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

All right. Great. Well, thanks, everyone, for joining us again. My name is Adam Seiden the U.S. machinery and construction analyst, if I haven't met you. For this session, we are pleased to have the folks from Lincoln Electric with us. Joining us is, Chief Operating Officer, Steve Hedlund; and Gabe Bruno the Chief Financial Officer of Lincoln as well as we also have Amanda Butler in the crowd from Investor Relations. So the format of this chat is going to be a fireside chat with myself, Steve and Gabe. We will take some time to do the audience response questions towards the middle of the session as well as then wrap up with any audience questions that you may have. So for those that were just in the room, I hope you like the new set, and we'll get started here. So guys, thanks so much for joining us.

Sure, Pleasure to be here. Thank you.

Great. So Steve, first time that, I guess, that we've had a chat in this setting here, I was taking a look at your bio, and I couldn't help but notice that it feels like you've run just about every business at Lincoln Electric. So I mean to you, what would you say stood out the most within the businesses? What's the lasting impression for you ?

Adam, I'd have to say that around the world, the Lincoln Electric teams are very dedicated to the company and very passionate about helping customers solve welding problems. And that's really uniform across the world, even though they are obviously very different cultures in Europe versus China versus South America. But the dedication of our employees really is what impressed me the most.

Yes. And your employees do a good job in executing. And that's going to be 1 of the transitions here for ourselves, I want to spend a little time talking a little bit about your comfortability around the cycle and the longevity of the cycle because I think on an execution side, your employees, yourselves, you've done certainly a very admirable job around that. So if you think about Lincoln's business, right, it's a very good tie in to the broader industrial economy. You have a lot of diverse end markets that you're playing in. Some of those high-level indicators that folks look at have been trending in different spots and so forth versus your very, very strong performance. So what to you, do you think has been different about this cycle and the way you guys have been able to execute and so far?

Well, I think as we move through this part of the cycle, we have constantly compared back to 2019 from a volume perspective. But you have to remember that 2019 was not a great year for industrials. We are entering a recession in the second half of the year. So as we look at it, we haven't gone back to peak yet. We're still on the upswing. We look at the end market demand and a lot of our industry segments is very robust. There's a lot of secular tailwinds that are driving investments in EV infrastructure for the automakers as they make the transition from ICE to EVs. There's a lot of investment going into energy and renewables and the like. So I think where we are in the cycle is a pretty comfortable place. Gabe, Do you want to comment further?

Yes. So just to piggyback on where you see peaks at. So we're seeing, as you've heard us, a lot of strength in the Americas, and it's broad-based. And when you think about going back to 2019, we said we were at 2019 volumes, but the mix is different. America is on top of it. The automation component of it has been accelerated to volumes international still about 5% behind 2019. So we're actively monitoring and you point to a lot of the broad metrics, and we're very much on top of it, whether it's the general industry, heavy industry, automotive. And we finished what we can see. We can't predict the cycles, but we have a robustness and look pretty excited about.

Got it. And just on the call the other day, you guys were talking about the robust backlog -- that you have today. So how much of that elevated backlog that you have, would you say is tied to those demand -- the demand picture versus how much is related to some of the supply challenges that everyone has been kind of dealing with for some time.

Yes. So I would just emphasize that with the mix of business, it's a natural part of our automation business that we have backlogs tied to the strength of orders and automation side? We still have challenge in our standard equipment supply chain. So we have a level of backlog that remains elevated. Because of that, and we continue to work through a lot of dynamics. On the consumable side of our business, though, we're seeing a lot more stability for well than it is in order to ship type of a business. But we still have some room to progress on the equipment side.

And on that progression, I thought I kind of comment from Chris talking about -- that he's optimistic that he could see some acceleration through the year in the Americas side. So you talked a little bit about where the end markets stand versus -- peak and so forth. But curious like which end markets would be driving that acceleration as we get through the year in America.

Yes. So I'd point to first broadly, general industries, while it's been relatively stable since the middle part of 2020. We were up in the fourth quarter, but more stable -- [ results ] part of 2023. You also have fundamentals around heavy industries and automotive with strong demand profiles at least what we can see through for the mid part of the year. So -- and then energy, energy still has a long ways to go before getting back to the peak in 2019 and that the fundamentals continue to be strong. So the dynamics of what we see across end markets are strong still. And we see upside potential with continued demand on the consumable side, standard equipment at very, very high levels of orders that extend beyond the first half of the year. So we're pretty well passed through drive demand profile.

