CA - Finning International Inc. (FINGF) Q3 2023 Earnings Call Transcript
2023-11-10 20:02:10 ET
Finning International Inc. (FINGF)
Q3 2023 Earnings Conference Call
November 7, 2023 10:00 a.m. ET
Company Participants
Greg Palaschuk - Executive Vice President and Chief Financial Officer
Kevin Parkes - President and Chief Executive Officer
Conference Call Participants
Yuri Lynk - Canaccord Genuity
Steve Hansen - Raymond James
Jacob Bout - CIBC Capital Markets
Cherilyn Radbourne - TD Cowen
Devin Dodge - BMO Capital Markets
Michael Doumet - Scotiabank
Presentation
Operator
Thank you for standing by. This is the Conference Operator. Welcome to the Finning International Inc. Third Quarter 2023 Investor Call and Webcast. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there'll be an opportunity to ask questions. [Operator Instructions]
I would now like to turn the conference over to Greg Palaschuk, Executive Vice President and Chief Financial Officer. Please go ahead.
Greg Palaschuk
Thank you, Operator. Good morning, everyone, and welcome to Finning's third quarter earnings call. Joining me on today's call is Kevin Parkes, our President and CEO. Following our remarks today, we'll open the line to questions. This call is being webcasted on the Investor Relations section of finning.com. We've also provided a set of slides that will reference during our prepared remarks. The slides are posted on our Web site as well. An audio file of this call and the accompanying presentation will be archived. In addition, in September, we hosted our 2023 Investor Day in Antofagasta, Chile, which laid out a refresh strategy and key objectives going forward. On our Web site, you can review our slide presentation as well as the full webcast of our Investor Day.
Before I turn it over to Kevin, I want to remind everyone that some of the statements provided during this call are forward-looking. Please refer to slides 10 and 11 for important disclosures about forward-looking information, as well as currency and specified financial measures, including non-GAAP financial measures. Please note that forward-looking information is subject to risks, uncertainties, and other factors as discussed in our Annual Information Form, under key business risks, and in our MDNA under risk factors and management and forward-looking information disclaimer. Please treat this information with caution, as our actual results could differ materially from current expectations.
Kevin, over to you.
Kevin Parkes
Thank you, Greg, and good morning, everyone. In our recent invest in Chile we presented our refreshed strategic priorities. I'll speak to our quarter three through those priorities. And as Greg mentioned, we do have the webcast and the presentation in the investor section of our website. And for those of you that haven't had a chance to hear - see and hear the presentation, I'd encourage you to do so. Following my remarks, Greg will provide additional details around the third quarter results. Please turn to slide two.
We delivered another strong quarter in Q3 through strong execution. Driving our product support business remains our primary street strategic objective. Product support builds customer loyalty through greater integration with our customers and the performance of their equipment. It is our biggest value driver, the largest opportunity for profitable growth, and the most resilient part of our business. We are capturing greater share of product support across the full asset lifecycle, growing customer value agreements, expanded our rebuild business and strategically growing our equipment population in our territories.
Optimizing our operating model and culture around full cycle resilience is a new explicit strategic objective. This includes building more contracted revenues and costs, finding ways to variable cost structure, and increasing working capital velocity. Building greater resilience into our business will provide more security and certainty for our employees, better support for our customers, and more reliable and consistent returns for our investors. Finally at Finning, we're building a sustainable growth platform. In addition to driving product support, we're excited about growing our addressable market and used equipment rental and power systems.
Building our used equipment capability is a great way to increase the install base in our markets, grow after-market opportunities, while also helping build full cycle resilience. We plan to grow our rental business and increase our customer base specifically around retail customers. And we also increase our capabilities in both prime standby power solutions as well as capacity power to support the growing demand for electrification. Please turn to slide three.
Our regions delivered strong performance in Q3 while managing through some unique challenges. In Western Canada, wildfires impacted many of the communities in which we operate. The safety of our employees, their families and their communities became our primary objective at times through this summer. In South America, the team has managed through a very difficult operating and economic environment in Argentina related to the presidential elections. I'm really proud of our teams continue to demonstrate their strength and resilience while providing important support for our customers being great colleagues and important members of their communities.
