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

I'm Saree Boroditsky, and I cover Industrials at Jefferies. I'm very excited we have the opportunity to host Lincoln Electric today, including CFO, Gabe Bruno, and Vice President of Investor Relations and Communications, Amanda Butler. We're going to dive right into Q&A today. Please feel free to submit any questions through the portal or e-mail me directly at sboroditsky@jefferies.com. Thank you guys so much for being here today.

So during your earnings call last week, you talked about being in the early innings of industrial cycle. Capital investment has generally been constrained since 2019, but you just saw automation demand inflect positively. How do you see the progression for automation demand from here?

So thanks, Saree, and thank you all for joining us today and your interest in Lincoln Electric. We are the global leader in welding and so that we'd like the opportunity to share some of the key insights to the execution of our strategy. So Saree, on last call, you did hear tone of increased level of confidence in the industrial cycle. And that really comes from seeing now a few quarters of broad-based strength and demand across the various end markets that we serve. So you saw that tone of being in the early progression of an expansion. So I feel positive. As it relates to automation, we had pointed to a strengthening of backlog after the first quarter release, and we continue to see that. And we had pointed to kind of midyear type expansion based on the mix of our backlog and orders and we saw an acceleration of that. So we're very positively seeing nice high teens type growth in automation. And that came on top of a second quarter of last year, that wasn't the trough for automation. So in the second quarter of 2020, we still had active projects see its way through, through the second quarter. So we're pretty excited on what we saw from an automation standpoint in the second quarter with good momentum, good strength in quoting, backlog entering into the third quarter.

And then how are you thinking about pent-up demand for automation and capital projects? Is there a way to think about these industrials or capital investment cycle versus past cycles you've seen?

Yes. So as you know, I mean, we've been navigating a softer market as it relates to capital investments since 2019. And broadly speaking, whether it's in automotive or heavy industries, we just saw a continued weakening in terms of capital investment. So when we see the turn in the cycle as we're beginning to see that does give us confidence that the level of pullback in capital and even the conservation of cash that we saw under pandemic is turning in. You can see in markets like automotive, like in heavy industries start to turn. And then broadly, in general industry. So we had acquired a couple of businesses back in 2019-ish timeframe that allowed us to expand into general industries and companies that had strength in applications within the appliance industry. So we've broadened the footprint, and so we're pretty excited that, that leads us into providing our value proposition from an automation standpoint in an expanding market. And you're starting to see more strength in the capital investment cycle, heavy quoting activity, backlog strengthening. So we're pretty positive on what the outlook looks for from an automation standpoint.

And so sticking with automation, as you think about reaching $1 billion in sales in 2025 from automation as if, how much of this should we think about coming from acquisitions versus organic growth? And has the pandemic changed any of this composition or thought process?

Well, first on the pandemic, I think, if anything, it only strengthens the value proposition and the strategic themes behind our automation strategy. So we're pretty excited about the continued growth in automation. Now what we've done in building out the capabilities over the last 5 years or so have been key to be able to introduce what automation can do in driving productivity and the pressures around labor, also meeting those needs as well. So inherently, we'll continue to look to acquisitions. We just completed an acquisition in the second quarter and automation tied to the structural capabilities. And so we'll continue to look for automation capabilities through an acquisition process. But I think, in general, we can think about half that growth coming through acquisitions and then half of that growth coming through on organic profile, which we believe is about 2x that of core welding. So we believe we're well on our way towards that target of $1 billion in a business model by 2025, and it will come from both acquisitions as well as organic growth.

You've talked about automation margins being close to the company average at about roughly 15% in the past. I believe the decrementals and incrementals should be higher in this business. As you think about the rebound in demand, how should we think about the impact to margins, especially in Americas, given the bulk of the exposure in that segment?

Yes. So first of all, yes, we had the profile on our automation business that was at the corporate average, and we like to anchor on that about 15% type target. Over the last couple of years with the decline in capital investment, we're probably operating about half of that. We did see nice progression now into the second quarter, and we're well on our way for our business model to perform at that corporate average. But as you point out, incrementals and decrementals because of the fixed cost structure tied into our automation business model, you would see normally higher than the core part of our business. So as we continue to grow and to expand, you'll see an acceleration of the margin profile and of which is largely anchored around our Americas segment. So inherently, our Americas segment, outside of automation, is a net high-teen profile. We had nice progression in the second quarter, EBIT being at that 16.9% level. And as automation continues to grow volume as well as the incrementals will arrive more at those historical levels from Americas standpoint.

In your slide deck, you talk about expanding the market potential for Lincoln Electric from $22 billion to $45 billion with the addition of automation and additive and servicing. That's more than double the market. So if you just talk about how automation expands your potential revenue opportunity, is it because the systems are more expensive? Or is there an increase applications?

