The Timken Company (TKR) Earnings Call Transcript & Summary

Thanks for joining us today. My name is Steve Barger. I cover industrial machinery and distribution here at KeyBanc. Joining us today for this session is the Timken Corporation. From the company, we have President and CEO, Rich Kyle; Executive VP and CFO, Phil Fracassa; and Director of Investor Relations, Neil Frohnapple. I know there's a lot of interest in Timken. We're scheduled for 30 minutes, so we're just going to jump right in. If anyone has a question, you can use the Q&A function, and we'll work it in as we can.

So I'm just going to start with a big-picture question. Timken is coming off a strong year in 2020. Margins were up 400 basis points relative to the prior trough, and then you recently reported record first quarter results. Can you just talk to the main drivers of the business transformation that led to this cycle-over-cycle improvement? And talk about how the company is positioned to drive further growth from here?

Yes. First, let me say thanks for having us today, Steve, and thanks for hosting the conference. It's always been a good conference so far. So I'd highlight 2 areas and really both decade-plus in the works, certainly not things that happened overnight, they happened through a decade-plus of incremental changes that, over time, have added up to really a transformation within the company's performance. I think that's indicative in our 2020 performance as compared to the 2015 industrial downturn or the -- even the financial crisis, which was '09, which would have been the closest parallel. And your question, I think the 2 biggest elements of that, the portfolio and the execution with the portfolio certainly being the most important part. And by portfolio, when you look at the products that we have today in our portfolio, the markets that we take those products into, the specific customer applications, we just couldn't have done when you look at what we -- the portfolio we had in 2008, heading into in 2009, heavily weighted to automotive. Of course, we have the steel business. It's not only more cyclical than the business we have today, but also has a big cyclical pricing element, which we really don't have in our business. We were in -- certainly in Asia and building our position in Asia, but we were much smaller. Didn't have the renewables platform back in that time frame, didn't have the marine platform. So when you look at, first, throughout the parts of our revenue that performed well through the pandemic, formed only in the last few years. Again, Asia, renewables, marine, defense, et cetera, those were either small or not in our portfolio. And then the diversity of our markets. Clearly, we still -- automotive is still a focus market for us, but a very narrow product offering to that market and not the growth engine of the business. So if you would have taken the same portfolio we had in '08 and put it into 2020, the results, despite our best efforts on the execution side, there's no way we could have done what we did in 2020 or in 2021, to your point of record results in the first quarter and guiding to record results. I don't think we could have bounced back nearly as quickly as well. Second part, execution. Really been very consistently focused on the same -- on the same strategy and the same focus on execution for the last 7 or 8 years. I think we're faster. We have a better digital platform to leverage. We've got an excellent operational excellence platform. We've got an experienced management team that knows these markets and the industries and the customers in which we participate in. And we went into the pandemic and came out of the pandemic. We were decisive, kept our employees safe, kept our customers up in production and managed both the balance sheet as well as the bottom line. And I think the combination of that delivered the 2020 results. And then again, coming back to the consistency and we've really been focused on the outgrowth and operational excellence pieces, generating the cash flow and a consistent return of capital deployment into improving the portfolio and improving the package of the portfolio. So a decade-plus of compounding those changes. And there were a few big ones in there. Obviously, the steel spend was a big one. The automotive divestiture of the needle roller bearing business and some shift in business there with some big ones. But this small steady adding up over 10 years is probably equally big.

It's a good overview. Thanks. And obviously, Timken has a really diversified book of business across end markets and geographies. Can you talk about what's leading versus lagging across the portfolio now as you see things recovering?

