Gates Industrial Corporation plc ($GTES)

We started with the team from Gates and great pleasure to Ivo Jurek on stage, CEO of Gates. I think this is the first time we've done a Pitera for a long time, some and we're looking forward to this. And Rich Kwas, Head of IR as well. So I don't think you've got opening remarks or anything, but maybe I'll just ask you, do you have open remarks, anything to say before we kick into the Q&A?

I really don't have anything specific prepared outside of the situation around the globe is actually reasonably constructive despite all of the turmoil that we see on the front pages of new news on a daily basis. I'm happy to go to the Q&A.

Great. Well, that's a great place to bring the eyes because lots of questions around how sustainable is the strength that we've seen. We've now had 4 months of ISM 50. Global PMIs are actually in ordinary expansion for the first time in a very, very long time. So -- is this real? Is it prebuy? I mean -- is it a head fake? Or do you think this is more sustainable?

Yes. Look, I think that we spoke about this a little bit on our Q1 earnings call. But when you take a look at POS, and as everybody knows, we have a large aftermarket business, about 65% of our revenue comes from aftermarket. So when we look at the POS data, the POS data would actually suggest that the businesses -- the underlying business is maybe even a little bit better. whereas inventories are not building out or not building up in a channel -- so any speak around prebuy, I think, is not real. I think it's very emotional to talk about the prebuy because of what's happening in the markets and particularly in the supply chain around the world, but we feel pretty good about where the inventories stand. When you take a look at the underlying demand for us, certainly for gates, about 80% of our end market exposure is in expansionary type behavior. which is good. Not everything is growing super fast. But we've got things that have turned from negative towards more neutral. And we have things that are actually seeing a reasonable level of strength in order intake and actually in business itself, underlying business itself. So I would say that so far, so good, it feels better than just the head fake. But there's a lot that's happening globally that could come to fruition at any given time.

So it's actually remarkable that we've got essentially the Middle East shut down at this point in time. yet, things feel very good. So I mean, obviously, we had a bit of a shock in March, which didn't seem to have a big ramification for our kind of demand profile, but that's continued. You're not seeing any second derivative impacts at this point in time.

No, we don't. And we've actually had -- and I think I stated it on the earnings call, we had a pretty good strength that we saw reasonably broadly in April as well. The orders were trending very, very nicely. The revenue was trading -- trending very positively, very much in support of our midpoint of our guidance. And so we feel reasonably okay at this point in time, better than okay. yes, there's lots of uncertainty out there. But we also need to remind ourselves that we have been -- we're coming out of kind of almost an unprecedented period of time. We had 4 years of negative PMIs just about, right? And that's really quite unprecedented. You've got to go all the way back to World War II, and you still wouldn't see 4 years of negative PMIs. So I think that there's lots of underlying pent-up demand. And I do believe that if you start seeing a little more stability, I think that you can actually see even more constructive end market demand?

I think the PMI is doing Web2 are actually pretty good with all the war planes can produce at a point in time. Okay. And obviously, April was good. It sounds like May continue on that track as well.

Yes. I mean it's pretty much on trajectory as what we've anticipated.

And 80% is -- of your portfolio today is an expansionary phase. Just remind us on the 20% still kind of flattish with that.

I would say actually ADOs down, which is a very small part of our revenue. this it's about 7%. Interestingly, maybe counterintuitively, energy is down still. and that's predominantly a result of the fact that we have fewer wells that drill actively today than we did even a year ago. I do believe that, that will invert with oil prices staying at the levels that they are staying and should even the war resolve itself imminently, I believe that you're going to see a prolonged period of higher energy prices anyways before you can replenish the reserves that are being consumed. So I think that there's going to be more drilling activity ultimately as we get into the second half of the year and exit 2026. So I think that, that end market should trend more positively as we get closer to the back side of the year. And then we have still seen a negative on-highway -- that being said, we spoke about positive inversion in orders, and we believe that second half of the year, that's going to invert as well. So I think that the other OE is going to remain under pressure for the year, but the other 2 end markets that kind of give us the 20% exposure, those should be a little more positive on the bank side.

Yes. Okay. Thanks, Eva. You reported down 3% and change organic in 1Q. You called out the selling days pressure, that was about 3-ish points 300 basis points. You had the ERP transition in Europe, which is another 300 basis points or thereabouts. I think you said Evo that underlying ex those 2 items that you're down about 3% organic growth in 1Q.

Actually, the math was that we actually thought we were up 300 basis points. If you take those 2 headwinds and you look at it, we were actually down 270 basis points year-on-year in revenues that would kind of give you the underlying growth rate of about 300 basis points. And that was about kind of how it felt and how we felt the business to be performing. And so when you think about going from comparatively speaking, 300 basis points to 350 basis points in the middle of us second quarter. That's totally attainable for us and when we set, we feel quite comfortable with that.

