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

Hi, everybody. Thanks for joining us here, especially at our conference this year. I know it's virtual. And I'm sure you've heard everyone say, we wish we were in Miami right now instead of some of us dealing with the winter storm, but we're happy to have Gates here with us this morning. I'm Sierra Homer, the Industrial Sector Specialist at Citi, joined by Ivo Jurek, the CEO of Gates. And so we'll go ahead and go through some of the near-term stuff and switch to some thematic themes at the company we're going to talk about this morning. And you can submit questions or e-mail me at sierra.homer@citi.com and I'll pass those questions along.

So again, thanks, Ivo, for joining us here this morning. Why don't we kind of start out, I think, maybe talking a little bit more about the quarter, some color. Particularly, I'd like to focus on the kind of '21 guidance you've guided there, 9% to 14% growth. Can you just give us some color kind of around the drivers looking forward in 2021 and kind of is it continued broad-based growth across the region and end markets and kind of what's driving that?

Yes. Sure. Look, I think that we've put in a terrific Q4 where we started to see what I keep calling a healing of our end markets. I think that many folks are trying to figure out if we are seeing a full recovery. We really haven't seen, I think, anything that's near full recovery presently. And so a great jumping off point in Q4. We have seen strength across all of our markets, across all of our geographies, probably with the exception of a very small presence that we have in oil and gas, less than 6% of our revenue. And then that market obviously has still some challenges that it is dealing with. And so when we take a look at where we came from and the incremental growth that we have been able to generate from organic growth initiatives, we felt quite well about being able to establish our guidance of 9% to 14% core growth for 2021. And we feel that as the year progresses, we will see continuation of constructive market recoveries and continuation of healing of these markets as we progress through the year.

Yes. That's great to hear. And maybe just diving into kind of the early part of the quarter. How should we be thinking about the progress you've seen thus far? Any disruption that's obviously been kind of up and center with some of the auto supply chain disruption, supply chain kind of tension in general that I've kind of heard throughout this week. So just talk about kind of what you've already been seeing and maybe some challenges that could pop up and how you guys are handling that.

Yes. So look, the performance we saw in January represented a continued trend of improvement. And frankly, that's what gave us a reasonably good confidence to offer a more detailed guidance for Q1. We are absolutely aware of the potential supply chain disruptions, particularly in auto, and we have taken that into account with our guidance. Look, I know that it may be sometimes sounds like these disruptions just occurred, but those supply chain disruptions have actually been around through Q4, and we're all dealing with that. And I know that the auto guys have been dealing with that at that point in time as well. So it wasn't a huge surprise to us. So look, I mean, I think that the supply and demand is slightly out of balance on auto new car sales front. I think that there's more demand than there is supply. And frankly, that supports the robust demand for used vehicle sales. And for some midterm amount of time, it will represent opportunities for us in our automotive replacement segment as well. So we are dealing with it. I think that we have tried to take that into account in our guide. And we, obviously, all have lots of work to do to manage through these issues.

Okay. Understood. And kind of sticking on the auto theme. We've obviously seen accelerating trends towards electric vehicle adoption, a lot of investments being made in that space in terms of new deals, current OEMs investing in platforms and just an increased focus kind of broadly on energy transition. So can you just kind of give investors an update on how you're positioned to kind of capitalize on these trends. I think it could be a big growth part of the story and just something I want to make sure investors are understanding.