Yes. Very -- what you saw in our first quarter results, I think, continues today. It's very much a mobile OEM-led recovery, but certainly, other markets are coming on, but the mobile OEM side, and that's really automotive truck and off-highway. So within mobile, it's those 3 with rail and aero again improving sequentially, but nowhere close back to prior peaks in those other 2 markets. And then geographically, certainly Asia led -- Asia never had nearly the falloff that Europe and the U.S. had last year. So it has far back to come back. And then within Asia, that's really where our renewables secular growth story has been. So much of our first quarter results have been within that renewal space, so within Asia. And then I would throw in renewables as well. It's more of a secular growth story versus a rebound story because we had a good '19, a real -- a huge step-up, a breakout year in '20. And then we've topped that in the first quarter and expect that to continue through the first half of this year. And we'll have a very good full year on top of a record year last year. So the lagging side, I mentioned rail and aero. Certainly, outside renewables process was lagging up until late in the first quarter. We saw distribution starting to pick up. And fairly typical of a longer cycle, the MRO cycle, et cetera, ticking in 6, 9 months after some of these other markets. So I think we're still early in that. Mix was not great for us in the first quarter. It won't be great for us in the second quarter as well. How much of a benefit that is in the second half, TBD. But certainly, by 2022, I would expect mix for us to continue to improve as the process side kicks in more and becomes a more dominant part of the revenue comps.

And so just to follow-up on that, do you think the sequential ramp feels stronger than coming out of the industrial recession in '15 or '16? Or what would you compare it to?

Yes, definitely stronger than '17. I think equally broad -- '17 was broad. '11, '12, some real strength, but probably not quite as broad, I think. So I think you'd have to go back to at least the '10, '11 time frame to have anything that's close. And then I think most of the things we're dealing with, a logistics delay or bringing new labor in the plants, adding a shift, steel prices going up, those are all normal things for us. I think when you look at -- there's been -- the abnormal ones, the automotive chip issue has certainly been a bit of an anomaly. And then I think for this early in a cycle, the labor shortage is a bit of a unique situation, where I think coming out of the financial crisis in '09 and '10, you had a lot of people in unemployment. And there was a lot of available labor and combination of coronavirus keeping some people out of the workforce for a period or absenteeism, to government incentives, to -- we entered -- you go back 18 months ago, it was a much stronger labor market than probably what we had in quite some time, particularly in the U.S. So I think that part being as tight as it is as early is a little bit of an anomaly as well. But most of the issues are the same. I would say it's a little steeper.

And so yes, just thinking about that kind of big picture over the past 12 years, there's been a lot of volatility over the industrial cycle. Any signs you can point to on what you're thinking about for cycle duration here?

Well, we're preparing for another step up. So I know we're preparing right now, as we sit here on one, we're -- these things are always hard to predict. But I think the supply challenges that everybody is having is going to take some time to work out. Inventory is probably coming even more in our favor than the other way, where you take the automotive situation as an example, cars are still selling, production is down, it has to push production. I think it almost has to be strong through the first half of next year in the automotive space. Commercial truck, generally globally strong. So I think we're looking at preparing for another step-up in demand in '22. Percentage-wise, probably wouldn't expect to be what we're dealing with this year coming the year off the pandemic, but a good step up. And certainly hopeful that it will run beyond '22 as well. But I'd certainly say we're planning for a continued net expansion in more markets with some puts and takes through 2022 as we sit here today.

I like that optimism. With end markets recovering maybe faster than people expected and Timken's tracking to a record revenue this year, how are you thinking about managing service levels with existing customers versus trying to drive new customer acquisition?

Well, it's a good question. Certainly, the focus is on existing customers. And we've got some gaps there, where we're not doing as well as our customers would like us to and/or as we would like to. So that is definitely our focus. But I have every reason to believe and confident that we can do both. And even today, in some markets, we can do both and other -- and some product lines, we could do both. In some, we would not, probably be looking to take on additional customers in the next month or 2 until we can -- it speeds on by. We -- as you know, Steve, in our markets, market share moves pretty slowly because most of it moves at new equipment design and so that happens over periods of years, not in OEs. But -- or it does move a little faster is when there are supply constraints. And again, those decisions by OEMs aren't taken lightly, but there are cases where that happened, and we're very confident that we won share in the early stages of the '17/'18 ramp that we held on to after that. And we believe we're in a market here, as we sit here today, that it won't be a lot to point to yet. But over the next 18 months that we're going to be able to be a little faster, a little more nimble, a little more responsive than some of our competitors. And I think we'll come out of that the net winner. And I think it also gives us an opportunity, in a situation like this where supply is tight, to move some pricing in some market and in some markets and be a little more selective where we do want to grow as well. So I think we're in really good position midway through 2021 despite what's a pretty turbulent market, clearly.

