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

Thanks and good morning, everyone. Thank you for joining us. My name is Angel Castillo, and I'm the U.S. machinery and construction analyst here at Morgan Stanley. Before we get started, I just want to read a quick disclaimer. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. And this morning, it's my pleasure to have Gabe Bruno, EVP, CFO and Treasurer of Lincoln Electric. So thank you for being here.

Thanks for hosting, Angel. It's great to be here.

Yes. And maybe just a good place to start would be your multiyear strategy. So this year, we're kind of lapping the higher standard 2025. And I know you'll probably want to talk about it in a little bit more detail later on. But to the extent that you can provide a preview or kind of set the stage for how you're thinking about the next few years with margins already kind of in the high teens, that is above what you had kind of laid out in your original plan? And just how you kind of expect to perhaps focus more on consumables or equipment mix versus automation, inorganic, et cetera? Just would love to start there.

All right. Well, thank you, Angel, again. When we think about our strategy, when we announced 2030 kind of key themes, first part of 2026, but the foundational building blocks are already established. So when we think about growth, think about leading with innovation in our 2025 higher standard strategy, our objective is to achieve high single-digit, low double-digit type growth. Fundamental drivers are leading with technology, innovation. We'll continue to drive accelerated growth through automation. And you've seen the continued investment and shaping of our business model there. And then acquisitions become an important part of our growth agenda, which again, 300 to 400 basis points of -- type of growth. So foundationally, those elements aren't changing, right? And we'll look for opportunities and adjacencies maybe to accelerate growth, but leading with technology, accelerating our position in the market, automation, acquisitions. I think about margins, you go way back in time, we like to share a slide in our investor deck that shows the shaping of our operating model over a 20-year period. And for each cycle, we've expanded our operating margins by 200 basis points. And you point to like in the current strategy period, and we've been exceeding the last few years the average operating profit that's based in our model. So while our average is 16% in the strategy period, we've been in excess of 17% now for now pushing 3 years. So we'll reset kind of how we think about the shaping of the next strategy period, but you can expect continued improvements in the operating model. If you just look historically, a 200 basis point type of an expansion in our operating model, it's probably a pretty reasonable place to be to start. And then we think about fundamentals of cash and capital allocation, ROIC, how we're deploying capital. When you think about growth and investing in acquisitions and that you've got core welding as well as automation. So on the core welding side, we just announced an acquisition in August that was core welding. Then we had one last year core welding. So you have a nice mix between automation types of opportunities as well as core welding. So that's kind of how we think about it, very much balanced across all of our business, but fundamentals of cash management, cash conversion, ROIC are all part of the structure we have in our business. You can expect those kind of things to continue into 2030 strategy.

That's very helpful. And as you think about it, I think this kind of leads us into a topic that's been probably the biggest area of debate, right, just in terms of what the implications are of tariffs now we had the expanded Section 232. You still have an outlook for the year of price/cost neutral. So as you think about both this year and kind of the longer-term ability to hit 200 basis point expansion, how is that kind of expectation being impacted by tariffs near term and just your overall strategy?

Well, our overall strategy is to be price/cost neutral. So we've got to be agile and responsive to the cost dynamics we see in our business. This is not a new thing for us. It's now in a different shape or size with tariffs, but the fundamentals are there, and we have to be very disciplined about understanding the changes in our cost structure and how we respond with our pricing strategy. Back to the strategic question. When you think about how we've performed in this 2025 strategy period, you start off with COVID in 2020, where the 2025 season has been covered with a lot of tariffs and administrative policy type discussion. So when you look at how we performed, organic actually is within the range, a little bit more pricing than volume, but all within the range. And that's how we think about it. We think about long term, we think about being very disciplined in protecting our model and understanding the fundamental cost challenges we have and putting in place pricing where needed to be able to protect our model. And but keep on thinking about long term, what are the drivers for incremental growth across the end markets and geographies that we serve.

And maybe just specifically to the expanded Section 232, I guess, any kind of ability to quantify the incremental impact of that? And how are you, I guess, already rolling through prices for that? Or how's kind of the strategy on that?

Yes. No, we're still evaluating the impact of just what's been announced over the last couple of weeks. And once we quantify it, then we'll put in place pricing actions to be able to do with the same fundamental discipline of price/cost neutral.

