Conference Transcript - GTES 2026-09-15

Brandon Knutson, Analyst — Morgan Stanley

Good afternoon, everyone. My name is Brandon Knutson. I'm a part of the multi-industrial team here at the research team at Morgan Stanley. Today, I have the pleasure of speaking with Ivo Yurik, CEO of Gates. Before we get started, I need to read a quick disclaimer. For important disclosures, please see the Morgan Stanley Research website at morganstanley.com slash research disclosures. If you have any questions, please reach out to your Morgan Stanley representative. All right, so to start off, Ivo, what do you think is the most underappreciated or misunderstood piece of the Gates story?

Ivo Jurek, CEO

I think that's a great question. We love the asset and the company that we have, and I think the company has performed reasonably well, particularly in a differentiated manner of the last three or four years where we have been operating in a pretty tough macro background, with PMIs being negative for nearly four years, historical length of time. During that period of time, we continue to deliver growth, and we continue to nicely improve operating margins, EBITDA margins, and gross margins through the cycle, which I think is giving us a great opportunity and a great setup into what I see as a present time of, you know, finally seeing an inversion of that industrial activity.

Brandon Knutson, Analyst — Morgan Stanley

And what are you seeing today that gives you the most confidence that this is a real cyclical inflection rather than a few quarters of laughing, easier comps?

Ivo Jurek, CEO

Yeah, I think very, very good question here. What we have started seeing, particularly I would say starting with Q4 of last year, has been a pretty nice rebound of volume that was coming through from our industrial OEM. side of our business. In our business, we frankly always have to see that the industrial OEMs have to recover first, and then two to three quarters thereafter, they start pulling in the rest of our business, so the industrial aftermarket business, the diversified industrial exposure that we have, and so on and so forth. So we've seen a very nice rebound in particularly commercial construction equipment in Q4 last year. Q1, we started to see an improvement in order flow for commercial truck, Class 8, 5 to 7. So across that commercial transportation section, we have continued to see strength and robust performance with our personal mobility business. Oil and gas business has started to recover kind of second quarter of this And so, you know, you have a better sense of broader pull-through in the economic macro. And as we entered Q3 of this year, I would have said that probably 70% or so of our portfolio exposure is in end markets or applications that have either inflected or already are demonstrating green shoots in demand. So I feel a much greater level of conviction in what we see. Again, we exceeded about 5% core growth in Q2, and we've guided a 5.5% organic growth in Q3 and 6.5% in Q4. and we believe that we are trafficking exactly at that range.

Brandon Knutson, Analyst — Morgan Stanley

Great. You've highlighted some of the end markets that you've seen an inflection in. What's that 30% that is still yet to inflect, and is that something you see improving over the next 12 months?

Ivo Jurek, CEO

So, look, we're still in kind of bottoming out of X cycle. We believe that that bottom has been formed in the first half of this year. We certainly anticipated that ag is going to improve in the second half of the year, add-on session of the year, but I think that the most recent industrial news is signaling that that's actually playing out that way. And so we anticipate that the ag exposure is going to start benefiting as we exit 26 into 27. 27, we anticipate, will be quite good for ag from a cycle perspective. Out of OEM is still, while this is a very insignificant amount of our revenue that comes from out of OEM, it's about 8%. Out of OEM is still pretty dislocated today globally.

Brandon Knutson, Analyst — Morgan Stanley

Great. You said that typically it takes two to three quarters, right, for OEM activity to funnel into your activity. So that is encouraging on the ag side. Switching over to aftermarket, two-thirds of your business goes through distribution. one encouraging aspect is that distributors remain fairly lean and the growth appears to be more sell-through than restocking activity. Does that make you more confident in the quality and the durability of the current growth and potentially accelerating from these levels?

