ESAB - ESAB: Business On Good Tracks To Continue Performing

2023-03-24 05:41:20 ET

Summary

• ESAB has strong potential for growth and margin improvement, backed by a competent management team.
• ESAB has numerous exposures to different end markets that are poised to experience positive trends in the near to medium term, with opportunities to grow into other lucrative fields.
• Margins' improvement initiatives and the company's M&A streak should also help boost profits and margins.

Investment thesis

In my opinion, ESAB Corporation (ESAB) has numerous exposures to different end-markets that are poised to experience positive trends in the near to medium term. Because of their consistent success in increasing profits by means of cost-cutting, M&A strategy, and new product and service developments, it is clear that the management team here is highly competent and knowledgeable in their field. The company can also grow into related, lucrative fields like digital solutions and robotics. In terms of competition, the fabrication industry is highly competitive worldwide, with numerous companies operating within it. I believe ESAB is a global leader in every market it serves, with the exception of China and North America, where it trails competitors ITW and LECO. ESAB's sales and global presence are more widely spread than those of LECO and ITW, its two main rivals, with the exception of North America, where it is weaker than both rivals, and China, where it operates on a smaller scale than local operators.

As such, the underlying organic growth, margin improvement initiatives, accretive M&A deals, and expected improvement in balance sheet strength should help ESAB improve its margin and valuation. As such, I recommend a buy rating for ESAB.

4Q22 results

ESAB announced sales and EBITDA results for the fourth quarter of 2022 that surpassed expectations. After adjusting for Russia exposure, net sales for the quarter increased by 7% to $614 million, which equates to 11% organic growth. Revenue in the Americas segment rose by 7%, while EMEA & APAC increased by 6%. The adjusted EPS of $1.05 was approximately 15% better than the consensus estimate. For the fiscal year 2023, ESAB management introduced guidance, projecting a 2-4% increase in net sales to $2.48 to $2.53 billion. This growth will be partially offset by an FX headwind of approximately 3.5%, but will be slightly boosted by acquisitions by 2.5%. Core organic growth is expected to be in the range of 3-5%. The company also provided guidance for EBITDA in the range of $420-440 million and adjusted EPS in the range of $3.80 to $4.00.

Pricing/Volume growth and orders demand

The positive pricing (3%-4% growth) and expected volume growth (1-2%) in FY23, with notable strength in emerging markets, should allow ESAB to meet guidance with ease. I also think the strong O&G markets in the Middle East and India , as well as rising spending on agriculture and infrastructure in India, should act as tailwinds for the market. Turning attention westward, I also have faith that Europe will remain robust despite macro softness, thanks to the revival of the auto industry and rising investments in renewable energy . What is also good to know is, according to management, demand patterns this year have been fairly consistent across both the Americas and Europe, the Middle East, and APAC. In the Americas, 4Q22 volume was down 3% year-over-year as ESAB lagged behind DD volume, but management said 20123 is off to a good start. In terms of timing, higher pricing are expected in 1H23, followed by relatively stable rates in the second half, which translates to a small increase for the year. Regarding orders, ESAB's growth rate is still exceeding that of the previous fiscal year as of the current quarter. I believe this indicates the company's demand resilience, which is supported by a diverse geographic mix that includes exposure to higher-growth emerging markets. These factors are more than offsetting weaknesses in certain areas of North America and Europe. However, management has noted a slowdown in retail volumes for light industrial products in the United States. Despite this, I believe ESAB's sales in this sector are largely accretive, given the company's current low market share. Elsewhere, there seems to also been some decline in demand for some home improvement products in North America and Europe, but I overall demand to be strong as growth in commercial vehicles, farm equipment, and renewable energy remains healthy.

Margins improvement

Among the things making me optimistic is ESAB's business excellence [EBX] initiative, which keeps finding new ways to save money. Simplifying product lines, developing AI-powered forecasting tools, and improving standard procedures are all good examples. Approximately $10 million in annual savings is projected from these initiatives, with an additional $10 million to $20 million in savings projected over the next couple of years. In addition to the obvious benefits, I anticipate further savings in the form of reduced inventory and enhanced FCF conversion. Without a doubt, these cost reductions improve margin, but I also appreciate the fact that management is making efforts to reinvest in the company. With this in mind, management plans to spend $15 million on strategic initiatives to boost sales of gas control and equipment. In addition to these "Fats-cutting" exercises, it is encouraging to see ESAB investing in emerging areas of expertise like Automation, particularly in the area of process expertise. As of October 2022, ESAB had already acquired Swift-Cut , which should help expand the company's reach in the automation market and open up lucrative aftermarket opportunities.

M&A streak

As a shareholder, I believe in ESAB's M&A strategy because it allows the company to shore up weak spots in its product line and boost its growth and profit margins (post-synergies). ESAB also acquired Therapy Gas Equipment on January 23 in addition to the aforementioned purchase. I have a positive outlook on this purchase because it will help ESAB improve their gas control infrastructure. In 2023, the company intends to continue its "bolt-on" acquisition strategy, with a concentration on smaller, immediately accretive businesses and a control of leverage within the 2.5-3x range. I don't think there will be any issues from a balance sheet strength perspective given a large chunk (>90%) of the debt will face maturity only in FY25 and beyond, which gives ESAB ample time to seek refinancing.

Risks

Remember that Europe is expected to go through an economic downturn soon, and that EMEA and APAC make up more than 50% of ESAB's sales. Given the increasing uncertainty in the macroeconomy, it is possible that one or more of ESAB's target markets may shrink faster than anticipated. M&A is one of ESAB's main strategies, but as with any merger or acquisition, integrating and implementing it can be challenging. Failing to execute this properly would waste resources and damage the credibility of management.

Conclusion

ESAB's 4Q22 results and FY23 guidance indicate strong potential for the company to continue growing and improving its margins. With a diverse geographic mix, exposure to high-growth emerging markets, and a competent management team that has consistently increased profits through cost-cutting, M&A, and new product and service developments, ESAB is well-positioned for future success. Additionally, the company's focus on business excellence initiatives, emerging areas of expertise like automation, and strategic acquisitions further support its growth potential. Therefore, I recommend a buy rating for ESAB.

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