Got it. And I do want to remind the audience, I guess, if anybody has any questions, feel free to raise your hand and we can get a mic to you. But maybe just sticking with the Americas for a little bit. One of the things that I guess has been a little bit surprising is you had talked about, I think, at the beginning of the year, an expectation for perhaps some elasticity from the customer to the price increases, which you really haven't seen as much. It seems like you've been able to flow that through and still see pretty decent volumes. So can you just update us on maybe how that's progressing, how your order intakes have been kind of flowing versus your quoting activity and just still...

We've been -- so we're seeing more resilience, generally speaking, in actual volumes. And we saw that continuing into the July time frame. And so we continue to see it today. It's just more steadiness in activity, not significant increases or any cliffing going on in our business, but in general, just stability. You're right, we did anticipate. We planned for. When you think about operating assumptions there, they're the assumptions that we were framing how we are addressing our short-term business operations. And so we were planning for to be ready that if volumes are impacted by pricing actions that we're ready for that. And that was the basis for our assumptions going into the second quarter. And as you point out, we held the volumes were more resilient, more so on the consumable side of our business. So when you think about the consumables portion, which is about a little over half of our business is consumables, that is a function of factory activity, industrial production trends. So when you see more of a steadiness in that, that's actually more positive for us. When you look at overall industrial production activity being slightly up, and that's what you're seeing in our consumables. It's -- the consumable numbers are higher than that because of pricing in general. But the steadiness is important for us because that gives an inflection point on if we do see real growth, we're very well positioned to participate in the growth trajectory.

And just wanted to clarify, I guess, so the steadiness that you were seeing in July, you're seeing that continue into August.

We see that's the current atmosphere in our operations.

Great. And maybe could we drill a little bit into kind of the specific end markets. I think you had mentioned a little bit on kind of the ag and the construction side. But if we could drill into kind of the various end markets, particularly within the Americas and how -- are those all kind of holding in that steadiness? Or are there some puts and takes?

Yes. No, they're different. As you point out, heavy industries has been challenged for the last now over 1.5 years or so. And we continue to see pressure on the heavy industry side. You're tracking things like the destocking going on in ag, for example, that has an impact on our heavy industry. So we don't see that inflecting to growth until sometime in 2026. I can't tell you when, but that's kind of how we see things, seeing good progress, destocking, but we just don't see growth there. And that's heavy industries, which is almost 20% of our business. So when you move from heavy industries into general industries, you saw we were up second quarter, high single digits and there's some pricing within that, but that comes back to our dialogue on what's consumable activity? Is it steady? What are you seeing in the sentiment, PMI? And what are you seeing in actual production. So it's -- we were up and some of the drivers we're hopeful are going to turn more -- at least steady to more positive as we progress in the next 12 months or so. Automotive actually has held up a little better than anticipated. You see the retail sales actually are stronger. And for us, it's understanding in automotive, the difference between what's happening in factory production, which is same conversations on consumables. And the production levels on the automotive side is going to drive more consumable activity. And then the second part of that is investment. So you think about automation, 80% of our automation business is tied to our Americas. When you see deferral decision-making on the capital side, that's where you're seeing the impact on volumes, both standard equipment as well as automation while consumables is holding up. So that's kind of an automotive dynamic. Energy, we're more bullish on energy. When you see potential investment progressing in oil and gas, particularly midstream, which is about half of our -- a little more than half of our oil and gas concentration, that's pipe mill, that's pipeline activity. That's positive. We're positive in the second quarter. We expect that to continue. So good momentum there. And that's just invested in the Americas, but you also have that dynamic in Middle East and Southeast Asia as well. So energy is positive. So that's kind of the key end markets that give you some perspective there.

That's very helpful. And I guess maybe just to go back quickly to the price/cost before I forget. I wanted to ask, so your LIFO accounting. What is the implications of that ultimately, I guess, in terms of your business and again, the speed at which you can flow through some of these tariffs and the speed at which you actually see them versus others while you also maybe have the offset of having more distribution?

