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

All right. Good morning, everyone. Thank you for joining us. My name is Mig Dobre. I am the Baird analyst covering machinery and diversified industrials. One of the companies in my coverage is Lincoln Electric, who's joining us for a presentation this morning. As you might know, Lincoln Electric is the global leader in manufacturing, welding, cutting and raising equipment as well as related consumables. Joining us today for an update, we have Chief Executive Officer, Chris Mapes. Chris, welcome to the Baird conference once again, good to have you.

Thanks so much. It's a pleasure to be here today and looking forward to it.

Absolutely. We wish we could have done it in person, I guess, it's virtual again this year, hopefully, hopefully, next year, we'll be able to see you all in Chicago. The way I was thinking we'd approach our conversation, Chris, is maybe we could start with a few high-level questions, and then we can kind of get into some specifics around your verticals and maybe 1 or 2 questions about margins as well. But where I would like to start is on the supply chain. And I'm not really talking about your customer supply chains and the challenges that they might have had, but rather your own supply chain. And it seems to me that you have fared quite a bit better than others. And I'm curious as to what allowed you to better navigate this environment? And I'm also curious if there are any changes that you and your company are sort of contemplating based on the learnings that you've had in 2021.

Yes. Well, thanks. And first, I think we have fared better or at least that's what our channel partners and our customers are telling us about our ability to service the demand needs in the marketplace. I think the first thing I'd go back to is the strategy side of the way we think about the business. And when the pandemic was hitting in very early 2020, we made some strategic decisions around the way we were going to think about meeting the demand as well as how we're going to service the market. And for us, it was all around strategically using our balance sheet. So you recognize that we're rather conservative in the way we think about our balance sheet, and it was an opportunity for us to say, look, if you have employees in your manufacturing facilities and components, go ahead and make those A and B items and place them on the shelf. And normally, we'd be very demand-driven, very much looking at what the demand is before we would make those products. But we did that on a global basis. And then entering 2021, we had 4 to 5 days of additional inventory on our shelves. That helps provide a buffer for us as these supply chain challenges have continued throughout the industry to mitigate some of those impacts. But we've also continued in thinking about being customer-first in the way we have been thinking about the supply chain, bringing in more components, confidence in our business model longer term, so placing longer-term orders out there with our suppliers because so many of us have heard today about the chip challenges that are throughout the North American market and the global market. Well, let me assure you, when you're talking about welding equipment and robotics associated with our automation business, we're talking about heavy utilization of those chips. So we've been able to minimize some of that impact by getting ahead of it, utilizing our balance sheet and staying really very straightforward with our employees about what our expectations are, which is we need to service our customers during this window, which allows them the freedom to be able to drive that supply chain.

Understood. And in terms of any changes that you might be making to your business as a result of what you learned in 2021? Anything to highlight?

Yes. I think the first thing is as much as I'm very proud of our team and the fact that I think we have positioned ourselves well, I in no way want to imply that there aren't supply chain challenges that are out there in the business for Lincoln Electric and still out there in the marketplace today; we're just managing those issues and continuing to confront those issues. But I will tell you that there are elements of the supply chain that are going to force a lot of large global manufacturers to rethink what they're doing. So we're internally talking about should we be bringing in some capacities to maybe make some of the components that we have been third-party procuring, is that going to make us the better supplier long term. With equipment manufacturing, a lot of that is the supply chain around the electronics. We invested years ago, during my tenure here, probably 7 years ago in a new Printed Circuit Board manufacturing facility here in our Cleveland operations to support our equipment manufacturing. We're asking ourselves whether we need to be doing the same thing for our business in Mexico for that equipment portfolio versus having a supplier provide those. And that's where we can use our balance sheet, we can use our understanding of this business to ensure that we're still viewed as the supplier of choice moving forward. So there are those types of opportunities. And I think that whenever you have this type of disruption in a marketplace and disruption in the business, those high-performing companies are willing to step back and challenge themselves as to what they could do better, how could we improve upon the business. And we're going to continue to do that at Lincoln Electric, and the supply chain will just be one of those areas that we'll challenge ourselves with.

