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

All right. Good morning, everyone. Welcome to the Stifel Cross Sector Insight Conference. With us today we have Lincoln Electric. Like to introduce Gabe Bruno, EVP and CFO. So today's format, I will be doing 3 Bear Cases followed by 3 Bull Cases to help better understand the story.

So with that, I'll jump into the Bear Case #1. Lincoln has done very well passing increased costs through to customers, including margin. When costs normalize, that pricing is going to reverse and earnings are going to decline. The business is over-earning right now.

All right. First of all, thank you, Adam, for hosting the conference. Great to be here. When I think of this bear case, I think about what our long-term positioning is with our operating model. For those of you who are following our company, we are very aligned to progressively improve the operating margins of our business. So as we're dealing with price/cost, it really anchors around how are we executing on our strategy of operational excellence at Lincoln Business Systems, what are the things we're doing structurally to drive for continuous improvement in our operating margins. Our posture in managing this inflationary environment from price/cost is to be price/cost neutral. So as we're managing through this cycle, which is nothing new. We've been through many cycles such as these in the past where we're dealing with inflationary environments, I'd like to point to the 2004 timeframe where we introduced many price increases. And frankly, as pricing and material cost had somewhat declined, we were able to hold on [ that's our posture ], hold on to pricing with some modest declines over the long term. So we're very disciplined in managing price/cost. It is a neutral position that our model is anchored around. When we think long term and how we're driving for organic growth, pricing is not a significant component of how we think about it. But in these times where we're dealing with the inflationary environment, which we have all experienced, we need to have the discipline in managing pricing, and so we've done so. But again, core is that we continue to look for opportunities to drive an operating model. We've proven in looking at areas of our business such as Harris a couple of years ago, like our international business, like our automation business that those are the long-term contributors to the improvements that we're targeting in our operating model. It's how we think about it.

Are there certain areas where you're either -- it's either easier or harder to get price, maybe on the equipment or consumable size or by channel?

It's very disciplined across our product lines. And when you think about our channel partners, there is a clear understanding of the drivers of inflation, particularly on the material side. So while it's never fun to push along a price increase, our customers largely understand that. And so we just got to work through communications with our customers, whether it's through channel or through OEMs and just keep that discipline that our commercial teams have in the forefront of communicating the pricing changes that are important for us to maintain the business model that we have.

All right. Moving to the second bear case. There was a lot of uncertainty with China lockdowns, war in Europe, inflation, rising interest rates globally, that all create a lot of uncertainty around demand in many end markets. Labor shortages also bring into question how quickly infrastructure spending can actually be executed. It's hard for investors to have confidence in the demand outlook right now.

So I think about the word you have here uncertainty, and I've been with Lincoln Electric now 27 years, and I can't tell you how many times in my experience that there have been times of uncertainty. We've just operated the last 2 years through a pandemic, and we understand all the dynamics of the supply chain pressure. So what uncertainty does for us is just keeps us focused on executing on our Higher Standard 2025 strategy, which you've seen throughout the last few years, just the discipline surrounding needing to adjust how we approach the markets to be able to serve our customers. And we've had our customer-first mindset. As we went through the initial stages of the pandemic was to retain our workforce, to invest in inventory levels, to be able to soften any potential impact on supply chain. So when you think about the China lockdowns and the conflict in Europe, inflation, those are additional uncertainties that we've got to manage through, and we expect to manage through that. We've been in business now 127 years. We have a very experienced management team. They have worked together through many different environments. And so we're confident that we'll continue to execute on our strategy despite all the different uncertainties. There'll be more as we progress in our careers and our livelihoods. But we know it's an environment of uncertainty, and we'll continue to execute.

Speaking specifically to end markets, what are you seeing currently maybe in order rates, what end markets are strong? And then if we think maybe a little longer cycle, what -- I'm thinking of maybe auto, where there's strong backlogs there. Could it potentially extend the cycle and maybe some longer-cycle end markets?

