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

Well, thank you, everybody. Super happy to be up here with Brooks Mallard, CFO at Gates and then Rich Kwas, VP of Investor Relations. Thank you both for coming to the conference.

Maybe starting off high level. Can you just give an update on what you're seeing across the business lines, the various end markets, company is pretty diversified. And then does anything stand out from a regional perspective when you look across the business?

Yes. I would say it's mostly what we thought it would be when we had our last earnings call. We knew on the industrial OEM side, there was softness there, particularly in the Off-Highway. So construction and ag. And I think you've seen that play out kind of largely as we thought it would. I think the additional piece there is we saw pretty early that the automotive OEM piece was softening as well. And that's not a big part of our business anymore. It's less than 10% of our overall business. And so that was something that we saw happening in the second half. I think on the industrial replacement side, again, it's a -- as PMI is below 50, and the manufacturing activity remains relatively muted. That's kind of where we thought it would be. Our automotive replacement business has done well, continues to be kind of a strength of the business as we work through the first half. And don't see that changing. We've got some of the business wins we've talked about there, and we'll get into that a little bit later. And then from a geography perspective, I think, again, largely what we thought it was going to be, right, kind of softness in North America, softness and in EMEA. So not a lot different than what we thought it was going to be.

Yes. I appreciate it. I guess for the end markets that have been softer, you called out the Off-Highway industrial like we've seen everywhere has been pretty soft. Are there anything that you guys are seeing that kind of give you confidence that those business lines are returning to growth in 2025?

Yes. I would say the one area that we feel like we're seeing the channel inventory get better. And as we look at some of the program wins we've had and as we look out into 2025. We feel good about the Mobility business, the Mobility business will be something that we can start to see growth again, especially as we get against some fairly easy comps. I don't think for everything else that we're kind of waiting and see. It's -- they're still trolling along the bottom here. And so I think like everyone else, we're waiting to see when that inflection point happens. I would say, we've said this a couple of times, I'll say it again. We don't expect a lot of help there in 2025. When you talk about the industrial OEM, Off-Highway stuff, I don't think we're thinking I guess, a ton better maybe in the short term here.

Are there business -- like when you look across the business, do you -- like where are the business lines maybe outside of mobility where you do have confidence in the next 12 months, things getting better?

Yes. Well, look, I think there's some growth areas of the business that we feel good about, right? I mean we talked about the Mobility business. The chain-to-belt initiative, we continue to think we're going to have growth opportunities there. Not only -- so we really attract that in two ways. One is with our industrial replacement channel partners, we look at conversions from chain-to-belt there and try to grow our market share. And then we also are looking at the machine OEMs, how do we convert chain drives, the belt drives upfront in the machine building process. And so we continue to think the chain-to-belt is going to be a growth vector for us. Data centers is a new kind of nascent technology that -- or a nascent, I think, application that takes advantage of our existing technology, including electronic water pumps, which were really developed in the electric vehicle space. And we've taken that application and use that and our ability to convey fluid through almost any application. And so as data centers move from air cooled to liquid cooled, we think that's an opportunity for us to grow. And then I think on the replacement channel side of things, both industrial and automotive, we continue to think we have opportunities to take share there. I referenced the two big wins we had in the U.S., one with an existing customer, one with a new customer on the automotive replacement side. We continue to think we can expand our market share and our market presence in places where we've been for a long time like North America and EMEA we've grown our China automotive franchise, automotive replacement franchise nicely. That's become a very nice business for us. We think we can continue to grow that business. And then also when you think about some up and coming, developing economies like India where the vehicles in operation are just starting to get to a point where it's meaningful. We think we can continue to grow there. We have the blueprint on how to grow like we did in China. And so we'll apply that to some of these developing economies and see if we can grow there.

Yes. Maybe digging in a little bit more on those organic growth drivers. Like you said, the company has kind of laid out mobility, industrial chain-to-belt and data center as kind of the critical pillars of organic growth. Just maybe starting with mobility. When we look out over 12 months, is that really just a function of the end market starting to turn? Or are there Gates specific actions that are also contributing to that?

Yes, I think it's both, right. So I think the -- certainly, there was a buildup of inventory in the channel, and we're seeing that flow out, and we're seeing that flow out and starting to see the orders come in again for the existing business. But we've had a lot of really nice program wins in 2024. And so when these programs get up and running in 2025, as the inventory gets to a more normalized position, we expect to see incremental growth there as well. So we feel pretty good about that. Chain-to-belt...

