January 22, 2015 Lincoln Electric Holdings Inc. Current Recommendation Prior Recommendation Neutral Date of Last Change 01/22/2015 Current Price (01/21/15) $67.15 Target Price $81.00 OUTPERFORM SUMMARY (LECO-NASDAQ) We are upgrading our recommendation on Lincoln Electric from Neutral to Outperform with a target price of $81.00. In the third-quarter 2014, Lincoln Electric s adjusted earnings increased 9% year over year to $0.94 per share. Revenues rose 3.5% led by widespread demand across the key segments. Lincoln Electric will benefit from improving end market trends in the general fabrication and structural sectors. Demand for innovative solutions, benefits from strategic initiatives and accelerated returns will also drive growth. Additionally, Lincoln Electric continues to undertake initiatives to provide improved returns through acquisitions. Moreover, further share repurchases and dividends will also benefit Lincoln Electric. SUMMARY DATA 52-Week High $75.46 52-Week Low $61.61 One-Year Return (%) -5.10 Beta 1.30 Average Daily Volume (sh) 265,325 Shares Outstanding (mil) 78 Market Capitalization ($mil) $5,238 Short Interest Ratio (days) 2.89 Institutional Ownership (%) 65 Insider Ownership (%) 2 Annual Cash Dividend $1.16 Dividend Yield (%) 1.73 5-Yr. Historical Growth Rates Sales (%) 11.3 Earnings Per Share (%) 35.2 Dividend (%) 14.3 using TTM EPS 17.0 using 2015 Estimate 16.0 using 2016 Estimate 15.0 Zacks Rank *: Short Term 1 3 months outlook 4 - Sell * Definition / Disclosure on last page Risk Level * Below Avg., Type of Stock Large-Growth Industry Mach Tls&Rl Prd Zacks Industry Rank * 240 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 719 A 727 A 692 A 715 A 2,853 A 2014 685 A 729 A 716 A 727 E 2,857 E 2015 722 E 767 E 749 E 781 E 3,019 E 2016 3,156 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.92 A $0.91 A $0.86 A $1.09 A $3.77 A 2014 $0.91 A $1.01 A $0.94 A $0.90 E $3.76 E 2015 $0.95 E $1.11 E $1.06 E $1.08 E $4.20 E 2016 $4.47 E Note: 2013 Quarterly figures will not add up due to rounding off. Projected EPS Growth - Next 5 Years % N/A 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Headquartered in Cleveland, OH, Lincoln Electric has more than 48 manufacturing locations, including operations and joint ventures in 19 countries and a worldwide network of distributors and sales offices covering more than 160 countries. Lincoln is a full-line manufacturer and reseller of welding and cutting products. The company s welding products range from welding power sources, wire feeding systems, robotic welding packages, fume extraction equipment, consumables and fluxes to regulators and torches used in cutting. The level of product technology varies from basic units used in light manufacturing to sophisticated robotic applications used in high-production welding and fabrication. Lincoln Electric produces three types of arc welding electrodes including stick electrodes, solid electrodes used for continuous feeding in mechanized welding, and cored electrodes that are also used for mechanized welding. Arc welding is carried out in many industries. The metal working field involves production of arc welding in transportation, construction, fabrication, petrochemical and other industries. Also, in the manufacture of metal products, arc welding applications range from production of consumer appliances to fabrication of heavy machinery and structural steel. Arc welding is the dominant joining method for building and other industrial construction, including oil and gas pipeline fabrication, and oil refinery construction. The company sells its products in both domestic and international markets. Lincoln has five operating segments, namely North America Welding, Europe Welding, Asia Pacific Welding, South America Welding and The Harris Products Group. The North America Welding segment comprises operations in the United States, Canada and Mexico. The Europe Welding, Asia Pacific Welding, South America Welding segments contain welding operations in Europe, Asia Pacific and South America, respectively. The fifth segment, The Harris Products Group, includes the company's global cutting, soldering and brazing businesses as well as the retail business in the United States. REASONS TO BUY We have upgraded our