Lincoln Electric Holdings, Inc. (LECO) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to day 2 of the Oppenheimer Industrial Growth Conference. Next up, we have Lincoln Electric, with CFO, Gabe Bruno; and VP of IR, Amanda Butler, joining us. Good morning, both. Thanks for being here.

Good morning, Bryan.

Gabe, I guess to start out for those a little less familiar with the LECO story, maybe provide an intro to Lincoln Electric, a bit of a history with the company, your competitive positions, key strategies.

Sure, Bryan. So let me just, first, thank all of you who are joining on this webcast conference and for your interest in getting up to date briefly on the progression of our business. So Lincoln Electric, we were the global leader in welding. We've been -- we celebrated 2020, 125 years, and we have a unique position in being able to provide a full product portfolio, only a few companies can say that, of welding products. So we can go from the manual type processes that are tied into welding to the robotic automated processes and capabilities that we offer up. Very much well-known to be experts. So we have that tagline of welding experts. So we invest quite a bit in innovation. We track a couple of key measures like how much we're investing in R&D as a percentage of sales, or the vitality index, which shares how much of our sales are driven by new product introductions. So very much innovative type focus, technology focus. And 2020, 54% of our equipment sales were from new product introductions over the last 5 years. So you can see the velocity of technology and investment there. Coming into 2020, we had just launched a new higher standard 2025 strategy. We anchored around 4 peaks. Two of those peaks deal with how we engage with our customers. So we have a customer focus and solutions and value, where we emphasize a level of engagement with our customers and specific alignment of resources to be able to develop applications and solutions to drive productivity and cost efficiencies within our customer base. And we also have a peak that's focused on operational excellence, and that's really a continuous improvement mindset that allows us to leverage capabilities, standards, systems across our group. And then lastly, we have an employee development peak that really focuses on the continued engagement into our -- with our employees. And we have a uniqueness in our business model and how we engage with our employees. And so those are 4 key peaks strategically that we focus on. Then we also wrap that around with some key financial measures. We're very focused on growth, and we have a balance in looking at growth between organic growth as well as through acquisitions and nonorganic growth. And when we think about on the acquisition side, we've averaged about 4% top line growth over the last 10 years, driven through acquisitions. So we have a very focused agenda on acquisitions. Then on the organic side, we have aligned resources to go after areas in the market that we know we're less penetrated, things like accessories. So very much focused on growth, and we have been investing also in automation. And so we believe that automation provides us an opportunity to accelerate growth over the long term. So real positive on that. We also have financial measures tied into operating profit. We are targeting 15% profile of operating profits through a cycle. So that's what our business model and our focus is on there. And then we're very disciplined in terms of capital investment and capital. We are a top quartile performance and return on invested capital, and we're also top decile performance in working capital. So very disciplined management team and executing on that strategy. So that's a little backdrop or the highlights on some of the things we think about, Bryan.

That's a great overview. We'll certainly get back to your automation story. As you know, that's something we're quite bullish on over the longer term.

Looking at your end market profile, given welding's importance across manufacturing, construction, energy, a reasonably diverse end market exposure. Can you offer an update on key end market trends? What you're seeing in the early part of 2021? And maybe rank order strongest growth, and then where growth may be lagging the increasingly broad recovery? I know that energy in your portfolio is a bit behind beyond the rest.

