Canada Research Industrial

Transcription

Canada Research
Published by Raymond James Ltd.
Industrial
September 23, 2013
Industry Report - Changes
Ben Cherniavsky | 604.659.8244 | [email protected]
Theoni Pilarinos (Associate Analyst) | 604.659.8234 | [email protected]
Greg Jackson (Associate) | 604.659.8262 | [email protected]
A Comparative Analysis of Finning and Toromont: "There is a Difference"
“I can’t see a difference; can you see a difference?” TV-viewers of a certain generation will remember this catchy advertising
tag-line. It aired during the 1980s on a series of commercials that asked consumers to compare ABC laundry detergent with the
‘leading brand.’ The key message was: “There is a difference! Price.” (http://www.youtube.com/watch?v=phEtATUR5Uk)
We can draw a loose parallel between this nostalgic ad and our current thinking on Finning and Toromont. As large, publiclytraded Caterpillar dealers, these two businesses appear seemingly identical. Yet one—namely Toromont—trades at a significant
premium to the other—Finning. This begs the same question that advertisers behind the soap plug rhetorically asked
consumers: “why pay more?” Their answer was a matter of value. So is ours: We believe that while Toromont’s superior longterm financial returns justify the premium that its stock now commands, there is currently more relative value in Finning’s
shares. This is reflected in our Outperform rating on Toromont and our Strong Buy rating and increased target on Finning.
This report explores in detail the issue of relative value between Finning and Toromont. In particular, we evaluate the historical
performance of both companies to explain why the valuation gap between them has transpired and what we believe Finning needs to
do to close it. Where segmented reporting permits, we have focused our analysis primarily on a comparison of Toromont’s Equipment
Group, Toromont CAT, and Finning’s Canadian operations, Finning (Canada). Not only does this help limit the report’s scope to a
manageable level, but it also provides us with the best apples-to-apples comparison of two CAT dealers operating in similar markets.
Moreover, we believe that Finning (Canada) warrants particular attention since it accounts for the bulk of company’s revenue (50%)
and most of its recent challenges. Some of the key observations that we make in this report are as follows:

Over the past one, five, and ten year periods, Toromont’s stock price has generated respective compound returns of 11%,
6%, and 11%, compared to -8%, -2% and 3% for Finning and 4%, 0% and 5% for the TSX Index. This outperformance is
consistent with the equally superior financial returns that the company has registered in terms of free cash flow,
profitability, and return on assets. Toromont has also generally maintained much lower debt levels than Finning over time.

There are numerous variables that account for the above discrepancies. In this report, we have organized them into three
categories: structural; operational; and cultural. Structural variables are those, such as geography, that are inherent to the
businesses of Finning (Canada) and Toromont CAT and which both companies have very little ability to control.

Operational variables mainly relate to the end markets that each dealer serves and the implications this has for its
respective operations. Specifically, we examine the unique challenges and opportunities of being a dealer to the mining
industry compared to more conventional markets such as general construction. We see this as a major differentiator
between Finning (Canada), which has sold nearly half of its new machines to mining customers over the past five years, and
Toromont, which has sold only 15% of its new machines to this market over the same time frame.

Without taking anything away from Toromont’s excellent track record (or excusing some of Finning’s past mishaps), we
believe that Finning (Canada)’s operations have become much more complex, and thus prone to error, as its mining
business has grown over the years. Improving the related processes, parts flow, and overall asset utilization therefore
represents a big opportunity to raise the dealer’s financial performance, in our view. To support this point further, this
report reviews Finning’s South American operations as a template for a very profitable mining CAT dealership.

The third differentiating variable that we explore in this report is Cultural. Both Finning and Toromont have long, rich
legacies of operating the leading dealership in their respective regions, which has engrained certain practices and
behavioural biases in their operations. This is not necessarily a matter of one culture being superior to another, but simply
an acknowledgement that different cultures can effect different results.
Please read domestic and foreign disclosure/risk information beginning on page 30 and Analyst Certification on page 31.
Raymond James Ltd. | 2100 – 925 West Georgia Street | Vancouver BC Canada V6C 3L2
Canada Research | Page 2 of 37
Company
Machinery
Finning International
Toromont Industries
Industrial
Ticker(s)
Primary
Secondary
FTT-TSX
TIH-TSX
Current
Price
C$22.68
C$23.32
Target Price
Old
New
C$24.00
C$26.50
Div.
Yield
C$30.00 3%
C$26.50 2%
Total
Return
35%
16%
Suitability
Old
New
G
G
G
G
Rating
Old
New
SB1
OP2
SB1
OP2
Note: Target prices are for a 6-12 month period; TR - Total Return, G - Growth, AG - Aggressive Growth, HR - High Risk, VR - Venture Risk; SB1 - Strong Buy, OP2 Outperform, MP3 - Market Perform, UP4 - Underperform, UR - Under Review, R - Restricted.
Raymond James Ltd.
Industrial
Table of Contents
The Same….But Different....................................................................................................4
Financial Analysis of Finning vs. Toromont .........................................................................4
One Part Structural; One Part Operational; One Part Cultural .........................................11
The Structural Differences ............................................................................................11
The Operational Differences .........................................................................................13
The Cultural Differences ...............................................................................................22
Investment Implications and Recommendation ...............................................................25
Industrial
The Same….But Different
For stock market analysts and portfolio managers, peer group analysis is a routine
exercise that compares and contrasts the investment merits of similar companies
operating in the same market. In most cases, these comparables (or “comps”) are also
competitors, each of which is defined by different branding strategies, product lines,
and price points, in addition to a myriad of other distinguishing variables. With Finning
and Toromont, however, investors are presented with the rather unique opportunity to
compare two virtually identical businesses that never effectively compete with each
other. This is a function of the exclusive territory rights that Caterpillar bestows upon its
equipment dealers.
With Finning and Toromont,
investors are presented with the
rather unique opportunity to
compare two virtually identical
businesses
Taking this peer group analysis one step further, we are particularly interested in
comparing Toromont’s Equipment Group (which we will refer to as Toromont CAT) with
the Finning (Canada) operations. Here we have two CAT dealers who sell and service the
very same product lines at virtually identical prices in the same currency against
common competitors (sometimes) to identical customers in separate, yet similarly vast
and rugged regions of the same country. Both companies are beholden to the same
single supplier; they both operate rental units (aka The CAT Rental Store) alongside the
equipment and power systems dealership; they both belong to public growth
companies that have, over time, helped Caterpillar consolidate its dealership network;
and they both boast long, rich histories in their respective markets.
We are particularly interested in
comparing Toromont’s Equipment
Group with the Finning (Canada)
operations
We recognize that investors cannot selectively carve the equity of Finning (Canada) out
of Finning International; nor can they invest in Toromont’s CAT business exclusive of its
CIMCO operations. Both companies, however, provide segmented reporting that, to a
limited extent, allows us to compare the operating units directly, apples-to-apples. In so
doing, a telling observation comes to light: these two seemingly identical businesses
have generated quite different financial results, particularly over the last five years.
While it may be more reasonable to expect performance to vary between a CAT
dealership in the UK or Chile and one in Ontario (due to differences in culture, currency,
competitive dynamics, climate, economics, etc.), investors have, in our experience,
struggled to reconcile the gap between Finning’s Canadian operations and Toromont’s
CAT dealership. Herein lies the key question (and potential opportunity) for investors:
what explains this performance gap and will it close over time?
These two seemingly identical
businesses have generated quite
different financial results
Financial Analysis of Finning vs. Toromont
Before attempting to answer this question in detail, it is important for us first to define
the performance gap itself. There are many ways in which we can run the numbers
between these two companies. But in order to manage the scope of the exercise, we
have narrowed our analysis down to a few metrics that, in our opinion, should matter
the most to investors in the dealership business. As noted, we are primarily interested in
comparing Finning (Canada) (which accounts for ~50% of the company’s total revenues)
with Toromont’s Equipment Group (~90% of total company revenues). However, it
would be remiss of us to overlook Finning’s other regions completely, or to ignore the
relative performance of these two companies at the consolidated level. With this in
mind, we present our comparative analysis as follows:
Share Price Performance:
Ultimately, it is the share price that investors care most about; everything else is simply
a means to this end. On this front, our analysis shows that Toromont shares over the
long, medium, and short run have consistently outperformed Finning shares and the
market at large, while Finning has underperformed the market during all these time
frames (see Exhibit 1). Toromont’s compression business had a material impact on the
Toromont shareholders have
consistently outperformed Finning
shareholders and the market
Industrial
company’s performance, which means that our analysis is not a pure reflection of any
differences between the two equipment dealerships. Likewise, its divestiture in 2011
further complicates the exercise of comparing total share price returns (our calculations
assume that Toromont investors sold their Enerflex shares at the time of their
distribution and reinvested them back in Toromont). Nevertheless, we think share price
performance is the most appropriate and telling place to start our story about Toromont
versus Finning.
Exhibit 1: Finning, Toromont and the TSX: Historical Share Price Performance
12.0%
10.6%
10.5%
10.0%
8.0%
5.6%
6.0%
4.0%
5.3%
3.8%
3.3%
2.0%
-0.1%
0.0%
1 Yr
5 Yr
10 Yr
-2.0%
-2.1%
-4.0%
-6.0%
-8.0%
-7.6%
TIH
S&P TSX
FTT
-10.0%
Source: Capital IQ, Raymond James Ltd.
Valuation:
While there are many ways to value equipment stocks, we have primarily relied on P/E
multiples to drive our target prices for both Finning and Toromont. Notably, over very
long periods of time the valuation ranges for these two stocks have been almost
identical (see Exhibit 2). From time-to-time, however, gaps emerge. For example, in
2007, at the pre-crisis peak, Finning’s stock was commanding a premium of two to three
points over Toromont. More recently, that situation has been reversed with Toromont
now opening a wide valuation gap over Finning (see Exhibit 3).
