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

All right. Perfect. Well, thanks, everyone, for joining us. My name is Adam Seiden. I lead the U.S. Machinery and Construction franchise at Barclays. For this session, we're really thankful and happy to have the folks from Lincoln Electric here. So joining us from Lincoln is Steve Hedlund, CEO; as well as Gabe Bruno, the Chief Financial Officer. So the presentation style here is actually going to be a fireside chat format. This session, a fireside chat between myself, Steve and Gabe. We would, though, of course, invite your participation. And there will be a mic runner around the room. If you have a question, feel free to raise your hand. If the mic isn't your style, we will be doing our audience response system, which will be done through the remotes that are sitting on the table in front of you. And that will be done sort of towards the end of the chat here. So with those ground rolls out of the way, team Lincoln, thanks so much for being here.

Well, thank you for having us.

Thank you.

Well, So here you are. Same Steve, new seat, same company. So you had about an 18-month or so in the COO role prior to CEO, and clearly had a very instrumental role in forming the 2025 strategy. So when you think about your vision and where you are, how are the areas of focus, either aligned or a disaligned versus where the company has been in the past?

Okay. Well, as you mentioned, Adam, Chris and I worked together very closely defining, developing and then implementing our Higher Standard 2025 Strategy. If you look at where we are about halfway through that strategy plan period, we are achieving or on track to achieve all of the targets that we've identified for investors. And so we're very confident in the strategy we have. We're very confident in our execution of the strategy, and we're very confident in the team that we have to drive the business forward. So over the next 2 years, you'll continue to see more of the same. We expect to make more progress in improving the margins, particularly in automation and in the International part of our business. But don't sleep on the Americas or Harris either. We see lots of opportunity to drive incremental growth and margin expansion in those 2 businesses. And I just note, if you look at the fourth quarter of this year, the Harris business was down on headwinds in the retail and HVAC sector of the business, but their margins were up 300 basis points, which reflects both some favorable mix but a lot of hard work by the team to improve the operating performance of that business.

Well, that's a good segue then just to talk about some of the strides you've made. So if you think about on that, there's been a number of areas that the company has called out, whether it's been the shared services center. And then also on the call, I think you referenced a centralized global procurement and I hadn't heard that before. So can you maybe talk a little bit about some of the things that you've done but then also on the procurement side.

Sure. So Gabe has been very instrumental in leading our effort with shared services to try to consolidate a lot of the administrative functions of the business and to move those to lower-cost countries or to automate those through chatbots and things like that. And that's had a very nice impact on our SG&A cost and SG&A leverage for us. On purchasing in particular, we have historically purchased some of our direct materials in a global fashion. So we have a group of people that buy steel for us around the world. We have a group of people who buy chemicals for us. But the indirect portion of our spend has been largely localized to date. And so what we are adopting, I guess, the current term in vogue is center-led instead it centralized but we are trying to extract more leverage out of our purchasing spend globally, so we can get both better pricing and better terms from our suppliers. And the new purchasing lead is about to hit his 100th day in office and is laying out his plan to drive those savings and improvements for us. I expect we'll capture some of that in 2024 but the bulk of it probably to come in 2025.

Got it. Well, hitting his first 100 days. So now you have some deliverables.

Exactly. The honeymoon is coming to an abrupt end.

That's right. So when you think about -- so one of the things that I like to do, especially at a conference like this, it's pretty broad, is just get a gauge of sentiment across different areas. And when it comes to Lincoln, certainly a company that has a lot of diversified exposure, some that's been really helpful for you guys over the last couple of years, so the years and months even. But -- so maybe to ask you, how has the conversation changed or not changed over the last 6 months amongst some of those end markets?

Sure. As you mentioned, Adam, we're very fortunate to have a broad diverse exposure. When we look over the past 12 months or so, we've been particularly happy with the fact that the capital side of our business has been very resilient. So that's the automation and standard equipment side of the business despite the declining macroeconomic indicators on industrial production and PMI, despite the higher interest rates, we see our customers continuing to invest in driving productivity and quality improvements in their business. It's been more the short-cycle part of our business, consumables that have been a little choppier, right? So we referenced the retail headwinds have been something we've had to overcome. We start to see a strengthening in at least the macroeconomic indicators for general industry at a time when some of our larger customers in the ag construction equipment space are now anticipating a slowdown. So it's a little early to see how that's going to play out but we're cautiously optimistic that we're going to see an acceleration in the general industry part of our business, which helps both consumables but also some of our equipment and automation business as well.