Yes. So not many companies, I guess, still account for their inventories, particularly in the U.S. on a LIFO basis, but I am getting the question more often from investors because we're talking about the impact of cost more immediately than going through a turn. So our team is very sensitive to understanding that the pricing actions need to take effect now because of the cost implications that are having an impact on our business now. We don't have the turn to be able to respond to that. So you saw in the second quarter, we had an accelerated charge, we call it LIFO charge, which all that means is that we are -- the cost impact of selling the current inventory first reflects a higher cost that's within the LIFO charge. So you saw for the half, we're at $10 million, most of that accelerated into the second quarter. That's what's built into our assumptions for the year. So our team is very disciplined in understanding pricing inherently, but then also what's the impact on inventory. And so we don't have much time to react being on LIFO accounting. So we're very disciplined about understanding that in our model.

And maybe from the pricing perspective, to your point, understanding kind of the urgency to pass that through, can you talk about what you're seeing in your distribution channel versus on your OE side?

Yes. So think about the first half of the year, and we put 5 price increases in place. And we're very sensitive to be working with our channel partners to respond in a very disciplined way and give them as much notice as possible to be able -- so that they can react to also the pricing challenges that they have. So we're very sensitive to that, and we do our best to accommodate our pricing actions to the needs of our customers. OEMs, so 60% of our business is sold through industrial distributors who are also very disciplined in managing their own models and pricing. The OEM conversation becomes a little bit more challenged from time to time, but it is working with our customers for them to understand the dynamics we're operating with and being sensitive to how we need to respond.

Got it. And I guess, yes, in this environment, are you seeing the, I guess, the pressure or the pushback from OEMs change? Or are they -- I mean, it's always I'm sure a tough negotiation, but just are you seeing that evolve at all?

There's nothing different in our discussions. Pricing is always a challenging conversation at any level, but nothing fundamentally has changed in how we approach the markets.

Got it. And then maybe sticking to that kind of price/cost, one last thing. Just in terms of cost management, can you just talk about some initiatives there and what you can do on that side in terms of additional opportunities to mitigate some of these headwinds both near term and into '26?

Yes. So I cover that first from a supply standpoint. I mean our teams are actively looking for alternatives in the supplier base. Think about steel, for example, we've talked about the source of steel being largely up north. And so the development of key U.S. suppliers are important for us. That's a pretty active part of how we look at the markets. And that's just not on steel. That's on other components where incremental cost tariffs and that has a real impact to our business model. So we're doing things to try to soften that impact. On a more longer-term perspective on costs, we're challenging our operating model. You've heard us talk about permanent cost savings in the second half of the year being between $10 million and $15 million. That's all about how do we shape our business model for the long term. So that's a key theme. You've seen that throughout our business, just a continued emphasis on how do we shape and improve how we operate. And that's part of my original comments of what are things we're doing to improve the margin profile of our business. And takes a lot of work to continue to shape 200 basis points plus on each cycle. And so our teams are very much sensitive to needing to operate in that manner.

Yes. No, that makes a lot of sense. And on the steel sourcing side, I guess, that's an area I kind of understand to be challenging in order to get the kind of quality or the specific type of steel that you need sourced in the U.S. I guess, could you maybe elaborate a little bit more on what the potential magnitude of the steel sourcing?

When you look at welding grade broad capacity versus the other flat long, it's not the top of a steel manufacturers agenda. But we do have opportunities to kind of work through that. So we're hopeful, call it the next 6, 12 months that we will have a couple of suppliers that we can work with. But it's an ongoing work of our team.

Yes. No, that's helpful. And then maybe one last one on the Americas side. You mentioned automotive has kind of held in better than you kind of anticipated. One, could you elaborate on that, but also on the automation side of the autos, I recall, I guess, the last 6 months or so or a little bit more, you've been talking about maybe orders or how quickly things are turning from quoting to orders remaining a little bit more of kind of a wait and see at the customer level. I guess, how are you seeing that evolve as autos has held in better, are you seeing any kind of more on the automation side also move forward?

