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

Hi, good morning. My name is Saree Boroditsky. I cover multi-industrials at Jefferies. We're very excited today to host Lincoln Electric and Gabe Bruno, CFO. We're going to host this as a fireside chat. If you do have any questions, feel free to interrupt. Just raise your hand. And with that, we'll just dive in. Thanks for joining us today.

Thanks, Saree, and also welcome all of you with the interest in Lincoln Electric.

So starting off, you highlighted strong momentum into July during your earnings call. First, have those trends continued? And then how are you thinking about the disconnect between some of the weaker industrial macro indicators we've been seeing over the last year? And what you're hearing from customers?

All right. Thanks, Saree, for that question. So as we reported our second quarter results, we saw strength across all 3 of our product areas, with significant backlogs in automation, equipment. And in particular, we noted as you cited the strength in the consumable activity at the end of the second quarter into July. And that's a good sign for factory activity. We did see that moderate into August, so more of a leveling year-over-year in the August time frame. August is always a difficult time to gauge, but I think it does give a little bit of indication in the third quarter of some moderation in the consumable activity in the month of August. So we saw strength coming into the quarter, kind of leveling off year-over-year. And when you look at the strength in our backlog, we remain in growth mode and very confident in our organic growth assumptions for the year. We've got a significant level of backlog scheduled to ship, particularly in the fourth quarter, and we remain very confident in the mix of business. In terms of the dynamics of industrial measures and activity, I like to think about short cycle in a long-term cycle on the capital investment trajectory. Second quarter, we saw general industries down single digits, which was the first time in a long time. But despite that, we've seen overall strength and growth in our business. So I think it's a mix of different parts of the end markets we serve. When I think about automotive, where we saw that end market down in the mid-single digits, still we've strong production levels there, significant amount of capital investment projected on the long term. So we remain confident. So still growth mode, still anchored on confidently into our organic assumptions for the year, which is in that mid- to high-single-digits organic growth.

And maybe digging into the end markets a little bit. You talked about auto being down on the slowdown in equipment and automation deliveries there. Have you seen any of that activity pushed out further, given some of the uncertainty around the auto strikes?

No, we continue to be bullish on the long-term capital investment in automotive. The transition to EV provides a nice growth secular driver in the long term. So we continue to be bullish on what automotive means to us in the long term.

And maybe on energy, it's one area that's come back strong, high levels of pipeline activity. I believe you talked about accelerating demand there, but maybe a little bit more detail on what you're expecting on that market going forward?

The fundamentals on oil and gas, LNG are pretty strong when you think about pricing and curtailment long term on capital investments. So we're pretty bullish on energy. We're still far behind 20%-plus from peak. So we think there's a lot of runway. There's a lot of good activity progressing in the North American markets, miles of pipeline midstream activity. We've seen good activity in the Middle East and Asia. So we continue to be bullish on what the energy profile looks like for us.

And then on structural, that business has been under pressure, I think, the last couple of quarters. What's driving this underlying -- what's driving this weakness? And are you expecting to see demand inflect positively there?

Yes. So we saw a good 2 years of strength in structural and infrastructure build-out and activity there. So we have been tracking against tough comps. We did see some softening. When you think about overall activity, we like to measure things like the Architectural Billing Index, and you saw that dynamic as we ended 2022. Starting to see that turn positive. So we are -- I do think we're at an inflection point. We do think that we'll see good activity progressively. Comps do become easier year-over-year, but we think the dynamics there from an infrastructure build out is going to start to inflect positively.

That's what I'd like to hear. Europe is one area of cautiousness for the business. I know August is a pretty hard month to gain any info from. But any update on what you're seeing there from an underlying demand perspective?

Europe in general, we remain cautious when you just track the overall industrial activity, but we're tracking in this third quarter seasonally, which means that in the second quarter, third quarter, you'll see the normal impact of the shutdowns. But we'll remain cautious. It's difficult to gauge. September is always an important month as our operations gets back from the shutdown, traditional vacation schedules in August. So we'll have more to see as we progress into this third quarter.

And then you've been understandably cautious on Harris given the residential and retail exposure there. How do you think about demand for this segment as comps get easier in the fourth quarter and into next year?

Well, third quarter is going to be tough because of the HVAC strength we saw last year. And we continue to see a challenge on the retail side, although we're optimistic that we've bottomed out and started to turn that around. But we're more bullish into the fourth quarter. Third quarter will be tough comps. We think we're behind the larger inventory adjustments that you see on the retail type sector. But once we get to the tough comps in the third quarter, I think we're in a good position to start to inflect our growth.

And then maybe turning to automation. I think you were at $400 million in sales in 2020. Now you're run rating at $900 million, closing in on your $1 billion target. How do you think about underlying growth from both an organic and inorganic perspective from here?

