Lincoln Electric Holdings, Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Lincoln Electric is the world’s largest designer, developer and manufacturer of arc welding and cutting equipment, including related automation, consumables, and aftermarket parts.

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

Lincoln Electric (LECO) operates within the industrial sector, providing essential equipment and solutions for welding and cutting applications. The company serves diverse industries, including:

  • Welding and Cutting Equipment: Offers an extensive line of arc welding products, automated cutting equipment and related components.
  • Consumables: Provides electrodes, wires, fluxes, and other supplies essential for welding processes.
  • Automation: Provides automation for welding and cutting processes.
  • Services: Provides services including robotic programming, training, and safety programs.

LECO’s global presence is a critical aspect of its business, with a manufacturing base that spans numerous countries, including the US, Mexico, and China. The company’s sales channels include distributors, project managers, and direct sales.

Revenue Distribution

LECO primarily generates revenue from three segments:

  • Americas Welding: This is the largest segment, focused on the North American market, primarily on the US but also Canada and Mexico. It includes both the core welding and cutting equipment business, as well as automation solutions.
  • International Welding: This segment operates across Europe, Asia, Africa, Latin America, Australia, and the Middle East. The focus in most of these markets is on selling the core welding and cutting products as opposed to automation solutions.
  • The Harris Products Group (HPG): This group produces specialized alloys, brazing products, and solders.

Geographically:

  • The company derives around 50% of its revenues from the U.S. market, with international revenue making up the other half. This international revenue tends to lean towards Europe, accounting for 20-30% of total sales.
  • The most important foreign countries include China, Brazil, Canada, Mexico, United Kingdom, France, Italy, and Germany.

The welding and cutting industry is cyclical and highly competitive. Some key trends include:

  • Increased Automation: Companies are automating their manufacturing processes, which has led to increasing demand for automated welding and cutting solutions.
  • Focus on Safety and Efficiency: Customers are increasingly emphasizing efficiency and productivity to enhance their own operations. There are also very high regulatory, health and safety standards in the industry.
  • Technological Advancements: In new tech, equipment that reduces power consumption, enhances worker safety, is faster, and is able to produce more accurate and consistent results is important.
  • Global Economic Conditions: Economic cycles greatly affect demand for industrial products, and therefore the entire welding and cutting industry. The company’s performance is heavily influenced by these global conditions.
  • Growth in Emerging Markets: Emerging markets are experiencing a growth in industrialization and infrastructure projects which is fueling a higher demand for welding products and services.
  • Raw Materials Price Fluctuations: The company is exposed to volatility in input prices.
  • Government Regulation: The company’s international operations face additional uncertainty due to global trade policies and sanctions.

Competitive Landscape

LECO faces competition from other manufacturers in the arc welding and cutting space. Main competitors include Illinois Tool Works Inc. and ESAB Corporation, as well as various smaller regional players.

What sets LECO apart:

  • Global Distribution: LECO has a vast distribution network around the world which gives it an edge over smaller and more regional companies.
  • Strong Brand and Customer Loyalty: LECO has cultivated a strong brand over its 125+ years in operation, which has resulted in strong customer relationships and customer loyalty.
  • Full solutions offerings: LECO has an extensive line of equipment, consumables, automation, and services. Few competitors provide the same breadth of solutions.

Financial Analysis

LECO’s financials reveal a relatively healthy business with some strengths and weaknesses.

Income Statement Analysis:

  • Revenue Growth: LECO has shown solid revenue growth in recent periods, mainly due to price increases and volume growth. The company is now leaning towards acquisitions to fuel further growth as the company has indicated that future market growth may slow.
  • Gross Margin: LECO has a strong gross margin which has remained at roughly the same level in the 20-25% range for the last 3 years. This has allowed LECO to sustain decent profitability across its various business units.
  • Operating Expenses: The company’s operational expenses have been somewhat volatile in recent years. This was largely driven by an increase in R&D expenses, as well as some restructuring activities due to acquisitions.
  • Net Income: LECO has consistently delivered solid net income, although, this metric has varied more YoY than revenue, being affected by impairments and restructuring costs, as well as acquisitions.
  • Earnings Per Share: The EPS for LECO is relatively high, although has been variable. This is a similar situation to net income, and also dependent on accounting adjustments and acquisitions.
  • Impact of Acquisitions: Acquisitions tend to have a big impact on all of the ratios. They increase revenue, and often increase net income (through synergies or consolidation of profits). However, they also come with restructuring and amortization costs.

