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

Well, good morning, everybody, and thanks for joining us for the third and last day here at the Laguna Conference. So it's my pleasure to have with me today, Gabe Bruno, EVP and CFO and Treasurer of Lincoln Electric. So thank you so much, Gabe.

Good to be here, angel.

Thank you. Well, before we get started, I just want to read a quick disclaimer. So for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please see to your Morgan Stanley representative.

So again, okay, thank you so much for joining us. Lots of things to discuss. And obviously, macro is a big aspect of what's happening right now. But I want to actually go a little bit more idiosyncratic at first and a little bit higher level. And back to your kind of rise strategy and start there in terms of talking about what you laid out as a longer-term outlook in terms of achieving kind of high 20s incremental margins by 2030. Maybe if we could start with that bigger picture and just talk about kind of the concrete structural changes inside of Lincoln and initiatives that are ultimately expected to drive that kind of improvement over the years.

Well, thanks, Angel. That's a great place to start. So thank you in focusing on long-term value creation. I've been with the company now this year about 31 years, and we have consistently improved the operating profile of our business. I think about an operating margin through each cycle, improving 200 basis points per cycle. So you've seen that. So that has taken us from a largely regional business model. So we manage the international business, the European, the Asia, the North American business is more as distinct business units. And over the years, we have determined that we can create a lot more value by looking at all of our operations, particularly where we should like in the welding business and think about what are those disciplines that can scale the enterprise. And so for example, we pointed to finance have a simple example. But over the last stranger, think about higher standard last 5 years, we improved the operating profit of our business by 50 basis points beyond. Just in finance. So we're looking at structural changes that we essentially drive an enterprise-wide view of our business and how do we leverage capabilities. Same in HR, same in IT, same and key disciplines like supply chain, procurement, engineering, you're going to see us do more and more of how do we leverage the capabilities across the enterprise and create incremental value. So that gives us confidence from accelerating the level of margin improvement over each cycle from 200 basis points to 300 basis points you go from a mid-20s incremental margin, which is our historical profile, to a high 20s incremental margins. And that, on top of what are the disciplines that are customer-facing. We're talking about our spotlight strategy that looks at operational capabilities, supply chain, how are we servicing our customers, that gives us confidence that we can achieve that. So a lot of great structural work you can anticipate in how we approach our business model, and that's what gives us confidence to drive a step change in that.

That's very helpful. And maybe just as we kind of work our way to some of the near-term dynamics, just given how much it's happening. Should we think about that as more of a steady cadence between now and 2030? Or how should we think about that progression and what you've already put in place?

I think it's the best way to think about it, a steady, ratable type of improvement over the next 5 years. There'll be elements that will be more accelerated than others. But on an enterprise level, that's a good way to think about it.

Perfect. And again, ultimately, there's so much happening. It's hard not to ultimately ask about kind of the near-term dynamics that are happening, right? So we still have -- it seems like a lot of self-help, a lot of initiatives internally that will drive that high 20s. But given the difficulties of kind of the current macro backdrop, I think last week, you indicated 3Q incremental margins, maybe a little bit more towards the lower 20s. And then just a lot of that obviously, inflation that's been very topical and very well covered. So can you just maybe help us unpack that a little bit more in a bit more detail, like what does that -- what are you exactly seeing in terms of that inflation? Is it what specific segments or pockets? And ultimately, should we think about that as kind of just a 3Q dynamic or also 4Q?

Yes. So there's a lot there. But inherently, we have been raising the issue of persistent inflation. We had announced price increases in the second quarter in the May time frame put those in place. But we have just seen consistent inflation across our welding businesses. So the actions we've taken cover both the Americas as well as the international businesses. And with energy costs, logistics costs, supply chain dynamics, all those point to an incremental consistent level of inflation. So because of that, our strategy is to be price cost neutral. And so we take the actions to maintain that kind of posture. Because we had seen that persistency, we took additional pricing actions in the Americas effective the beginning of September. In the international markets, we'll have some towards the end of September. We won't see that fully mature into the fourth quarter time frame. That incrementally represents about 100 basis points of incremental price that you'll see in the fourth quarter. But in the meanwhile, because of the cost pressures, we moved from mid-20s incrementals to low 20s. That on top of a very strong demand. The same dynamics that we have talked about across all the product lines in the Americas segment in particular. Consumables, standard equipment, automation, just continued [ strengthening in ] from a demand perspective. So we're just navigating a price/cost dynamic, which is part of our discipline. We want to make sure that we're protecting the operating model.

And that was actually -- you kind of started on my next question is just ultimately you did talk about that momentum that we're seeing from the demand side, it doesn't seem like anything really is slowing down. So can we just unpack that a little bit more in terms of, one, when you take those 2 pieces, the inflation, the incremental price on that basis, is this still in terms of earnings going to wash out [indiscernible] neutral? Is it the incremental strength in demand that you're seeing is that kind of, again, offset that or still a little bit of negative, which is, again, the trajectory in the right direction?

