Gates Industrial Corporation plc ($GTES)

Thank you very much, everyone, for joining Gates Industrial Corporation. This is Tomo Sano SMID-cap Industrial Analyst at JPMorgan. And with me, we have Brooks Mallard, CFO; Rich Kwas, Senior Vice President, Investor Relations and Strategy. Brooks, Rich, thank you very much for joining.

Absolutely.

So before we begin, I wanted to highlight why Gates Industrial is such a compelling story for this conference. And Gates is a global leader in Power Transmission and Fluid Power with outsized growth in personal mobility, data centers and robotics and over 70% of sales coming from resilient aftermarket channels. So their innovation-driven transformation has delivered record margins and strong free cash flow, positioning them for continued structural growth. So to kick things off, Brooks, if you could help us to start with the introduction to Gates, who the company is, what you do and your story.

Well, look, I think one thing, Gates has got a long history, it's got a great brand name, but we're still a relatively young company, right? And so if you think about the DNA of Gates, going back many, many years, over 100 years, I think. They have a culture of material science, innovating new products, a very strong customer focus. And really being the brand of preference for the Power Transmission and Fluid Power products we make. And you can go anywhere in the world, and you can see the Gates brand and you can talk to customers who will go, give me a Gates belt, give me a Gates coupling, and that's just what they walk in and ask for. And so what have we added since we've been a public company, Blackstone acquired the company, I think back in 2015, we brought in a management team different people from different companies, primarily with an industrial focus on what have we added, right? What we think we've added is we've become a very data-driven company. We like to use data to make decisions. And then we've added a level of accountability in terms of, hey, look, you promise us this, and then we're going to give you the money to invest and then we're going to hold you accountable. And so we develop that culture of accountability. So everybody knows that we all have a we all have a part to play. And then we've also got a focus of continuous improvement. We know that we're in a competitive environment. We know that we've got to go out there and develop better products. We've got to develop lower cost products. We got to service the customer better. We've got to do all these things to continue to drive improvement in the company. And then organizationally, we've tried to create a lean organization, a culture of transparency and then also to be process driven, right? So we want to be driven by process -- by process capability, use that and data to make all the right decisions. And if you kind of put all that together to really make our customers happy. And so I think that's really kind of the -- without getting into all the different products and everything, I mean that's the culture that we've built at Gates. And that's what we've been able to go through, if you think about the past 6 years, even going back to the last downturn in 2019 and you look at all the disruption that's happened over the course of the past 6 years, we went through COVID, then we went through material disruption and inflation and then Ukraine war and then tariffs, and now we've got the new thing. Well, when you look at where we are, and we kind of feel like we're at the trough from an industrial perspective, we've improved the profitability of the company over 300 basis points, right, kind of mid-19s to mid-22s from an EBITDA perspective. We've improved -- since 2020, we've delevered the company from 4.8x to under 2x, right? So we're at our midterm target already in terms of leverage. We've deployed capital. We've paid down a significant amount of debt. In addition, we bought back about 15% of the company's float since 2020. And so we feel like the culture we've built and then the results that those have produced really kind of show where we are. And then it goes back to kind of what you led off with. We feel like we're positioned now for that next phase of growth, particularly if we can get a little bit of help from the industrial macro.

And then based on your 70% over aftermarket sales business model, and for the cyclical perspective, like how do you say where we are in the cycle and how actually you try to embrace those and capture the opportunities for the cycle?

