The Timken Company (NYSE:TKR) Q4 2023 Earnings Call Transcript

The Timken Company (NYSE:TKR) Q4 2023 Earnings Call Transcript February 5, 2024

The Timken Company isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, everyone. My name is Bruno and I’ll be your conference operator today. At this time, I would like to welcome everyone to Timken’s Fourth Quarter Earnings Release Conference Call. [Operator Instructions] Mr. Frohnapple, you may begin your conference.

Neil Frohnapple: Thanks, Bruno, and welcome, everyone, to our fourth quarter 2023 earnings conference call. This is Neil Frohnapple, Head of Investor Relations for The Timken Company. We appreciate you joining us today. Before we begin our remarks this morning, I want to point out that we have posted presentation materials on the company’s website that we will reference as part of today’s review of the quarterly results. You can also access this material through the download feature on the earnings call webcast link. With me today are The Timken Company’s President and CEO, Rich Kyle; and Phil Fracassa, our Chief Financial Officer. We will have opening comments this morning from both Rich and Phil before we open up the call for your questions.

During the Q&A, I would ask that you please limit your questions to one question and one follow-up at a time to allow everyone a chance to participate. During today’s call, you may hear forward-looking statements related to our future financial results, plans and business operations. Our actual results may differ materially from those projected or implied due to a variety of factors, which we describe in greater detail in today’s press release and in our reports filed with the SEC, which are available on the timken.com website. We have included reconciliations between non-GAAP financial information and its GAAP equivalent in the press release and presentation materials. Today’s call is copyrighted by The Timken Company, and without expressed written consent, we prohibit any use, recording or transmission of any portion of the call.

With that, I would like to thank you for your interest in The Timken Company. And I will now turn the call over to Rich.

Richard Kyle: Thanks, Neil. Good morning, and thank you for joining our call. Timken delivered a record fourth quarter, which concluded an excellent year. Revenue was up 1% for the quarter with the benefit of acquisitions and currency slightly more than offsetting a 5% organic decline in revenue. As expected, wind energy in China were the largest headwinds in organic revenue, with wind revenue down more than 30% from prior year. Given the significant decline in wind and softening demand across many other industrial markets, we responded well to the situation and delivered a very solid quarter. We expanded margins 70 basis points versus last year, despite the lower volume levels. Price-cost remained positive and sequential cost increases continued to moderate.

We continued to adjust our inventory and production levels down to both normalized supply chain performance as well as softer demand. Earnings per share of $1.37 was a record for the fourth quarter and was up $0.03 over last year. We closed on two acquisitions and one divestiture in the quarter, and we also purchased 450,000 shares. Despite a very active year for capital allocation, we ended the year near the middle of our targeted debt-to-EBITDA range. Before I turn to the full year, let me comment on the two acquisitions completed in the quarter. iMECH expands our industry-leading Engineered Bearing product portfolio with a niche product line of bearings that are focused on operating in extreme conditions in process industries. The business sells almost exclusively in the United States, and we will leverage Timken’s global channels to expand their position beyond the U.S. We acquired Lagersmit near the end of the year, Lagersmit is a leader in sealing systems in the European marine market.

Synergies here are in cross-selling our other bearing and Industrial Motion products in the Lagersmit channels and expanding their global position outside of Europe. Both iMECH and Lagersmit will be accretive to earnings and margins in ’24. For the full year, we delivered record revenue, record earnings per share and our highest operating margins in recent times. Revenue was up 6% for the year, earnings per share were up 9%, and margins were up 70 basis points. This was achieved despite a sudden and deep decline in demand in our largest market, renewable energy, continued inflationary pressures, and a general softening industrial demand through the year as supply chains returned to normal. Timken continued to demonstrate the strength and diversity of its portfolio and our ability to profitably grow and perform through a wide variety of market conditions.

We achieved positive price-cost for the full year and have demonstrated over the last several years that we can perform through declining, flat or inflationary cost environments. We advanced our strategic initiatives, both organically and inorganically. Organically, we continue to drive outgrowth through our focus on innovative product solutions, leadership in customer engineering, channel excellence and outstanding service. Inorganically, we completed six acquisitions during the year. Our inorganic growth continue to both scale us in existing products and markets like the acquisitions of American Roller Bearing and Rosa Sistemi, and expand us into new products and markets like the acquisitions of Des-Case and Lagersmit. Our focus on operational excellence and the subsequent results have returned to pre-COVID levels as we drive safety, quality, productivity and capital efficiency across our operations and supply chains.

