An Industrial Supply Company With Focus
William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When looking for an investment, it’s always best to look for a company with focus. Companies that hone in on a single core competency generally do better as an investment. Lincoln Electric (NASDAQ: LECO) focuses on welding and cutting supplies, such as welding power sources, wire feeding systems, robotic welding packages, consumable electrodes and fluxes. This equipment is used in important infrastructure projects such as power plant building, mining, and pipeline construction.
Lincoln's competitor Colfax (NYSE: CFX) produces welding and metal supplies through their ESAB division. However, Colfax also produces fluid handling products such as pumps, compressors and valves. And while Lincoln Electric remains dedicated to its chosen field, Colfax's lack of singular focus shows in its fundamentals.
Lincoln Electric possesses many fundamental leads over Colfax, as you can see in the chart below. Revenue for the trailing 12 months for Lincoln Electric stands at $2.9 billion, outpacing Colfax’s $2.3 billion in revenue.
Lincoln Electric’s operating and free cash flows both stay positive during difficult times, surpassing those of Colfax, as you'll see below. Lincoln Electric’s 253% increase in operating cash flow far exceeds the downturn in Colfax’s year-to-date operating cash flow. Lincoln Electric’s boost in free cash flow amounted to 700% year to date versus this time last year. Lincoln Electric’s cash-to-stockholder’s equity ratio stands at a decent 24%.
While Lincoln Electric's long-term debt-to-equity ratio clocks in at 2% (as the chart below reveals), Colfax’s long-term debt to equity ratio towers over it, at 80%. During the most recent quarter, Lincoln Electric and Colfax’s total debt-to-equity ratio stands at 58% and 185% respectively. My personal threshold for total debt is 85%.
Lincoln Electric currently pays an annual dividend of $0.68 per share, for a 1.7% dividend yield. Is this payout sustainable? Year to date, Lincoln has paid out 21% of its free cash flow -- pretty low, in my opinion. In the most recent quarter, Lincoln's dividends represented 9% of the cash on its balance sheet. For the full year in 2011, dividends amounted to 40% of free cash flow, placing Lincoln Electric’s payout on solid fundamental footing. In contrast, Colfax doesn’t pay a dividend, which gives investors more of an incentive to look at Lincoln Electric.
Weighing the risks
While Lincoln Electric’s cash flow and revenue posted solid gains so far in 2012, it also has fundamental concerns that need addressing.
Year-to-date revenue declined in Lincoln Electric’s international segments. Volume declines affected the European, Asia-Pacific, and South American divisions, with the heaviest volume decline occurring in the Asia-Pacific division. The European segment experienced a 5% loss in year-to-date revenue versus this time last year, and the Asia-Pacific segment experienced a 7% loss. The 32% year-to-date gain in the North American segment more than made up for the losses in the other segments, although this may not last (see chart below). Consolidated revenue increased 13% year to date.
Unfavorable currency translations throughout all of Lincoln Electric’s segments give the company strong political risks, especially in the European segment. Political turmoil results drives investors' flight to safer currencies. The euro, a currency from a region of the world perceived to have troubles, weakens, making the dollar more expensive -- thus contributing to Lincoln's 5% revenue drop in the European segment.
Market Price risk for Lincoln Electric hovers in the low range. The P/E ratio as of this writing on Sept. 24 is 14. Lincoln Electric’s free cash flow yield is around 7% (see chart below).
Lincoln Electric certainly leads in revenue and cash generation capability, and it can maintain profitability in difficult times by focusing on welding and metal cutting. It also has considerably less debt than Colfax. However, with the global economy facing a downtrend from the EU crisis, and a softening Chinese economy, I am compelled to wait before making a Motley Fool CAPS call or investing. I'll be putting Lincoln Electric on my watch list.
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