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

Okay. Good morning still everybody. Welcome to the Second Day of Stifel CSI Conference, and welcome to Lincoln Electric. We're very pleased to have Gabe Bruno, Executive Vice President and CFO; as well as Mr. Amanda Butler down here, VP of IR, with us today. Thanks for joining us, Gabe.

Thanks, Nathan.

I'm going to run through a format here where I'll present three bear cases on the stock. Gabe will tell me why I'm an idiot, then I'll present three bull cases on the stock. Gabe will tell me why I'm a genius. I finished with the bear one, so I can feel better about myself. Finished with the bull ones, did I say that? Finish with the bull ones. So Gabe can tell me why I'm a genius and I feel better about myself at the end of the day. Okay. So the first one here, alternative methods of joining metals, including laser welding, are becoming more cost competitive with traditional arc welding methods and will gain share in the future, potentially shrinking the addressable market for Lincoln Electric.

All right. Well, great to be here, Nathan, that Lincoln Electric practiced a golden rule, so I won't call you an idiot, for this bear case. But look, this is a fair question. It's a question we get from time to time from investors. And it really talks about where is the industry going in terms of metal joining. When we think about laser welding, you hear a lot of discussion on welding, and what it could mean in automotive, for example. And that really is anchored on spot welding. So there is dynamics in the market surrounding spot welding. When we look at laser welding is an opportunity for us. That fits very nicely into our automation offering, and it's a growing space for us. So, we look at that as an accelerator for growth. We have with the EV evolution. We have a particular application tied to battery tray fabrication, and it leverages laser technology. So there's obviously, a space for laser welding, and we embrace it and it's an opportunity for us to accelerate growth.

So I mean, I was out at Lincoln a few weeks ago here, and we saw laser welding happening within your facility. So clearly, Lincoln is involved in laser welding, and you're a customer of some of your competitors in that space. How does Lincoln look at playing in the laser welding space? And what do you think your competitive advantages are versus somebody who's just a more of a laser company?

Yes. I'd like to go back to the automation discussion. We like to emphasize solutions in the automation part of our business. And so, we consider laser and we have a whole technology footprint that embraces laser technology in a solution. So, we continue to develop and educate where we see a nice fit. And as I mentioned, we had an EV seminar last year, and laser is a big part of that. So I mean, we've got technology leaders within our business that are developing solutions. And I think the automation footprint gives us a nice avenue to leverage capabilities to drive growth.

Do you think it's net competitive threat or an opportunity?

I think it's an opportunity. .

All right. I'll go on to the next one. Here, we have -- the welding industry has put through a lot of price over the last 2-plus years, related to inflation, obviously. And as growth in the economy slows and we potentially see recessionary conditions, Lincoln and the industry are going to have to give back some of that price, which will lead to earnings dilution.

Okay. So again, the golden rule applies here again. Nathan, but just consider the long-standing disciplines of our business in managing price and really, it's a response to the inflationary dynamics that you've seen, and it's to protect our business model. So, we like to emphasize that our posture is to be price cost neutral and that's through the management in a very disciplined way, all the different cost drivers and then positioning quarter-to-quarter and how we see the impact to our business. So some quarters, you may be a little bit behind on price cost, sometimes is a little bit ahead, but we look to be neutral overall, and that's where we ended up the last couple of years, and that's how we see the need there. So, when you think about recessionary talk and the uncertainties and economies, I point to our historical performance. And when you think about the great recessionary period of 2009, our volumes were down 30% or so, and pricing was down 50 bps. So we hold price, but it is a very disciplined part of our business strategy. And our customers understand it and never customers ever want to receive price increases, but it's an important part of how we protect the business monitoring and the long-term interest of the company.

To highlight what a good job Lincoln has done over the last 2 or 3 years with price. When you say price cost neutral, you're talking about price cost neutral at the gross margin level, right? You're not talking about on a dollar for dollar basis?