Got it.

Gabe, you have anything you want to add that?

Yes. No, that's our posture. I mean you've seen what we've done. Historically, we've been known to be short cycle, and we've just made a tremendous investment in broadening out the long cycle type part of our business. And I think that's what you've seen differentiate us over the last 12 to 24 months, that automation footprint, we continue to build on provides that long-term capital investment cycle. So I think we've got a very nice balance between long cycle and short cycle. And I think that's what makes our investment in Lincoln pretty exciting.

That's fair. And automation is certainly a focus for you guys. And I just wanted to actually dig deeper on the general industry side. So I think automation as you guys have become more diversified in terms of where you serve there. It could impact certainly on a quarter-by-quarter basis because of the lumpiness of that. Some of that does fall in general industry. So just what was the underlying growth within general industries or underlying trends, I should say, within general industries that you saw? And how is that different or not versus the prior couple of quarters there?

Yes. So just to add. So if you pull out the automation impact, which we had strength, as you saw in general industries, our general industries would be down to low single-digit type of growth. And that's important for us for a couple of reasons. One is broadening our footprint of where we introduce automation solutions. We've been very intentional about that, introducing a Cobot into small midsized fabricators. But also, how do we monitor and progress core welding business. And so still pretty healthy at the low-single digits but certainly an impact on the growth of automation. Same dynamic of heavy industries, right? So when you pull out the automation impact on heavy industries, we're probably in the mid-single-digit type of growth. So a very meaningful growth trajectory in automation but pretty healthy still in some of the core areas of our business.

Got it. Now -- so now when you think about the '24 guide and so forth, I think in the transcript, I got it felt like conservative. I think even maybe it was mentioned a few times out there. So when you're looking at that, can you explain just where those areas of upside may potentially be? And then you referenced consumables earlier and so forth. So how does the volume portion of your organic growth guide split between consumables and equipment?

Yes, I would, Adam, emphasize of what we have the line of sight for, right? And so when we talk about a low to mid-single-digit organic assumption for 2024, midpoint is 50-50 volume and price. That volume trajectory is anchored around of increases in our automation business. And as we see progression in the general markets short cycle, you'll see it first in consumables, you also will continue to see it in standard equipment. So I think we're pretty conservative in starting the year. It's a long year ahead of us. But I want to point to things we have visibility to, and that's largely on the automation side.

Got it. So just looking at automation and assuming that asset.

Yes.

Got it. So I wanted to ask a follow-up on that. We'll move on. On the new product side, if you think about new products, it's always been a key contributor for the business. When I think of the slide decks that your team puts together, the Vitality Index is always all over it. So when you think about this year, is there a lighter or a heavier year of new product introductions? And then -- and then also just more longer term, I'm curious like what is the growth curve typically like for a new product in terms of seeing the ramp in sales?

Yes. So it's interesting out of it. It differs quite a bit between the equipment and consumable side of our business. What we typically see is for new equipment, there's a ramp-up in the first 2 years of the product being in the market. But by the time the product has been out 5, 6, 7 years, it starts to get generally long in the tooth. Now there are some exceptions to that and sort of niche applications where you've got a highly differentiated piece of equipment. If we think about the type of equipment that goes through the distribution channel, for general industry applications. It's important that you have a fairly consistent product refresh cycle so that you can maintain momentum in the market. We launched 51 new products last year. If you look at the Vitality Index for equipment, I think it's 57% of sales, equipment introduced in the last 5 years. We want to keep pressing the accelerator on that. We want to keep bringing innovation and new features and new functionality to the market. It's a way for us to drive the replacement cycle on equipment to get customers to upgrade the existing equipment they've got in their fleet. And secondly, it gives us something to talk about besides price because we don't like talking about price.

Yes. So Adam, I will just add that 57% consistent with 2022, we just updated our investor deck with those figures. So 57% is consistent over the last couple of years.

