2023-06-01 10:25:21 ET
Summary
- The Toro Company is experiencing strong revenue growth and increasing operating margins, driven by demand in the professional segment and efficient order backlog growth.
- TTC's financials appear robust, with a net debt/EBITDA ratio of 1.34 and a strong cash position, making it well-equipped to handle debt and engage in shareholder-friendly actions like raising dividends or increasing buybacks.
- The company's valuation appears reasonable, and I assign a buy rating based on current trends and forecasts, as well as its sound balance sheet and impressive margins.
Investment Summary
The Toro Company ( TTC ) is a company specializing in outdoor equipment and irrigation. With a focus on lawn care and maintenance, Toro offers a wide array of products such as lawnmowers, trimmers, blowers, and sprinkler systems. These products are carefully designed to improve the aesthetics and well-being of outdoor spaces.
Company Portfolio (Investor Presentation)
The first report to start off 2023 showed the company able to grow revenues even in a market where consumers are cutting out or minimizing excess or non-vital products and services. TTC was still able to grow the topline by 23% YoY, reaching $1.15 billion and an EPS of $1.01. This growth doesn't necessarily mean the company is a great deal now, but paying around 20x forward earnings for TTC, with the growth they have and the dividend yield I think is reasonable, and will be rating them a buy.
Outlook For The Market
The market that TTC operates in is expected to continue seeing strong demand for years to come. In a report by Grand View Research , they estimate the market to grow 6% CAGR between 2023 - 2030. One of the main drivers behind the growth seems to be the higher portion of elders we have in our society, paired with a higher life expectancy too. It leaves more room and time for people to spend time in their gardens or in other areas where perhaps tools that TTC supplies would be of use in my opinion.
Market Growth (Grand View Research)
Where TTC has set themselves apart in this market by being the only company that offers both equipment and irrigation solutions here. This gives them the benefit of having a wider array of products available for consumers, both segments go hand in hand creating a better catalog for customers and in turn, increasing the likelihood of higher spending.
Apart from this, the increase in government spending for infrastructure is creating a strong area of growth that TTC can tap into. Besides just the commercial side placing demand on the company, the government side creates a new opportunity for revenue growth. With TTC being specialized in underground equipment, they have the chance to land multi-year contracts where they supply products.
Company Position (Investor Presentation)
Looking at the full year for 2023, TTC expects the EPS to land between $4.7 and $4.9 per share, which would be an increase of around 14% compared to 2022 numbers. Growth like this is what seems to drive the valuation of the company. It's not that often you find solid earnings outlooks like this with a decent dividend and a history of buybacks too. The next few quarters will be key to looking at the growth of the margins. The company started off 2023 by growing operating margins from 32.2% in 2022 to 34.5% in Q1 2023, seeing if they can remain on this track will be interesting to watch.
Quarterly Result
As mentioned throughout the article already, TTC had a strong start to the year with revenues growing 23% YoY, and the operating margin growing too. The market share the company has managed to gather is seeming to pay off right now in big numbers. Looking at a comment by the CEO Richard M. Olson, he seems optimistic about the remained of the year, "Our momentum continues to be supported by the exceptional demand and substantial order backlog for products in key professional end markets, as well as the expected benefits from our pricing and productivity initiatives".
Earnings Highlights (Earnings Report)
Seeing that they are able to grow the order backlog efficiently is a nice added bonus in my view. It reaffirms the demand they are saying they are experiencing. One note however from the report that I reacted to is that the company is expecting supply chain issues to continue to ease which would help them both with growing revenues and increasing margins. I fear that if there isn't the betterment that they are hoping for then a compression in the share price might happen, given margin improvements are one of the drivers for the share price being this high right now in my opinion.
Growth Targets (Investor Presentation)
The segment that saw the most growth in the quarter was the professional segment, where the earnings grew 54.5% YoY. The growth was noted to be fueled by higher price realizations and better production for the quarter. Seeing that they are able to raise prices effectively is making the company even more appealing, as it really reaffirms their status in the market as a leader. With momentum expected to stay, I think if we don't see a noticeable QoQ increase in the coming quarter, then the valuation might need to be adjusted. But for that to happen, it seems supply chain issues will need to both persist and get worse. Demand is there and TTC is so far able to satisfy it.
