Lincoln: Electric A Quality Niche Industrial

By Stephen D. Simpson, CFA | February 24, 2011 AAA

With a 42% rise in the stock over the past year and 140% since early 2009 lows, clearly there have been rewards for the nimble and patient with welding equipment maker Lincoln Electric (Nasdaq:LECO). Lucky for Lincoln Electric, though, welding is strongly tied to industrial activity, and the company seems to be looking at a prolonged multi-year recovery in business.

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A Solid End to a Rebound Year
Lincoln Electric surpassed analyst expectations for the fourth quarter, posting 22% revenue growth and surpassing the high-end analyst estimate by 7%. Those results are good enough in their own right; even better when considering the 9% sequential growth and the historical trend for the fourth quarter to be soft. Looking at the company's markets, North American sales jumped 25%, while South America was the laggard at 8% growth. Overall, the company saw volume increase 20% - a strong testament to the increased business activity and product demand.

Profitability was more of a mixed bag for the company. Gross margins shrank by nearly three full points as the company reversed a large LIFO credit to a small charge, but the company did recover a lot of this through an even bigger reduction in SG&A spending. All in all, adjusted operating income rose 26%, while adjusted net income increased 38%.

The Road Ahead
Put very simply, welding demand is tied to industrial activity and, to some extent, the demand for steel. Automobile production is increasing, and that is good for Lincoln. Oil and gas exploration activity is also increasing, and that's good for Lincoln. Steel demand looks strong for 2011, and that's mostly good for Lincoln, though higher input costs will be a burden on margins. Better still, while the BRIC countries are trying to cool inflation in their economies, growth is still strong and Lincoln is seeing good business prospects overseas.

Lincoln also benefits from being one of the few big fish in a pretty large sea. Lincoln, Illinois Tool Works (NYSE:ITW) and Britain's Charter all lead the sector with low-teens shares, and there are dozens of smaller firms that make up the rest. That is not only a fertile field of potential niche acquisition candidates, but also a field of competitors that lack the leverage and efficiency to compete with these larger companies.

One question, though, is whether Lincoln will continue to be able to pass on costs. Charter recently disappointed investors when it reported earnings that highlighted an inability to pass some of these costs on through to end users. Costs are a problem for everyone ranging from Caterpillar (NYSE:CAT) to Ford (NYSE:F) to ABB (NYSE:ABB), and Lincoln will have to see how much pricing power it really has, as ArcelorMittal (NYSE:MT) and U.S. Steel (NYSE:X) are not going to back down from higher steel prices just for them.

The Bottom Line
Not only is Lincoln in good position to exploit the ongoing U.S. industrial recovery, but also ongoing emerging market demand and an eventual rebound in commercial construction. Better still, the company has good management and a pretty solid track record (relative to other industrials) of translating incremental revenue into free cash flow. Even allowing for some margin compression, high single-digit revenue growth over the next five years would be sufficient to produce a mid-$80s near-term price target. Although Lincoln Electric is not the cheapest stock around, and some investors may hesitate to buy in after the big move from the lows, this is a great company and a good way to leverage the ongoing global industrial recovery. (To learn more, see The Ups And Downs Of Investing In Cyclical Stocks.)

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