We are pleased that our products support growth, strong operating margins and return on invested capital. Our revenue mix shifted to the due to the high proportion of large mining equipment we delivered from our backlog to install - to increase our installed base and product support opportunity. Our product support revenue was up 13% year over year growing across all regions. Since Q3 of last year, we've had 370 technicians globally to support the increased number of product support contracts and strong demand for rebuilds. As we highlighted at our Investor Day, we are very focused on improving invested capital performance to drive ROIC higher and build greater resilience into our business. Initiatives underway in each of our regions are in place to drive more efficiency in our operations, higher velocity and our invested capital was most importantly increasing our customer service levels.
Key focus areas include automating our warehouse operations, working closely with customers on planning component exchanges and rebuilds and increasing velocity in our new equipment preparation. Improving supply chain is a positive for our customers, our operations and our business performance. And we're pleased with the progress. Our adjusted return on invested capital was 20.2% in Q3 of 190 basis points from a year ago led by South America.
Looking ahead, we are excited about sustainable growth at Finning. We're building capabilities and empowering people, our people to drive long term customer loyalty. We expect continued momentum in our business to be supported by robust commerce customer activity across our diverse and markets, healthy equipment backlog that stands at 2.3 billion and a strong demand for service.
From a regional standpoint, Chile is a premium business and mobilizing for growth. Our Canada business is positioned for steady growth. It has the largest addressable market in each of rental used equipment and power systems. And our UK and Ireland business is resilient sharing best practices to drive innovation and efficiency across our company.
I will now hand it back to Greg to provide greater level of detail on our third quarter results.
Greg Palaschuk
Thank you, Kevin. I'll talk about our third quarter performance in more detail including our regional results. And I'm turning the slide four. Q3 was another strong quarter. That revenue was 2.4 billion up 16% from Q3 2022. We saw a strong new equipment deliveries and product support volumes in Q3 led by mining. We're also pleased with the momentum in our power systems business across all regions underpinned by strong demand and effective project execution.
EPS of a $1.07 was up 9% from Q3 2022, operating margins were solid and SG&A as a percentage of net revenue was below 17% in the quarter. The proportion of large lower margin mining deliveries in the revenue mix and higher financing costs were the main reasons for EPS to grow at a slower rate than revenue compared to Q3 2022. But Q3 2022 was also a very strong quarter and we're pleased with the steady growth in earnings year over year. Q3 free cash flow was at breakeven and our net debt to adjusted EBITDA with 1.8 times at the end of September.
On slide five, you can see changes in our net revenue by line of business compared to Q3 2022, and the comparison of our backlog by market sector. New equipment sales were up 28% led by mining deliveries in Canada and Chile, as well as higher power system sales in all regions. The Product support revenue was strong and all regions up 13% on a consolidated basis.
Our equipment backlog of 2.3 billion is down slightly from the end of June. Equipment backlog in South America grew driven by significant mining orders was offset by lower equipment backlog in Canada due to strong deliveries and lower equipment backlog in the UK and Ireland.
Our quoting activity remains robust in mining and power systems with customers continue to increase capital expenditures and operating budgets to support fleet investment and production increases. Our mining and power systems equipment backlog continues to grow as a proportion representing roughly 45% and 25% respectively, of total equipment backlog as of September 30th. We see supply chain improvements as a positive in our Canadian and Chilean construction businesses. We're seeing core market share improved as a result.
Turning to slide six which shows our EBIT performance, gross profit was up 14% on strong new equipment and product support volumes. As a percentage of net revenue gross profit was down 30 basis points primarily due to higher proportion of large mining deliveries in the revenue mix. In the third quarter, we delivered 26 ultra-class trucks, which is highlighted in our Investor Day is great for a long-term product support growth. SG&A as a percentage net revenue was 16.9% up 20 basis points from Q3 2022. EBIT was up 12%. EBIT as a percentage of net revenue is a solid 10.3%.