Well, I was actually thinking it actually feels a little bit conservative because you're assuming no real improvements, you got a little bit of a push out from 1Q, and you got some extra price going in. So 3.5% for 2Q might steel a little conservative. Is that a little bit spice to say that? Or is it totally fair?

Okay. I think that the underlying business activity remains quite okay and again, I think we spoke there are lots of risks that can come into fruition. And so we are trying to be pragmatic in my resurrecting my favorite word pragmatic. So yes, I think that overall, the business should feel better than what we have guided, but we just want to be pragmatic.

Nigel, on your point about pricing really in terms of the inflationary impacts that we're really going to see that in nerves in the third quarter. I think it will be a little bit in the second quarter, but really all scheduled for the third quarter.

So maybe if I just through the lens on the second half of the year. If we do see on-highway to to pivot back to growth -- it seems to me the shale activity in North America, given the production rates right now, it has to, in fact, pretty hard in the second half of the year. It feels like there could be some nice upside in the second half. Again, you want to be pragmatic. But again, is that the way you're seeing the world right now?

Yes, we do. I think that the underlying activities again remain very constructive. We also believe that exiting kind of a 350 basis points of growth in Q2 and then kind of going into the back half and kind of 4.5% core feels totally doable for us. particularly when you take into account that you will be getting -- we've lost 2 days in Q1. We will get 1 of those days back in Q4. So we don't feel that back half of the year is a stretch in revenues, certainly taking into account where we see the activities presently. And on the margin side, we are getting about $10 million of benefit from the restructuring in North America that we are doing. So we are certainly on track of being able to deliver that. You will have no headwinds that we have experienced in the first and second quarter from the ERP implementation and the incremental cost of that restructuring. So the 23.5% of EBITDA add the back half of the year feels very doable for us.

Okay. Yes. I do want to come back to the EBITDA margin dynamics because there's a lot of loopback there. I just wanted to take a step back and think about what you're doing to accelerate growth and kind of trying to make your own luck as opposed to just being a cycle jockey -- so maybe just talk about some of the incentives and initiatives in play to really overdrive the cycle?

Yes. Well, first of all, I look at what we have done with this business over the last, say, 10, 7, 5 years vis-a-vis growth. Certainly, since we became a public company, we have reduced our automotive OEM exposure by 50%. So that's very dramatic, like it went from about 16% of our total revenue down to about $7 million. We didn't shrink the company. The company grew during the period of time, nominally. When I take a look at the 10 7, 5. 3, so not to cherrypick, core generation of compound annual growth rate organic. We run about 3% to 3.5% over all of those periods of time. So if you take a look and compare us to some of the multis and you look at their organic growth rates, we are very much smack in the middle of that pack. So we have delivered growth while we have improved our portfolio. How did we do that? Well, we've done that by focusing on driving some organic initiatives within the company. So 1 of the big organic initiatives that we have driven was around our person ability. And person ability, as you know, is converting chains on bikes, motorcycles and scooters into a Gates belt drive systems. That has delivered a very nice offset to that portfolio pruning that we have done with other OEs. That business has peaked at about $150 million, $160 million in 2022. we will certainly exceed that peak or get right on that peak in 2016. That business now continues to grow at kind of 20% to 30% range. And we have quantified that we anticipated that business will continue to grow at that rate kind of through 2028. And then we'll take a look and see if we can continue that level of growth in the future, which is not inconceivable, obviously, but at that point in time, that business is going to be much more sizable. Obviously, we have a nascent portfolio of data center applications in the liquid cooling side that we believe is going to be kind of the next leg for us into that '27, '28 time frame, and we frame that, that we see about $100 million to $200 million of opportunity. We have an initiative that we call industrial chain-to-belt conversion. While I haven't spoken a lot about that for number of different reasons. We've actually built a very nice underlying franchise. And we believe that between '27 and '28, that's going to become much more relevant in continuing to drive growth for us. in the industrial space. And we are certainly super excited about it, and we'll spend more time at our next CMD in '27, framing that opportunity and what it represents from what baseline. So I would say that the incremental organic opportunities are there and they are quite tangible and they're quite exciting for us. In verticals that are probably being much more durable and sustainable over the midterm. And our core portfolio of products is actually growing as well nicely throughout the cycles, but that's more cyclical. So the organic opportunities that have outlined are much less cyclical in nature. They are more secular and I think that when you marry that cyclical portfolio and the secular opportunities, we feel that we can deliver again an organic growth in excess of 3.5% over the midterm.

Okay. Okay. And would that be 3.5% average across the cycle. So therefore, we could maybe expect 3.5% plus in '27, '28, especially if data centers start to kick in.

Yes, absolutely. I think that's kind of how we look at it. We are looking at through the cycle, and that's why it kind of started with the 10, 7 -- 5- and 3-year growth rates.