Ivo Jurek, CEO

Yes. I believe that, you know, as the industrial distribution starts to firm up, it's believed that there's actually a real inflection, which, as I've indicated, we believe that we have seen. they will start restocking more. Presently, as you indicated, it is more pull through, you know, sell out equals sell in from the channel partner to us and us to them. So, you know, it's very balanced, but I certainly anticipate in 2027 that the industrial distribution in particular should be more robust than what it has been so far in 2027. Now, that being said, we did start seeing improvements in order rates in Q3, and we certainly anticipate that, you know, we are starting to see formation of a normal cycle.

Brandon Knutson, Analyst — Morgan Stanley

Okay. And then auto aftermarket has been really strong. How much of that business is driven simply by miles driven and vehicle age versus some Gates-specific share gains and initiatives?

Ivo Jurek, CEO

Yeah. Yeah, so look, when I take a look at my auto aftermarket business, which is about 36% of our revenue, it's the most underappreciated asset that we have in our portfolio, frankly. It is an amazing business that's got some terrific drivers of that business. If I take a look at a business of the last 10 years, the business has grown at 4.5% compound annual growth rate. So I will take a business that grows over a 10-year period of time at 4.5% any given That being said, the last three years, our automotive aftermarket business grew high single digits, so about three years going back to 2023. That was predominantly driven by market share gains, so about half of that was kind of a normal market activity, and half of that was through market share gain. The dynamics are very solid, obviously. The age of car fleet ages. We predominantly benefit when the car fleet is seven years or older. So the car comes out of a warranty, and then the end user is more interested in an affordable option for repair. That's where we come to play. Miles driven are still quite high. New car sales are impacted by different factors, cost of money, the cost of the vehicles, and so on and so forth. So the setup for our business to continue to outperform the general market is quite all right.

Brandon Knutson, Analyst — Morgan Stanley

And what's been driving that share gain within aftermarket, and how do you see that continuing?

Ivo Jurek, CEO

Yeah, look, I think that Gates is one of the pristine brands recognized globally. We specialize predominantly in the do-it-for-you part of the market. We continue to be focused on ensuring that our operational cadence is right in line with the expectations of the end market. And our portfolio breadth continues to evolve to support the breadth of brands and breadth of end-unit applications that are in use. and there's very few companies that have the capability to do that in the automotive aftermarkets to the extent that Gates Corporation does.

Brandon Knutson, Analyst — Morgan Stanley

Got it. I want to shift a little bit to data centers. So data center revenue, you've targeted a potential $100 to $200 million of data center revenue by 2028. Given the momentum today, is that opportunity beginning to skew towards the higher end of that framework?

Ivo Jurek, CEO

Yeah, look, we'll expand in greater detail of our data center exposure and how we are presently thinking about that exposure during our CMD that's scheduled November 19 at the NYSE. But less to say that we see significantly more opportunity today than we did maybe a year ago. A pipeline of opportunities continue to grow, and frankly it grows exponentially presently. you know we are pretty bullish about what we see in the marketplace most recently we have announced the initial production ramp up of our industrial pumps that are going to the largest US based server manufacturer in rack cooling so the portfolio continues to do exactly what we anticipated we'll be exiting this year kind of 25-30 million dollars of revenue base Again, that's about 2.5x of what it was last year, and we anticipate that it's going to continue to scale up at a significant clip into 27, 28.

Brandon Knutson, Analyst — Morgan Stanley

Okay, and the revenue doubled, more than doubled there in Q2, and you're ramping up programs that you've already talked about. What has been the product suite or application that you've been winning in today? And then you just highlighted you've seen new opportunities for applications. What are those applications for Gates products?

Ivo Jurek, CEO

Yeah, so I would say that, you know, we have been ramping up design wins with the infrastructure builders. So, you know, thank the cooling infrastructure providers that are out there. We have launched and we are presently in process of launching a new suite of product offerings in the fittings and coupling space that are not only just specifically targeted for the data centers, but they're highly differentiated. We are super focused on ensuring that we actually are solving some of the biggest problems that our customers in liquid cooling have, which is liquid flow, offering higher flow rates from the same kind of a diameter of a space utilization. that's opening up some significant opportunity pretty much across the suite of that entire portfolio. And, you know, in general, that space is ramping up quite rapidly, and we believe that we are very well positioned to capitalize on the opportunities that are coming our way.

