Lincoln Electric's Greatness Doesn't Come Cheap

| About: Lincoln Electric (LECO)

Arguably the best testament to the quality of Lincoln Electric (NASDAQ: LECO) is the relatively gentle treatment that the Street has given this stock. While many quality industrial names like Cummins (NYSE: CMI), Illinois Tool Works (NYSE: ITW), and Siemens (NYSE: SI) have lagged the market, Lincoln has been rather strong over the past year. As much as this is a great industrial company to own for the long haul, investors may want to hope for another Wall Street freakout regarding the global industrial economy before buying shares.

Four Among Many

Welding and cutting tools are integral to a wide range of industries and so it's probably no great surprise that it's a large and highly fragmented market. Only four companies really stand out in the industry with significant share and Lincoln Electric is the largest with roughly 12% share. After Lincoln comes Colfax (NYSE: CFX) (through its acquisition of Charter International), Illinois Tool Works, and Air Liquide. All together, though, these largest players account for maybe one-third of the market.

This fragmented market lends many of the usual advantages to Lincoln. Lincoln can invest more in R&D, leverage better profits through its manufacturing and sales infrastructure, and boost growth through selective deals.

Multiple Shots On Goal

The market for welding tools and consumables is huge and diverse. Automakers, shipbuilders, and non-residential construction are perhaps the first industries that come to mind, and two of those three haven't been especially strong of late. The energy market, though, is also a major customer, as is aerospace and the general manufacturing space.

This puts Lincoln Electric in the same good neighborhood as MRO suppliers like MSC Industrial (NYSE: MSM), Grainger (NYSE: GWW), and Fastenal (NASDAQ: FAST); all of which have been delivering double-digit revenue growth and positive guidance. At the same time, companies like Caterpillar (NYSE: CAT) and Boeing (NYSE: BA) continue to look to boost production and, parenthetically, have complained about the difficulty in finding skilled welders.

Europe And China, The Usual Suspects

The biggest risks to Lincoln Electric are the same as the risks to its large customers like Caterpillar, Deere (NYSE: DE), and General Electric (NYSE: GE) - recession in Europe and the risks of slowing growth in China. China is already more than 10% of Lincoln Electric's sales base and a key growth opportunity, though investors should remember that Latin America (Brazil) and Eastern Europe (Russia) are also major growth opportunities, especially in the energy sector.

Europe may be what gives new investors a chance in this stock. Large industrials like Siemens have intimated that the first half of 2012 will be challenging, but that the second half will be better. The question, then, is whether industrials are already running on optimism for the second half of the year or whether there's still a chance that Europe-related worries could slow things down in a month or two.

A Hint Of Good Things To Come?

Cleveland news sources reported about a month ago that Lincoln Electric had paid out a substantial profit-sharing bonus. At about $84 million, that would work out to about $31,000 per employee, a 39% increase from last year, and the largest-ever bonus paid out. If those reports are accurate, that suggests a very strong finish to the year for Lincoln Electric and likely a very strong fourth quarter report.

The Bottom Line

Not buying Lincoln Electric shares back in late September/early October of 2011 may go down as another face-palm moment in my investment history, as these shares usually only get cheap on widespread fears of global economic contraction. As it stands now, though, these shares aren't a huge bargain.

Even allowing for over 10% structural free cash flow growth over the next decade (quite an improvement over the past decade) and a lower-than-market average discount rate, the shares about 25% undervalued. That doesn't sound so bad for a company of Lincoln Electric's quality, but remember that the projections assume better performance than the company has delivered in the past.

Industrials are running here in early 2012 and it's tempting to chase Lincoln Electric. Still, with cheaper and arguably safer bets like Cummins and Siemens out there, it's hard to argue for that. Lincoln Electric is a great stock to buy on pullbacks, but perhaps not the best idea at this moment.

Disclosure: I am long MSM.

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