Over very long periods of time the
valuation ranges for these two
stocks have been almost identical
Exhibit 2: Finning and Toromont: Historical P/E Multiples
Finning's Historical P/E Multiples
EPS (Ca s h)
Stock pri ce
Hi
Low
Average
FWD. P/E
High P/E
Low P/E
Average P/E
EPS growth (%)* EPS growth
*CAGR for EPS
2000
2001
2002
2003
2004
2005
2006
2007
0.49
6.90
4.93
6.11
14.2
10.2
12.6
26.0%
0.76
10.18
6.05
8.51
13.5
8.0
11.3
55.7%
0.82
14.43
9.83
12.20
17.6
12.0
14.9
8.5%
0.86
16.60
11.50
14.30
19.4
13.4
16.7
4.5%
0.86
17.70
14.43
15.76
20.5
16.7
18.3
0.8%
0.92
20.63
16.13
18.17
22.3
17.4
19.7
7.0%
1.31
23.90
18.05
19.80
18.2
13.7
15.1
42.2%
1.55
33.50
23.10
28.58
21.6
14.9
18.4
18.1%
… continued on the next page
2008
2009
2010
2011
2012
2013E
5 yr. Avg.*
10 yr Avg.*
15 yr Avg.*
1.49
0.77
31.15 19.06
12.09 10.15
23.77 15.12
20.9
24.8
8.1
13.2
16.0
19.6
-4.0% -48.3%
1.06
27.40
16.54
20.47
25.8
15.6
19.3
37.7%
1.56
30.25
18.55
25.79
19.5
11.9
16.6
46.7%
1.90
29.80
21.81
24.94
15.7
11.5
13.1
22.1%
2.00
27.25
20.69
23.59
13.6
10.4
11.8
5.2%
21.3
12.1
16.9
4.1%
20.9
13.7
17.3
8.8%
19.6
12.7
16.3
8.2%
Industrial
Toromont's Historical P/E Multiples
2000
EPS (Ca s h)
Stock pri ce
0.56
10.38
6.93
8.57
18.5
12.4
15.3
2.5%
High
Low
Average
Forward P/E
High P/E
Low P/E
Average P/E
EPS growth (%)* EPS growth
*CAGR for EPS
2001
2002
2003
2004
2005
2006
2007
2008
0.71
0.64
12.91 13.00
7.63
9.33
10.00 10.71
18.1
20.3
10.7
14.6
14.0
16.7
27.1% -10.0%
0.91
16.62
9.92
12.61
18.2
10.9
13.8
42.6%
1.09
20.76
16.25
18.59
19.0
14.9
17.1
19.3%
1.23
25.52
20.50
22.76
20.7
16.7
18.5
12.8%
1.56
27.10
21.21
24.39
17.4
13.6
15.6
26.8%
1.68
30.00
22.49
26.67
17.9
13.4
15.9
7.7%
2.06
32.88
20.01
27.50
16.0
9.7
13.3
22.6%
2009
2010
2011
2012
2013E
5 yr. Avg.*
10 yr Avg.*
15 yr Avg.*
1.86
1.19
27.79 31.74
19.77 22.95
23.53 27.84
14.9
26.6
10.6
19.2
12.7
23.3
-9.8% -35.8%
1.37
33.25
15.80
23.99
24.3
11.5
17.5
14.7%
1.56
24.95
19.21
21.40
16.0
12.3
13.7
14.2%
1.56
24.40
21.50
22.87
15.6
13.7
14.6
0.0%
19.5
12.7
16.1
-1.4%
19.1
13.3
16.1
9.3%
19.3
13.2
16.1
8.9%
Exhibit 3: Finning vs. Toromont: Historical P/E Multiples
25.0x
TIH
FTT
23.0x
21.0x
In the past several
months, we have seen
the differential between
TIH and FTT's forward P/E
increase markedly.
19.0x
17.0x
15.0x
13.0x
11.0x
9.0x
7.0x
Jan-13
Apr-13
Jul-12
Oct-12
Jan-12
Apr-12
Jul-11
Oct-11
Jan-11
Apr-11
Jul-10
Oct-10
Jan-10
Apr-10
Jul-09
Oct-09
Jan-09
Apr-09
Jul-08
Oct-08
Jan-08
Apr-08
Jul-07
Oct-07
Jan-07
Apr-07
Jul-06
Oct-06
Jan-06
Apr-06
Jul-05
Oct-05
Jan-05
Apr-05
5.0x
Capital Structure:
Another notable difference between Finning and Toromont has been in their respective
capital structures (see Exhibit 4). Specifically, over the last ten years Toromont’s debt to
total capital ratio has averaged 20%, within a range of 32% and -6% (i.e. positive cash
balances). Comparatively, Finning’s ratio has averaged 45% over the same period of
time, within a range of 52% and 35%. Here again we are not comparing apples-to-apples
(Toromont’s ratio can’t be segmented for the Equipment Group alone nor does Finning
provide segmented balance sheets for its three regions). However, we still think this
comparison says something about the two companies’ respective philosophies towards
debt.
Over the last ten years
Toromont’s debt to total capital
ratio has averaged 20% compared
to 45% for Finning
While Finning has always been a more leveraged company, there has never been a time
when it faced severe stress from the banks (not at least in the 15 years that we have
followed it). In other words, even though Finning’s debt ratios have always been higher
than Toromont’s, it has arguably never assumed too much debt. In fact, this analysis
might suggest that Finning has maintained a more “efficient” capital structure while
Toromont has taken on too little debt over the years and has arguably been too
conservative with its balance sheet. We also believe that Finning’s relatively high
leverage ratios add some context to the company’s tendency to incent and measure its
Industrial
performance on a return-on-equity basis as opposed to ROIC which Toromont uses for
the same purposes.
Exhibit 4: Finning vs. Toromont: Debt to Capital Ratio (2003 – 2012)
60.0%
FTT
TIH
55.0%
51.6%
50.5%
50.0%
48.9%
50.0%
46.0%
44.6%
45.0%
40.0%
40.0%
40.8%
42.0%
40.5%
35.3%
35.0%
32.0%
31.0%
30.0%
29.7%
26.7%
24.8%
25.0%
18.8%
20.0%
16.9%
16.2%
15.0%
12.7%
10.0%
4.4%
5.0%
0.0%
-5.0%
-6.1%
-10.0%
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
10 yr AVG
Source: Finning International, Toromont Industries, Raymond James Ltd.
Free Cash Flow:
Free cash flow is another area where it is impossible to remove the influence that
Toromont’s compression and refrigeration businesses have had on the company’s
financial performance. Still, we have included it in our comparative analysis if for no
other reason than to show that there has been a significant difference in this metric
between the two companies. Although they have both been net generators of free cash
flow over time (which is an inherent attribute of the dealer business in general),
Toromont has produced much steadier and more significant amounts on a per share
basis (see Exhibit 5), allowing it to effect very meaningful dividend increases (see Exhibit
6). Comparatively, Finning has also managed to raise its dividend respectably, albeit by a
little less than Toromont. Both companies have maintained relatively similar payout
ratios (see Exhibit 7), meaning that their dividend growth has been generally in-line with
their earnings growth. However, it appears that the extra financial leverage Finning has
assumed over time has also played a role in sustaining its dividend policy. In other
words, if Toromont was comfortable with Finning’s capital structure it could fund a
significant dividend increase and higher payout ratio. Alternatively, if Finning had
Toromont’s earnings to cash conversion cycle, its dividend could be much higher under
the current capital structure.
Toromont has produced much
steadier and more significant
amounts of free cash flow per
share
Industrial
Exhibit 5: Finning vs. Toromont: Free Cash Flow Per Share (2003 – 2012)
$3.50
FTT
TIH
$3.00
$2.83
$2.70
$2.63
$2.50
$1.94
$2.00
$1.53
$1.50
$1.50
$1.27
$1.00
$0.54
$0.50
$0.55
$0.42
$0.38
$0.30 $0.30
$0.13
$0.12
$0.00
-$0.32
-$0.50
-$0.52
-$0.62
-$1.00
-$1.23
-$1.29
-$1.50
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Exhibit 6: Finning vs. Toromont: Dividends Per Share (1997 – 2012)*
$0.80
FTT
TIH
$0.75
$0.73
$0.70
$0.66
$0.65
$0.62
$0.60
$0.60
$0.56
$0.55
$0.55
$0.50
$0.48
$0.51
$0.45
$0.47
$0.40
$0.40
$0.35
$0.43
$0.44
$0.36
$0.32
$0.30
$0.26
$0.28
$0.25
$0.21
$0.20
$0.16
$0.15
$0.10
$0.13
$0.17
$0.10
$0.20
$0.18
$0.15
$0.10
$0.10
$0.22
$0.18
$0.14
$0.10
$0.10
$0.10
$0.05
$0.00
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
*for 2011/12 we include EFX dividends for Toromont
Industrial
Exhibit 7: Finning vs. Toromont: Dividend Payout Ratio (2003 – 2012)
FTT
TIH
2003
21.0%
23.0%
2004
22.8%
23.9%
2005
23.8%
26.0%
2006
20.9%
25.6%
2007
23.2%
28.6%
2008
28.8%
26.0%
2009
57.1%
32.3%
2010
44.3%
48.1%
2011
32.8%
30.7%
2012
29.0%
30.7%
Revenue Growth:
At this point, we can start to do some apples-to-apples analysis of Finning and
Toromont’s respective CAT dealerships. On a segmented basis, Toromont’s Equipment
Group has generated CAGR in revenue of 5.6% over the past ten years. This compares to
a 7.5% CAGR for Finning at a consolidated level, a 10.0% CAGR for Finning (Canada), an
18.6% CAGR for FINSA, and a -4.9% CAGR for the UK (see Exhibit 8). The lattermost
region is widely recognized as Finning’s most mature and competitive market, an
attribute that is reflected in these numbers. But the UK’s long-term CAGR has also been
skewed down by a series of strategic divestures that were made over the period of time
we have examined (Lex Harvey, Hewden plant hire, and Hewden tool hire). The fact that
Finning’s revenue growth in Western Canada and South America has outpaced
Toromont in Eastern Canada and Manitoba is unsurprising in the context of the robust
economic activity that has taken place in these parts of the world. It is also, we believe,
indicative of another important difference between these two companies—namely that
Finning has been a much more revenue-centric organization over the years, particularly
in mining, whereas Toromont’s guiding principles have been more about profitability
and return on capital.
Finning’s revenue growth in
Western Canada has outpaced
Toromont in Eastern Canada
Exhibit 8: Finning vs. Toromont: 10-year Segmented and Consolidated Revenue CAGR
20.0%
18.6%
15.0%
10.0%
10.0%
7.5%
5.6%
5.0%
3.4%
0.0%
-5.0%
-4.9%
-10.0%
FINSA
FTT (Canada)
FTT (Consolidated)
TIH (CAT)
TIH (Consolidated)
UK Group
Margins:
This is where we start to get into the guts of our analysis. Particularly over the past five
years, there has been a lot of discussion about Finning and Toromont’s respective EBIT
margins. Here is the evidence that suggests Toromont has maintained a more profitcentric mentality. Over the past ten years, its Equipment Group EBIT margins have
Toromont has maintained a profitcentric mentality
Industrial
averaged 9.5% within a range of 6.9% and 11.9%. By contrast, Finning’s Consolidated
EBIT margins have averaged 6.7% within a range of 5.5% and 8.1%. On a segmented
basis, Finning (Canada)’s EBIT margins have averaged 7.3%, within a range of 4.1% and
9.8% (see Exhibit 9). Notably, the higher end of this range prevailed in the 2003-2007
period, when Finning (Canada)’s margins were slightly higher than Toromont’s
Equipment Group. Since then the numbers have moved in the opposite direction with
Finning (Canada)’s margins going down and Toromont’s going up.
Exhibit 9: Finning vs. Toromont: Consolidated and Segmented EBIT Margins (2003 – 2012)
FTT (Consolidated)
2003
7.1%
2004
6.4%
2005
6.1%
2006
7.7%
2007
8.1%
2008
6.5%
2009
5.5%
2010
6.2%
2011
6.4%
2012
7.5%
10 yr AVG
6.7%
TIH (Consolidated)
7.7%
8.3%
7.5%
9.4%
9.5%
8.7%
8.4%
9.9%
10.7%
11.3%
9.1%
FINSA
2003
10.7%
2004
9.5%
2005
9.3%
2006
10.8%
2007
9.6%
2008
9.9%
2009
10.3%
2010
8.9%
2011
9.1%
2012
9.7%
10 yr AVG
9.8%
UK Group
6.3%
5.4%
4.3%
5.3%
5.2%
4.2%
3.2%
2.4%
6.2%
5.6%
4.8%
FTT (Canada)
8.3%
8.4%
7.3%
8.9%
9.8%
7.3%
4.1%
6.1%
5.8%
7.2%
7.3%
TIH (CAT)
7.1%
8.0%
6.9%
9.3%
9.9%
9.9%
9.7%
11.2%
11.2%
11.9%
9.5%
These margins must be considered within the context of revenue mix. It is a wellunderstood fact in the equipment dealership business that the highest margin activity is
aftermarket support (aka parts and service). Therefore, the dealer with the highest mix
of revenue from this activity should also have the highest margins. Remarkably,
however, Toromont’s superior margins to Finning (Canada) have been generated
despite having a consistently lower mix of the highest margin business (see Exhibit 10).