Brandon Knutson, Analyst — Morgan Stanley

Great. How much visibility do you have once you're specified into a data center platform? Is it similar to an OEM design win business, or is it more of a project-driven industrial business?

Ivo Jurek, CEO

All of these projects are project-driven design wins, but, you know, once you are present on a project, as these projects repeat with those specific customers, in general, you get specified straight into the next project that goes into maybe a different geolocation in an application. So it's more project-driven design winds.

Brandon Knutson, Analyst — Morgan Stanley

And what is the biggest constraint on growth within that market today?

Ivo Jurek, CEO

For Gates, I don't believe that there are constraints other than just continuing to garnish more design winds and then continue to ramp up our production capabilities. As I've indicated, as an example, ramping production of e-water pumps for use in rack cooling. We will be adding another set of capacities for us in Asia as that business continues to scale up. So I would say it's getting a foothold in having adequate capacity and continue to win the business as customers evolve.

Brandon Knutson, Analyst — Morgan Stanley

And then within that $100 to $200 million of data center revenue, it sounds like that forecast was made when the opportunity set was a little smaller. So essentially the update on that number should be positive probably coming in the investor day is what I would imagine.

Ivo Jurek, CEO

Look, I do think that that space continues to evolve very, very rapidly and the set of opportunities continues to grow in scope. I do also believe that we've got to demonstrate meeting the commitments that we have set out there, certainly before we reset any sort of parameters. But presently, I don't see that the opportunity set is getting anything other than bigger. And that just bodes well for the future of this set of applications for our company.

Brandon Knutson, Analyst — Morgan Stanley

Is there any reason why margins may be better selling to data centers than the rest of the business, or is it consistent?

Ivo Jurek, CEO

I think that the way that you should think about it is that the core parts of our portfolio, so if you think the hoses and the fittings and couplings, the margins are basically company-wide average, so they're quite good. And as we ramp up our water pump business, I think we are starting from a lower margin side because we are in early production cycle. And as that business ramps up to the volumes that we anticipate, we believe that those margins will be in line with company-wide margins.

Brandon Knutson, Analyst — Morgan Stanley

Great. And then shifting to the other big secular driver, you all talk about personal mobility. How much of personal mobility growth is tied to the underlying market growth versus new design wins and conversion from chain to belt within the industry?

Ivo Jurek, CEO

Yeah, if you think about that end market, you know, that end market actually doesn't grow dramatically, right? That opportunity set is pretty fixed. It's about 180 million units annually that are being produced in the two-wheeler space. But for us, it's an opportunity of penetration where we are converting a non-traditional competitor. We are converting a belt drive into a space where a chain drive used to reside. So for us, it's driving penetration and market share gain.

Brandon Knutson, Analyst — Morgan Stanley

And what is the penetration today relative to what you see as the long-term addressable market?

Ivo Jurek, CEO

Yeah, you know, we're still starting, you know, this is still very early for us. We are starting from a very small penetration out of that 180 million units. So I would say that we kind of have a 2%, 3% market penetration today. We will exit the year kind of in that $160 to $165 million of revenue on that 2% to 3% penetration. And we certainly believe that it is not unreasonable to anticipate that kind of over the next 10 years, we ought to have a 10% market share of the market. And that would bode really well for a company that represents a rather significant potential growth driver for us.

Brandon Knutson, Analyst — Morgan Stanley

And is there a difference in penetration between certain geographies or certain applications?

Ivo Jurek, CEO

Yeah, look, we have done really, really well in Europe in particular. You know, the Europeans still believe that a bike commute is more efficient than commuting through an automobile. automobile. And that's also a market that was accepting much more premium products from early on. Those bikes and e-bikes were more costly, and it was a good target for us to penetrate. But as we have developed more optionality, greater technical capability and expertise, and we were able to develop products that now can penetrate the mid-market portion of the two-wheeler space, that opportunity set has opened up across all geographies for China, India are growing very nicely for us. United States is starting to grow very nicely for us. So we believe that we are well positioned to continue to capitalize on that opportunity set. And, again, that's an opportunity that's going to be with us for, you know, the next decade plus.

