Lincoln Electric: A Quality Company, Currently Overvalued (NASDAQ:LECO)

About the Company

Lincoln Electric Holdings (NASDAQ:LECO) is a leading manufacturer of welding, cutting and brazing products. The company has three segments, Americas Welding, International Welding and The Harris Products Group. The company has performed very well over the past year with a return of more than 50%, almost doubling that of the S&P 500 ETF Trust (SPY) which has returned 26.8%. I think the company could be a great investment; however, it is quite expensive now and would need to pull back before I would consider investing.

Financial Metrics

As you can see from the table below, Lincoln Electric Holdings has steadily grown revenue over the past 5 years at a rate of nearly 9% annually. As with many companies, there was a slight setback during peak COVID-19. This likely hit LECO a little more than domestic companies, given that this company has a moderate footprint internationally and is consequently subject to exchange rate fluctuations.

Anytime a company has multiple segments, I think it is useful (and interesting) to see how much each area of the company produces in terms of revenue and which is growing the fastest. The Americas Welding segment has been more than 50% of all revenue in the most recent five years, with its peak being in fiscal year 2023, where it was 63%. International Welding has struggled the most, topping out at 30% of all revenue in 2020, but in the last two fiscal years it has dropped to just 25%. Furthermore, The Harris Products Group increased its percentage minimally from 2019 to 2021, where it went from 11 to 14 percent before dropping back to 12 percent in 2023. The two segments, Americas Welding and Harris Products Group, have grown revenues at a compound annual growth rate of 10% each, while the International portion has only increased at about 5% per year since 2019.

The company has increased earnings per share overall at a rate of approximately 19% since 2019. There was a slight hiccup in 2020 where the company saw a decrease of almost 27% from the prior year, primarily related to the uncertainty of the COVID-19 effect. However, since then, LECO has done an extraordinary job increasing earnings per share, including a jump of nearly 75% from 2021 to 2022. This jump, according to their 2022 annual report, was driven by price increases as well as a more stable operating environment.

The last financial metric I want to examine is the company’s operating margin, which has again increased over the last five years. It recently reached a new high at just over 17% in 2023, an increase of more than 60% since its low in 2020 when it was just 10.6%. Increasing this metric over time is important as it shows the company’s ability to control variable costs such as materials and labor, especially in an environment of high inflation.

The Dividend

Lincoln Electric has paid a dividend for more than 25 years, putting it in the coveted dividend champion group. The company currently yields just 1.14% but has done a phenomenal job of growing its dividend with its 3-, 5- and 10-year CAGRs all around 10% according to the company’s dividend page on seeking alpha. Additionally, LECO currently sports an “A” dividend safety grade, with the payout ratio below 30%, and it has not exceeded 50% in the past five years.

When comparing LECO to its closest peers, it does lag a little in yield. For example, Illinois Tool Works (ITW) yields a little more than 2% and Snap-on (SNA) yields even more at about 2.50%. However, what Lincoln lacks in yield it has more than made up for with stock price appreciation, in just the past year it is up more than 50%, while ITW and SNA are both up closer to 10%. Furthermore, over the past five years, LECO is up nearly 190% while ITW is up 80% and SNA is closer to 70%.

Valuation

To determine if a stock is possibly over or undervalued, I use two methods. The first is dividend yield theory, which is based on the premise that if the current yield is higher than its historical yield, the company is undervalued, and vice versa if the yield is lower. The other method is more common, and it is the price to earnings ratio, which is calculated by dividing the current price by the earnings per share for the prior twelve months. While neither is an exact science, they are a quick way to see if a company is worthy of further research.

As you can see from the chart below, LECO currently yields the lowest it has in the past four years. During the tail end of the pandemic, the company briefly had a yield of just over 3%, a mark it had not reached since the housing crisis in 2008 and 2009. Soon after, the yield decreased and has since maintained a level close to its four-year average, only recently has it continued to dip more.

The price to earnings ratio has varied a lot more over the past four years when compared to the company’s yield. LECO had a p/e ratio of just below 14 in early 2020, then it shot up rapidly post pandemic and remained close to 30 for nearly a year. In mid to late 2022, the company’s p/e ratio dipped back to the low teens and began to recover in 2023 and has since remained relatively stable. LECO’s four-year average is just a tick above 22, combined with its trailing twelve-month earnings per share of 9.37 give it an approximate value of $206, implying the company is potentially overvalued by a little more than 20% at its current levels.

Risks

The first risk is the company has international operations. This is always going to expose a company to exchange rate fluctuations as well as global economic conditions. As noted in the financial portion of this article, approximately 25% of sales come from the International Welding segment of the company. This does not even include the fact that South America is included in the Americas Welding segment, leaving it open to more international exposure. The company appears to do a serviceable job managing this issue, but it is something to consider if investing in this company.

Another risk is something the company has more control over, and that is its acquisitions. This is a potential concern because it states on Lincoln’s website that acquisitions are a key initiative in expanding and increasing its revenue. This is somewhat of a red flag because often, acquisitions do not pan out the way the acquiring company had planned for a multitude of reasons. That being said, LECO has done a phenomenal job of making acquisitions that fit into the company’s range of expertise and market. One of their more recent acquisitions, Fori Automation, was for more than $400 million and will help the company achieve its strategic goal of more than $1 billion in automation sales by 2025.

Companies take on a lot of risk with where they do business and the different segments of their business. LECO appears to have found a niche, particularly with their acquisitions, and while most companies struggle to integrate a company they acquired, LECO thrives. The company has made more than 25 acquisitions in its history and has shown an ability to adjust based on customer needs and demands.

Final Thoughts

Lincoln Electric has seen a significant run-up in stock price over the last year, thus leading to it becoming overvalued. This is a well-run company that endured the uncertainty of COVID-19 and has continued to increase revenues and earnings per share very well. In addition, the company has increased its operating margin at an above-average rate, with no signs of slowing. Furthermore, the dividend has also grown and is well-covered by a low payout ratio, which any dividend investor can appreciate. Ultimately, I do think LECO is currently overvalued, but if it were to get closer to $200, that would be a much more ideal time to buy and give an investor a better margin of safety in the long run.