Gates Industrial Corporation plc (GTES) Earnings Call Transcript & Summary

Great. So welcome, everyone. My name is Julian Mitchell. It's my pleasure to have for our fireside chat now Gates Corporation and Ivo Jurek, CEO. Please, if anyone has question, email me those, and I'll make sure to try and get around to asking them. In the meantime, I'll hand over to Ivo for some prepared remarks before we go into Q&A.

Thank you, Julian. Thank you for hosting us today and giving us the opportunity to talk about what we believe are exciting times for Gates. Over the past several years, we have driven fundamental improvements in the business and ultimately reposition it to achieve above-market growth and margin expansion. We have invested significantly, putting more efficient and flexible capacity in the ground and revitalizing a large portion of our portfolio of mission-critical components and products. We are also starting to see the benefits of our targeted organic growth initiatives, which we have focused on attractive end markets, mainly of which have a positive secular growth dynamics. Our products play an important role in helping our customers to deliver on their efficiency targets and support the overall drive towards sustainability across industrial ecosystem, resulting in greater demand for our products. In addition to capitalizing on our growth, we are committed to expanding our margins, as we have discussed. Our restructuring programs remain on track and is expected to deliver full run rate savings later on this year, 2021. Over and above this savings, we expect our new products and productivity initiatives under the Gates production system to continue to contribute incremental margin expansion also. We have emerged from 2019-2020 downturn in a stronger position and demonstrated the resiliency of our business model. With our ability to generate strong cash flows, we now have a line of sight 2x, 3x net leverage, which we expect to achieve later on this year. As a result, this will provide our business with additional capital allocation optionality and opportunities to drive shareholder value well into the future. So with that, I'll turn it back over to you, Julian.

Thanks, Ivo. And perhaps it would be helpful to level set us on where we stand in terms of demand expectations, near-term gains albeit a short-cycle business, a very good sort of barometer of industrial spending trends, OE as well as aftermarket, of course. So maybe just give us an update there what you're seeing in Q1 would be a good start.

Look, we have exited 2020 with demonstrating a pretty broad-based growth across our franchise. We have grown across all of our geographies. We have delivered growth across both of our product lines. And I would say, maybe with the exception of oil and gas, most of the demand trends across our portfolio are very positive. We anticipate that as we progress through 2021, the markets will continue to heal, and we will continue to see positive trends to impact our business. And frankly, we're also now starting to see nice shifts on sustainability, efficiency improvements and equipment uptime. And those offer very attractive growth opportunities for us across just about the entire segment of our portfolio. I've talked about some specifics around industrial automation, e-commerce, logistics and warehousing and personal mobility, to name a few. So we feel actually quite positively about 2021, and we believe that the markets are just in very early stages of healing.

Perfect. And that's a good intro. And I suppose looking geographically, the China strength you're seeing, I think, is in common with other companies, but you do have a large presence there. What's your perspective on the sort of how 2021 will play out in your China business? I think you had mid-teens growth exiting '20. So how are you thinking about the slope of that growth this year in China?

Look, I think I spoke on my earnings call about our performance in China in 2020 exiting very strong organic growth. 2020, the growth was led by industrial end markets, particularly on the first fit side of the business or the OEM side of the business. Look, many occasions, I have spoken about our focus on developing our automotive replacement side of our business. And we see some very strong underlying market fundamentals there as well given the very high level of auto productions over the past decade. Our AR business nearly doubled just over the last 3 years, and we are very confident that we're going to continue to see that level of growth, certainly, over the midterm future for us. Look, the overall market demand continues to be a very bright spot for our performance overall. And we clearly believe that we are a clear leader in Asia, in China in the AR side of the market. And I think that we are really well positioned. And so overall, we are very constructive on China, and we expect that 2021 will be another year of solid growth for us, especially taking into an account where we exited the year in Q4 of '20.

And then if I switch to maybe North America, it's a part of the world that's seen quite sluggish industrial spending trends versus other regions even in the last few months. Gates, an exception to that, very good growth exiting last year in North America, much better trends than most of the motion control peers, for example, leaving aside automotive. What do you think is driving that uplift in Gates in North America? What's driving those share gains?

Yes. So look, I mean, I think, again, in North America, in particular, we have seen reasonably broad-based strength across all of our markets with the exception of energy, oil and gas. Despite the fact that it is a reasonably small amount of business for us, we are predominantly focused on land extraction. All the other markets were very, very solid for us. And I think that demonstrate our ability to take market share away. We have spoken quite substantially over the innovation cycle, launching new products. And I think that you are finally starting to see the design wins turn into revenue. That is driving above-market growth rate. And frankly, that is driving above-market level of profitability as well. So I think I can, in general, speak about similar trends, right? The ESG drivers are pulling our products as people become -- this is becoming much more important topic for all manufacturers. It doesn't really matter where you reside in the universe of industrial manufacturing. Whether or not it is a noise pollution reduction or it is energy efficiency or energy conservation, reduction of potential incidents from HSE perspective, our components facilitate general improvement in all of those metrics in your industrial equipment. And so I would say that our point to that as probably the biggest driver for us in Q4 and I believe in 2021.

And when you look more broadly on a global basis, and either you have seen at different companies many different industrial cycles and ups and downs, when you're looking at this upturn beyond just this year, how do you think it will play out? What does it remind you of? How does it differ from some of those industrial recoveries we saw 4 years ago, 10 years ago? Any context -- understanding that it's very early recovery.

