Investors betting on a cyclical recovery in the global economy would love to be able to cherry-pick industrial companies.
That would be
Terex
(ticker: TEX), a manufacturer of equipment used in construction, mining, maintenance, and other industries. It is a small-cap industrial with a strong balance sheet and the potential for profit growth. And its stock is cheap.
If you know the name Terex, it may be because of its cranes. Businesses including cranes accounted for half of the company’s sales in 2015. But those divisions had operating profits of 4% or less that year. So the following year, a new CEO, John Garrison, set about slimming down Terex’s portfolio.
“We developed a strategy predicated on focus, simplifying, and executing to win,” Garrison tells Barron’s.
What’s left is a company that is leaner and potentially more profitable through economic cycles.
Today’s Terex comprises two main segments. The larger one is aerial work platforms, or AWP—cherry pickers and other lifts that enable workers to reach high-up jobs. Its flagship brand is Genie, with its bright blue branding. The chief competitor is orange-hued JLG Industries, a division of
Oshkosh
(OSK). Together, the two control north of 80% of the North American AWP market.
The pandemic bottled up Genie: Sales dropped 38% in the first half of 2020 from a year ago. Its main customers—large equipment-rental firms like
United Rentals
(URI) and Sunbelt Rentals, a unit of
Ashtead Group
(AHT.UK)—slashed their spending as the virus hit.
United Rentals’ capital expenditures fell to a guided midpoint of $850 million from $2.4 billion last year. Sunbelt’s went to a projected $512 million from $1.6 billion. That’s below replacement levels, notes Christian Frenes, a managing director at Nuveen, TIAA-CREF’s investment-management division.
“The point is, unless the world ends in 2021, this is very likely the trough of North American rental capex,” Frenes says. “So this is the point of maximum pain.”
Nuveen’s funds own about 6% of Terex, having nearly doubled their stake in the past year. Wall Street consensus estimates are for Genie’s sales to return to growth next year, but to take several years to fully recover.
AWP equipment tends to operate on an eight-year replacement cycle, which is now coming due. That and a potential infrastructure spending package from Washington could add fuel to Genie’s sales rebound.
But it’s more than just a cyclical bounce that can buoy sales of Genie’s boom lifts, scissor lifts, and telehandlers. The company also has a clear opportunity for self-improvement.
“They used to have margins that were actually slightly ahead of JLG, and over the last three or four years they’ve lost that edge,” says Jefferies industrials analyst Stephen Volkmann, who rates Terex a Buy. “I don’t think they’re getting much credit for their ability to close that gap.”
His model has Terex’s profit margin returning to its pre-2019 levels in the next few years. His $30 price target on the stock is a 48% premium to its recent $20.33. That’s about 12.5 times his estimate for Terex’s 2022 earnings per share, versus the stock’s current roughly eight times. Competitor Oshkosh trades for about 11 times its fiscal 2022 consensus earnings, while Japan’s
Sumitomo Heavy Industries
(6302.Japan) goes for 10 times. Large-cap machinery makers like
Caterpillar
(CAT) and
Deere
(DE) trade for at least 16 times 2022 estimated earnings.
Garrison has taken a more hands-on approach to the Genie business. He assumed the role of president of Terex’s AWP segment in June, and now spends about two weeks of every month at Genie’s assembly plant in Redmond, Wash. “Our job is to return the business to its historical operating margin level, and I’m confident that we’re going to be able to do that,” the CEO says.
E= Estimate
Source: Bloomberg
He points to efforts to improve the sourcing of components, make manufacturing processes more efficient, and expand Genie’s higher-margin parts and service business.
A longer-term opportunity for Genie could come from Asia, where the use of AWP is in its infancy. China is the world’s largest construction-equipment market, but spending on AWP per dollar of construction spending is about an eighth of what it is in North America. Terex has manufacturing in China for the domestic market, and for exports to Europe.
Terex’s other segment—materials processing—accounts for a third of revenue. It has product lines like crushing and screening equipment, concrete mixers and paving machines, and its remaining crane business.
The most promising opportunity is in mobile crushing and screening equipment, which is in a similar adoption phase globally as Genie is in Asia, Garrison says.
Wall Street expects materials-processing sales to decline 13% this year, to $1.2 billion. Analysts see that growing about 10% a year through 2023, to about $1.6 billion. Operating profit margins have historically run in the low teens for the segment.
When the pandemic hit, Terex cut operating costs and suspended its dividend and share buybacks. Despite the drop in sales, the company expects to generate free cash flow this year. Its balance sheet is in good shape: The company has roughly $400 million in cash, $600 million available on its revolving credit line, and no debt covenants to meet in 2020. No major borrowings come due before 2024. There is little to worry investors.
To play a recovery in global economies, here is a cheap, industrial small-cap that can rise above.
Write to Nicholas Jasinski at [email protected]
