Gates Industrial Corporation Ltd. (GTES) Earnings Call Transcript & Summary

All right. We're off and running here. Welcome to the Gates show. And very pleased to welcome 2 folks from Gates with us this afternoon. We have Ivo Jurek, who is the CEO, Rich looks after Investor Relations. We're going to run this as a bit of a fireside chat. I think. You don't have any slides to start with here. So I will sort of kick things off. We'll have a bit of a conversation. We'd love to have participation from anyone who's interested as well, so we'll make an opportunity for that. I think we're being webcast here today. So I was admonished this morning because I went through one of these sessions, and I didn't ask the company if there are any updates that they wanted to talk about since it was a webcast presentation.

So with that, having been learned, I will kick off with that way. Is there anything you'd like to update us around since this is a webcast conversation.

You, Steve. I don't think that we have any meaningful update to what we have discussed on our second quarter earnings call. Our business continues to evolve meaningfully in line with our updated guidance. And as a reminder, for all we've band our guidance up by 100 basis points across board in revenue generation, saw 5.5% core growth guidance for midpoint of Q3 and 6.5% core growth target for a organic growth in Q4. SP1 Right. Good. Okay. So that contrasts, if I'm not mistaken, to about 1% growth in the first half. So obviously, a nice inflection that you guys are seeing how broad-based is that? What's driving it? And what gives you confidence in this fairly large increase in the second half. Yes. So we have seen a very nice acceleration that frankly, occurred in Q4 of last year. We went into Q1 with a well-broadcasted ERP implementation, that has occurred on our European business in February that has resulted in about 300 basis points core headwind in Q2 due to the ERP implement which, by the way, went flawlessly. It was executed well. And as we exited Q1, we've begun to fully recover on the revenue targets that we have set up, while we had a small cost headwind in Q2 associated with the ERP. We've already delivered very nice core growth acceleration in and that acceleration order intake that resulted about 8% to 9% organic core growth in terms of orders in Q2. And the 2 or 3 secular drivers that we have in our business, personal mobility, which as we have highlighted has been growing in the mid-20s to about 30% compound annually that continues to drive about a point of incremental growth for our business, accelerating revenue generation in our exposure in data centers, with our data center, enterprise initiative and frankly, reasonably broad-based strength across our core business. There are still -- while there are still some businesses that yet need to inflect -- we have highlighted that while ag has stopped generating negative deceleration -- and we anticipate in the second half of this year. Ag is going to start recovering. We certainly are seeing those trends, and I think the most recent announcement by major ag manufacturer would indicate that we have seen the bottom and we should start seeing a recovery into 2027. So while there are some puts and takes, in general, there is a broad strength. We've built a little bit of backlog in Q2, which generally speaking, as a short-cycle book and ship business, we don't necessarily like to see, but that's just an indication of a reasonably strong end market demand environment.

Great. I think that ag producer is in the building actually and has reiterated your outlook against Talk a little bit in case people aren't intimately familiar with it in terms of the personal mobility opportunity.

Yes. So personal mobility business, it's actually quite an interesting opportunity for us. And in a nutshell, it is an opportunity where we are substituting a chain drive with Gates engineer belt drive. It is much cleaner, much more efficient, much more elegant solution and from our vantage point, it is an opportunity where we are converting or competing against a nontraditional competitor. So it is a story of penetration and while we don't necessarily require the end market units to grow and for reference, there's about 180 million 2-wheelers that get manufactured every year. So it is a very broad-based, very large market opportunity. We have been very focusly paying attention to engineering a solution that is cost appropriate that will get us to a much closer cost proximity of the chain drive in those 2-wheeler applications and with all the other benefits that I have highlighted that we deliver to the end user. We believe that we have a decade-long opportunity to take market share away from chain and continue to deliver a premium growth over the midterm in that business for us.

Are there other areas in end markets where there could be this similar substitution?