Balance Sheet Analysis

  • Assets: LECO has very liquid assets, with a healthy amount of cash and marketable securities.
  • Liabilities: LECO’s liabilities are moderate, and appear easily manageable. The company has relatively short-term debt, and some noncurrent liabilities as a result of acquisitions.
  • Equity: The company’s equity is high, reflecting a strong overall financial position.
  • Financial Health: LECO has a relatively healthy balance sheet, with strong financials. The company also has very little short term debt. This is very good because the company is able to support itself on the revenue that it has without the need for extensive financing, although it has become more leveraged recently because of acquisition activity.

Cash Flow Analysis

  • Positive Cash flow: LECO shows a trend of producing steady and positive cashflow, although cash from operating activities has been volatile. The company also has shown to have positive free cash flow in recent years.
  • Acquisitions & investments: Most of the company’s cash outflow in recent years, other than debt payments, seems to stem from acquisitions. If a company does not properly evaluate its acquisitions, it may destroy cash flow and shareholder value.

Moat Analysis

LECO possesses several advantages that create a narrow moat:

  1. Strong Brand: Lincoln Electric has been a well-recognized brand in the welding industry for more than a century. This gives the company a head-start in attracting and retaining customers.
  2. Global Distribution Network: LECO’s distribution network in developed and developing markets gives it an edge over the vast majority of competitors that lack such scale.
  3. Location-Based Cost Advantages: LECO is able to utilize its manufacturing capabilities and locations to offer competitive pricing.
  4. Switching Costs: Customers that already use LECO equipment benefit from the interconnectedness of hardware, consumables, and service offerings. The switching cost of abandoning LECO can be significant for many.

However, the company does face considerable threats to their moats, resulting in an overall rating of 3/5

Risks to the Moat

While LECO has several advantages, it faces risks:

  1. Technological Disruption: Continuous innovation by competitors could result in products and services that supersede those of LECO’s. This could quickly erode their brand and other benefits. For example, AI-powered robots are already showing promise in taking over repetitive manufacturing processes, and they are improving by the day.
  2. Competition: Increased competition, from regional players or other larger competitors, could erode market share and profitability.
  3. Raw Materials Prices: Increased raw material prices can increase costs for the company and lower margins.
  4. Geopolitical Risk: The volatility of geopolitical events could impact supply and sales in specific regions. Also, rising tensions between superpowers may cause import/export difficulties for the company.

Business Resilience

LECO has shown resilience in past economic downturns, however, this may not be the case in future conditions as the company relies heavily on economic growth. The following factors contribute to LECO’s resilience:

  • Global Diversification: Diversification across numerous regions can protect from downturns in specific regions.
  • Strong brand: The company has a long-lasting brand that can prevent consumers from switching in downturns.
  • Focus on operating efficiencies: The company is focused on reducing waste, and optimizing efficiency, which helps to weather short term economic downturns.

Understandability

I rate LECO as having an understandability of 2 / 5, because:

  1. LECO provides a large suite of different products and services.
  2. It serves very niche industrial markets, which can be hard to understand from the outside.
  3. The company has complex revenue streams from geographic divisions as well as products and services.
  4. The company’s accounting practices are not always straightforward and have been adjusted frequently due to new GAAP / IFRS regulations.

Summary

LECO is a well-established company with a strong history, and is well positioned in the arc-welding equipment space due to its global presence and large distribution networks. However, LECO does face considerable threats, especially in the technology sector. Also, management is continuously trying to grow the company and its profitability, which, given the competition, may prove challenging. Investors will need to focus on whether this expansion can be done without destroying the strong financials, and how to interpret accounting and reporting changes that result from the acquisitions.

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