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

Good morning, everyone. I'm Nathan Jones. I'm the covering analyst for Lincoln Electric at Stifel. We're very glad to have CFO Gabe Bruno with us today. Just before we get started, a couple of housekeeping items. I'm going back to the bull case, bear case format this year. We abandoned that last year because of the singular focus on COVID 12 months ago. Updated 3 bear cases and then 3 bull cases. Gabe will have the opportunity to respond to each of those. And then if there's time, we'll dig into each topic with questions. For people on the line, feel free to ask questions on any of the topics through the chat box on the conference portal. I welcome questions from investors. I'm sure that would be much smarter than any of the questions I'll ask anyway. So if you do have questions, please do ask them.

With that, I'll begin with the first bear case here. The current inflationary environment could have multiple negative impacts with these levels of inflation not often seen. This could make it more difficult to realize pricing and, if pass through, could eventually adversely impact demand?

Yes. Nathan, first of all, thanks for having us this morning, and I appreciate all of those who are calling in and listening into our discussions and your interest in Lincoln Electric. Yes, this environment is very interesting. And frankly, I see a lot of similarities to the markets that we saw back in 2004. So I started with the company in 1995, so I've lived through and engaged in many of the cycles. And the commodity escalation and costs are interesting, and that a lot of the demand-supply dynamics are more like into what we saw in 2004. Now when you think about inflation, when you're thinking about input costs, you could appreciate that we're very disciplined in navigating and working with our suppliers and the key commodities. So whether it's steel or chemicals or in our Harris business, silver or copper, very disciplined in understanding the dynamics of the inflationary pressures within our business. And with that, also our responses. So when we announced our first quarter results in April, we had already put in place 3 price increases. And again, very responsive to what we're seeing from input costs and very much protecting our business model, the margin profile of our business. And we'll continue to be very disciplined in navigating inflationary pressures and making sure that we're driving the right response for the kind of dynamics we see. Going into the second quarter, you talked about demand and the pricing dynamic. We saw very, very strong demand. We had our equipment -- standard equipment business at record levels of backlog. And so just a significant level of demand while providing an updated assumption in overall organic sales where we said low to mid-teens and overall organic sales, with about half of that being in pricing. And so we're very well prepared to navigate through this environment. We've got a long-standing discipline in managing input costs and pricing. So we appreciate the dynamics, and we'll execute along those lines.

Lincoln does have a really good track record of being able to pass through pricing in inflationary environments and actually to be able to hold on to some of that pricing in deflationary environments over time, being one of the few companies, who actually reports pricing every year. So I'm a little less concerned on your ability to pass through price side, as I think maybe people are on -- the impact that, that might have on demand over time. I mean we're talking about some pretty large price increases. Some of the types of things that you sell, particularly on the consumables side, have very high raw material content. So I'm sure those things have gone up quite a lot in pricing. You talked about 2004, the inflation mirroring kind of 2004, which actually ended up being a very strong cycle for the next few years. And those pricing increases didn't really have any impact on demand. Maybe you can just talk about... [Technical Difficulty] Okay. Apologies for the audio problems. Welcome back. I'm going to jump on to the second bear case here in the interest of time and move through these. So the second one here, European welding businesses are not good businesses, with margins in the vicinity of 1,000 basis points lower than domestic welding businesses. The Air Liquide acquisition and integration has been more complicated and distracting than anticipated, and it's going to take a lot longer than originally expected?

All right. Well, Nathan, thanks for this bear case discussion because we're very excited about our European welding business. And we acquired the Air Liquide welding business back in 2017. And yes, there is a lot of integration work and -- yes, it was complicated. I wouldn't say it was distracting, but it was very much -- had a lot of work to be done to be able to integrate the businesses. And when we addressed the commercial teams, we addressed product rationalization, manufacturing, rationalization, ERP systems. So there was a lot of work to be done to position our business model, of which we are very confident that we're progressing into our double-digit EBIT margin profile type target. And then we'll use that as a platform for continuously improving our business model in Europe. So it is a very good business, and we're excited about where we are progressing in our business model. We've talked about having some level of volume increases off 2019 to achieve our double-digit EBIT margin profile, and we're well on our way. So we're excited about our European welding business, and it positions us in the long term of being a very attractive complement to our overall strategy. So we're very excited about our European business.