We will explore this observation in greater detail below.
Toromont’s superior margins have
been generated despite having a
consistently lower mix of the
highest margin business
Exhibit 10: Percent of Sales from Product Support vs. EBIT Margins (5 Year Avg.)
11%
TIH - CAT
10%
FINSA
9%
EBIT Margin
8%
7%
WJX
6%
FTT - CAD
5%
CVL
RME
FTT (UK)
4%
TITAN
3%
SQP
2%
1%
10%
15%
20%
25%
30%
35%
40%
45%
50%
Product Support % of Sales
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Return on Assets:
In order to compare the operating efficiencies of these respective dealerships we use a
relatively rudimentary return on assets calculation in lieu of return on capital. This is
simply a practical matter because the latter calculation can only be run on a
consolidated basis, whereas segmented return on asset information is provided by both
companies. Our analysis yields results that look similar to what we observed when we
compared EBIT margins (see Exhibit 11). Specifically, between 2003 and 2007 Finning
(Canada)’s average ROA was actually higher than Toromont’s Equipment Group (while
the former’s UK dealership dragged down the company’s Consolidated returns).
However, for the more recent five-year period between 2008 and 2012, Toromont’s
average ROA has significantly increased, while Finning (Canada)’s has decreased. This
again is indicative of issues that we will discuss in this report.
For the more recent five-year
period, Toromont’s average ROA
has significantly increased, while
Finning (Canada)’s has decreased
Exhibit 11: Finning vs. Toromont: Segmented Return on Identifiable Assets (2003 – 2012)
FINSA
2003
13.6%
2004
14.1%
2005
14.4%
2006
15.3%
2007
16.0%
2008
13.7%
2009
12.9%
2010
12.1%
2011
13.4%
2012
13.0%
10 yr AVG
13.8%
UK Group
5.8%
4.9%
3.4%
3.8%
4.7%
4.2%
2.4%
3.4%
11.0%
10.1%
5.4%
FTT (Canada)
11.4%
12.2%
12.3%
15.6%
16.3%
12.0%
5.3%
8.9%
9.6%
10.6%
11.4%
TIH (CAT)
10.3%
10.8%
9.6%
13.4%
15.4%
15.2%
12.8%
17.0%
18.7%
19.3%
14.3%
One Part Structural; One Part Operational; One Part Cultural
There is, in our view, no single variable or “silver bullet” behind the performance
discrepancies between Finning and Toromont that we have outlined above. Certainly,
we must consider how Finning’s struggles in the UK market from 2003-2007 weighed on
its share price and consolidated results over that period of time; similarly, the ERP
derailment in 2011 clearly impacted Finning (Canada)’s numbers and, in turn,
contributed to the gap that formed between it and Toromont’s CAT dealership over the
more recent five-year time-frame. However, our theory extends far beyond these two
simple (albeit important) factors into much more complex and convoluted matters. In
the interest of simplicity, we have summarized the issues that we have identified into
three basic components: structural, operational, and cultural.
The Structural Differences
The structural issues are those that we feel are inherent to the respective businesses of
Finning (Canada) and Toromont CAT. Geography is the best example of this. Both
dealerships cover vast, rugged territories (see Exhibit 12). However, Finning (Canada)’s is
arguably more challenging to serve for a number of reasons. First of all, it is more
sparsely populated with enormous distances separating its various branches. This adds
complexity to some of its key performance indicators such as parts inventory turns,
rental utilization rates, and overall supply chain management. Obviously, Toromont
faces similar challenges in parts of its territory as well (Nunavut is almost twice the size
of the Northwest Territories and equally as sparse). However, offsetting this are the
disproportional benefits of operating in Ontario. This is particularly true in the “Golden
Horseshoe” area, which is a densely-populated, highly-industrialized region in southwest
Ontario where Toromont generates a significant amount of its revenues (at least half of
the company’s CAT Rental Stores, aka Battlefield, operate within or close to this subregion). Finning (Canada), by contrast, has no comparable “high velocity” parcel of
geography within its territory. In fact, its most densely-populated region—namely, the
BC Lower Mainland—presents additional structural challenges in that it is very close to
Geography is the best example of
a structural difference
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the Port of Vancouver, which has historically made it a very contestable market for
Asian OEMs, who have been known to “dump” their products into the region.
Exhibit 12: Geographic Comparison of Canadian Territory for Toromont and Finning
BC
AB
YK
NWT
Total
ON
MN
NFLD
NV
Total
"Golden
Horsehoe"
Sq KM
944,000
661,000
482,000
1,346,000
3,433,000
FTT
Population
4,400,000
3,600,000
34,000
41,000
8,075,000
Density (pop/km2)
4.66
5.45
0.07
0.03
2.35
Sq KM
1,076,000
568,000
405,000
2,038,000
4,087,000
TIH
Population
13,500,000
1,200,000
514,000
31,000
15,245,000
Density (pop/km2)
12.55
2.11
1.27
0.02
3.73
33,500
8,800,000
262.69
Source: Raymond James Ltd.
Geography has blessed Toromont with another important advantage over Finning
(Canada): closer proximity to Caterpillar. This provides additional benefits to the supply
chain and further facilitates a higher velocity of inventory and asset utilization, at least
for the operations that are concentrated in Ontario and southern Manitoba.
Importantly, CAT has addressed this discrepancy between the two dealers’ regions.
Specifically, last year in 2011 it announced plans to expand its Parts Distribution Centre
in Spokane, Washington from 125,000 ft2 to 500,000 ft2. Going forward, Finning expects
this new facility, which opened last year, to reduce shipping times of parts by four to
five days, thus greatly enhancing its supply chain management practices throughout its
branch network in Western Canada.
Geography has blessed Toromont
with another important
advantage over Finning (Canada):
closer proximity to Caterpillar
The difference in economic landscapes is another important structural variable to
consider when comparing Finning (Canada)’s performance with Toromont CAT. It is no
secret that Western Canada’s economy, particularly in Alberta, has been significantly
more robust than Eastern Canada’s over the past five to ten years. As reflected in our
earlier comparison of revenue trends, this has presented Finning (Canada) with an
abundance of growth opportunities that generally dwarf what Toromont has had. That
said, managing the rapid growth that Finning (Canada) has experienced also involves
significant challenges, not the least of which include access to reliable and qualified
labour. This is not to say that Toromont has been swimming in a sea of well-trained,
low-cost technicians. It too has faced challenges on this front. However, in a relative
context, it is fair to say that in regions such as Ontario, where the manufacturing base
has suffered, equipment dealers do not face the same labour and cost inflation
headwinds that exist in the West. Nowhere is this more obvious than in the oil sands,
which provides us with a good segue into our discussion on mining.
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The Operational Differences
In this section we consider the ways in which the operations of Finning (Canada) and
Toromont CAT differ from each other. As we will illustrate, these differences are mainly
related to a key structural variable—namely, end market composition. Finning
(Canada)’s territory is very mining intensive. As a result, its operational dynamics vary
significantly from a more conventional construction equipment dealer such as
Toromont. To put this important distinction in perspective, over the past five years
~45% of Finning (Canada)’s new machine sales have gone to the mining industry vs.
~15% for Toromont. Similarly, whereas Toromont derived over half of last year’s
product support revenues from the construction sector, the mining industry dominated
Finning (Canada)’s aftermarket business generating 65% of the related revenues.
Processes, Parts Flow, and the Intricate Complexities of a Mining Dealership
The unique intricacies of being a CAT dealer to the mining industry may not be strikingly
obvious, but they are very important for us to consider when comparing Finning and
Toromont. Put simply, it is a much more complicated business (not to mention a lot
more cyclical!). With this complexity comes high barriers to entry and, in turn, fewer
competitors. This, in theory, should lead to higher margins for the dealer (countless
shady-tree mechanics can fix CAT 320 excavators, but how many of them would dare
touch a 797 haul truck?). Yet, as we have shown, Finning (Canada)’s margins have been
lower than Toromont’s over the past five years despite having much heavier exposure to
mining.
The unique intricacies of being a
CAT dealer to the mining industry
are very important to consider
when comparing Finning and
Toromont
This perversity is a function of many different factors. First of all, the sheer size and
price of mining equipment plays a role. That is to say, bigger machines that are sold in
larger packages have a lower markup for the dealer; hence a large mining truck order
may generate outsized revenue numbers but with slightly smaller margins. Also, highly
customized mining machinery is not as inventory intensive as general construction
equipment, which means the dealer doesn’t need to be compensated for the same
working capital costs. That said, the dealer does play an important role in “prepping”
the equipment for delivery to the customer. Even for smaller machines “some assembly
is required,” but for large mining equipment, which is highly customized, the process is
exponentially more complex. Whereas it typically takes anywhere from 400 to 1,200
man hours for a dealer to prep large mining machinery, only 50 to 100 hours are
typically required for the general product line. The dealer gets paid for this service.
However, the margin is at risk of getting squeezed if the assembly process is inefficient,
which is more likely to happen with mining products where complexity is very high and
margin for error very low.
Whereas it typically takes
anywhere from 400 to 1,200 man
hours for a dealer to prep large
mining machinery, only 50 to 100
hours are typically required for
the general product line
This is a challenge that dealers also face in the rebuild business. Increasingly, equipment
owners, particularly in mining, are embracing rebuilds as a cost-effective alternative to
ordering new product for replacement demand. Although the customer’s decision will
always vary according to his needs, dealers have consistently told us that they would
much rather rebuild an old truck than sell a new one simply because the related margins
are much higher. But that assumes solid execution, which is not always the case. Indeed,
rebuilding a mining truck is more complex than prepping it for delivery. Not only do you
have to put the truck together, but you also have to take it apart—and you have to do
this under the confines of a fixed price contract (in simple terms, the proposition to the
customer is “it will cost you X dollars to rebuild this truck and Y dollars to buy a new
one”).
Rebuilding a mining truck is more
complex than prepping it for
delivery
Under these circumstances, databases, processes, and parts flow become paramount to
the dealer. In the bidding stage of the contract, the estimator must be armed with
extremely good information about the life of the truck and all of its parts in order to
understand the task at hand and price it appropriately: What is the life expectancy of
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each part? Which parts have been replaced? When? And by whom? How many hours
and what condition has the machine been utilized? etc. Moreover, all of this information
gets highly scrutinized by a very sophisticated customer, who can be more informed
with data and have an unparalleled understanding of mining equipment, as well as the
dealer’s track record. Then, in the next phase—namely, execution—everything has to
flow seamlessly for the dealer’s parts managers and technicians. If, for example, the
wrong parts arrive at the right time or the right parts arrive at the wrong time (or even if
too many of the right parts arrive at the right time), freight and emergency shipping
costs, as well as excess inventory expenses, escalate and the margin on the work order
begins to contract.
More significant is the risk that the whole project simply grinds to a halt while the
technicians wait for such bottlenecks to be rectified. Rebuilding used mining equipment
into “like new” condition is more of an integrated than modular process. As a result, if
the right part does not arrive at precisely the right time labour can be stuck literally
sweeping the shop floor. When this happens, the related costs get allocated to SG&A,
rather than cost of goods sold (i.e. it becomes overhead or an unallocated labour
expense), which further compromises the overall profitability of the job.