Now, moving to our Canadian results in Outlook, which are summarized on slide seven. New equipment sales were up 57% led by mining deliveries oil sands customers. Product support revenue increased by 10% led by mining including higher rebuild activity. We're also driving strong growth in power systems business in Canada. The power systems equipment backlog, up significantly from Q3 2022. EBIT was up 10%. And EBIT as percentage of net revenue was 10.8% below Q3 2022 again due to higher proportion of large mining equipment sales and the revenue mix. Canada's adjusted ROIC increased a 170 basis points from Q3 2020, driven by improved invested capital turnover and strong operating margins.
Western Canada is well positioned for steady growth going forward. Our mining and energy customers are financially healthy, increasing investments into their fleets and production. In the oil sands demand for product support is expected to remain strong than we are in active discussions with customers planning for me to rebuild.
Turning South America on slide eight, in functional currency, new equipment sales were up 37% driven by deliveries of large mining equipment in Chile. Product support sales were up 12% also led by strong mining activity. EBIT was up 20%. And EBIT as a percentage of net revenue was 12.3%, which was comparable to Q3 of 2022. South America generated ROIC of 27.6 up 490 basis points from Q3 2022 are highest ROIC to date, reflecting both improved profitability and invested capital turns.
As reviewed in detail in Antofagasta in September, our business in Chile is mobilizing for growth. The strong outlook for mining supported by growing demand for copper and approved political clarity. We're encouraged by recent government approvals of large scale brownfield expansions and increasing customer confidence to invest in new projects. We continue to see demand for large contractors supporting mining operations in Chile, while infrastructure construction activity is expected to remain stable. Additionally, power systems activity is growing in industrial and data center markets.
In Argentina, we're operating in an environment of high inflation, significant currency restrictions and import regulations that are impacting our business. While we're actively managing and mitigating these risks, the significant prolonged important currency restrictions put in place during the current election process has increased the risk and likelihood of losses and negative tax impacts in the fourth quarter. Please turn to slide nine for our results in the UK and Ireland.
In functional currency, net revenue decreased by 17% from Q3 2022 due to lower equipment sales and construction, which is partially offset by higher power systems revenues. Product report revenue was up 6% driven by strong customer activity and equipment utilization in power systems. EBIT as a percentage of net revenue was a solid 5.9% reflecting our continuous focus on growing the product support business. Product support activity in the UK and Ireland is expected to be resilient to steady machine utilization and growing contribution from Hydraquip. As HS2 deliveries are now complete, we continue to expect lower new equipment sales in the UK compared to the record levels of 2022. In power systems we continue to expect strong demand for both primary and backup power generation in the data center and utility applications.
In summary, we're pleased with the Q3 results and continued momentum. Our focus is squarely on executing the refresh strategy as outlined as Investor Day to drive product support, full cycle resilience and sustainable growth for the long term.
Operator, I'll now turn the call back to you for questions.
Question-and-Answer Session
Operator
Thank you. We'll now begin the question-and-answer session. [Operator Instructions] The first question comes from Yuri Lynk with Canaccord Genuity. Please go ahead.
Yuri Lynk
Good morning, guys.
Greg Palaschuk
Good morning, Yuri.
Yuri Lynk
Good morning, guys. Greg, can you ring funds for the potential loss in Argentina that you alluded to?
Greg Palaschuk
Yes, sure. So, you know, as we've talked about in previous discussion, so Argentina is a business that's, you know, fairly small, you know, we keep it in a box. We've typically focused more on product support. What we've seen is pretty unique circumstance really, through the election process, as they've kept the peg at about 350 peso. So, you know, in the past, historically, if you had kind of two weeks without access to U.S. dollars, that would be unusual, and we're now more at the two-month point. So, we just have a higher exposure through that period. So, we'll manage through that effectively as we can the elections on the 19th. And so, you know, there could be an impact from that. We'll have to see how it plays out. But ultimately, you know, we'll put Argentina back in the box after that process and probably a tighter box than ever. And so, you know, it might be notable in the quarter in the grand scheme of Finning, you know, not a huge impact.
Kevin Parkes
Yuri, I would just add as well, you know, that, you know, one of the best ways for Argentina to work through this is develop - to develop the resources in country, which are gathering more and more momentum. And obviously, we are well placed to support that resource development, which we believe long term or will help us through this - will help us through this situation in a short to medium term, but long term is still an exciting opportunity.