Maybe you can comment on where you are in the integration process. Are we through all of the heavy lifting here? Is it really on volume that we need to see now to get to those double-digit EBIT margin? And maybe if there's any commentary you can give on where you think those margins or what the margin entitlement might be over the long term?

Okay. So first of all, the integration work is complete. I mean that's been largely complete over the last 1.5 years as we were in 2019. In 2019, as I mentioned, the industrial cycle in Europe was in the contraction since the beginning of the year. And so we looked to some modest growth of 2019 baselines towards that double-digit EBIT margin profile. And so once we arrive at a sustainable, consistent double-digit margin profile, we'll continue to look at aspects of our business model that we continuously improve on that. So we're well on our way. You've seen nice progression over the quarters. Our team is very focused on the execution of our strategy in Europe. And so we're very excited that we're well on our way.

Great. I'll jump on to the third one in the interest of time. The move to lighter weight materials in many industries [ Audio Gap] welding industry and for Lincoln Electric?

Okay. So Nathan, you were cut off. We all read the bear case here. So I'll just respond to the case here. And so when you think about lighter weight materials, think about alloys, think about aluminum, think about 3D printing, think about laser, when we look at those as other opportunities in looking at metal joining capabilities. So when we talk about alloys, we have teams that are focused in looking at how best to integrate consumables with power sources to be able to solve welding opportunities with different alloys. So that's an opportunity for us. When you think about 3D printing, we have talked about investing in a wire-based additive capability that leverages our metals knowledge, software capabilities, robotic capabilities, and we're positioning for a commercial offering into large parts and tooling in those capabilities. So we've been investing now over the last couple of years in that market space, and we're excited of introducing capabilities that address supply chain challenges and looking at large parts and toolings and gives us an opportunity to position resources to capture potential accelerator for growth. So we're excited about that. In laser and laser welding, that's a market that we estimate to be less than $1 billion. And so we're continuously engaged and monitoring the progression of technology. Still some capital barriers. I mean it's an intensive type of offering that's pretty costly from a capital standpoint. So there are some structural dynamics within laser from a competitive standpoint. But we're the largest integrator of laser automated cells and opportunities. And so we look at laser, 3D printing, alloys as opportunities for us to look at alternative ways for metal joining as opportunities for growth.

I know you guys have been investing in the additive manufacturing space, and that is a long-term growth opportunity for Lincoln. Can you maybe talk a little bit about what you think the potential market size is there? And how long it really takes to materialize and become a material part of Lincoln's business?

Yes. It's -- this is still, Nathan, in the early stages. I mean particularly during the COVID pandemic, it's much more difficult to sell a new sourcing strategy to our customers. And so getting the -- having the comfort, whether it's in aerospace or whether it's on the automotive sector and changing outsourcing strategies are challenged in this kind of environment. But we set a target in our automation and additive business to be $1 billion in revenues by 2025. And we see this as a nice potential to drive a higher-margin type growth potential within our business that leverages and all the same capabilities that we have in play from an automation standpoint. So it's still in the early stages. We're looking to tooling and the large parts as being the platforms for adopting this sort of technology, but we're excited about what this offering is -- potentially offers up in growth.

Okay. I'll jump over to the first of the bull cases. Sales in welding, driven by productivity improvements. As one of the 3 technology leaders in the industry, Lincoln has a long track record of innovation, which drives long-term market share gains from smaller players, who can't invest at the same, right? Size matters in welding?

