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

Good morning. My name is Saree Boroditsky. I cover multi-industrials here at Jefferies. We're really excited to have Lincoln Electric, CFO. Gabe Bruno with us today. Lincoln is a global leader in welding that's coming off a strong margin performance quarter despite operating in a very dynamic environment. Over the long term, we expect the company to compound earnings through its strong position in automation and capital deployment strategies. So thank you for joining us today.

Well, thank you for having us. Saree. It'd great to have Jefferies host us and talk about our business.

So it's a fireside chat format. So if you do have any questions, please feel free to raise your hands. And otherwise, we'll just jump into it. So maybe we'll just start with the current environment. On the last earnings call, you continue to see customers defer capital spending and maintain this kind of wait-and-see approach. Has this changed at all as customers digest this 1 big beautiful bill, maybe Section 232 tariffs now? So what are customers waiting for to execute on some of these projects?

Well, just to give you a broad perspective on the environment, we kind of paint a picture of the active current production cycle versus the capital investment cycle. And we went into the second quarter knowing that there's just a lot of uncertainty. Our posture is to protect our business model with our pricing strategy to be price cost neutral. And so we entered the second quarter considering a volume potential compression that would offset pricing. We didn't see that. We saw resilience, particularly in our North American markets. As well as in our consumable part of our business, which is a key indicator of what you see in the production cycle. So we're pretty positive with that. There is a bit of a wait-and-see sentiment, when you're thinking about capital investment that has impacted both our automation offering as well as standard equipment, and that hasn't changed. So we saw resilience in overall -- in our overall business, but deferral kind of a flattening level of business within our automation business. So it's very active in terms of quoting, but not so much in terms of pulling that to orders. In terms of the Big beautiful bill, we do see potentially some acceleration of investment, particularly with small and midsized fabricators that may take advantage of accelerated depreciation. It's too soon to tell. Typically, that would come into play around the fourth quarter, but we haven't considered that within our overall operating assumption. So the tone in the current environment is stability and some resilience, particularly in consumables as well as North America.

And then I had to add in this question after yesterday, I think the big topic on people's minds was Section 232 tariffs. So obviously, that's kind of broadened the coverage. Can you just quantify like how you're thinking about it from a pricing or supply chain perspective?

Yes. So I think what's important to know is what our posture is. And our posture is we'll navigate the uncertainty. We'll quantify the impacts to our business and then we're going to take action on pricing to mandate a price cost neutral a posture. We have been very active in looking at alternative suppliers in the U.S. for where is -- where we've seen the specific optionality and sourcing, but that will continue to be a pretty key for us. Our team in this latest round of actions and administration, there's a little bit more of a challenge in getting it through the bill of materials and understand the component impacts to that. But once we quantify, we'll respond as we always have with the price cost neutral posture.

Keeping the supply chain guys and girls busy. Heavy industries is 1 area that you've stressed is operating in a weaker environment this year. I think you've expected it to prove into next year. So just maybe kind of frame expectations and how far will a mid-cycle are you in that?

Yes. So when we think about heavy industries, we've been navigating a compressed environment, particularly with the destocking dynamics going on within ag and heavy industries. So our best view when you go back to peak 2019-ish time frame and with the compression we've seen, we're probably down mid-teens in terms of volumes. We do, as you would expect, have easier comps progressively in the second half of the year. But we don't point to any expectation of growth into sometime in 2026. So that's going to be 1 of those end markets, which represents about 19% of our business. They're going to be somewhat of a challenge. Now within that, we do have some optimism around construction, mining that could offset that. But in general, we don't look to growth into 2026.

Maybe 1 more specific end market. You've talked about energy being strong domestically and internationally. Maybe just the key drivers there and the visibility to growth over the next few years.

