The Timken Company (TKR) Earnings Call Transcript & Summary

Perfect. Thank you all, and good afternoon. It's my pleasure today to have Lucian Boldea, CEO and President of Timken as well as Mike Discenza, EVP and CFO of Timken. So before we just get started here, just a quick disclaimer. For important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. [Operator Instructions] And with that, again, thank you, gentlemen, for joining me.

Thank you for having us.

So maybe just -- it would be great to just start out with the Elevate to outperform strategy that you laid out at Investor Day, a pretty significant step-up in growth, margins, earnings profile through 2028. So just for those that may be less familiar with the shift in strategy and Lucian, you've kind of laid out in terms of the key pillars, the targets of where you want to take the business here, both through '28 and kind of your vision for longer term. Can you just kind of give us a walk through some of those basics?

Absolutely. So first of all, thank you for having us. It's very great to be here. So when we look at Elevate outperforming, why we launched the strategy, and what we're trying to accomplish for it, it really deploys this 80-20 mindset as a foundational way of approaching and solving the problem. But the problem that we're trying to solve is really to accelerate profitable growth, expand margins and then drive value to shareholders as a result. We do this by really focusing on three different pillars. First of all, our portfolio really holding ourselves accountable to be a disciplined and active portfolio manager of our own portfolio, making sure we analyze the portfolio on frequent basis, and we ask ourselves what belongs. We apply an 80-20 mindset to that, what do we need more of, what do we need less of and really manage that actively. We then look at the markets that we focus on and make sure that we have appropriate revenue exposure to high-growth markets so that we can really outperform by having the market tailwind help us outperform. Last but not least, there's a third pillar that involves regional penetration. Our business is unique from the standpoint that our Industrial Motion portfolio of businesses that represents over 1/3 of the company is really mostly constituted of regional businesses, already being able to expand these businesses from one region to another, affords kind of, I call it, a bucket of self-help, but really revenue that we can generate growth from that we can then help ourselves outperform above the market.

That's very helpful. And I tend to think about Timken is a firm that's already made a lot of transformation going from like low teens EBITDA margin to high teens EBITDA margin, and you're proposing taking the business to -- into the 20s, right? So this 80-20 is a big aspect of that. So I was hoping you could help us kind of understand maybe a little bit more from -- into that 80-20, unpack that a bit more in terms of gross profit margins impact, working capital needs impact or just even at the operating cultural level within the firm, what does this mean to...

Yes. And I'll ask Mike also to offer his view here. But I think if I step back from overall the goal that we've laid out at Investor Day just a few months ago, we said we're going to structure improve margins by 500 basis points. And that's that's a significant number because it's not by some time out there by 2028. And the clock starts pretty soon on 2028. So we're not that far away. So we understand the timing. But we laid out a very credible road map on how we get there. And it's really across the three pillars. It's really looking at structurally improving margins from belts and then it's looking at the market and outperforming with the markets and then finally, the regional penetration. But underpinning all that, which is what I'd like Mike to comment on is your 80-20 question of what we can do to really support the cost structure to be able to do that.

Yes. Thanks, Lucian. So a couple of things on that. First of all, we're well underway. So as you said, we've launched 80-20 by the end of this quarter. We'll have more than 75% of our organization trained and initiatives underway. So some of those initiatives that started earlier are going to start producing results, and you'll see that show up in margin uplift as early as the first half of next year. So certainly, our own help on 80-20 just from the initiatives are underway pricing, et cetera. Secondly, we're getting to the point now where we're looking at our cost structures and going through the zero-up process, Anyone familiar with 80-20. We're now looking at our cost structures, identifying where simplification creates capacity, if you will, and frees up resources. Part of our growth strategy is around redeploying those resources into the growth areas. But of course, it provides an opportunity for margin uplift as well. So next year, we'll be looking at how to carry those simplification savings into the business, reinvest where it makes sense and then look to expand margins as well. And then you mentioned the last thing, working capital. We do believe there's a working capital unlocked through simplification. In our 2028 targets, we communicated, we thought there was about 1% of sales per year. kind of unlock on working capital to sales. So we do think there's an opportunity to generate cash as part of this 80-20 initiative as well.

And you mentioned pricing as one of those aspects or those levers that you can ultimately pull with 80-20. Can you just help us understand how does the deployment of that play out? Is it across the business as a whole? Is it a very specific with specific customers, like -- and just ultimately, how we should think about the flowing of that in the P&L?