Yes. So Nathan, when I think about our business in the context of the welding industry [Audio Gap] for one of the brand names you have about the welding experts. And so we commit a continuous level of resources, investing in research and development. That doesn't include all the other engineers and project managers that are working with our customers in providing solutions. But we track about 2% of sales in research and development. And having -- we're one of the 3, as you mentioned here, but having the full portfolio of products allows us to engage in our customers in such a way to offer our productivity, efficiencies and quality in their own processes, anchored on introducing new products to drive productivity, safety, quality in their own processes. And so we've been in our long history, very focused in differentiating ourselves with knowing how best to weld in the various applications. We've talked about guaranteed cost reductions for many years in working with our customers and how to best position the power source and the consumable, high-quality consumables to be able to meet their needs. We track something that we call a Vitality Index. And we're in our 126 years of business this year. And when you think about how we track the level of impact of new products into sales is key. So in the last year in 2020, we captured 54% of our sales that were tied to new product introductions over the last 5 years. So it's a very competitive environment, but being a technology leader, we have continued focus levels of investment and looking for ways to drive more efficiency and productivity within the welding process. So that's a key differentiator for us in the industry. We also have industry segment leaders that are assigned to work within the various industries and develop the kinds of welding applications that are going to optimize the welding process. So whether it's in the automotive industry or heavy industries or general industries, structural steel, very much tailored welding applications to solve our customers' needs in welding. And so innovation is a very important part of our technology evolution. We've also have been a leader in the Internet of Things and machine-to-machine capabilities over the last 25 years. We're in the midst of deploying significant upgrades into our platform and looking at machine-to-machine capabilities, which tracks welding efficiency, the process uptimes. And so innovation is a key driver to our business strategy.

I think investors for us are always talking about who's gaining share, Lincoln Electric versus ITW's Miller business versus [ compact ] [indiscernible] busines. I've always thought of it more as the larger guys against the smaller guys, and it's not really trading share amongst the 3 of you guys, but all 3 of you having the ability to use innovation and use the size of the company to capture share from the smaller guys out there. Can you comment on that?

Right. When you remove from the top 3 leaders in the industry, it's a very fragmented market. And that's why we -- when you look at acquisitions, I mean, that's a key part of our strategy and looking at how we can continue to broaden our capabilities through an acquisition strategy that aligns to many of the capabilities, which we believe are going to drive growth within our business. We've been investing, for example, significantly in automation capabilities over the last 7 years. That's taken that fragmented level of competitors and building out a capability that really accelerates our ability to drive productivity and automation within the markets. At the same time, we're looking at whether it's a Harris opportunity or international Americas opportunities outside of automation. That allows us to capture market share, to introduce key competitors and businesses within our portfolio that positions us well for growth. And so you're right, it's a very fragmented market outside of the big 3 and many opportunities for us to use acquisitions as a platform for growth.

Jumping on to the next one. I think we've touched on automation a little bit, but Lincoln's approach to welding automation, being the integrator rather than a supplier to the integrator is differentiated in the industry. Customers are going to prefer this model as they are buying robots to enable welding, not the other way around. This will give Lincoln a long-term advantage and drive above-market growth?

Yes. So when we think about automation, Nathan, we look at this as a growth engine that's 2x what you would otherwise consider as the core progression around core welding. And the driver behind us is, we all recognize that within manufacturing, you have the pressures of workforce and workforce development, aging welder-type population. And so this is an opportunity that we believe is going to differentiate for us in allowing solutions in automation that will make the factories around the world more productive. And so by such, we have deepened capabilities over the years in surrounding the welding automation with cutting as well as material handling capabilities and being able to broaden our footprint. This market has been led by the automotive industry and then has progressed also with heavy industries. We have been looking at more in a broader sense of general industries, which introduces the same capabilities in a broader way and also allows for accelerated growth. And we believe these key secular drivers in the workforce in a drive to drive more efficiency and productivity within the factory will allow for more accelerated growth. And when you think about just progression around welding automation, it was the robotic cell with the power source, and those types of projects would range between $150,000 to $350,000 in that range. But now we're talking about projects that are into the millions that have looked at, in a more broader sense, level of factory automation that surrounds the welding experience and ties in other capabilities. So we're pretty excited about leading in this space, and this being a differentiator for us in the industry and working with our customers in a deeper way [Audio Gap] This strategy is going to yield good fruit as we progress over the years.