Yes. So we're bullish on energy, and that's not short term but long term as well on both the U.S. as well as in international markets. When we think about projects and energy driven by oil and gas. About 2/3 of our energy, we estimate position is in oil and gas, and we've seen some really good activity in pipe mill and pipeline activity, which would be in the midstream components of oil and gas, which is more than half of oil and gas for us. We also are pretty active in Powergen and you have different projects to really drive it in Southeast Asia and Middle East. And so we're pretty excited about what energy plays out for the foreseeable future. So good momentum, where we were growing in the second quarter. We'll continue to expect that for the balance of the year.

You mentioned a little bit earlier about the consumables, [ heat-reflecting ] factory activity what does this tell you about underlying demand versus the willingness to invest in equipment right now?

Yes. So what it's telling you is that customers are buying what they need for production because consumables is a function of production. When we think about some of the key underlying macros that we track are aligned to production or PMI. That's a measure of sentiment, and you saw that -- the PMI just released saw a little bit of strength in new orders. So while still contracting, particularly in the U.S., you're seeing some components that could be more optimistic. But the other measure that's important, which is reflective in our business is actual industrial production. Being it's been kind of flattish. It was up maybe just over 100 basis points from the July period. But that's kind of what we've seen in our business. So when you see in a consumable activity, it's essentially flattish on volumes. It's an indication of what our production levels across the various markets. So it's a pretty important indicator for us, does provide a framework on what our customers' needs are currently. When you point to growth, which we haven't seen, generally, it's been flattish. You see consistent growth that would also lead into further capital investment. And that would yield into growth into standard equipment, into even automation and other drivers for us. So consumables is a pretty important product reference, which is more than half of our business, 52% of our business is consumables.

One of the things, I often hear is kind of consumables is kind of more generic. Could you just kind of talk about what differentiates your consumables business?

High-quality consistency when you're dealing with an automation offering, you want to have a kind of bulk packaging that doesn't tangle. So you want to drive productivity, efficiency. And so we're -- our products are differentiated for its quality. On the automation side, if you're investing in millions and an automation line that's anchored on welding capabilities. You don't want tangling, you don't want to invest and/or procured consumable products that are going to cause some productivity issues on the line. So that's what differentiates us.

Well, you brought up the automation angle. So I believe 1 of the benefits of automation was that it increases customer loyalty and like the stickiness of consumables. So just how do you see that play out? And what percentage of automation customers use Lincoln consumables?

So we shared some figures recently. So what's not captured in how we communicate automation sales are the consumables sales that we sell into robotic applications. And we estimate that to be about $300 million last year. So you think about 15% of our consumables are anchored around supply and robotic applications. And we have substantially all of the business there because again, you have customers that are making large-scale investments and they need to be able to have consistency and the quality of the products being used from a consumable standpoint. So our team would tell you substantially all of the businesses, our business. So very sticky, very much aligned to the value proposition of the automation within the welding fabrication part of our business, 55% of our automation offering is tied to welding fabrication. So it's a very sticky part of our business.

The original guidance called for lower volumes basically to completely offset the higher prices, but obviously, volumes were not as impacted as feared. Was the original guidance just overly conservative? Or have you seen customers in certain segments respond differently than you would have thought?

Well, for sure, there is some conservatism there because as we think about our operating assumptions and how we communicate them, they're really a posture of how we're looking at our business. And our posture was to -- to protect our model with pricing actions, knowing there's a lot of uncertainty on what a response would look like in volumes or what the markets in general would respond to the tariffs and the dynamics there. But as [ Vittoria ] just talked about it, it was pretty resilient from a volume activity. So when you look at some of the key markets, automotive has held up better. So you've seen the latest on SARS. We track production, SARS on the sales side, but also production levels on the automotive side as well as inventory levels. So that's pretty key for us. And so production seems to have held up a little better than we would have anticipated. Distribution. Industrial distribution in general has been held holding its own, too. So we look at that channel is about 60% of our business and the strength there. So it was very good as well.