Well, actually, it's both, right? So there are adjacencies that are tied to automation within the welding space. And so whether it's material handling, structural components, bending steel and that sort. So there are adjacencies as we offer up capabilities from an automation project standpoint. But inherently, typical robotic system is going to be in that $250,000 to $350,000 range versus our more traditional welding offerings being into the thousands. So it's a big difference in terms of the offering. There are projects though, many projects are into the millions. So the profile of projects are much larger within the automation space versus what we see in our core welding. So that's what gives us the confidence that the market opportunities are much larger as we continue to grow from an automation standpoint.

You had a very strong volume quarter up 26%, but highlighted potential for some of this demand to be related to an acceleration in second half orders. Does your current backlog include some longer-than-normal lead times? And are you seeing customers place orders differently today, given the supply chain concerns broadly?

Yes. And that's pretty difficult to try to estimate it, try to understand the dynamics there. But we do have a very strong backlog. We had a very strong backlog getting through in the second quarter, very strong backlog now continuing to the third quarter. And there are a lot of pressures in the market. It's related to supply chain, that's continuing to work through pandemic concerns. And so we believe there's some level of activity there. But the underlying strength of demand in the end markets is what we're driving towards and being able to meet our customer requirements. And as we talked on the call, we've got strength during the third quarter, good momentum. And so irrespective of whether or not there's some potential pull forward in orders, we'll service our customers. We've got a high level of backlog and more importantly, the underlying strength of the cycle and our comments surrounding going back to the beginning stages of the quarter are so important.

Auto and transportation demand almost doubled in the quarter. There's been some concern around production issues there. So can you just talk about what you're seeing from a demand perspective? How are you thinking about the benefit from production versus line changeovers versus automation investments in that industry?

Yes. So when we think about the automotive segment as we service, I do separate between the needs in servicing production, which you saw significantly up year-over-year. And granted last year, we had the trough and there were broad shutdowns across the automotive industry for up to 1.5 months in some cases. So the comps are much easier, of course. But then we also have capital investment, right? So our common stock in automation, new product introductions that sort of things have become pretty important in terms of model years and supporting that. The positive is that the underlying drivers to production are very healthy. Consumer demand record lows in terms of inventory levels just point to a need for driving production. And we serve a broad base of customers that support the automotive industry. So we're very well positioned and continue to be in servicing production requirements and then also in participating in the needs of our automotive customers and expanding capital needs. The EV dynamic is also we're very engaged in and that allows us to offer automation capabilities to serve a growing capacity expansion on electric vehicles. And so we look at both. Both the capital, the long-term investment requirements, but also production. And we think it's a very healthy end market right now. Whether things get pushed between quarters because of production issues and component challenges from an automotive standpoint, the underlying demand and the low levels of inventory that I pointed to continued need to expand production. That may shift between quarters, but very healthy.

Just sticking with some end market commentary. construction and infrastructure was another strong performer in the quarter. There are some science that the infrastructure bill is now moving forward to be another arrow in your quiver from a growth perspective. You've talked about benefiting from bridges, but what other areas in this wider definition infrastructure could you see higher demand given that 15% to 20% of your sales are related to renewable energy and infrastructure?

Yes. So just think broadly, coming into 2021, we expected the structural markets to be a little bit more choppy. And actually, it's just continuing to strengthen. So we're pretty bullish around structural markets, and we're tracking -- that's about 10% of our business that we measure on structure. But we're tracking the architectural buildings, metal building construction, and it's been pretty positive. That said, yes, this bill that's progressing through Congress is going to be an impact on infrastructure. And as you mentioned, 15%, 20% of our exposure. And not only the fundamentals of welding within infrastructure, but that includes also power sources, equipment that's used within the industry. But there's a lot of discussion also around EV capabilities, battery charging stations and adding -- and the equipment and the sources that we offer up could be used in construction are going to be a potential for us. So we're pretty excited about what that opportunity provides us for growth.

International margins were at an all-time high in the quarter. And you talked about identifying what the next step in improvement is for margins as you get into 2022. We'll obviously take any hints on what the target is today. But in the meantime, can you just talk about some of the actions that you took to get margins where they are today? And what are some of the things that are left to do there? And then just on, are margins structurally lower versus Americas? Or do you think there's opportunity to close the gap over the long term?

There's a lot there in that question, Saree. I'll give you a hint. So the hint would be higher than what it is currently, right? So no, we're really excited about what we've been able to accomplish in our international business. And our team has been very focused in execution. And our business model, we're very confident to drive that double-digit profile. It's very disciplined. There's been a lot of work, as you know, since the acquisition of the Air Liquide Welding business back in 2017, we've touched down every aspect of our business. So whether it's in the manufacturing capacity, areas of product rationalization or how we engage from a commercial standpoint, back office capabilities, really every part of our business has been impacted by the integration work in the shaping that we have put forth in refining and developing our business model there. So we're very excited that all that work behind us. We'll continue to look for opportunities as we deal and as core to our execution philosophy and our business' continuous improvement core to our strategy, programs like Six Sigma and the like, that are constantly challenging how we are doing things and how we continue to develop our business model. But we are in a growth mode. We're focused on growth. We believe we've got the business model set in such a way that we can expand on the platform we have developed and going after growth opportunities across the market. And so we're very excited about how we have positioned our international business in this cycle.