I guess on the chain-to-belt, can you maybe just talk about how uptake is there? What's the value proposition to the customer? And then maybe the other side of that is what's the pushback that customers kind of give?

Yes. Well, so with the pushback, there's always a cost of conversion, right? And so there's a cost of conversion. However, there are certain applications where it just makes a lot of sense for a belt drive versus a chain drive. It's quieter. It doesn't require lubrication, so it's cleaner. It's more energy efficient. And so we've seen kind of you can go vertical market by vertical market, right? We've seen some penetration in things like pharma, material handling, food and beverage. And it's really a process of going vertical by vertical and developing and creating wins for yourself and then kind of cutting and pace them across that vertical, right, and showing what your capability there. And look, most of the applications has a -- that we win these designs and have a very strong payback, right? And so once you kind of get in and you show what the strong payback is and they see what the application is, it can kind of roll on top of itself like that.

Yes. I appreciate that. And then maybe going to data center. Can you just maybe talk about the value-add that you guys are providing in data center. You mentioned liquid cooling, still relatively early days there. But how are conversations with customers going on the data center side?

Yes. So we've -- I think we just announced a new host package for -- specifically for liquid cool data centers. There was a press release we did yesterday. In addition to developing some new technologies around fluid conveyance, which is the hoses, so you think about regular fluid conveyance and then you think about metal free, right? So you have metal-free hoses, so you don't leach metals as the fluid moves through, you think about things like halogen-free that we're developing. So it doesn't leach other chemicals from the hose as it moves through the data centers. And so there's different applications just in the fluid conveyance. Another big value that we bring is the electronic water pumps. Again, we developed that as part of our battery electric vehicle technology, in particular, for the replacement business. But as you move in these different powers, or the different power outputs of some of these different electronic water pumps, that lends itself very nicely to the application of pumping the water through the liquid cool data center, right? And then we have some belt applications, right, for some precision HVAC, precision cooling that goes on in a data center that fit in very nicely as well. And so it's technology that we've developed over time for -- with a new application. And so a little bit of tweaking and it develops very nicely for that application.

Yes. Chris, I was just going to add just that on the electric water pump. Think about the packaging and the efficiency we can have it in a smaller package, and it's more powerful and more efficient relative to the competition. And so that's one of the advantages that we bring to the table that's courtesy of our material science capabilities.

Right. And I think that's something when you look at our whole package that some people may have water pumps and some people may have fluid conveyance, but we have all and the couplings as well.

And is that -- when you're going to data centers, being able to provide both do you feel like that's a differentiator when you're talking to customers?

We do. And like you said earlier, it's nascent, right? But we're starting to develop these different packages, selling packages that include all the different pieces of the puzzle, right? And so as we're going out and starting to sell them to all these different kind of constituents within the data center universe. They see the value that we bring to the table.

Yes. I mean clearly, efficiency is everything to the data centers when it comes to energy efficiency. Is it the same competitors in data center that you see across your other served markets? Or is it a very different competitor base?

No. I mean we see pretty similar competitors in terms of fluid conveyance. I think the -- from the fluid conveyance side, I think kind of the differentiator again for us is the electronic water pump and the efficiency we can bring with that and then our ability to look at different applications and maybe do some different things for people based on what their application is.

Yes. Maybe moving from organic growth to margins, the company appears to be tracking very well to the 2026 margin targets that you guys have laid out. Can you just maybe talk about some of the opportunities that you see on the horizon and confidence in being able to continue to deliver that margin expansion?

Yes. So first, let me talk about kind of material science, material savings. As we went through some of the inflationary times we went through in '22 and '23 and some of the supply chain headwinds, material acquisition headwinds that you went through in 2023, 2022 and 2023. That kind of reset our material cost base. And so we've really put our material science team to work to kind of look at formulations and compounds and how we do different things. So we developed a set of initiatives to really drive material cost out I think that's been one of the big levers that's helped us even as volumes have been a tough plot here over the '23 and '24 we've driven incremental margins pretty nicely, right? And we've got a pretty good jumping off point as we move through 2024 toward our path of 24% to 25% EBITDA margins. And so that's been kind of one of the big levers that we moved so far. On our 80/20 initiative, we continue to use that to simplify the business and how do we optimize pricing and different things like that. So that's been a nice lever for us. And then I think the newest one we've just announced is the restructuring program. And so we haven't, we weren't really specific. We had a target out there, but we weren't specific on timing and what we're going to do there. And now that we've kind of looked at the timing, look at the kind of what's going on in the markets, we're able to pull that forward. And now we've got specific targets out there, $40 million of savings, 40% of that will be in run rate as we exit 2025, and the balance 60% will be in run rate as we exit 2026. And so that's going to be a nice lever to drive over 100 basis points of incremental margin improvement over the next couple of years.

