Summary
- Terex delivered better than expected fourth quarter earnings, with a double-digit operating income beat, and guided above expectations for FY23 with 6% revenue growth.
- I see some risk of turbulence in orders as non-residential activity slows, but underlying fundamentals are strongly supportive of demand for multiple years.
- Supply chain pressures, persistent inflation, and inefficiencies tied to shifting production to a new plant likely cap immediate margin leverage, but the longer-term outlook is stronger.
- I'm concerned industrial stocks have rallied too far, but I still think Terex screens out as undervalued and attractive for 2023 and beyond.
I thought Terex ( TEX ) stock was attractively undervalued coming out of its December analyst day , but I didn’t expect to see a one-third jump in the stock in just two months. Fourth quarter results and guidance were good, but not quite that good, though I do think this was a name where institutional investors needed some reassurance and Terex provided that. Moreover, other calls on 2023 have been generally benign to better than expected, laying the groundwork for higher base-case expectations.
Supply chain constraints are still a risk, as is the possibility of order turbulence further into the year. I believe Terex is looking at multiple years of strong underlying demand, but fleet operators sometimes focus more on short-term needs, and that can drive that turbulence. Terex isn’t as cheap as I’d like after this run, but a multiples-based valuation approach can still support the shares into the mid-$60’s.
A Nit Or Two To Pick, But A Fine Quarter
Margin in the aerial work platform business was a little lackluster and margin leverage is likely more capped than I’d like in the near term, but there wasn’t much else to complain about with fourth quarter results.
Revenue rose 23% as reported or 31% in constant currency terms, driving a strong 11% beat relative to Street expectations. The Materials Processing segment saw 32% constant currency growth, beating by 12%, while Aerial Work Platform also grew 32% and beat by 11%. Oshkosh ( OSK ) reported similar 29% top-line growth in its AWP business. While the Materials Processing business is more challenging to benchmark, I can point to Metso ’s ( OTCPK:OUKPY ) 9% growth in the quarter, Sandvik ’s ( OTCPK:SDVKY ) 7% growth in Mining & Rock Solutions and 5% growth in Rock Processing, as well as numerous companies’ commentaries on end-market demand in heavy off-road machinery, and say that Terex did quite well.
Gross margin rose almost two points from the year-ago level, but fell about two points sequentially to 19.3%, missing by 140bp as inflation remains stubbornly persistent (and/or sell-side analysts remain persistent in their optimism that it will ease). Operating income rose 73%, beating by 10%, or about $0.14/share, with operating margin up almost three points yoy and down about a point qoq to 9.9%.
Segment profits rose 60%, with margin up almost three points yoy and flat sequentially at 11.6%. Materials Processing profits rose 39%, beating by 14%, with margin up two points to 15.8%. AWP profits rose 113%, with margin up almost three points to 8%, but the beat here was a more modest 4% and margin was actually about 70bp shy of expectations.
Riding A Loaded Backlog Into 2023
Booking did decline very slightly in the quarter, but backlog grew 22% yoy and 4% qoq, with a 14% yoy and 5% qoq increase in the backlog intended to be delivered within 12 months. With this backlog in place, about 70% of 2023 revenue is already covered, and management guided to reassuring 6.4% growth at the midpoint of its range.
I do expect some order turbulence in the near term, and particularly in the aerial work platform space. While AWP fleets are still overaged (around 55 months versus a target range of 40-50 months) and deliveries disappointed in 2022, residential construction is weak and I expect non-residential to weaken in 2023 as well. Even though I think 2024 will be a stronger year for both, I could see fleet operators getting nervous later this year and pulling back on orders. On the other hand, given what the industry has experienced with product availability, they may place their orders and just “white-knuckle it”, afraid to lose their spot in the queue.
Production issues with Oshkosh and Terex have definitely led to a misshapen replacement curve for AWP, but I believe underlying demand should remain stronger a while longer. Up-cycles in this space are typically multiyear events (usually around three years), and I think that should support demand into 2024. I would also point to increased infrastructure and public works projects ramping up later in 2023 and in 2024 as a driver for ongoing growth.
Looking at the Materials Processing business, I have some near-term concerns about Europe and China that are macro-driven. China should have a backlog of demand given the pandemic disruptions, but those same disruptions continue to slow the recovery, while Europe is facing a more run-of-the-mill economic slowdown.
Beyond those near-term challenges, I think Terex is well-positioned for the next few years. I expect strong cement and aggregate demand in 2024-2026 on infrastructure projects and rebounds in residential and non-residential construction, and that should drive solid demand for over 60% of the segment. Likewise, I think healthy construction activity and ongoing utility demand will be good for the lifting business.
The one thing I don’t see is much operating margin leverage in the very short term. Supply chain issues and input cost inflation remain headwinds and I don’t think there will be much pricing power to offset that in 2023/2024. Terex is also going to be in the process of moving production to a new facility in Monterrey, Mexico, and while that should drive a couple points of margin leverage once it’s fully operational, it will be a drag in the near term that caps margin leverage.
The Outlook
With non-residential not falling off as much as I expected yet and management’s healthy guidance, I’ve bumped my FY23 revenue estimate by about 3%. I believe a lot of this is pulling forward demand, though, and I’ve basically neutralized the impact beyond FY’23, so my long-term revenue growth rate ends up at 3.5%. At this point I’m about $100M below management’s “$6B-plus” revenue target for FY’27 and I do see real opportunities for higher revisions on strength in both business segments.
Between this last year and FY25 I’m expecting about two to three points of EBITDA margin improvement and I’m fairly confident management can hit the lower end of its 13%-14% operating margin target for FY27.
I do still think that Terex can get to double-digit free cash flow margin over the next couple of years, but I don’t believe it is sustainable, and I expect long-term FCF margins to average out in the mid-single-digits. That still supports high single-digit long-term annualized growth, though.
At this point I still see upside from my discounted cash flow model, though I’d say Terex is more “fairly valued” than significantly undervalued. My multiples-based approach is more accommodating, though. Given the longer-term margin improvement I expect, the strong backlog, and where we’re at in the cycle, I’m comfortable bumping my forward multiple up by 0.5x to 9.25x, and that produces a $63.50 fair value on my FY’23 EBITDA number.
The Bottom Line
I don’t think investors should expect another 30%-plus move over the next two months from Terex. In fact, I do have concerns that the market has been a little too eager to accept the narrative that the economy is going to see a gentle landing in the third quarter and rally strongly after that. Given the set-up going into this downturn (high inflation, high inventories, supply chain issues, and so on), I do think there’s more downside risk in the macro outlook.
Still, I think there’s money yet to be made on Terex on the likely strength in multiple markets in 2024 and beyond, and I don’t think the shares have run beyond reasonable value yet, even if I do see more near-term sentiment risk for the sector.
For further details see:
Terex Enters 2023 With Strong Momentum, But Mind Some Of The Risks