Cabot Small-Cap Confidential Issue: March 2, 2023

The Big Idea

There have been three important recent acts of legislation that suggest multi-year growth for companies involved in building out U.S. infrastructure, manufacturing capacity and clean energy capacity.

First is the Infrastructure Investment and Jobs Act (IIJA). Weighing in at $1.2 trillion this act includes over 10,000 projects ranging in size from $100K to $3 billion.

Roughly 80% of the funds apply to roads and bridges, electric power grid, rail/transit/airports, broadband and water/sewer/environmental projects.

These projects are expected to start between 2023 and 2025.

Takeaway: a lot of demand for diggers, dump trucks, aerial lifts, materials processing equipment, etc.

Second up is the Chips and Science Act. Weighing in at $280 billion the legislation is aimed at boosting American semiconductor R&D and manufacturing.

Tax credits are part of the program, as is almost $40 billion in direct funding for U.S. semiconductor manufacturing. Projects must start by December 2026.

Takeaway: lots of demand for the same type of equipment as for the IIJA, just more specific to commercial construction.

Last but not least is the Inflation Reduction Act (IRA). Weighing in at $738 billion the act authorizes $391 billion in spending on energy and climate change.

Part of this means adding around 300 gigawatts of new solar generation by 2030. That’s three times what we currently have. Another part is building 13 electric vehicle and battery factories, at an average cost of $3.5 billion.

Takeaway: you get the picture.

The bottom line is the U.S. is investing a ton of money into infrastructure. And we’re not alone. Other countries are doing the same thing.

One way to gain exposure is to buy shares in boring, old-school, picks-and-shovels-type companies.

That’s what we’re doing today.

Specifically, I have a small-cap industrial company that is growing, pays a dividend and is trading at a discount to peers even though it is the market leader in several categories of the coveted materials processing market.

The Company

Terex (TEX) is a manufacturer of capital equipment used in construction, maintenance, manufacturing, energy, recycling, minerals and materials management applications.

The biggest markets are North America (56% of 2022 revenue), Europe (22%) and Asia/Pacific (17%). The company works with customers through the entire product life cycle, from initial specifications and financing to parts and service.

Big picture, Terex offers investors exposure to massive investments being made in global energy and infrastructure markets as companies and countries jockey for competitive advantage and try to get on a path of more efficient and sustainable development.

Terex management says they see the company as being particularly well-positioned to grow from infrastructure investments (nearly $50 trillion being invested through 2030), electrification (250 million EVs set to hit the roads in coming years), waste and recycling (a $220 billion market by 2027) and digitalization (a $350 billion market by 2030).

The company has a market cap of $4 billion, pays a dividend of 1% and grew 2022 revenue by 14% (to $4.4 billion) and EPS by 41% (to $4.32).

At the end of the year, backlog (firm orders that are expected to be filled) was $4.07 billion, up 22% from a year ago. That suggests Terex’s business should continue to do well in 2023.

TEX stock looks fantastic. That said, it may look a little too good! We’ll start with a half-sized position to give us some wiggle room should TEX pull back.

Products

Terex has three segments; Materials Processing (MP), Aerial Work Stations (AWS) and Other (financing, leasing, used sales, etc.).

Materials Processing

The Materials Processing (MP) segment includes equipment used in processing aggregate material for construction industries as well as equipment used in infrastructure, recycling, mining, landscaping, biomass production, and material handling industries.

Think of things like crushers, material screens, trommels and feeders, washing systems, conveyors, concrete mixer trucks and wood/biomass chippers and grinders.

A few of the brands in this segment include Terex, Powerscreen, Fuchs, EvoQuip, Cedarapids, CBI, Simplicity, Franna and MDS.

Materials Processing generates about 60% of Terex’s profits.

In 2022 the MP segment grew revenue by 14.8% to $1.94 billion and operating margin expanded 1.1% to 15.8%. Backlog at the end of 2022 was $1.17 billion (+12%).

Aerial Work Platforms

The Aerial Work Platforms (AWS) segment includes equipment used to get people and materials safely up in the air. In many cases, they are a far better option than a ladder (for people) or a bucket/pulley system (materials).

This equipment is used to build and maintain industrial, commercial and residential buildings/facilities as well as utility and telecommunication lines. It also includes equipment for tree trimming, foundation drilling applications and various other infrastructure projects.

Think of things like trailer-mounted, self-propelled and portable aerial lifts and telescopic booms, scissor lifts, material lifts, insulated aerial lifts, and telehandlers. The major AWS brands are Terex and Genie.

United Rental (URI) and Herc Rental (HRI) are highly visible Terex AWS customers, given their expansive rental fleets.

In 2022 the AWS segment grew by 14% to $2.48 billion and operating margin increased 0.9% to 7.9%. Backlog at the end of the year was $2.9 billion (+27%).

Growth Initiatives

Leverage Megatrends: Terex is well-positioned to capitalize on big-picture trends, including infrastructure spending, electrification/utility growth, materials processing, etc. These are the big trends that management needs to go after for TEX stock to do well.

Execution: Yes, operational efficiency is boring to talk about, but when you build heavy equipment, it matters a lot. Especially when you have a history of missteps. Terex has been doing much better than in the past, and continued cost management coupled with efficiency gains should do wonders for investor confidence.