We ramped down our production costs through the course of the year. And by the end of ’23, we have lowered the staffing levels in our plants by over 8% from the start of the year, with most of that taking place in the second half. We continue to advance our manufacturing footprint with the investment of over $180 million in the capital projects and the consolidation of three manufacturing facilities into existing plants. Additionally, we purchased over 4% of the outstanding shares during the year, and we increased the annual dividend payout for the tenth consecutive year. The full year once again demonstrated our ability to respond to and perform at a high level through a variety of macroeconomic conditions. And in addition to our strong financial performance, our Timken team was recognized by several third parties for our leadership as a responsible corporate citizen, as an employer of choice and as an innovator.

Turning to 2024. We are planning for revenue to be down over 3% for the full year and over 6% organically at the midpoint. Let me separate our wind energy outlook from the rest of the markets. We had a very strong first half of ’23 in wind and then faced a steep decline for the rest of the year. We expect the first half of ’24 to be down slightly more sequentially from the fourth quarter and then to level off in the second half. We do not have firm visibility demand in the second half, but at this point, we are not seeing any imminent callous for a rebound in demand in China. If it plays out as we’re planning, wind demand will be down year-over-year over 40% in the first half, and then be flattish in the second half on the much lower comps.

So we expect to start ’24 with a sizable renewable energy headwind, but we also expect that headwind to moderate significantly in the second half of the year. Longer term, we believe this is just a cyclical decline and we remain bullish on the long-term outlook for growth in wind energy. Beyond wind, we are currently experiencing a relatively normal softening of demand across a broad range of industrial markets. The outlook for the rest of our markets range from up slightly to down roughly 10%. This includes the expectation that inventory will continue to be reduced across many of our channels. In most of our markets, we only have a few months of firm visibility to demand. While we are not forecasting a strengthening in the second half of the year, it is certainly possible.

And if so, we will be ready to capitalize on it. We’re guiding to margins of over 18% for the full year and a decline in earnings per share in the mid-teens, with lower volumes being the primary driver. We’re planning for modest inflationary pressures through the course of the year and price to be modestly positive, less than 1%. We expect to generate a step-up in free cash flow from ’23 with conversion of over 100%. We have a good pipeline of self-help initiatives intended to mitigate the revenue and margin impact. The six acquisitions and one divestiture we completed in ’23 are expected to add over 2% to the top line and be accretive to both margins and earnings. We also have a good pipeline of new business activities and cross-selling opportunities that will support our long-term outgrowth objectives.

From a cost perspective, we have excellent focus and good momentum on our operational excellence initiatives. We will benefit from the CapEx and plant closures completed last year and the additional planned actions for this year. We have four more plant consolidations currently underway for ’24 and our productivity is the best it has been in several years. We will also benefit from integration synergies. As an example of this, we took further steps in the second half of ’23 to integrate both GGB and American Roller Bearing further into our global bearing organization. These actions will deliver improved business results and do so at lower cost levels. We expect the first quarter to be the toughest revenue comp. The last few years, our first quarter was up sequentially over 10% on the top line.

We are expecting that to be in the mid- to high single digits this year, primarily due to wind and China headwinds. We still expect a sequential step up in margins and earnings per share in the first quarter, but not enough to get us back to ’23 levels. Before I turn it over to Phil, I want to reference Slide 11, which highlights our financial results for revenue, margins and earnings per share over the last five years. We’ve set new revenue and earnings per share records in five of the last six years and new margin highs in two of the last five years. Since 2016, we’ve been demonstrating our ability to perform and profitably grow the business through a wide variety of market conditions. And while we’re starting ’24 in a challenging demand environment, the Timken portfolio is strong, resilient and diverse.

We’re confident that our strategy and our execution have put us in a position to quickly return to setting new levels of performance. The cash flow of the business is solid, and we have proven the excellent allocators of that capital. Our acquisitions have made the portfolio more diverse, less cyclical, higher margin and higher growth. We are well positioned to continue to grow the earnings power of the company and to advance and scale Timken as a diversified industrial leader. Phil?

