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[Note:  my share count converts the $172 million of convertible debt and my debt numbers correspond to that adjustment.]

 Though the next year will probably continue to be awful, Terex is selling for less than 7 times my estimate of mid-cycle earnings power.  Though you would not know it from their last quarterly release, not to mention the liquidity crunch they had last summer, the company will soon be debt free, with a net cash position of $200 million.

 Terex competes with Caterpillar in a number of heavy equipment segments (mainly roadbuilding) and are a solid #2 in a number of categories.    They are global, with less than half of sales in the U.S.  They have a large Aerial Workplatform business which is just getting killed right now where they are #2 globally (30%+ market share).  Terex's crane business leads in certain segments (including port equipment) though there I would call them a #2 or #3 competitor.  They just exited their mining business.  End markets are commercial construction, roadbuilding, infrastructure, oil & gas, 10% residential construction.

 I found the idea a month ago when Terex announced the sale of its mining business in December for $1.3 billion ($1 billion net proceeds).  That is kind of interesting for three reasons.

• 1) They had net debt of about $800 million (I have the $172 million convertible that was debt in the Sept. quarter in my common share count). Now they are about to have cash greater than debt.
• 2) The mining business was only about 15% of their historical revenues and profitability (and hardly a great business, though probably would have been their best one in 2010). Net proceeds were 32% of enterprise value at today's stock price (before taking out the $1 billion of proceeds).
• 3) It is very rare to see a management sell a business simply because they got a great price. Though I'm sure it annoyed the sell-side types that Terex sold the one business that was starting to recover, it looks like a great deal for shareholders provided they reinvest the proceeds wisely. Terex management is known as very acquisitive. With this deal they proved that they understand they have a sell button on the controller as well.

 It sounds like they may use the cash to acquire, not necessarily in their core businesses.  That certainly bears watching, though they have been pretty sensible buyers in the past and the kinds of things they are looking at are probably a buyer's market now.

Here are the basic historical numbers pro-forma for what is left after the mining business is sold:

                                                             Revenues                      EBIT

 2004                                                    4,593                           193

2005                                                    5,659                           325

2006                                                    6,814                           616

2007                                                    8,004                           842

2008                                                    8,416                           663

 2009 9 mos YTD                                 2,976                           (253)

 [We can add to this the Fantuzzi port equipment business that they acquired (stole?) in July.  That had over $600 million of revenues in 2007, the only data they have disclosed.  Though revenues have fallen a lot since 2007 and the business is losing money at the moment, they paid a very small multiple of those 2007 revenues.]

Clearly this is a business that benefited from the global commodities boom in 2005-mid 2008 just like Caterpillar.  It is trading at about 4x peak after-tax earnings.  Caterpillar looked very interesting last summer trading at 5.5x peak earnings, and looks reasonably cheap to me still even after its big move though that is outside the scope of this writeup.  [the two stocks would be an interesting Graham-like comparison.  Both earned $5-6 per share at peak, now one is trading for 53 and the other for 19.  I fully understand CAT is a much better business - I own that too - but the two stocks side by side are interesting nonetheless.]

 Revenues are down more than 50% year over year - 2009 was not a good year to be selling construction equipment to say the least.  They have been producing somewhat below retail demand as many of their core rental customers stopped ordering and decided to just age their existing fleet.  They took inventory on their own balance sheet down by $500 million year to date, but the inventory on dealer lots and rental yards matters more in a business like this than the inventory the investor can see.  I would guess they still have too much in the channel.  [note, this is not like Deere or Cat with a captive dealer network, though that is part of their business.  Their biggest customer is rental fleets.]

Cash flow has been roughly breakeven if you ignore tax noise.  Change in working capital has roughly funded the big loss on a free cash flow basis, which is about all you can ask for in a year like this.

They have no finance subsidiary but are on the hook for various guarantees and residual value promises to the tune of $450 million.  This number, while bothersome, doesn't look big enough to hurt as a) it is not going up the last couple quarters and b) these are secured by equipment and customer solvency so it would be extraordinarily unlikely that potential losses would be anywhere close to that notional value number.

Their end markets are later cycle - I would guess about six months to a year later than CAT's.  A lot more commercial construction which is not getting better any time soon.  Not much U.S. housing, so you are not going to get a big pop there - that was roughly 10% of sales when times were good.  They sold the mining business which was already starting to bounce back.  Road paving is a good chunk of end demand which does not look like a quick recovery either.  Stimulus spending should benefit them in a number of businesses, and we would expect to see that coming in the next couple quarters.  But I expect them to lose money again in 2010.

Management called the inflection point in the 3Q.  They say orders have stabilized, inventory is getting toward where they want to be, and they are confident the sickening plunge has ended.  However, management is downplaying any expectations of profitability in 2010.  I think they are hoping for breakeven, but without the mining business I would guess they could lose $50 million.  Though that is considerably below current estimates, I think that looking at this year's number is missing the point.  The stock is very cheap looking out 2-3 years and now that they have a debt free balance sheet, if somebody wants to sell this down to 15 again because they take down 2010 guidance I would be happy to take some shares off their hands.

Valuation:

Average revenues for the five years before the disaster in 2009 were $6.7 billion, with an average margin of about 8% (525 EBIT).  Let's add to that $400 million of future Fantuzzi sales (2/3 of peak) at a 6% margin ($25 million more EBIT) and that gets us to the 550 range for EBIT ($350MM after tax or about $3.00 per share.)   If we call that "earnings power" - some years its much higher, some years its much lower - we have a debt free company trading at less than 7 times mid-cycle earnings, and 4 times prior peak.

Enterprise value/mid-cycle sales = about 30%.

For what its worth (and obviously I don't put a lot of weight on this number) management argues that Terex could earn $6 per share in the next up cycle.  That would be nice, but I'm not banking on that any time soon.  I will just point out that that number is out there, and demonstrates the kind of operating leverage this business has off a bottom even with an overcapitalized balance sheet.

Neither my numbers nor management's $6 number include acquisitions which management might do with their newfound cash.  Effectively I am assuming they pay down all their debt.  If they can reinvest that cash at above after tax interest I guess that would be accretive to my numbers.

Though I see no reason to get excited about Terex in the next 12 months except the valuation, looking out a few years it is not at all hard to see this trading in the low 30s or higher.  If 50% gains haven't gotten a lot harder to come by for you lately, you're playing ball on a different field than I am.

[The views expressed are those of the author and do not necessarily represent the views of any other person. The information herein is obtained from public sources believed to be accurate, reliable and current as of the date of writing.  The author will not undertake to supplement, update or revise such information at a later date.  The author may hold a position in the securities discussed.]

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