Yes. So I would say it's interesting. The automotive aftermarket business has typically for many years before we went public, has really been -- was really a very stable part of the business, right? And then like in 2019, when they had the first kind of trade tariff war they -- we saw some pretty significant disruption. You saw some stocking up and then some destocking and kind of a lot of different things going on in automotive aftermarket, which we believe weren't a big part of the trade war, but it was disrupting the market overall. And then after that, you saw COVID. And so COVID affected the automotive aftermarket hugely. You saw people stop driving, guess what, when people stop driving, automotive aftermarket slows down a little bit and then it jumped back up. And then we started to see, again, like I went through before, some of the disruptions with materials and supply chain and things like that. And so it took us until about -- from the disruption of the trade war, it took us until about 2023 to get through all those disruptions. And now if you look back over the course of '24 and '25 the automotive aftermarket business is actually working the way we always thought it would, right? It's kind of a strong business with strong margins. We've got great pricing power. So we're able to inflationary times, make sure we're able to maintain margins. We've got opportunities to grow the business, particularly in some of the emerging markets. And it's -- that business is going to grow 2%, 3%, 4%. And so it's acting like we always hoped it would. On the industrial side, I think that's where you've seen more of the headwinds over the past 3 years, especially. We've been kind of in a prolonged trough. I think if you go back and look at ISM and all these different metrics, we've been in a prolonged trough. And really, I think that's typically the last piece to come out of it. So what you'll typically see is the industrial OEM business start to perk up a bit. And we did start to see a little bit better orders in that. And so in our last earnings call, we saw -- we were a little bit cautiously optimistic that what we were seeing on the industrial side with some of the OEM orders that maybe we're seeing a bit of a turnaround. And -- but then typically, after those come through and you start to see factory activity pick up, that's when you'll see the industrial aftermarket business start to pick up some. So I would say that's kind of where we are right now. We're still kind of in a wait and see kind of how things turn out as we get through kind of the busy part of the season. But that's kind of how I see the aftermarket business as part of overall.

Let's talk about our growth engines, which are personal mobilities and data centers, robotics and automation. So personal mobilities and data center applications are driving outsized growth. So what are the key competitive advantage that you have and also allow Gates to sustain high growth and defend the share in these markets?

Yes. So on Personal Mobility, think of that as a market where electrification is penetrating the industry. So you probably all -- particularly if you're in city centers, you see a fair amount of electric bikes, and so that continues to permeate. And so the belt-driven applications that we provide are really attractive the bike manufacturers and the overall electrification. They're more efficient. There's less maintenance required and they're more durable. And they've just worked better with the overall electric powertrain. So we've been able to get design wins over the last several years. And you saw our growth approximately close -- came close to 30% last year on a year-over-year basis. And so on an overall -- for the personal mobility market. And so we have a 30% CAGR targeted out through 2028. So we expect to achieve that over the next couple of years. And it's really just think about penetrating new applications within the electrification. So as you think about electric e-bikes, those in the developed markets are growing double digits, so through the balance of the decade. So that's creating a nice base. But then on top of that, we're penetrating applications within that. So one example of that would be electric mountain bikes. That was an area that we've won some programs recently. That was an area we had not penetrated previously. So we're bringing the cost down of our belt drive and that's allowing us to penetrate higher-volume applications. And we continue to focus on that here going forward. That will allow us to -- if you think about lower-cost systems that will allow us to penetrate higher volume applications. So that continues to be an opportunity. We see that a good growth trajectory through the balance of the decade and even longer. On data center, that was under about -- under $10 million last year in terms of the base. We're really focused on liquid cooled applications. So if you think about how data centers are now being built. There's a lot of focus on liquid cooled applications. And so that creates an opportunity for us. We're more of a consumable though. So we come in on the back end. So with our hose and hose assembly and couplings. So that ends up being more on the back end of things. So there's a -- we have a project pipeline that continues to build. We expect off the base in '25 to grow multiples of that in '26. We have a target of $100 million to $200 million of revenue by year-end 2028. And so we think with the liquid cooled applications permeating the market over the next few years, that creates a nice opportunity for us. And so we're working across the board, whether you look about -- look through the hyperscalers, all the way down to the ODMs, working with the server manufacturers, the cooling distribution unit manufacturers across the board. And so there's significant opportunity. We think it will be a nice growth algorithm for us over the next few years. And then we also have a focus on trying to develop new relationships and gain share of shelf with our replacement customers. And so that's an ongoing focus for us. And so couple -- within the last couple of years, we won a big North American auto distribution partner, and we've been serving them for the better over the last year or so. And so there's opportunities that come across here and there. We're not going to get those wins every year that are that chunky, but there's always opportunities to gain new customers and also gain share of shelf with existing customers.

So double-click on data center reach, if you could talk about the pipelines cadence like from $10 million to over $100 million, $200 million, are you ready for in terms of capacities and how it's actually come to margin profiles for data centers?

Yes, we've added selectively on capacity, and we continue to do so. And so we've got -- we feel good about our capacity position here as we look out the next couple of years. From a margin standpoint, think of it as fleet average. So it's going to be a solid contributor -- we expect to be a solid contributor to our profitability. And so as you think about, there's some incremental costs that we've been incurring here over the last year as we have commercial resources, deploy commercial resources, et cetera, and build the team behind it. We continue to hire people from the industry. So as the volume increases, we expect to lever that pretty nicely.

