity and most importantly, our Smart & Connected strategy to get us to 25% connected by 2023.

Walter Liptak -- Seaport -- Analyst

Okay. Got it. Thank you.

Robert J. Pagano -- Chief Executive Officer and President

Thanks, Wal.

Operator

There are no further questions at this time. I will now turn the call back to Bob Pagano, for closing comments.

Robert J. Pagano -- Chief Executive Officer and President

In closing, thank you again for taking the time to join us today, for our fourth quarter earnings call. We appreciate your continued interest in Watts. And look forward to speaking with you, during our first quarter earnings call, in May. Have a great day. And stay safe. Thanks.

Operator

[Operator Closing Remarks]

Duration: 56 minutes

Call participants:

Timothy MacPhee -- Treasurer and Vice President, Investor Relations

Robert J. Pagano -- Chief Executive Officer and President

Shashank Patel -- Chief Financial Officer

Nathan Jones -- Stifel -- Analyst

Jeff Hammond -- KeyBanc Capital -- Analyst

Bryan Blair -- Oppenheimer -- Analyst

Brian Lee -- Goldman Sachs -- Analyst

Joe Giordano -- Cowen -- Analyst

Walter Liptak -- Seaport -- Analyst

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