recommendation on Lincoln Electric from Neutral to Outperform on positive outlook for 2015. Lincoln Electric s adjusted earnings increased 9% year over year to $0.94 per share in the third quarter of 2014 driven by strong top-line growth and margin contributions from North America Welding and Europe Welding segments. Although Lincoln Electric did not provide any specific guidance for 2014, the company is expected to benefit from improving end market trends in the general fabrication and structural sectors. Demand for innovative solutions combined with benefits from strategic initiatives and accelerated returns will also drive growth. In 2014, Lincoln Electric initiated a rationalization plan within the Europe Welding segment. The plan includes headcount restructuring to better align the cost structure. Lincoln Electric s European business witnessed improved performance in 3 out of the last 4 quarters. The company is also introducing some new products and solutions in the European market. Though concerns regarding geopolitical issues in Europe persist, the company remains optimistic about long-term improvements in the business and expects consistent organic growth over the next 2 to 3 quarters. Lincoln Electric continues to undertake initiatives to drive improved returns through acquisitions. Prior acquisitions have considerably enhanced Lincoln Electric s product portfolio in many key high-growth areas. In 2014, Lincoln Electric acquired Easom Automation Systems, Inc. in order to strengthen its position in automated welding and cutting. The acquisition will provide Lincoln Electric an opportunity to expand its automation capabilities and end-sector reach. Easom s innovative solutions, patents and Equity Research LECO Page 2
techniques will help Lincoln Electric to improve customers operational efficiency and increase profitability. The company continues to search for attractive acquisition scopes that will help in driving inorganic growth. In the third quarter of 2014, Lincoln Electric s returns on invested capital (ROIC) was solid at 18.3%. In the quarter, the company returned approximately $138 million to its shareholders through $18 million in dividends and $130 million by repurchasing 1.9 million shares. Lincoln Electric increased its 2014 share repurchase target by 20% to $300 million, which compares with its prior target of $250 million. Further share repurchases will provide support to the stock. The company also raised its quarterly dividend by 26% to $0.29 per share from $0.23. The company paid dividends of $18 million in the quarter. RISKS Lincoln Electric posted 3.5% year-over-year rise in revenues in the third quarter. However, segment wise, Asia Pacific Welding and South America Welding recorded decline in sales. South America was the most challenged, with a 40% decline in volumes, as the Venezuelan business continued to contract due limited operations and from intermittent local supply disruptions in the quarter. Lincoln Electric expects that the disruptions will continue to affect its business in the fourth quarter of 2014. The US Architecture Billings Index (ABI) is an economic indicator that provides an approximately nine-totwelve-month glimpse into the future of non-residential construction spending activity. The November 2014 ABI score was 50.9, down from a mark of 53.7 in Oct 2014. Architecture firms remain concerned with finding quality contractors for projects, coping with volatile construction materials costs and finding qualified architecture staff for their firms into 2015. Raw material costs have been escalating and the company has a strategy of increasing selling prices to pass on the raw material costs. However, if the company is unsuccessful, in the future, due to competitive pricing within its various market sectors, margins will be affected. RECENT NEWS Lincoln Electric Beats Q3 Earnings on Top-line Growth Oct 30, 2014 Shares of Lincoln Electric Holdings Inc. gained around 1.8% and closed at $72.48 on Oct 31, a day after the company reported strong third-quarter 2014 results. Adjusted earnings increased 9% to $0.94 per share from $0.86 in the year-ago quarter driven by strong top-line growth and margin contributions from North America Welding and Europe Welding segments. Earnings