Yes, absolutely. I think that what we have done in personal mobility is actually taking a very difficult set of applications that are very sensitive to certain market dynamics in terms of price versus benefit, and we have demonstrated that we can deliver a solution that is efficient and that we can start delivering broad market adoption of those solutions. If you think about another market opportunity for us, it's an industrial chain drive. There is about $7 billion market opportunity that we view where the industrial change resides today and we have been working towards development of solutions that would be broadly adaptable for these industrial type applications. And we have announced recently that we'll have a CMD or capital market update on November 19, and we will be providing a pretty fulsome update on how we view that market, how we view that opportunity to continue to evolve for us. And while over the last 3 or so years, we have developed a very nice base of business. We believe that, that's another opportunity similar to what we are seeing with the personal mobility that we can realize, again, nicely incremental secular supplemental organic growth over the midterm.

Okay. Great. You mentioned the data center piece. So let's dig in there for a second. What do you do that's applicable to data centers? And how is that outlook for you?

Yes. So interestingly enough for us, the data center opportunity resides in kind of our core products of our core portfolio and fluid power, we manufacture fluid convened products, houses couplings and fittings, and we have manufactured elect batter pumps for applications in electric propulsion, that happened to be extremely unique in construction and very energy efficient and very space efficient with very sizable throughput of liquids through those pumps. And so we manufacture for data centers basically the end-to-end fluid cooling loop, pump house fittings that get adapted towards a manifold or a server rack or an on-chip liquid cooling directly on those in those server applications. So core parts of our portfolio, specifically tailored for the data center application, obviously, various set of specifications and certifications that are required to be complied with that we have now been able to secure, and we are working across the broad portfolio, a broad spectrum of customers from the server manufacturers and their ODM partners to hyperscalers to infrastructure manufacturers to the construction companies that build the buildings and facilitate the great spaces before you start actually getting into that white space for the IT equipment.

And you've talked about, I think, the opportunity for between $100 million and $200 million of revenue from this end market by 2028. Are you happy that we're on track there? Could that even be conservative?

Yes. So look, when we start talking about the $100 million to $200 million of market opportunity for us, the industry forecast where that less than half of the data centers that will be coming out of the ground in the future will be liquid I would say that we all certainly view that being an extremely conservative estimate because, frankly, everything that we see today that is going into that core AI-based infrastructure is liquid cooled. That also has expanded our TAM from about $1.5 billion to more than $1 billion just in the last 18 months, and we believe that, that that, that size of the market will continue to evolve and get larger. We have done a very good job in our minds in building a pipeline of opportunities, building new customers. Those were all new applications for our company. So we've had to build our infrastructure, front end infrastructure to be able to actually understand how to address these type of customers list of opportunities. So we have done that. We have tailored specific solutions for those customers. And we have discussed on our quarterly earnings calls that our business has been growing by hundreds of percent year-on-year from a small base. We anticipate that this year, we'll do between $20 million and $30 million of revenue into that space. that will again grow pretty dramatically in 2027. And I certainly feel that our pipeline, our business awards and opportunities that are in front of us should give us the opportunity to more than exceed that target that we have set for ourselves. Certainly, towards the end of the decade, we see that those numbers should be more than conservative SP1 And I guess if you had an Analyst Day coming up, there might be an opportunity to Yes, we will do that.

How about maybe let's switch topics a little bit. How much of your business -- just remind us goes through distribution these days? And what are you seeing in terms of distributor activity, stocking, et cetera?

Yes. So we're actually a very unique business because the channel partners or the distribution side of our business represent about 70% of our revenue or 70% plus. That's a very unique composition of revenue generation. And certainly, for the last 2 to 3 years, we have seen pretty subdued level of activity in the channel. We continue to see an improvement in channel activities. We have not seen any rebounds in inventory rebalancing, any signs of restocking of inventories the channel partners have remained being disciplined, ordering patterns are very much in line with their end user demand. So the sellout is very balanced with the selling that they take from the partners like gates and competitors and such.

Is that the new normal? Because we hear that actually from a lot of different companies that they're really not seeing much distributor stocking and obviously, in previous cycles, have expected some of that. Is -- are they just going to run leaner from here on out? Or are they just being careful and ultimately, they will restock?