I see. And I know you reported earnings recently, and you commented on your visibility going forward. But I just sort of want to get an updated view in terms of how do you think that kind of plays into 2022? At what point in time do you think there's going to be some normalization? And as far as you can tell, are things getting sort of more challenging here? Or are we finally reaching a point of some stabilization?

Well, I certainly don't think we're reaching any point of stabilization. When we were in front of the marketplace talking about earnings, we had mentioned that we didn't think we'd seen peak inflation, and I can assure you over the last several weeks since we were in the market talking about our third quarter performance. The data points that I have coming in continue to amplify the fact that inflation is continuing to grow in the marketplace, still challenges associated with the inflation. Portions of that inflation are in transportation, and so we're still seeing some of those transportation challenges that do impact the supply chain piece. So I really think that our discussions around the business and what we saw with the business moving into Q4 and moving into 2022, have only -- the last few weeks have only continued to give us confidence in the positioning with the business, which is we haven't seen peak inflation. We expect there to continue to be supply chain challenges. Those challenges will mitigate in certain product categories. We're seeing fewer of those challenges in the consumable side of our business. We may not like the inflation, but our fill rates on our consumable side of the business are in the high 90s. So at the end of the day, that side of our business, we may not like the inflation, but the supply chain has been mitigated. And yet on the electronics side and some of the other areas of the business, we still see supply chain challenges, and we expect those will continue well into 2022.

Understood. I have to ask you about the news of the week, which is the passage of the infrastructure bill, finally, and I know that we've talked about this on and off for the past year or so. But I would love to get your perspective in terms of what it means for your business. I mean as we all know, you've got, call it, 10-plus percent of your revenue is directly exposed to construction and infrastructure. But I suspect that there is more to the story than just this direct exposure. So how do you think about it? How do you see it? And how do you prepare the business to take advantage of whatever opportunities this might [ crop ]?

Yes. So when I think about the infrastructure bill and the passage of the infrastructure bill, I see that as another catalyst for Lincoln Electric. So I think the challenge that we've seen with infrastructure bills in the past is how much of that is shovel-ready today? How much of those projects are going to be moving quickly. So do I see it as a long-term catalyst? Absolutely. It's a positive. I would tell you that when I think about the infrastructure bill, it probably impacts maybe the high teens percentage of our business, maybe 15%, 17%, 18% of the business. Some of that's moving through the channel. So it's difficult to have an exacting number as it's associated with that, but it's a material piece of the business. And as we see that capital start to move into the economy, we expect that, that will be a favorable impact for us. But I don't think it will be a favorable impact in Q4. I think it will be a favorable impact as you're trending through '22 and '23 as those dollars move into the marketplace. And I really think the important piece of that is it's another positive catalyst to believe that the elongation of the favorable industrial cycle will occur. So we've talked for a while at Lincoln Electric and with you that we believe we've moved into a favorable industrial cycle. Those cycles tend to run from 8 to 10 to 12 to 14 quarters at a time. And quite frankly, the inflation and the challenges with the supply chain very well could have elongated that because demand is pushed out. Well, when I think about the infrastructure bill and that capital come to the marketplace, in my mind in thinking about the business, it's another positive catalyst in believing that the favorable industrial cycle will be elongated because those dollars will be out there, certainly in '22 and '23 supporting various areas of the business.

Yes. It's interesting. Several of your peers in discussions at conference have pointed the same thing that while this might not be driving activity immediately into 2022. What it does is essentially extends the growth cycle into 2023, 2024. It sounds like you have a similar view to that. Then I guess what I would like to ask you is some thoughts on your available capacity. And I want to leave out this supply chain near-term dynamics. But structurally, fundamentally, where are you in terms of capacity in the business? Can you support the sort of growth that you're talking about here? Or do you need to make additional investments whether it's rooftop whether it's labor. And I want you to maybe focus a little more on the labor component as well because I'm presuming that this is sort of a big portion of what you're going to have to deal with down the line?