Yes. I guess on that pulling forward of some of the investments that we saw, it doesn't change the overall size of the program. It's just that you guys are bringing it forward.

That's exactly right. I mean we -- the size of the program really hasn't changed. I think what we've done is we pulled it forward. And then we really kind of laid it all out where we're confident to go out and lay out these targets that people can count on.

Yes. Maybe turning to the replacement side of the business. And I guess maybe auto specifically, the company's biggest served end market. Auto replacement, it's been a good, healthy market. Cars are -- the affordability of cars has not been great. I guess what do you see on that market as you look out? And is it just a function of new vehicle production? Like is that -- the new vehicle production goes higher? Like would you expect the replacement market to soften? Or are there things that you're seeing that could keep it healthy?

No, I don't think so because, look, the car park in general, continues to get bigger, right? And so the number of cars out there gets bigger. The age of the car park continues to get higher, right? And so as long as the car park continues to age, as long as the car park continues to grow in size, as you add new vehicles to it, it clearly doesn't take anything away from our automotive replacement franchise. That doesn't figure into the calculus of it, right? And so while some may come on and some may go off, the market that we're serving continues to grow. And so we feel good about that.

Is there -- sorry.

One more thing. And it's not just about the size of the market, right? We continue to think we have great opportunities, as I said earlier, to grow our market share on the AR side, both geographically and from where we are today. We have great coverage overall upwards of 90% -- and 90% in a lot of our biggest markets. And so we serve almost every car that's in operation. And so we continue to believe we can grow our market share in places where we've been established for a long time and we believe we can grow it geographically in some of the places that have emerging economies where the vehicles in operation are growing to the point where it actually becomes a nice material tailwind for us.

Yes. No, makes a lot of sense. The average vehicle in the U.S. seems to just get older every year. I made a part of that as things get better, the useful life gets longer, but also we've been kind of underproducing for 5 years. Is there a sweet spot for age vehicle?

I would say got 7 to 15 years for us, 7 to 15 years. I'd like to know as over 15 years, I mean, that's where it kind of starts to fall off, but it keeps getting -- the average age keeps getting older, right?

One thing I think that was very interesting on the company's strategy in auto is that you guys have kind of tried to pull away from the OE market over time. But you really kept a strong foothold in the replacement market. Can you just talk about the strategy there? Because from the outside looking in, it seems like winning on the OE side kind of helps facilitate that replacement business. At least at the dealership level.

Yes. And that's really kind of a little bit of a misnomer, right? When you have coverage of all these different vehicles in operation, right, you have to have the ability to both do high volume kind of low mix manufacturing, but also you have to be able to do a lot of high mix, low-volume manufacturing, right? And that doesn't necessarily lend itself to kind of hard core, automotive OE, right, where you want to do long runs of very similar products and turn everything very quickly and not keep a lot of inventories, right? And so from a manufacturing perspective, we're really good at that. We know we're really good at keeping our inventories healthy and manufacturing things in an efficient way and so things like that. In addition, there's a product development side of this, where you look at all the vehicles in operation, how the fleet is aging, when do you need to have new products developed and then you develop the product and you -- and then you market it to all your distributors and you talk about putting inventory positions in place. And so you try to time it perfectly. So when it starts to hit that 7-year age, you've got all the inventories in place, all your distributors have all the inventories they need, the orders start to come in for these replacement parts, right? And everybody is happy, right. And that's a tough calculus to do. I mean that's a whole different kind of business than what OE business is, right? And so we've kind of -- we feel like we've done very well with that. And so that's a big part of why we kind of focus on that side of the business. And it really doesn't impact the ability to win business in the automotive OEM space really doesn't impact our ability to continue to win in the automotive replacement space.