And overall, you're expecting organic growth of 15% at the midpoint this year, and that's up from an original guide of 9%. Just as a reminder for everyone, is that all volume and not much price? Or how are you thinking about price in the context of that guidance and just the input cost inflation you're seeing?

Yes. So it is almost all volume. And certainly, we came out with the beginning of the year guidance, we said we expect the price to be flat. We're actually a little up in the first quarter. With steel pricing where it is, we'll probably be up a little bit more in the second quarter because we do have these pass-through mechanisms. We got tension a little bit with that in the fourth quarter of last year with -- as price shot up, and then it took us a quarter for those mechanisms to kick in, but we did end up a little more positive priced. It's crept up a little further now, so we'll get a little bit of price from that. But really, we're just now getting into looking at where are we going to look to move pricing. And in my insight, we -- as we look to move pricing, we look to move pricing in a way that sticks, and we only go one direction. We don't go back. So we have positive pricing in '20 despite a down market. That was really a reflection of the markets in '19, more than '20. We will have positive pricing next year. We could probably be more suppressive in some areas, but then we really try to build a model that -- and what we put into the market, one we can win share with. And two, it's not cyclical pricing. It's market pricing that is going to last through contract periods and is going to last beyond those contract periods. So definitely, this is a year our margin story is more of a volume story. I think next year, one, it will be a little bit more price. And then two, I would also expect it will be a more productive year, more efficient year for some of these cost and efficiencies that we've been taking in through the first half of this year should certainly be better than the comps in the second half of next year -- or first half of next year, sorry.

And just to continue on with kind of supply chain, it's been a big topic at the conference here. Everybody is talking about constraints, whether it's labor or material availability. Where do you stand on those issues? And any other supply chain things that are top of mind for you that we should be thinking about?

Yes. I would say when you go back to our call, we had a lot of these issues in the first quarter. Early in the year, they were some U.S. issues, and then moved to Europe. By the time we got to the call, we're still dealing with Europe. U.S. was largely behind us. We are in the early innings of India. I wasn't sure how bad that would get. It got probably every bit as bad as we thought it would, but it's also been pulling back probably faster than what we thought it would. So the situation is improving pretty rapidly over there, although it also did get pretty bad in terms of -- we had a steel supplier shutdown for periods and absenteeism in our plants and health issues with some of our employees' families and things. So certainly became a difficult situation there, but getting better. Probably the one thing that, again, we had somewhat factored in, it's gotten a little bit worse this quarter than what we would anticipate, it would have been the automotive chip situation. Too early to call if that could be made up in the second half. Right now, there are customers that say they will make that up in the second half. Again, we had a lot of it factored in. We probably even hedged it a little bit, but it has deteriorated a little bit more on that. For us, that's been really an automotive issue, a spot issue here or there in off-highway or heavy truck, but it's really been contained on automotive on any kind of scale. Still think second half is on track to be less of these issues than the first half. Obviously, the U.S. situation is stabilizing quickly. Europe is stabilizing quickly. Europe's -- or I'm sorry, India is far from stable but improving quickly. So I think that prediction should still hold that we should see less volatility in the second half of this year.

Since you brought up India, is that more important to Timken from a production standpoint in your own facilities or in terms of end market demand from some of your customers? And is that a material impact, do you think?

So it certainly could be, and it was last year when the country was shut down. This year, we're talking about, if we would want to be at a 100%, maybe we're at 85%, maybe we're at 90%. So I mean that's not unlike what we dealt with in the first quarter with Poland and Eastern Europe. It's 5-ish percent of the company's revenue. We do export out of there as well. So it's not immaterial. But again, I think we expected that when we came into the quarter, and I wouldn't say that it's played out materially differently than what we would have anticipated. I'd say the bearing industry is probably a little overweighted to India, not unique to Timken, but probably unique to diversified industrials that more of the global bearing supply chain is a little India-independent. So we export out of India. We have suppliers in India that supply us in Europe and other parts of Asia. So maybe a little more exposure, but I think contained and never, for us, never went off a cliff. It was more just interruptions.

When you reported 4Q earlier this year, there were a lot of conversations around temporary cost rolling off and variable cost stepping back up as volume increased. Then in 1Q, you had a really nice SG&A performance. Is that expense back to normal? Or any other big pluses or minuses we should be thinking about in terms of operating costs?