Brandon Knutson, Analyst — Morgan Stanley

And in that 180 million unit market, is there a reason that – is there a part of the market where it wouldn't make sense to transfer from a chain to a belt, or is the TAM really 180 million, potentially?

Ivo Jurek, CEO

Yeah, I would say that about one-third of that market is not going to be attainable for us. but very low-cost devices where we just don't envisage that we would want to break into that low-end market. So I would say the mid-market to premium market, that's a sweet spot where we will operate. And so I think about it as kind of, you know, 120 million type units of opportunity for us.

Brandon Knutson, Analyst — Morgan Stanley

Okay. And the personal mobility grew roughly 25% in Q2. You've highlighted multiple times you expected to grow 25% to 30%. over the next couple of years, what is giving you the confidence that this growth can remain at that level as the base becomes larger?

Ivo Jurek, CEO

Yeah, in this business in particular, we have a large visibility because of the pipeline of opportunities that we are working on, the design wins that we have been able to secure. Our pipeline of opportunities is north of $300 million today. So, you know, we have a much greater visibility of what we certainly anticipate is going to occur over a short period of time. And as you are penetrating and growing the base, you are starting to get a sense that there is an inflection point that's coming. And when that happens, we certainly believe that we should continue to maintain rather healthy growth rates well into the future.

Brandon Knutson, Analyst — Morgan Stanley

And how do you size that $300 million pipeline you talk about? Is there like a certain segment of the market that's refreshing products every two to three years? Or how are you determining what the pipeline is for the next 12 months?

Ivo Jurek, CEO

Yeah, that's a really good question. So first of all, all these products are getting refreshed every couple of years, number one. But number two, more importantly, if you continue to just participate with the same brand on the same application, that's really, you're not going to be gaining market share. You're going to be kind of stagnant, right? So for us, it is penetrating broader subset of manufacturers and broader subset of devices that have different price points. So again, we started with the high end, and now we've migrated towards the mid-market set of applications. So, you know, if you're a specialized, you know, you're making bikes for the premium market and the mid market and the more less premium market, you know, we've penetrated the mid and the premium market. And that's kind of how we drive penetration. And you go across different applications, right? So bikes and e-bikes is one set of applications, but there is, you know, there is scooters, there is, you know, electrically powered scooters, motorcycles, and, you know, they range in size and capacity and breadth of product portfolio, and we are targeting all of those.

Brandon Knutson, Analyst — Morgan Stanley

Great. And as this business scales, how does the margin profile in personal mobility compare with the Gates average?

Ivo Jurek, CEO

Yeah, so personal mobility margins are at or above company fleet average. And as we continue to scale up, you know, we anticipate that that's going to be a strong driver of future EPS growth.

Brandon Knutson, Analyst — Morgan Stanley

Great. Thank you. And now shifting gears a little bit to Asia. We continue to materially perform with you all, showing strong execution, not just in China, but also East Asia and India. How much of this strength is end market recovery versus gate-specific execution and share gains?

Ivo Jurek, CEO

Yeah, look, I think that we have demonstrated that we consistently outperform our higher multiple and multi-industrial pure set in Asia. So we are delivering growth in both of the regions that you have highlighted, so China and East Asia and India, based on opportunity set that's present to us. We believe that we are taking market share. Certainly the numbers would speak for themselves as we're doing such. But more importantly, we have terrific teams there, and they execute really, really well. We don't focus our activities in East Asia and India and China on exports to the U.S. or export to Western economies. We are predominantly focused on capturing opportunities within the regional growth set that's available to us. So, you know, in China, we are like any other Chinese competitor. We compete for business in the local economy, on local applications, as we do in India. And it's bode well for us.

Brandon Knutson, Analyst — Morgan Stanley

And China has been an area generally where other industrial companies remain cautious. What are you all seeing differently or doing differently on the ground to drive this continued strength?

