Trygve FinkelsenInvestment Thesis While ESAB Corporation (NYSE:ESAB) faces near-term challenges from weakness in its key end markets, such as automotive and heavy industry, I remain optimistic about its long-term growth outlook given its strong position in emerging markets and continuous focus on new and innovative product launches, which are helping it outperform peers. Further, in the medium to long run, tailwinds like reshoring, energy transition, and infrastructure funding should drive good end-market demand and support revenue growth. Besides organic growth, the company has a healthy balance sheet, which should enable it to pursue bolt-on M&A. On the margin front, the company’s margin should benefit from product line simplification initiatives, footprint rationalization, manufacturing consolidation, a mix shift towards higher margin equipment sales, and margin accretive M&A. Further, the company is using AI tools to optimize operations and improve sales personnel efficiency, which should contribute to margin growth. The stock is trading at a discount to its peers despite posting better results. Considering the good long-term growth prospects and attractive valuation, I continue to have a buy rating on ESAB stock. Revenue Analysis and Outlook I last covered ESAB in November 2023 where I talked about the company’s good growth prospects benefiting from robust demand for its equipment and automation product lines, secular trends like reshoring and sustainability, and a leading position in emerging markets. Since then, the company has reported its Q4 2023, Q1 2024, and Q2 2024 results. While the company posted Y/Y growth in Q4 2023 and Q1 2024, its net sales turned slightly negative in Q2 2024 as the higher interest rate environment started negatively impacting its end markets. In the second quarter of 2024, with a challenging end-market situation in developed countries, ESAB saw a ~2% Y/Y decrease in sales on a reported basis due to continued low demand for the consumables segment. However, excluding the 300 bps FX headwind and 40 bps M&A benefit, the organic sales grew by ~1% Y/Y. The growth in organic sales was mainly driven by equipment and automation businesses’ high-single-digit growth year-to-date, ESAB’s strategy of improving product mix towards equipment with an updated equipment portfolio and less cyclical automation and mission-critical gas control products. In Q2 2024, ESAB’s organic sales in the Americas grew by 4% Y/Y, where 3% was due to strong price performance and 1% due to volume increase. The acquisition of Sager S.A. also benefited their overall sales. However, all these positive factors were offset by an unfavorable currency translation of 5%. In the EMEA & APAC segment, net sales declined by 3.1% Y/Y and 1% Y/Y on an organic basis. Core sales, excluding Russia, declined by 3.6% Y/Y and 2.3% Y/Y organically. The decline in core sales was due to a decrease in customer pricing of 3% and an unfavorable currency exchange impact of 1%. However, volume grew by 1% Y/Y as weakness in filler metals demand in Europe was effectively offset by strength in emerging markets like India and the Middle East. ESAB’s Historical Net Sales Growth (Company Data, GS Analytics Research)While the broader macroeconomic environment remains tough with challenges in key end markets like automotive, the company continues to do well and outperform its peers. For the last several quarters, ESAB’s organic revenue growth has outperformed its peers Lincoln Electric (LECO) and Illinois Tool Works (ITW) welding segment growth. This can be attributed to the company’s favorable emerging market exposure (over 50% of revenues) as well as its launching of new innovative products. The company saw a double-digit growth in markets like India and the Middle East last quarter, and the strong demand in these markets should continue to help its outperformance versus peers moving forward as well. The company’s strategy to focus on new product launches, especially in the light industrial and automation side, is also helping it gain market share and drive end-market outperformance. A good example of recent product innovation is the Renegade VOLT, a battery power welder, which is getting good response from distributors. As the company continues to roll out this product across its distribution channel, it should also help ESAB’s outperformance. In addition to product innovation and sales plan execution, the company is focusing on geographic expansion of existing product lines. The company has recently announced a distribution partnership with INFRA Group to expand the reach of ESAB’s welding and gas control equipment in the Mexican market. Under this agreement, INFRA group will offer ESAB’s innovative products to its customer base in Mexico. This includes the award-winning, battery-powered Renegade VOLT and equipment from its leading Rogue, Rustler, and Arcair product lines. The company’s end markets are also poised to benefit from secular tailwinds, including the recent reshoring trend, the energy transition, and a large pipeline of infrastructure upgrades. Further, the company has a leading position in several emerging markets like India and the Middle East, which are benefiting from increased infrastructure investments. According to management, emerging markets are growing twice as fast as developed markets. The company’s strong market position in these high-growth markets enables it to capitalize on this trend (~56% of the sales derived from EMEA & APAC in FY23). Apart from organic growth, the inorganic sales growth from its bolt-on M&A strategy should also support its overall revenue growth. The company’s M&A strategy focuses on acquiring faster-growing, less cyclical, and higher-margin businesses that complement its existing portfolio and expand its geographic reach. At its