also beat the Zacks Consensus Estimate of $0.90. Adjusted income excluded a net effect of $0.37 per share pertaining to asset impairment charges. The year-ago quarter figure excluded net charges of $0.06 per share associated with long-lived asset impairments and severance and other costs from the consolidation of manufacturing operation. Including these, reported earnings were $0.57 per share in the quarter versus $0.80 in the year-ago quarter. Total revenue rose 3.5% year over year to $716 million. Excluding the unfavorable impact of foreign exchange translation, sales increased around 6%. The year-on-year growth was led by widespread demand across the key segments in North America, Europe and in Harris Products Group. The reported figure surpassed the Zacks Consensus Estimate of $702 million. Segment wise, increase in sales in North America Welding (7%) and Europe Welding (8%) were offset by Equity Research LECO Page 3
decline in Asia Pacific Welding (10%) and South America Welding (37%). South America was the most challenged, with a 40% decline in volumes, as the Venezuelan business continued to contract due limited operations and from intermittent local supply disruptions in the quarter. Cost and Margins Cost of goods sold increased 3.3% year over year to $474 million. Gross profit increased to $241.6 million from $232.7 million in the year-ago quarter. Gross margin rose 20 basis points (bps) year over year to 33.8%. Selling, general and administrative expenses increased 4% to $136 million from $131 million in the yearago quarter. Adjusted operating profit increased 3.7% year over year to $105 million in the quarter. Adjusted operating margin remained flat year over year at 14.7%. Financial Updates As of Sep 30, 2014, Lincoln Electric s cash and cash equivalents were $280 million versus $300 million as of 2013-end. Cash flow from operations came in at $149 million in the reported quarter as against $155 million in the year-ago quarter. Debt-to-capitalization ratio was 6% as of Sep 30, 2014, up from 1.2% as of Dec 31, 2013. The company repurchased 1.9 million shares for $130 million in the quarter. Lincoln Electric increased its 2014 share repurchase target by 20% to $300 million, which compares with its prior target of $250 million. The company also raised its quarterly dividend by 26% to $0.29 per share from $0.23. Annualized, this represents a payout of $1.16 per share. The raised quarterly dividend will be paid on Jan 15, 2015, to shareholders of record as of Dec 31, 2014. The company paid dividends of $18 million in the quarter. VALUATION Currently, shares of Lincoln Electric are trading at 16.0x our 2015 EPS estimate of $4.20. The company s current trailing 12-month earnings multiple is 17.0x, compared with an 16.5x peer group average and 18.6x for the S&P 500. Over the last five years, shares of Lincoln Electric have traded in a range of 12.7x to 28.6x trailing 12-month earnings. The current is at a 34% discount to the peer group for 2015. We are upgrading our recommendation on Lincoln Electric from Neutral to Outperfrom, which indicates that it will perform above the overall market. Our $81 target price, or 19.3x our 2015 EPS estimate, reflects this view. Equity Research LECO Page 4
Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Lincoln Electric Holdings Inc. (LECO) 16.0 15.0 N/A 14.2 17.0 28.6 12.7 Industry Average 24.4 21.0 9.5 10.9 16.5 105.4 19.4 S&P 500 16.1 15.1 10.7 15.9 18.6 19.4 12.0 Kennametal Inc. (KMT) 11.5 10.0 8.5 7.5 12.2 91.3 8.6 Stanley Black & Decker, Inc. (SWK) 15.0 13.1 10.5 13.2 17.1 21.4 10.6 Amada Co. Ltd. (AMDLY) N/A N/A N/A 14.9 18.8 130.8 18.8 Actuant Corporation (ATU) 12.5 11.3 9.5 7.9 12.9 29.8 11.8 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Lincoln Electric Holdings Inc. (LECO) 4.0 4.2 1.9 21.5 0.0 1.7 10.0 Industry Average 1.8 1.8 1.8 9.0 0.3 1.6 5.3 S&P 500 5.1 9.8 3.2 24.8 N/A 2.0 N/A Equity Research LECO Page 5
Earnings Surprise and Estimate Revision History Equity Research LECO Page 6
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of LECO. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1114 companies covered: Outperform - 15.6%, Neutral - 78.1%, Underperform 5.7%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research LECO Page 7