Yes. Look, Sierra, we could probably spend the next 2 hours about this subject alone. And I think that we are actually quite excited about what is happening with the change in propulsion. Look, we know the company that prefers one over the other. We are agnostic. But we have been making quite a bit of investment over the last few years into ensuring that we have developed technology that's going to be differentiated. And frankly, that's going to give us an opportunity to tap into some of these opportunities as the transition to electrification starts occurring. And we certainly view that transition as net positive for Gates as frankly more content is available to Gates as that transition starts occurring. So let me give you an example. The example that I like to use with folks is water pumps. There are water pumps that are used today on an ICE. And those water pumps are basically mechanical. They have a low degree of sophistication and they don't need to have lots of output power. They are simply unidirectional and they are either always on or always off, right? As we go into electric vehicles, in electric vehicles, you are actually starting to increase dramatically the complexity of these water pumps. And that's more associated with the fact that you have much more complex demands on cooling the batteries and cooling the inverters that electric vehicles use. So what happens? Why do we think that the complexity increases? Well, the complexity increases because your output requirements increase. So they go up maybe from 50 to 75 watts on an ICE to 75, to 200, to 400 watts, up to 1.2 kilowatts. That's scaling the demand up. You also have a demand for now bidirectional and on and off cooling. So you now cannot get away simply with a mechanical device that is either on or off. You now need to add an electrical machine and a control board and the diagnostics electronics that will give you the opportunity to have better level of controls. So okay, that sounds good, Ivo. What does that really mean for you? Tell me really the meat of the matter in here, right? Well, what it means for us is that the mechanical water pump that we may be selling today for an ICE application may have an average selling price of kind of $8 to $15. Whereas that electrically controlled water pump in an electric platform now has an ASP that may be in that $30 to $65 on a auxiliary application, whereas if you have a water pump that's going to be cooling batteries and inverters now, that water pump ASP goes to $75 to $135. So as you can see, our content in this one device alone goes up from maybe $10 average to, say, $75 average, which is a 7x increase. And so that's why we are quite excited. And I can spend quite a bit of time talking about the hoses that are used to cool the batteries and inverters, again, very similar. You may have thermal management devices like hoses that cool the engine block today. And those sell kind of in the average of $15 to $30 range. Whereas the hoses now, they are much more sophisticated that cool batteries and the inverters on an electric vehicle. The ASPs for those hoses go up to kind of $100 to $200 ASP range. And they're very sophisticated. They are not just hoses that all they do is cool. They need to cool and they need to have the ability to provide the function of heating the passenger cabin in a cold weather. So the complexity grows. The technology is evolving. You have a trend where a lot more companies are coming up to the market with these electric platforms. And we are right there. We are very excited about it. Our technology is very differentiated. And we will start spending a lot more time as we move through 2021 talking about some of our design wins and participation in the OEM space. Maybe on a side note, on my last call, I've talked about our first design, first major design win that I would say in the on-road industrial application in heavy-duty truck. So we already have a record of being able to compete and win in that space. And we are very progressively looking towards building out that design win registry as we move in '21.

Definitely. That's a ton of exciting stuff. And kind of sticking with the new products, your kind of differentiation within your product and kind of growth initiatives. I mean, in the past, you've noted mid-single-digit outperformance versus your end markets in Q4. That's kind of been supported by these new products and growth initiatives. So how can we think about that sustainability of this level of market outgrowth going forward. You said there's competitors that you're kind of competing at that level. And mid-single digits is a huge impact. So I'd love to kind of, what's a reasonable through-the-cycle level of outgrowth driven by these new products and initiatives that we can be expecting going forward?

Sierra, excellent question. I mean, I think that for us, I've spoken quite a bit about the investments that we have been making in revitalizing our product portfolio. And as you mentioned, that is paying dividend. And it's paying dividend not just in kind of traditional applications that Gates has supported historically. But frankly, it's opening up some new opportunities for us across a number of end markets, particularly in the diversified industrial space. We have, on a number of occasions, I have certainly mentioned the chain-to-belt wins in the industrial application such as logistics. And these markets have tremendous amount of tailwinds, particularly when you think that belts are performing significantly better and they are delivering higher reliability and more precision movement without the necessitation for significant amount of maintenance. Within diversified industrial, staying with that theme, we have noted wins in HVAC applications, in pharma, food processing. And those are some of the few areas that we are very excited about where we are able to not just participate with new builds, but we also are able to retrofit existing units and typically provide good energy efficiency gains for our customers, right? And so I would almost introduce a pause in here and introduce the fact that the natural driver for pull for our products is also embedded in all of us having desire to do better with ESG, particularly with the environmental attribute of being an industrial company. An industrial company, it's hard to be very progressive and deliver incredible impact on the environmental attributes. And we look at the products that we manufacture being able to do just that for people. I mean, you check all the marks. We are able to reduce noise pollution with our products. We are able to reduce energy consumption. We are eliminating health and safety standards by offering customers the opportunity to eliminate lubrication from being able to service their equipment that they use in their factories. And I can go on and on. There's a long list of why ESG ultimately is going to be a significant net positive pull for the demand for our products, particularly for the newer products in the secular set of applications that we believe are going to be very, very accretive to our shareholders and our company over the midterm.