Philip Fracassa: Okay. Thanks, Rich, and good morning, everyone. For the financial review, I’m going to start on Slide 13 of the presentation material with a summary of our strong fourth quarter results which capped off another record year for Timken. We posted revenue of just under $1.1 billion in the quarter, up about 1% from last year. Our fourth quarter adjusted EBITDA margin came in at 17.9%, up 70 basis points, and we delivered adjusted earnings per share of $1.37, up about 2% from last year. Turning to Slide 14. Let’s take a closer look at our fourth quarter sales performance. Organically, sales were down around 5% from last year as continued positive pricing was more than offset by lower volumes across several industrial sectors.

As expected, we saw the largest declines in wind energy and off-highway during the quarter. Looking at the rest of the revenue block, the impact from acquisitions, net of divestitures, added 5 percentage points of growth to the top line. And foreign currency translation contributed roughly another point to revenue in the quarter. On the right-hand side of the slide, you can see organic growth by region, which excludes both currency and the net impact of acquisitions and divestitures. Let me comment briefly on each region. In the Americas, we were down modestly against last year’s very strong fourth quarter, driven mainly by lower shipments in the off-highway and general industrial sectors, partially offset by growth in rail and industrial services.

In Asia Pacific, we were down double digits, driven almost entirely by China, including the sizable decline in wind energy shipments. On the positive side, we continue to see strong growth in India. And finally, we were close to flat in EMEA as lower renewable energy and industrial demand was almost fully offset by growth in other sectors, including heavy industries. Turning to Slide 15. Adjusted EBITDA in the fourth quarter was $195 million 17.9% of sales, compared to $186 million or 17.2% of sales last year. Our margin improvement was driven by positive price-cost, which more than offset the impact from lower volume and unfavorable currency in the quarter. Adjusted EBITDA was up $9 million or about 5% in the quarter, and that’s on a sales increase of only around 1%, so, strong operating leverage.

Looking at the increase in dollars. You can see that we continue to benefit from favorable price mix, lower material and logistics costs, and recent acquisitions. Manufacturing performance was also slightly favorable in the quarter for the first time in quite a while. These positives more than offset the impact of lower volume, unfavorable currency and higher SG&A other costs. Let me comment a little further on some of the key profitability drivers in the quarter. With respect to price mix, price realization was higher again in both segments compared to last year as we continued to secure additional pricing with our customers. Mix was also a slight positive in the quarter. Moving to material and logistics costs. Both were lower off last year’s levels and largely in line with our expectations as costs continue to moderate globally.

On the manufacturing line, the modest year-over-year benefit was driven by improved operational execution by our team, targeted cost reduction actions and supplier recoveries, which more than offset the impact of lower production volume and ongoing cost inflation. Looking at the SG&A other line. Costs were up versus last year, but lower than we expected, driven by our efforts to reduce discretionary spending to better align with demand levels. And finally, with respect to currency, we saw a sizable year-on-year headwind in the quarter, driven mainly by the unfavorable impact of transaction gains and losses in the respective periods. On Slide 16, you can see that we posted net income of $59 million or $0.83 per diluted share for the fourth quarter on a GAAP basis.

The current period includes $0.54 of net expense from special items, including pension mark-to-market charges, acquisition-related charges, and deal amortization expense, offset partially by some net discrete tax benefits. On an adjusted basis, we earned $1.37 per share, up from $1.34 per share last year. Our adjusted tax rate for the year came in at 25.5% or the low end of our prior guidance, which resulted in a fourth quarter tax rate of 24.4%. Depreciation and interest expense were both higher versus last year, as we expected. And finally, we benefited from a lower share count in the quarter, reflecting buybacks completed during 2023. Now let’s move to our business segment results, starting with Engineered Bearings on Slide 17. For the fourth quarter, Engineered Bearings sales were $724 million, down 2.4% from last year.