No, we don't -- that's why I emphasized the business model, right? We don't just pass through material costs, for example. We want to maintain the kind of business model, which we believe is -- it helps support our successful strategy. I mentioned during our first quarter call, that we continue to operate in an environment which is inflationary. And so we had another -- we estimate exiting the first quarter 100, 200 basis points of pricing actions that are taking hold now in the second quarter. We anniversary some significant price actions in the first half of last year, which were necessary. But you're right, Nathan, it's a very disciplined way of how we ensure the integrity of our business model.

Lincoln's one of the more transparent businesses in terms of disclosure and you guys have disclosed pricing per quarter for 10 years or so, at least as long as I've been covering the company. And price has been very resilient even during recessionary times, deflationary times. But, there's never been this much inflation before. So we've never seen a situation where your customers were boosted to take this much in the way of pricing increases. What's your level of confidence that, that historical resilience on price during downturns will maintain during this one, just given how far out along the curve we are on price increases?

Okay. So golden rule again, but I've been with the company about 28 years. And during the commodity boom years of the 2003, 2004, we saw a very significant price increases in the markets, and we maintain our posture there. So we have a long history of just being disciplined in managing price. Now, one thing you'll find interesting is that, as an executive team, we aren't incentivized to drive price when you look at organic sales. Our pricing component is capped at 2%. So, we drive our pricing strategy driven around the business model requirements long term. And so, while lot of inflationary pressures in that. It is responsive to the dynamics in the market, and we've got a long history of maintaining our pricing foothold. Great Recession, commodity boom are some of the time frames I think you could point to the economic contractions that we've had an experience or expansions with the inflationary pressures there.

Certainly, I think you guys have a lot more exposure to long steel than declared steel prices that most people look at, which have been much, much more volatile and came down a lot in 2022. Coil steel did long steel, I don't think came down anywhere near as much. And you just noted that you put price through in the first quarter of '23. Are you still seeing net cost increases for you in the business where if we add in commodities, labor, all of the kind of things, are we still operating in an inflationary environment?

Absolutely. We had -- typically, during the April time frame is where we put in place our merit increases, wage increases. And so, where we have historically been between 3%, 3.5% we're pushing 4%, 4.5% of labor increases into -- in the April. So in general, we're still operating in an inflationary environment, a little bit different in how we look at content between consumables and equipment, a little bit more on the equipment side. But in general, we still operate in an inflationary environment.

What's your view on where labor inflation settles down? I mean you said historically, 3%, 3.5%. Do you think, we're in an environment where that labor inflation is going to be structurally higher?

Well, just starting to get -- you're starting to see the tone of unemployment, employment and labor in that. So, we went through the last couple of years where I think the labor markets which were much tighter than what you'll see in the next 6 to 9 months. So I think, you'll see a little bit more leveling on labor inflationary-type pressures. Whether you get back to 3% or 3.5%, it may take a little bit more time, but we're going to get back to a normalized environment, I believe, the next 6 to 9 months.

All right. One more golden rule. Macro uncertainty in Europe and China since slowing GDP growth in North America provides uncertainty in the growth outlook for the business over the next few quarters.