Yuri Lynk
And what about the tax impact, like, what would your effective tax rate being in the fourth quarter?
Greg Palaschuk
Yes, I mean, it'll depend on the level of devaluation that occurs post-election. So, our, you know, tax pools would be in pesos. And so it would be directly correlated with, you know, whatever level of devaluation occurs post.
Yuri Lynk
Okay. Just last quick one for me on SG&A. What - I think, you know, it was down quite nicely as a percent of revenue in South America, but not so much in Canada. Can you just speak to the nature of the expenses that you incurred there, particularly around the fixed variable split between them?
Greg Palaschuk
Yes, sure. So, I mean, I think, you know, SG&A was down slightly quarter over quarter, but on a bit lower revenue. You know, we're always pleased to keep that below 17% and continue to have that as a key goal. You know, you'd have within the quarter in Canada, you'd have a little bit of non-recoverable times. You do some of the disruption in a couple branch closures for part of the quarter. And then otherwise, you know, just due to the strong performance, you've got some higher, you know, short term incentive comp numbers within Canada. I guess those would be the two to call up.
Yuri Lynk
Okay, I'll turn it over. Thanks, guys.
Greg Palaschuk
Thank you.
Operator
The next question is from Steve Hansen with Raymond James. Please go ahead.
Steve Hansen
Oh, yes. Good morning. Thanks for the time. Just a question on product support, the consolidated number was up quite nicely in the period as you highlighted. The Canadian operations did dip sequentially though quarter over quarter. Just curious, what's going on in that specific instance? And how to think about the ramp going forward given the large set of deliveries you've been doing to help us through maybe some of the forward cadence on that?
Kevin Parkes
Yes, sure, Steve. So, - I mean, the first thing is, when you talk about the dip, you know, I mean, it's really strong comps on the back of, you know, quite a favorable pricing environment as well. You know, we're very optimistic about product support growth as we mentioned in our Investor Day. In fact, you know, since our Investor Day, I would say that, you know, our outlook over, you know, the next period of time or 12 months is probably at the top end of that range. But, you know, we did talk about product support growth, you know, growth levels moderating, as we move forward. And, you know, that's what you're seeing. Right now, we, you know, the levels that we were growing at, you know, will moderate over time. And obviously, just think about the price and impacts in the last 12 months.
Steven Hansen
Okay, helpful. And then just how used equipment side, I understand the initiatives are relatively new. But maybe just help us understand sort of how we should think about that growth as well, because we did see some fairly sizable year over your dips in certainly in the Canadian business, but also in the UK as well, Canada in particular as be my focal point, as we think about the growth on the used side there?
Kevin Parkes
Yes. We're happy with the progress we're making in used equipment. We're super excited by some of the initiatives - excuse me, that we spoke about at the Investor Day and that will come to life in Q4. Specifically around Canada, there was an extremely strong quarter in Q3. So, you know, pretty unrepeatable used equipment up in deliveries in Q3 last year related to the, you know, the ability to get new product. And so we were very creative to get product in the hands of our customers in Q3 last year. So, that's the biggest comparison. There's no doubt that the used equipment market is softening. So, that would be an additional factor. But the biggest issue in Canada was the comparisons. And the softness issue would be the same narrative for the UK.
Steven Hansen
Okay. Thank you. I appreciate your time.
Operator
The next question is from Jacob Bout with CIBC. Please go ahead.
Jacob Bout
Good morning. I had a question on backlog looking for a bit more granularity. Maybe we'll just start specifically with Canada, you know, obviously strong deliveries in the corner. But, you know, do you expect a RELO going into the fourth quarter in and 2024? And, you know, are you seeing any weakness at all in Canada? I know some of your competitors are calling up construction markets.
Kevin Parkes
Yes. So, that's the first thing to say, I don't think that backlog is the best measure of forward looking activity. I know some of the people spoke to this over the past few weeks. But obviously, there are things in backlog over the last two years that wouldn't typically go into backlog under a normal free supply or a better supply environment. And so there's definitely an impact in construction, because construction is where the, you know, the supplier has improved more so than in the larger engines and larger mining equipment. And so, you know, we're very optimistic about, you know, the order intake levels and the activity levels we'll see. You know, it's hard to say whether the backlog will continue to build because obviously, as I just described, you know, there's the improvement supply chain, you know, provides more fluidity in the sales outlook, but we're happy with the growth that we are looking Canada as it relates to construction. And we're really happy with the market share gains that were seeing there. So, you know, I would not describe our construction equipment market in Canada as softening.
