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

And is there a difference in penetration between certain geographies or certain applications?

Yes. Look, we have done really, really well in Europe, in particular. The European still believe that a bike commute is more efficient than committing through via automobile. And that's also an end market that was accepting much more premium products. from early on. Those bikes and e-bikes were more costly, and it was a good target for us to penetrate. But as we have developed more optionality greater technical capability and expertise, and we were able to develop products that now can penetrate the mid-market portion of the tubular space. That opportunity set has opened up across all geographies for us. China, India are growing very nicely for us, United States is starting to grow very nicely for us. So we believe that we are well positioned to continue to capitalize on that opportunity set. And again, that's an opportunity that's going to be with us for the next decade plus.

And in that 180 million unit market, is there a reason that -- is there a part of the market where it wouldn't make sense to transfer from a chain to a belt or is the TAM really $180 million potentially?

Yes. I would say that about 1/3 of that market is not going to be attainable for us. That's very low-cost devices where we just don't envisage that we want to break into that [ end ] market. So I would say the mid-market to premium market. that's a sweet spot where we will operate. And so think about it as kind of 120 million type units of opportunity for us.

Okay. And personal mobility grew roughly 25% in Q2. You've highlighted multiple times, you expected to grow 25% to 30% over the next couple of years. What is giving you the confidence that this growth can remain at that level as the base becomes larger?

Yes. In this business, in particular, we have a large visibility because of the pipeline of opportunities that we are working on, the design wins that we have, we have been able to secure. Our pipeline of opportunities is north of $300 million today. So we have a much greater visibility of what we certainly anticipate is going to occur over a short period of time. And as you are penetrating and growing the base, you are starting to get a sense that there is an inflection point that's coming. And when that happens, we certainly believe that we continue -- we should continue to maintain rather healthy growth rates well into the future. .

And how do you size that $300 million pipeline you talk about? Is there like a certain segment of the market that's refreshing products every 2 to 3 years? Or how are you determining what the pipeline is for the next 12 months?

Yes. That's a really good question. So first of all, all these products are getting refreshed every couple of years. number one. But number two, more importantly, if you continue to just participate with the same brand on the same application, that's really -- you're not going to be gaining market share, you're going to be kind of stagnant, right? So for us, it is penetrating broader subset of manufacturers and broader subset of devices that have different price points, right? So again, we started with the high end and now we have migrated towards the mid-market set of applications. So if you are specialized, you're making bikes for the premium market and the mid-market and the more -- less premium market. We've penetrated the mid and the premium market, and that's kind of how we drive penetration. And you go across different applications, right? So bikes and e-bikes is 1 set of applications, but there is the scooters, there's electrically powered scooters, motorcycles and they range in size and capacity and breadth of product portfolio, and we are targeting all of those.

Great. And as this business scales, how does the margin profile in personal mobility compare with the Gates average?

Yes. So personal mobility margins are at or above our company fleet average. And as we continue to scale up, we anticipated that's going to be a strong driver of future EPS growth.

Great. And shifting gears a little bit to Asia. We continue to materially outperform with you all, showing strong execution, not just in China but also East Asia and India. How much of the strength is end market recovery versus Gates specific execution and share gains?

Yes. Look, I think that we have demonstrated, we consistently outperform our higher multiple in multi-industrial field set in Asia. So we are delivering growth in both of the regions that you have highlighted, so China and East Asia and India based on opportunity set that's present to us. We believe that we are taking market share. Certainly, the numbers would speak for themselves as we're doing such. But more importantly, we have terrific teams there, and they execute really, really well. We don't focus our activities in East Asia and India and China on exports to the U.S. or export to Western economies, we are predominantly focused on capturing opportunities within the regional growth set that's available to us. So in China, we have like any other Chinese competitor we compete for business in the local economy or local applications as we do in India. And that bodes well for us.

And China has been an area generally where other industrial companies remain cautious. What are you all seeing differently or doing differently on the ground to drive this continued strength?

Again, great team, terrific execution, focused predominantly around local manufacturing activities. I think that it is really easy to get negative in China, particularly when you read around the weakness in consumer in China, obviously, some of the biggest brands in the United States are consumer oriented, and they are significantly impacted by lack of growth there. But our products are predominantly focused on industrial applications. The industrial economy in China is reasonably healthy. It's doing quite well. Industrial activity in China has been expanding over the last 3, 4, 5 quarters, and we have benefited from that. And I believe that is going to remain reasonably buoyant for the foreseeable future. I don't -- why I don't anticipate that China is going to be growing 11% every quarter, I'll take it, but I don't think it will. Certainly, in our view around China's growth kind of mid- to high single digit would be terrific for our company.

And the other industrial companies have talked about there being in China, higher competition where local companies may have a preference for local suppliers. I mean that's sort of getting a stronger trend over time. Is that something you're seeing as well?

Well, I don't know how to answer that question because we are a local supplier. We are a local company to [ serve in local ] economy. Yes. I'm just trying to be fatitious in here. But look, we have -- when I joined the company in 2015, I actually joined it from China. I [indiscernible] at 4 to 5 years. And one of the strategies that we have deployed pretty immediately after I joined the company is to retool our focus away from doing business with large multinationals and focus on doing business with local brands and local customers. So we have been doing that now for over a decade. And I believe that we are starting to see the reward of that effort. It isn't something that we have to overreact to [ overture ] to today we have been doing that for an extended period of time. And I think that they are being viewed as a local operating unit, and we have more than capable to compete with the Chinese competitors. I think they have great competitors. They are very efficient. They are very innovative. But so are we. And I think that we like sitting where we sit in China.