Acquisitions net of divestitures and currency were both positive in the quarter. Organically, sales were down 6.4%, driven by lower volumes across several sectors, partially offset by higher pricing. With respect to organic revenue performance by sector, the renewable energy and off-highway sector saw the largest declines in the quarter. In addition, distribution and general industrial were down slightly, while the on-highway and heavy industry sectors were relatively flat. On the positive side, we saw growth in aerospace during the quarter, and rail was up as well driven by higher shipments in the Americas. Engineered Bearings adjusted EBITDA in the fourth quarter was $133 million, down slightly from last year, with margins coming in at 18.3%, up 20 basis points.

The improvement in segment margin reflects the favorable impact of price mix and lower material and logistics costs, which more than offset the impact of lower organic volume, higher operating costs and unfavorable currency. Now let’s turn to Industrial Motion on Slide 18. In the fourth quarter, Industrial Motion segment sales were $367 million, up 8% from last year. Acquisitions net of divestitures contributed just under 10% to the top line and currency translation added over 1%. Organically, sales declined about 3% as lower volumes were partially offset by higher pricing. With respect to organic revenue performance by platform, belts and chain, drive systems and linear motion were lower in the quarter driven by softer general industrial and off-highway demand.

On the positive side, we saw significant growth from our service business driven by strong MRO activity, while automatic lubrication systems and couplings were relatively flat. Industrial Motion adjusted EBITDA for the fourth quarter was $82 million or 22.2% of sales, compared to $65 million or 19.1% of sales last year. We expanded margins 310 basis points in the quarter, driven by positive price-cost, the benefit of ongoing cost improvement initiatives, and higher capitalized variances, which more than offset the impact of lower organic volume. Turning to Slide 19. You can see that we generated operating cash flow of $128 million in the quarter, and after CapEx, free cash flow was $75 million. Looking at the full year, free cash flow was $357 million, up from $285 million last year.

The increase in free cash flow was driven mainly by improved working capital and higher adjusted earnings, which more than offset the impact of higher cash taxes including $55 million of tax paid related to the sell-down of Timken India. Looking at the balance sheet. We ended the year with net debt to adjusted EBITDA at 2.1x. This includes the impact of the recent acquisitions completed during the fourth quarter. Turning to Slide 20, you can see a summary of our capital deployment in 2023. In total, we allocated more than $1.1 billion of capital during the year, with over 70% directed towards CapEx and acquisitions to advance our profitable growth strategy. We also completed six acquisitions that collectively add more than $250 million of pro forma annual revenue at attractive margins.

And we returned $345 million of cash to shareholders during the year, including $56 million in the fourth quarter. In total, we bought back more than 3.1 million shares or over 4% of total outstanding, and raised our quarterly dividend by 6%, achieving 10 straight years of higher annual dividends. And we deployed this record amount of capital while maintaining a strong balance sheet and leverage near the middle of our targeted range. This sets Timken up well for 2024 and keeps us in a great position to continue to execute our strategy through capital allocation. Now let’s turn to our initial outlook for 2024 with a summary on Slide 21. We’re taking a cautious view on the outlook given the current demand environment, limited visibility and overall level of uncertainty, especially in sectors like wind in geographies like China.

Starting on the sales outlook. We’re planning for full year revenue to be down in the range of 2.5% to 4.5% in total versus 2023. Organically, we’re planning for revenue to be down 6.5% at the midpoint, reflecting lower volumes, partially offset by slightly higher pricing versus last year. We expect net acquisitions to contribute around 2.5% to our revenue for the year, which includes the net impact of 2023 acquisitions and divestitures. And we’re planning for currency to be a tailwind of around 50 basis points for the full year based on current spot rates. Now let me comment a little more on the organic sales guidance. The midpoint of our range essentially implies that we see no acceleration or recovery of current demand levels through the year other than some seasonality.

Note that we would expect the first half year-on-year organic sales declines to be more pronounced and then flatten out in the second half as comps get easier, especially in wind energy. On the bottom line, we expect adjusted earnings per share in the range of $5.80 to $6.20. This earnings outlook implies that our 2024 consolidated adjusted EBITDA margin will be in the low to mid-18% range. Our margin outlook reflects the unfavorable impact from lower volumes and continued inflation in labor and other input costs. On the positive side, the net impact from acquisitions should be accretive to margins, and we expect price cost to be largely neutral for the year. We’ve stepped up our efforts around operational excellence and cost reduction initiatives, which should mitigate the headwinds and help us deliver resilient margin performance in 2024.