Yes. Look, I appreciate that question. And I think often when people hear 80-20, they -- it's called 80-20 and not 20-80 for a reason because the 80 is why you do it, that's where you want to focus. And then the 20 is where the resources come from, so that you can afford to take better care of the 80. Pricing is one of those avenues. So if you think about the world of 80s customers and 20s customers and 80s products and 20s products, we've been very transparent to share that in our engineered bearings business, our half of our customers, our bottom half of our customers account for less than 1% of the revenue. And half of our products account for less than 1% -- about 1% of the revenue. So now you might say, well, that's easy. Why don't you take action immediately because you have to look at it by quadrant. And your large customers buying your fast-moving products, you want more of that. You want to delight those customers, you want to have better delivery terms. You want to really take care of and grow that business. Your small customers buying the one-off products that's not business we'll ever be able to be profitable with. So that's a business that you have to over time share in an appropriate way. Your small customers buying fast-moving product, that's why you have channel partners. That's why you have e-commerce. That's why you have distributors, you ask them to consolidate purchases and so on. So you manage them that way. And then your large customers buying your one-off products, that's where you have to have you have to have that conversation very carefully because some of those small products may be very valuable to your large customers, you have to have a logical transition. So treating these quadrants differently is key. But then inside those quadrants, we have certain places where price increases are absolutely one way to do that, one way to -- I wouldn't say test for the value, but to make sure you're appropriately getting paid for the service that you're offering because one of the things just fact of life, your accounting system will never be able to keep up appropriately with allocating sufficient cost to the customer that literally places $100 or $200 order versus a customer that's a $20 million customer. You can't allocate enough cost to the small customer with normal cost allocation, which means your profit will always be overstated on the small customer and understated on the large ones, you have to account for that and prices wanted to do that. So we are looking at price increases for those quadrants to be able to get them to at least some better return, but over time, really push the message of, okay, maybe we're not the best supplier for those really one-off products.

And I think kind of embedded in that is ultimately how you go to market with each of these customers. But the commercial side of your organization is an area that you've made a lot of changes of late. So just as well as at the Investor Day, you talked about more of a systems approach to selling. One, could you just help us understand and unpack that? What does that strategy look like in terms of implementation? And then as you think about like the customer's perspective, how does that ultimately also help add value to the...

Yes. Thank you. So yes, so one of the things that we've done, and it's a pretty dramatic change in the org structure. So we went from really two verticals on engineered bearings and industrial motion to horizontals that report to me directly. So one, we have a single storefront for Timken, which is the commercial organization led by a Chief Commercial Officer. That's where the entire sales team, field marketing, all the market-facing resources are. And then we have sort of the back of the store, the P&Ls, the operations, that's all aligned with a single Chief Operating Officer. And we've done that so that we achieve operational efficiencies. We apply 80-20 in a consistent way. We have operating model in a consistent way. But most importantly, if we present ourselves to the market in a consistent way. And why would we have done that, we realize very quickly that the fundamental sales motion in selling a component like a bearing, fulfilling demand to a person that already knows they need bearing is very different from the sales motion of engineering a system and designing a system. One is the procurement RFP. The other one is an engineer-to-engineer conversation. We have both sales motions in both businesses, but the predominant sales motion in industrial motion is the engineer-to-engineer and the predominant one in bearings is more of that component supply. So then when you put this together, the aha moment, at least for me, was this has to be an IM first and not an EB first. And the reason is IM involves usually is involved earlier in the design cycle. It involves when somebody is thinking of the next big piece of machinery, the next industrial automation machine, the next excavator, the next combine, whereas EB sometimes comes in when we're selling components. So -- and it's good to be involved early. It's good to be involved in the design process. So IM allows us to do that. So putting that story together has been kind of the first step and no regrets. Now under that, we've put together platforms that are complementary technologies, the same solution. So if you think about our Spinea acquisition or our Cone Drive or [indiscernible] or others, those capabilities can be somewhat interchangeable. So being able to present ourselves to the customer to say, you can have this problem, you can use solutions, A, B or C, here are the trade-off, also gives us more credibility. And when you step back and you look at it, what I'm really very, very excited about is we have a lot of early proof that this is working. So we've now had a number of quarters in a row where Industrial Motion and engineered bearings numbers are quite different. Growth rates are different. Profitability is different. And that really illustrates the fact that this one Timken approach does help and then the regional translations help as well.

That's very helpful. And I guess another area of ultimately to elevate to outperform and -- but it was maybe a little bit further down the line was M&A and inorganic role to ultimately continue to grow the industrial motions business, but just your broader kind of capabilities in business. Can you just help us understand the role of M&A in your strategy, the fact that your multiple has started to move up, does that kind of accelerate your ability to actually take some advantage of some of the opportunities there? And yes, just particular kind of pockets where you think there's more opportunities or capabilities.

