Despite a few dark clouds, prospects for major Canadian heavy-equipment distributors are good. In particular, securities analysts favour Vancouver-based Finning International Inc. because of its substantial exposure to the Canadian oilsands and mining in South America. But some analysts also are bullish on Concord, Ont.-based Toromont Industries Ltd. and Mississauga, Ont.-based Wajax Corp.
With concerns about China’s economy slowing, oil prices have fallen. But analysts don’t expect them to fall enough to cancel or delay energy and mining projects – unless there’s a global recession resulting from financial market turmoil caused by the European sovereign-debt crisis, something they don’t expect.
There has been some moderation in mining companies’ capital expenditures, spurred by investors’ desire for more discipline in those companies’ expansion activities, says Joe D’Angelo, portfolio manager with Signature Global Advisors, a subsidiary of CI Financial Corp., in Toronto. As a result, he thinks that there will be more capital spending in energy. However, he adds, mining companies are still “skewed for growth.”
Analysts also say that even though major government infrastructure programs aimed at stimulating their economies in the wake of the global credit crisis and recession are over or winding down, there are still lots of ongoing government and private capital-spending projects.
The big profits in heavy equipment are made by servicing the equipment, which has margins of around 30%; margins on initial sales are only in the mid-single digits, says Jason Moss, equities research analyst with Bissett Investment Management Ltd. in Calgary. Put another way, says D’Angelo, the revenue from servicing a product such as a 400-tonne truck, which would involve being rebuilt a few times over its 10- to 12-year lifespan, is likely to be around the $5 million-$6 million that was originally paid for it.
Both Finning and Toromont are exclusive dealers for Peoria, Ill.-based Caterpillar Inc. And Caterpillar’s 2011 purchase of South Milwaukee-based Bucyrus International Inc. is adding to Finning’s and Toromont’s product lines with surface and underground mining equipment that’s used in both oilsands and mining projects and not previously offered by Caterpillar. In fact, there’s little overlap between Bucyrus’s and Caterpillar’s products. Finning already has signed an agreement with Caterpillar to distribute Bucyrus’ products; Toromont is in the process of negotiating a similar deal.
The addition of Bucyrus’s products will be particularly important for Finning, given the latter’s large degree of exposure to the oilsands and mining, Moss says, as it increases the company’s ability to offer one-stop shopping – a major competitive advantage.
Wajax, for its part, sells other brands of heavy equipment as well as power systems (also offered by Finning and Toromont) and industrial services, including process and automation technologies.
Finning is by far the biggest company of the three, in both revenue and market capitalization; Finning’s market cap is $3.9 billion, vs $1.7 billion for Toromont and $845 million for Wajax. (Both Toromont and Wajax qualify for small-cap investment funds.)
Finning is international in scope, with operations in South America, Britain and Ireland, as well as in Alberta and British Columbia. Toromont is in Ontario, Manitoba, Newfoundland and parts of Labrador, and Nunavut. Wajax has operations in all of Canada’s provinces.
All three firms pay dividends and have a history of increasing them. Wajax’s is the most attractive, with a dividend payout ratio of 6.5%, vs 2.5% for Finning and 2.2% for Toromont.
Here’s a look at the three companies in more detail:
– finning international inc. is the world’s largest Caterpillar dealer, with exclusive rights in Alberta, B.C., Chile, Argentina, Bolivia, Uruguay, Britain and Ireland.
Finning generates about half its revenue in Canada – 49.9% in 2011. The company provides and services equipment for the oilsands, mining, construction, power systems (including for resources projects) and forestry sectors. A recent report from Finning notes: “Capital spending on new projects and mine expansions in the oilsands is expected to increase the mining equipment population by about 50% in the next five years.”
The company’s new, 16-bay service facilities in Fort McKay, Alta., which will increase its servicing capability, is expected to be completed by the end of this year. In addition, Finning’s new enterprise resource-planning system is expected to increase margins in the Canadian operations.
