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Systematic Ideas : Long Lincoln Electric (LECO US) & Short Vallourec (VK FP) - 04 Oct

Long Lincoln Electric (LECO US)

 Lincoln Electric has a track record of generating strong free cash flows and has been steadily improving gross & net margins over the last 10 years. They remain committed to enhancing shareholder value and this is reflected in the $429 million   returned to shareholders through buybacks and dividends through 2016 (an impressive 18% of revenues). 

 The company has invested heavily with over $350 million in R&D spend over the last 10 years; indeed over a third of the company’s 2016 sales is driven by new product revenues.  An equally intense focus in M&A (having invested ~$500 million in this space over the last decade) has seen the company acquire Air Liquide Welding for $115 million. This is widely expected to start adding to EPS from FY2017 itself.

 Fig 1 shows the relative performance of LECO v/s the US Hand/Machine Tools index in net profit terms (& v/s the global variant in revenues). The fall in the former below 2 S.D. & a subsequent break out above resistance  in July 2009 presaged a few years of outperformance (by c. 50%).  A similar set up is perhaps in place.

Short Vallourec (VK FP)

 Rising debt on the balance sheet and declining net margins have been a constant feature of Vallourec’s financials over the last decade. Negative CFROI is likely to persist and February guidance on FCF remained subdued.

 While the company expected to see recovery in their key shale markets into the year-end, they will need to see stronger crude prices to sustain for any uptick in hydrocarbon exploration. In the meantime utility margins continue to decline and that keeps the power generation CapEx  in check. Sales in this area have already declined by 50% over the last 10 years. Given these circumstances the restructuring and cost cutting plan which requires volumes going back to the 2014 highs seems hard to achieve in the near term.  

 Fig 2. shows the relative rotation graph of Vallourec versus the Bloomberg EU Industrials Machinery peer group as well as relative to the Stoxx 600 Index; the stock is in the lagging quadrant in both on a monthly time frame. This indicates sustained under performance ahead.