Well, there's always a lot of uncertainty that we operate in, and I'd like to emphasize that we don't try to say where we are in the cycle. We got to manage to what we know the drivers are and be prepared to respond to expansions and contractions. And we've got a long history and the kind of business model that an experienced management team that knows how to navigate through expansions and contractions. But there is, as you all know, a lot of talk of recessionary-type talk uncertainties, what's going on in the market. So I'll just kind of walk through a little bit of how we see it. So starting international, you mentioned Europe and China. International organic sales were a push in the first quarter. Saw a little bit of dynamics in Europe when you consider year-over-year Russia activity in our business in the first quarter, anniversarying that, different projects throughout the European, Middle East kind of driving a little bit of tougher comps there. But in general, we see a relatively steady environment on the international side. China, if you remember, second quarter last year coming off all the lockdowns are going to be easier comps in general. We talked about that. However, the acceleration of industrial activity a little bit less opening up or aggressive than you would otherwise think in China. So we look at the international environment going to the second quarter is relatively stable. You look into -- I just make one comment Harris before talking about the Americas, but Harris, the most significant dynamic we've seen is the retail side of that business. And so, very strong couple of years in retail-type growth up to last year's first quarter. But just the last 4 quarters, second quarter of last year to this first quarter this year, just a lot of pullback on consumer activity. And then, you see the -- also the impact on inventory posture amongst the retail channel also have an impact. So, we're more hopeful that a lot of the inventory adjustment is behind us, but we've seen significant softness in the retail side over the last 12 months. On the other side, Americas, we had a very strong first quarter in organic activity, in particular volumes, volumes were up 11% in the first quarter in Americas, and it was broad-based. All of our three major product lines, consumables, standard equipment and automation were up in volumes. So that was good. Consumables are an important bellwether to factory industrial activity, so being up low single digits in volumes. It was a good signal. But we've seen tremendous growth across our automation business across standard equipment, record backlogs. So we saw the same strength of momentum going into the second quarter, and we saw going into the first quarter. So that's kind of a broad perspective. And that backlog, particularly on the automation side, it can go up to 3, 6, 9 months. So, we've got a lot of good booked orders to take us out for some time. That said, you're right, a lot of uncertainty. We're well postured for managing through the uncertainty, and we'll continue to navigate what that means for us. When I think about end markets, 4 of our 5 key end markets that we talk about, we're in a growth mode. Heavy industry, general industries, automotive, energy, we've seen a little bit of constraints in the structural infrastructure side of our business, but we think that's largely timing. You got some real market dynamics there. But in general, I think that's the timing and tough comps there, but become easier comps as we wind down 2023 on that. But in general, we're seeing good strength broadly, products, end markets good, to see Americas as strong as it is. But we're going to manage our business to what we see and be agile and responsive to the uncertainty in the marketplace.

There are certainly some pretty good mega trends in industrial overall that Lincoln is exposed to that even should we hit a recession from a macro perspective, I think probably helped support the business. So maybe, if you could talk a little bit about the impact of where you're exposed on things like reshoring. Obviously, all of the above energy policy, LNG, wind, solar, all of those kinds of things. Lincoln is going to have exposure to that infrastructure spending, where you're exposed to that. So, it would seem that even if we got into -- I mean, those things are not going to be recession-proof, but they're certainly going to be recession-resistant maybe making the bottom a bit higher. So maybe, if you could just talk about some of those mega trends and how they impact Lincoln's business?

No, I think that's a great point, Nate. So, there are countercyclical drivers that we believe that we're well positioned for when thinking about growth throughout whatever uncertainty that we see before us. First, think about the labor markets and the need to drive productivity efficiency in plants. Our automation footprint is leading in the industry. We've very invested in it. We have seen growth on the automation side, go from $400 million in 2020 to a run rate now of $900 million. . So, we're very excited about our positioning in automation solutions, and we expect that to continue to drive accelerated growth through the cycle because the investment is key there. We also think about electrification in a broad sense, and we think about not only the migration in terms of welding content from ICE vehicles to EV, which we think it's generally a push. Content is a little different, but the value add is about the same. So, we think of that as a push. But significant investment in growing capacity within the automotive industry and EVs. And so our automation solutions fit very nicely in there. And we see that progressing. Obviously, is a big push across administrations, whether it's in the U.S. or Europe or other markets to get EV capacity in place. So we're well positioned to drive growth in our business and supporting the solutions required there. The third area are the infrastructure build, particularly in the U.S., which we're focused on, in this case is, how do we introduce leverage our technologies around DC fast chargers. So, we think that over the next 7 years when you think about the 2030 targets that have been established from the administration as an opportunity to drive incremental growth. And then, you talk about infrastructure. We know there's been a significant amount of administrative investment targeted in the infrastructure build. And we estimate that about 10%, 15% of our business is exposed to infrastructure, renewables, about offshore wind, which is a slow investment cycle, but we're well positioned with applications that are anchored in those areas. So, when you think about infrastructure, the automation, reshoring means that there's more planned activity and the build up, because of the supply chain dynamics in the Americas, that gives us an opportunity to continue to work through factories of which is our strongest position in the Americas. So there are definitely these megatrends that we look to be countercyclical throughout this environment.

