Thermadyne Holdings: Earnings Exceed Expectations

| About: Victor Technologies (THMD)

Singular Research is reiterating their BUY rating on Thermadyne Holdings Corporation (THMD) after the company exceeded the firm's expectations on revenue growth and margins. Key excerpts follow: 

Company Overview

Thermadyne Holdings Corporation (THMD) is a leading global supplier of cutting and welding products.  It designs and manufactures welding and cutting torches, consumables, power sources and accessories globally. 

The company's products are used by fabricating, manufacturing, construction and foundry operations to cut and weld ferrous and nonferrous steel, aluminum and other metals.  Common applications of the company's products include shipbuilding, manufacture of transportation, mining and agricultural equipment, many types of construction such as offshore oil and gas rigs, fabrication of metal structures, and repair and maintenance of processing and manufacturing equipment and facilities as well as demolition.  Welding and cutting products are critical to the operations of most businesses that fabricate metal.

THMD was incorporated in Delaware in 1987.

On November 19, 2001, the Company and substantially all it's domestic subsidiaries filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code.  THMD's total debt in FY:01 amounted to $808 million and it incurred $76 million in interest expense on total revenues of $438 million.

THMD emerged from Chapter 11 bankruptcy protection on May 23, 2003.  The Plan of Reorganization provided for a substantial reduction of the company's long-term debt. Under the Plan of Reorganization, total debt was reduced to approximately $220 million.  The company embarked on a restructuring program, which involved selling non-core assets and improved margins through a sustained cost reduction program.  The company sold seven business units with $100 million in revenues and $4 million in EBITDA for $45 million and used the proceeds to retire debt.  It focused on three higher margin categories where it had significant market share – arc accessories, gas equipment and plasma cutting. The company developed a three-tier product strategy, which enabled it to target different market segments based on price.  THMD also embarked on a cost cutting program through better manufacturing processes, closing higher cost facilities and global procurement, reducing $60 million in costs from FY:05 to FY:07.

Principal Products and Markets

The company operates in five major product categories within the cutting and welding industry: (1) gas equipment; (2) arc accessories including torches, guns, related consumable parts and accessories; (3) plasma power supplies, torches and related consumable parts; (4) welding equipment; and (5) filler materials. The following shows the percent of total sales for each of the major product categories for each of the previous three years:

The gas equipment products include oxy-fuel torches, air fuel  torches, consumables (tips and nozzles), regulators, flow meters and safety accessories that are used for cutting, heating and welding applications.  The company also sells gas flow and pressure regulation equipment and manifold capabilities used for a variety of gas management applications across an extensive range of industries.  These products typically range in price from $10 to over $1,000 for more complex gas management systems.  The company is one of the largest suppliers of gas equipment products in the world, based on annual sales.

Arc accessories include automatic and semiautomatic welding guns and related consumable parts, ground clamps, electrode holders, cable connectors and assemblies.  THMD also sells a line of carbon arc gouging and exothermic cutting products.  The welding accessory products can be used with both the company's and its competitor's arc welding power supplies.  The arc welding metal inert gas ("MIG") guns typically range in price from $90 to $1,000. The company is one of the largest manufacturers of arc welding accessory products in the United States based on annual unit sales.

Filler metals are consumed in the welding process as the material that is melted to join the materials to be welded together.  There are three basic types of filler metals used: stick electrodes, solid wire and flux cored wire.  Stick electrodes are fixed length metal wires coated with a flux to enhance weld properties. Solid wire is sold on spools or in drums and is used in the semi-automated process with a MIG welding gun, power source and shielding gas. Flux cored wires are similar to solid wires; however, they are tubular wires that allow the use of flux and other alloys to improve deposition rates and weld quality.  There is a gradual shift to more sophisticated higher productivity welding processes using solid and flux cored wires, which would benefit international companies selling technologically superior products.

THMD sells manual and automated plasma power supplies, torches and consumable parts.  Manual plasma systems typically range in price from $900 to $5,000 with manual torch prices ranging from $300 to $800.  Automated cutting systems range in price from $2,500 to $50,000 with torches ranging in price from $1,000 to $2,500.  Both manual and automated plasma systems use front-end torch parts that are consumed during  the cutting process and range in price from $5 to $50. The company is one of the largest suppliers of plasma power supplies, torches and consumable parts in the United States and worldwide, based on annual unit sales.