Got it. Got it. So maybe this almost close to the follow-up. But when you think about consumables, I mean, it seemed like consumables could be up in North America, I think, from the transcript. So is that similar broadly across the International regions as well?

The International region really is location specific, right? So the European business, I think, has been challenging for every industrial company, the energy policy and a lot of the other things that are driving in Europe is not the most conducive environment. People want to put capacity expansions in place. Middle East has been a very robust market for us. So a lot of investment in oil and gas infrastructure there. Southeast Asia has been very strong for us. India has been a great market for us. China never really came out of the post-COVID period the way that a lot of people expected it to snap back. So it's been a little more choppy market for us, but on the whole, across that whole portfolio, we're very excited about the International business.

Got it. And you teed me up by saying that you don't like talking about price. So now I have to ask you a question about price.

I will walk you into that one.

There you go. So essentially, when you look at the pricing strategy of Lincoln, is that simple price cost neutrality? Is what you guys are [ acting? ]

Yes. That is our goal is to be price cost neutral at the margin level. So we price for material inflation or labor inflation plus our margin on it. We don't want inflation to be dilutive to the business. And so that's been the posture of the big quarters. We're slightly ahead, slightly behind based on timing but that's what we shoot for overall. And then driving margin expansion really through operational discipline in the factories introducing new products, driving our commercial teams to promote those solutions in the market. That's where the margin uplift comes from.

Got it.

I would also add that when you think about this long term, pricing is in that 100 to 200 basis points type of impact on organic growth. The updates we provide the market last week and strategically a progression around sales growth. We cap the pricing at 2%, right? So that growth is actually more accelerated when you had the full impact of pricing. But our team recognizes that over the long term, that 100 to 200 basis points is a normalized view of pricing that we should be thinking about.

Yes, I saw that a little last [ trick ] on your recap side, which is, I think, commendable actually because a lot of folks would just take that and run with it. You take the credit for it too. So maybe on the shorter-term side of price, just to put a fine point on it, within Fori, there had been some of those contracts, I believe, needed to be rebased. So when you think about the contribution, that 1/2 of that organic growth being from price, is that included in that number? Or is that on top on of the Fori?

Pricing was a key lever for us to improve Fori business. As you mentioned, we inherited a lot of contracts that didn't have appropriate inflation escalation measures in them. But when we think about price, we don't track any price in the automation business because it's all project to project, bid to bid. It's -- their price we report is all in the core business in Harris of legacy products that we're selling from 1 period to the next.

Got it. So when you guys lay out a nice slide of all the successes and you've had tons on the 2025 strategy. To play devil's advocate for a second, when I look at, right -- Like you're going to go that way. When I play devil's advocate, the spread between the Americas and the International business hasn't narrowed all that much. So while the margins are definitely going up and hitting that range, the spread is kind of going up kind of moving with it. So how do you guys look at that? Is that something we should expect to see narrow between the segments there?

Yes, that's a great question, Adam. Part of the challenge is the Americas Welding margin is a moving target, right? We're continuing to drive profitability in the Americas business. Part of that is improving automation because about our automation sales are reported through the Americas segment. But a lot of it is just good, solid progress in the core business in the Americas. So while International has made progress, right, they haven't necessarily close the gap because America keeps moving forward. Will International ever get to the Americas margins? No, I don't think so. The market structure and dynamics are different in the 2 markets. And so we see that there will always be a difference between the 2 of them but we're trying to get both businesses to perform as best as they possibly can. And then again, don't sleep on Harris because they're making a lot of progress there as well.

On -- so moving to automation a bit. The company is just shy of about $1 billion mark after seeing some good growth in the past year. So where is the mix now of the automation portfolio versus where you think it needs to go?

It's broad based, right? I mean we've been very intentional in looking at how we accelerate growth through introducing solutions like Cobot. It's a small, midsize fabrication upwards to $15 million to $20 million projects that are pretty complex on the industrial base. So when you think about where we started the year with the acquisition of Fori. We had lean a little bit more on the automotive side. At end of the year, 45% automotive, 25% general industries and the balance into heavy industries and structural fabrication. So we've got a very healthy mix and where -- our footprint is broad to be able to provide an automation solution across various industries. And I think we're very well postured for that.