Yes. Maybe just bring us up to speed in terms of the path to commercialization for the liquid cooling portfolio I think you've said second half of this year, maybe fourth quarter, we start to see some meaningful benefit from that. Is that still the case? And you said $100 million to $200 million in 2028, that's quite a wide range. I mean based on what you see right now, I mean, do you think midpoint of that range is likely?

Yes. Look, I think what I see today is that the opportunity scope is getting bigger. I think I will frame that I think liquid cooling was very nascent technology in only a smaller subset of data centers. I would say that today, we see these opportunities scaling up. Vast majority of data centers is going to be liquid cooled by '27, '28. And we feel confident that we will be able to deliver that range of revenue -- and when we get to '27, we will talk more about what that revenue base is going to be. But the opportunity set is growing. Our pipelines are growing. Our exposure to projects is growing. -- when you start thinking about Verarubin, you see a bigger content of liquid cooling in those applications. So I feel reasonably confident that we should be right in the middle of that range.

And is the gating factor at this point in time, is it -- I don't know, is it verarubin rollout? Is it qualification on certain platforms is the gating factor?

It's qualification. It's a ramp-up of our technology. It's scaling up production in the applications -- we are in a full range of applications where we are already supplying, obviously, we're talking about a very substantial growth rates that we are quantifying to the Street. And we have done that, yes, from a small revenue base, but growing very, very nicely. So we are generating good revenues, and we have more technologies that are ramping up. We anticipate that in the second quarter of this year. So this quarter, we will be ramping up our Evadapumps in the first commercial application. So that's pretty exciting for us. Obviously, we have lots of fittings and coupling opportunities that we are now in process of scaling up and that capacity is going to be coming online in '27. So I think that the scale up is what is going to give us more breadth of actual invoice revenue. The opportunities are there, they are pretty sizable and they continue to grow because the exposure grows.

Okay. And then you mentioned going back to chain the belt. You said '27, '28 would be more impactful for that. Why...

Predominantly because we are working on a couple of new technologies that will give us the opportunity to get to closer cost proximity of drive costs. So the pockets and the chain of pockets on the belt, and that opens a whole new subset of opportunities, particularly with the industrial OEMs, who value a little different value proposition than maybe the end user operator. The end user operator is focused on greater efficiency, reduced energy consumption and lower maintenance, whereas the OEM is much more focused on getting the right price point into the upper items that they're going to supply to the end user.

Great. I think the big news from last quarter was the acquisition of the Timken Belts business. Your first deal as a public company CEO, I think, Ivo, -- it seems like a great deal. But is that the bar? I mean, 1 deal every 8 years has to be a huge ROI type transaction? Or are we going to see more deals with them here.

Well, obviously, it was the first transaction because for the last 7 or 8 years, we were working on cleaning up our balance sheet. And our balance sheet today is in a very, very good shape. It's nicely below 2x leverage. which we believe gives us the right to start thinking about how do we deploy our capital in efficient ways and more than just perhaps buybacks or organic investments. We see a ton of opportunities to add to our capability right at the core of what we do in the Timken transaction, certainly, it was more opportunistic, but it gave us an opportunity to do a smart deal to acquiring assets that perhaps made less sense with the prior owner. We certainly have a better owner of those assets. And so that will be an opportunity where we can not only improve that business over the midterm, but it's an asset that is right at the core of what we do and we will do well with it. So I wouldn't -- Nigel, I wouldn't say that we need to demonstrate that we can deploy capital in a very, very effective manner, and this is a very effective deal, and it will be a very, very smart transaction for us. But we will deploy capital much more frequently. And we have a good pipeline of opportunities, everything from things that we are in the due diligence on to things that we are in good discussions about getting engaged, and we feel pretty well that we'll be announcing something more this year.

And obviously, the Timken acquisition is straight down straight down the belt, I guess, you could say. Is that the road map going forward? Is it more a case of just basically taken in smaller competitors consolidate in the markets, but essentially keeping the core philosophy.

I think certainly for the first few transactions, we believe that scaling up our product lines plugging some holes that we have in portfolio perhaps, adding breadth and scale to geographic presence. I'm really big on in region, for region manufacturing in region for region customer support. And so I think that we have opportunities to scale that up. Obviously, we are super well present in North America. I think that there are opportunities for us to be more present in Europe, more present in Asia. And so those are things that, in my view, are opportunities where we could deploy capital efficiently. And we are not planning to do something that would be potentially viewed as adding a third leg presently. I don't think that, that's necessarily what -- where our focus is. We want to demonstrate that we can do transactions that are reasonable where we will generate good returns for shareholders and where our shareholders can take a look and say, Yes, I get it. This makes sense for the company to do that type of a deal.

Okay. If worth to dream of a third leg. I mean, when we think about some of your larger competitors that play within sort of hoses and hydro systems, filtration would be a natural area. But is that sort of where longer term you could branch into those kinds of areas?