That's good. And so that covers the demand picture, I guess. So if we think about the other side of the organic growth equation on pricing, right, very strong pricing fundamentals out there in the industry, and you guys have been very successful yourselves. One thing, I think, from the investor side we try engage is how much of your -- how much of this industry or even your sales pricing ability is tied to your own customers' ability to drive through the value chain and so far?

Well, just to give you the big picture first, and you talked about an organic assumption in the mid-single digits, half of that being priced. That's the progression of pricing and that's just taking to date. But we contemplate pricing actions and responsive to the inflationary environment that we have. And so you'll continue to see very disciplined price/cost neutral posture in how we manage price. And largely, the channels are very disciplined in knowing and driving in the place [ or presence. ] We think by distribution, they'll be very disciplined in that and that environment also very disciplined functionally managing through inflationary pressures. So we respond to what we see, but we maintain that price cost mutual -- posture.

Got it.

Adam, I'd also keep in mind that for a lot of our customers, welding is a very small part of the raw material spend -- and we focus a lot on the total cost of ownership with Welding. If we were charging a premium price for a consumable, but that consumable allows the customer to be a lot more productive that's a trade-off that they're willing -- in the environment we're in today, labor is still extreme. And so productivity solutions that allow customers to be able to meet their productive objectives with less labor has a lot of appeal.

Got it. Got it. So key then, look, you're saying it's a small part of the overall cost bucket for some of your customers and inflation certainly has been some of the driver around pricing. But looking at the pricing connector large customers, you wouldn't -- that's not necessarily the best indicator. Could you say.

No, I wouldn't think so I would rely entirely on that.

Okay. So -- I think one of the key questions that where a lot of folks are trying to answer at this conference is with the strong pricing momentum that's out there in the industry, the broader industrial industry. Does this -- does this -- the prior -- or I should say, the pricing environment in the last 2 years, does that have any effect on your ability to get pricing -- has there been any sort of -- go forward? Or -- how do you see that playing out over the next couple of years?

I see us maintaining that same price cost neutral posture. I mean you've got long history of a very disciplined business and how we execute and we're going to maintain that posture.

Got it.

There was very little pull forward in demand in our industry. The channel -- the main channels don't stock a lot of product other than perhaps the retail big boxes -- our customers don't tend to buy forward and forward [ materials ] and try and price time in the markets. And if they need the well, they need our products. As Gabe said, we'll continue to price to offset inflation to remain price cost neutral.

Got it. And on those backlogs that you were talking about earlier, and I think, Gabe, you made the point about automation, how -- just could you give us -- give us a sense of when an order comes into their -- sits in your backlog? Are there any escalator -- de-escalators on the raw material environment or other sort of pricing conditions in there that we should think of?

Yes, the automation side, our teams are very much targeting to tighten that material, the procurement parts -- or the parts -- components of projects to the overall costs that were built into the project. So we have very much discipline to make sure we don't have inflationary pressures that lead into the margin profile of projects.

Got it. Now I think we probably beat the pricing, sorry, with the [ debt or is it the year ] . So maybe if you shift over to margins, right? You guys gave pretty good color on where you see the margin trajectory for this year. and ultimately, Harris International, it means that they'll be relatively stable steady to improving performance certainly in the Harris case. In the Americas, though, the margin guidance implies you're saying at the around the balance at the high end, maybe even a little -- potentially even a little lower. I just wanted -- I guess, maybe the question is, can American margins grow year on year given that range that you're going to be within the 2025 targets?

Yes. When you think about Americas margins, first of all, the demand profile would suggest for you maintain that kind of mix of what you see. Now there is a pressure on adding the 4 business into the Americas segment. We estimate that if you just take the assumptions of 75% of [ 4 years ] tied to the Americas at that low double digits, maybe 50 basis points up of an impact on the EBIT profile. But we continue to drive improvements in the automation profile through our Lincoln business system disciplines surrounding automation. So I mean there is upside opportunity, but we'll have some offsetting pressures from Fori.

Fair enough. And maybe, Steve, just -- or and also for Gabe, when you guys came out with your '25 strategy, there was about a 500 basis point delta -- in the midpoints of your 2 welding regions -- based off of some of your own internal execution and focus and so forth. Has there anything that's changed over the last 2 years here that would shift where that margin gap would be between those 2 segments?