Ivo Jurek, CEO

Again, great team, terrific execution, focused predominantly around local manufacturing activities. I think that it is really easy to get negative in China, particularly when you read around the weakness in consumer in China. Obviously, some of the biggest brands in the United States are consumer-oriented, and they are significantly impacted by lack of growth there. But our products are predominantly focused on industrial applications. The industrial economy in China is reasonably healthy. It's doing quite well. Industrial activity in China has been expanding over the last three, four, five quarters. And we have benefited from that. And, you know, I believe that that is going to remain reasonably buoyant for the foreseeable future. I don't, why I don't anticipate that China is going to be growing 11% every quarter. I'll take it, but I don't think it will. You know, certainly in our view around China's growth kind of mid to high single digit would be terrific for our company.

Brandon Knutson, Analyst — Morgan Stanley

And the other industrial companies have talked about there being in China higher competition where local companies may have a preference for local suppliers. I mean, that's sort of getting a strong, being a stronger trend over time. Is that something you're seeing as well?

Ivo Jurek, CEO

Well, I don't know how to answer that question because we are a local supplier, we are a local company to serving local economy. Yeah, I'm just trying to be fictitious in here. But look, you know, we have – when I joined the company in 2015, I actually joined it from China. I resided it for five years. And one of the strategies that we have deployed pretty immediately after I joined the company is to retool our focus away from doing business with large multinationals and focus on doing business with local brands and local customers. So we have been doing that now for over a decade, and I believe that we are starting to see the reward of that effort. You know, it isn't something that we have to overreact, to over-torque to today. We have been doing that for an extended period of time. And I think that we are being viewed as a local operating unit. And we are more than capable to compete with the Chinese competitors. I think they are great competitors. They are very efficient. They are very innovative. But so are we. And I think that we like sitting where we sit in China.

Brandon Knutson, Analyst — Morgan Stanley

Great. Appreciate all of that. Switching over to margins, you've done substantial work around footprint optimization, restructuring, and cost optimization. How much incremental self-help remains beyond what investors will see back half of this year in early 27?

Ivo Jurek, CEO

Yeah, look, maybe I'm a dinosaur, but I believe that that work never stops. So you always have an opportunity set to continue to improve your operational performance through self-help. And whether or not it's 80-20, you know, that journey is a long journey and offers many opportunities to drive operational improvements. I believe that we're on the cusp of realizing some AI-facilitated benefits in back-end, So particularly in manufacturing, as you are going to deploy some of the higher efficiency tool sets. Look, we are focused on driving innovation. We will be exiting 2026 kind of around, you know, high teens of new product vitality index. Our target is to be in the low to mid-20s. Every time you launch a new product, you have an opportunity to enrich your margins because new products are generally more competitive than some of the subs that you've been manufacturing for many, many years. I believe that we continue to have opportunities in harmonizing our raw materials and doing more internally in terms of mixing and compounding polymers and further differentiating our construction of the products that we manufacture. So I wouldn't just feel that the journey has ended. I don't think that it ever ends. That being said, I also do believe that our focus is pivoting towards driving more robust growth over the next period of time, the next three, five years, and demonstrate that this company is capable of delivering differentiated growth algorithm. And, you know, that's going to, you know, reward our shareholders through better financial metrics as that volume is capable of delivering kind of, you know, 35% plus incremental margins when you kind of normalize after maybe you have four quarters of delivering kind of 45% plus incrementals.

Brandon Knutson, Analyst — Morgan Stanley

Yep. And part of that growth algorithm is going to come from price as well. And you've historically been pretty good at moving quickly on pricing. Does an improving demand environment make those conversations easier, or are customers becoming more resistant after several years of industrial inflation?