Yes. We're very excited about where we are in our strategy to drive growth through our automation portfolio of offerings. We're well on our way to exceed that $1 billion target. We're anchor on organic growth into that high single digits. We'll continue to look for opportunities to look for acquisitions to continue to broaden out our portfolio. So we're very excited about the long-term trajectory of automation.

And then how has automation driven customer loyalty or stickiness? Have you seen an increase there?

Yes. So I'll give you a couple of examples. So when you think about multi-plant operation, you make a significant investment. We've got a lot on the line from a customer standpoint. And so you see stickiness when you build out 1 plant, the capabilities around an automation solution, then you continue on multiple plants. And you'll also see the tie-in to consumables. So consumables is not part of how we report out our automation results. But substantially all, if not all, of the operations that we put into place with automation solutions use our consumables. So you see that stickiness in just the anchor down the quality, reliability of the solutions we deploy.

Is that mandated that they use the consumables on automation?

It's not mandated. But when you're investing significantly in automation, you want to make sure your uptime, your productivity is meeting the objectives. And so the high-quality wire that we provide helps ensure that.

What's the return on investment for an automation project for an OEM? And assuming they're getting a return, like how do we think about pricing for higher margins? And does that change over time?

Yes. So I'll differentiate when you think about [ coal bonds ] or standard engineered-type robotic cells, their payback could be 12 months or less in shorter cycle, looking at labor content within that. When you're looking at larger scale investments that can get into the multimillions, even in the tens of millions, you look at paybacks, they're probably in that 2- to 3-year type of period. So we price on value, like we do for all of our business. Our margin profile is driven by how we have shaped our business. So we continue to expect work around LBS, our Lincoln Business System as well as volume type growth, and we'll continue to leverage that as we continue to ship our business model. So we're anchored on that mid-teens type profile within our automation business. And we'll continue to price in our value proposition that makes sense in how we engage our customers, but we look to continue to drive margin improvement.

And then beyond that mid-teens margin level, do you think that there's potential upside for there given that you're providing a return to customers?

We believe that's the right target for now. We've got some work to be done still there, but we're well on our way.

Can you talk a little bit about the competitive environment and automation and how your solutions differ from competitors?

Yes. So we're very much solutions-driven, as you pointed out, and we serve a broad base of end markets, automotive, general industry, heavy industries. We think about the competitive market in North America, which is a very fragmented. You're working competitively against systems, other systems integrators. So that provides us opportunity for acquisitions, looking at system integrators that may tie into certain end markets or certain capabilities that continue to build out our portfolio. On the international side is much different. A lot of the robotic suppliers are vertically integrated, and they also act as systems integrators. And so for us, we think through how do we continue to broaden our footprint international. The Fori acquisition was important for us for that basis. So we had -- they had presence in South Korea, in India, in China and Europe. And so that's a focus point for us, how do we broaden out our automation solutions and footprint around the international markets, and that's how we look at it.

Lincoln has historically had a pretty flexible cost structure given your compensation structure in Americas. Automation is obviously more of a fixed cost business. I think you have over 2,000 employees there. How do you think about this impacting your cost structure from a decremental, incremental margin perspective?

Well, you're right. Saree, you pointed out that the fixed cost structure on our automation business is much different than the core welding, particularly in the Americas segment. We've got over 2,000 engineers, technicians, employees within our automation footprint. We look at that as more of a fixed part of our business and our business model. We got significant footprint of many facilities as we're building out the significant automation solutions. So we expect higher incrementals and higher decrementals. And so that's going to be a pressure point on the downside, and it will be an accretive opportunity for us on the upside.

Kind of going back, started talking about the auto industry. You've talked about secular growth opportunities from the transition from EVs. So I was just wondering, when an auto OEM decides to add a line, and maybe that's an EV or a changeover, what is the typical revenue opportunity from Lincoln per that line?

Yes. So first, I'll comment, when you're looking at these product changeovers. I mean, you're dealing with high-volume production equipment. So typically, you don't see the OEMs anchored on the used equipment. They're building out new because you got uptime, productivity, efficiency requirements and the product offering. So expect a redundant level of investment as new product lines come to play. When you think about how we participate in that, you've got -- obviously, production translates into consumables. So we'll always have a little tie-in to how automation solutions investing, and it could be investment into low-single-millions to tens of millions. And when you look at the opportunities like a Fori type business, it could be tens of millions. So we've got a lot of opportunity in our standard equipment, ongoing consumable opportunity, but then in the ongoing footprint on how you build out a line, and it could be tens of millions.