Yes. No, we've seen more of the same on the automation side. Typically, you would see -- think about automotive in the back half of the year with the seasonality, which generally leads to an uptick in the second half of the year, just the staging of project completions of that. We haven't seen that level of activity that would play out to a seasonally higher level of sales in the back half than you would see in the first half. So our tone has been more of a flattish trend. The implications of that is that we're down for the year in automation by mid-single digit for the full year. So you're seeing a steadiness of almost like a run rate $250 million a quarter, seeing more of the same. Now for automotive, on the capital side, we are very interested in seeing how the new program launches for 2027 and 2028 play out on long lead time items. In every April and October, the industry publishes kind of its reset on program launches. So in October is the next kind of reset in communication from an industry standpoint. And so we're hopeful that, that would lead into more longer lead time capital investment on the automotive side. But we haven't seen anything to date, high-level quoting activity that gives us perspective that the orders and ultimately, the revenue recognized will be any different than what we've seen first half of the year.

And are customers telling you anything in particular as they maybe hold off on that quote turning into an order as to what it is? Is it just macro uncertainty? Is it interest rates? Anything notable?

I think it's an overall just confidence in kind of where we are in the economic cycle. So much, as you know, on the administrative side of things and policy-wise, just kind of wait a little bit, wait and see kind of how that plays out. As I mentioned, quoting activity is very high. We do think it's just a matter of timing because the value proposition we're presenting with productivity and efficiencies and facilities and introducing automation, very much sound. The way we track our quotes is we assess the probability of this becoming an order in the next -- in this month and the next and the very high level probabilities. The dynamic we've seen though is that every month that's been pushed out another month. And it's been going on all year. So that has translated into a relatively steady level of business activity, but not the incremental volumes that we would otherwise expect from a quoting standpoint.

Got it. No, that's very helpful. And maybe just switching over to the International market, if no one has any questions on kind of the Americas here. I guess just -- this is an area where I think of the International -- your International business as being more competitive and perhaps a little bit more difficult to pass through pricing, you actually had still 40 basis points of positive price in that market. So I was wondering if you could kind of talk about both your strategy in the International market as well as just kind of the execution and what's driving perhaps some of the flattish to more positive pricing in International as well.

Yes. So pricing, when I see flattish, that's just kind of holding position, right? So that's what it is. But when you think about International long term, taking a business and I think about what it was in 2015, mid-single-digit type business. We acquired a business in 2017, the great 2018, '19, kind of drove the margins down because it was pretty much 0 margin type business. So we come into the strategy period into kind of again the low mid-single digits EBIT, but we more than doubled that. And we had a target that we established at the beginning of the strategy period to be between 12%, 14% EBIT. And with some volumes, we believe we're there. But we're tracking a little less than that for the first half of 2025, we're at 11.5% in the EBIT margins for International. And so what does that mean for us is that we need to continue shaping the operating model. We're excited about markets like the Middle East and Southeast Asia. We bought a business in Australia in August that's going to give us the ability to leverage its capabilities in other parts of the world. Europe is -- continues to be, call it, a challenging environment. We're hopeful, though, that more investment on the industrial markets in Western Europe, Northern Europe as well as maybe defense does contribute to more industrial activity. But in the meanwhile, until we see some real volumes, we're going to continue shaping our business model. And we do believe that with some volumes, we'll be in the higher end of that range, but that's kind of where our posture is on the International side.

That's very helpful. And maybe just kind of honing in on the Europe side. You mentioned it remains challenging. I guess could you talk about that from the competitive landscape? Like how are you seeing the competitive behavior in terms of discipline? Because you've been holding steady in an environment that's a little bit more challenging, I think it seems like a positive.

Yes. No, we're #2 player in Europe. Competitive environment is you get a lot more fragmentation for sure. I mean the big player there and then we're #2. So I can't point to anything materially different competitively, but it is more fragmented. Structurally, it's more challenging to maneuver in the operating model, but nothing else pretty to note there.

And maybe just in terms of maybe kind of a preview of 2026. You mentioned some optimism, I guess, on Middle East, Southeast Asia, again, maybe some for infrastructure. First, I guess, are you -- is that to mean you're not necessarily seeing any step change yet from infrastructure kind of spending in Europe? And second of all, how do you kind of see that as you think about 2026 or potential for improvement?

Yes. No, we haven't seen anything that gives us in the short term any confidence that we're going to go into a growth cycle here on the industrial side. But we're hopeful in Europe. So we're -- our posture is to be able to participate and grow and get our fair share of activity in the European markets. We just haven't seen that yet.

And then maybe switching over to Harris. I think you had -- I guess, you had this onetime kind of retail sell-in in last quarter, I guess, for Harris. Can you talk about just what normalized kind of pull-through of demand that perhaps Tractor Supply in our partnership potentially gives you?