Yes. From a dollar perspective, we feel confident it's more about the -- what's the incremental margin contribution. The demand profile continues to be strong. Just additional comment on that. We point to is that we had already seen consistent -- consistency in volumes on the consumable side of our business, flat to slightly up. And then we saw in the Americas mid-single-digit type growth in volumes. Standard equipment, very, very strong. So that continued through this third quarter to date. And so then on top of the strength we've already seen in the order patterns, the backlog on the automation just continues to give us very strong conviction on the demand profile of the business.

So I guess, fair to say that even with all the geopolitics and macro, you haven't seen any kind of step change as we've kind of evolved from August, September. I know we're -- September can be a big month, and it's still -- we're only halfway through it. But -- it doesn't sound like you're seeing any...

We're seeing the same kind of demand profile.

Got it. Very helpful. So let's keep going and get a little bit deeper now, and perhaps going into Americas. Again, maybe on the industrial environment, just you talked about, again, the [ mean ] acceleration. Could we maybe talk about the different end markets. I think there's a lot of questions around the manufacturing activity, the PMIs that we're seeing. Just help us understand a little bit deeper into your business, ultimately across the different end markets. in some of the product lines, consumables, equipment, but just the different end markets, what are you seeing in terms of that demand?

Yes. So I think it's pretty important to understand what is happening in real production activity across end markets. When you are servicing factory activity, you can think of consumable activity, production requirements, volumes. And when you see consistency over a period of time, that generally leads to investment. So when we point to standard equipment, the velocity of incremental investment, that would give you a sense that there's a progression in the potential expansion in the industrial activity. So when we look at the end markets, for example, when you look at general industry, a little over 1/3 of our business, you look to what's happening on industrial production how consistent is that production velocity? What is the sentiment on 8 months in a row now of the PMI and orders and all the dynamics there pointing above 50, so expanding. Now what does that mean in terms of investment. So when we talk about standard equipment and then talk about how the progression of automation, ties into that. You see not only factory activity, production activity steady to improve in, but then conviction to capital and capital deployment. So that's what we point to. So general industry, you're seeing that. Heavy industry, the key driver there is to think through what's happening in construction and ag and mining. We believe that we've seen a trough and we believe that because we've seen more steadiness in consumable volumes and that's production and then starting to see more improvement in investment. So when we look at point to heavy industry, we're talking about that. Steadiness and actual activity, then also conviction of investment. Same thing on structural fabrication. We've seen a lot of strength there. Energy, strengthened in the Americas, obviously, some pockets of pressure in the Middle East and that, but very bullish on energy. And then where we're seeing mid-single digits down year-over-year is in automotive. In the automotive side, think about our consumables following what the headlines are on automotive production, which we're right on line on. And the question becomes when do you start to see a conviction of investment. So that's how we point to what are the program launches out 2028, '29 mean to us, what are the S&P's report out going to look like in October. Seem positive there and then seeing the level of quoting activity increase in our business and seeing that turn into orders will give us more conviction on the automotive side of the end market. But except for automotive, the strength in production and investment we're seeing progressive across all the end markets.

That's super helpful. And I think I do want to get into automation a little bit, which touches on autos a lot in a second. But maybe before we go into that, just maybe one extra layer I want to put on the pricing front. You mentioned the 100 basis points in what you've kind of implemented in September and one year in late September. Can you help us understand, I guess, just the broader picture of price for your business and the cadence as we should think about the patients to kind of price cost as we start to get into 2027?

We're going to take pricing actions where we're dealing with inflationary pressures. So we just took pricing actions in September. We expect to be price/cost neutral with those actions. And we'll take additional price actions if we see otherwise. But our posture is to maintain a price/cost neutral posture. We believe we've taken the price actions to achieve that in the fourth quarter and then obviously leads into 2027 and beyond. But that's our posture. If we see things otherwise, it will take additional pricing actions.

And as you think about the different distribution terms, you have distribution, you have OEMs, any differences in terms of your ability to kind of get that price and achieve that pricing trial?

Yes, it's a great question, Angel, because I'd like to reinforce that more than 60% of our business is sold through channels and the channel is very disciplined. We provide notice. We announced our -- for example, the price increases are effective in September and August to provide the channel some lead time and being able to net changes in pricing. [ So 60% of plus ] is sold through the channel, 20% automation, which is really about value proposition. And the other 20% is really where we're dealing with OEM specific type of pricing. So largest part of our business is very disciplined through a channel through automation. It's really about how do we manage the notice and level of alignment to our price/cost posture.

