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

And can we talk about industrial OE? So we're seeing channel inventory filling out of the OEMs. I'm wondering as you look at your book of business, where do you see you have the longest lead times? Which end markets and regions? And where do you see some choppiness?

Yes. I mean, we see a lot of strength in construction and ag still. I mean we think, yes, there are some of our customer channel inventories are starting to improve, but we're seeing pretty steady order rates and consistent business there. I mean construction has been -- I think we posted mid-teens growth in the quarter. Ag, not quite that strong, but still positive. We're starting to see, again, China still down a bit, but we're seeing early signs of recovery there. Europe performed strong in those markets in the quarter. Am I missing anything there, Rich?

Europe has been pretty good for the last couple of quarters, and we're taking a pragmatic view there, but it's been so far, so good. So we've been pleasantly surprised.

And can we talk about auto aftermarket in China? So after how much your activity has been artificially cut, how significant is this snapback, this normalization, 20% type growth? Just calibrate us because it can be interesting given the law of small numbers.

Yes, I think we don't see it being a V-shaped snapback, quite like that, but we're seeing nice recovery. Vehicle miles traveled in China were down in the past couple of years due to COVID and the lockdowns. Our anticipation is those will get back to close to pre-pandemic levels this year, which supports us. You get the largest car parc in the world. It's aging more rapidly than other car parcs. So pretty strong fundamental dynamics in the market there. People are starting to bring their cars back into the shops after maybe not having them do it as much over the past couple of years. So I think there's good tailwinds behind the auto replacement market, in particular, in China. We're in a great position. We spent the past several years building out a broad channel, broad product portfolio coverage, really replicating our success in our more mature markets like Europe and North America, where it's really is all about having channel and all about having the right products for the market. And that's where we've been investing for the past 5 or 6 years, and we think that it positions us -- or actually, longer than 5 or 6 years, but positioned us well for that recovery that we see starting to happen.

And Rich, you want to say something?

I was just going to say, in China aftermarket, the average age of the vehicle now is in that 6- to 7-year neighborhood, and you think about where our product suite really starts to see significant growth is in post 7 years. So we're starting to get to the early stages of that cycle where we should really get to the meat of that growth. And so that would seem to indicate that we're in a good position here in the succeeding years here to benefit from that trend.

And Tom, you mentioned returning to pre-COVID levels. Is that 10% up year-over-year? 20%? Just can you calibrate us versus last year?

It's -- I don't want to throw a number out, but it's -- it won't be the V-shaped bounce that we might have seen maybe in the early days of COVID in '21 in some markets. It's going to be a progressive, but nice growth. I'd hate to venture a number, but...

Okay. And the strategy in China, can you expand on that? Because obviously, you've been able to grow that business, which is pretty hard to grow in a new market organically in that part of the world. So just talk about how you folks have been able to do that and how much more runway you have.

Yes. I mean I think a lot of it is that, very early on, as we looked at the market for auto replacement there and we saw the trends in new vehicle purchases, we really got in and started building out channel coverage. So very broad channel coverage in every province, not just the Tier 1 cities, but we've -- our team has done a nice job of building out coverage. And then product coverage, if you don't have the right products to cover the vehicles in the market, you won't get off the starting line. It's something we've done historically very well in North America and Europe, and we just took the playbook and reapplied it in China. Some of the market dynamics, obviously, are different. It's maybe more -- 5, 10 years ago, it was more of a greenfield market. But we've done a nice job, I think, of establishing a strong brand. We believe we're the leader in our product categories in China. Yes, it's a competitive market. But having a broad portfolio of the right parts for the right applications, this makes our channel partners' lives easier. So they keep coming back.

And in terms of -- from a pricing point standpoint, can you talk about where you folks stand versus the competition in that region? And essentially, in other parts of the world, you earn your margin through on-time deliveries and the product SKU. Is it the same playbook?

Yes. I think -- I mean, I think it's -- I would say in most, if not all, markets in the auto replacement segment in particular, really in all of our segments, we're a premium brand. We're known for high quality, we're known for delivery, we're known for having a broad portfolio that makes our channel partners' lives easy. And the same is true in China. We have a strong brand that's recognized. Yes, I think that combination of brand products, product quality, innovation have helped us be the premium player in most of the markets we serve for many years.

And getting excited about your market position here, Tom. Can we talk about auto OEM? So you folks have really focused on getting the right type of OEM business at the right margins. So can you just talk about is that a shift that's now largely complete? Or as additional platforms come up, is that something we should still keep in mind?