And Chris, just as an example to put a finer point onto Brooks -- what Brook said, 20 plus years ago or so, the company exited light vehicle OE engine hose, completely eliminated that. And that business is a very strong business for us currently and 20 years later in the aftermarket.

So I mean like the correlation there, I think there's a misnomer that you have to be on these programs to be able to serve the aftermarket and it's not accurate.

Yes. No, I appreciate that. Kind of maybe thinking about some future developments in auto, obviously, electric vehicles, are coming, maybe there's choppiness on the penetration, but they are coming. What does that mean for Gates?

Yes. Well, look, we've got automotive replacement coverage for a lot of the battery electric vehicles that are starting to hit kind of that 7-year age. And we're starting to see some sell-through electronic water pumps. We're starting to see a sell-through from electronic water pumps that we developed specifically for when the fleet would start to age, right? The -- it's going to be a slow roll. The amount of electric vehicles in operation that are in our sweet spot, it's very small, right? And so we've taken a very pragmatic view of it. We think we've invested in the right place and we invested in the right time to be ready for battery electric vehicles as they come to the right age and we're able to replace it. At the same time, we want to continue to make sure we have all the products and high service levels ready for all of the internal combustion engine customers or the hybrid customers as well because that's going to be a long -- it's going to be a long time before that goes anywhere.

I think the OEMs have tried to in-house the aftermarket for a long time. There hasn't been a ton of success. Tesla seems like has done a nice job of it. Does that -- given that you guys are so tied to the aftermarket, if -- what does that mean for Gates if the OEMs are, whether it's because these vehicles are now connected, there's more software maybe things are more proprietary, does that have any impact?

No. I mean, we don't really have -- our content tends to be for a battery electric vehicle, our content is actually higher than it is on an internal combustion vehicle, right? And the reason is you have the electronic water pump, which we think we do a really good job of. And then you have all these branched hoses that go out and cool the inverters and they cool the battery and different things like that. So there's a lot of hose in there. And again, those are -- that's something that we've been doing for 100 years very efficiently, right, making all different kinds of fluid conveyance hose. And so we feel good about our position in terms of being able to have really strong market coverage around all these different electric vehicles. And that's just not -- I just don't think that's in the core.

Yes. The automotive OEMs do like make hose. So they got bigger things to worry about. Does anyone in the audience have any questions that they would like to ask?

I was curious for the data center piece. What's your go-to-market for that? And how would -- what you're providing compete with other like HVAC kind of focused data cooling companies like Vertiv.

Well, I mean, look, those kind of the companies are the ones that we're going to work with to supply air cooling technologies, right? And so whether it's aggregators or chip manufacturers or we have a partnership with a company called CoolIT as well. We're going to work with all these different companies as this kind of application evolves, right? It's still pretty nascent in terms of how it's going to work out. What we want to make sure of is that we have the in-house expertise in terms of being able to interface with these different constituents. And the in-house product capability to serve all those customer needs. And so as these data centers start getting built, that we can win the spec positions as they start getting built, right? And like I said, we think we have a really competitive package of both data center specific hose. And then we also have the additional really efficient electronic water pump that you can use in that application that we just kind of head start on, right? We've been working on that for -- since battery electric vehicles came out. So we've got a head start on that.

And just to clarify, we really have significant content opportunity on the liquid cooled side. There is some on the air cooled side, but it's more significant to liquid cooled.

You mentioned earlier, you talked about a couple -- or two specifically larger replacement wins. Can you just maybe talk more about those awards and what it could mean for -- as a growth driver in '25?

Right, right. So the one award with an existing customer was our fluid power technology. And so we were working with them on expanding our coverage from a product line perspective, and we're now rolling that out. Another was a -- is a larger customer where we started with the PT technology, and we've got additional both geographic and product line expansion opportunities with that customer. And as you think about 2025, 100 to 150 bps of top line growth we would expect for 2025 from those wins.

Well, Got it. On the -- we haven't really talked about on-road production down this year. ACC does forecast a recovery as we look out into '25/'26. How are your conversations with customers on the on-road side?