So let me give you a bit more color in end markets and how we look at some of these regional activities. So as we ended the first quarter, we did talk about a pull forward in activity. And what we saw in Europe is just concern around supply chain, obviously the conflict, the general environment from an economic standpoint in Europe. So we know that that's pressure into -- has a positive side. Now we ended the first quarter, pressure in the second quarter. Same dynamic continue on into China. So we think about those regions, particularly in the international markets, some pressure we knew going into the second quarter. But we're very bullish in the end markets across the Americas. When you walk through the automotive industry and you know the inventory levels are at low points in the cycle still, and you're hearing a little bit more positive on some stability on the chip shortages and you have the healthy level of demand still, we think the automotive still has some time to run its course with a lot of good, healthy demand drivers. When you look at general industries, it's been holding up and it's been holding up very nicely since the mid of 2020. We continue to see that strength there. We also have heavy industries with the fundamentals around heavy construction and mining and ag, and you can read some of the headlines and see some of the particular company reports on backlogs and inventory positions, so we're pretty bullish on where we see heavy industry as well. If you think about structural, fabrication and infrastructure, we estimate about 15%, 20% of our business tied to infrastructure. In the U.S., for example, we haven't seen the impact yet of the infrastructure bill as that worked its way through Congress. So we expect towards the end of 2022, beginning of 2023 to see more of that impact in the demand profile of our business. And then lastly, the energy markets, fundamentals in oil and gas as we know are pretty strong. You have potentially some movement of sourcing from Russia markets to other parts of the world, including the U.S., and the pressure building up capacity. But you also have alternative renewables energy sources that are going to continue increasing profiles and demand like wind. And so we're bullish in our posture on servicing those markets. And what that means in the longer term, meaning the next 6 to 12, 18 months, so pretty positive in what we see throughout the Americas markets and end markets.

That's great. I'll do Bear Case #3. We move to lighter weight materials in many industries, the rise of 3D printing and wider adoption of laser welding are structural headwinds for traditional welding, which impairs the long-term growth potential of the welding industry and potentially Lincoln Electric.

Yes. So when I look at this bear case, I think of it as a bull case for Lincoln Electric. And when we think about lighter weight materials, I think of alloys like aluminum welding and that's a big part of where you see the automotive sector sourcing some of the lighter weight materials. And those are more complex type of welding solutions, and we have a broad base -- set of solutions that drive into light aluminum welding and other alloys. So I see that as an opportunity for us, and we continue to grow in that area and as the markets continue to adopt lighter weight materials, we have welding solutions that service into those markets. When I think of 3D printing, you know that we have been investing into additive -- in our additive business, which is the largest wire-based additive capability in the markets. We have been investing this over the last few years now in developing the commercialization of sourcing large parts through a wire-based additive process, and so we're very excited about that. Very difficult during a COVID pandemic environment to introduce to our -- to cut large parts to industrial and aerospace types of customers because that does require a whole change in how you think about sourcing parts. But we're very excited about that. We just announced. There was a press release on some work we had done with a refinery customer for us that we provided a large part that was required in their maintenance operation, and we were able to shorten up to the supply chain the lead times to be able to source those parts. So when we think of 3D printing, we think about additive, wire-based processes that anchor around our software, robotic capabilities, the metallurgy surrounding wires, that's an opportunity for us. And so we've put together a growth plan to be able to continue to drive the commercialization as part of our 2025 strategy. When I think about laser, we think of the fact that we're one of the leading integrators from an automation standpoint in laser. We are actively involved in looking at solutions that incorporate lasers into our automation offering. We have, for example, as we are working through the EV markets, the battery trays are leveraging aluminum-based wires and so with that our alloys. And so with that, we've developed solutions called hotwire laser to be able to deal with a very difficult, complex welding process. So we think of laser has a footprint within our offering, particularly in the automation side of the space, and that provides us an opportunity to accelerate growth. So each of these areas we think about as providing incremental opportunities to accelerate growth.