Yes. And so look, Lincoln Electric, like other manufacturers is challenged in being able to acquire the labor that we're looking for to assist us in manufacturing our products. We've been managing through those pieces, but those challenges are there for our employees today. I will share with you that we're committed to the structural improvements in automation long term, but we do that not only from a customer-facing perspective. but also in the way we think about our business. So we've spent probably $50 million over the last 3 or 4 years inside of Lincoln Electric deploying automation. So that quite frankly, we can make some of those tough jobs easier. We can mitigate some of those labor requirements around some of those roles. That's put us in a little bit better position. So as I think about the labor side, we believe that labor will continue to be a challenge, certainly through '22, as long as we see this type of demand curve, it's logical that the labor will continue to be a challenge. But as it relates to pure capacities and thinking about a manufacturing facility, Lincoln Electric is well positioned. And we're well positioned because in '19 and '20, we were investing back in our business to be able to develop more capacity. We've put an additional $25 million or $30 million in our European assets, in Turkish assets to be able to support those capacities on a global basis. So we've been investing in our business model, believing that, quite frankly, that growth was going to be out there for us, and we're well positioned. So on the equipment side and on the consumable side, I feel like we're in very good positioning. Automation could be in a situation where we need more floor space, okay? Because our -- the automation business, we're trending now towards nearly $500 million on a run rate basis. The backlog is strong. The order activity is solid and quite frankly, I need to be able to know that I've got enough floor space to be able to turn those projects effectively. So it's the one area of the business where we're evaluating whether we need more capabilities from a floor space perspective to be able to generate the kind of revenue and growth that we want to see longer term. Now fortunately, that's probably the easiest capacity to bring on. So it's very easy for us to be able to accomplish that. But that's the one area of the business that we're evaluating whether we need to put more assets in place to meet our growth targets. And then certainly, if we were able to continue to acquire in that space, that will mitigate some of that need.

Understood. And obviously, your automation growth goals are quite robust as we're looking out to 2025, essentially trying to more than double this business. Since you brought up automation, maybe it's a good point to actually have a discussion here on this specifically. I guess what I would start is with a question on how you view automation penetration across the various industries that you serve. It's pretty clear that automotive at this point is pretty well penetrated. But I'm curious as to the other verticals out there and where do you see maybe the low-hanging fruit in terms of being able to deploy these solutions to customers that don't currently have them or use them.

Okay. So look, I think that a couple of real foundational comments for those investors that are looking at this webcast and thinking about automation. Look, the structural drivers remain the same. And actually, probably the pandemic has amplified those structural drivers. One, difficulty in finding labor. And we're probably at -- certainly at my career in manufacturing over 30 years, probably as a more challenging window of identifying and finding labor as we've ever seen. So that continues to push more automation. And then the secondary piece, look, the technology and the ability to utilize the technology to solve some of these challenges, quite frankly, continues to advance. It makes it easier for manufacturers to implement it. So the structural drivers, I think, absolutely remain for the business. Second major point when I think about that automation and that advancement of automation in the business beyond those foundational structural drivers is really continuing to see that our business as much as we talk about automotive. Automotive today in our automation business is only about 50% of the business. So we have moved that down about 20% over the last several years, and we've done that from acquisitions, bringing in the Zeman business, which is structural steel applications, the Burlington business, the Coldwater business that we brought in, that was much more focused on appliances, has really helped us continue to distribute our business across the segments. But -- maybe one thing you said about penetration and, I think, is important for individuals to understand. So has automotive been a long-term user of automation, that answers, yes. But remember, when we're talking about the automotive business, nearly every time you're moving in a new platform means you're going to replace those lines and you're going to retrofit all that work. So penetration doesn't mean that, that is static, they generally every 5 to 7 years that are rotating through. So you're seeing that demand come back as it relates to the automotive business. We're absolutely sieving it though permeate across other segments. And I think when people think about Lincoln Electric and automation, the other element that's important is that, look, it's not just about the welding automation. Do we do welding automation? Absolutely. We believe we're better at it than anybody in the world. Do we do cutting automation? Absolutely. But Lincoln Electric also does tube bending. We do press transfer units. We do material handling. We do a host of things in the automation space because for us to be in automation, we recognize that our customers expected us to do more than just the welding portion of the cell. So the breadth of that business, the expansion of that business into the various segments, I am very confident about our ability to get our business to $1 billion and the execution of our Higher Standard Strategy. And I think it's going to be exciting for our business and our shareholders long term.