Innovation Investments: There is a lot of room for innovation when it comes to moving people and heavy things around. Specific examples are in robotic recycling and vessel-mounted material handlers. Expect more updates on innovation in the coming quarters.

Tracking to Debt-Free Affords Flexibility: Exiting 2022 Terex’s net debt is $471 million ($776 million gross debt minus $304 million in cash) implying leverage is about 1.0x. The company is on track to be debt free by mid-2024.

Return Cash to Shareholders: With free cash flow also tracking above expectations ($152 million in 2022 and guidance for $225-$275 million in 2023) there appear to be opportunities for more cash to go to shareholders in the form of dividend increase (recent 15% increase) and/or share buybacks ($97 million in 2022).

Acquisition Potential: With balance sheet flexibility, Terex also has the potential to acquire assets. The 2022 acquisitions of Steelweld (heavy fabrication manufacturer in Ireland), ZenRobotics (recycling robotics) and ProAll (mobile concrete mixers) are examples of tuck-in acquisitions we should expect to see more of.

The Business Model

Terex designs and manufactures equipment at multiple facilities around the world, primarily in the U.S., Europe and Asia/Pacific. Depending on the end market, equipment is distributed to a global network of independent distributors, to rental companies and/or directly to customers. Terex is intently focused on providing equipment to customers that help them generate positive return on invested capital (ROIC), i.e., over the life cycle of the equipment customers need to make money with Terex machines.

The Bottom Line

Despite continued supply chain challenges, Q4 2022 (reported February 9) revenue grew 23% to $1.2 billion (31% after adjusting for foreign exchange) and adjusted EPS was up 63% to $1.34. Gross profit margin grew 1.9% to 19.3% versus Q4 2021, showing that Terex is controlling costs.

Full-year 2022 revenue grew by 14% to $4.4 billion while EPS grew 41% to $4.32. Sales in North America were up 18%, Europe was up 11%, Asia/Pacific was down 8% and the Rest of World was up 41%.

The company returned $132 million to shareholders in 2022 and recently increased the quarterly dividend by 15% ($0.02) to $0.15. Investors that own the stock by March 9 will receive this dividend, which is payable on March 20. I expect more dividend increases in the coming quarters. The stock’s current annual yield is about 1%.

At the end of 2022 backlog was up 22% to $4.1 billion (roughly 70% of guided revenue).

Turning to 2023 guidance, management has guided for revenue of $4.6 billion - $4.8 billion (+6.4% at the midpoint), operating margin of 10% to 10.4% (up from 9.5% in 2022), EPS of $4.60 to $5.00 (up 12.3% at the midpoint) and free cash flow of $225 million to $275 million (+65% at the midpoint).

It’s hard to complain about any of those numbers, and the trends suggest Terex should do better in anything but a hard-landing scenario.

Risk

Recession: A widespread, hard-landing recession scenario would be bad for infrastructure stocks, including Terex, potentially somewhat offset by major infrastructure spending bills.

Cost & Labor Inflation, Supply Chain Issues: As a global manufacturer Terex faces parts and labor shortages/cost increases. While it is managing well so far, execution will need to be very good for the company to meet demand and for investors to maintain confidence in the stock.

Residential Spending Slowdown: Terex has some exposure to residential construction and this bears watching. However, it also has exposure to commercial construction, infrastructure stimulus, material processing and more, so some residential slowdown shouldn’t be a major concern.

Foreign Exchange (FX): Management assumes a couple percentage points of FX headwinds in its 2023 guidance, offset by some price increases. Where this ultimately lands is anybody’s guess, but suffice it to say significant FX headwinds would be challenging.

Competition

There are a lot of competitors in Terex’s various industries. A selection of the better-known ones includes Deere (DE), Caterpillar (CAT), Sandvik, Matec, Bandit, Astec Industries (ASTE), Skyjack, Oshkosh (OSK), Altec, Dur-A-Lift and CNH (CNHI).

The Stock

Trading Volume: TEX trades an average of 780,000 shares daily. We shouldn’t move the stock.

Historical Price: TEX has been around for a while and has had its fair share of ups and downs. A few years prior to the pandemic (in 2017) the stock peaked at 50 and was in a multi-year downtrend prior to the pandemic, after which it fell to a low of 11.5. By May 2021 TEX was near 55. That was a multi-year peak, and shares drifted lower, ultimately bottoming near 26.6 in July 2022. After bouncing around a little, TEX took off last fall, consolidated in the 40 to 47 range through the end of the year then got moving higher again in 2023. The stock has been consistently trending higher since and broke through the May 2021 high of 55 with barely a pause.

Valuation: TEX currently trades at 11.2-times estimated 2024 EPS of $5.32. That’s lower than the long-term average forward PE multiple of 13, and well below the multiple range of 13x – 14x that DE and CAT trade at. This implies multiple expansion potential for TEX if/as fundamentals and execution continue to improve and share buybacks are announced (hopefully).

Buy Range: Expect to buy in the 55 to 65 range within the next month. BUY HALF

The Next Event: Nothing on the calendar until Q1 2023 earnings around April 28.

Current Recommendations

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.

Glossary

Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.

Disclosure: Tyler Laundon owns shares in one or more of the stocks mentioned. He will only buy shares after he has shared his recommendation with Cabot Small-Cap Confidential members and will follow his rating guidelines.

The next Cabot Small-Cap Confidential issue is scheduled for April 6, 2023.