Investor Day last year, the company shared its target of over $4 billion in sales by 2028, with M&A adding ~$0.7B of sales. The company has created a funnel of over $7 billion of current prospects for acquisition to support this long-term objective. Further, the company has a healthy balance sheet with a net leverage of ~1.7x at the end of the last quarter, which should support its bolt-on M&A strategy. Overall, I am optimistic about the company’s organic and inorganic revenue growth prospects. Margin Analysis ESAB delivered strong margins last quarter. Its gross margin expanded 160 bps Y/Y to 38.2%, primarily driven by lower material costs and a favorable product mix. However, it was partially offset by the impact of currency translation. Adjusted EBITDA margins expanded by 160 basis points Y/Y to 19.9%. This was due to EBX and AI initiatives implemented at their manufacturing plants, which improved the company’s operational efficiencies. The company also had additional benefits of $5 million from restructuring projects. In the Americas, the adjusted EBITDA margin increased by 210 bps Y/Y primarily due to pricing increases, lower material costs, product simplification, and restructuring initiatives. In EMEA & APAC, the adjusted EBITDA margin expanded by 120 bps Y/Y due to lower material costs and improved product mix. ESAB’s Adjusted EBITDA and Gross Profit Margins (Company Data, GS Analytics Research) ESAB’s Segment Wise Adjusted EBITDA Margins (Company Data, GS Analytics Research)Looking forward, I expect the company to continue expanding its margins. Over the last year, the company has worked on its product line simplification (PLS) initiative to eliminate low-volume SKUs and focus on less cyclical and higher-margin SKUs. Now, the company is deploying PLS to drive growth in the business. This includes using PLS to identify key customers and refining the product line. The company is also focusing on footprint rationalization and manufacturing consolidation and has several projects lined up for the next couple of years. Reducing factories lowers fixed costs and thereby improves margins. Further, the company is using AI in two main areas, i.e., operational excellence and commercial growth. The company uses AI tools that help it reshape material planning and production processes to lower inventory levels and enhance service levels, creating significant cost advantages. In addition to operational improvements, the company is deploying AI tools to drive commercial excellence, including increasing sales personnel efficiencies. The company’s margin should also benefit from a mix shift towards equipment sales. In the welding business, equipment carries a higher margin than consumables, and the company continues to focus on shifting the portfolio towards a higher mix of equipment sales. The company has a target of increasing the equipment mix to 35% of sales (from the current 31%) by expanding its welding equipment, automation, and gas control equipment portfolio. In addition, the company has also been implementing a bolt-on acquisition strategy and acquiring businesses with gross margins above 40%. The acquisitions of Sager, SUMIG, and LIPL are margin-accretive, and I expect the company to continue implementing its bolt-on M&A strategy and further improve the margin mix. At its Investor Day last year, the company shared its target of achieving an adjusted EBITDA margin greater than 22% by 2028, which, I believe, is easily achievable looking at the progress made so far. The company is well-positioned to continue improving its margins through its PLS initiative, footprint rationalization, operational improvements and increased sales efficiency using AI tools, mix shift towards high-margin equipment sales, and margin accretive M&A. Valuation and Conclusion ESAB is trading at 19.28x FY24 consensus EPS estimates of $4.88 and 17.58x FY25 consensus EPS estimates of $5.35. The company’s valuation is at a discount when compared to its peers, Illinois Tool Works trading at 23.15x FY24 consensus EPS estimates of $10.22 and Lincoln Electric Holdings trading at 20.65x FY24 consensus EPS estimates of $9.09. I am positive about ESAB’s growth trajectory in the coming years, supported by new product introductions, good execution, solid end-market demand fueled by trends like reshoring and energy transition, strength in emerging markets, and inorganic growth opportunities from M&A. The margins should also expand due to the reasons previously listed. The valuation also looks attractive when compared to its peers. Given good long-term growth prospects and an attractive valuation, I continue to have a buy rating on ESAB stock. Risks The company focuses on bolt-on M&A to expand into new markets and enhance its position in the existing markets. However, inorganic growth is relatively riskier compared to organic growth and there are always risks related to integration missteps, overpaying for an acquisition, and the leverage a company takes to make an acquisition. In case any future acquisition goes wrong or the management fails to realize the anticipated benefits of an acquisition, it may negatively impact the stock price. The company is exposed to risk related to fluctuations in foreign currency rates, as it derives ~78% of net sales (as per FY23 sales) from operations outside of the United States. The company is seeing softness in its key end markets due to the uncertain macroeconomic environment, resulting in weakening industrial activity and low levels of capital investments. If the current macroeconomic environment deteriorates, it could further reduce the end-market demand and adversely impact the company’s overall financial performance.
sekar nallalu Cryptocurrency,ESAB,GS Analytics,ITW,LECO ESAB: Good Execution, Strength In Emerging Markets And Accretive M&A Make Me Bullish