Okay. Now you get to talk about, how smart I am and how dumb I am. So golden rule the same for me then.

Yes.

So, I'm actually going to skip the automation one because we talked a little bit about that and maybe come back to it, if we have time. I'm going to go to the EV charging stations. EV charging stations provides 100% incremental and large opportunity for LECO to grow revenue. Lincoln will have capacity to deliver 500 units a month, representing about $600 million in annual sales, as the market ramps. This is pretty clearly a very large opportunity for Lincoln. $0 in revenue currently. $600 million on a $3.5-odd billion revenue company is a huge opportunity. So maybe you can talk about how you see that market progressing, why you're able to play in that market, why a welding company can do EV charges. I think, it's probably a good place to start for people who don't know the technology. And we'll go from there.

That's great. So, we're very excited about this opportunity. And I'd like to start off and point out, this particular strategy had not been built into our original document. So when you think about our Investor Relations deck and our 2025 higher standard strategy, these aren't drivers for the growth and operating model trajectory that we see in this potential here. But about a year ago or so, one of our engineers came to our executive team and had identified that the guts of a charger look very similar to one of our niche pieces of equipment in the cutting automation space. And so, as we spend more time and then we figured what this is anchored on the same types of power electronics potentially that we offer into the market. So, we spent time in evaluating the technology footprint of these DC fast chargers. We did a proof of concept. It worked, shared across our Board and our executive team and started allocating resources to drive a strategy surrounding chargers, DC fast chargers. And so, we look at this as significant potential opportunity with very little risk. We talked about investing $15 million of capital in this first quarter, to be able to drive to the capacity, you outlined of 500 units per month beginning in 2024. What does that mean for us? Well, when you look at a 150-kilowatt type of charger, price points are about $100,000, leveraging our footprint, manufacturing, engineering, operations, supply chain, that is very attractive to us. So 500 units, 100,000 where you get your $600 million. But, the market is in a position to significantly grow beyond this. So I'll give you a perspective of that. So best estimates now are that the charge points in the U.S. are about 30,000 charge points, some around there. And 2/3 of that is driven by Tesla. So, you still have a very early stage of development in this infrastructure. The bills that have been introduced by the U.S. administration targets 500,000 charge points by 2030. So, you can just kind of see the order of magnitude there. And then, you have private study. Yes, and I talk about 1 million charge points. So, we look at this opportunity is leveraging our core technologies to be able to develop the kind of quality, reliable products that are power sources from a welding standpoint driving the market, of which is a significant gap currently in the reliability, quality from where we understand a lot of the customer input that we see, the charge stations, to introduce the kind of product that can make a differentiated position that we have in providing this type of equipment. So it's an exciting opportunity. We are in earnest going through initiating a beta phase and going to drive that over the course of the next few months. So, we want to be positioned to start shipping product in the fourth quarter with this type of capacity framework. And, as we see demand accelerate and our position in the markets grow, then we could easily just drive additional capacity. So this is a very interesting opportunity for us. We look at this as certainly not margin dilutive for overall business model. But, it's going to be a very interesting 6 months in getting into the market and then kind of driving growth from there.

Can you talk about what differentiates your product? What gives you the right to play here, what the competitive dynamics are like, what kind of market share you're looking at getting here? Because I mean, at this kind of volume, it's not a huge market share, it's maybe 10%, 15% of the market or something, over the next several years. But just, what gives Lincoln the right to win in this market?