Definitely. And I think ESG has probably been one of the biggest focuses of the conference this week, just everyone kind of talking about sustainability goals, both on small companies, big companies kind of across the spectrum. And it's a question that I get day in and day out on the work we're doing around ESG investing. So what do you think is the messaging you want to give to investors? Do you have a team working a lot on that to kind of deliver that ESG story in addition to kind of all the other growth products that you're seeing because I do think it's becoming a more important narrative. And like you said, especially as an industrial company, it's always on top of the list for any of the companies to kind of be ESG-focused. So how are you kind of working on your messaging there and making that story out to investors?

Look, I think that you will, again, hear more from us in terms of the importance of ESG and the importance of ESG within Gates, right? So when I look at ESG and when I think about it, and I very rarely do that. But as you can probably tell from my accent, I'm European by birth, and I think that the European companies have been maybe a little more forward leaning in ESG. And I certainly feel that it is a very important part, and it's our obligation to leave the planet in much better shape than it is today. But look, ESG is kind of a front and center. It has been for a while at Gates. There's a great ESG report that we have published over the last couple of years, where we're making our goals and objectives known. But let me give you a couple of stats, right? Just over the last couple of years, we have focused on making our operations more ESG-proof, right? We have reduced GHG emissions by over 31% over the last few years. We have reduced water consumption in our plants by over 31% over the last few years. And we have reduced energy consumption by over 14% in our plants. That does not touch on the objectives with health and safety, which are certainly right there with the ESG objectives that people require. Just in the last 3 years, we have improved our safety by over 27%. Our lost incident rates have dropped by 42%. And we believe that this is kind of table stakes. So you have to have that set of attributes within your core operations. Obviously, we have embedded objectives to improve diversity and inclusion and equity. And that is a huge part of our desire to continue to drive progress within Gates. And then I mentioned that one of the things that I believe really differentiates us is our innovation where everything that we do, the core key attribute of new products that we launch is driven by being more environmentally conscious. So whether or not it is less material that we use in building out the products, lower weights, higher efficiencies, more eco-friendly products, removing bad components of materials from construction, ESG certainly is front and center in everything that we do, Sierra.

Awesome. Yes. That's good to hear. And I look forward to kind of hearing more updates on that and progress going forward. But sticking kind of on the innovation piece, that's obviously kind of a key component to the Gates story. Obviously, the pandemic has totally shifted the way we think about the world. And I want to take a second just to kind of think about how the pandemic has changed your end markets. Mobility and recreation business is a relatively smaller portion of your total sales. But it does seem kind of like the work-from-home trend we're seeing, avoiding public transportation. You and I were just talking about New York City before this. It should continue to materially benefit business trends kind of more on the drivers on the road and more e-commerce within the auto replacement channel. So could you just give kind of more color on what you're seeing there and kind of how Gates fits in there and the innovation you've done?