More than one-third of Finning’s revenue comes from South America (36% in 2011); its operations in the region began in Chile and the firm now also is active in Argentina, Bolivia and Uruguay. Finning also sells and services mining, construction and power-systems equipment in this region. The addition of Bucyrus’s equipment line is particularly important as Bucyrus had employed about 650 in South America who will now work for Finning. In contrast, Bucyrus’s staff count had been 250 in Canada.
Finning also operates in Britain and Ireland (14.1% of 2011 revenue), where the company is involved in coal mining, power systems and “rehandling” (recycling and waste management).
As a result of Finning’s large exposure to resources, the company’s revenue and earnings are particularly volatile – although somewhat less so than resources companies because of Finning’s large servicing business. For example, new product sales fell by 32.3% to $2 billion in 2009 from $2.9 billion in 2008, while servicing revenue was virtually unchanged during that period.
D’Angelo considers Finning’s current share price attractive, and many other analysts agree. This includes Moss, as well as analysts with Toronto-based Desjardins Capital Markets Inc. and TD Securities Inc. Analysts with both Desjardins and TD have “buy” recommendations on Finning’s stock. Desjardins’ 12-month target price is $33; TD’s, $36. The 172.5 million outstanding shares closed on June 8 at $23.76 a share.
A June 6 research report from TD notes the concerns about China’s slowing economy, but says Finning’s stock is “already discounting considerable downside risk.” The report also points out that Finning continues to experience “robust order intake and no unusual cancellation activity.”
Net income was $254.9 million on revenue of $6.1 billion for the year ended March 31, vs net income of $102.9 million on revenue of $4.9 billion for the corresponding period a year earlier. Finning had raised its quarterly dividend to 14¢ from 13¢ on May 8.
– toromont industries ltd. has exclusive rights to Caterpillar products in Ontario, Manitoba, Newfoundland and certain regions of Labrador and Nunavut. This is Toromont’s primary business, but it also has a successful refrigeration business involved in building skating arenas and industrial refrigerators. Toromont recently got a substantial contract with Maple Leaf Foods Inc.
Toromont’s long-term strategy includes increasing its exposure to mining. The company now is bidding on gold and iron ore projects in Ontario.
Catarina Prato, manager of AGF Canadian Small Cap Fund, sponsored by AGF Management Ltd. of Toronto, considers Toromont to be a high-quality Canadian company with an excellent management team that’s good at capital allocation and managing inventory.
TD analysts have a “buy” rating on Toromont’s stock, with a 12-month price target of $28, while Desjardins analysts rate the stock as a “hold,” with a target price of $23. The 77.5 million outstanding shares closed on June 8 at $21.20 a share.
Net income was $242.1 million on revenue of $1.4 billion for the year ended March 31, vs $110.1 million on revenue of $1.3 billion a year earlier. The company had raised its quarterly dividend to 12¢ from 11¢ on Feb. 24.
– wajax corp. About half of this company’s revenue comes from sales and service for the 15 brands of heavy equipment it sells; 25% from power systems; and 25% from industrial services, including process and automation technologies.
Marc-André Robitaille, president of Robitaille Asset Management Inc. in Toronto and portfolio manager of AGF Dividend Income Fund, prefers Wajax among the three distributors because its stock trades at a cheaper multiple than Finning’s and Toromont’s, even though Wajax has a higher return on equity and good growth prospects. “I prefer cheaper names,” he says, “because if [expected] growth doesn’t materialize, there isn’t as big a hit on these stocks.”
In fact, Robitaille considers Wajax to be in the “sweet spot” of mid-cap stocks, in which there’s usually a significant amount of dividend growth. Wajax, which used to be an income trust, pays a monthly dividend and had raised it to 27¢ from 20¢ on March 6.
Both Desjardins and TD analysts have 12-month price targets of $54 and rate the stock as a “hold.” The 16.9 million outstanding shares closed on June 8 at $50.30 a share.
Net income was $68.1 million on revenue of $1.4 billion for the year ended March 31, vs net income of $60.3 million on revenue of $1.2 billion a year earlier.
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