Well, as I mentioned, this is a particular niche product in the welding space. So, you don't hear the other large players in the welding space talking about DC fast chargers because there is a particular differentiation in this offering we have. But as the leaders in product quality and reliability and being the welding experts, when we're meeting with either the public or private sector in looking at charge stations and operations. Our Lincoln brand means something to the market. And so -- there's a lot of confidence that when we say we're going to come to market with a quality and reliable product that has 99% type of experience and uptime, whether you're working in the desert or working into Alaska, in different parts of the world where the uptime requirements are necessary in welding and introducing that same quality reliability into an infrastructure position with DC fast chargers becomes very interesting.

You should be looking for a reliable supply with like 25%, 35% of the installed base, but doesn't actually work, right?

So yes, you can see what's happening here that reports out of California about reliability and quality consistency in charge stations. So, very early in the development of the infrastructure, and we think this is the right time to get in. And to drive additional capacity, we're leveraging our core technologies and core operational capabilities. So, it's a good position to be in. You're right that when you think about 500 units a month doesn't sound so significant. But at these kind of price and margin opportunities we have $600 million or 500 units, that's very attractive for us.

Yes. I'll go into the third bold case now. Innovation and capital deployment are targeted to provide 500 basis points of market outgrowth. And combined with automation and market growth, we're seeing Lincoln's total revenue growth up close towards double-digit levels, organic plus inorganic. Maybe, you can just talk about the pieces of those and how they build up to get you close to that kind of level over the next few years?

Yes. So you're tracking us since we announced our 2025 higher standard strategy. You see that we're ahead of our growth objectives. We have within our deck to building blocks of how we think about high single-digit, low double-digit type growth. And we always want to start off in leading with technology. So, to give a perspective of that, we track what's called a vitality index which gives you a perspective of the velocity of introductions of new technologies into our product offering for 2022 on the equipment side of our business, 57% of our equipment sales were from new products introduced in the last 5 years. So, we know that technology and solutions and how we innovate, differentiate us in the market and gives us an opportunity to accelerate growth. So, we talk about 100, 200 basis points of incremental growth on top of the cycle. Again, we say we're not going to predict cycles, but we're going to navigate them effectively, and we're going to be agile in how we manage through the cycle. But, being the welding experts, being a solutions-driven type of business that -- so we think that's a differentiator, and we've seen it and how we've grown. We believe automation is going to give us 2x growth there. We're ahead of that so far in this strategy period. But, we know that inherent megatrends, we talked about that a little bit in automation is going to give us the ability to drive 2x growth there. And we've seen it. Automation just quickly, we went from $400 million in 2020, $500 million in 2021, $650 million in 2022 and now our run rate is $900 million, and that includes organic plus acquisitions. On the acquisition side, we've got a very disciplined strategy around, how do we identify opportunities in a very fragmented market, both on the core welding as well as in automation to continue to build out our business. And our track record is 300 to 400 basis of growth through acquisitions that just tie into our core segments or automation. And that's just a lot of $50 million, $100 million type of businesses that are nice add-ons to automation and core. And so, we've built out a strategy that allows us to leverage an aligned business system whether it's in our core welding or automation to be able to integrate these businesses and become part of our core business. So, we're very much focused on growth. When you think about capital allocation, we're always going to lean on internal investment, which is new products, capacity, automation, other areas of efficiency, but also acquisitions. And that's been a very nice footprint, which we have a lot of disciplines across our companies to make sure that we identify opportunities and then we integrate them as part of our core business.

Last one on capital allocation. Over the last few years, we've seen a lot of the M&A capital going into automation. Before that, there was the Air Liquide business in Europe for international expansion. What are the -- is automation the main area of focus for M&A, international expansion, something else?

It's all of the above, but automation has been a larger part of the building blocks that we have developed over the last 7, 8 years and will continue to be. I mean, the market opportunities, we believe, are significant in automation. I mean, you pull out the welding side and the competitive framework different in automation. Just a lot of fragmentation. So, we just see a lot of opportunities, not just core. We did deals in the last couple of years at Harris and the international side, but we do see automation as a nice avenue with the fragmentation to drive growth.

Awesome. Well, we're up on time. So thanks very much for being here.

I appreciate it.

Thanks, everyone, for coming.

Yes.