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

Good morning. My name is Saree Boroditsky. I cover multi-industrials here at Jefferies, including Lincoln Electric. We're super excited to have Gabe Bruno, CFO of Lincoln Electric here with us today. We're doing a fireside chat. [Operator Instructions] So thanks for coming.

So I guess just to start with, during your earnings call last week, you talked about being in the early innings of an industrial cycle. What are you seeing in some of your major end markets? And what gives you confidence on that growth outlook?

Listen. Thanks, Saree. Great to be here for all of you as well. Thank you for your interest in Lincoln Electric. So we've been -- our tone has been pretty bullish in how we look at the end markets. And as I walk through that, I always, first of all, think about where is the company in the cycle in the context of 2019. So 2019 levels, we have not yet hit yet. And we're progressively on track to arriving at a volume -- level of activity commensurate with 2019. 2019, if you all remember or tracking, the European markets were largely in a contraction. The U.S. markets in the middle part of 2019 started a contraction. So then as you turn to the context of where is the broader business and then where are the end markets, we see there's a lot of potential upside with automotive. You think about production levels and targets to replenish inventories across that industry. We still see pretty good momentum currently. You think about heavy industries. A lot of pent-up capital investment tied into mining, ag, heavy construction, very high levels of backlog. So we feel there's a lot of momentum also in heavy industries. General industries since the middle part of 2020 has been relatively stable, a little bit ups and downs. If you think through, what we all track, PMI and industrial production. But general industry seems to be holding up fairly steady. And then we've had really good momentum in thinking through structural fabrication, nonresidential type of activity. And that's just been strength over the last couple of years. So we're pretty bullish on that. And in energy, about 2/3 of energy is tied to oil and gas. And then we have the balance in power generation and renewables such as one in that. And we just think there's a lot of potential upside in demand. So that's what gives us a bullish tone when we walk through the end markets, knowing we've got some positioning to get back to 2019 levels. And then lastly, I would say, with those dynamics, there is the regional risk profile. And we did comment on that on our call, and that includes the European markets. A lot of dynamics there. We're just going to have to navigate over the next -- this month and additionally in July, August and just navigate understanding where is the demand profile after the normal seasonality shutdowns progress within the European markets. But in general, there's just strong fundamentals still underlying demand drivers within the end markets. And that's what gives us a bullish tone.

The revised Build Back Better bill includes incentives for financing, domestic manufacturing of things like wind turbines among other funding targets. Could you just talk about how Lincoln could benefit from some of these initiatives?

Yes. So we know there's going to be a lot of investment, right, with the bills that have progressed through Congress. And let's see how this one -- the latest Inflation Reduction Act plays out. But we know there's a lot of investment that are broad-based infrastructure as well as into energy and climate and those dynamics. And we feel we're well positioned to participate in our fair share and accelerated growth in different pockets. We have solutions that are tied into wind, for example. And as the markets continue to drive investment into wind onshore, offshore, we believe we're going to get our fair share and some in the growth opportunities there. We're also deep into servicing EV. When you think about automotive and the investment, that's progressing, to continue to expand both within industry as well as government incentives. We feel we're very well positioned to engage in the EV side of things. So a lot of investment obviously into the markets. It takes some time to work its way through. The Build Back Better, for example, we have been talking about potentially seeing accelerated impact towards the end of this year, construction may be into next year. But we're very well positioned to gain our fair share of activity.

Just briefly, you mentioned energy earlier had been performing, seems to be coming back pretty strong. Where within that are you seeing strength? And could this help support volumes in Europe if we do see some weaker recessionary expense there?

Yes. So when you think energy broadly -- I mentioned 2/3 of our energy is tied into oil and gas. The dynamics, we've always talked historically of what are the drivers of investment. And they haven't necessarily followed that dynamic over the last year or so with the price of oil and that. But in general, we do see, for example, midstream progressing. We're not back into the 2018, '19 levels of activity. So that's what gives us a bullish tone on where we see even investment in oil and gas. But we do expect that to continue to expand. Then we have the power generation renewables there. And we're pretty excited about particularly the wind and the welding solutions that are tied into wind. So we're very well postured on the energy side.

Switching to automation. Sales were up mid-20% in the quarter. You discussed seeing some very strong quotation activity. What end markets or regions are really leading in the demand for that business?