It makes a lot of sense. Moving on to the good ones, Bull Case #1. Sales in welding are 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 rate. Size matters in welding.

All right. So when I think of this case, I think that we are the welding experts and the welding experts translate into productivity. There's a nice chart that we put together in our updated deck this year that talks about all different avenues of how our products and our offering improves the productivity of our customers. And so as we think about the technology offering, one of the things that we like to discuss is a measure of vitality. And what does that vitality index means? It means that for new product introductions what is the composition of our sales. So for sales in our machines, for example, equipment sales for 2021, 57% of those sales were from new products introduced over the last 5 years. And when you think about an industry like welding, arc welding, we've been in business for 127 years. That level of velocity of innovation and technology introduction is core for us to continue to be a leader in driving productivity solutions that we engineer within our broader portfolio of products. When you think about what are the drivers? Obviously, being the experts in metal joining, the metallurgy behind welding, software, think about automation, all that ties into solutions surrounding productivity. And so we're very deep in continuously investing in opportunities to differentiate ourselves in the market. When you think about the various industries, different application in dealing with energy, then the automotive, then general industries, lots of different ways to solve for customer challenges in welding and metal joining, and that all translates to how do we optimize and the productivity of the experience from our customers. And we continually invest in those areas. So an example I mentioned the battery tray example from an EV standpoint. That's our engineering team working with our solutions, having an industry focus with the kinds of applications that are going to make a difference with our customers. And we're structured that way. So we have segment leaders that have an eye on each of the various industries, whether it's in automotive or whether it's in energy or whether it's in heavy industries that are looking at ways to work with our engineering teams to provide solutions that are going to drive for productivity. I meet with our industry segment leaders every month because I'm interested not only in the end markets and the progression of our business across the end markets but also on the solutions that are going to provide a meaningful opportunity to accelerate growth. When you think about smaller players in this bull case, yes, it's much more difficult to compete with the holistic approach as we have with all of our offering -- consumables, equipment, automation -- that ties into a solution. And so the investment and our strong balance sheet and how we look for opportunities to accelerate growth become very meaningful way in how we position ourselves in the marketplace.

We hear a lot about shortage of skilled labor and shortage of welders in the industry. Do you have any specific technologies that can maybe increase at a faster rate welders?

Well, we're going to tie into the introduction of training and education for welders, right. So that's a big part of our strategy. So we'll talk about it a little bit. But think about automation inherently, right. So we know there's going to be a lot of pressure, and well there has been a lot of pressure on the progression of an aging workforce on the welder side. The automation solution addresses that. So when you look at some of the key trends in manufacturing, they're going to require more automation capabilities, we're the industry leader in automation. So the labor challenges, the needs for productivity, and the upgrades in the manufacturing space that all ties in to how do we introduce automation to deal with some of these challenges. And so we're pretty excited about how automation fits into that, and we'll talk a little bit more about how education and training fit into our strategy.