That Finning (Canada) has been experiencing many of these supply chain bottlenecks is
vividly evident in their SG&A to sales ratio, which is significantly higher than Toromont
(see Exhibit 13). We see this is a critical distinction between these two dealers and a big
factor behind Toromont’s higher historical returns. Importantly, this is not strictly a
matter of circumstances. That is to say, we do not believe that Finning (Canada)’s
business is inherently confined to lower margins than Toromont simply because it is
heavier into mining. On the contrary, as we pointed out earlier, it is far more intuitive to
expect service margins in the mining business to be higher because competition is more
limited (Wajax demonstrated this with its Letourneau product line). However, our key
point is that in order for Finning eventually to realize higher margins, its execution will
have to improve.
We do not believe that Finning
(Canada)’s business is inherently
confined to lower margins than
Toromont simply because it is
heavier into mining
Exhibit 13: Finning vs. Toromont Consolidated SG&A as a % of Sales (2003 – 2012)
25.0%
FTT
23.2%
23.0%
TIH
23.1%
22.5%
22.5%
22.4%
21.7%
21.7%
21.2%
20.7%
21.0%
20.2%
19.0%
17.0%
16.2%
15.0%
15.0%
14.5%
13.1%
13.0%
12.9%
14.6%
14.2%
13.2%
12.6%
12.4%
11.0%
9.0%
7.0%
5.0%
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
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It was in pursuit of this ‘operational excellence’ that Finning (Canada) embraced its now
infamous ERP platform two years ago. Without rehashing all the gory details, we feel it
is worth mentioning this three letter acronym at this point in the report because it has
been designed—at least in theory—to address many of the potential supply chain
bottlenecks noted above. Specifically, in migrating from an old green-screen platform to
this slick, new system Finning expects to see exponential improvements in parts flow,
parts failure predictability, inventory management, and a host of other processes—
including service order planning, bay utilization, warranty recoveries, quoting, etc.—that
should effect much better execution in its mining rebuilds and overall service activities.
Bringing the ERP system into this part of the discussion also sheds some light on how
lost Finning (Canada)’s business became during the most difficult days of its ERP
implementation (3Q11-2Q12). With no system to guide parts ordering and flow, most of
the company’s processes were totally in the dark and, as a result, many work orders
literally stood still. While Finning (Canada) has since made great progress in restoring its
operations from these depths of despair, its main focus to-date has been to prioritize its
customers’ parts flow needs over its own internal parts requirements (i.e. for rebuilds
and in-house customer service work). This means that it still has some systems work to
do with respect to parts flow in the ERP recovery. Once this issue is resolved, the
margins on the related revenues are expected to improve. Meanwhile, Toromont
continues to utilize a modified and upgraded version of Finning’s legacy system (DBS)
which, based on its reported performance, appears to be serving its (arguably simpler)
needs very well.
It was in pursuit of ‘operational
excellence’ that Finning (Canada)
embraced its now infamous ERP
platform two years ago
Meanwhile, Toromont continues
to utilize a modified and upgraded
version of Finning’s legacy system
(DBS)
Finning’s “Spine” of Support for the Mining Industry
The very complex flow of parts and information that is inherent in servicing the mining
industry has had other profound influences on Finning (Canada) beyond its ERP system.
For example, its entire network of bricks and mortar infrastructure was specifically
designed with the intent to optimize efficiencies related to maintenance work,
equipment prep, and rebuilds for mining machinery. Given the particularly challenging
complexities of the latter two activities, Finning has centralized them in a large,
specialized environment that is conducive to high volumes and repetitive processes. This
is the rationale for its Centre of Excellence (COE) facility in Red Deer (see Exhibit 14).
Supporting COE is also OEM in Edmonton, which performs the very technical component
rebuild work that is an integral part of the process. These two facilities, combined with
the new branch in Fort McKay (see our Jun-27-13 Brief “The Oil Sands Tour: Confessions
of a Caterpillar Dealer”, price $21.52, for details), form a “spine” of support for Finning’s
mining operations (see Exhibit 15) and the related customer base that is unrivalled by
any of the other dealers in the market.
Finning has centralized its
equipment prep and rebuild work
in a large, specialized
environment that is conducive to
high volumes and repetitive
processes
Industrial
Exhibit 14: Finning’s Centre of Excellence (COE)
Source: Finning International
Exhibit 15: Map of Finning’s Key Facilities in Western Canada
There is little doubt that Finning (Canada)’s strategy, as outlined above, has played a
critical role in its ability to secure dominant (>80%) market share for CAT machines in
Western Canada’s mining sector, particularly the oil sands. To be sure, the quality and
scale of dealer aftermarket support carries more weight than any other variable in the
buying decision among customers in this market (it’s all about uptime!). This, in turn,
has been a big driver of the company’s robust new equipment revenue growth over the
years. But it has also consumed an enormous amount of capital1 and fundamentally
changed the economics of the business. Specifically, Finning (Canada)’s heavy
investments in bricks and mortar have modified its model from being a pure capital-light
distributor to more of a fixed-plant manufacturer. This is meant as an observation not a
1
Finning (Canada)’s heavy
investments in bricks and mortar
have modified its model from
being a pure capital-light
distributor to more of a fixedplant manufacturer
We estimate that COE, OEM, and Ft. McKay have consumed >$400 mln of capex over the past eight years.
Industrial
criticism. We see nothing wrong with this strategic shift provided that it yields positive
and sustainable benefits for shareholders. The problem, however, is that such
benefits—beyond market share and revenue growth—are difficult to discern in light of
the financial metrics that we reviewed earlier.
We are thus presented with a bit of a paradox about Finning (Canada)’s business. The
company’s capital expenditures on facilities and infrastructure have effected significant
sales of new machines to mining customers in Western Canada and nurtured years of
growth for the aftermarket business. However, nearly ten years since this strategy was
first hatched with the opening of OEM, there is no overwhelming evidence to suggest
that it has generated higher margins or enhanced returns on capital. On the contrary,
these metrics, as we demonstrated earlier, have gone down over this period of time.
The corollary is to question whether or not all the cash that Finning invested in these
buildings would have been better suited back in the hands of the shareholders?
Would all the cash that Finning
invested in these buildings have
been better suited back in the
hands of the shareholders?
Before jumping to any conclusions, however, we must consider the consequences of
such an alternative course of action. Indeed, it is hard to imagine Finning simply turning
its back on all of these mining opportunities given CAT’s commitment to this market and
the obligation that the dealer has to represent the manufacturer. With that in mind,
there is a certain “go big or go home” argument to be made, particularly in the oil sands
where a large concentration of “yellow iron” presents Finning with an opportunity to
centralize processes and leverage economies of scale to overcome the challenges of
prepping and rebuilding complex mining machinery. As a big, public dealer with access
to significant capital and a broad product line, this is a competitive advantage that very
few competitors (arguably none) can exploit.
Therefore, to suggest that Finning would be a smaller but higher return business if it had
not invested in large-scale infrastructure runs the risk of throwing the baby out with the
bathwater. This is because it assumes that the facilities themselves are the problem
rather than how they are utilized. There is no doubt that all of Finning (Canada)’s extra
floor space has added overhead, increased capital requirements, and translated into
higher fixed costs, but with the right processes and the correct manufacturing
disciplines, the company should be able to capitalize on the enormous opportunity that
it has created for itself and realize dominant market share along with higher returns. In
other words, we feel it has been the execution of the strategy rather than the strategy
itself that has been flawed.
We feel it has been the execution
of the strategy rather than the
strategy itself that has been
flawed
How Long-Term Service Contracts Can Throw a Wrench into Margins
The economics of long-term service contracts round-outs our discussion of a mining
dealership’s various intricacies. These complex arrangements are structured in many
different ways that make it difficult to discuss in a general context. However, in the
simplest terms, they are designed by the dealer to guarantee parts life, availability,
and/or complete equipment uptime for the customer. The idea, in theory at least, is to
present a win-win proposition: The operator gets complete confidence in his fleet’s
availability (or at least knows he will be compensated if something fails) while the dealer
locks-up a long-term recurring stream of aftermarket revenues.
These long-term service agreements, which are a relatively common practice in the
mining industry, can significantly influence equipment purchasing decisions. Certainly, in
Finning (Canada)’s case, it is hard to imagine that they have not had a material impact
on the dealer’s mining market share and the 12% CAGR in its customer support services
revenue over the past ten years. Their impact on margins, however, is more difficult to
discern. For one thing, the mark-up on the parts that are sold under these agreements is
usually less than the margin that would be recognized on the sale of a similar part to a
“walk in” customer at a general construction branch. This simply reflects a standard
volume discount that is ordinarily offered to any large customer in any business. It also
provides an element of price certainty that is necessary to get equipment purchasers to
Long-term service agreements can
significantly influence equipment
purchasing decisions…
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commit to a single parts supplier over a long period of time. Nevertheless, these
discounts will skew aftermarket profitability down for the mining dealers that
underwrite the contracts.
Other—more important—factors that will influence the margins on these contracts
include parts failure predictability, labour productivity, and a host of other uncertainties
that must be “priced into” the agreement when it is initially signed. In effect, the dealer
will estimate and assume many of the long-term risks related to these variables in
exchange for a pre-determined recurring fee (“pay us $X per year and we will make sure
your trucks never stop running”). Normally, this should not be problematic since the
dealer—together with the OEM, who also plays an integral role and will share many of
the related risks—has an unparalleled understanding of the product and everything that
is involved in servicing it. Here again robust systems play a critical role in the process by
arming the dealer with useful data to manage some of the unknown variables related to
these contracts.
Of course, no amount of knowledge or information can ensure perfect visibility on the
performance of these machines, which is another way of saying that these contracts can
and will sometimes go wrong. The risk of this happening is particularly high when a new
product is introduced to the market. CAT’s 797 400 ton mining truck provides an
excellent case in point. Although this truck represented game-changing technology for
the mining industry, its ultimate success in the market was not achieved without
considerable growing pains, much of which Finning had to bear. The 797 is now in its
third generation (the F-series) and has been significantly reengineered. However, in the
past, reliability and parts life—particularly with the transmissions—proved to be
problematic. This left Finning vulnerable to some of the long-term contracts associated
with this truck, which we believe has had an impact on margins as the product has
matured. As noted, CAT was involved in “sharing” the risk, but it did not completely
eliminate it. Furthermore, under these circumstances, the onus is often on the dealer to
provide the OEM with the detailed information it requires to assume its responsibility in
the agreement. If it cannot, the dealer may have to take the hit (the same is true of any
standard warranty claim). Yet again, this raises the importance of having strong systems
to track this process.
…but these contracts can and will
sometimes go wrong
But equipment does not need to be revolutionary in order for it to be unpredictable.
Even legacy products can end up being much more costly for the dealer to support than
it initially assumed. This is particularly true in the oil sands where wage inflation and
labour productivity have been ongoing challenges. Inefficient parts flow can also have
an inimical impact on aftermarket contracts. For reasons that we outlined earlier,
disruptions to any work order can be very costly to a dealer, especially if it incurs related
penalties under a guaranteed uptime contract. There are a number of ways for Finning
to mitigate these risks through covenants and/or conditions in the contracts (for
example, provisions are often made for wage inflation). As noted, these are complex,
customized agreements that we have grossly oversimplified for illustrative purposes.