Yes. We've -- going back to your initial question on how we've been executing the strategy and positioning the business since the IPO, I mean, we're really focused on this auto OEM strategy of selective participation. So we're pretty selective about the business we take. We want to -- we want programs where we bring something to the table in terms of differentiated technology or maybe some sort of system solution that gives us some advantage over the competition. We've taken that business from roughly, I'd say, mid-teens percent of total Gates sales to sub-10%, which has been our stated goal. And we intend to sort of manage the business in that sub-10% of total Gates sales range by being selective. We walk away from a lot of potential programs that we could win, but we're trying to manage that business appropriately.

And so sub-10% today, is it going to go to sub-5%? Or is this...

No. Our target is to keep this sub-10%. Will it ever go away? I don't know. It won't go away. But I don't think it will go away. But we'll keep it where we can -- yes, if our selective participation strategy causes us to wean that down a little bit more, we're actually okay with that. That's part of the stated strategy.

And the other piece of that is just we'll have growth in other areas, right, that are just going to dilute it. So we'll be selective participants on programs and then put incremental capital in other areas that grow, and so that will dilute it as well.

And we've more than made up for what we've said in auto OE with growth and auto replacement growth and initiatives like mobility, where we're leveraging a lot of that expertise and those product capabilities in new applications where there's a lot of secular market growth.

And if we just assume the margin gap is 10 points between auto OE and the rest of the business, that shift of 5 points that you spoke about, Tom, that suggests margins are boosted by 50 basis points, something to that effect, from the transition?

Yes. The mix away from auto OEs towards, say, mobility will naturally help that margin mix. Mobility is accretive to fleet average and auto OE is dilutive. So yes, natural.

Good. Can we talk about electric vehicles? And so you folks obviously have the advantage of having the channel in aftermarket. Talk to us about how you can leverage that from an aftermarket standpoint and your views on your potential market position.

Yes, a couple of things. I think one is the content opportunity per vehicle goes up pretty substantially for us as you move from an ICE application to an EV application. So we really like that content uplift. The mix tends to shift from maybe more historically power transmission products to what we would refer to as thermal management products in an EV application. So we're an incumbent in both those areas. So yes, within Gates, a little mix shift from PT to more thermal solutions, but a nice uplift in content. Same playbook, I mentioned, about China. How do we win in the aftermarket as EVs start to enter the aged part of the car parc? Well, we win through our channel partners and working with our channel partners and bringing a broad portfolio of products to the table. And we believe that we've been investing in building out our EV catalog coverage for several years now and believe -- again, our product categories are the leader in the independent aftermarket in terms of product coverage.

And so Tom, can you expand on that point? Because there is no 1980 Toyota Camry in the EV world, right? So that big advantage that you folks have with the product SKUs might be smaller in an EV world. Can you just expand on how you can leverage your existing position?

So I think the way you see aftermarket car parcs develop is we've seen rapid penetration at the new vehicle level of EVs, right, in really every part of the world. But the time it takes to age those EVs into that 7- to 12-year sweet spot window -- that 7 to 12 years, right, so it takes time to get into that age window. Sitting here today, the number of vehicles -- the number of EVs around the world in that window of 7 to 12 years is relatively low. So we're building our product catalog out ahead of that wave that's coming in the 3- to 5-year time frame, give or take, where we start to see a significant population of vehicles in that aged window. We'll be more than ready for it when that hits. But it takes time for the car parc to age, right, in that mix.

And you have agreements, I believe, with O'Reilly and NAPA and the major distributors. Are you finding that you're getting the call to provide these new components?

Yes. What I'm hearing and seeing from my teams that are out in the field pitching our capabilities in the space is we believe we're leading with messaging around parts availability, coverage, training materials to support both our channel partners, but also their end customers, the installers and shops, in terms of being ready for this aged car window to start to open up in a few years as these vehicles enter that age sweet spot. So we get good kudos from our channel partners on the work we're doing and being out ahead. And again, it's just -- it's executing that playbook that has made us a strong player in the aftermarket for a long time, channel access and product coverage.

And low initial volumes, presumably, that's a benefit to you compared to other players that are not current suppliers, right?

I mean I just want to -- one of the strengths, naturally, if you have broad coverage of a car parc is you have a lot of SKUs to cover that. So we are, I think, quite proficient at managing an appropriate level of complexity to serve the market. And I think that's an important point. Tying back to the 80-20 concept, we don't just cover everything for the sake of covering everything. We're thoughtful about building out catalog coverage for parts of the car parc, where we've got the near-term market opportunity.