Moving to free cash flow. We expect to generate approximately $425 million for the full year or over 110% conversion on GAAP net income. This is around $70 million or 25% better than 2023 and reflects favorable working capital performance and lower cash taxes, which are expected to more than offset the impact from lower earnings. We’re planning for CapEx of around 4% of sales, with the spend continuing to optimize our manufacturing footprint and support our growth and margin objectives. Our CapEx spend for 2024 includes some big projects, including the completion of our plant expansions in India for bearings and in Mexico for belts. And finally, we anticipate full year net interest expense to be roughly flat with 2023 and for the adjusted tax rate to be approximately 26%.

So to summarize, Timken delivered strong results in the fourth quarter to cap off a third straight year of record sales and adjusted EPS. Our team is executing well in this environment, and we’re focused on delivering resilient performance and advancing our strategy in 2024. This concludes our formal remarks, and we’ll now open the line for questions. Operator?

See also 25 Most Popular Fast Food Restaurants in America and 13 Worst Rated Fast Food Restaurants in America According to Reddit.

Q&A Session

Operator: Thank you. [Operator Instructions] We do have our first question, comes from Steve Volkmann from Jefferies. Steve, your line is now open.

Steve Volkmann: Great. Good morning, guys. Thank you so much for taking the question. I guess the key sort of feedback I’m getting here is that people are trying to figure out sort of how conservative this guide is, and I recognize you don’t have a ton of visibility into the second half. But you have, on Slide 8, changed your outlook for a number of these end-markets pretty significantly. And I think I understand what’s happening in wind, but things like heavy industries and industrial services and rail, sort of went from positive high single digits to negative high single digits. So I guess I’m just trying to sort of tease out how much visibility you have there and how much this is maybe destocking, and what sort of the underlying drivers of those things might be? Thanks.

Richard Kyle: Thanks for the question, Steve. Certainly, as you look at the chart from 2023 compared to 2024, most of these didn’t move and quite a few of them would have had stronger first halves than second halves. So I think as we – as you look at the end of the year, this is more reflective of where we finished with our fourth quarter 5-ish percent decline in organic revenue and what made that up. And then some extrapolation of that and again, no assumption of any strengthening. So as an example, we have heavy industries here down high single digits. We actually grew heavy industries in the fourth quarter last year. We grew it every quarter last year. But we have been consuming backlog for the last three quarters, and we’re assuming that trend will continue and the second half of the year would be negative.

And then also, as we’ve seen from really since late second quarter of last year, we went from – we inverted from probably overshipping our customers’ demand and stocking inventory to a destocking situation, so we’re in at least quarter three, maybe quarter four or five of that phenomenon. So we are and have been underselling most of these markets to what our customers are selling. And it’s – they’re not huge numbers, but you see our off-highway customer was down 3% or 4% organically, maybe our sales to them were down 5% or 6% organically. So it’s, I’d say, a reflection of the fourth quarter with really no improvement on it, and then seasonality laid on top of it. Phil, anything you would want to add to that?

Philip Fracassa: No, I think you captured it, Rich.

Steve Volkmann: Okay. And then just for the follow-up, Rich, this probably isn’t quite fair. But do you still think the ISM index is a reasonable way to forecast your business? And if so, if it were to turn positive here at some point, what type of lag might you expect relative to your business?

Richard Kyle: I think it’s a reasonable one. I wouldn’t say it’s – the timing is exactly right, and accuracy is not real high. But certainly, directionally, when it’s moving favorably, is a positive for us. But again, the timing of that, predicting the lag, I wouldn’t want to put too much into that.

Steve Volkmann: Thank you, guys.

Richard Kyle: Thanks Steve.

Operator: Our next question comes from Stanley Elliott from Stifel. Stanley, your line is now open.

Stanley Elliott: Hi, good morning, everyone. Thanks for the question. Just to clarify, on the last question in terms of destocking versus end-markets, you mentioned kind of destocking being three, four, five quarters out. So you – so this move in a lot of these end-markets really kind of – you’re saying that’s end-market demand as opposed to destocking? Just to clarify. Thanks.

