A Hot Domestic Market Continues To Propel Lincoln Electric

By Stephen D. Simpson, CFA | April 27, 2012 AAA

Certain stocks torment investors with excellent performance and valuations that just never seem to get quite low enough. Welding equipment and consumables manufacturer Lincoln Electric (Nasdaq:LECO) is one such company. While I would argue that this is one of the best industrials that most people don't know about, the stock seldom trades at a bargain. Although strong sales in North America are fueling excellent growth today, perhaps fears of emerging market slowdowns will take a little steam out of the stock.

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Another Fine Quarter
Lincoln Electric is a pretty simple business and so is the explanation of its performance. Revenue rose roughly 21% this quarter and slightly beat expectations as the company saw great demand in North America.

Organic revenue growth clocked in above 16%, as the company coupled nearly 13% volume growth with about 4% of price growth. Sales to North America rose 36%, as the company continues to gain share from smaller players, while growth in Europe was a more modest 10%. Emerging market action is more mixed - weakening economic conditions limited growth in Asia to 6%, while strong building and energy markets helped the small South America business grow 17%.

Although a price hike of 4% doesn't sound especially robust, Lincoln Electric still saw good margin leverage. Gross margin improved nearly three points, while reported operating income jumped 54%.

SEE: How To Decode A Company's Earnings Reports

Does the Company Need to Spend More Overseas?
Lincoln Electric garners more than half of its revenue from North America, and conditions here are quite good right now. As companies like Grainger (NYSE:GWW) and Fastenal (Nasdaq:FAST) have reported, overall growth and business activity is still really solid in the U.S. industrial sector. Moreover, large companies like General Electric (NYSE:GE) continue to report good industrial demand in the U.S.

Now, Lincoln Electric is not performing badly at all. But it has to be pointed out that Illinois Tool Works (NYSE:ITW) reported organic welding revenue growth of nearly 19%. Illinois Tool Works is also benefiting from a strong domestic market, but it seems like this rival is a bit better positioned to reap the benefits of strong international energy and construction markets. Likewise, with some turbulence at Charter-ESAB in the wake of its acquisition by Colfax (NYSE:CFX) there could be a window of opportunity here.

The Bottom Line
Arguably the biggest risk for Lincoln Electric right now is if high energy prices (and rising prices overall) act as a brake on North American economic growth. Although LECO's European business activity is holding up reasonably well, those markets are still soft and Asia has clearly seen a significant slowdown.

Lincoln Electric should be in good position to further leverage its fixed costs and benefit from incremental acquisitions as the years go on, and that should support solid free cash flow growth. On the premise that LECO can continue to outgrow the global economy over the next decade with 6-7% free cash flow growth, these shares are underpriced, but perhaps not so much so that they demand purchase today. That said, if these shares would sell off into the low $40s, investors should be looking to pounce.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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