And by no means are we suggesting that the practice of underwriting these contracts
has been unconditionally unprofitable for Finning or the sole source of its margin drag.
Rather, our key point is simply to shed some light on the intricacies of these service
contracts and how they can, under different circumstances, impact a mining dealer’s
systems, operations, and profits.
Inefficient parts flow can have an
inimical impact on aftermarket
contracts
How Does FINSA Do It?
While we have anchored the above discussion on Finning (Canada)’s operations, we
must also mention Finning’s South American CAT dealer, FINSA. Its business is even
more skewed to mining, while its margins and return on assets have been higher. This,
in our mind, demonstrates that mining is not an inherently lower margin market to
serve for a CAT dealer. On the contrary, it can be a very lucrative business.
FINSA demonstrates that mining is
not an inherently lower margin
market to serve for a CAT dealer
Industrial
While much of the discrepancy between Finning (Canada) and FINSA simply relates to
execution, there are—like our comparison of Toromont CAT to Finning (Canada)—some
important circumstances that have also played a role. Geography is not one that works
in FINSA’s favour. In fact, the South American operations are even further from CAT’s
supply chain than Canada. The climate, however, is generally more conducive to
equipment usage and, more importantly, repair. For example, some of Finning’s
equipment prep and service work can be done by its technicians outdoors, thus
mitigating the same need for large scale (and heated!) bricks and mortar facilities.
Similarly, where FINSA has made investments in its infrastructure, the related land and
building costs have generally been lower. We believe these economics have played a
role in the FINSA’s higher returns.
Labour is another important variable. Like Western Canada, there has been an acute
shortage of technicians in Chile. However, FINSA has generally managed this headwind
better than Canada. In particular, through its very successful recruiting and training
strategy—which involves the Think Big program and Finning Instituto Tecnico—the
company has effectively created and monopolized its own labour pool (Finning does a
lot of training in Canada too, but it is subject to union influence and generally done on a
smaller scale through independent technical institutes such as NAIT and SAIT). There,
are of course, other options for a machine technician to pursue after being hired and
trained by FINSA, but employee loyalty is generally stronger in Latin America than it is in
the money-soaked, Gold Rush infused town of Ft. McMurray.
Union dynamics are also different in South America. While FINSA technicians are
represented by organized labour, there is generally less of the coercion and competition
that arises in Canada from inter-union politics. Some of this has to do with the fact that
the mines in Chile tend to outsource more of their labour to FINSA, which means that
the customers don’t have a local competing workforce to placate (it also means they
don’t poach the dealer’s trained labour to the same extent as they do in the oil sands).
This outsourcing increases the appetite for the comprehensive maintenance and repair
contracts (as opposed to a parts-only contract) which are structured differently in South
America. Specifically, FINSA’s MARCs are more like “take or pay” agreements where the
dealer invoices the customer on the number of hours that the truck is running rather
than the number of labour hours that go into supporting the equipment. This changes
the relationship between productivity and profitability.
Union dynamics are also different
in South America
There is one final important difference between Finning (Canada) and FINSA that is
worth noting: namely, the systems. Whereas the former operation embraced the new
Lawson ERP platform, the latter is still using the legacy (DBS) software—and getting
higher returns from it. Of course, Finning (Canada) is still in a transition process to
Lawson, where the related benefits have yet to come to full fruition (while the related
costs have depressed recent returns). If Lawson achieves its targets, we expect it to be
rolled out to Finning’s other regions, including FINSA. For the time being, however, this
transition has been put on hold.
Toromont CAT: Canada’s Other Mining Dealer
Tying this analysis back to our comparison with Toromont, we cannot forget the fact
that it has also been a mining dealer for a very long time (it is still servicing some 785
trucks that it sold to the Porcupine mine in 1994). Toromont’s mining exposure is
considerably smaller than Finning (Canada), but it has been growing rapidly over the
years (see Exhibit 16). This growth, of course, has slowed this year, but there are still
many untapped mining opportunities in the dealer’s region (see Exhibit 17). Hence,
when (if?) the market in Eastern Canada comes back to life, we expect Toromont’s
overall mining exposure to expand even further. In the meantime, its parts and services
revenue stream from the mining product that it has delivered over the past few years is
poised to grow as those machines mature. All of this raises the question of whether or
Toromont’s mining exposure is
considerably smaller than Finning
(Canada), but it has been growing
rapidly over the years
Industrial
not Toromont’s underlying fundamentals will change (i.e. become more complex) as its
mining business gets bigger—and if this will have any corresponding impact on its
margins and returns.
Exhibit 16: Toromont’s Installed Base of Mining Equipment
Source: Toromont Industries
Exhibit 17: Mining Opportunities in Toromont’s Region
Source: Toromont Industries
Having just expounded upon all the various intricacies that a dealer confronts in the
mining market, it would be disingenuous of us to argue that there would not be any
implications for Toromont’s business as its exposure to this specific market continues to
expand. Take, for example, the electric drive Caterpillar 795 trucks that the dealer
delivered to Detour Gold last year. In many ways, this product promises to be an
earthmoving development (pun intended) for the mining industry, just like the 797 was
15 years ago (for details see our Jan-17-11 CAT Report “An Electric Drive to the OneStop-Shop for Mining”, price: US$94.14). It is, however, a brand new product that
Toromont sold with long-term service contracts attached. As a result, it faces the same
unknowns—and potentially the same problems—that impacted Finning with the 797
truck.
This is simply a risk, not a certainty. In fact, there are a number of reasons to believe
that these contracts will be unproblematic—and on the contrary very profitable—for
Industrial
Toromont. First of all, in light of management’s exceptional long-term track record, we
simply have to give them (and their systems/processes) some benefit of the doubt that
they have structured (and will account for) these contracts appropriately. Equally
important, as an electric drive truck, the 795 has a fundamentally different drive train
from the mechanical drive 797. Put simply, it has far fewer moving parts, which means it
is a much less complicated product to operate and support (i.e. with fewer moving parts
come fewer potential problems, as well as less aftermarket revenue).
The 795, however, is an exceptional product. Generally speaking, there is a direct
correlation between the size of equipment and the complexity associated with
assembling and servicing it. As a result, Toromont has arguably faced fewer challenges
with its mining operations compared to Finning. For example, whereas Finning (Canada)
has sold and serviced over 200 of the massive 400 ton 797 trucks in Western Canada,
the largest mining truck that Toromont has ever delivered (prior to the 795 last year) is
the 150 ton 785. Similarly, there are almost 300 850 horsepower D11 dozers in Finning
(Canada)’s market, whereas the biggest dozer Toromont has ever sold is the 400
horsepower D9. Finally, Toromont’s territory has many more underground mining
operations than Finning, which further impacts the product profile and the related
complexities (for example, underground equipment generally does not get sold with
long-term service contracts).
Toromont has arguably faced
fewer challenges with its mining
operations compared to Finning
There is another important distinction between the respective Toromont and Finning
mining operations. Specifically, Toromont’s capital investments in bricks and mortar
have been much more limited than Finning’s. This partly reflects the smaller scale of its
operations (i.e. without Finning’s huge installed base of equipment it is difficult to justify
the same kind of investments). But even if Toromont had 200 797s and 300 D11s rolling
around its territory it is doubtful, in our minds, that they would put the same kind of
capital into the business. For one reason, if they were to build an OEM or COE type
facility, where would it go? Unlike Finning (Canada) where the vast majority of its mining
equipment is concentrated within a radius of a few hundred kilometers around the oil
sands, the mines in Toromont’s region are vastly dispersed, which would present major
logistical challenges.
Toromont’s capital investments in
bricks and mortar have been
much more limited than Finning’s
Moreover, with a closer proximity to CAT’s remanufacturing facilities, Toromont has
historically leaned heavily on the OEM for much of its components needs (Toromont
does have a component rebuild facility near its Concord head office, but it resembles
only a fraction of the scale and capabilities of Finning’s OEM facility). We believe they
will continue with this strategy as their mining platform grows. Indeed, the main reason
that Toromont would be adverse to making a large scale investment in equipment
prepping and rebuild facilities is, in our view, philosophical. That is to say, management
has always subscribed to a more decentralized manufacturing and assembly model that
involves lower capital investments and provides the dealer with more cost flexibility to
manage cycles. The related trade-off, vis-à-vis Finning’s model, is that Toromont cannot
centralize its most complex tasks in one facility where it stands to benefit from scale and
repetition. But this is a moot point anyway since, as we have noted, the geography and
size of the mining market in Toromont’s territory limit the merits of any such operation
in the first place. The company circumvents this challenge by outsourcing many of its
remanufacturing needs to CAT, which boasts a world-class manufacturing practice and
unparalleled economies of scale. Thus far, this approach has served Toromont—and its
shareholders—very well, which gives us very little reason to question it.
Toromont has historically leaned
heavily on CAT for much of its
components needs
Industrial
The Cultural Differences
“Company cultures are like country cultures. Never try to change one.
Try, instead, to work with what you’ve got.”—Peter Drucker
Throughout this report, we have made a recurring reference to the word “execution.”
By this we are simply talking about a company’s ability to get the job done effectively
and profitably. Speaking bluntly, and armed with the evidence we presented earlier, we
believe that Toromont has executed its strategy better than Finning. As we have argued,
there are many other variables to consider, beyond execution, that have made Finning’s
job more difficult. However, in the final analysis, we cannot say that the discrepancy
between Toromont and Finning’s results is all related to circumstances.
We cannot say that the
discrepancy between Toromont
and Finning’s results is all related
to circumstances
Before going any further with this rather sensitive topic, we need to recognize that
there are countless committed and high quality people working at both Toromont and
Finning, many of whom have dedicated most, if not all, of their careers to these
respective companies. This observation has been drawn from our extensive contact with
various members of their executive teams, mid-level management, and shop floor
employees. It is hard for us to imagine that anyone could work for either of these two
CAT dealers and not have considerable pride in their rich corporate legacies and the
world class products they represent. Still, we feel that “there is a difference” between
the culture at Toromont vs. Finning.
Analyzing company culture is not a particular area of expertise for us. Nor is it typically a
topic that consumes a great deal of thought or discussion among analysts and investors
(“where does it go in my model?!”). That said, we believe that culture has been a critical
differentiator between Toromont and Finning over the years. At the start of this report,
we suggested that Finning is a relatively revenue-centric organization, whereas
Toromont tends to emphasize profits and return on capital. We have drawn these
conclusions from our own impressionistic observations over the years as well as from
feedback provided by employees, competitors, and customers of both organizations.
The numbers substantiate these descriptions as well, with Finning having a considerably
higher CAGR in its revenues, compared to higher margins and returns on capital for
Toromont.
Our Observations on Finning’s Culture
In Finning’s case, the company has had a very long history of being uncompromisingly
focused on “the customer.” Obviously, Toromont also keeps a laser focus on its
customers (what successful company doesn’t?), but in Finning’s case we believe it
indiscriminately became the company’s guiding principle—sometimes to a fault. One
example that comes to mind is when oil sands producers turn to Finning to help manage
their peak activity levels. In a customer-centric organization that emphasizes market
share and revenue growth, there would be no reason to turn this business away.
However, saying “no thank you” to some of these opportunities may, in effect, be the
optimal decision if the intended outcome is to drive margins and ROIC sustainably
higher.