Well, I think it's important to understand when you look at the international business, about 3/4 of that is Europe for us. And Europe tends to operate as a very high fixed cost environment with the labor policies. So it tends to have very high incrementals when the business is growing, and it tends to have very poor [ debt miracles business] and shrinking. The market is very fragmented there. There's a lot of small private manufacturers in the market that, that don't have the same sort of margin ratio goals that a public company has. And so one of the challenges we have is when the market there gets soft, you see a lot of price competition in the market as people are trying to maintain volume to keep their factories running. So that's sort of the structural difference between the two and now a lot of the work that we've been doing in the last couple of years is to change our cost structure in Europe to move more of the production east of Western Europe to give us more labor flexibility to have lower on average labor wages and to rightsize the portfolio there to the demand profile that we see. So as we look back at 2022, one of the drags that we had in that business was we were probably overcapacitized from a late point given the demand volume that we saw. And as we are trying to reduce our inventory levels towards the end of the year, you have a little bit of a double whammy of soft demand, a little bit more capacity than you need and you're drawing down production to draw down inventory. So we expect that will all correct in 2023. And then we're looking at the potential need for further restructuring actions to continue the journey on getting Europe to be at the right cost.

Great. And that explains international markets and -- going forward and your trajectory going forward as well for '23. Maybe just for broader context actually for the audience, can you remind us the split of that international business that where it sits between Europe versus APAC versus or India versus APAC? And then specifically calling out within APAC, China, how much of that is China?

Yes. So APAC, Europe represents about 25% of the international business, overall. China is about 5% as -- consolidated -- pretty important how we progress the business. Back to Steve's point, when you think about 2022, I mean, you were at the 12% EBIT profile for international. And that's really good progression and working in that international. So our teams are very focused on what are the things we need to do to shape the model, considering all the uncertainty and dynamics where there's production inventory levels on that. but our team is very much focused to increase it to 12% - 14%.

Got it. And I hate to take time for just 5% of the business, but I do have to ask the question on China because clearly, we've seen a shift in -- a reopening here in those markets, and those are markets that are broadly been under pressure for China. So just curious, when you look at for yourself, how -- have you seen any change command in China since reopening, it's early days, but more so just trying to think of like the makeup of China, who your customer base tends to be and how that may influence what sort of recovery into interim plans ?

We're heavy into automotive, heavy industries in China, and we do believe there's upside in time. I mean 2022 as we know, a very difficult environment -- aside potential in China.

We also take very disciplined approach to China. We serve primarily multinational customers that manufacture in the 2 industry segments that Gabe mentioned. We don't do a ton of business with the local manufacturers in those product categories because it tends to be heavily price driven. So we're working with the customers that appreciate will pay for our value. We also have a very large business importing high-tech products that we make in the U.S. or in Europe that might have specialty applications around energy and the like. Those are products we don't make in country for IP reasons, but we have.

That's helpful. And then maybe to conclude on the segment here for a second. Just on Harris. You guys had been speaking about a bit of the stocking that you expected through an -- it seems like that materialized, just curious on your confidence that we've done past that for in '22 and ultimately in '23, we can see a bit of that recovery here.

Yes, that is as mentioned, Adam, was one of the challenging areas in their business in Harris. But we're fairly confident that the larger given traction the fact that are behind us. That's still yet to be seen. But we're more confident that we're back into that EBIT range that we think about. So that's tied into -- into metals, retail -- additional strength -- we should see strength in the springtime. So we're back into the range. And we feel that our business will be positioned to as some of the volume adjustments that we went through in 2022.

Excellent. So at this point, we'll pivot to the audience to questions good. So the first question here is, do you currently own the stock? One: Yes, overweight? Two: yes, market weight? Three: Yes, on the weight or no?

By model.

There you go. Next question. What is your general bias towards the stock right now, positive, negative or neutral? Okay? Fairly even split as well, but more positive. Next question, please. In your opinion, through cycle, EPS growth for Lincoln would be above peers, in line or below peers?

Yes it is.

Next question, please? This is Gabe's favorite question in your opinion, what should -- I can do with excess cash? Both on M&A, larger M&A, share repos, [ divis ] debt paydown and internal investment. Okay. Fairly even split here with repos a little bit larger. Moving to the next question. In your opinion, on what multiple of '23 earnings should link in trade. These are standardized ranges across the conference, but less than 10x and -- a little higher than 21x? Nice stair step up into the '19 to '21 times count. Moving to the second last one here. What do you see as the most significant share price headwind facing Lincoln today? Core growth, margin performance, capital deployment or execution. I hope they don't say execution by the way. There you go. I influence the audience. Core growth is number one. And then last one and new to this year is, does ESG play an active role in investment decision relating to the company? and they probably want to know this one.