Look, I think that's a really good question, Julian. And when I take a look at 2019 and 2020, in particular -- maybe folks will cringe when I say this. But to me, it looks very much analogous to 2008 and 2009. If I take a look at the integral under the curve, we see almost duplicate copy of that 2008 and 2009 behavior in '19 and '20. So if I say, hey, look, '19, '20 look like '08, '09, and then I take a look at what happened in '10, '11, '12, '13 and '14, despite popular belief that these cycles go very quickly down and then very quickly up and then they peter out, '10 to '14 was very good time for Gates. 2010 was a very solid year. I believe that our guidance indicates that 2021 is going to be a very solid year for Gates. And so although it is very early, as you've indicated, I do look towards maybe some more sustainable level-loaded growth rather than necessarily seeing this large recoveries and then the large impacts that we see from this external shock. So I'm very hopeful. We are early in the recovery. We are very optimistic about 2021. And I believe that the work we have done from '18 to '20 in terms of the transformation of the company, not just in operating cadence and restructuring, but frankly, more on the side of innovation, revitalization of our product portfolio, I believe that we can be real beneficiary of some of these positive trends that open opportunities that are more secular in nature, not just cyclical in nature.

And if we look at the very short -- there's a healthy discussion around how much restocking might be needed in the industrial world, whether it's selling into OEMs or distributor and channel partners. Inventories seem low, but perhaps that's a secular phenomenon. And each upcycle now, you see less and less sort of restock. What's your assessment of that? Inventories are low, do you think we get a big whip upwards in the next 6 months or perhaps not?

Look, I certainly hope we don't, to be completely honest with you, because the inventory stocking and restocking and destocking is creating havoc in, I think, industrial companies such as ours. And I think that all of our customers are becoming much more efficient operators as well. And I think that they rely more on companies like Gates to be able to manage their demand without necessarily having huge amount of stock. That being said, my sense is that you will see some restocking because I believe that the inventories, as you said, are very, very low. And in order for these distributors and channel partners to be able to effectively service their customers, I think it's going to be tough for them to do that from the level of inventory position that they all have today. Now the complication is going to be that there have been a pretty significant supply chain disruption that we all have lived through from second quarter of 2020 onwards. And it's going to be interesting to see how supply chain start healing. But my sense is that we'll probably see some rebalancing of inventories as we see continuation of the market healing.

Maybe looking at thematic point in the automotive world. Every day, it feels like we're getting headlines around this or that OEM accelerating EV investments, scaling back the ICE investments. And COVID perhaps accelerated that. Remind us how does Gates view that transition affecting the company itself, what's the content per vehicle like. But also, I suppose, with those OEMs in that transition, is Gates confident it can get its fair share within the various OEMs on the EV-based platforms?

Yes. I think this is a great question. Look, I will be the first one that I will admit that we have been doing quite a bit of work under the skin to prepare our company for this transition. We haven't been very vocal about the technology that we have developed. And I think that you will hear us hear a lot more speaking about that as we transition to 2021. I think on my last call, I stated that, look, we will start talking about more design wins. We have spoken a little bit about the design win that we have secured in Q4, a heavy-duty truck. That, we believe, is a really good design win for us, and it will start our more broad participation in the electrification. You're right. Almost every day, you hear somebody talking about their desire to accelerate the transition into full electric vehicles. Look, we participate today in the auto and heavy-duty truck markets with more traditional components. Our components go beyond just the power transmission side. Our components that we participate is -- are also thermal management products like engine cooling -- hoses that provide aging cooling and water pumps. Now on these platforms, these products as they transition into full electric, they have also -- they also cause a transition in technology. So on a passenger vehicle, on an ICE passenger vehicle, you may have a couple of mechanical water pumps that are kind of in the 50 to 75 watts of output that are single directional, really purely mechanical, reasonably low cost, kind of, call it, $7 to $10 of content, at times maybe $2 or $3. Those water pumps go up in output. They go to kind of 200, 400 watts to 1.2 kilowatts. So you're getting an increase in complexity from the output of power. You're getting complexity to -- these pumps now become bidirectional, on/off-type pumps, and they are electric. And the content goes maybe from $7 to $10 to anywhere from $25 to $100 in content. This is the top of the content where we talk about the opportunity for us. That's the top of the content that we are very excited about. On the thermal management side, on the kind of what traditionally was engine cooling, we no longer are going to have an engine coolant. But what we have is we have much more complex cooling of the inverter and of the batteries. And so the content for us versus the traditional ICE on the inverter and battery cooling goes up exponentially as well. And so we believe -- that is why we believe we have a tremendous opportunity with electric vehicles. And again, I think that you will start hearing us talk more about participation on OEM side of the electrification more intently in '21 and beyond. Now at the same time, I want to remind everybody that we are primarily focused on replacement business. And the replacement side of the business is going to take quite a time until the propulsion technologies transition until they age to 7 to kind of 14-year-old car park that is a sweet spot for our company. But that being said, we are not really waiting until we build out that SKU count for that existing car park that we see today. And I spoke, I think, on my last -- our last quarterly update that we have launched over 30 SKUs for existing EVs that we will continue to build up and we will get ready. So that by the time that this becomes a more significant part of the car park, we'll be in a situation that just like we are in ICE, we are the reliable partner for people to go to, to get their automobiles repaired and go for the components that they need to do so.

Is there, on the Gates side, much reinvestment needs, R&D or CapEx alongside that transition that the suppliers and OEMs are doing in automotive? Or is that sort of in your run rate already and you balance it with some scaling down of the ICE-related investment?