ESAB Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

ESAB Corporation is a global fabrication technology company, providing welding and cutting products and equipment for various industries.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

ESAB is a global leader in fabrication technology, offering a diverse range of welding, cutting, and automation solutions. The company serves industries worldwide and is organized into four main operating segments: Americas, EMEA, APAC, and Business Functions (P&S/Services). ESAB also has a diverse customer base, with over 600,000 customers ranging from small fabricators to large industrial companies.

  • Revenues by Segment: ESAB’s operations are divided into the following:
    • Americas: Focuses on the North and South American markets.
    • EMEA: Covers Europe, Middle East, and Africa.
    • APAC: Includes Asia and Asia Pacific.
    • Business Function: Product and Services which cut across all geographies.
  • Industry Trends: The welding and cutting industry is highly competitive and globalized. The demand for welding products is driven by economic activity in general and from specific end markets such as construction, manufacturing, and energy sectors. As it is a cyclical industry, we can see the revenues fluctuates with economic cycles and capital spending.
  • Competitive Landscape: The global market for welding equipment is highly fragmented with many regional players in addition to global market competitors, like Lincoln Electric, ITW, and Miller Electric. ESAB differentiates itself through its integrated solutions approach. This implies that ESAB does not rely solely on equipment but also offers related products and services.
  • Product Offerings: ESAB’s portfolio includes consumables like welding electrodes, gases, and filler materials; equipment like manual and automated welding machines, plasma cutting systems, gas control equipment, and robotics automation; and aftermarket services including repair, training, and system optimization.
  • What Makes the Company Different: ESAB’s strategy emphasizes a combined approach to value creation:
    • Innovation: The company focuses on R&D, which helps maintain their competitive edge.
    • Brand equity: the company owns many well-known brands.
    • Global presence: They have presence in every geography, allowing them to be well-positioned.
    • Solution provider: ESAB is not just a supplier, rather a partner offering solutions to customers.
  • Financial Overview: Revenue for the first 9 months ending September 30, 2022 was $2.48 billion, a 9% increase over the same time the previous year. Net sales of American operations decreased from $771 million to $746 million. However, sales from EMEA operations increased from $1.25 billion to $1.38 billion. Sales from Asia Pacific rose to $529 million from $492 million. It is a business that has a moderate-high net margin of ~10%, and a reasonably high 17-18% EBITDA margin. In the last few years, their debt has gone down, and they have been buying back shares, while also making acquisitions. We will talk about the latest acquisitions in more detail later.

Moat Analysis

Moat Rating: 3/5

ESAB has a narrow moat, which means they have a limited but still present competitive advantage.

  • Intangible Assets: ESAB has strong brands in welding, cutting and automation space. However, these brands can lose their luster over time because the industries and technologies used are constantly evolving.
  • Switching Costs: It has many customers which are tightly integrated into their products, making it challenging for them to switch to a competitor. They are particularly present in more technically complex industries, like aviation.
  • Cost Advantages: The company’s production and distribution model help achieve efficiencies. They are present all over the world, and hence can capture the growth and demand in many markets. Their supply chain can also help them offer their solutions at a competitive cost.
  • Network Effects: ESAB doesn’t benefit strongly from network effects. Their operations are primarily linear in nature where one party does not benefit from multiple other parties using the same service, except possibly in the online side of the business.

Business Resilience

ESAB has a few features that allow it to perform well in a wide variety of business environments, and provide it with a good level of resilience.

  • Recurring Revenue: The company’s consumable sales generate recurring revenue. It also has a substantial and high-margin aftermarket services.
  • Diversified Customer Base: The company has a large customer base with over 600,000 customers in all industries worldwide, including large enterprises as well as smaller businesses. This diversification reduces dependence on a single customer or industry.
  • Geographic Reach: ESAB is global, giving the company more stability than if they were confined to a single geographic area. They also have the capability to shift production across geographies if one market becomes too unstable.

Risks to the Moat and Business

  • Technological Disruption: ESAB operates in a technology-related space, so their technology could be obsoleted by a competitor. Also, new technology might emerge that changes the competitive dynamics in the space.
  • Cyclicality: The company’s revenues are strongly correlated to economic cycles. During economic downturns, sales may fall, affecting the profitability.
  • Competition: There are several established players in this industry, and more competitors could enter the market, bringing pricing pressure and reduced market share.
  • Supply Chain Issues: Global supply chain problems could affect the business and the customers, specifically regarding the availability and prices of raw materials, semi-finished products, and equipment used for manufacturing.

Financial Analysis

Understandability: 2/5

The business has a moderate level of understandability, the processes of a industrial machinery and equipment company like ESAB is more difficult to understand than software companies or brands. It’s not too complex, but still not basic.

  • Revenue Model: ESAB generates its revenue mainly from the sales of products and services. The company earns more money by selling its consumables and providing its services (as their margins are higher), than from the sales of equipment. Revenue model is relatively easy to understand. However, you have to be careful when seeing the overall revenue because the effect of acquisitions can skew growth rates.
  • Profitability: ESAB has strong gross profits, with margins around 35%. EBITDA margin is fairly high at around 17-18%, reflecting a level of pricing power and well-managed operations. However, we did see a trend of shrinking profitability in a few historical periods which should be a focus. It’s also important to watch their return on invested capital, since ROIC indicates how well the company can create value.
  • Capital Intensity: It is important to examine the company’s capital expenditures because industrial companies can be capital-intensive. ESAB’s capital expenditure is moderate, implying they don’t rely on a lot of capex to sustain operations. However, we did see their capital spending rise recently to accommodate increased market demand, which is an area to monitor.

Balance Sheet Health: 3 / 5

Overall the company has an average balance sheet, they have low debt currently, and have ample cash, but also have several financial obligations and other liabilities that need to be considered.

  • Leverage: ESAB has a moderate level of leverage, with total debt being roughly equivalent to one year’s worth of earnings.
  • Cash Flow: The company had a good cash balance of ~$350 million at the end of the last quarter.
  • Cash flow generation: In general the company is able to generate a steady stream of cash, even after its various expansions and acquisitions.
  • Liabilities: ESAB has significant amount of liabilities including employee benefits, leases, and other contractual obligations. Also, there is a good portion of goodwill on their balance sheet. These are all important factors to keep in mind when looking at the business and its health.

Recent Concerns and Management Response

  • Inflation and Supply Chain: Management acknowledged on multiple occasions that inflationary pressures and supply chain issues have been affecting their results. To mitigate these issues, they are focused on raising prices, cutting cost, and maintaining operating efficiencies.
  • Acquisitions: ESAB has been acquiring smaller companies recently to add capabilities and growth. The company management believes these acquisitions are good strategic decisions and contribute to value creation in the long term. However, it remains to be seen how these acquisitions will actually play out and help their long-term growth. In the last earnings call, they have also communicated that the costs associated with recent acquisitions are less than the revenue generated by them. They have also talked about synergies, and improvements to profitability.
  • Currency Translation: The company’s revenue and earnings can fluctuate with changes in currency valuations, specifically with the value of the Euro against other currencies. Although this is usually a non-cash item, it can still influence the financial performance of the company.

In conclusion, ESAB is a company with a narrow moat which can generate excess returns on capital for longer periods than its competitors. Their strategy is good and their focus is in the right areas. However, it’s not a simple business to understand, and may require constant monitoring of various factors. While the balance sheet is healthy enough, it is not as stellar as their other capabilities and needs careful monitoring of various factors as well.