Jacob Bout
Okay, and then how about the U.K. and Ireland?
Kevin Parkes
Yes. So, the U.K. and Ireland is soft in the market, is reducing at that for sure. And that's on the back of, you know, the comparisons with HS2 deliveries last year. So, that is more challenging. Again, we've seen good - more recently good ordering tight levels, as some of the larger rental companies, you know, look forward into next year and start their reload - reloading their fleets or putting orders into reload their fleets. I've been pretty encouraged by recently about the ordering tight levels, but there's no doubt that there is a little softening in the UKk as it relates to construction equipment. You know, and that is compounded as well by the supply chain is improving faster in the UKk as well, because of the mix of products they sell there. So, one of the most improved supply chains around excavators which would be a much greater mix of the UK sales compared to Canada or South America. So, I think the combination of slowing market and improved supply means that we're carrying a little too much stock there. But, you know, it's healthy, it's young and the team are working through it. And we're optimistic with the recent performance.
Jacob Bout
And then how much pressure on pricing is there as a result of the improving supply chain?
Kevin Parkes
You know, we have to be competitive. You know, our margins as you can see in Q3 remain strong. And we're very focused on being competitive in our marketplace. We've been selling acceptable premiums forever and we continue to do that. And so, you know, we will - we're growing share in, you know, in Canada or in Chile. And so I think the teams are well-versed and well - they have strong capabilities and be able to sell the premiums and the value proposition that we have. So, we don't see that pressure.
Jacob Bout
Okay. Thank you.
Operator
Our next question is from Cherilyn Radbourne with TD Cowen. Please go ahead.
Cherilyn Radbourne
Thanks very much and good morning. We've seen a couple grown equity income pickup in Canada from pipeline machinery. So, I'm hoping you could give us a bit of color on how that business is performing and what kind of forward visibility it has?
Greg Palaschuk
Sure, yes. No, we've seen a nice pickup and there were certainly some difficult years and there were a lot of their activity from the US actually shifted up to Canada. But as you can see, the activity in the U.S. has picked up quite strongly. And you've seen some M&E activity start to happen and some more activity level. So, some of that gear will shift down to the U.S., but it's, you know, that businesses really picked up and we expect that to continue into next year.
Cherilyn Radbourne
And then in terms of the capex increase that was telegraphed in the press release, can you help us in Understand how much of that is related to the rental fleet and strategic mining truck investments, and how much just relates to the timing of plan facility disposals?
Greg Palaschuk
Sure, yes. So, - I mean, obviously through the year, the growth that we've seen has been healthy as the years progressed, but also, as we highlighted Investor Day, some strategic areas of focus, including rental. So, some of it would have been higher rental investment, but also fewer disposals than we planned at the beginning of the year. And we've got some good value assets in that fleet that we'd like to keep running for longer. As well as some deferred - one deferred real estate sale, it'll move into next year. As well as some investments in mining truck fleet, some to support some contract. Product support contracts with one, but also some to just demonstrate the new capabilities with potential conquest customers. So, yes, I'd say that's roughly about a third, a third, a third.
Cherilyn Radbourne
Okay, very helpful. Thanks for the time.
Greg Palaschuk
Okay.
Kevin Parkes
Thank you, Cherilyn.
Operator
Our next question is from Devin Dodge with BMO Capital Markets. Please go ahead.
Devin Dodge
All right. Thanks. Good morning. So, a lot of my questions have been answered, but just one for me for probably for Greg, but there was a pretty sizable increase in working capital in the quarter, how should we be thinking about, you know, working capital in Q4, and that outlook for a full year of free cash flow?