Got it. And in terms of any OE opportunities in the EV environment. I know we spoke about the business in its entirety not being a huge focus, but what about EV specifically?

Yes. I mean we're taking the same strategy of selective participation. So there are opportunities we're walking away from, and there's opportunities that we're chasing hard. We've got content on -- I won't name names, but many platforms that you might see on the road every day. We're also quite excited about the heavy-duty opportunity in that space. We talk about the content uplift from an IC engine to an EV platform in the auto space. But if you think about that in a heavy-duty truck, where you've got a much more distributed architecture, it's just a much physically bigger vehicle, there's a lot more product content on those for us. And we've -- some of our technical capabilities with our new water pump and our thermal management hose capability are nicely suited for heavy duty. So we see a good opportunity there as well.

And when you say heavy duty, is that automotive or truck?

Truck, bus, commercial vehicles. Last-mile delivery is an interesting space, right, where I think EVs have a nice advantage with a lot of start-stop, right? So we see some good opportunities and some good programs in those applications as well.

And can you say more? So the component that you would sell into those applications, what's the ASPs?

We've got maybe a representative program that's 4 or 5x more content than, say, a typical automotive platform. Just it's a multiple. It's not an order magnitude, but it's a multiple of what you might see in auto, just due to the sheer size of the vehicle and the distributed architecture of these thermal management systems.

Very interesting. And can we shift gears a little bit to talk about the company's distribution. So 370,000 SKUs, most of them delivered within 24, 48 hours. Any interesting technological developments that you folks are implementing behind the scenes that could be a tailwind for the business?

Yes. I mean in terms of getting product to customer, we're pretty comfortable with our distribution footprint. In terms of technical capabilities, there's always ways to run your DCs better and improvements in software solutions and business operating processes. Yes, I think we're doing some interesting things, I think, with digital tools and tying digital tools to demand creation. So on the PT side, we recently launched the mobile version of our Gates-designed power tools, which you can design a belt drive in the field on your iPhone. We've had desktop versions, and we've upgraded those desktop versions. But those tools make it very easy for our customers to design in a drive, determine benefits such as energy efficiency improvements, et cetera. Those lead to demand generation, which we ultimately will fulfill through our distribution networks and our distribution partners. On the FP side, as I think we've shown publicly or I know we've shown publicly our GC20 crimper platform, which is a digital platform that enables assemblers and distributors to assemble hydraulic hose assemblies. Well, when they're doing that digitally, we're able to support them in the process of making the assembly, but also monitor consumption and potentially use that to maybe do auto replenishment schemes. And just to make sure our customers in the field have the latest information about our products, the latest training and access to products in real time as they consume that product in the field. Maybe less about the distribution centers themselves, but more about how are we using digital tools to create demand downstream from our DCs. Those are some of the examples.

And any potential for a push marketing sort of thing? So...

Yes. So what we've seen in our crimper platform when we launch a new product, we can push information about that new product to the screen right in front of the operator. So you can imagine, hey, you're currently using this product, here's a new product from Gates and here's the 3 benefits of this product. Have that show up right at the point of use, which is pretty powerful from a marketing standpoint. And there's training materials and best practices, troubleshooting, things we can do with the digital platform that you couldn't do with the legacy analog platform.

So we spoke about electrification. Any other industry trends that you're monitoring that could be interesting for your folks?

Yes. I mean we've talked about this one quite a bit, but we really like the electrification trends in the 2-wheeler personal mobility sector. I mean, okay, is it a corollary to the electrification in automobiles? Maybe. But we think it's happening much faster in 2-wheelers. It's hard for me to imagine a 2-wheeler without a belt drive -- an electric 2-wheeler without a belt drive solution. I'm sure there are examples you could find that don't have a belt drive solution. But if you're driving a nice, quiet e-2-wheeler, you don't want to hear the chain slapping around and making a bunch of noise and having to be oiled and retension-ed. The belt drive solution is just a really elegant solution for an electric 2-wheel vehicle. So that's a nice supportive trend. And I think industrial automation, in general, benefits our products. Infrastructure build-out. If you're building a road, you're using a machine that's using hydraulics most likely. The mega project investments that are ongoing could support our construction applications. So there's a number of strong secular tailwinds behind what we're doing. We just got to make sure we're there with the right products and the right channel partners at the right time to serve them.

Super. Yes. Well, that's all the time that we have. Please join me in thanking Tom and Rich for coming out. Gentlemen, thank you.

Thank you. Thanks, Jerry.

Thanks, Jerry. Thank you.