LECO - Lincoln Electric: Quality Business Has Regained Its Quality Price

2023-09-11 11:01:33 ET

Summary

• Lincoln Electric has seen a strong performance in its shares over the past year, even after a recent pullback.
• The company is a leading manufacturer of welding equipment and has benefited from long-term trends such as labor shortages and increased investments in renewables and infrastructure.
• While the company's earnings have improved, the stock's valuation has also increased, making the risk-reward less attractive at the current price.

In October last year, I thought that Lincoln Electric ( LECO ) looked like an attractive welding play. The company had seen a strong 2021 and first half of 2022 at the time, as this strong operating performance and sluggish share price performance created an interesting set-up.

With a sound long term capital allocator trading at an attractive valuation, I was quite upbeat given the long term potential. This has turned out to become reality rather soon, as shares have seen a rather spectacular advancement over the past year. Even after shares have seen a recent pullback, this is far from sufficient to reveal any appeal here.

A Rock Solid Business

Lincoln has been founded in the late 19th century, having become a quality equipment manufacturer of welding equipment and related consumables. With substantial operations, notably in North America, the company is competing against other peers like Colfax ( ENOV ) and Illinois Tool Works ( ITW ) , among others.

The company was benefiting from some long term trends which favored the business which include labor shortages, increased investments into renewables and infrastructures, as well as the need for safer and energy efficient solutions.

On top of the core operational expertise, the company has often engaged in bolt-on acquisitions to further grow the business. For the year 2021 the company generated $3.2 billion in sales, with margins reported in the mid-teens, resulting in earning in excess of $6 per share, all while leverage was quite modest at around 1 times.

Operating momentum continued in the first half of 2022 with first quarter sales up 22%, and second quarter sales up 20%, as earnings were trending at just over $8 per share. With shares having traded stagnant at $120 in October last year, the resulting 15 times multiple looked very reasonable, although it was based on relatively strong earnings results at a good point in the cycle.

With a roughly $7 billion equity valuation at those levels, Lincoln announced a substantial deal with a $427 million acquisition of Fori Automation, adding $225 million in sales, to thereby grow the business by 5-6% as the purchase price was in line with Lincoln´s own valuation.

Pro forma net debt jumped to $1.1 billion, pushing up leverage to 1.5 times with EBITDA seen around $700-$750 million, all while the company continued its long term organic growth, bolt-on dealmaking and share buyback strategy.

A Recovery

Since October shares of Lincoln Electric have gradually risen to a peak at $210 in July, marking 75% gains over a relatively short period of time, as shares have now settled at $180, still up 50% from nearly a year ago.

This came as revenue growth slowed down to 16% in the third quarter of 2022 and 10% in the fourth quarter. This made that full year sales were up 16% to $3.76 billion. Operating margins rose by two points to 16.3% of sales, resulting in net earnings of $472 million, equal to $8.04 per share.

Net debt came in at $1.0 billion, as no guidance was provided for 2023, but of course the Fori deal will start to contribute from this year onward.

In April, the company posted its first quarter results with sales up 12%, in part aided by Fori, although that an 8% increase in organic sales was decent as well. Amidst modest operating margin pressure it was GAAP earnings of $2.09 per share which were flat compared to the first quarter of 2022, in fact down four cents.

In May the company announced a bolt-on deal in Brazil, acquiring Powermig in a small deal set to add $15 million in sales, adding less than half a percent to total growth. In July, second quarter sales were reported up by 9%, split roughly equally half-in-half between organic growth and the impact of Fori. With operating margins doing quite well, earnings per share rose by eighteen cents to $2.36 per share. Moreover, net debt is rapidly coming down to $900 million, with leverage ratios rapidly coming down towards 1 times.

So Where Do We Stand?

Compared to the situation last year, we have seen growth slow down, but this was to be expected. With earnings power now solidly seen in the >$8 per share range, in fact close to $9 per share, the situation looks good. That said the earnings improvement has been less pronounced than the share price performance, as quite frankly the stock has re-rated from 15 times to 20 times.

Quite frankly, I think that the risk-reward has deteriorated greatly, with organic growth rapidly slowing down and valuations having risen to a more than market multiple. While the stock is down 10-15% from the peak earlier this summer, the pullback is not sufficient to get involved here with the stock just yet.

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