Yes. Well, I mean it's a relatively smaller part of our business. Again, I think we're kind of in a wait-and-see mode. I mean, you hear some things about inventory levels being down and purchases being down and maybe there being an uptick coming, we want to be ready for that. At the same time, we're kind of taking a wait-and-see approach. I think the -- we are able to flex kind of through the cycle from a production perspective, and we will get some -- we're a short-cycle business. So we get pretty good visibility when the worm starts to turn, whatever the application is, and so we'll be ready for it.

No, just to add to that, we've actually outperformed versus what you see from a unit standpoint. We've picked up some share in certain geographies. So that's helped us in terms of a core growth standpoint.

Yes. No, absolutely. Earlier, you were talking about, it sounds like the destock has largely run its course and maybe there are some pockets, I think you said in ag and commercial construction. So I guess where do you think Gates is in that destock cycle? And maybe what gives you confidence that a lot of the end markets are kind of starting to come out of it?

Yes. Well, look, I think, first, let's talk construction and ag. I don't know whether we're out of that yet. So let's wait and see kind of how that turns. Look, I mean, we've had an extended period of time of lower industrial activity and low PMI, right? And so volumes have been tough for a while. And so we know that there's going to be at some point, it's going to start to pick up, right? At some point, it's going to start to pick up. We feel pretty confident in some areas. I talked about mobility. We've got pretty good visibility to what's going on in the channel from a mobility perspective. We think that, that's going to start to -- the market is going to start to come back there. Also, we've got some good program wins there. So we think the market is going to start to come back there. From a comps perspective, I think we're running up against hopefully, comps that are getting pretty close to the bottom. So when you look at some of the things where we think we're going to grow the AR wins continue to take market share in AR, mobility program wins as well as mobility market. We think there are some nice growth things that we can layer on for 2025, even as some of the other markets continue to stay pretty stagnant. So we feel pretty good about that.

Maybe to China, it feels like China has been a challenging market for everybody. What are you seeing there? Any pockets of green shoots, anything to kind of be optimistic about when you look over at China?

Yes. So look, I mean, like everyone else, auto OEM is not doing great in China. Our industrial replacement business has seen some nice green shoots. Our China business overall is resilient. It's nicely profitable. The automotive replacement business remains a strength there. And so we've been able to weather through whether it's kind of some of the industrial OEM headwinds and now auto OEM headwinds, we've been able to find some nice green shoots of growth in different places, particularly on the replacement side to help offset that, right? And so we feel like we're in a good position there to continue to capitalize on growth in the replacement markets and continue to be able to expand our market presence there. And then when the OEM starts to turn, that will be a nice tailwind for us as well.

I guess on that the green shoots or the relative strength you're seeing in replacement. I mean, is that just a function of replacement is more durable, more resilient business? Or is it -- is there share wins? Is there something going on with the channel that's allowing you guys to do that?

Yes. Well, look, I think it's a combination of both, right? I mean we've got a global product line we take a global view of all of our product lines, and we make them available kind of in, in-region for region perspective, right? And so I think we continue to expand our market presence, both in terms of going out and winning business because we've got available product there. And then also not too different than automotive replacement if OEM business is down, that means the other stuff, they're keeping in life a little bit longer, right. There's an opportunity to get some growth there, right? And I think that's one of the great things about our replacement franchise is, it is a nice offset to -- if you see some weakness on the OEM side, if you've got the right franchise, the right products, the right sales force, which I think we do, you can go out there and offset that and continue to grow.

Yes. On last conference call, you guys were talking about some areas of cost pressure, some spots still feeling inflation. I guess, kind of taking that and thinking about price cost moving forward, is that is there an expectation that you guys are going to stay price cost positive? And how important is that to achieving some of the 2026 margin targets?

Yes. Well, look, we always want to stay price cost positive, right? And so 2/3 of our business is through distribution. Pricing and distribution tends to be pretty sticky. In addition, as where we continue to grow and expand our 80/20 coverage across all geographies and all channels. There is strategic pricing and pricing optimization programs that we're working with there. We make a lot of SKUs. We make hundreds of thousands of SKUs. And so it's very important that we price optimally both on the front end of the higher volume stuff and then the long tail of lower volume stuff, right? And so we're going to continue to work through that pricing optimization. And we feel like that's going to be a tailwind as we move forward as well.

No, I appreciate it. Well, we're up on the 30 minutes. Very much appreciated the time. I love the conversation. Thank you, guys.

Yes. Thanks, Chris. Appreciate having for us. Thank you.

Thank you. Thank you.