It depends on how you view the evolution of industrial complex over the longer term? I mean I think that it would be kind of a natural evolution that 1 could get to. But my view is that we want to be a much bigger player in industrial automation. And we want to revolutionize how power is being transmitted in industrial automation. So obviously, we believe that mechanical transmission of power through belted system is more efficient than through chains. I think that there are opportunities around sensors, actuators, they are in a very close proximity that give you a better presence to build up a nice portfolio of electromechanical automation. And I think that, that would be something that I would look at. There are also opportunities where we are in -- we're obviously in well-defined end markets today, but there are opportunities with some of the things that we are working on presently vis-a-vis think data center applications. the fittings and couplings that we are deploying into data center applications. They have great scalability and applicability in biopharma, in food and bath in medical devices. And so you could also think about an expansion through penetration of some interesting new verticals through the product portfolio that we may potentially already have at our disposal. So I think that I would look at it in those 2 axes.

Okay. Any questions in the room?

So EVO, the stock is a little bit cheap. You've been leaning more on buybacks than M&A, obviously, in the last several years. How do we feel about that mix right now based on the pipeline opportunities you see? Is there more of a more bias towards M&A here in the buybacks?

Okay. I think that we can do both. We generate a ton of free cash flow -- as I said, presently, I mean we are living in a certain neighborhood. I don't have the opportunity to go and pay 15x, 16x for some transaction because it may make sense. So I think that we'll be doing smart M&A where we don't overpay for assets that have the opportunity to return capital back to shareholders and drive appreciation. And along the way, because of our free cash flow profile, I think that we can also continue to do buybacks. And the stock is very inexpensive I think, for the quality of an asset that we have.

Yes, I agree with that. Just want to finish off on margins. You mentioned -- obviously, we've got some headwinds you're absorbing, especially in Onkus also in 2Q. Second half, you said 25% I think the words were very doable or was the effect. You said you're in print with 24% EBITDA margin for 2027, with no volume benefits. Is that -- with all the moving pieces on inflation, et cetera, is that still in play this 24%?

Yes. Look, let me nuance a little bit. Okay. So in the first half of '24, we will get incremental $10 million -- sorry, $27 million [indiscernible] in the first half of '27, we'll have an incremental $10 million benefit from the restructuring. That's the second half of the benefit that we will deliver in the second half of this year. So that should bring you very close to that 24% EBITDA at that point in time, obviously -- you will want to get a little bit of a component of volume to continue that trajectory. But taking a look at where we sit today, it would be, frankly, inconceivable until something really broke that you wouldn't have some volume growth, right, and potentially have a decent volume. So I don't look at the 24% as kind of a stopping end station. I only look at it as a kind of a intermediate station on our journey to continue to improve the quality of our assets. We have a great company, fantastic brand. We make things that people need in all scope of industrial applications, some traditional, some emerging and exciting new opportunities. And so I think that there's an opportunity to drive long-term value creation for shareholders that have a good horizon of time. And I think that the opportunity -- I'm super excited. I know that the best time is ahead of us, not behind us, and maybe better future than we have envisaged even 3 or 4 years ago.

That sounds great. So if I had to say to you, what's your major concern right now? What keeps you up at night. Where would that be?

I would say presently, it's more of the geopolitical instability that obviously is not helpful. But we have done a lot during '22, '23 to diversify our supply chain, invest a lot more heavily in material science, protect our supply chains, fortify them diversified supply chain viability. So -- and we continue to spend quite a bit of management resources and time on ensuring that during this present time, we can protect our customers. and protect our ability to manufacture. And I feel reasonably okay that we're going to be able to do that even without a near-term resolution potentially to some of the things that are happening geopolitically.

And right now, the supply chain is functioning quite well inflation on the track.

Yes. I think that the supply chain is still in a good shape. I mean we certainly are doing a lot to ensure that it stays that way. Look, inflation is going to be what inflation is. The commodities are what they are. We don't control those, so we will price for them.

But there's -- you wouldn't say the customers are right now in complete price fatigue mode still accepting price.

Look, I think that everybody is in a price fatigue. We are in price fatigue. Our customers are in price fatigue, but this isn't something that we control. And in a way, I would say that with some customers, it may even become an easier conversation because they see those. The inflation today is not vague. It comes from very well traded commodities, steel, aluminum, copper, oil, right? And so I think it's visible to everybody on a daily basis. And so in a way, that conversation has -- it's never easy, but it's easier. It isn't like, well, my wages have inflated and the carbon is very different when you have those type of -- the top of the dinar -- and they deal with it every day.

Yes, that's right. Well, Ivo, I think we'll draw a line there. Thanks for the conversation. That was a great conversation, and thanks for being here.

Thank you. Appreciate it.