Yes.

ESG is part of that and then there's some no answers as well. Okay.

Relatively even split a few more on the new side actually.

Okay. Great. So thank you very much for your participation there. Hopefully if we can shift forward here on automation, so you provided some standpoint automation you gave where your sales were. Just curious where your margins ended up for 2022, just given -- I know there's a goal of trying to get that into the [indiscernible].

Yes. So we ended up low to mid double digits, so very nice progression within our business. That's almost 100% improvement margin profile, but very good. The very the business is progressing to the longer-term targets, which is in that corporate average exceeded double digits teens, so we're pretty excited where the business is progressing.

Great. And you talked a bit about your guys' ability to exceed the $1 billion. Your confidence is to exceed -- $1 billion. you're adding [four in to that. ] But going forward, is that a goal on an organic basis? Or is that including future...

Look, we always look for opportunities if you look at bolt-ons that seems to take the organic assumptions we have in automation, you see us getting pretty close to that. And you were talking about where we were tracking at the 650, half of that would be upto through organic growth and half is [indiscernible] math where got out of that half it forward. you did.

So maybe let's touch on for then, right? So Fori is a little bit different of an automation solution than -- I think we've seen in the past from the outside. So -- can you maybe talk a little bit about automated material handling? And ultimately, are there synergy opportunities with some of the more welding solutions systems business that they have there.

There's 3 things that we really like about the Core business. The first is they do larger line builds, so people who are retrofitting an entire factory, let's say, as opposed to individual cells in the factory. So they give us the ability to do much larger projects. They have a nice international footprint. Most of our automation business is North America focused. So they have a nice footprint in Korea, China, India, Europe and Brazil, which we can leverage. And then the thing that we're probably most excited about is the automated material handling so that the AGVs or automated guidance -- most people might look at that and say, where is the excitement AGVs have been around for decades and warehouses. What they make is an AGV that is specifically designed to handle very large heavy unbalanced parts, move them through a factory and align them very precisely at the next stage of -- and they have done that repeatedly in the automotive industry, but they haven't had any real reach outside that. So we look at our customers and things like heavy industries and structural steel, that's a big issue being able to move parts from one station to the next. And to date, their only real option has been overhead trains. And so this gives a much more flexible productive solution. We're seeing great interest from customers outside automotive in those solutions.

Helpful. And maybe to wrap up here just on strategy. So on the call, I think there was a comment that you guys are thinking about your -- the next phase of the strategy for or -- and when I think about higher standard '25, to me, that was a bit of a step as opposed to necessarily a pivot per se. I don't expect to breaking news here, but ultimately, would you anticipate that the next strategy is a bit more of that more of that -- or that step? Or can we see something there like a pivot going from there?

You start off?

Sure, I would say I wouldn't expect to see a big pivot. I think it will be a lot more than the next step in our journey -- and it really will come down to continuing to improve the performance for welding business and trying to drive above-market growth and improvement in earnings -- generation of that business, continuing to mature the automation business. And we think automation has a very long runway. Automation originally started in this industry is trying to tackle the really hard jobs for a human to do and replace [indiscernible]. We're seeing a lot of interest in. I just want to eliminate labor in total. I can't get labor. I can't find reliable, high-quality trained labor. So looking at things like machine [tank], which is a fairly simple operation for a human, but is a more difficult challenge for a robot. So we think there's a lot of places to take the automation business where there's good differentiation and capabilities and good profit pools. And then we've got a couple of bets that we've made that really give us some optionality around EV chargers and around additive manufacturing. And so we look to see the additive business mature and hopefully become a nice profit contributor for the company. And then the EV space is something that we're rushing right now to participate in and have cautiously high expectations. Let's put it that way.

And I would add. So Steves talked about how do we drive accelerated growth and really leverage the capabilities we have as a business and integrate multi-focus on growth. But we've also continued the discipline around shaping our business model and think about this cycle strategically, and we're looking to drive 200 basis points expansion in the operating profit profile of our business. And that's been a pretty steady progression over the last 15, 20 years of continuing to shape our business -- to drive a model that adds more to an operating profile, and we'll continue to do that. So as we progress into the next strategy. We're going to be challenging ourselves but we're the -- were another 200 basis points type opportunities for us to continue to shape the business. So that's always an area for us to shape.

Got it. That's great. So I guess we'll all stay tuned and see how it shapes out there. But I think we're out of time here. Thank you so much for joining us and to Lincoln Electric team. We really appreciate you being down here.

Thanks for having us.