And then if we could talk about the robotics. Recently, JPMorgan, we published a note about the robotics automation opportunities in the U.S. And the Gates, advanced belts, power transmission solutions play a key role, I think, is for the robotic system running smoothly. So how do you see the gates role evolving on robotics automation adaptations for acceleration across the industrial space.

Yes. So look, we've been -- we've got a focus on applications within the four walls of the factory, going back here. Really, I think, since we've been public, right? And that's really our chain-to-belt conversion initiative, right? And we had great success with it on the mobility side, which is kind of more of a mobile application. And we've always been very strong in mobile applications, whether it's two-wheels or four-wheels, heavy-duty truck, construction all these different things. And so what we really focused now on -- and this aligns directly with the robotics and the automation, the stuff within the four walls of a factory is making sure that we get in and we have a strong selling solution along with a strong product portfolio to sell to the machine OEMs, right? We've had good success on retrofitting applications within the four walls of a factory using belt -- Gates belt drive systems. And we're trying to take that focus and apply it now to the machine OEMs. So we get in on the floor of all these applications. And the big driver there has been, as we've continued to work on cost productivity and material efficiency and new products is we're getting closer and closer to cost proximity with chain-driven systems. And so the closer we get to cost proximity to where the actual decision on the cost between one and the other is very, very close. When you look at the energy efficiency when you look at the downtime when you look at the cleanliness of the Gates belt drive systems. When you look at all those and you've got cost proximity, then you've really got the equation that you need to go in there and really get some market share gains on the machine OEM-side. And that's really what we're focused on right now.

I think no. I think that's just think about getting in, in terms of that initial install cost, and we can penetrate that market. And we've had more success historically on the operating the user, end user in terms of conversion. And that is still ongoing, but there's a distinct opportunity with the machine builders to get installed first, and that creates obviously a replacement opportunity longer term.

And the key there was the cost proximity piece, right? Because like I say, chain-driven systems, they've been working on the since there's been chain, right? And this initiative has only been ongoing for 10 years, and we're already getting pretty close. And so we'll continue to work on that. And like I said, the closer we get on cost proximity, the more opportunity we're going to have.

And then if you could talk about the humanoid, any exposures and anything that we can be excited about the humanoid exposure?

I'd say it's a possible opportunity, I would say, though, that nothing to talk about materially today as it relates to that. But, always an opportunity.

Looking forward to it. All right. And if you could talk about the most important areas of innovations, whether it's actually material science, digital monitoring, predictive maintenance that will drive Gates differentiation, value creation in the next -- the phase of factory automation and robotic.

Yes. Look, I mean, I think from a -- Gates is really a material science company, right? That's what we are we're very focused on, right? And so we're going to continue to develop new material combinations. We're going to continue to look at continue to be flexible in terms of some of the different combinations of resins and compounds and things like that, that we do that produce products with specific -- with specifications that our customers want. I do -- I think we have a lot of opportunity to use new digital tools and AI and things like that to expand our capability on material science, right? And so can you run iterations on compounding to see what the outcome is going to be. Can you get a lot faster in determining what's going to be success and what you might not want to do, right, when it comes to a material -- from a material science perspective, right? And so we're looking at all these different tools to improve our material science capability. I think also, when you think about product applications, when you -- whether you're looking at to make yourselves better or you're looking at tools that other people are using to make themselves better. Our products are used in so many different applications, but it opens up a wide aperture for us. And I think like the data center is a great example, right? I mean, when you think about hoses and couplings, these are things that doing for 100 years, right? And so as liquid cooling became a big opportunity, we already have the products, right? We already have the capability then it was just a matter of matching up specifics, specifications with capability and products with the right set of end users and customers and specifiers and things like that. And we've created this great new opportunity. And so look, we're always going to look at all the different applications that are out there. We're going to look at the different tools that are out there, and we're going to use those to drive not only our material science focus, but our new product development and product application focus. And that's where you kind of marry those two up. And that's why I think customers love to do business with Gates, because we can marry those two up. And really kind of scratch any itch they have, right, and really take care of the customer in a great way.

