TTC - The Toro Company: Price Reflects Maximum Growth Potential

Summary

• TTC faces intense competition, and the main question is whether the post-covid growth is sustainable.
• TTC product lines and its massive backlog order go through cycles and normalization of demands.
• All the positive factors and future growth outlook look priced in at the current price of $116.

Thesis

The Toro Company ( TTC ) has reported strong financial results, and the company's management has provided positive guidance for the future, citing continuous growth in demand for its products. However, with TTC in a highly competitive market, coupled with the product offering going through seasonal cycles and normalization of demands, I am neutral on the stock. I deem the current price of $116 to be pricing in the maximum growth potential.

Company Overview

The Toro Company is an American company designing and producing outdoor maintenance equipment, such as lawnmowers, snow blowers, irrigation, and landscape construction products. TTC has two business segments – Professional, which represents 76% of consolidated net sales, and Residential. TTC is also active in other business acquisitions and has a global presence in more than 125 countries through its family of brands.

TTC competes mainly with other turf maintenance equipment manufacturers, such as Deere & Company (DE), Husqvarna (HUSQF), CNH Industrial ( CNHI ), and AGCO Corporation ( AGCO ).

1. Price reflects the positive growth, but the sustainability of the growth is questionable

Looking at TTC revenue growth, the growth averaged 5% pre-covid and 14% during the covid period. The strong performance is attributed to the increased demand for its products, particularly in the residential segment, where people invested in their lawns during the Covid pandemic.

TTC also mentioned in the latest earning call that they are entering the year with an order backlog of over $2 billion, the majority of which is for underground and specialty construction and golf and grounds.

TTC products go through seasonal cycles and the normalization of demands. For example, the golf turf maintenance machinery is usually seasonal and most heavily used during the golfing season. Depending on the location and climate of the golf course, as well as the individual golf course's maintenance policy, the machinery may be used less frequently or none at all during the off-season. As for machinery replacement, heavy-duty machinery would usually last around 3-5 years. Hence, it begs the question of whether the company's growth is sustainable over a longer horizon.

2. TTC faces intense competition from both inside and outside its home ground

TTC operates in a highly competitive environment across its various industries and product lines. Their main advantages are that TTC is a well-known brand name, has continuous product innovation, and can sell its products through its network of distributors.

TTC Residential segment products generally have higher competition due to the low entry barriers. Outside the U.S. and primarily in the European market, intense foreign competitors sell comparable products in their respective countries. Many of these companies also offer warranties and repair services to help customers maintain their tools over time.

On top of the traditional brick-and-mortar retail stores, many online retailers sell residential maintenance tools, for example, Amazon, to compete with the local stores. The residential maintenance tools market is highly competitive, with many companies vying for market share.

Macroeconomic effects such as the wage pressure driven by higher inflation expectations, overall cost pressure for its parts components, and the supply chain logistics have impacted most companies to a certain degree.

With the macroeconomic challenges, TTC management mentioned its ability to increase its pricing across its product lines to offset the cost pressure. The cost and supply chain delay will gradually ease in the short term. However, with a strong USD and competitive market, TTC's pricing power may be limited to remain competitive and maintain its market share.

3. TTC has a history of acquisition but has a low cash balance to support future M&A opportunities

TTC has a history of numerous acquisitions to build and support its family line of products. As we move towards a lower carbon future and increase demand for automated products and services, it is a good move that TTC has acquired TurfLynx and Left Hand Robotics to improve their innovation capacity in designing and manufacturing autonomous equipment.

For FY2022, TTC has a low cash balance of $188 million, which may impact its ability for future M&A considerations. Their cash flow from operations is $297 million, and the net debt has increased from $356 million in 2021 to $882 million in 2022, mainly due to the $400 million acquisition of the Intimidator Group in Q1 2022. Also mentioned in the earnings call, TTC spent $143 million in capital expenditures, made dividend payments of $126 million, and share repurchases of $140 million.

Excluding the acquisition, TTC does generate a healthy amount of cash flow from its operations and holds a good level of cash-on-hand, which can support the rising interest expense and provide financial flexibility to sustain the dividend and share buyback program.

Valuation and opinion

My valuation for TTC is based on TTC's financial statement and earnings forecast, and the data is driven by seeking alpha data. ( The Toro Company Earnings Report )

I think TTC is well-positioned to weather the weak economy. Given all the positive factors and future growth outlook are probably priced in, it will be challenging for TTC to outperform the current optimistic earnings forecast.

At the current price of $116, I would not define the stock as a "sell" rating, but I would like to point out that it is in an expensive price zone. I recommend long-term investors enter at a lower price point. However, I recommend reducing the position if you are already a holder.

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