And I'll just pause and see, if there's any questions from the audience. Okay. Thinking about conservatism. The current guidance assumes automation stays stable through the year, which I think implies a decline for the full year. That says, you kind of talked about steady order rates and elevated Quotium activity. So what do you need to see for those quotes to turn into orders to actually hit this year? And could we see a positive surprise?

Well, we're running out of time this year, hitting September to see some meaningful change in order activity, but have an impact on our current assumptions. Flattish implies -- and we were essentially almost spot on $215 per quarter for the first half. We see more of the same for the second half. And so, while that appears to be steady, we had a pretty strong fourth quarter last year. If you remember, automation business peaked at $270 million of sales in the fourth quarter. So we don't see that for this year. That's built into the operating assumptions. We need to see real conviction on the quoting activity, which is still very strong and very broad-based. And when we think about broad-based end marks, we're talking about automotive, heavy industry, general industry type opportunities, but just haven't seen that translate into a meaningful incremental orders that would change our posture within our operating assumptions. We're still pretty excited about what we see. And just for us, it's just a matter of timing I mean our win rates are improving over time. So we're pretty well positioned to drive the kind of posture we would expect on our automation business, but we're just kind of seeing -- we haven't seen it yet. But we do think it's a function of time.

Automation sales are skewed obviously to Americas and to auto markets. How do you think about diversifying this business either geographically or by end market? And does this require additional investment or acquisitions that you're thinking about?

So for sure, we look at acquisitions as part of our growth start there. So when you think about what we've done within our automation model is we've increased from $400 million in 2022, we're right on top of the $1 billion target. We get some mix of 1 capital orders are accelerating. But our growth trajectory is by organic and inorganic growth. So we continue to see opportunities on the acquisition side, both in the U.S. and outside the U.S. And outside the U.S., when we acquired Fori couple of years ago, that allowed us to give us a nice footprint to continue to mature our positioning in India, in China, South Korea and Europe, and we'll continue to do that. Our largest component, as you mentioned, is in North America, 80% of our automation businesses in the Americas, but we're continuing to look at geographically, our ability to do acquisition or maybe specialized automation business as we've done in the past and continue to broaden out the footprint through acquisitions in North America. And then when you think about end markets, our posture has tilted a little heavier on the automotive side, since our acquisition of Fori. But we were before that acquisition, a third split between general industry, heavy industry and automotive and with a very much intent of presenting solutions into the markets that would accelerate adoption. So while the automotive industry has been a leader in automation, heavy industry has also been pretty deep and then look into small midsized fabricators to also adapt welding technology. And so we've broadened out our product offering. We got on the -- on the, say, lower end in terms of value proposition is $100,000 or so on the coal bonds and you've got hundreds of thousands for pre-engineered robotic cells. That ties into the small, midsized fabricators nicely, who are more recently into the adoption of automation technology. So I see that as a way to broaden our footprint and to continue to present solutions that would accelerate adoption.

I just want to circle back to your prior comment on the high quoting activity. Are you seeing customers quote like different locations, different countries, or is it just trying to like scenario plan? Or are all of these kind of like fixed ideas?

No, they're really -- the way we measure our quoting activity is our team is engaging with our customers, and then they're assessing a probability of that level of order. So you get into deep design and quoting, so as we're defining that, they're not just superficial quotes. They're deep engineered designs that are part of how we present our value proposition to our customers. So these are largely quotes that our team has assessed with the 90-plus percent probability in this month. And so what we've seen is that level of confidence slip from 1 month to the next to the next to the next. So we have confidence in the quality of the portfolio of quoting activity, but just it hasn't been pulled into actual orders. And we've seen that throughout the year. Just pulling back the months quote to order.

Yes. I thought at this conference, maybe we could talk about things getting a little better with more certainty with the big beautiful bill and maybe tariffs, but now we have this new, are you -- has this impacted anything like people still pretty uncertain or people...

I would say it's more of the same. So since we announced in July, it's more the same resilience, seen some steadiness in actual production and order patterns, but I haven't seen an acceleration.