And let's talk about execution, operational excellence and margin expansion. So despite the macro headwinds, Gates has delivered record margins and strong free cash flow. And then from your perspective, so what are the key drivers behind this on the ground culture how do you maintain it across the organizations, especially during the recent large-scale ERP and footprint optimization projects.

Yes. So look, I think when I talked earlier the culture of the company. I mean I think really this is the key element of how do you drive continued improvement on your financial metrics through the cycle, right? And so from a material science perspective, right, we always had a strong capability in materials science. And I will tell you that when we went through the big issues with material availability with what went on with the Ukraine Russia war and some of the displacement that was going on there and things like that. We shifted our focus somewhat on our material science efforts. And we started looking at, hey, look, we've got some issues in terms of material availability, with cost, with things like that. How do we look at that and say let's focus on cost and how do we start getting our costs realigned and looking at what we can do to kind of have the same specifications but do it at a lower cost or do it with materials that are much to get, right? And so we refocused our efforts and said, okay, let's do this. And we've seen great success over the past 2 years, and we think we'll have great success year in terms of being able to kind of realign our material costs, right, and get better there. From a cost perspective, right, we've done a lot of work on taking cost out kind of in line with what we've seen from some of the volume headwinds to try to maintain our cost productivity the factories. And then to kind of cover a point that you were talking about. And then we've also looked at -- look, let's take a look at our overall footprint and see what we need to do from a cost productivity perspective as well as the labor availability perspective and kind of where you see an inflation in your labor force and realign our footprint so that we're going to be able to do better from a conversion cost perspective with labor and overhead costs and things like that. And so again, I mean, that's really kind of focus on being focused on data being focused on making sure that you take cost out every year kind of that and then focus on that continuous improvement effort, right. To kind of switch gears on to the ERP. The -- look, I've been through ERP implementations before, and they're never easy. But they're necessary sometimes. And the one that we did in the EMEA region was necessary, given kind of some of the infrastructure things that were going on there. I will tell you that the team came together and has done a good job. So far, we're where we thought we would be from an ERP perspective. And look, I think as they get through the heavy lifting on that, then they're going to come out a much better baseline in terms of understanding where they are and then a system to run it to then start to put in more improvements and start to get better as they move forward. So I will tell you that as we sit here and look today at it, I'm very encouraged as we get through this quarter and then get through next quarter about the future for EMEA in terms of improving a lot of things not just the cost side, but really the working capital side. So we're going to have better visibility, inventory management. We're going to have a better visibility to customer demand and forecasting and things like that. So I'm very encouraged about what they can do in the future.

And then shifting gear to regional performance. Your global player engaged has outperformed in Europe and China versus peers, what are the key factors behind this success? And how replicable is it in other regions as well?

Yes. I mean -- so I think if you go back to the fourth quarter, we had solid growth in the EMEA region were up almost 6% year-over-year on a core basis. And I think over the course of the second half of 2025, you saw some improved demand trends in general in the market over there. And so we were able to capitalize on that. And so things turn the corner a little bit, if you will. As you all know, some of the PMIs have kind of crept back towards 50 and maybe have exceeded 50 at this point in certain those jurisdictions. And we saw good receptivity in the back half of the year in terms of our -- particularly on the industrial OE side, and that kind of fed our comments somewhat around improved demand trends on industrial OE orders as we exited the year. So -- and then in China and generally in Asia, we've seen solid sturdy demand trends really for the most of the last couple of years. And so we have a very strong franchise in China. I think our team is really well versed over there and well positioned, done a great job. And we've transformed some of the mix of that business, which was maybe a little more auto-centric, if you go back a decade ago. And while we still have a strong position in auto, it's really transitioned to more of a replacement mix rather than an OE mix in China, and we've grown the industrial side of things there. And then in North America, I think we started the year towards the end of last year. And really, in the fourth quarter, we saw improved OE order trends in North America as well, and that kind of also helped us as we exited the year. And then as we started this year, we saw improved order trends on the OE side in North America. And that kind of fed some of our cautious optimism here as we entered this year. And so we typically see one thing that's different now versus maybe the last couple of years when we saw a little bit of a head fake with the PMIs in '24 and '25 is that the industrial OE orders have started to improve, and our book-to-bill was solidly above 1. And what typically happens is when you see industrial OE orders turn, you'll ultimately see the replacement aftermarket start to turn. It takes them a little longer, but that gives us some greater optimism overall that, that market will start to turn as we get through 2026.