Yes. Sierra, I mean, you've kind of touched on all of these attributes. Look, in personal mobility, yes, you're right. It is a smaller area of our business today, but it is one that is experiencing very substantial growth. Even in a down year like we all lived through last year, that business grew over 20%, and it's more than doubled just simply over the last couple of years. And every big business needs to become small one first, and it needs to have high rates of growth. And I believe that this one checks everything that, that requires. Look, some of the other markets that we see having tailwinds are, as you said, people are rethinking their commuting needs, right? So if it's transportation, I mean, we all relate to that. Look, fitness options, right? We all like, I mean, I know that I like fitness. I mean, historically, I had been more outdoor individual, so having my bicycle that's powered by Gates belt was essential. But over the last year, I'm certainly a proud owner of a couple of Peloton devices, and I love them. And it's going to be very difficult for me to convince myself that I want to go back to a gym. And so the proliferation of these devices, by the way, are important to us because they are not chain-driven, they are belt-driven, right? So that's a good trend. As population elects to shift away from high-density areas to more suburban areas, I think we've touched on that as well earlier before we started this conversation, right? People want more suburban living again, and you see a significant demand for new and used vehicles. This bodes really well for our participation in frankly both of these segments, in new and particularly in the replacement side of our automotive business. And maybe lastly I would say that, we are seeing much greater focus on sustainability. We talked about that. Efficiency, efficiency improvements of equipment, uptime, and that creates huge opportunities for us in industrial automation, e-commerce-driven logistics and warehousing. And I've talked about that personal mobility piece. So we are kind of in a sweet spot of what we believe is going to be an extended demand over the long term for our products that goes way beyond just the healing of our underlying market drivers.

Now that's good to hear. I've had numerous conversations kind of investors looking for stories that are pandemic recovery stories but that go beyond just kind of initial COVID impact. So it's good that you guys have some longer term kind of runway there that I think will continue to add to the story. Kind of just shifting a little bit, just kind of more region-wise. How should we think about material differences kind of by region for Gates? China had really strong growth, but we'd kind of love to hear your thinking just about the different regions and how those markets look going forward.

Yes. Look, China has been terrific for us. Out of all regions, China actually delivered a tiny amount of core growth in 2020, which was a very tough year. So hey, look, for an industrial company, I'll take that as a really terrific performance and obviously built up, particularly on the strength in second half, exiting Q4 with over 14% core growth. So that was quite terrific. That growth was fundamentally supported by our incredible presence in automotive replacement channel. I've talked about it quite substantially over the last several years. That is, our team in China is executing extremely well on our objective to continue to scale up our automotive replacement channel there. That business has been growing quite substantially and more than doubled over the last 3 years. Again, from a smaller base to a very nice base, and we've exited Q4 with China AR on more than $100 million run rate. So it's no longer a small business, but we still believe it's going to continue to grow in double-digit growth rate over the midterm future. We've also, frankly, seen a very strong growth in industrial applications, particularly in the general industrial marketplace there. And so as you can probably sense from me. For me, I'm quite constructive on China, and we believe that we're going to have another terrific year in China in 2021. We have a terrific team there, terrific set of opportunities and frankly, a terrific set of assets that we have positioned in China to support that growth. Now when it comes to the other regions, look, Europe and North America performed really well in Q4 and delivered very strong growth. And I will put our growth, our core growth in Q4 in North America and Europe against anybody out there, any premium industrial peer. I think we have outperformed the expectations. And certainly, we have outperformed the growth of our peers. Why? Again, innovation, organic growth initiatives, pull for our product. Some of our new products, I've talked quite a bit historically about, as an example, our MXT product line. Our MXT product, a product that is part of our hydraulics product portfolio, continues to accelerate and it continue to accelerate through the quarter and frankly, throughout the full year despite the pandemic. I mean, that product line revenue grew very substantially in 2020. Chain-to-belt progressed nicely. So we got some really good organic initiatives that will help us over and above the healing of those markets. And then I did mention that we have seen a very strong performance in East Asia and India. That was a very problematic region for us for some time, but we have seen a very nice recovery there that has been predominantly driven by the industrial on-highway and off-highway applications. So all markets did well. Our teams are executing well. We are excited about 2021, and we are excited about the slew of initiatives that our teams globally have been working on and executing.