Well, I appreciate that. And -- but let me press you maybe a little bit for some specifics. Is it heavy equipment or structural steel? Like where do you see as the next automotive, if you would, in terms of the potential scale that automation could bring to your business. Is there any that look like auto?

Yes. Look, so I think when I talk about the verticals, I think that you're going to see a host of those verticals move forward. Look, I'm not trying to avoid the question. The structural steel applications that we have now with our Python product and our Zeman product, we're seeing real growth in structural steel. We're also seeing real growth in appliances, real growth in heavy industries. We've got a cobalt line that, quite frankly, is going to be going to the general fabrication area. So I think there's going to be an elevation across the multitude of those segments. And again, the real opportunity for our business and our stakeholders long term, is today, that business is operating in that mid low single digits from an operating profit perspective. And we believe, fundamentally, we can get that up to the average at Lincoln Electric. And we start talking about putting 500, 600, 700 basis points of additional profit on top of that business as it continues to grow. That can be a significant value creator for our stakeholders long term.

And you anticipated what I was going to -- the next question I was going to ask, which was on margin. And it sounds to me like what you need here is additional volume in order to get this automation business to the kind of margins that you want. I am curious though, is there an argument to be made for additive manufacturing, which has been obviously an initiative that you've highlighted in the past as maybe being able to more quickly catalyze this margin expansion?

Yes, potentially. I think the challenge we may have with that is what is the rate of adoption on the additive manufacturing portion of our business. So I've always said that 1 of the advantages I have as the CEO at Lincoln Electric and I've had during my tenure at Lincoln Electric is we really do have a board and a business strategy that focuses on the long term. I'm adamantly confident that our additive manufacturing strategy is going to be successful. But the rate of adoption on that and whether that rate of adoption is quick enough for it to be enough of a catalyst in executing on the 2025 strategy. I think is a question mark, and we get it up to be large enough to be material enough. But I will tell you, I'm very confident in being able to expand that margin profile in that existing automation business. We've had windows where we've seen it perform at that level. And for us, it's really twofold. It's the growth to minimize some of the choppiness within the business. So making that a larger business for us and then making sure that we can distinguish that Lincoln Electric's Automation business is not a collection of businesses, but it's a platform. It's a business that, quite frankly, can be scaled and can be expanded because that platform scalability will assist us in being able to be a better supplier to the marketplace. And I believe we have a better margin profile for that business as we're moving forward.

Understood. I want to shift gears here and talk about automotive for a second. And one question we often get from investors surrounds this evolution towards electrical vehicles, and how that might impact your business? And I guess there's 2 elements that I'd like you to comment on. First is this whole idea that castings might be something that will end up being used more than we're currently seeing as this EV transition is occurring, obviously, that would have a detrimental impact on welding demand. So I'd love your view on that. But then also other processes, things like gluing or riveting or -- and so on, how do you sort of position your business to benefit, frankly, or to maintain it in the face of this transition towards electrical vehicles?

Okay. So let's start at the macro level and talk about electric vehicles in total. When we think about electric vehicles in total versus the internal combustion engine. Obviously, there's not a lot of welding in the internal combustion engine. Those are machines and gas parts. So that removing engine isn't a huge detriment to the welding processes. So when we look at those 2 at that level. Actually, the value creation because of the materials that are utilized in an EV vehicle versus internal combustion engine, it's about equivalent for us when we look at that market opportunity. We look at that business. We see it's about 60% business that's driving consumables and it's about 40% of our spend in there would be CapEx business, a portion of the business, automation and/or equipment. So the EV vehicle itself at a macro level, we don't see as a detriment. As we get into some of the other specifics for the continuing emergence of the EV vehicle, if they move to axles or if they move, quite frankly, the frame to cast parts, one of my first comments would be there's a portion of me that would like to see that because that cast part could very well be an additively manufactured part. End of the day, we could -- we have done that. And we could easily be in a position where we're participating in that market through our additive processes. The second comment I would make is that at the end of the day, if they're going to do that from a casting perspective, there's going to have to be automation that's developed for them to be able to achieve that, and we could participate in that portion of that marketplace. We see that, but we don't see that cast frame as a large portion of the market anytime near term. So as we're thinking about executing on our 2025 Higher Standard Strategy, we see it, but we don't see it as a big detriment to the market opportunities that we would see, although it's potentially a longer-term risk. The gluing, the riveting, the other processes, the -- those things have been around the marketplace for decades. Most of those are actually more of a competitive threat to spot welding than they are arc welding because basically, you're thinking about just tacking, just holding something together. That's not really where the arc welding portion of the product portfolio is. That's more spot welding. We do some automation cells around spot welding, but we're not a manufacturer of spot welding processes and equipment. So even if those were to move more into the marketplace, they're much more of a competitive threat to a different product category than Lincoln Electric.

