Makiko Tanigawa
It has been a long time since I have last provided coverage on Lincoln Electric (NASDAQ:LECO), in fact it was 2015 since I have last checked out the prospects for the firm. Ever since, the company has seen very modest growth, as shareholder returns have been driven by share buybacks, bolt-on deals, and now a larger deal as well.
Some Perspective
Back in 2015, Lincoln celebrated its 120th birthday, having steadily grown the name as a quality equipment manufacturer of welding equipment and related consumables. At the time, the company employed over 10,000 workers which were mostly active in North America, and to a smaller extent the other major geographical areas of the world. The company was up against large competitors like Colfax and Illinois Tool Works (ITW).
At the time, the company was generating sales at a run rate of around $2.8 billion on which it posted operating margins in the mid-teens. With shares trading around the $70 mark, Lincoln was valued at 20 times earnings, as the company actually held a small net cash position at the time.
Believing that Lincoln in the essence was a cyclical player with a strong market position, I was urging for a bit of caution as the company was enjoying a relatively strong point in the cycle, amidst lower interest rates helping valuations as well. With the valuations at the time looking full to me, I concluded to become a buyer around the $60 mark, levels actually seen later that year.
Slowing Down After A Strong Momentum Run
After acquiring a modest position around the $60 mark later in 2015, shares rapidly rose to nearly the $100 mark in 2018. Following some volatility around the start of the pandemic, shares rallied to a high of nearly $150 late in 2021, as it recently revisited these levels in August.
The company continues to believe in a prosperous future as a few secular trends are aiding the business. This includes labor shortages, increased investments into renewables and infrastructure, as well as the need for safer and energy efficient solutions. The company believes heavily in pursuing bolt-on acquisitions to grow the business, as it has pursued more than 20 deals over the past decade. These are often smaller deals as the combined deal tag of these acquisitions comes in at just below $800 million.
The reality is that Lincoln has seen fairly modest growth since my last take in 2015, as the scope of the activities is still largely the same. Total revenues rose to $3.2 billion, marking a mere 15% revenue growth in about six years’ time, nothing too spectacular, as margins have been stable in their mid-teens. While this is not too exciting, the company has managed to reduce the share count by 23% since 2015, as the share count was reduced to 60 million shares.
Modest sales growth, stable margins and a reduction in the share count made that earnings have essentially risen from about $3.50 per share to $6.22 per share (on an adjusted basis) in 2021. This marks solid growth as shares are currently trading around the $120 mark, resulting in a 19-20 times earnings multiple.
Contrary to 2015, the company has built up a net debt load which now totals $577 million. This is substantial in dollar terms, yet with adjusted EBIT posted at $491 million in 2021, and D&A trending at $81 million, leverage ratios come in around 1 times EBITDA, still very manageable.
Momentum – Cools Down
After posting very strong results in 2021 on the back of very strong organic growth performance, Lincoln Electric started 2022 on a strong note. First quarter sales growth accelerated with organic revenues up 22% as revenues rose to $925 million. Amidst very strong operating leverage, adjusted earnings per share rose 53% to $2.10 per share.
Second quarter organic sales rose another 20%, as a stronger dollar hurt the reported sales growth to 17% with revenues reported at $970 million. Adjusted earnings rose 30% to $2.18 per share, very strong results as earnings still comfortably trend above $8 per share. Part of the strong earnings growth stems from continued buybacks as the outstanding float has been reduced to 58 million shares here. Net debt stood at $685 million by the end of the second quarter, yet with improved earnings power I peg net debt still around 1 times EBITDA here.
The 58 million shares now trade at $120, resulting in a $7.0 billion equity valuation and $7.6 billion enterprise valuation. This is applied to a business generating about $3.8 billion in sales, for a 2 times sales multiple as the company trades around 15 times earnings here. So while the paragraph header suggests some slowdown, that is still mostly seen in the share price, not yet in the actual results. That being said, a stronger dollar and softening economic conditions likely make that expected near-term results will come a bit under pressure, or perhaps a bit more.
A Bolt-On Deal
By mid-October, Lincoln announced a next deal, as it has reached an agreement to acquire Fori Automation. The deal differs a great deal from past (much smaller) deals as a $427 million price tag is substantial.
Fori is a designer and manufacturer of complex and multi-armed automated welding systems, as the company is set to add some $225 million in sales, about 5-6% to pro forma operations. The purchase price at 1.9 times sales is in line with the valuation of Lincoln itself here. That is interesting as the similar valuation makes that Lincoln will make progress on meeting its 2025 targets, especially with regard to automation of operations.
Pro forma net debt will jump to $1.1 billion here and with margins reportedly similar to Lincoln we can construct some pro forma implications. Assuming similar operating margins just above the mid-teens, the company deal will likely boost operating earnings by some $35 million. That suggests that EBITDA might improve from, let’s say, around $700 million to $750 million, as leverage ratios remain very much reasonable at 1.5 times EBITDA.
Based on 15% margins, the EBIT contribution is seen around $35 million. Assuming a 4% cost of debt on $427 million in additional net debt, and interest expenses will increase by $17 million. This results in an after tax earnings contribution of around $13 million, having the potential to boost earnings by about $0.20 per share, on a more than $8 earnings per share number in terms of the current earnings run rate.
Concluding Remark
The truth is that Lincoln looks quite compelling here. Trading at a less than 15 times earnings multiple, the earnings yield is decent as Lincoln has a great long-term track record. On the negative side, the company has been incurring some net debt, to the tune of about 1.5 times EBITDA following buybacks and the latest deal.
This is still perfectly manageable albeit that a strong dollar, inflationary pressures and slower economic growth will likely hurt the results in the coming quarters. Weighting it all together, I see appeal luring here as these 52-week lows make for a nice entry point at current levels to slowly initiate a position on dips.
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