Sure, Bryan. So let me just -- first of all, we have a very focused team that's monitoring the progression. I mentioned the applications and the capabilities across the end markets. And so we are very disciplined in tracking progression in that regard. But real positive first quarter. We talked about 80% of our end markets are in the growth mode, so real positive. When you think about automotive, transportation and heavy industries, combined, that's about 35% of our business. We expected heavy industries to show more acceleration on growth by the middle of this year. When you think about some of the longer-term dynamics into heavy construction, small construction, mining and ag, we did see dynamics that we expected by the middle part of 2021 to be in more of a growth trajectory. But we saw very strong accelerated growth in this first quarter. So we're real positive, both on the automotive transportation, heavy industries, they're up in the mid-teens. So a real positive growth there. And we also saw, on the structural side of things, this is where we're dealing with residential, nonresidential buildings and things like that, real positive growth as well. And again, that's been more of a choppy part of our business when you look at the last few quarters, of course, up, down dynamics, but things returned more positively on the structural side. That's about 10% of our business, but again, real positive momentum there as well. General industries, so general fabrication, that is about 1/3 of our business. That has been steady. When you're tracking things like the ISM Purchasing Manager Index, you see some real strength there. So we're pretty positive on the trajectory of general industries. So that was positive as well into the high single digits in that area. So a real positive there. Where you mentioned energy, we're a little bit more bearish on the energy side of our business, particularly when you look at the components of oil and gas, and that represents, we estimate, around 15% of our overall business out of that 22%. We're positive on renewables with the infrastructure bill that's progressing through the administration. We estimate -- we mentioned this on our investor call last week, but about 15%, 20% of our overall business exposed in potential growth areas as a result of that infrastructure bill. So we're real positive on how we can play into that, whether it's through equipment, construction, or through some of the structural dynamics, the structural manufacturing as well as the energy, particularly on the renewable side of things, so we're positive on that. So that's big picture, Bryan, view of the end markets.

That's helpful. And if you don't mind, maybe touch on oil and gas trends a bit more, as the, call it, the laggard in your portfolio for now, countering, obviously, very good momentum elsewhere. The concentration that you have on the midstream side, we tend to think of a relatively standard lag to commodity price movement. And then the confidence upstream getting to midstream investment, a little less so right now, given the regulatory environments and then potential for incremental hurdles on that front. How is your team thinking about that dynamic?

Yes. So Bryan, I think you've touched on some of those key drivers, right? I mean when you think about policy and how the administrative positioning is on pipelines and the sort, that's going to be a bit of headwind. A lot -- otherwise, when you think about some of the drivers, we look at price of oil, that's been more positive. Start to see maybe an opening up in demand and more -- and discipline on production side, those are good positive drivers. But just haven't seen enough to turn the corner into more of a growth capital investment type mode. And so we're monitoring. Obviously, the comps get easier. We had a significant shortfall third, fourth quarters last year. So probably more of a stability in the energy type sector, particularly in oil and gas is kind of where we're at. And we'll continue to obviously monitor it and provide updates as we progress throughout the year.

Yes, makes sense. And then how that geographic trends? Obviously, Asia Pacific demand has led the recovery, continues to lead the global recovery. The Americas seem to be on better footing. Europe a bit choppier overall in terms of industrial trends. Do you expect the dynamic of Asia-led demand recovery to continue over the near term? Or could we see a shift to more of Americas-led growth over the second and third quarter?

Yes, Bryan. So that's pretty interesting. So coming into 2021, the first quarter, we saw a nice progression across all of our regions, all of our segments, as you saw. Asia strong. The comps start to get more challenged, but we're looking for continued growth, both in the European and the Americas volumes. So we're pretty positive that all the drivers are there. We should start to see a little bit more strength, I believe, in the Americas and the European side. We had been talking over the last 12 months as we saw the progression within the pandemic first in kind of first out. But we're seeing more strength on the Americas side. So I would expect a little bit more acceleration, comparably speaking, on the European and the Americas side of our business as it relates to the comparisons to Asia. Asia is still being strong, but sequentially, creating that consistent momentum in that part of our business is good, but we should start to see a little bit more positive on the European and Americas side of our business.

Got it. Okay. And then in terms of your updated organic sales guide, low to mid-teens for the year, you -- Chris more specifically had said, just think about it as about half volume, half price. On the volume side, how should we think about restocking effects versus underlying demand contributing to that mid-to-high single-digit kind of range?

Yes. So Bryan, it's a great question. Hard to specifically state whether or not you've got dynamics of just pressure from a customer standpoint and looking at their stocking levels for both supply chain risk as well as pandemic risk. But we've got great momentum coming into the second quarter. We talked about the overall organic mix being about half priced in the balance in volumes. But very good momentum. We'll continue to be very disciplined in understanding the demand patterns, but we're pretty positive entering the second quarter with what we're seeing in demand patterns, knowing that there's a lot of challenges in the markets, particularly looking at supply chain dynamics as well as we're still operating within a pandemic environment. So a real positive momentum coming into the second quarter.