And then as -- does the shift to EVs change anything from a welding perspective? Like outside of Tesla, have you seen any OEMs lowering the number of parts used to construct the vehicles?

Yes. So our engineers have gone through the analysis on traditional ICE vehicles and EVs, and we look at the value-add in consumables to be a push. So we don't -- we see that the move from a muffler exhaust system to battery to complement the overall value-add in welding. So we don't see that. In terms of components, we haven't seen any significant changes in the component profile with an EV and ICE. There is some discussion on castings, whether that's an opportunity for driving efficiency in the parts manufacturing, but that's still some time to really take hold and see if that's an appropriate long-term process.

There's been a lot of talk about the DC fast charger initiative. First, is this right on schedule? I think the production launch is in the fourth quarter of this year. And then are you impacted by the recent joint venture that was announced by a number of the auto OEMs, still looking to build about 30,000 chargers?

Yes. So think about 3 key work streams on our EV strategy initiative. One, on the commercial side, progressing very well. And when you think about this opportunity on the private sector, whether it's public or private, that's an opportunity for us. So we look to -- our first launch is anchored on a 150-kilowatt DC charger. We're on schedule from a product development to second work stream. And from an operations capacity standpoint, we're on schedule. So we'll continue to update the markets, but we're very confident that we continue to work on schedule.

And how do you think about the margin profile on the chargers? And does that change over time as you ramp up production and then manufacturing know-how?

It's still early. So a lot of work to be done in the months and years to come. But we do believe it will be accretive to our EBIT profile. So we're leveraging capabilities in manufacturing. The equipment we're producing is within our equipment manufacturing facility. So the investments we're making, $15 million investment, is anchored around PC, electronics, power electronics, so we can leverage that. So a lot of leveraging we're doing around that. So we think it's going to -- it's a modest investment for a lot of upside. So we're very focused on that.

And one more question on the chargers. Thinking about that ramp, does the price to customers change over time as you ramp production?

Well, it's early on pricing as well, but we're anchored on that 150 kilowatt DC fast charger at that $100,000 price point. And so we'll continue to navigate that as the market matures.

And then, I guess, just quickly, is there any questions from the audience? Okay. We'll go on. International margins have been pressured versus last year despite seeing some sequential improvement. What do you need to see to get back to that strong margin performance you saw in the first half of 2022?

So for our International segment, our EBIT target, as you know, is that 12% to 14% range. And I'm very proud of our team and how we've shaped our business over the last few years. The first half of 2022, we had position -- we had some acceleration on activity because of the Russian dynamics. We had a little bit of advantage on costing and our FIFO inventory in Europe. So we hit that 14%, the high end of that range. And as you remember, we talked about hitting double digits again, EBIT first quarter, and then getting into that range in the second half. So we're ahead of schedule. First half of the year, we're at over 12% EBIT profile and our teams are anchored on continuing to drive improvement. Right now, we're going through our 2030 strategy and refreshing. There is a focus, and I can assure you that our international team is anchored on driving the higher end of that range.

We're happy have a preview of that 2030 target today, if you maybe want to share. One of the reasons for the margin difference in Americas versus international is the fragmentation. Is there an opportunity to consolidate this over time? Or what else could you see to help drive those margin profiles closer together?

Well, you're right that the fragmentation of the markets have a real impact on competitive positioning, and we look at that as an acquisition opportunity as well. We know as you can appreciate the core welding markets very well. There's a lot of private companies that we'd be interested in. They just don't come to play yet in terms of an acquisition opportunity, but we continue to monitor. So you have that dynamic that provides an opportunity, but that's the competitive footprint internationally. The other driver which is important is inherently the fixed cost structure, which has been a key driver to how we have improved the international margin profile. So a lot more flexibility, as we've already talked about in the Americas and the variable cost structure we have there. More challenged on the international side. So we'll continue to see that difference in what a margin profile looks to from Americas International because of that fixed cost structure and look to the fragmentation competitively as opportunities for acquisitions.

Maybe turn a little bit to pricing. Total pricing up, I think, almost 25% since 2020. How are you thinking about additional price increases today? And given the magnitude of price increases over the last couple of years, do you expect to see any price declines if input cost start to come down?

Yes. So price increase are a function of inflationary drivers, right? And our posture is to be price/cost neutral. And we continue to operate in an inflationary environment. So we expect that kind of posture. When you look at our business model long term, we have held price. There may be one-off OEM types of contracts that we'll have to work through. But in general, we hold price and we respond to inflationary drivers through a price/cost neutral strategy.

Maybe a little bit on capital deployment. Acquisitions, I think, are expected to add 3% to 4% to top line growth over time. Obviously, recent acquisitions have focused on automation. Maybe talk about any geography or end market preferences going forward? How are you thinking about deal sizes that you'd like to acquire as well?