Got it. Okay. No, that all makes a lot of sense. And again, maybe now shifting over to automation. This is an area that has become a broader part of your business, a lot of acquisitions over the years. as well as very strong organic growth. But more recently, it's been obviously a little bit softer because of the [indiscernible] to ultimately automotive. As you think about this automation business, I think it's broader than just robotic welding, right? It's a handling testing and other things. Where do you ultimately see Lincoln Electric as you think about automation in the value chain longer term and like where you'll play?

Yes. So I think a key driver for that is thinking about our customers, what are the solutions requirements. You just follow the needs of our customers. And that's broad-based. So if we're talking about automotive, how do we deepen our capabilities to provide the kind of automation solutions that we have. Think about acquisitions over time where 40%, 50% of our business tied to the welding fabrication. But we've added capabilities in material handling and testing and positioning that broadens the offering. And that's kind of how we see it. And how do we follow our customers and enhancing the value proposition, the solutions we provide in automation. When you think about broadly then outside of automotive, how do we also then foster an adoption of automation capabilities. So over the last few years, you've seen the introduction of [ Covance ]. We're working to introduce physical AI, and we have a trade show coming up in October and introducing the prototypes that we've done to be able to take orders. So how do we drive better adoption in automation in small, midsized fabricators as well as some of the larger players in the heavy industry. So, we want to provide the kind of solution set that is following the customer -- our customer needs but then also enhancing the adoption of automation capabilities across end markets. We -- prior to our acquisition of Fori, let's say, in 2022, we're pretty balanced in looking at general industry, heavy industries, structural fabrication, automotive. We leaned more heavily with the acquisition into automotive, but it introduced capabilities to, again, provide deeper solutions to our customer base. So think about it in that context, following customers with a broad set of capabilities of automation solutions.

Yes. I mean, you kind of answered it in that light, but also I wanted to maybe about it from the perspective, at least for me, I always think about automation as much easier to do in high-volume areas, very standardized areas. As you start to get, you mentioned to smaller fabricators or manufacturing operations that might be more customized or lower volume and making automation make sense there. Can you just talk about that? Are there any structural limitations that you see? Or is it just about adding like you said, value propositions, technologies that ultimately make it more enhance the value kind of offering from automation for them? Like, how do you think about that longer term? Or will it still be primarily kind of the standardized autos market?

No longer term is how do we leverage our IP capabilities to rich in the mix of our business. And when you think about the margin profile of our automation business, so we're pushing high single digits last year and into the first half of this year, and we got an objective to achieve mid-teens type of an EBIT profile. And that does mean how do we structure the kinds of solutions that are going to be accretive to the model. Pre-engineered type components, you hear us talk about that, what are those offerings in robotic cells or Cobots or the technologies that can enhance the mix of business from an automation perspective [ and to ] meet all the customization requirements, integration requirements for our customers. So, it depends a little bit about the context of our customer needs, but also our own objectives to continue to drive high single-digit organic growth in the long term with an objective of mid-teens type of an EBIT profile.

And actually, you got perfectly weaving it into my next few questions here, just but the pre-engineered sales, I think that dynamic has been a factor in terms of impacting the margins, right? The more kind of impact perhaps from large engineered systems that might be a little bit lower margin. Just ultimately, how should we think about the balance of the portfolio? And when -- is there a point where perhaps the business becomes more meaningful kind of scalable in that less project-oriented type of business and more preengineered. How should we think about that progression of shift of the mix?

Well, we definitely want to [ rig in the mix ]. We have our EBIT objectives to achieve that mid-teens. And it also depends on where our customers are progressing, right? So if there's -- obviously, there's going to be a need for integration and the custom requirements for the offerings on a project basis, but also, we've done some very, very nice acquisitions in structural fabrication, the Zeman and Python ex capabilities. We introduced some years back. We'll continue to nurture that in a very strong market. So the pre-engineered component becomes strategy for servicing pretty areas of the business that are growing, but also an enriching the mix of business.

And maybe just last one, I guess, on automation. I think just if you could walk us through the progression of that over the next few quarters. Again, had faced a little bit of more challenges over the last year, but you're starting to see better orders and better some signs of kind of improvements. So how should we expect that business to ultimately progress here?

We are on a path that we believe high single-digit organic growth with a continuous improvement in the margin profile of the business. And that's kind of how we see it.

And that kind of -- the exit rate already puts you in a good spot from this year into next year?

Absolutely. Yes.

All right. Perfect. And maybe just wanted to switch over to a little bit more of the gap or geopolitical backdrop. But as we think about EMEA, you've been a little bit more cautious on your expectations on the region. [ Perhaps you share the ] reasons with everything happening with Iron U.S. conflict and just broader kind of energy prices. But as you think about that unrest, what are the implications? And just broadly, how -- what are you seeing today in terms of has it had any impact on the business in the region? And just how are you seeing that kind of unfold?