Okay. And how about on the price side, being the other half of that low- to mid-teens growth outlook, a little under 4% price in the first quarter with quite a bit of lift from Harris? What should we think about in terms of price contribution in Q2? Is it a meaningful step-up from that well?

Well, just a couple of key things to keep in mind. We -- the pricing impact of the actions that we had taken have not been fully realized in the first quarter. So it's typically a lag before you see the full impact of that. We were intentional about our discussion surrounding the impact of input costs, the inflation we saw on the input side, material side, as well as the pricing actions taken. So from a pricing standpoint, we expect to see that fully mature during the second quarter. We did not provide any more input in terms of what the forward-looking view could look like for inflation as it relates to input costs or related pricing. So the comments really were all surrounding what we've done to date, having the second quarter more fully mature in those actions and knowing that we're still continuing to operate in an inflationary environment.

Understood. So given the actions you've taken to date and current visibility, how should we think about price-cost cadence throughout the year? There's typically a lag. You have very good pricing power -- proven pricing power through the cycle. Usually 1 quarter or 2 lag during stronger inflationary periods. Is that a reasonable base case for 2021? I think for the full year, you're still targeting neutral to positive spreads, perhaps some compression in 2Q, 3Q, and catch up third, fourth quarter?

Yes. So let answer, first, you're right, Bryan, very disciplined in driving a balanced view of pricing commensurate with the cost changes that we have seen in our business. So we'll continue to be very disciplined in managing that dynamic. Price-cost first quarter was slightly negative. And you mentioned the lag and the progression of pricing, we do expect to be neutral. So to get there probably in a more short term, start to progress a little bit more positive on the slightly negative first quarter. That -- probably second quarter into the third quarter, that dynamic of getting back to neutral. And then with a bigger picture discussion of, look, we're not talking about yet other inflationary-type progression or pricing actions on top of that. So we're confident that we've taken the actions necessary to get to that neutral position in price-cost.

Okay. That's fair. And then 2 prospects that are on the radar for investors. You mentioned the U.S. infrastructure bill. That seems to have some momentum behind it. We'll see exactly how that shakes out in terms of funding levels and then the allocation there, but good momentum behind it. And then re-shoring or onshoring of production gets a fair amount of attention as well. With both of those, how do you think about the potential impact and then catalyst for Lincoln going forward?

Yes. So first on the infrastructure bill and how that progresses through the administration is kind of hard to tell. But we know that we're -- that's upside for us, and we're very exposed to many of the dynamics of where the bill touches, whether it's things like the infrastructure bill on EV or construction or building bridges, all these dynamics, we feel we're very well positioned to take -- have an opportunity to participate in that. Timing is always difficult, right? I mean when they start -- when the bill is approved and how that starts to roll out, so I'm not sure if that's going to have a real impact in 2021. But once that kind of investment does start taking hold, then we'll be participating in that. As it relates to onshoring and re-shoring, all those dynamics, we're well positioned to participate in that as well. I mean we know that there's pressure in factories from an employment standpoint, workers. And so the dynamics that existed before the pandemic of being a shortage of factory workers or the need for automation, our automation portfolio of businesses are very much ready and able to participate in that kind of growth trajectory. So we're very excited about how those 2 dynamics kind of play out into the capabilities that we offer the markets.

That's a perfect segue to get into your automation strategy. Maybe offer a little bit of background on the build-out of that strategy, where Lincoln differentiates? And if you don't mind, touch on the decision to be an integrator, because that was kind of a game changer years ago.

