林肯电气

Lincoln Electric's second-quarter adjusted EPS of $2.93 beat the FactSet consensus estimate by $0.12, as organic sales came in above expectations thanks to strong growth in the Americas and Asia Pacific.

Why it matters: Volumes inflected positively, returning to growth after nine consecutive quarters of year-over-year declines. Management raised its outlook and now anticipates full-year net sales growth in the low double digits, up from high single digits previously. Second-quarter volumes grew 2.4% year over year, as 7.1% growth in the Americas more than offset declines of 4.7% in international welding and 8.2% in the Harris Products Group. Second-quarter organic sales increased by 10.1% from the prior-year period. We were encouraged to see improved capital spending trends in the Americas, which translated into organic sales growth in the high single digits in equipment and mid-single digits in automation.

The bottom line: We've raised our fair value estimate for narrow-moat-rated Lincoln Electric to $238 per share from $229, driven by our more optimistic near-term revenue growth projections and the time value of money. We were pleased to see Lincoln Electric expand its second-quarter adjusted operating margin by 50 basis points year over year, from 17.9% to 18.4%, thanks to volume leverage and better cost management. Lincoln Electric narrowed the price-cost gap to 10 basis points in the second quarter. Management expects price actions to help the company achieve a neutral price-cost spread in the second half of the year.

BLANK PAGE

We are raising our fair value estimate to $238 per share from $229. This reflects our more optimistic near-term revenue growth projections and the time value of money after the company reported second-quarter results.

We forecast roughly 6.5% compound annual revenue growth through 2030. We expect Lincoln Electric’s investments in R&D will continue to drive revenue growth from new product introductions. Additionally, we anticipate automation solutions sales to grow well above the core welding growth rate in the long run.

In the long run, we expect Lincoln Electric will continue to generate operating margins in the high teens. We model an approximately 20% operating margin for our midcycle assumption. We assume an 8.5% weighted average cost of capital and a 22% long-run effective tax rate in our model.

We believe Lincoln Electric, a leading global provider of welding solutions, has built a narrow moat based on intangible assets and customer switching costs. Founded in 1895, the firm has established a strong brand and maintained a reputation for quality for over a century. The company has consistently delivered lucrative returns on invested capital, averaging roughly 21% over the last 10 years, and with its business protected by a narrow moat, we believe Lincoln Electric is likely to continue outearning its cost of capital over the next decade.

We think Lincoln Electric’s moat rests on intangible assets, including its reputation for quality, patent portfolio, and strong relationships with distributors. The company has one of the most trusted brands in the welding segment and enjoys leading market share in the industry. We believe brand loyalty is relatively high in welding; customers tend to stick with one manufacturer. The top brands in the industry resonate with customers, who often refer to the equipment by a brand’s traditional color scheme (for example, red for Lincoln Electric and blue for ITW’s Miller brand), and welders tend to stay loyal to their preferred brand based on the equipment they trained on, familiarity with the product line, and customer service. Lincoln Electric capitalizes on this through its welding schools and training programs, which create exposure to the brand and drive brand loyalty among new professional welders.

The company has a strong record of innovation and new product introductions. We believe it spends adequate funds on research and development (1.5% of sales on average over the last 10 years, compared with 1.5% for ITW and 1.0% for ESAB) to protect its competitive position. The firm’s investments in research and development continue to bear fruit as Lincoln Electric has a roughly 34% vitality index (the percentage of total revenue derived from new products launched within the last five years). Additionally, the company regularly engages in mergers and acquisitions to supplement its portfolio of offerings. For example, the acquisition of Baker Industries has enhanced Lincoln Electric’s capabilities in automation and additive solutions.

To a lesser extent, we also believe Lincoln Electric benefits from customer switching costs. Alongside ITW and ESAB, Lincoln Electric is one of the top three global players offering a complete welding solutions package, including equipment and consumables. We think this differentiates the company from smaller competitors that only offer either equipment or consumables, as some customers value Lincoln Electric’s one-stop-shop approach and comprehensive suite of welding solutions. Further, based on their experience and familiarity with their preferred brand’s equipment, we believe that welders tend to be reluctant to switch brands without the promise of a meaningful improvement in performance or reduction in cost.

We also believe Lincoln Electric’s investments in automation and Internet of Things solutions will reinforce customer switching costs. Lincoln Electric seeks to differentiate itself by becoming an automation integrator in the welding space, whereas many of its rivals sell equipment to third-party integrators. While sales of traditional equipment and consumables are often one-off transactions, sales of automation solutions inherently involve closer client relationships, as suppliers often collaborate with customers to develop highly engineered solutions that may be customized to their needs. As automation solutions are tightly integrated into the customer’s manufacturing process and perform a mission-critical function, we believe customers are reluctant to switch vendors, given the potential cost of unscheduled downtime or possible modifications to the production line. Therefore, Lincoln Electric’s engineering capabilities and experience with welding and automation give the firm a competitive advantage in a niche market with relatively high technological barriers to entry.

We think new Internet of Things solutions, including digital capabilities that improve weld accuracy and control, as well as data analytics, will enhance customer switching costs. For example, the firm’s CheckPoint software allows customers to monitor their welding operations, including real-time data on productivity and material consumption. By combining digital solutions with its equipment, Lincoln Electric will be able to offer an integrated package and thus create stickier customer relationships, in our view.

While we believe Lincoln Electric merits a narrow moat, its international welding business is not as strong as its Americas operations. We view the international segment as a no-moat business, as its operating margins have averaged 8.4% over the last 10 years, significantly lagging the 18.6% average operating margins of the Americas welding segment. There are several reasons for this subpar performance. For one, the industry is substantially more fragmented in Europe, and Lincoln Electric’s brand does not carry the same weight as in the US, where the firm has been an industry leader for over a century. Another factor is Lincoln Electric’s unique management system in its US factories, which gives the company the flexibility to adjust workers' hours from as low as 30 hours a week to over 50 hours a week throughout the business cycle and effectively converts a portion of fixed costs to variable costs. Although management is pursuing initiatives to drive operating margin expansion in international welding, and we think the business has some moat-forming potential in the long run, the segment’s returns are currently below the firm’s cost of capital, and we believe the international welding business lacks an economic moat.

Lincoln Electric has established one of the most trusted brands in welding and enjoys leading market share.

Automation solutions have the potential to deliver revenue growth well above the core welding growth rate.

Lincoln Electric is one of the industry leaders in terms of R&D, and it has been able to gradually capture market share from smaller players thanks to the introduction of new or improved products.

Lincoln Electric's international welding business is not as strong as domestic welding, with operating margins lagging the Americas welding segment by roughly 900 basis points.

M&A is an important part of the firm's revenue growth strategy, which creates the risk of overpaying for acquisitions.

Lincoln Electric has exposure to cyclical end markets, including energy, automotive, and construction.