Ivo Jurek, CEO

Yeah, look, I mean, you know, we price for value. So in general, our products are highly engineer and mission critical, and the cost of our products is insignificant in comparison to an idle industrial asset. So, in general, for us, the conversations are more around availability than price. And, again, you know, I think that we are being reasonable stewards, and we try to ensure that our pricing activities cover inflation and not necessarily are viewed as, you know, a price grab. So we indicated that, you know, even the latest bout of inflation that we actually feel quite okay with being able to pass the pricing on, and we've guided taking into account that we will exit the year with cost price neutrality dollar for dollar. And I don't think that that's difficult to defend in a reasonably high inflationary environment.

Brandon Knutson, Analyst — Morgan Stanley

And now switching over to capital allocation, with the cycle improving and you guys generating a good amount of cash, how do you rank buybacks, M&A, and organic investment today?

Ivo Jurek, CEO

Yeah, look, we have been very balanced over the last three, four, five years, particularly as we felt that we wanted to improve significantly the quality of our balance sheet. And I think we've done that. We anticipated we'll exit this year kind of, you know, 1.6 times plus or minus levered. So our balance sheet is in a very good shape. While we have been improving our balance sheet, we have also been stepping up our buyback activity. and reducing our in-depthness. So we can do all three of these things at the same time. Now, that being said, now we have a capability to go and deploy capital into inorganic activities. We have a reasonably sizable capacity with the balance sheet where it is at today, and we anticipate that we will be deploying that capacity over the next 12, 18, 24 months. We don't necessarily feel that we need to be rushed to do any transaction, but we certainly like the opportunity set that we have, and we have been working very diligently on cultivating a good amount of targets directly. We anticipate that we'll be doing something interesting.

Brandon Knutson, Analyst — Morgan Stanley

Within that opportunity set, what types of acquisitions are most attractive to you today, and how high would you take leverage for the right deal?

Ivo Jurek, CEO

Yeah, look, we don't anticipate to step out of kind of our foundational core that we operate today. We believe that we don't necessarily have an aspiration that we need to build a third leg today, okay? Let me put it this way. From a leverage perspective, look, you know, through the cycle, or we want to kind of operate in between that, you know, one and a half times to three times leverage. If there was a good deal and good opportunity to add high-quality assets to our portfolio and we need to improve, you know, increase the leverage to kind of three and a half times, would we do that? We would have a robust debate about it. But, you know, we feel comfortable kind of residing in that, you know, three, three and a half times maximum leverage. I don't think that we would lose enough sleep. But we would have to have a very good line of sight of very quickly delivering the balance sheet back to, you know, the two times kind of thing, 18 to 24 months.

Brandon Knutson, Analyst — Morgan Stanley

Great. And then looking beyond 26 into 27, without giving guidance, how should investors think about this setup entering next year? If the industrial recovery continues, distributor restocking potentially takes place and secular initiatives are all contributing?

Ivo Jurek, CEO

Yeah, look, again, we will not be giving guidance in here for 2027, but, you know, if you subscribe to the theory that we've discussed at the beginning of the session, right, and I have indicated, I believe that we are starting to see validation of a turning industrial cycle that, by the way, we haven't had since 2018, right? we are accelerating our growth rate through the second half of the year again 5.5% core midpoint in Q3 6.5% midpoint in Q4 I do not believe that it stops in Q4 as I indicated I believe that 27 is going to be probably a very robust year so you can kind of decide today is it mid single digit growth rate I don't know we will provide that guidance on our January Q4 earnings update. But it is not unreasonable to anticipate that if things remain constructive as they are today, you could see a mid-single-digit volume growth. If you see mid-single-digit volume growth, we have already represented that in the first two quarters of next year, we anticipate to deliver 45% plus incrementals on incremental volume. And in the back half, we anticipate we will deliver 35% plus incrementals on incremental volume. So we believe the setup is quite positive today. Now, obviously, things can change, and they have historically changed in the last four or five years in a reasonably volatile world. But from where I see today, we feel quite good about what we see, and we believe that we are the beginning of a durable recovery.

Brandon Knutson, Analyst — Morgan Stanley

Well, that's our time for today. Ivo, thank you for the time sitting with us today, and thanks for coming to the conference. Thank you very much. Appreciate it.