Got it. And on the short-term side, it seems like quoting activity was pretty good. It's elevated today. So how reliable is quoting activity to turning into orders as a whole?

Yes, that's something we track very carefully in terms of really being able to plan the capacity of the business going forward. And there is a fairly consistent relationship between if I quote x amount of business in my pipeline, y is going to translate into orders. So we haven't seen a significant change in that over the last couple of quarters. And as you referenced, the quoting activity continues to be very healthy.

Got it. And certainly, you have your aspirations in automation to get that to a mid-teens margins, correct me if I'm wrong. But in the team's margins, just so we have the starting point of where we are today, and I guess we should say the starting point of years ago, just where did it come from? And then where is it today and how that path to get to that mid-teens?

Yes. So let me start off with where we ended in 2023, low teens type of EBIT and that includes the Fori business. So if you remember, we started the year with Fori being the low double-digit EBIT profile. So we're very pleased with the execution of our automation business to be able to complement Fori business plus Cobot and still achieve low teens type of EBIT profile. So we have a clear line of sight of achieving our mid-teens type corporate average EBIT profile. When you go back to the 2020, 2021-time frame, we're talking about a doubling up of the EBIT profile of our business. And we've done a lot of structural work, a lot of work around our business systems and practices and the teams we have done a really nice job of bringing it all together. So we continue to grow on our platform and drive an EBIT profile that's in line with our corporate average.

Got it. And you gave us the helpful mix of what the automation split is by end market and so forth. We love all our children per se. But are there some that are growing a bit faster than others? And then more so, I guess, from the profitability side, is there -- are there areas that are a bit more financially beneficial for U.S.?

It doesn't vary quite so much by industry segment, as you might expect. One of the things that we find is repeat business is great for us, right? So if a customer asks for a custom engineered solution, the first time we do that, there's a lot of engineering work upfront in making that system work. When they start ordering multiple copies of the same thing, that's when the business gets really, really attractive.

Got it. Got it. So maybe we will go into -- actually, let's do Harris, and then we'll go into the questions here. So on Harris, one thing I'm going to take away from this conversation is don't sleep on Harris. So could you maybe walk through a little bit of some of the things that you're seeing within that business as far as the ability to push that forward, I guess, longer term, but then in the shorter term, some of those bottlenecks that you guys have called out in the past, are those alleviating?

Yes. So I think a lot of the progress that we've seen in the Harris business, 1 is on the gas equipment side, which is industrial valves and regulators and cutting torches. We've started expanding that business into specialty gas applications for hospitals, research labs. So moving outside of our core industrial customer base, but leveraging the competence we have in gas flow and metering technologies. So that's been a great profitable growth avenue for us. We did a couple of acquisitions on the brazing side of the business to start to move a little bit downstream in serving our HVAC customers with fabricated parts and components. We've done a lot of work to restructure that business and move production to lower-cost countries. So we see a lot of just good progression in the basic operation of the business that should enable us to continue to grow and expand margins. And then to the degree that the U.S. consumer and the HVAC market comes back, that's just further tailwind for us.

Got it. All right. So let's shift into the audience response questions, if we could. So to participate, please there's a clicker on each one your tables there.

[indiscernible] clickers?

No, no, no. Do you currently own the stock? Yes, overweight, market weight, on the weight or no? All right. Opportunity. Moving to the next one. What is your general bias towards the stock right now, positive, negative or neutral? All right, about 70% towards positive? Very good. So again, I've seen this in other sessions as well. No -- not owners of the stock but they're positive. So really potential opportunity. Moving along to next one. In your opinion, through cycle EPS growth for Lincoln will be above, in line or below peers? All right. A bit above. Next question? In your opinion, what should Lincoln do with excess cash? This is Gabe's question. Bolt-on M&A, larger M&A, repo, [ divis ] debt paydown or internal investment? Don't disappoint Gabe, guys.

I'm just going to try and remember now what each number quarterly.

Yes. There you go. A little split between M&A and internal investment.

That is our capital allocation strategy right there. Internal investment, bolt-on M&A and then returning excess cash to shareholders.

You got it. So it's a very balanced.

Yes.