Understood. That's good color. Let's talk a little bit about International. And here, I have to commend you guys on being able to deliver really good margin performance as we've seen this year. But that's the question as to what the longer-term opportunity is here? You've more than accomplished the goal that you initially set to accomplish double-digit margins, right? Now the question is where do we go next? And I'm going to ask the question relative to the Americas margin, understanding that probably this business is not going to be as profitable as the Americas business. But -- to what degree can we actually close this gap? Can it be as profitable as [ Paris, ] for instance?

Yes. Look, that's the right question. So I guess I'll start by saying for those individuals that are watching this call and when we talk about our ability and our confidence in making improvements in the automation margins, should be individuals that understand a few years ago, we had confidence in improving the Harris margins and the Harris margins have been improved. We had confidence in making improvements in the International margins. The International margins have improved. So we have a track record of being able to show that we can drive operational and profitability improvements within these businesses. As it relates to International business, really proud of our team. We have met our target. We said we were going to get that to double-digit margins. And I expect that as people are looking at Lincoln Electric, early in Q1, you'll probably see us revisit our 2025 Higher Standard Strategy targets and probably set additional targets for our International business. Do I think it can get to long term to where we would want to see for the average of the corporation, yes. I do believe long term, there's a path there. I'm not thinking that, that will be our next set of targets. But we will be expecting it to make another significant move from an operational profitability improvement scenario. I don't think it will ever be as strong as the Americas business. They're just dynamics associated with that market there that probably limit its ability to get to high teens-type margin profiles. But there's still a lot of upside in our International business, an upside that we're going to place in our new targets that we'll be bringing to the marketplace early in 2022 as we reset a couple of areas of our Higher Standard Strategy because of our performance. We need to go back out and set some new challenging goals in a couple of areas for the company as we're executing on the strategy.

We have 2 minutes left. So I'd like to end maybe with this question. As you talk to investors, Chris, and I know you're active in speaking with the investment community. I'm curious, do you get the sense that there is a portion of Lincoln's either growth algorithm or I should say, earnings and value creation algorithm that is, at this point, underappreciated that maybe you would like to highlight for us today?

Yes. Thanks for that question. Look, I would tell you, it's in a couple of areas. I still believe that Lincoln Electric is a little underappreciated because at times, it's viewed as more of a metals industrial. And what I mean by that, if people really understood where the value creation is within Lincoln Electric, you'd say it's automation, software engineering and advanced metallurgy. And quite frankly, it's probably not viewed as that level of a technology company, but that's really where you're creating value within the business. And then my second comment would be, in the marketplace today, I'll admit, I sometimes look and read about start-up companies or companies that are trying to do things to advance technologies within the business. And I look at those financials, and I understand the challenges associated with start-ups. Lincoln Electric provides an investor an opportunity to be with an industry leader with decades of performance and still have the opportunity to see the upside from automation and additive manufacturing which are probably 2 of the highest growth catalysts that people talk about in the industrial space. So I'm not sure that always the investor sees the opportunity to get the high-performing company, the market-leading company as well as an opportunity to also have the upside of automation and additive manufacturing that are within our portfolio. And I believe as we continue to execute on those strategies, we'll be recognized for that. But I think that's the opportunity that we provide to the marketplace. And again, very proud of the work our team is doing and confident in our ability to execute on our longer-term strategy.

That's wonderful. Thank you for your time. Thank you for your comments this morning. To everyone that's watching this webcast, you can continue your discussion with Chris. We're going to have a breakout in 5 minutes. Chris, thanks again for participating in our conference this year.

Yes. Thanks so much. Great to be here.