Richard Kyle: I would say, yes, we’ve seen some of our customers go to – especially if you take price out, negative organic revenue in the third and fourth quarters of last year. Now again, they may be saying that’s their destocking in their distributor inventory, other things. But we’ve seen our customer revenue probably flatten out to go slightly negative and then throw us a little more negative due to the inventory destocking.

Philip Fracassa: Yes. I think, Stanley, if I could just add I think it really is a combination of both from our perspective. I mean we do feel like customers started destocking last year. And obviously, different quarter-by-quarter, some would be flat, some would be down. But net-net, we did see – we did sense that inventories were coming down a little bit, and we would expect that to continue into 2024, at least through the first half, I would say. And as Rich commented on the last question, I really think the outlook really is more a function of what the industrial markets and the demand environment was pretty – it’s pretty soft right now. It was soft in the fourth quarter with our organic sales performance. As we sit here today, we don’t really see a catalyst for an acceleration, certainly in the first half, limited visibility in the second half.

So in – said in the outlook, we thought it was prudent to kind of assume the current demand environment, with pluses and minuses, as Rich said, wind maybe getting a little bit weaker, maybe some markets get a little bit better. But net-net, no recovery of the current demand environment, other than maybe some seasonality and for – and if markets were to accelerate in the second half or at some other point, we’ll certainly be ready to jump on it.

Stanley Elliott: And then I guess, second question on the Industrial Motion margins, you called out MRO activity. I mean is that just strictly a function of mix? Are you all able to offer more services now that you have a much broader portfolio in that part of the market? Any color there would be helpful. Thanks.

Philip Fracassa: Yes. I would say a couple of things. Certainly, the services business is – it’s aftermarket business, so it tends to be, relatively speaking, better from a mix standpoint. I would say that’s one. We would say the margins last year were reflecting some activities that were going on, the consolidation of our chain facilities and some structural improvement work we were doing that we’re starting to kind of see the benefits of as we move forward to this year. And then probably the last point would be Industrial Motion did perform a little bit better from an organic volume standpoint. So obviously, they had a little bit more volume to work with or less of a decline to deal with, if you will. And as we move forward to next year, we’ll probably see relatively more resiliency in Industrial Motion margins versus bearings, is because we do expect bearings to be down a little bit more organically because of the wind situation year-on-year.

And then obviously, we do have a bit of a higher fixed cost base in the bearing business, so a little more sensitive to volume there than in the Industrial Motion business. But it’s been a lot of initiatives we’ve been working on to get those margins up. We do view both segments as north of 20% EBITDA margin businesses, and we were just happy to see the nice step-up in Q4.

Stanley Elliott: Perfect guys. Thanks so much.

Operator: Our next question comes from David Raso from Evercore. David, your line is now open.

David Raso: Thank you for taking the question. When I look at the margins that are being given, if you had told me organic down 6.5%, obviously a drag, but price-cost neutral while it’s happening, and then acquisitions come in relatively favorable on margins, I probably would have thought maybe decremental margins 40% or so. But I see the implied guidance is nearly 60% decrementals. And if you told me 60%, I would have figured there must be some negative price-cost, but you’re saying there isn’t. Can you help us understand why the decremental would be that large if price-cost is neutral? And I assume it’s something with mix, maybe renewables a little more profitable than we think. And then the follow-up, the cadence, the cadence of that, for the year.

Like if I think about how low the margins are in the first half of the year versus second half, I’m thinking more year-over-year when I think about decrementals. So I’m just trying to get a sense, how much is it front half loaded, the weakness year-over-year, on the decrementals? And again, why would the decrementals be that weak with price-cost neutral? Thank you.

Philip Fracassa: Yes, sure, David. This is Phil. I’ll take at least the first part there. So on the decrementals, I mean, first of all, great observation in terms of what the guidance implies. But we’ve got acquisitions and currency contributing positively, and then obviously, the volume declines are negative. So if you sort of assign margins to each of the components, actually, the organic decrementals are closer to 40%. So kind of closer to what you’d expect in, call it, a year or two of a slowdown, if you will. But it was just sort of – the acquisitions will come in, positively speaking, net higher than our than our adjusted EBITDA margins. Currency will be probably a little bit more modest, but the net organic incremental or decremental should be right around – closer to 40%, as you pointed out, and that’s sort of what’s embedded in it.