Terex (NYSE:TEX) numbers among the main global manufacturers of materials processing machinery and aerial work platforms, like the ones shown in the picture above. As such, the company’s business is poised to benefit from strong macro-trends which are currently seeing a manufacturing re-shoring or near-shoring process financed by the U.S. government coupled with strong infrastructure spending in many areas around the world. As Terex reported during its last earnings call: “The US government has announced more than 40,000 projects in transportation, climate, and broadband. Spending on manufacturing is up approximately 70% in the last 12-month period”.
Being interested in industrial stocks and, in particular, in the machinery sector, I want to initiate my coverage of this company now that it has just released its FY 2023 Annual Report. We will look at the company’s business, we will then assess its financials and, finally, we will see if the stock is a good buy right now or not.
Terex: Business Overview
Terex runs its business in two different segments: Materials Processing (MP) and Aerial Work Platforms (AWP). The former manufactures equipment such as jaw and cone crushers, washing systems (i.e. wash plants to separate, wash, scrub, dewater, and stockpile minerals and industrial sands), screens, trommels, apron feeders, pick and carry cranes, concrete mixer trucks, concrete pavers and similar. It owns brands such as Powerscreen, Fuchs, and Finlay, among others. The latter manufactures portable material lifts, aerial work platforms, different kinds of articulating and telescopic booms, telehandlers, and similar. For those who are unfamiliar with aerial work platforms in general, it is the equipment used to position quickly and safely workers and materials to elevated work areas. In other words, through this equipment, working at different heights from the ground becomes possible.
Terex works in many different segments. As such, it doesn’t have a few competitors, but, in every segment it operates in, the company faces competition from several peers.
Being a manufacturer, the company needs to invest in R&D, which can be seen as a risk. It also depends on raw material prices which can push input costs of the manufacturing process up or down. Moreover, the company is linked more than others to the economic cycle and its expansions.
This leads us to a look at its financials to see how the environment and the market Terex operates in can impact them.
Terex: Main Financials
To take a look at the company, let’s observe its financial history since the beginning of the century. We will look at some of the main items of each financial statement.
Income Statement History
Considering Terex’s revenue and net income from January 2000 to today, we easily see the cyclical nature of the business, with peaks and troughs. Some of these ups and downs are linked to the divestment or sale of some branches of the company. At the same time, the company has not been shy when the opportunity of an accretive acquisition was presented.
In any case, we see how both its top and bottom lines reflect a certain cyclicality. Moreover, we see how its net income margin is around 10%. Taking a step back, the company’s operating margin is usually above 10% and was recently at 12.4%. At the same time, we can easily spot from the graph below how, each time Terex’s profitability plummets, so does its EPS, which can even come in negative under certain harsh circumstances such as the Financial Crisis or the Manufacturing Crisis of 2016.
Balance Sheet History
Industrials are often capital-heavy businesses that take on a lot of debt to finance in advance their manufacturing activity to assemble a certain product. As a result, it is not rare to find highly indebted companies within this sector. While carrying a lot of debt may not be harmful during the peak of the cycle or during low interest rates; it can be quite a burden when the cycle weakens and/or interest rates rise.
Now, if we look at a few items shown above from Terex’s balance sheet, we see how the company usually has $350 to $500 million in cash, while carrying a debt between $500 million and $1.5 billion. However, since 2008, Terex has begun to pay down its long-term debt significantly, bringing it down to only $623 million. Considering the company currently has $370 million in cash, we have a net debt position of only $253 million.
With an EBITDA of $687 million and an interest expense of only $63 million, the company can meet all of its obligations while sporting strong enough earnings power to let investors sleep well at night.
Terex itself highlights the efforts it has undertaken to deleverage significantly its balance sheet, as shown below.
In terms of the overall capital allocation, Terex states in its annual report that
Our Disciplined Capital Allocation approach remains an important part of our overall strategy, including maintenance of an optimal capital structure (of approximately 2.5 average net debt to EBITDA over the cycle), growth investments, restructuring investments, and efficient return of capital to stockholders via dividends and share repurchases
Terex also puts considerable focus on its working capital and the returns it gains from it, to monitor how efficient it is in using its resources. At the end of FY 2023, Terex reported an ROIC of 28.5%. Thanks to this high rate of return, the company was able to generate increasing FCF (more on this later) and deploy its capital as shown in the pie chart below, spending $151 million in capex and investments, while returning to its shareholders another $104 million between dividends and buybacks.