Yes. So to start off, so I'm going to give you a big picture trends, automation. In 2020, where we're tracking about $400 million of sales; 2021, $500 million. We're tracking now $600 million plus. So very good activity. And we go into the third quarter with record levels of backlog. So we've got just a lot of momentum activity surrounding our automation business and strategy. Our targets are to target revenues of $1 billion by 2025. So $600 million tracking 2022. $1 billion target, we expect about half of that to be tied to organic growth. And we typically think about high single digits, low double-digit type organic growth on the automation side even though you're seeing a much more accelerated organic growth in this last couple of years. But that's our posture in organic. And we'll continue to look to acquisitions to continue to drive growth and positioning in the market. So that's how we get to the $1 billion. One of the things that we've done intentionally is we've diversified the end markets that we serve. So if you go back a couple of years, you would have seen much more concentration on the automotive side of the industry. And that continues to be robust. We continue to see that particularly with EV being also another accelerator. But we're more balanced. About 1/3 now of our automation business is tied to automotive, about 1/3 now into general industries. And we've introduced products to enhance adoption of automation capabilities, for example, cobot. We introduced that as an entry point for small to midsized fabrication. So you see a much more broadening footprint around -- amongst channel industries. So I think third automotive continue to be strong, accelerated investment, particularly when you look at capacity drivers, EV, general industry and the adoption because of some of these key secular trends on labor needs, skill labor, productivity, capacity requirements, generally speaking. And then you have heavy industries and energy that kind of balances out the remaining 1/3. So we're very well positioned. We broadened our footprint in the markets that we serve, and we're well positioned for growth.

There's been a lot of talk about reshoring or labor shortages. When you talk to your customers, are those sort of things driving continued demand in automation?

Sure. So I touched on labor, for sure, labor and productivity, skilled labor needs particularly in welding are going to continue to drive demand. But there is a dynamic and we have lots of conversations on reshoring, onshoring because of the pressure points that the global supply chain has introduced over the last couple of years. So we believe there'll be a continuing trend to move some capacities into, for example, the North American markets. And our largest positioning on automation is within Americas. So 75% of our sales for our automation business are within our Americas segment. So we feel that those drivers will continue to drive key demand within the automation sector. So we're pretty excited about those as being additional accelerators.

I think cumulative pricing is up almost 30% in America since 2020. How are you thinking about additional price increases today? And just given the magnitude of recent price increases, how do you think those will hold on if you start to see commodity prices come down?

Okay. So in pricing, so our posture is to be very much a price cost neutral position, very disciplined. Our teams are very much on top of what we've seen in terms of cost trends and then we're responding to it in price. Price cost neutral is our position. We're still operating in an inflationary environment, right? I mean if you just look at the producer price indices, CPI, we're not out of the woods broadly, I believe, not just Lincoln but the whole market on inflation. So we'll continue to manage as we have in an inflationary type of environment. So that is the broader picture, short term. Longer term, and we have a track record, a long track record of maintaining our pricing position over several quarters. So that is our posture. It is anchored on a price cost philosophy being neutral. But we'll continue to be very disciplined in managing price cost.

Now Lincoln made the decision very early on to add an inventory in the pandemic to make sure you had products available to your customers. Where does that strategy stand today? And how do your lead times look?

Okay. So I would start off and just remind our investors that we are a top decile performer on working capital and our targets are 15% working capital to sales. And that's been just a lot of fundamental changes in our business over the last 20 years with investments in systems, process capabilities. So we remain very disciplined on that. We did intentionally posture to invest into inventories with a customer-first type of philosophy early on. So this goes back to the beginning of the pandemic, April and May. We've spent a lot of time debating what risk profile we're potentially seeing. And we decided we needed to invest. And I think that was the right business decision. And I think it's proven itself out over time. We invested in raw materials that are broad-based, not just core steel or chemicals and that but components. And we continue to see challenges on the supply chain particularly on the equipment side of our business. There are just so many more components that are required to be able to build a power source for welding. So there's a lot of complexities there. And the issues change week-to-week, month-to-month. So we'll continue to maintain that posture. We are seeing more stability on the consumable side of our business. And so that will continue to evolve. But we'll continue to see pressures on the equipment side. I will tell you that I'm very active with our business teams in challenging kind of how long do we maintain this posture. We will continue to maintain that posture for some time. But I am starting to have conversations about certain parts of our business and kind of returning -- what it means for us to return to our historical top decile performance on working capital and management. It's really an inventory conversation. Very healthy on DSO, payables, but it's on inventory we need to take a look at that longer term.

Sticking with top performance, I want to talk about your margins and the targets you put out there at the beginning of the year. Starting with the Americas, you have a target of between 17% and 19% through the cycle. You're at the very high end of that currently. Is there anything nonrecurring in your current margin performance? And given how you performed so far this year, how do you think about the upper range of that?