Yes. So if you go back probably 7-plus years, and we began a very focused strategy to broaden out automation capabilities. And that's deep. I mean it touches the robotic application time, which we've been involved with many, many years in that aspect of it, but also touching on different areas of cutting and even material handling and such. And very broad portfolio of customer engagements. I mean you can get to the robotic cell to multimillion dollar types of automation investments. So we believe, because some of the dynamics between the aging workforce of welders as well as just the dynamics of a need to drive for more productivity and efficiency across factory floors that, that will give us some more accelerated perspective on growth. So we believe that the automation strategy will yield a growth trajectory to be 2x cold welding. And when you're -- we talked about the end markets and the cycles and -- so we'll continue to navigate that. But we really believe that, that kind of portfolio of automation capabilities that we've built out will give us 2x that level of growth opportunity. So you have a growth driver, and then we believe that the profit pool, when you think about it from an OP level, will be tied into our consolidated average. So we're real positive about how the automation portfolio fits into our strategy and the potential for escalation and growth, but also in profitability, so real positive.

That's excellent. And to frame where your strategy is now, including your recent Zeman acquisition, if we think strictly about equipment revenue, is around $500 million the right figure? Perhaps a little higher than that?

Yes. Bryan, so we're tracking around that $450 million level with the acquisition we just announced. Our target is to be $1 billion in 2025 as part of our higher standard strategy. We'll continue to see more accelerated organic growth and opportunities to acquire additional companies within our capabilities and broadening out our platform. So very much looking to accelerated growth organically as well as in our acquisition strategy built that out. We're focused on that $1 billion. And we were upwards of $500 million a couple of years back before the capital cycle had softened. So we're very confident that we're on that trajectory for growth.

Yes. And going back a couple of years, you had cyclical downdraft and then a pandemic hit. So it's tough to blame the business for a step down. And in the interim, the outlook seems very strong. And just to confirm, the $1 billion in 2025 revenue target, now that's strictly equipment still, correct?

Yes. That's our automation additive. We do have an additive component that we've been building out. That's -- just to comment on that, we're very excited about how that is progressing, although it's been more of a challenge in really getting engaged with customers and looking at alternatives and sourcing large parts. But we feel very confident that the capabilities that we have put together with robotic know-how, with the metals capabilities, our software, so we feel that because of those capabilities we pulled together, that we'd be able to grow our presence in additives, so wire-based additives. So that's also part of that $1 billion target, although largely, the -- an automation strategy will drive it.

Okay. I appreciate that clarification. You had mentioned combined organic and inorganic contribution to getting to that revenue scale. Should we think of a balance between the 2? Or a weighting to one side?

Well, for sure, I mean, we'll continue to look at acquisitions as part of that growth strategy. But we like to think about organic growth within that part of our business to be in the high-single digits. So it would be a complement of both organic as well as through acquisitions.

Understood. Okay. And then thinking about capital allocation overall. Your balance sheet is in great shape. It looks like you're going to generate a lot of cash this year, probably into next year. How are you prioritizing your capital allocation strategy just broadly thinking about it? Obviously, you're going to invest in the business organically, that's given through the cycle, balancing the consideration of opportunistic repurchases, M&A strategy, dividend, et cetera?

Yes. So Bryan, you kind of touched on it a little bit, but we have a very disciplined capital allocation strategy. We want to first focus on growth, and that growth comes through the internal investments. So we have a very disciplined process in identifying areas to drive productivity efficiency, but also the capital required to grow through our new product introductions, the tooling and capacity required there. So very much a focused agenda on the internal investment, which we have a very nice return profile on that. And then we mentioned acquisitions. Acquisitions are core to our growth strategy. When you look back over the years, we have -- I think I mentioned in my opening comments, about 4% on average of a contribution to top line compounded growth through acquisitions. So we're very much going to continue to look for opportunities across all of our segments. There have been a lot of acquisitions on the automation side. But we've done acquisitions in Harris or the international or cold welding in Americas, and we're going to continue to be very focused and looking at opportunities to grow across all of our businesses. So capital allocation, very much first priority is to grow and putting our capital into use in a more accelerated way. Then we're also very committed, and you've seen this over the years, to returning cash to shareholders. In 2020, we announced another dividend payout increase. It was a little over 4%, and that was 25 years in a row where we've had consistent increases in our dividend rate. So we're very committed to returning cash to shareholders. We also -- as we think about share repurchases, a couple of comments there. We look at maintenance level being between that $50 million, $60 million level, and that's really driven by the stock programs that we have. And then also, we look opportunistically to buy back shares. So this first quarter, we purchased around a little over $28 million of shares, and we'll continue to be very disciplined and looking at both maintenance as well as opportunities in the -- from a per share repurchase standpoint. But we'll continue to be very disciplined in looking at capital allocation.