Finning has had a very long history
of being uncompromisingly
focused on “the customer”
As Finning has learned over the years, the work that tends to get outsourced to them in
a mining boom is often both low-margin and ephemeral (i.e. it is the first work that the
customer will in-source in a bust). The related problem is that it is very difficult for the
dealer to create a cost structure that is flexible and nimble enough to scale up and down
with the vagaries of the cycle. This is especially true in the oil sands where labour and
other resources can be described as anything but flexible. In recognition of this
challenge, Finning is starting to change its approach to these “peak shaving”
opportunities by being more selective in the work that it assumes. However, this
requires a shift in the culture as much as anything else and will therefore take time to
effect.
Industrial
The oil sands have been problematic for Finning’s revenue-centric mindset in another
respect. Specifically, we believe that the sheer size of this opportunity has had an
intoxicating effect on the company over the years, causing it to dedicate the vast
majority of its energy and resources to chasing growth (at all costs) in this single
segment of the market. In this process, Finning took its eye off of some of its bread-andbutter businesses such as general construction, forestry, and power systems and
accordingly lost market share. To address this problem, and nurture a more balanced
approach to the market, Finning has recently restructured its organization into
independent business units—namely, general construction/forestry, power systems,
and mining (see Exhibit 18)—each with its own financial statements and senior
manager. The idea is to create more direct accountability in the organization and
prevent one or two big wins in the mining business from obscuring a large number of
small losses in other segments of the market.
Some of Finning’s work order practices provide us with a final example of how a
customer-focused culture can sometimes effect unintended negative outcomes.
Specifically, without the best systems and controls in place, the company’s technicians
have had a great deal of discretion to expand work order scope without proper
customer authorization. While this may be done with the best service intentions in mind
(i.e. to expedite the job, provide preventative solutions, and/or fix problems that
customer may have been unaware of), the practice often leads to disputes over the bill,
many of which Finning concedes to the customer. The new ERP system that Finning
installed in 2011 was designed, in part, to address these issues by creating more
structure around managing work orders. But the initiative back-fired on two fronts.
First, it proved to be very difficult for Finning to get its people to accept the new
discipline that was built into the system (i.e. the culture rejected the system on the
grounds that it was “too rigid.”). Second, in order to recover some of the goodwill that it
lost during the botched implementation process in 2011, Finning was forced to make
additional concessions to its customers in the market. Notwithstanding the irony of this
outcome (the ERP was supposed to lead to fewer concessions, not more of them), we
expect these practices to abate as Finning’s new systems become more embedded in
the operations.
Exhibit 18: Finning (Canada)’s Organizational Structure
Andy Fraser
President,
Finning Canada
Joel Harrod
SVP, Power
Systems
Kevin Tatlow
SVP, Construction
& Forestry
Cristian Chavez
VP, Operational
Excellence
Dave Primrose
EVP, Mining,
Construction & Forestry
Gordon Finlay
VP, Coal & Metals
Brent Davis
VP, Oil Sands
Gary Agnew
VP, Customer
Solutions
Mona Hale
VP,
Finance
Randy McDonald
General Manager,
Mining Equipment
Management
Mike Davies
VP, Human
Resources
Brian Shaw
General Manager,
Drills, Shovels &
Mining Systems
Finning has recently restructured
its organization into independent
business units each with its own
financial statements and senior
manager
Industrial
A proper analysis of the role that Finning’s culture plays in the company’s performance
must extend well beyond the handful of examples outlined above (for more details see
our Jan-23-12 Report “Focus on Canada: Resurrecting the “New Finning””, price $27.18).
Suffice it to say here, however, that changing some components of employee behaviour
remains a top priority for management—albeit one that has been complicated by other
variables, including a downturn in the market, the integration of the Bucyrus product,
and the departure of the company’s previous CEO. We must also emphasize that there
are some very strong and positive components of Finning’s culture that need to be
preserved through this process. After all, we are not talking about wholesale change of a
broken organization. Rather, in a word or two, we simply believe that more “discipline”
and “accountability” need to be embedded in the existing culture. Our initial impression
of Finning’s new CEO, Scott Thomson, is that he recognizes the importance of this issue
very well and will address it early in his tenure. If he and the rest of the management
team can effect the right kind of behavioural change, we believe all stakeholders will be
better off. But again, this is an exercise that will take time to effect.
Changing some components of
employee behaviour remains a
top priority for management
Our Observations on Toromont’s Culture
Compared to Finning, our analysis of Toromont’s culture is a little less complex because
the company’s impressive track record is a clear manifestation of its very effective
culture. Still, the question remains how does Toromont do it? Here again, it is a
challenge to distill our thoughts on culture down to a handful of observations and
anecdotes. But at a very high level we believe the key ingredients to Toromont’s longterm success can be summarized as follows:
Toromont’s impressive track
record is a clear manifestation of
its very effective culture
Emphasis on financial literacy, especially return on capital—Toromont has always put
great emphasis on investing in its people. In addition to aligning itself with community
colleges to promote the recruitment of technicians, the company has also established a
very effective management training program that is used to identify and develop future
leaders. During this two year rotation, employees touch every part of the business and
are schooled in the importance of systems, product knowledge, and customer service
standards. The program also puts a heavy emphasis on financial literacy and measuring
the KPIs for the business. A particular focus is placed on return on capital as a defining
feature of incentives and compensation for the organization, right down to the branch
manager level.
Strong controls—A very disciplined organization cannot exist without strong controls,
which, in turn, requires modern and robust systems. As opposed to Finning’s “big bang”
investment in technology, Toromont has taken a more gradualist approach to its
systems, modifying, upgrading, and investing in its legacy DBS software over a long
period of time. As a result, the company now has a very powerful and functional ERP
system that provides management with excellent insight into, and powerful control
over, the day-to-day performance of the business.
Empowerment—Armed with good training and strong systems, Toromont’s employees
are largely cast free to act as independent business owners and operators. This has
engrained into the culture a very successful balance between entrepreneurship and
accountability. Talk to people at the dealership who go back to the days when it
belonged to the Crothers family and they will likely say that the employees were
“liberated” by Toromont’s management practices after they bought the operation in
1993.
Toromont’s employees are largely
cast free to act as independent
business owners and operators
“Skin in the game”—Getting employees to act like owners also requires them to have
“skin in the game.” Accordingly, Toromont creates strong incentives for its people to
own the stock. This philosophy extends right up to senior management and the Board,
where a heavy emphasis is put on buying the company’s stock with “out of pocket after
tax money” rather than incenting with options. Notably, this has effected a significant
difference in stock ownership levels between Finning and Toromont’s top executive and
Industrial
Board members (see Appendix), although more continuity among the ranks of the latter
organization has clearly played a role.
Productive paranoia—In his latest best-selling book Great By Choice management guru
Jim Collins studied companies that rose to greatness within environments of
unpredictable and uncontrollable change and volatility. According to his research, one
of the many defining features of these “10x companies” (i.e. companies that beat their
industry indices by at least ten times over fifteen years) was a culture of “productive
paranoia” which—albeit without replicating Collins’ rigorous empirical study and
analysis—we believe aptly applies to Toromont’s management practices and culture.
Specifically, we summarize Collins’ concept of productive paranoia using the following
excerpt from his book:
The concept of “productive
paranoia” aptly applies to
Toromont’s management
practices and culture
“10Xers remain productively paranoid in good times, recognizing that it is what
they do before the storm that matters most. Since it is impossible to
consistently predict specific disruptive events, they systematically build buffers
and shock absorbers for dealing with unexpected events….Certainly, 10X
leaders took risks, but relative to the comparisons in the same environments,
they bounded, managed, and avoided risks.”
The rather glowing description of Toromont’s culture that we have outlined above is not
meant to suggest that the company and its people are perfect or infallible. Nor would
we want Finning to see this as a call for it to defenestrate its own rich and uniquely
strong culture in an attempt to recreate what Toromont has built over its many years of
existence. Rather, in the spirit of Peter Drucker’s sage advice (quoted earlier), we think
Finning should work with what it’s got to drive more discipline and accountability into
its current organization. Likewise, there are areas where Toromont—despite its great
track record—could still improve and evolve into an even better operation.
There are areas where Toromont
could still improve and evolve into
an even better operation
Toromont’s management is the first to admit this, as a number of recent initiatives
demonstrate. For example, last year the company made certain changes to incentive
and reporting structures that are designed to optimize the performance of its Battlefield
rental operations. Similarly, Toromont has also embraced a more segmented
organizational structure that—akin to what Finning has done—will make it more
difficult for regional managers to bury any of the “sins” that they may commit with the
general construction product line in the larger scale mining operations. Specifically,
independent operating units, each with its own senior manager and financial reports,
have been established for Toromont Construction Industries, Toromont Resource
Industries, Toromont Power Systems, and Battlefield the CAT Rental Store. Changes like
this suggest to us that Toromont’s track record of continuous improvement and
operational excellence isn’t over yet.
Investment Implications and Recommendation
Having dispensed with this detailed comparative analysis of Finning and Toromont, we
are left to answer the single, pressing question: which stock should investors own? The
short answer to this question is that we believe both companies will generate
respectable returns over our forecast horizon (i.e. we suggest investors buy both or
either). However, if asked to recommend only one of the two stocks, we would tell
investors to buy Finning over Toromont at the current prices. This is reflected in our
Strong Buy rating for the former vs. our Outperform rating for the latter.
Which stock should investors
own?
Our bias towards Finning over Toromont at this point in time is based primarily on the
bottoms-up analysis that we have presented in this report. This is not to suggest that
top-down variables related to macro forces have been omitted from our investment
thesis. On the contrary, we continue to pay very close attention to the current state of
the infrastructure and construction markets and, in particular, the related demand for
Our bias towards Finning over
Toromont at this point in time is
based primarily on the bottomsup analysis
Industrial
and supply of heavy equipment (for details see our most recent Machinery sector Brief
“2Q13 Post Mortem”). But in the final analysis, we can’t make this the distinguishing
feature of our call because at present both Finning and Toromont generally face similar
industry conditions.
An important caveat to the above is that, in a regional context, we believe the long-term
outlook for construction activity in Western Canada and Chile remains more promising
than in Ontario, Manitoba, and Newfoundland. Likewise, recognizing that all resource
markets are soft, we prefer Finning’s relative exposure to copper and oil vs. Toromont’s
exposure to gold and nickel. Nevertheless, if our call is based primarily on bottom-up
fundamentals, not end market outlooks, it might surprise some investors that we are
recommending Finning over Toromont. Indeed, shouldn’t the performance discrepancy
that we outlined earlier in this report lead to the opposite conclusion?
Even after considering the underlying differences in these two CAT dealerships, it is
difficult to deny that Toromont has demonstrated a stronger track record. But that
doesn’t necessarily mean that it is the better stock to own right now. Although we are
recommending Toromont’s shares (with our Outperform rating), we believe that
Finning’s risk-reward profile looks more attractive. The main reason is that we see
significant potential for multiple expansion on Finning’s stock if it can address some of
the operational and cultural issues we have outlined above and improve its execution.
For reasons that this report has discussed, Finning’s margins in Canada may never reach
Toromont’s level, but if the company can leverage enough change to generate higher
ROIC, better free cash flow, and steadier earnings through a cycle, we believe its
multiple will expand. On the other hand, if Finning fails to improve its performance, the
valuation downside is, we believe, limited by the fact that the stock is already trading
near an historical low and at an unprecedented discount to Toromont.