Yes. No, we were very excited. I think it's very public that Tractor Supply has moved to Lincoln as a supplier for the welding industry. So we're pretty excited about that. I estimate about 2/3 of the growth volume in Harris in Q2 was driven by this new customer of ours, of which included stocking -- initial stocking requirements there. Normalized level of business there is probably somewhere half of that. So it's in the range there. We'll have probably a little bit more stocking into Q3, and then it will be -- it will normalize. But we're pretty excited about retail position in Harris and continues to grow.

And maybe just given the differences in the distribution channel for Harris, I guess, perhaps being a little bit closer to the consumer in a way. I guess, could you just talk about what this kind of tells you about the broader economy, the health of the macro as you see it out there?

Yes. The biggest difference in the Harris side is the retail positioning, the consumer end of things. And if you take outside of the Tractor Supply business in Q2, we're probably more flattish type of environment, which is more in line to what we're seeing across industrial distribution, frankly, the tone that we're sharing across in general, just more of a stability, flattish, some challenge there. But consumer activity, if you just use the proxies of kind of the Home Depot, those types of reports, kind of a framework for us.

Got it. And then maybe just a little bit on kind of the capital allocation side. Just between Americas, International and kind of Harris, I guess, where do you see yourself wanting to be more or less or bigger in kind of the next few years? And just kind of which product lines, geographies and markets you might be looking to allocate more capital to? You mentioned some of the inorganic side and automation is still an interest, but just more broadly would be helpful.

Yes. So, you know that we've been leaning on capital investment, internal capital investment, doubling it over the last 5 years plus. So it's really broad-based. When we think about capital allocation, our first priority is growth. And our highest returning investments are all the internal investments we do. So this is why it's important for us to make sure we've got capital resources assigned for new products, capacity, operating capabilities in our business. And that's across all of our businesses. So that's a pretty active level of capital allocation. Then we mentioned acquisitions. While I would call it, we've had individually more transactions on the automation side. We think about a TAM in that space of $35 billion. So in total, we talked -- if you look at M&A comments within our investor deck, $60 billion type TAM, of which $35 billion in the automation space, $25 billion kind of core welding, we estimate. So it just tells you that we'll probably have on average a little bit more transactional -- transactions around the automation space, but very much balanced and looking at across the markets. And the reason is because of the level of fragmentation. In core welding outside of some of the top 3 players and some of the regional players, very fragmented market, and we'll continue to navigate opportunities there. On the automation side, it's just a lot of fragmentation. So we'll be allocating capital first to drive internal growth investment and also for inorganic type growth, but it's not anchored on one particular segment or not.

And it's just the general level of kind of macro uncertainty impacting either the timing of some of these investments or the kind of attractiveness of any of these. And I'm just wondering, even from a kind of an interest rate perspective, like are there reasons to perhaps wait for more cuts? Are there reasons to move faster because of the opportunities that they might be affording now? I guess just if you could talk about in that context.

It hasn't had an impact on how we think about capital allocation. I mean we're looking at it long term, and we're not pulling back on internal investment, very active. Same thing on acquisitions. We're looking to what strategically fits, how we can create incremental value and how do the synergies of the business case line up within our 3-year framework. And so those are the drivers in our decision-making, less about interest rates and the cost of capital.

Yes. No, that makes sense. And then maybe just last one kind of on the capital allocation side. So you recently had the Alloy deal announcement. Just curious how the full kind of integration of that or just the acquisition of this kind of stake has gone, I guess, any incremental or potential kind of cross-selling or just other opportunities that this affords you in the business?

Yes. So we're really excited about the potential for the business. So -- and we had acquired 35% of the business back in April. So we had already been pretty deep in some of the integration work. So the integration is going very well. The teams are in place and thinking about how do we scale capabilities in a business that is tied to mining and repair and it has a unique positioning that leverages core technology that we're already in. So it's an adjacency that aligns up to a lot of the work we do today. So it works nicely. And so we think that this is an opportunity for us in the Americas and other parts of the world to deploy what's called wear plate type technologies or hard-facing technologies that are used in the heavy industry type of markets that provide strong maintenance and repair capabilities. So we think it's a great opportunity for us to now deploy that same technology around the globe.