The welding equipment products include inverter and transformer-based power sources used for all the main welding processes as well as plasma welding power sources.  These products typically range in price from $400 to $6,000. 

The company sells most of its products through a network of national and multinational industrial gas distributors including Airgas, Inc. and Praxair, Inc., as well as a large number  of other independent welding distributors, wholesalers and dealers.  The company sells in the United States from approximately 2,500 locations. THMD distributes its products internationally through its sales force, independent distributors and wholesalers.  In 2007, sales to customers in the U.S. represented 59% of sales. In 2007 and 2006, the company had one customer that comprised 13% and 10%, respectively of global net sales.

The company's large competitors offer a wide portfolio of product lines with an emphasis on filler metals and welding power supplies and lines of niche products. They focus on their position as full-line suppliers and their ability to offer complete product solutions, filler metal volume, sales force relationships and fast delivery. The single-line, brand-specific competitors emphasize product expertise, a specialized focused sales force, quick customer response time and flexibility to special needs as their primary competitive strengths. The low-priced manufacturers primarily use low overhead, low market prices and direct selling to capture a portion of price-sensitive customers' discretionary purchases. International competitors have been less effective in penetrating the U.S. domestic markets due to product specifications, lack of brand recognition and their relative inability to access the welding distribution market channel.

All the major companies, including Thermadyne, follow similar strategies. They focus on growth in the international markets with higher technology products, serving a range of end-user industries and setting up manufacturing facilities in the larger and low cost markets.  They differ in their emphasis on the various product segments. For instance, LECO and ESAB derive about 27% of their revenues from welding equipment whereas THMD derives only about 10%.  LECO and ESAB generate about 65% of their revenues from filler metals whereas THMD generates only 18% of its revenues from filler metals.  The balance of revenues for THMD comes from gas equipment and arc accessories.  

THMD has been improving its margins and is catching up to its competitors.  It is the leader in the $2.5 billion segments of arc accessories, plasma and gas equipment.  The company management has stated that given its product mix with a higher proportion of high margin consumables and torches  it expects to achieve a higher gross margin than its competitors.  THMD still derives about 64% of its revenues from the slower growing North American market in FY:07 as compared to 61% by LECO and 19.4% by ESAB.  The company derived only 19.4% of its revenues from the Asia-Pacific market as compared to the region's 40% share of the global market.  The company recently bought out its partner in the Chinese subsidiary.  With an increasing share of revenues coming from the international markets, we believe that the company has the potential to accelerate its revenue growth and increase its operating margin.  

Summary of Q2:08 Results 

THMD reported strong Q2:08 results with revenues growing 10.7% YOY while gross margin increased 350 bps YOY.  The increase in revenue was driven primarily by strong growth in the Asia-Pacific and East European markets.  Gross margin increased 350bps from Q2:07 and 100 bps from Q1:08 primarily due to price increases and cost reduction programs.  The company's cost reduction program has yielded $10 million year-to-date.  SG&A expenses as a percent of sales remained steady at 20.9% of sales.  Net Income grew 261.8% YOY and EPS grew 266.4% YOY.  We expect FY:08 revenues to grow 10.3% and operating income to grow 34.0%.  We had earlier estimated revenues to grow 9.6% and operating income to grow 16.8%.  We raised our estimated margins to reflect the better than expected margins in Q2:08.  The stock is currently attractively priced at 11.0x our FY:08 EPS estimate of $1.62.  We view the stock as significantly undervalued.  We reiterate our BUY rating .

Risk Factors

  • The company has a debt-equity ratio of one and long-term debt including capital leases on the balance sheet of $206.0 million as compared to TTM sales of $508.6 million.
    • THMD generated cash from operations $15.7 million in the second quarter through a combination of higher margins and better working capital management.  It paid down $15 million of its second-lien facility.  The company had cash and access working capital facility of $61.0 million at the end of the second quarter.
  • The business is cyclical and is affected by industrial economic conditions. 
    • The company has a diversified geographic spread for its revenues with about 52% of operations from the North American market and the balance evenly spread over Asia-Pacific and Europe.  The share of international markets in the company's revenues increased from 40% in FY:07 to 48% in Q2:08 primarily due to high growth in Asia-Pacific and East European markets.  This should enable the company to achieve a stable growth.  
    • The current strong demand is derived partly from infrastructure build-outs in the developing countries. 

We expect the increasing exposure to this infrastructure build-out to moderate the cyclical nature of demand from developed economies.