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

Good morning. Welcome to Day 2 of the 18th Annual Oppenheimer Industrial Growth Conference. Next up, we have outperformer, Lincoln Electric, represented by CFO, Gabe Bruno today. Good morning, Gabe.

Good morning, Bryan.

For those a little less familiar with the Lincoln story, maybe provide a quick intro, history of the company, overview of your current reporting structure and strategic priorities.

Sure. Thanks, Bryan. So glad to be here today, Bryan, and those interested in hearing the Lincoln story. This year marks our 128 years in business. And so we are the global market leader in arc welding, cutting and automation solutions. And so very well recognized brand in our industry with a broad footprint around the globe. When you think about Lincoln, you think about the welding experts, deep technology footprint, anchored around keen knowledge in metallurgy in software in electronics, and how do we provide capabilities to enhance the productivity and efficiency of our customers. So very much a solutions application-driven technology company. And so when we think about productivity and the introduction of new products, we like to emphasize the metric that we call a Vitality Index and give you perspective, the velocity of new product introductions. In 2022, 57% of our sales and equipment were from new introductions over the last 5 years. And I say that to emphasize how we anchor in our capabilities to be able to introduce new ways to drive productivity and efficiency within the welding experience. So we serve a broad end market base in various industries, and we tailor our solutions to be able to be responsive to what best fits the industries from the welding application standpoint. We have very much a structured strategy that emphasizes how, we're going to grow and grow in what we have defined into the high single-digit, low double-digit type of trajectory. We also are very disciplined in thinking through how we continue to shape our business model. And so we translate that in results of our operating profit. So we have defined -- you can review our investor deck and our website, but we have very structured peaks in this strategy cycle that we believe differentiate ourselves in the marketplace, to drive accelerated growth, to look for opportunities, to continue to develop our business through acquisitions. And to do it in a very disciplined way measured through metrics like an operating profit or a return on invested capital, which is a top quartile type performance. So we look to a very balanced capital allocation strategy and very much a high cash-generating business and a focus on the long term of cash conversion ratio of 100%. So that's a little bit background of our business.

Excellent overview. You mentioned kind of the technology underpinning like -- and that's been part of our thesis. We think it's still pretty broadly underappreciated. We'll certainly hit on some of the key points there. Also mentioned the relatively broad end market exposure that you have. Perhaps walk through key end markets, where you're seeing the greater strength, what are areas of relative weakness, how you see markets progressing through '23.

Yes. So I'd like to walk through this in terms of the biggest -- smallest parts of our end markets. And we think about the trajectory of our business over the last couple of quarters, I mean, 85% of our end markets have continued to be in a growth mode. The largest part of our business, we define within general industry, so almost 1/3 of our business tied to what we define as general industries. And that has been relatively stable strength over the last few years. As we know, key measures like industrial production or PMI are key market indicators to give the perspective of what's happening in general industry. And so we're pretty pleased that we continue to have growth in this first quarter. We're mid-single digit type growth in general industries, pretty stable level of demand. And so despite a lot of the challenges that we read about in industrial production or PMI, we continue to see the stability. So that's a good driver -- a significant driver to our business, so that's been pretty positive. When you look at now heavy industries or automotive, which represents about 19% each of our business, we think about good tailwinds that have contributed to a nice backlog and a nice order pattern. Heavy industries, for example, this is servicing a lot of the big players in heavy construction or large ag or in mining, and that, also continue to see very strong momentum. We're up in the low teens and entering the second quarter, again, good level of demand and backlog to service that part of the market. So we continue to be pretty well positioned in how we see heavy industry is evolving. We still have some room before we believe we're going to hit our peaks that we saw in 2019 in heavy industries. So we're pretty positive on how that positions us. And we do play it [ close eye ] as we all read about some of the big players in this market and what it means into the next 12, 18 months, but our current position is pretty robust. Then you've got the automotive side, and I think about automotive from an industry standpoint in a broad way. You've got real activity in the short term, that means how are we servicing production to meet demand on the automotive space. And we all know about what has -- how has inventory positioning had a real impact on production. So we continue to see strength there. Again, first quarter, we were up in the low teens and with good momentum. One of the key indicators, short term, for us is keeping an eye on the inventory levels. And so we don't believe as the market has -- the industry has outlined that the industry will go back to pre-COVID levels, and I think they've reached an interesting balance in how the industry looks at inventory levels. But consumer demand has been relatively steady, considering increases in interest rates. And so we see continued strength in the automotive industry as we enter the second quarter. And then we think about energy. Energy is about 16% of our business as we estimate, and we saw very good strength up in high teens in this first quarter, good momentum, big demand entering in the second. Oil and gas represents about 2/3 of energy. And so we saw good strength there. I mean we're positioned in renewables, like, for example, wind applications that are specifically tied to technology offering that we have. So we see good potential on wind renewables as well. Where we've seen a little bit more pressure is on the structural infrastructure side of our business. And that's -- it's been down the last couple of quarters. I think some of that, we believe, is market driven. I like to track things like Architecture Billings Index as an indicator, but we also have some choppiness that represents some of the project work that we do, do in this end market as well as tough comps. I mean we've had a very strong run in this space over the last 2 years through COVID into 2021 and 2022, so with tough comps, but we feel there's still some strength in the market, and we'll see how project-driven type activity progresses in the months to come.

Understood...

That's a broad view of the markets.

Yes, I appreciate the walk through there. And I guess same question on geographic trends. Most exposure in the Americas that's been -- in the region, quite impressive growth in region. International has actually felt a bit better than I anticipated at least. Just curious what you're seeing regionally, the puts and takes, and how you see the trend shape.