Well, let me start with deal sizes. As you'll see, on average, we're probably in that $50 million, $100 million range when you look at the fragmentation in the markets, both in core welding but also in automation. So those will continue to be opportunities for us. We are very disciplined in navigating targets and opportunities from an acquisition standpoint. We have a senior executive that is driving a top-down approach and looking at the markets and what potential pipeline looks like of acquisition opportunities. You have seen more in the last 10 years tied to automation, but we're looking at all parts of our business. We've done, as you know, acquisitions on the Harris side to broaden out our footprint servicing customers. We look to businesses in South America or in international to continue to broaden our footprint, but also add capabilities. So we're -- we look to all the geographies in co-welding and automation. That's a key driver for us in long-term growth. And our strategy outlined is to be at that 300 to 400 basis points CAGR. We'll put a lot of pressure on ourselves as we continue to grow the company. And 3% to 4% is a much bigger number over time, but we're very focused on this key part of our strategy.

Have you seen deal multiples come down recently?

Well, it depends what you're looking at, right? On the automation side of things, we continue to see multiple pressure there. That's continued to be at growth mode, but we'll continue to monitor and see how that progresses.

Then sticking with capital deployment. You've been buying back shares consistently. How are you thinking about returning cash to shareholders versus investing internally?

Yes. Well, first, we want to invest for growth. And you saw that we moved up our CapEx assumptions for this year. And very much looking at -- our internal investments are high return investments. So we don't do anything to limit our ability to grow and invest internally on new product introductions or capacity or automation within our own businesses and cost reduction activities. So we're going to prioritize investment, and we're not going to limit any investment on the internal CapEx. Then as we just talked about acquisitions, right? So we are very much focused on internal and inorganic type growth as the first priority in capital deployment. Then we return cash to shareholders in a very disciplined way. We've increased the dividend rate 27 years since trading on NASDAQ in '95, and we'll continue to look at that as a means for returning cash to shareholders. The way we think about share repurchases is maintenance first, which is we have around $60 million for maintenance. And then we're opportunistic. So you've seen us steadily in the market, and we're just opportunistic as we see the progression of excess strategic cash, and that's how we look at it.

Question from the audience?

Just on the charger business, if we thought about the end market where you were most likely build a sustainable business, would we be right thinking really the industrial space as mines electrify their fleet work lifts versus going head to head in what we all picture to be fast-charging competing with Tesla? And if you look at the end markets where you'd be most likely to succeed and where you are targeting on...

Yes. So that's a great question. And the way we look at it is that we're going to participate and where the opportunities are both in the public and private sectors. So the fleets are nice opportunities for us. And so we're navigating the commercial opportunities there, but we're anchored on both opportunities, the public charging opportunities and ChargePoint operators, but then working with fleets as well as an opportunity for us to grow. So we haven't differentially said this is going to be more of an opportunity for us. So we're just feeling our way through how to position our high-quality type products in the market.

And could those opportunities be white labeling the charges for the OEM JVs, Tesla longer term? Or this is your brand and...

I mean, we're open, obviously, our brand means reliability, quality in that, but we're still working through how we brand and how we commercialize our product line.

Okay. Just one more on the charger quick, if I can. Why did Ohio -- because it's your home town really or state, why did they choose a Taiwanese charging company? Is it price where you didn't have a product yet?

Well, I think a lot of it has to do with them not having a product available yet, but I'm not going to speak to their own decision-making. But once we do introduce our products, we start taking a foothold into the markets and introduce our Lincoln brand into reliability, quality. And we expect -- we're confident that's going to provide a driver for growth.

Any other questions from the audience? Okay. Maybe just sticking a little bit, building on that question, really, how do you evaluate entering new areas such as EV charging and additive? Like what do you need to see to proceed with those investments?

Both of these opportunities anchor our core capabilities. When you think about the EV DC fast charger, it's power electronics, and it looks like a lot of the guts of some of our boutique equipment. So it's anchored on our -- are leveraging our key capabilities. Additive is the same thing, where we're leveraging robotic capabilities, our wire, software to be able to introduce a capability that could be a game changer in the supply chain in large part sourcing. So we're first anchored on, does it make sense to us and how we operate with our core capabilities? What's the investment profile for each of those dynamics? We look at both of those to be modest investments with significant upside opportunity. So that gives us the opportunity to be patient in nurturing and developing the technology, the commercial footprint, the products, the operating capabilities and look long term to drive an acceleration in growth. So both of those are anchored right in our sweet spot and capabilities.

Well, thanks for joining us, and I'll see you next week at [ BAAB Tech ].

All right. Thank you.