Yes. Steve, if you kind of remind ourselves that we really haven't seen a pure industrial cycle since 2017. I'm not quite sure what the new normal is. To be honest with you, everything is a new normal for us in an industrial set of complexities that we all deal with. I do think that there will be every stocking. I think that the natural instinct side you see a continuation of demand pull, the channel partners recognize that their value is in availability and ultimately, if you don't have availability and if you depend on your OEM component supplier like Gates or any other partner that they may have to be in a position to on-demand supply, they will lose opportunities. So my view is that as the cycle matures, they will restock their inventory.

Okay. All right. we can look forward to that. Let's talk about auto aftermarket, specifically a little bit here. So you were able to actually add a pretty significant new distributor last year. You've now anniversaried that, but you're still growing the business pretty nicely. What are the dynamics that you're seeing there?

Yes. Look, first of all, I think that automotive aftermarket for our company is the most underappreciated gem in our portfolio. It is a terrific business. If I take a look at over the last 26 years, that business has had 1 down year in 2009, and it was quite insignificant deceleration. It is a super stable business that provides durability to our portfolio. we like that business very much. And that business basically grows kind of low to mid-single digits throughout the cycle, net of any acquisition of market share or any market share gains. We have, over the last 2 to 3 years, growing that business very, very nicely, way in excess of that kind of a normalized rate trajectory. We do continue to see significant opportunities to grow that business. We have a very strong presence in Western world. We have built #1 market share position in products that we manufacture in China. We do believe that we have a similar opportunity in India. We see very nice growth rates in aftermarket in India. We have a very strong franchise in Latin America. And we still believe that there remain to be opportunities that we can execute on in market share gains in Western World. So while the business is very durable with kind of the natural market dynamics. And I do remind everybody that our business realized predominantly a do-it-for-you professional mechanic service component. We only participate in opportunities on automobiles that are post out of warranty. So we don't really participate in them the warranty period of time. So kind of that car park that is 7-plus year of age, this car park that has grown quite dramatically in the Western world is the oldest in history between Europe and North America. We had been talking about 12 to 14 years to age, which is a very, very good sweet spot for our products. We only manufacture products that are mission-critical that require to be replaced when they need that replacement. So we have nondiscretionary. We do not participate in discretionary. We have nondiscretionary repair critical components and that serves well for the long-term stability of this business.

And I think -- correct me if I'm wrong, but I think the car park even in China is now getting older, right?

It is -- it's approach to 7-year a sweet spot for us, and it's been a very good place to reside last certainly 4, 5, 6 years.

Okay. Good. All right. So another kind of key part of the Gates story, in my opinion, is the margin trajectory, which has been very strong. Maybe just bring us up to speed on kind of what you've accomplished and where you think you can go from here?

Look, we've been able to deliver a very strong margin expansion during market downturn. We have demonstrated that over the last 3 years, we have been able to grow our margins over 300 basis points in a decelerating market backdrop that speaks to the resiliency of our franchise. The importance of our products, the criticality of our products. And frankly, the strategy that we have deployed in focusing on operational efficiency through enterprise initiatives. Our enterprise initiatives to remind everybody, consisted of 80/20, which -- where we have seen a very nice incremental benefit, 80/20 in our case, did not necessarily mean that we were trimming our portfolio, really just focusing 80/20 on the productivity improvements. We've been able to gain significant margin expansion through reengineering raw material composition deployed in construction of our products to be manufactured and frankly, through footprint optimization projects that we have been executing through the last 2 to 3 years that delivered a significant benefit. So with that, we will be exiting the 2026 second half at kind of the 23.5% plus EBITDA margins, which puts us in a very, I think, unique category as an industrial company. And frankly, we have been able to deliver that with a very significant benefit of volume. Volumes were very muted in the last 3 years, and we have been able to drive that expansion very, very nicely. So we're very proud of where we sit, and we believe that we have more opportunity to be able to do more.