Yes. So let's start with the Americas. We've seen very robust activity. Our volumes were up 11% in this first quarter with strong momentum into the second. So Americas continues to be very robust. All the product lines have been -- are up. The automation component of Americas have been very strong with record backlog levels. Think about the automation business now that's running at a $900 million clip. And with 75% of that business has been the Americas segment. So very strong momentum on the Americas side, which is very broad-based. And so we're pretty well positioned when you think about the momentum into the second quarter from Americas, the highest margin part of our business, and so we're pretty well postured there. On the international side, yes, you're right, Bryan. The activity level was more stable than you otherwise think, considering what we're seeing on the industrial side. But we saw some strength across Asia. Middle East has been relatively as strong. A little choppiness in Europe. There's a little bit of timing of impact on business activity in Russia and year-over-year and some timing of projects. So we feel that the European context is more stable as we go into the second quarter. But those are some of the areas that we're watchful of. If you remember this time last year, China had some lockdowns progressing into the second quarter. So China, easier comps. That's less than 5% of our business, but when you think about year-over-year, you should see a little bit better activity in China. So we're tracking the industrial space, as you can imagine, pretty closely in China. But that's kind of the puts and takes on the international side. And then on the Harris side, all of the pressure on volume is driven off our retail business, which is our sales -- consumer-driven type sales to the big boxes. And that has, over the last few quarters, been weaker. Last year's first quarter was very strong. So the comps are pretty challenged on the retail side. But there's a dynamic there of real demand, but also inventory corrections and adjustments to stabilize big boxes to the demand level they're seeing. And so we're hopeful that we've gone through the larger portion of any inventory adjustment on the retail side, but we're looking for more stability there. But all in all, outside of that, been relatively stable on the Harris side.

Okay, understood. Setting aside automation for now, it certainly deserves its own discussion. Maybe walk through Lincoln Electric's exposures to some of the other mega trends in terms of industrial spending, re-shoring infrastructure spending kind of the broadening wave of electrification. From our perspective, your team is pretty attractive in -- likely accelerated exposure in each of those areas. Just perhaps touch on that, and what you think the opportunity set is going for...

Okay. So let me talk about the mega trends there first, Bryan. Then we can talk about automation or we may leave that in and speak specifically...

Let's leave automation out, I guess, for now, and we'll focus on that more singularly.

Okay. All right. So let's talk about some of these mega trends. So a lot of conversation as the challenges in the markets and supply chain has pressured industrial markets, us, others in the industrial space in thinking about supply chain. And obviously, we've lived through a quite challenging environment. I mean our posture was to make sure that we minimize any risk of customer disruption. And so we were intentional in building up inventories to respond to that. But with that dynamic, more and more challenging the thinking of, do we need to rethink supply chains and think about near-shoring or re-shoring to tighten up the ability to respond to shocks into supply chain. And so we see some of that, but it's very hard to quantify what that means into incremental capacity. But we do know this, that the largest driver, we believe, will be is in some investment in the Americas. And obviously, that's the biggest part of our business. And so whether it's a dynamic in North America, we're looking at capacity in Mexico to support the U.S. or Canada and looking at that dynamic through South America, I mean we -- our footprint here is well positioned to introduce automation solutions to support labor challenges in re-shoring or near-shoring and participate in what should be a tailwind for growth in the long term, again, has been responsive to looking at supply chain, looking at other capacity constraints in the market. Then when you go to infrastructure, we all know there's been a lot of bills passed, a lot of money being invested in kind of updating infrastructure. And we estimate that about -- some of the studies we've done internally, that about 10% to 15% of our sales or revenues are tied to -- direct or indirectly, to infrastructure, renewables, electrification types of investments. And so we believe that while the administration has taken some time to look at projects and investments that will begin to accelerate, and so we'll be participating as fabrication needs progresses with an infrastructure type of tailwind. So I think that's more ahead of us in looking at the acceleration of infrastructure investment. And then when you think about electrification broadly, Bryan, another mega trend, we think there's a long tailwind there. And the way I like to frame that thinking of strategically is in 3 buckets. One is, how does -- particularly on the automotive industry, how does welding content, how is that impacted by going from a traditional internal combustion type of vehicle to an electric vehicle? And so our -- we believe and our engineers have gone through this, that the value-add content within a vehicle is a push. There's a little bit of trade-offs between a battery carriage and engine and components and that sort of thing, but we think that's a push. And that's a pretty important assumption for us as we look to the impact of a changing footprint in the automotive space. And then you think about capital investment, which is how is, for example, the automotive industry then retooling capacity to be able to serve an EV type of space versus traditional ICE vehicle. And we know that typically in the industry, I mean, there's change out of line. So there's not a lot of going back and kind of refurbishing some of the equipment use on traditional lines. So heavy investment over the long trajectory, and you can read the highlights on the big players and how investing in EV. Well, a lot of that ties to the solutions we have in automation, in providing those types of capabilities within the capacity build. And so our industry segment leaders are very much tied, been working with the industry on how our solutions fit into the built-out of capacity. So that's going to be another tailwind driver in the long term. And then the third area that we like to emphasize, which has been a newer area over the last 12 months or so is looking at how we can participate in the built-out of infrastructure to serve electric vehicles, and what kind of DC fast chargers that we can develop and introduce to be able to participate in this significant growth opportunity. So that's how we look at those 3 broad mega trends and how we fit into this over the next few years, which should be very interesting.