And if the right opportunities were to come along with regard to your M&A strategy, what do you think as dry powder at this point, either in terms of the dollar figure or the level of gross or net leverage you'd be comfortable with over 2021, '22?

We got a lot of flexibility. So we're -- there's nothing holding us back necessarily, and looking at where we deploy capital really is getting the right fit strategically. We're not going to overprice our potential targets, and we're going to be pretty balanced in making sure that whatever targets we have are going to complement our strategy. So we have a lot of flexibility in capital, and we'll put that to use where it makes sense.

We've got a little bit of time left. Maybe circle back to the Zeman acquisition, discuss how synergistic that is? Seems to be a great fit with your PythonX one, helps to further diversify the automation strategy, maybe touch on those thoughts?

Yes. Zeman, we're really excited about Zeman. We talked about being accretive through the $0.05 this year, but it really fits really nicely into the structural cutting steel part of our business. It complements -- you mentioned the PythonX type of our business. But I also emphasize that it gets us into that international footprint in Europe that's real positive for us. So it's kind of expanding our geographic presence. So we're really excited about that business fitting into our portfolio very complementary.

And we've always thought of automation, and I guess it has been historically more levered to the automotive space. I think in the recent past, you've discussed a rough balance between auto and non-auto. After this deal, what's the pro forma mix? Is it 60% non-auto?

Actually, Bryan, let me just broaden that conversation a little bit because we did have a couple of acquisitions that were more into general industries. So I think because of what we saw in heavy industries over the last couple of years, we have a pretty good balance between automotive, slightly less than 50% with continued look to capital. And then you've got heavy industries and general industries now. So I think we got a pretty good balance across those industries. One of the things that's interesting on the automation side, and we got a question from time to time about how early in the progression of automation capabilities are we? I think we have a long runway still to go. Yes, the automotive side of industry has been more progressive than looking at automation capabilities and how does that fit into their own strategy to drive productivity and efficiency in their factory floor. So as you start to see this more broaden out into general industries, I think you're going to see more positive momentum in how business engages in factory automation. So it's more balanced now. We have more concentration in general industries than we would have otherwise a few years back. So we're real positive in the mix that we have within our business.

For what it's worth, I agree with the secular thematic, the broadening appeal of automation throughout industrial verticals.

It's a bit more positive.

We've got a few minutes left. Gabe, any message you'd like to leave us with today?

Well, look, it's great to start the year as we have. One of the things we haven't talked about here, but if all the different comps as we start getting into the trough from 2020 with the pandemic in the second quarter, we're confident, based on everything that we see, that we're going to follow a more traditional seasonal model, which we're not deeply seasonal, but we expect second quarter to continue that kind of momentum we had in the first quarter. It's been slightly up, and we're excited about what we're seeing. Third quarter typically is softer than -- slightly soft in the second and fourth, in line with third, but we're really excited about the drivers we see. Automation, backlog is increasing nicely there. You'll see that in the second half of the year. There's typically a 3- to 6-month lag between seen and backlog to realize into revenue. But good, positive momentum, real disciplined in executing on our strategy. And as I mentioned in all the various questions, Bryan, we discussed, we just have a lot of positive momentum. We're -- there's been a lot of pent-up demand, if you will, in many parts of industries. Think about heavy industries, mining and ag and such, that's been many years where you start to see really an expansion there. And so we're really excited about what we're seeing across the markets.

It's all great to hear. Gabe, thank you. Really appreciate the color. Amanda, thank you.

Thank you, Bryan.

Thanks.