Maybe you could just talk a little bit about your approach to automation versus some -- or pretty much all of your competitors in being the integrator and how you think that differentiates you and how customers view the difference there?

Yes. So we've got a much deeper business model with a considerable investment in the capabilities surrounding the integration of the robot in the automated experience. And what that does for us, it creates a level of intimacy in working with our customers to drive the level of productivity that our customers are desirous from a welding but also surrounding the weld cutting and the material handling. And one of the dynamics is being able to navigate through the cycle with that type of fixed cost structure tied into an automation footprint. And so when the capital markets slowed in 2019 and then we had the pandemic also in 2020, where you've had a larger mindset for conserving cash, we saw a bit of an impact on that. But we've got the kind of strength in our financial position and our model to be able to navigate through those types of cycles. And so we're excited now to see more capital expansion and a lot of key secular things like onshoring, like reshoring like broadening capabilities within factories. And the issues that we're seeing in terms of manufacturing workforce aren't going away. And we believe that's, again, going to be a differentiator for us. And we have a full complement of an offering that drives the capabilities for automation.

You mentioned onshoring and reshoring there. Maybe you could just comment a little bit on what you think the opportunity for Lincoln might be there over the next few years? And what are your expectations for onshoring and reshoring to manufacturing capacity post COVID in the U.S. are?

Yes. I mean, it's difficult to give a specific number on it, but it's certainly a key theme. And so when you look at opportunities to leverage automation, to deal with the workforce challenges, and we're well positioned to be able to offer up a solution there. Again, we look at growth to be 2x the core welding through automation capabilities. And as more and more pressure to build out capacity and the challenges of a welder or manufacturing workforce and provides us a lot more opportunities to introduce automation to solve those needs from a customer standpoint.

Great. I'll jump to the last one in the interest of time. Brand loyalty in welding is high, and Lincoln has differentiated brand building initiatives in working schools and training product programs, which exposed welders to the Lincoln brand early and create customers "for life." This represents a significant off-balance sheet asset that Lincoln can continue to use to drive share gains over time.

Nathan, I was just kind of reflecting here as we were getting our Zoom call in line. The operator was using our Lincoln Red welder, right? It's an Ac-225 [Audio Gap] experience loyalty and the recognition of the brand of Red Lincoln technology in driving high-quality, highly supportive services to our customers is what recognizes Lincoln amongst the welding industry. We're very much committed to investing in welding schools and technical capabilities. We have a welding school as the longest-standing welding school in industry. It's over 100 years old. We have reinvested in welding technology centers around the globe. And our facility that I'm here today on is our welding technology center that we opened up in 2018. With 38 different welding technology centers over the last 3 years or so, we've opened up new facilities in Frankfurt and Shanghai and in Singapore, obviously, the U.S., Dubai and others. And so we're very much committed in working within the industry in developing the welders of the future on new technologies, on new processes and working with our customers and sharing how various welding applications can optimize the welder experience. And that creates that stickiness in working through our product offering. I mean we're, as I mentioned at the start, I mean we've got one of the 3 players, the key top players that have a full offering in Red products that's available, whether it's a helmet, whether it's a power source and whether it's offering up an automation capability or consumables. We're recognized for that high-quality products, the level of kind of support and commitment to the industry that drives that longer-term for life commitment and knowing that Lincoln will lead the industry as it relates to the products, the processes, the services that drive a differentiation within the industry. And so we're very committed to that. And whether it's on schools or technology or developing curriculum, very much involved in the early stages of the development of a welding experience. And we've been in business 126 years, and the industry understands that we're here to stay and drive capabilities within the industry.

Yes. I think it's a very important off-balance sheet asset that it continues to bring new folks into Lincoln. I see we're up on time. So I guess we'll leave it there. My apologies for the audio problems a little earlier. So Gabe, thanks very much for joining us today, and thanks to everybody on the line. Have a great day.

Yes. Thanks, Nathan.