Before I open up the Q&A, I wanted to ask about the capital allocation, M&A, leverage record lows and strong cash flow generation. How do you prioritize between buybacks, organic investment and M&A at this moment?

Yes. So look, I mean organic investments are always going to be our first use of capital because they typically have the highest IRRs. They typically have a 25% plus IRR. Now there's only so much money. I mean, typically, from a capital perspective, your sweet spot for our company at the current size right now, maybe $100 million to $120 million. And then -- and that's how you can get the right people focused on the right projects, make sure you get them to the end, declare victory and then move on to the next one. We typically have significantly more of a pipeline of good projects, then you can really execute on in the short run, right? It's just -- it's a matter of people and time and effort things like that, you want to be balanced in your approach on working on projects versus daily productivity and delivery to the customers and all these other things, right? So that's always a good first use of capital. We still think our stock is undervalued in terms of where we rank compared to our peer group. We've still got a significant amount of ability left in our current stock repurchase program that we plan to use. And so we'll continue to use that. We'll continue to look at debt paydown as an opportunity, especially as -- if interest rates do start to pull back and we start to see some opportunity there to kind of reconfigure our debt and maybe shave some basis points off of that, we'll certainly look at that as an opportunity. But then M&A, as I think is something that we're opening up the aperture on, right? And so look, M&A is tricky, right? There has to be something that's actionable, right? It's got to make sense for your business. It's got to have the right payback. We certainly would like to, I think, add some inorganic to our profile. That's something that's been missing from the company. And so I think that's something we want to add in. So given all that, we -- from an M&A perspective, we're going to stay close to the core, right? It's going to be something that aligns with our current product portfolio. It's going to be something that has -- that looks very much like what Gates does today. It's going to have something that's critical application in nature. You have to have our products to run whatever it is you're running, whether it's a combine harvester or whether it's automated machine in any different vertical or whether it's an electric bike or whatever it is. Typically, we'd like it to have a large replacement business. The large aftermarket business that we can tap into and tap into kind of our total distribution system. And we like it to have good financial metrics, right. And a large synergy play that we could fold in into our business.

So thank you, Brook. So I would pause here to see anyone have any questions. Moving a little bit more. And you talk about under-appreciation about the valuations Brooks. So are there aspects of Gates business aftermarket material innovation, digitalization, your role in the robotics, automation and value chains that you believe are underappreciated? Any thoughts?

Yes. I would say -- I'll give one thought, and then I'll let Rich go and then we'll see how much time we have left. I think one thing that people have underestimated about the business is the cash generation part of our business. We're able to generate cash at a high level year in and year out, good cycle, bad cycle. When you go back to 2020, we delevered the business almost 3x in addition to, as I said, buying back, about 15% of the outstanding float as Blackstone exited the business and they're no longer own any shares of the business at all. And when you can generate cash like that during -- even when the cycle is down and things aren't great, it puts you an opportunity whether you want to use that as an opportunity to buy back stock when you think it's really undervalued or you want to step up your M&A capability and things like that. And it's something that I hope that investors will take to heart and go, if we do a little bit more M&A or if we don't, this business is going to delever over time, half a turn every year. It's just what's going to happen. And whether we use to take that cash and buy back stock or do M&A or pay down debt, it's going to generate cash year in and year out, right? And that's going to give us great, great flexibility and opportunity from a capital allocation perspective, which we think is one of the absolute key things that's going to drive shareholder value in the future.

I was just going to say, I think the sturdiness of the franchise is underestimated. This brand is known across the world. You'll walk into any part of Asia, any part of Europe, people recognize the Gates brand. It's unlike other companies, maybe that have added acquisitions over the years and maybe their core brand is relevant in one part of the geography, half the world, but the other half, they use other brands to drive their value proposition. This is a one core brand, and I think that's pretty unique among many companies. And I'd say the other thing is just in general, the company has been around 115 year, our management team, our Board is focused on keeping this business running for the next 115 years. And we -- I think they're -- we're starting -- you're starting -- you've seen that with personal mobility where we've created a new market essentially. There's opportunities to do that in the future, and we intend to do it.

All right. Thank you. I think it's time up. So I'd like to wrap it up with the many thanks, Brooks and Rich, and thank you, everyone, for joining.

Thank you.

Thank you.