Great. I appreciate all of that. Switching over to margins. You've done substantial work around footprint optimization, restructuring and cost optimization. How much incremental self-help remains beyond what investors will see in back half of this year and early '27?

Yes, look, maybe I'm a dinosaur, but I believe that, that work never stops. So you always have an opportunity set to continue to improve your operational performance through some help. And when that journey is a long journey and offers many opportunities to drive operational improvements. I believe that we are on the cusp of realizing some AI facilitated benefits in back end, so particularly in manufacturing, as you are going to deploy some of the higher efficiency tool sets. Look, we are focused on driving innovation. We will be exiting 2026 kind of around high teens of New Product Vitality Index. Our target is to be in the 20s -- in the low to mid-20s. Every time you launch a new product, you have an opportunity to enrich your margins because new products are generally more competitive than some of the subs that you have been manufacturing for many, many years. I believe that we continue to have opportunities in harmonizing our raw materials and doing more internally in terms of mix and compounding polymers, further differentiating our construction of the products that we manufacture. So I wouldn't just feel that the journey has ended. I don't think that it ever ends. That being said, I also do believe that our focus is pivoting towards driving more robust growth over the next period of time, next 3, 5 years and demonstrate that this company is capable of delivering differentiated growth algorithm. And that's going to reward our shareholders through better financial metrics as that volume is capable of delivering kind of 35%-plus incremental margins when you kind of normalize after maybe you have 4 quarters of delivering kind of 45% plus incrementals.

Yes. And part of that growth algorithm is going to come from price as well. And you've historically been pretty good at moving quickly on pricing. Does an improving demand environment make those conversations easier? Or are customers becoming more resistant after several years of industrial inflation?

Yes. Look, I mean, we price for value. So in general, our products are highly engineered mission-critical and the cost of our products is insignificant in comparison to an idle industrial asset. So in general, for us, the conversations are more around availability than price. And again, I think that we are being reasonable stewards and we try to ensure that pricing activities cover inflation and not necessarily are viewed as a price graph. So we indicated that even the latest bout of inflation that we actually feel quite okay with being able to pass the pricing on, and we've guided taking into account that we will exit the year with cost price neutrality dollar for dollar. And I don't think that that's difficult to defend in a reasonably high inflationary environment. .

Right. Now switching over to capital allocation. With the cycle improving and you guys generating a good amount of cash, how do you rank buybacks, M&A and organic investment today?

Yes. Look, we have been very balanced over the last 3, 4, 5 years, particularly as we felt that we wanted to improve significantly the quality of our balance sheet. And I think we've done that. We anticipate that we'll exit this year kind of 1.6x plus or minus levered. So our balance sheet is in a very good shape. While we have been improving our balance sheet, we have also been stepping up our buyback activity and reducing our indebtedness. So we can do all 3 of these things at the same time. Now that being said, now we have in capable -- if we have the capability to go and deploy capital into inorganic activities. So we have a reasonably sizable capacity with the balance sheet where it is at today, and we anticipate that we will be deploying that capacity over the next 12, 18, 24 months. we don't necessarily feel that we need to be rushed to do any transaction, but we certainly like the opportunity set that we have, and we have been working very diligently on cultivating a good amount of targets directly. Do we anticipate that they'll be doing something interesting.

Within that opportunity set, what types of acquisitions are most attractive to you today? And how high would you take leverage for the right deal?

Yes. Look, we don't anticipate to step out of kind of our foundational core that we operate today. We believe that we don't necessarily have an aspiration that we need to build a third leg today. Okay, let me put it this way. From a leverage perspective, look, through the cycle, we want to kind of operate in between that 1x to 3x leverage. If there was a good deal and good opportunity to add high-quality assets to our portfolio and we need to improve -- increase the leverage to kind of 3.5x, we would do that. We would have a robust debate about it. But we feel comfortable kind of residing in that 3, 3.5x maximum leverage. I don't think that we would lose enough sleep. But we would have to have a very good line of sight of very quickly delevering the balance sheet back to the 2x kind of think 18 to 24 months.

Great. And then looking beyond '26 into '27, without giving guidance, how should investors think about the setup entering next year through industrial recovery, continued distributor restocking potentially takes place in secular initiatives are all contributing?

Yes. Look, again, we will not be giving guidance in here for 2027. But if you subscribe to the theory that we've discussed at the beginning of the session, right, and I have indicated that I believe that we are starting to see validation of a turning industrial cycle, that by the way, we haven't had since 2018, right? We are accelerating our growth rate through the second half of the year, again, 5.5% core midpoint in Q3, 6.5% midpoint in Q4. I do not believe that it stops in Q4. As I indicated, I believe that 20% is going to be probably a very robust year. So you can kind of decide today is it mid-single-digit growth rate. I don't know we will provide that guidance on our January Q4 earnings update. But it is not unreasonable to anticipate that if things remain constructive as they are today. you could see a mid-single-digit volume growth. If you see mid-single-digit volume growth, we have already represented that in the first 2 quarters of next year, we anticipate to deliver 45%-plus incrementals on incremental volume. And in the back half, we anticipate we will deliver 35% plus incrementals on incremental volume. So we believe the setup is quite positive today. And obviously, things can change. They have historically changed in the last 4, 5 years in a reasonably volatile world. But from where I sit today, we feel quite good about what we see, and we believe that we have -- we are at the beginning of a durable recovery.

Great. Well, that's our time for today. Ivo. Thank you for the time sitting with us today, and thanks for coming to the conference.

Thank you very much.