Cash Flow History
How well does Terex protect its free cash flow? Does it generate substantial amounts of it or not? These questions need answers.
First of all, if we look at the orange line below, which traces Terex’s capex since January 2000 we see something I deem positive: its capex increases very slowly and currently amounts to $127 million. At the same time, apart from 2011, the company has always managed to be FCF positive, with peak years close to $400 million.
So, overall, we have a company able to generate a few hundred million in FCF each year. At the same time, Terex’s FCF seems cyclical, too, and, more importantly, doesn’t seem to be steadily increasing year over year. This means that, when running a discounted cash flow model, we should have low expectations about future FCF growth.
Q4 and FY2023 Results
Let’s look at Terex’s most recent report.
For the quarter, net sales were flat YoY and came in at $1.22 billion. Gross profit increased by almost $30 million to $262.5 million, which is a 21.5% gross margin (19.3% in Q4 2022). Net income was $128 million which translated into EPS of $1.88, vs. $92 million and EPS of $1.34 reported in Q4 2022.
For the full year, sales increased 17% to almost $5.2 billion. Net income was up by $216 million to $636 million (+51.5% YoY) leading to an operating margin of 12.4%. As a result, Terex reported a yearly EPS of $7.65 vs. $4.38 reported at the end of 2022.
This means Terex’s outstanding results were built in the first three quarters of the year.
Overall, these results came in not unexpectedly. Many manufacturing companies have seen huge margin expansion this past year as supply chain bottlenecks eased and unfinished equipment was finally finished so that it could be sold and shipped.
What is more important than the past, however, is the future. In particular, we have to consider how Terex views its new fiscal year that has just begun.
First of all, companies such as Terex usually report their backlog. This is because the equipment Terex manufactures requires several months, or even quarters, to be built, shipped, and installed. Therefore, many orders received during a year will automatically build the following fiscal year’s order book.
Looking at the bar column chart on the left, we see the post-Covid cycle, fostered by huge government spending across the globe. This seems to have peaked at the end of 2022, but 2023 was rather strong too, although declining YoY. At the same time, the bookings trend seems stable, as shown on the right. Knowing a company’s backlog and booking trends can help us determine what the fiscal year will look like. Given what we have seen above, we have two issues: tough comparables behind it, and weakening demand before it. Nonetheless, we should acknowledge that Terex’s backlog is still significantly above historical levels and is the second highest in the company’s recent history (it was just over $1 billion in 2019 and close to $1.7 billion in 2018).
Terex disclosed a FY 2024 outlook which was a bit concerning. Net sales, as we can read below, are expected to be just slightly above the result reported for the year just ended.
Terex’s operating margin should improve by 40 bps while its EPS is expected to come within a range where they could either be lower or higher compared to the prior year. Free cash flow is seen as flat or slightly lower.
No wonder the stock declined more than 10% after this report. There is almost no growth for another year. This strengthens the idea that Terex’s financials keep on moving within certain boundaries.
Terex doesn’t trade at a demanding valuation. A fwd P/E of 8.2 and an fwd P/FCF of 8.6 are not the highest ratios we can find in today’s market. Things get even better if we look at its fwd EPS and FCF yield, which are respectively 12.9% and 9%.
However, buying the stock just because of these metrics could lead investors to the risk of buying a value trap. In fact, if we consider the company’s cash flows to be rather flat for the next five years or increase by just 1%, we have the following outcome: the stock’s intrinsic value should be around $53.
Now, it would take just a 5% FCF growth to consider the stock undervalued by 12-15%. But Terex has yet to prove it can grow its FCF steadily by 5% for a long period of time. Therefore, this model suggests Terex is still a bit overvalued by around 6%. This means, to me, that the stock should be rated as a hold.
Terex is a company that intrigues me. On one side, it owns a portfolio of well-established brands operating in several key niches. It is the go-to company for aerial work platforms, for example. On the other side, it doesn’t seem to show the kind of growth I expect even from mature businesses. Moreover, it still seems heavily dependent on the economic cycle, without a stand-alone service business that could offset part of the cyclicality of the environment in which Terex operates. Last, as we have seen above, I think the company, even after the recent sell-off, still trades a bit above its intrinsic value, leaving a small margin of safety for those who want to step in right now. This is why I will leave Terex on my watchlist for now, rating it a hold until either the price drops more or something impacts its operations creating new conditions for growth.