We believe Finning’s stock will get
rerated upwards if it can address
some of the operational and
cultural issues we have outlined
above and improve its execution
Importantly, we are not suggesting that Toromont’s shares are overvalued. The
company’s strong performance and superior balance sheet clearly warrants a premium
multiple. However, we see less opportunity for its multiple to expand from here, at least
without Finning following along. In fact, as (if?) Toromont evolves into more of a mining
dealer there is, in our view, a risk that its returns might deteriorate as the operations get
more complex. This, in turn, could lead to some valuation downside over time. Given
the company’s excellent track record and impressive culture, we believe this risk is fairly
limited. Still, it is something for investors to consider when we evaluate the relative riskreturn profiles of these two stocks.
To put a final point on the current valuation gap, we refer back to Exhibits 2 and 3 of this
report. There we can see that over the past 15 years, the weighted average forward P/E
multiple for Toromont’s stock has been 16.1x, which is almost exactly the same as
Finning’s weighted average P/E multiple of 16.3x. The variance around these averages
has also been quite similar over time, although the respective multiples have never
tracked each other perfectly. For example, at the peak of the last cycle (2007), Finning’s
stock was trading at roughly a three-point premium to Toromont. More recently, that
situation has reversed and Toromont now commands nearly a four point premium.
There is still value in Toromont’s
stock, but we see even more value
in Finning’s stock
Taking this report full circle, we return to the question: why pay more? The answer, we
believe, lies in the superior returns that Toromont has been able to generate over a long
period of time. In other words, notwithstanding its premium price, we believe there is
still value in Toromont’s stock and we encourage investors to buy it and rate it
Outperform. However, we see even more value in Finning shares. Accordingly, we rate
the stock Strong Buy and have increased our target price to $30.00. Using a target P/E
multiple of 13.0x our 2014 EPS estimate—one point above the 5-year average low P/E—
we are still assuming that it will trade at a discount to Toromont ($26.50 target; equal to
5-year average P/E of 16.0x) but that the spread will slightly narrow as Finning
performance improves in its Canadian operations.
Industrial
Appendix: Finning vs. Toromont Executive and Board Member Share Ownership
FTT
Name
Doug Whitehead
Andrew Simon
Ricardo Bacarreza
John Reid
Kathleen O'Neil
Bruce Turner
James Carter
Michael Wilson
David Emerson
Chirs Patterson
Name
Smith
Villegas
Fraser
Marchese
Director Since
1999
1999
1999
2006
2007
2006
2007
2013
2008
2010
Title
CFO
COO
Pres. FTT Canada
Pres. FINSA
# shares owned
Value of shares owned
158,299
$3,591,804
35,000
$794,150
28,000
$635,320
20,000
$453,800
14,000
$317,660
11,090
$251,632
10,000
$226,900
10,000
$226,900
7,300
$165,637
4,175
$94,731
Total Director
$6,758,534
% of mkt cap
0.17%
Average Director
$675,853
Median
$284,646
FTT Executive Managers
# shares owned
# of DSUs
21,679
27,169
15,184
20,173
Total Exec
% of mkt cap
Average Exec
Tenure-adjusted value of
shares (value/ # yrs)
$256,557
$56,725
$45,380
$64,829
$52,943
$35,947
$37,817
$226,900
$33,127
$31,577
$84,180
$49,162
Value of shares/DSUs owned
$491,897
$616,465
$344,525
$457,725
$1,910,611
0.05%
$477,653
TIH Directors
Name
Ogilvie
Hill
Franklin
Medhurst
MacCallum
Galloway
Chishom
Name
Ogilvie
Medhurst
Jewer
Casson
Director Since
1986
1988
1994
2012
1985
2002
2011
Title
Exec Chair
CEO
CFO
Pres. TIH CAT
# shares owned
Value of shares owned
2,015,896
$47,877,530
222,000
$5,272,500
117,700
$2,795,375
61,185
$1,453,144
60,000
$1,425,000
23,500
$558,125
12,000
$285,000
Total Director
$59,666,674
% of mkt cap
3.27%
Average Director
$8,523,811
Median
$1,453,144
TIH Executive Managers
# shares owned
# of DSUs
2,015,896
61,185
$9,981
26,507
$28,555
135,523
$14,007
Total Exec
% of mkt cap
Average Exec
Avg (excl. Ogilvie)
Tenure-adjusted value of
shares (value/ # yrs)
$1,773,242
$210,900
$147,125
$1,453,144
$50,893
$50,739
$142,500
$546,935
$147,125
Value of shares/DSUs owned
$45,740,680
$1,614,757
$1,249,357
$3,392,836
$51,997,629
2.85%
$12,999,407
$2,085,650
Data as of December 31, 2012. Data only includes shares purchased in the market or
earned in lieu of cash compensation; options or PSUs not included.
Industrial
Finning International FTT-TSX
Current Price (Sep-20-13)
52-Week Range
Market Capitalization (mln)
Shares Outstanding (mln, f.d.)
10 Day Avg Daily Volume (000s)
EPS
2012A
2013E
2013E
2014E
2014E
Old
New
Old
New
Old
New
Old
New
2012A
2013E
2013E
2014E
2014E
1Q
Mar
C$0.39
0.45A
0.45A
NA
NA
Rating:
C$22.68
C$27.30 - C$20.37
C$3,908
172.3
488
2Q
Jun
C$0.47
0.48A
0.53A
NA
NA
3Q
Sep
C$0.49
0.52
0.52
NA
NA
Strong Buy
Target Price (6-12 mos)
Total Return to Target
Dividend/Yield
Current Net Debt (mln)
Enterprise Value (mln)
4Q
Dec
C$0.55
0.55
0.55
NA
NA
Full
Year
C$1.90
2.00
2.00
2.30
2.30
Revenue
(mln)
C$6,622
6,640
6,640
6,800
6,800
Suitability:
Growth
Old: C$24.00 New: C$30.00
35%
C$0.61/2.7%
C$1,988
C$5,896
EBITDA
(mln)
C$711
737
737
792
792
P/E
EV/EBITDA
11.9x
8.6x
11.4x
8.0x
9.9x
7.4x
EBITDA
Segmented Segmented Segmented
Margin (%) Revenue
Revenue
Revenue
(mln):
(mln): U.K. (mln): FINSA
Canada
10.7%
C$3,278
C$901
C$2,444
3,081
843
2,717
11.1%
3,081
843
2,717
3,175
850
2,775
11.6%
3,175
850
2,775
Source: Raymond James Ltd., Thomson One
Toromont Industries TIH-TSX
Current Price (Sep-20-13)
52-Week Range
Market Capitalization (mln)
Shares Outstanding (mln, f.d.)
10 Day Avg Daily Volume (000s)
EPS
Old
New
Old
New
Old
New
Old
New
2012A
2013E
2013E
2014E
2014E
2012A
2013E
2013E
2014E
2014E
1Q
Mar
C$0.22
0.23A
0.23A
NA
NA
Rating:
C$23.32
C$24.54 - C$18.61
C$1,799
77.2
110
2Q
Jun
C$0.33
0.35A
0.35
NA
NA
3Q
Sep
C$0.43
0.41
0.41
NA
NA
Outperform
Suitability:
Target Price (6-12 mos)
Total Return to Target
Dividend/Yield
Current Net Debt (mln)
Enterprise Value (mln)
4Q
Dec
C$0.59
0.55
0.55
NA
NA
Full
Year
C$1.56
1.55
1.55
1.65
1.65
Revenue
(mln)
C$1,507
1,527
1,527
1,581
1,581
Growth
C$26.50
16%
C$0.52/2.2%
C$167
C$1,967
EBITDA
(mln)
C$223
225
225
238
238
P/E
EV/EBITDA
14.9x
8.8x
15.1x
8.7x
14.1x
8.3x
EBITDA
Margin (%)
14.8%
14.8%
15.0%
Source: Raymond James Ltd., Thomson One
Industrial
Company Citations
Company Name
Agnico Eagle Mines
Baffinland Iron Mines Corp.
Caterpillar Inc.
Cervus Equipment Corp.
Cliffs Natural Resources
Detour Gold Corp.
Enerflex Ltd.
Goldcorp
HudBay Minerals, Inc.
Newmont Mining Corporation
Osisko Mining Corp.
Rainy River Resource Ltd
Rocky Mountain Dealerships Inc.
Stillwater Mining Co.
Strongco Corp.
Titan Corp.
Wajax Corp.
Ticker
AEM
BIM
CAT
CVL
CLF
DGC
EFX
GG
HBM
NEM
OSK
RR
RME
SWC
SQP
TTN
WJX
Exchange
NYSE
TSX
NYSE
TSX
NYSE
TSX
TSX
NYSE
TSX
NYSE
TSX
TSXV
TSX
NYSE
TSX
NYSE
TSX
Currency
US$
Closing Price
29.44
US$
C$
87.84
19.75
C$
C$
10.60
14.07
C$
9.06
C$
5.65
C$
11.54
C$
3.86
C$
37.34
RJ Rating
3
NC
2
2
NC
2
3
NC
3
NC
3
NC
3
NC
3
NC
3
RJ Entity
RJ LTD.
RJ LTD.
RJ LTD.
RJ LTD.
RJ LTD.
RJ LTD.
RJ LTD.
RJ LTD.
RJ LTD.
RJ LTD.
Notes: Prices are as of the most recent close on the indicated exchange and may not be in US$. See Disclosure section for
rating definitions. Stocks that do not trade on a U.S. national exchange may not be registered for sale in all U.S. states. NC=not
covered.
Industrial
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Industrial
are only permitted to sell those positions five days after the rating has been lowered to Underperform. The Analyst and/or
Associate or a member of his/their household has a long position in the securities of Caterpillar Inc. The Analyst and/or
Associate or a member of his/their household has a long position in the securities of Finning International. The Analyst
and/or Associate or a member of his/their household has a long position in the securities of Toromont Industries.
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Ratings and Definitions
Raymond James Ltd. (Canada) definitions
Strong Buy (SB1) The stock is expected to appreciate and produce a total return of at least 15% and outperform the
S&P/TSX Composite Index over the next six months. Outperform (MO2) The stock is expected to appreciate and
outperform the S&P/TSX Composite Index over the next twelve months. Market Perform (MP3) The stock is expected to
perform generally in line with the S&P/TSX Composite Index over the next twelve months and is potentially a source of
funds for more highly rated securities. Underperform (MU4) The stock is expected to underperform the S&P/TSX
Composite Index or its sector over the next six to twelve months and should be sold.
Raymond James & Associates (U.S.) definitions
Strong Buy (SB1) Expected to appreciate, produce a total return of at least 15%, and outperform the S&P 500 over the next
six to 12 months. For higher yielding and more conservative equities, such as REITs and certain MLPs, a total return of at
least 15% is expected to be realized over the next 12 months. Outperform (MO2) Expected to appreciate and outperform
the S&P 500 over the next 12-18 months. For higher yielding and more conservative equities, such as REITs and certain
MLPs, an Outperform rating is used for securities where we are comfortable with the relative safety of the dividend and
expect a total return modestly exceeding the dividend yield over the next 12-18 months. Market Perform (MP3) Expected
to perform generally in line with the S&P 500 over the next 12 months. Underperform (MU4) Expected to underperform
the S&P 500 or its sector over the next six to 12 months and should be sold. Suspended (S) The rating and price target have
been suspended temporarily. This action may be due to market events that made coverage impracticable, or to comply
with applicable regulations or firm policies in certain circumstances, including when Raymond James may be providing
investment banking services to the company. The previous rating and price target are no longer in effect for this security
and should not be relied upon.
Raymond James Latin American rating definitions
Strong Buy (SB1) Expected to appreciate and produce a total return of at least 25.0% over the next twelve months.