And we've talked about the deployment perhaps organic and inorganic. Can you maybe talk about the shareholder side or the shareholder return side? So I think you had a target of $300 million to $400 million of buybacks this year. You've already done $230 million as of 2Q. Just if you could kind of expand on that, maybe the cadence for the rest of the year, the attractiveness of repurchasing more shares at this level?

Yes. So we think strategically in returning cash to shareholders versus the dividend. And for 29 years in a row, we increased our dividend rate, and we'll go through a policy in our October meeting with our Board. And then in terms of share repurchases, first, we want to cover maintenance. So we want to make sure we're covering the dilution impact of any employee programs. And then we're opportunistic in looking at excess strategic cash. And so this is the reason why we decided to provide an expanded framework in Q2. You mentioned that we're over the $200 million already for the half. But that's kind of the range that we're kind of set for this year. And so we'll be steady and looking at the level of share repurchases within that range.

Yes. Got it. And I just want to check any questions from the audience? Remember, raise your hand if you have anything. If not, just wanted to go back to automation a little bit. I think we talked about, obviously, some of the challenges right now. But also wanted, I guess, on 2 sides of that, right? On the near term, the potential impact from higher fixed costs of this business of at $250 million versus perhaps the ramp-up and potential kind of longer term, if you could kind of just remind us again the structural margin that you see that business ultimately attaining? And can that just be achieved organically? Or do you need some inorganic help?

Yes. So you know that our target is for the automation business is to be at the corporate average operating margin, think about the EBIT margin of the business. And we haven't achieved that yet. So if you look at 2024 as a proxy, our sales were $911 million, and we were a low teens type of EBIT. So our target is to be at the corporate average. We still have about 300 or so basis points of margin improvement, of which half of it you said is going to be driven by volume improvements or increases and then you have continued shaping of our model. So as we've integrated acquisitions, as we've incorporated the businesses into our Lincoln Business System, those are avenues for us to continue shaping our model. So we have a clear line of sight to be able to achieve our corporate average margin while we're navigating kind of the markets currently. We started off the strategy period targeting $1 billion in revenue in automation. And as I mentioned, $911 million last year. I mentioned that just based on the level of activity, we're probably going to be down mid-single digits. So our business model is in place to be able to meet and exceed the objectives of $1 billion plus. And so you'll see an improvement in our margin profile as we achieve that as you start to see quoting activity become real orders and then we recognize the revenue, a large part of it over time. We'll be right on top of meeting not only the sales objectives but getting closer to the margin as well.

And maybe just going back to kind of the original question around your next 5 years and longer term. So that $1 billion mark was kind of, again, was set for kind of the 2025 time frame and $900 million, even down a little bit from there, still pretty darn close to that. I guess as you think about the next 5 years, do you see that growing exponentially both inorganically as you go and get that recovery?

Think about it -- so I'll give you the history first. So in 2020, our automation business was $400 million. We targeted $1 billion. Our model is essentially there, right? So accelerated growth on the organic side and a very fragmented kind of market on the inorganic side, and we'll continue to push both avenues in terms of our business model. So you see the top line growth more accelerated than core welding and then you'll see continued expansion in the margin profile.

Got it. No, that's very helpful. And then one last one I had, just in terms of maybe going back to Americas and a little bit of the core. How do -- what does the -- I guess, the cadence of consumables versus equipment deliveries in your business tell you about the market or the opportunity either down the line of growth and just your overall kind of establishing and stickiness with the business?

Yes. No, it's pretty important for us. Consumables, again, is a function of what factory activity is, what production levels are. Industrial production trends are a good barometer of that. When you start seeing more growth, not just steadiness, but more growth, that typically would lead into an investment cycle. And we look at standard equipment, standard welding equipment separate from the automation side. So you should see more investment -- capital investment on the equipment side with steady and improving trends on the consumable side. Automation is a little bit different. You're going to have more of the confidence on investing in capital and plants and productivity and efficiencies. And again, for us, it's just a matter of timing now in the broader market, the confidence to start accelerating investment there. So for us, it's timing.

Perfect. All right. Well, I think that brings us to the end of the time. Thank you so much, Gabe. Appreciate it.

Thank you, Angel. Nice talking to you.

Of course. Thank you.