Moving to the next one. In your opinion, on what multiple '24 earnings should Lincoln trade at? And it ranges from less than 10x to higher than 21x. Again, these are standardized ranges for the conference. Just got to start that clock. There you go. All right. All right. More towards the higher end of the spectrum, let's put it that way. All right. Moving to the next one. So what do you see as the most significant share price headwind facing Lincoln? Is it core growth, margin performance, capital deployment or execution strategy? I should do a executive test on this before I match it up to the audience. See how it works out.

Yes. That's right.

All right. So it's about 60% on the core growth side, about there are 40% margin. But I guess probably more standing out is that there's no one that's at capital deployment or execution and strategy. So like you said, capital deployment, very well balanced over time on a year basis to a degree. Could you -- let's talk a little bit about M&A. So as far as automation, automation has been that fertile ground where you've done some acquisitions there. Are there examples of places within the core welding portfolio that also could potentially attract more inorganic investment as well?

Yes. I think in the core business, the investment opportunities for us are geographic. So building our presence in markets where we feel like we have good traction but we'd like to accelerate that. So India is a prime example of that. And then there are also a few product categories we'd like to bolster our competitive position and portfolio in, for example, cord wire or plasma cutting would be attractive investments for us. So we continue to be very active in all segments of the business. We look at a lot of automation opportunities that just reflects the highly fragmented nature of that market and the fact that there are a lot of properties that have reached a point in their growth curve where they feel like there's a better owner for the business than the current owner. But we continue to look at a lot of opportunities in Harris and the core welding business as well.

Got it. And thinking still about capital deployment and really more so on the free cash flow generation side. So from a working capital perspective, certainly, it looked like you made a bit of progress here. through the year. So maybe if you could just talk a little bit about as far as what helped drive that? And then essentially how we should be thinking about free cash flow conversion and so forth?

Yes. Our target is to be at that 15% top decile performance. And what you've seen over the last year is progression back to where our posture has been in working capital execution. We intentionally elevated inventories, part of our customer-first type focus. And that's just a lot of discipline surrounding sales, inventory, operations, planning, the use of the tools, and we have on instance of SAP, for example. So the team is just having the discipline of understanding demand patterns, looking at where we can optimize inventory positions and then just a lot of discipline. And so we're very focused on that longer-term target of 15%. You saw a very healthy progression this year. And so we'll continue to look to a continuous improvement philosophy in optimizing our working capital position.

Excellent. And maybe to wrap up here, I did want to ask a question on some of those long-term growth initiatives. So both additive manufacturing and fast charging. I guess the first point is essentially what milestone should we be looking at for both of those in terms of measuring the growth of that. And then from an investment side, just remind us the amount of investment that, that requires?

So let me start with the latter. The investment has been very modest for a company of our size and market cap. We invested about $15 million in the EV charger initiative but that was largely in capacity in our electronics factory that also feeds the welding machine business. And really, that was to avoid ever becoming capacity constrained and having to choose between selling a charger or selling a [indiscernible]. We didn't want to be put in that position. So the capital investment was very modest. A lot of the assembly operations are using existing factory that we have in Cleveland. And on the additive side, it was investments in basically welding robots that we sell to everyone else. Our additive business is basically using a welding robot as a matrix printer. There's a huge amount of software that makes that work. That gives us, we think, a very differentiated and proprietary solution in the market. To the first part of your question, we're now seeing very strong interest in additive from the defense industry and from the energy industry as a replacement for large casting. So pump housing and the like where -- if a part goes out of service, it's 8-plus months to get a replacement, and it just can't afford the downtime to do that when we can give them a solution in 8 weeks or so, right, not very price-sensitive customers because of the tremendous value creation opportunity there. So we feel like additive is on the cusp of making a breakthrough from a commercialization standpoint. And then on the EV charger side, we're just working through the product validation and testing requirements of all the customers that we're talking to. They recognize that this is a pretty significant capital investment they're making. They've been burned by some of the choices they've made in the past. And so they're just being very conservative in putting us through our bases before they'll declare the product to be fits for service. So we're just working through that process with them, and we'll continue to drive that forward.

Yes. We'll keep watching it. So with that, I want to thank the Lincoln team for being here today. Let's give them a round of applause.

Thank you.