Outperform (MO2) Expected to appreciate and produce a total return of between 15.0% and 25.0% over the next twelve
months. Market Perform (MP3) Expected to perform in line with the underlying country index. Underperform (MU4)
Expected to underperform the underlying country index. Suspended (S) The rating and price target have been suspended
temporarily. This action may be due to market events that made coverage impracticable, or to comply with applicable
regulations or firm policies in certain circumstances, including when Raymond James may be providing investment banking
services to the company. The previous rating and price target are no longer in effect for this security and should not be
relied upon.
Raymond James Euro Equities, SAS rating definitions
Strong Buy (1) Expected to appreciate, produce a total return of at least 15%, and outperform the Stoxx 600 over the next 6
to 12 months. Outperform (2) Expected to appreciate and outperform the Stoxx 600 over the next 12 months. Market
Perform (3) Expected to perform generally in line with the Stoxx 600 over the next 12 months. Underperform (4) Expected
to underperform the Stoxx 600 or its sector over the next 6 to 12 months. Suspended (S) The rating and target price have
been suspended temporarily. This action may be due to market events that made coverage impracticable, or to comply
with applicable regulations or firm policies in certain circumstances, including when Raymond James may be providing
investment banking services to the company. The previous rating and target price are no longer in effect for this security
and should not be relied upon.
Industrial
In transacting in any security, investors should be aware that other securities in the Raymond James research coverage
universe might carry a higher or lower rating. Investors should feel free to contact their Financial Advisor to discuss the
merits of other available investments.
Suitability Categories (SR)
Total Return (TR) Lower risk equities possessing dividend yields above that of the S&P 500 and greater stability of principal.
Growth (G) Low to average risk equities with sound financials, more consistent earnings growth, at least a small dividend,
and the potential for long-term price appreciation.
Aggressive Growth (AG) Medium or higher risk equities of companies in fast growing and competitive industries, with less
predictable earnings and acceptable, but possibly more leveraged balance sheets.
High Risk (HR) Companies with less predictable earnings (or losses), rapidly changing market dynamics, financial and
competitive issues, higher price volatility (beta), and risk of principal.
Venture Risk (VR) Companies with a short or unprofitable operating history, limited or less predictable revenues, very high
risk associated with success, and a substantial risk of principal.
Rating Distributions
Coverage Universe Rating Distribution
Investment Banking Distribution
RJL
RJA
RJ LatAm
RJEE
RJL
RJA
RJ LatAm
RJEE
Strong Buy and Outperform (Buy)
61%
51%
43%
47%
34%
25%
0%
0%
Market Perform (Hold)
39%
43%
57%
32%
23%
10%
0%
0%
Underperform (Sell)
0%
6%
0%
21%
0%
3%
0%
0%
Raymond James Relationship Disclosures
Raymond James Ltd. or its affiliates expects to receive or intends to seek compensation for investment banking services
from all companies under research coverage within the next three months.
Company Name
Disclosure
Agnico Eagle Mines
Raymond James Ltd - the analyst and/or associate has viewed the material operations of
Agnico Eagle Mines.
Raymond James Ltd - within the last 12 months, Agnico Eagle Mines has paid for all or a
material portion of the travel costs associated with a site visit by the analyst and/or
associate.
Caterpillar Inc.
Caterpillar Inc..
Cervus Equipment Corp.
Cervus Equipment Corp..
Raymond James Ltd. has provided non-investment banking securities-related services
within the last 12 months with respect to Cervus Equipment Corp..
Raymond James Ltd. has received compensation for investment banking services within the
last 12 months with respect to Cervus Equipment Corp..
Raymond James Ltd. has received compensation for services other than investment
banking within the last 12 months with respect to Cervus Equipment Corp..
Raymond James Ltd. makes a market in the securities of Cervus Equipment Corp..
Industrial
Company Name
Disclosure
Detour Gold Corp.
Detour Gold Corp..
Raymond James Ltd - within the last 12 months, Detour Gold Corp. has paid for all or a
associate.
Raymond James Ltd. has managed or co-managed a public offering of securities within the
last 12 months with respect to Detour Gold Corp..
Raymond James Ltd. has provided investment banking services within the last 12 months
with respect to Detour Gold Corp..
last 12 months with respect to Detour Gold Corp..
Enerflex Ltd.
Enerflex Ltd..
Finning International
Finning International.
Raymond James Ltd. has managed or co-managed a public offering of securities within the
last 12 months with respect to Finning International.
Raymond James Ltd. has provided investment banking services within the last 12 months
with respect to Finning International.
last 12 months with respect to Finning International.
HudBay Minerals, Inc.
HudBay Minerals, Inc..
Raymond James Ltd - within the last 12 months, HudBay Minerals, Inc. has paid for all or a
associate.
last 12 months with respect to HudBay Minerals, Inc..
Raymond James Ltd. makes a market in the securities of HudBay Minerals, Inc..
Osisko Mining Corp.
Osisko Mining Corp..
Raymond James Ltd - within the last 12 months, Osisko Mining Corp. has paid for all or a
associate.
Rocky Mountain Dealerships
Inc.
Rocky Mountain Dealerships Inc..
Toromont Industries
Toromont Industries.
Raymond James Ltd - within the last 12 months, Toromont Industries has paid for all or a
associate.
Wajax Corp.
Wajax Corp..
Stock Charts, Target Prices, and Valuation Methodologies
Valuation Methodology: The Raymond James methodology for assigning ratings and target prices includes a number of
qualitative and quantitative factors including an assessment of industry size, structure, business trends and overall
Industrial
attractiveness; management effectiveness; competition; visibility; financial condition, and expected total return, among
other factors. These factors are subject to change depending on overall economic conditions or industry- or companyspecific occurrences.
Target Prices: The information below indicates target price and rating changes for the subject companies included in this research.
Valuation Methodology: We value Finning on a comparative basis to historical P/E multiples.
Valuation Methodology: We value Toromont on a comparative basis to historical P/E multiples.
Risk Factors
General Risk Factors: Following are some general risk factors that pertain to the projected target prices included on
Raymond James research: (1) Industry fundamentals with respect to customer demand or product / service pricing could
Industrial
change and adversely impact expected revenues and earnings; (2) Issues relating to major competitors or market shares or
new product expectations could change investor attitudes toward the sector or this stock; (3) Unforeseen developments
with respect to the management, financial condition or accounting policies or practices could alter the prospective
valuation.
Risks - Finning International
a) Several sources of foreign exchange risk could affect either favourably or adversely Finning’ financial performance.
Finning sources most of its products from the U.S., and records the results of its U.K., Chilean, Argentinean and Uruguayan
operations in Canadian dollars. As a result, changes in any of the aforementioned country’s currencies directly affect the
company’s performance. To mitigate the foreign exchange risk, Finning uses a combination of derivative strategies; b) our
financial forecast assumes that Finning will continue to be able to identify appropriate markets in which to expand. Failure
to do so would likely have negative implications on the company’s earnings; c) Finning’s business is reliant on agreements
with several equipment manufacturers and distributors, the most significant being Caterpillar; d) Finning’s operations are
also influenced by commodity price fluctuations, however, we believe that the company’s broad operations in the forestry,
metals, petroleum and thermal coal sectors help minimize commodity-related risks; and e) interest rate fluctuation may
adversely or favourably affect the company’s ability to raise capital in the form fixed or floating rate debt.
Risks - Toromont Industries
a) Toromont’s future growth is sensitive to the general level of economic activity and the company’s ability to identify
suitable acquisition candidates and/or appropriate markets in which to expand; b) Toromont’s business is reliant on
agreements with several equipment manufacturers and distributors, the most significant being Caterpillar; c) Toromont
sources products and generates revenues from the United States. As a result, fluctuations in the C$/US$ exchange rate
directly affect the company’s financial performance; d) Toromont’s operations are also influenced by commodity price
fluctuations, especially natural gas; e) demand for the Caterpillar/Toromont products and services may be significantly
impacted by fluctuations in commercial and industrial construction, infrastructure spending and the level of economic
activity; f) labour agreements could subject the company to greater risks of work interruption and impair Toromont’s ability
to achieve cost savings; and g) interest rate fluctuations may adversely or favourably affect the company’s ability to raise
capital in the form of fixed or floating rate debt.
Additional Risk and Disclosure information, as well as more information on the Raymond James rating system and suitability
categories, is available for Raymond James at rjcapitalmarkets.com/Disclosures/index and for Raymond James Limited at
www.raymondjames.ca/researchdisclosures.
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Industrial
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RJL is a member of the Canadian Investor Protection Fund. ©2013 Raymond James Ltd.
Industrial
EQUITY RESEARCH
HEAD OF EQUITY RESEARCH
DARYL SWETLISHOFF, CFA
RAYMOND JAMES LTD. CANADIAN INSTITUTIONAL EQUITY TEAM WWW.RAYMONDJAMES.CA
INSTITUTIONAL EQUITY SALES
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INDUSTRIAL & TRANSPORTATION
BASE METALS & MINERALS | IRON ORE
ADAM LOW, CFA
TRACY REYNOLDS (ASSOCIATE)
BASE METALS & MINERALS | PLATINUM GROUP METALS
ALEX TERENTIEW, MBA, P.GEO
ROSS YAKOVLEV, CA, MBA (ASSOCIATE)
PRECIOUS METALS
PHIL RUSSO
PRECIOUS METALS
CHRIS THOMPSON, M.SC. (ENG), P.GEO
BRIAN MARTIN (ASSOCIATE)
URANIUM | JR EXPLORATION & DEVELOPMENT
DAVID SADOWSKI
416.777.4935
416.777.4951
0.207.426.5632
0.207.426.5612
INSTITUTIONAL EQUITY TRADING
CO-HEAD OF TRADING
BOB MCDONALD, CFA
ANDREW FOOTE, CFA
TORONTO (CANADA 1.888.601.6105 | USA 1.800.290.4847)
PAM BANKS
ANTHONY COX
OLIVER HERBST
ANDY HERRMANN
ERIC MUNRO, CFA
JAMES SHIELDS
BOB STANDING
PETER MASON (ASSISTANT)
VANCOUVER (1.800.667.2899)
NAV CHEEMA
FRASER JEFFERSON
DEREK ORAM
MONTREAL (514.350.4450 | 1.866.350.4455)
JOE CLEMENT
PATRICK SANCHE
604.659.8222
416.777.4924
416.777.4923
416.777.4922
416.777.4947
416.777.4937
416.777.4983
416.777.4941
416.777.4921
416.777.7195
604.659.8224
604.659.8218
604.659.8223
514.350.4470
514.350.4465
INSTITUTIONAL EQUITY OFFICES
Calgary
Suite 4250
525 8th Avenue SW
Calgary, AB T2P 1G1
403.509.0500
Montreal
Vancouver
Suite 3000
Suite 2100
1800 McGill College
925 West Georgia Street
Montreal, PQ H3A 3J6
Vancouver, BC V6C 3L2
514.350.4450
604.659.8200
Toll Free: 1.866.350.4455
Toll Free: 1.800.667.2899
Toronto
International Headquarters
Suite 5400, Scotia Plaza 40 King Street West The Raymond James Financial Center
Toronto, ON M5H 3Y2
880 Carillon Parkway
416.777.4900
St.Petersburg, FL
Toll Free Canada: .888.601.6105
USA 33716
Toll Free USA: 1.800.290.4847
727.567.1000

Canada Research Industrial

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