All right. So following up on that, Bull Case #2. 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 we're very excited about our leading position in our industry in automation. And what it means to be the integrator is that we capture the solution from design, to the execution, to installation, to training, any follow-up supported on that. So it's capturing the whole solution as we're working through with our customer needs from an automation standpoint. And so we have over the course of the last 15 years or so, we've been in automation much longer than that, but we have accelerated our footprint in looking at adjacent capabilities that continues to build out how we introduce automation to our customers. And so as we differentiate ourselves into a market that we know is going to drive to accelerate and grow, we like to talk about growth of 2x core welding market. And that's built out into our long-term operating model. We have set for us a long-term target of having our automation business to be USD 1 billion in revenue by 2025. And that's a combination of organic growth as well as through our acquisition strategy. And we've been very much in acquisitive mode in the automation space for some time now. But think about a business that in 2020 was USD 400 million run rate, 2021 USD 500 million, run rate, this first quarter we're at a USD 600 million run rate, and we have a very focused agenda to drive the kind of execution that's going to expand our margin profile within automation, yet capturing market growth, organic growth at 2x the core welding market, and then continuing to add on acquisitions on top of that. It's been a journey where we have grown with an integrated approach within our business in developing a business through acquisitions that complements our capabilities from robotic technologies into material handling and others that allow us to drive through broader solutions from an automation space. And so with that, we went through a journey that required us to think through our business model, think about what's the margin profile, how do we position ourselves for an expansion of our margin profile. We had been talking about targeted EBIT margin profile into that mid-teens where we started the year out this year in a low-double-digit type profile and margins. The largest portion of our business in automation is in the Americas, although you've seen acquisitions also tied on the international markets. But as we're continuing to grow and think about our customer profile, it is about that automation space and how do we deal with some of the broader demand drivers of labor and manufacturing upgrades and productivity. But we're very much on a path on the long-term growth as well as having a business model that ties into our objectives.

Are there certain industries that are sweet spots for Lincoln in terms of automation? And then if you think longer term, where can automation go? Can it go across multiple industries?

Yes. So if you were to speak to us a few years ago, you would know that we had a much larger concentration in the automotive space. And we've been very intentional about broadening the footprint of the industries we serve. So now we're probably more like 1/3 of our portfolio that's tied into automotive, although continuing to grow. Very active in EV investment, very active in the traditional upgrades the automotive industry is doing from a capital standpoint. But we have grown in general industries. We introduced last year a Cobot, which is a much more simplified way to introduce robots -- automation and robot into small- and medium-sized fabricators. So we're pretty excited about what that does for us in broadening our footprint. We're deeper in heavy industries. We acquired a company out of Europe last year. It was big into structural fabrication. So we have broadened the footprint intentionally, so we're not concentrated in one particular industry. But the adoption in automation we know will continue to grow, and it's a key driver to the long-term demand profile within the welding industry, and we are confident that as the leaders in this industry in automation that we'll continue to drive that kind of footprint.

Great. Then finally, Bull Case #3. Brand loyalty in welding is high and Lincoln has differentiated brand-building initiatives in its welding schools and training products and programs, which expose young welders to the Lincoln brand early and create customers for life, which represents a significant off-balance sheet asset that Lincoln can continue to use to drive share gains over time.

So we're very proud of our positioning and our brand in the industry. When you see a red welder, you're going to think Lincoln Electric. And that starts off as this is strategically important for us to be able to train young, new welders into our products and offerings that become a meaningful part of how they grow into their experience in welding. We have a state-of-the-art facility, welding technology and training center in our headquarters. And we have the oldest weld school in the industry, over 100 years old. And we invest in ensuring that the opportunities for new welders have such experience with our red equipment and our consumables and our solutions so that they become brought into our strategy over the long term. That said, we also have for professionals that are deep into various industries training and upskilling skills opportunities for the various professionals in the various industries to come back and do training across them, whether it's energy, oil and gas type training or OEM-specific type training or distributor type training. We know that the more that we can do to foster the understanding and the upskilling of the welding experience is important. And being trained in our Lincoln products and services and tying back to that discussion on productivity and having the welders and those who are having the impact of joining the [indiscernible] understand what the solution means from a Lincoln product standpoint is important for us. We have -- I mentioned the Welding Technology Center we have at our corporate headquarters, we have 39 facilities around the globe from the U.S. to Germany to Singapore to China, and the intent of those technology centers are to engage our customers, to understand what kind of solutions that we have available to them, and to see how that fits into improving their own productivity. So the training in the schools and training into the industry becomes a key differentiator for our business model. And so as we think about red welders and what that means as an experience, that becomes a long-term tie-in and the stickiness of identifying with the Lincoln experience.

All right. Well, that concludes today's presentation. Gabe, I want to say thank you once again.

All right. Well, thank you, Adam.