Looking ahead, the company is reporting earnings quite soon, on June 8th . My expectations and hopes for the report are to see a clear increase in both the topline, but also the volumes the company is seeing. I think as the market is heading into the summer season, it will be easier to get rid of some inventory, but if there is a disturbance in the demand then I find it very likely the margins will take a hit. If TTC starts to struggle with getting their products sold, then I think we will need to revise the yearly guidance downwards a fair bit, and that will of course also drag the share price down with it. Topline estimates are at over $1.4 billion, and I honestly think anything under that is a big disappointment. EPS estimate at $1.52 I think is achievable if TTC can capture demand efficiently and keep a solid inventory turnover for the quarter.
Financials
Moving over to the financials of the company, they look robust and solid at first glance. The cash position may have decreased slightly on a QoQ basis, but not by an alarming amount. It sits at $174 million and can make a decent impact on long-term debts of just over $1 billion. This is usually a figure I look at first, if the company has a strong amount of cash that makes them able to handle debt, then that is a major perk and bonus to investing in the company.
The cash position is sufficient to pay off all the short-term lease liabilities if they wanted to. But could also use the nearly $100 million TTM levered FCF for it too. Which further puts the company in a flexible financial state.
The company has managed so far to gather a net debt/EBITDA ratio of 1.34. This is far below my threshold of 3 and, to me, it indicates they are unlikely to end up in a position where debt can be paid without the use of share dilution. This also means that shareholder-friendly moves like raising the dividend or increasing the budget for buybacks are more likely. For long-term positions, these are things I particularly look out for to make sure I end up with a quality company. With TTC, I see those qualities here.
Risks
Looking at some risks facing TTC is that inflation starts to pick up again and companies like TTC are forced to raise prices to battle it. I think that will alienate certain markets for TTC as Americans would stop spending on outdoor equipment if the prices keep increasing. It's not something essential and more of a luxury purchase than anything. Negative trends like that will halt any momentum the company has gathered so far as they will be forced to make sure inventory levels don't rise too much and become more of a liability than assets.
So far, though, the trend seems to suggest Americans are still spending a lot of money in this industry. The best indicator of the trend shifting however would be the company building up inventory in a quarter where they had a QoQ decrease in revenues. I think that would set my alarms off and force me to take a much closer look at what is happening.
Valuation & Wrap Up
Regarding the valuation of the company, I think they sit quite fairly valued right now. It offers good growth prospects and a solid dividend too. It's an interesting sector to be a part of, and I think TTC is where you want to be in that case. Paying about 20x forward earnings for a company growing above 10% is fine by me. They have already established a dividend and have a history of buybacks. Looking at another company that also gets similar exposure, we have The Scotts Miracle-Gro Company (SMG). Where I see more value had in TTC is firstly the lower FWD p/e they have. SMG may have a higher dividend yield at over 4%, but I think TTC will win out in the long run with its superior margins and its less leveraged balance sheet. With so much debt, SMG just won't always be able to dedicate FCF to shareholders as some of it will be needed to pay down current liabilities and share dilution to raise capital for a dividend is not a scenario I would like to see happen or risk being a part of either. The likelihood of a raised dividend for TTC feels much higher than for SMG because of this. Looking at just the margins of the companies, TTC wins out by a fair bit, with TTM gross margins of 33% against SMG's 25%.
As mentioned before, the larger catalog of products and markets that TTC are active in seems to be paying off greatly here, it has made them able to grow margins at a solid rate over the years. Even if TTC has a much higher market cap, SMG holds far more long-term debt, at nearly 3x as much, reaching above $3 billion. I think the financial flexibility of TTC is highlighted here and will give them a better chance to raise the dividend without risking dilution or destabilizing the balance sheet.
Looking at the history of the margins they have been on a very impressive climb in the last years and I think with the company established as a leader, maintaining these margins will be the next challenge. With that said, the coming years will be about scaling the business and keeping up with demand. The order backlog increasing steadily is reassuring that this trend is continuing. But to conclude, I am rating TTC a buy based on the trends seen already and what is forecasted. The company has a sound balance sheet and impressive margins, which I view to be possible to maintain.
For further details see:
The Toro Company: A Market Leader With Strong Margins