Yes. Look, what I hope Elevate outperformed does for everybody is lay out a road map that you can hold us accountable to, and it's a mirror for ourselves on what M&A should make sense. And so is it accretive to our portfolio, if you look at that lever -- that pillar of the strategy, then does it align with focused markets? And does it enhance our position in a market that's of rapid growth. And then last but not least, does it have a regional footprint that puts us in a unique position to deliver some synergy. Are we, in other words, the natural owner of this target. To the extent that we have targets that we do have several that we're excited about. We're going to see what material or not in the world of M&A, you can't really count on that. But we are constantly looking a rich pipeline of opportunities that really meet the criteria that are accretive to the portfolio that we are uniquely positioned to deliver value from. But if you can't answer M&A without the context of just capital allocation, so maybe turn it over to Mike to talk about our philosophy on how we think about capital allocation in the context of M&A because it's really a key driver.

Sure. Yes. And maybe just a couple of points before I get to the capital allocation, I want to reiterate. We talked about M&A, but portfolio management overall is an important part of what we look at. So M&A, we think about what goes in, but we're also very much focused on making sure we know what doesn't belong. And as we've announced, we've taken several actions on our portfolio already. So that discipline of portfolio review is something that we're committed to. So M&A is important and portfolio management overall. As it relates to M&A, look, we're -- we have been and will remain a disciplined allocator of capital. We -- I think we've done that well, both allocated capital to both share buyback, where over the last 10-plus years, we bought back 25% of our shares, as Lucian said, several acquisitions, 15-plus acquisitions. So we've balanced that capital approach. We'll stay disciplined. The good news is we have a really good balance sheet. So our leverage finished last year at 2x. We are generating significant cash this year. And as we look out over the next three years, expect to generate $1.6 billion of cash. So between our strong balance sheet and the cash generation, we have lots of optionality. We're committed to our investment-grade balance sheet. We're committed to that disciplined allocation, dividend. We're a consistent dividend payer well over 400 quarters of consistent quarterly dividend payments, increasing our annual dividend now for over 11 years. So we'll continue to balance that approach and maintain the discipline.

That's very helpful. And I think -- I mean that's one of the things that [indiscernible] on exciting about Investor Day, right, that with that $1.6 billion, I don't know that was included in your $850 million target by 2028. So that seemed like all kind of upside opportunity. But maybe just to continue down the line of like potential areas of white space or technology that you could ultimately take advantage of. I wanted to talk about market share gains in terms of Timken continuing to evolve and grow faster, part of that, I'm assuming comes from penetrating deeper into or getting higher content with a customer, some market share gains. Can you talk about what the opportunity set looks like the magnitude? And is it just about you -- your commercial organization being more direct about targeting those, or is there capabilities or technology that you would need in order to break into some of those opportunities?

Yes. Look, it's a little bit of both. So I think if you look at market share gains, there are certain -- all this -- the entire third pillar of the strategy, that regional penetration, you could call that a market share gain because we are going into new regions where we're underrepresented or completely underpresented, and we're gaining share there. So that's certainly that entire factor. No apologies that that's a share gain. There's a element of create demand that should create a share gain, but in the end, it is a share gain. But outside of those geographic approaches, it's more of a share of wallet play with your 80s customers. So when you -- when we present ourselves differently to our 80s customers, and we tell them that we will treat them differently, and we honor that commitment with better lead times, better service, faster access to new products and innovation, faster access to prototypes and samples and so on, they see value in that. And as a result, they reward us with more of their share of wallet. We bring in more solutions that we didn't have -- maybe they were a loyal bearings customer for the last 50 years, but they weren't aware we have an automatic lubrication system business because that was more of a European business, their footprint is in the U.S. we can bring that across. So there are a number of approaches. But really, in the end, yes, we have focused markets. Yes, we have regions, but who buys product is customers. So the rubber meets the road at the large customers at our 80s customers, which is who we need to grow a share of wallet with.

Yes. And maybe just continuing on that line in Industrial Motion. I guess, this is where you have the faster growth aspects of your business and exposure to some kind of interesting and secular themes like automation, robotics, medical. Just can you just help us understand, ultimately, as you think about these verticals and not only have faster growth or better economics, what is the size of your exposure today? What is the opportunity set? And like as you think about the business and the portfolio evolving, like which of these are kind of a bigger focus?