Greg Palaschuk
Sure, yes. So, you know, throughout the business, and we've got, you know, quite a bit of growth across the complex, we've got a lot of backlog that's getting closer delivery here through the end of the year and to the start of next year. And so you've got that, which is at an elevated level, also service work in progress is very healthy accounts receivable also up. So, we've got the working capital use there. But normal seasonality, you know, we would expect strong free cash flow in the fourth quarter. And then as we highlighted in Investor Day, you know, we recognize that there's work to do to increase investment capital turns in velocity and we've got plans in place in each of the regions. And those teams are working away and mobilizing to make that a big priority in 2024 and 2025 as discussed in Investor Day.
Devin Dodge
Okay. And just a quick follow up. When we think about 2024, do you think is it reasonable to assume that you guys could get to that 50% free cash flow conversion you've talked about previously?
Greg Palaschuk
I think it'll depend on the growth trajectory. Of course, at a more steady growth environment, that would be the target. We'll see how it ultimately plays out in terms of end markets. As we've highlighted in Investor Day, we see mobilization in Chile, steady growth in Canada and resilience in the U.K. So, that's overall a pretty steady market. And, you know, those are the sorts of markets where that conversion makes good sense, but left ultimately, see how that plays out.
Devin Dodge
Okay. Thanks. I'll turn it over.
Greg Palaschuk
Thanks, Devin.
Operator
Once again, if you have a question, please press star then one. The next question is from Michael Doumet with Scotiabank. Please go ahead.
Michael Doumet
Hi. Good morning, guys. The first question, I guess, just, you know, following up on some of the discussion with Jacob and Devin. Just on inventories, you know, you've invested about 1.2 billion in inventory since the beginning of 2022. And I understand that unit costs have risen and demand is also strong. But just trying to get a sense, given, you know, supply chains are easing, how far you are from, you know, where you think inventory should be to support this level of sales?
Kevin Parkes
Yes. So, - I mean, as we discussed at the Investor Day, Michael, we put a pretty explicit invested capital target out there, if which, you know, a good proportion of that will come from inventory optimization. You know, and, you know, we improved our invested capital terms in the quarter, but, you know, the growth, we're still growing at a healthy rate than we've described the long-term outlook in our Investor Day. So, there's no doubt that we will see inventory levels optimizing. We see that already happening in construction equipment. But our power system business is up 50% year over year. It's another key part of our strategic plan. There's some long lead time in large engines in that. And of course, the mining equipment is very lumpy in terms of how it comes to us and how we get out to customers and it's not as fluid as we would have experienced in the past, and certainly, not as fluid as we aim to be in the future.
And so, you know, I think there's - it's a big part of our strategic objective. And you can expect us to focus a lot on that as we move forward and improve the velocity that we're seeing in there. But we're more concerned with the velocity than we all with the absolute level, because the absolute level supports the growth that we're seeing in the company.
Michael Doumet
That's helpful. Thanks, Kevin. And then, you know, with the exception of Argentina, I mean, I read your commentary on the regional outlook is largely unchanged. I'm just curious, you know, given how interest rates have moved up in the last few months, you know, whether your visibility into 2024 is better or worse than your visibility into 2023 at this point or last year, just trying to get a sense for that, please.
Kevin Parkes
Yes. I would say it's definitely yes, Michael. I would say our visibility into next year right now in all regions. And I would say, you know, if you think about the main sector that's impacted by the higher interest rates would be construction equipment. And I feel better about construction equipment than I did even in the summer. You know, it's normalizing, it's competitive. But as I said, we delivered more large construction equipment in September in South America than we ever had by some considerable distance somewhere. And so the teams are absolutely focused on winning market share regardless of the condition. You know, market share levels offer us an opportunity regardless of, you know, the market conditions. And so, I would say we're optimistic. And as we think about the Investor Day commentary, particularly in Canada, our expectations or outlook would be at the top end of that range for 2024.
Michael Doumet
Perfect, thank you.
Operator
This concludes the question-and-answer session. I'd like to turn the conference back over to Greg Palaschuk for any closing remarks.
Greg Palaschuk
Great. Thank you, Operator. This concludes our question-and-answer session. I'd like to - well, and thank you everybody for participating and I hope you have a safe day.
Operator
This concludes today's conference calls. You may disconnect your lines. Thank you for participating and have a pleasant day.
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Finning International Inc. (FINGF) Q3 2023 Earnings Call Transcript