Description

Terex Corporation (TEX US)

Terex is a lifting a materials handling company with five divisions:

1.)  Aerial Work Platforms: designs, manufactures, services and markets aerial work platform equipment, telehandlers and light towers.  Products include portable material lifts, portable aerial work platforms, trailer-mounted articulating booms, self-propelled articulating and telescopic booms, scissor lifts, telehandlers and trailer-mounted light towers as well as their related components and replacement parts. Customers use these products to construct and maintain industrial, commercial and residential buildings and facilities and for other commercial operations, as well as in a wide range of infrastructure projects. This business is largely driven by

2.)  Cranes: designs, manufactures, services, refurbishes and markets mobile telescopic cranes, tower cranes, lattice boom crawler cranes, lattice boom truck cranes, utility equipment and truck-mounted cranes (boom trucks), as well as their related components and replacement parts. Customers use these products primarily for construction, repair and maintenance of commercial buildings, manufacturing facilities, construction and maintenance of utility and telecommunication lines, tree trimming and certain construction and foundation drilling applications and a wide range of infrastructure projects.

3.)  Material Handling and Port Solutions: designs, manufactures, services and markets industrial cranes, including universal cranes, process cranes, rope and chain hoists, electric motors, light crane systems and crane components as well as a diverse portfolio of port and rail equipment including mobile harbor cranes, straddle and sprinter carriers, rubber tired gantry cranes, rail mounted gantry cranes, ship-to-shore gantry cranes, reach stackers, empty container handlers, full container handlers, general cargo lift trucks, automated stacking cranes, automated guided vehicles and terminal automation

technology, including software, as well as their related components and replacement parts. Customers use these products for lifting and material handling at

manufacturing, port and rail facilities. Our MHPS segment also operates an extensive global sales and service network.

4.)  Material Handling and Port Solutions: designs, manufactures and markets materials processing equipment, including crushers, washing systems, screens,

apron feeders, biomass and hand-fed chippers and their related components and replacement parts. Customers use these products in construction,

infrastructure and recycling projects, in various quarrying and mining applications, as well as in landscaping and biomass production industries.

5.)  Construction:  designs, manufactures and markets two primary categories of construction equipment and their related components and

replacement parts:

• Compact construction equipment, including loader backhoes, mini and midi excavators, wheeled excavators, site dumpers, compaction rollers, skid steer loaders and wheel loaders; and

• Specialty equipment, including material handlers, concrete mixer trucks and concrete pavers.  Customers use these products in construction and infrastructure projects, in building roads, bridges, residential and commercial buildings, industrial sites and for material handling applications.

Looking at the company overall, the business mix is

35% nonresidential construction

16% residential construction

11% port equipment

16% industrial

12% service and

10% other.   

From a geographical standpoint, the business is

41% North America

31% Western Europe

12% Australia and Asia

6% Latin America and

10% other.   

When looking historically at Terex’s business both from both a segment and geographical standpoint we draw the following conclusions:

From a geographical standpoint, it is clear that

• The US has been steadily recovering.

• Europe is still close to the trough, while

• Australia and Brazil have come down significantly due to exposure these economies have to commodities. While there is no doubt the commodity supercycle is over, we think most of this is behind us for Terex, as their Australian and Brazilian business are done massively over the last few years (brazil down over 90% in AWP for instance).  

When looking at the various segments, 4 out of the 5 segments were below average cycle levels in 2014.   Starting with cranes, the segment did $86 million in EBIT in 2014, while it did $402 million in 2008. The business has grown through acquisitions, but even if we don’t account for this, the lowest level of earnings over the last 14 years was in the recession of 2002, when it did $25.4 million.  

Simplistically, this puts average cycle earnings of this segment at $214 million or 250% above the 2014 level.  The construction business has been restructured over the last few years, but it generated only $1 million in 2014, with some loss making pieces having been sold. Outside of the extraordinary collapse in 2009 due to heavy writedowns and massive inventory destocking, this business has done between $16 and $60 million per year. Given the changes to the business, we estimate this business does a modest 3.5% normalized EBIT margin, generating EBIT of $30 million.   The material handling and port solutions did $58 million in EBIT in 2014. This business is predominantly the Demag Cranes business acquired in 2011 (industrial cranes, port cranes and services).  When looking back at Demag’s financials we see that this business is close average cycle (5 million above). The business did $100 million in 2008 but only $6 million in 2010).  These numbers understate the cash earnings of this business, given the close to 50 million in annual goodwill amortization expense Terex incurs.  This is an important point as the $482 million that Terex reported in adjusted EBIT in 2014 on a consolidated level, are really $532 million once we back out the non-cash amortization.  The materials processing segment generated $60.5 million in EBIT in 2014, which is $13.3 million below normalized levels (did $190 million in 2006 but lost $42 million in 2009). While the business does have some scrap still exposure, the business is very leveraged to cement, aggregates and building materials. It is therefore no surprise that the peak in this business was in 2006, with the peak of US housing.

Finally, the AWP business is the one that is above average cycle, but we think far from peak, as suggested by the sceptics.  AWP did $303 million in 2014, but lost $140 million in 2009, for an average cycle of $164 million. Given the secular growth in some of the new markets due to safety standards, I think this average cycle number is too low, but for argument’s sake let’s leave it at $164 million.  While many analyst have talked about how this business is back to peak, this is clearly not the case.

Here is why:

1. Regulatory changes have increased pricing for AWP equipment from 15% to 30% since the last peak so despite the North American revenues from AWP being close to peak levels, units is meaningfully below.

2. Rental companies (main customer segment) have been much less aggressive this cycle than in prior cycles and therefore carry fleets, that while younger than during the recession, are barely back to average levels.  In this business, at the peak for the equipment makers, the rental companies carry a fleet whose age is significantly below normal so they can age the fleet in the downturn allowing them to survive.   The fleets in Europe are extremely old by any standard and the companies there have recently started to replace equipment despite the European economy not having seen much of a recovery in construction.  The businesses outside of US and Europe are clearly close to trough as shown by their Brazilian business, were sales are down over 90%.

3. Among the rental customers, the big national chains are the first ones to invest in equipment, so while companies like URI are talking about flat capex in North America, the smaller independent players are much earlier in their investment cycle.  I suspect, AWP will be flat to down maybe 5% only given the still reasonably elevated ages of the fleet, while the European business should slowly accelerate and the other market slowly come off the trough. Given that the US business is over 50% of this segment, I assume that the whole segment can be down a little bit. The company claims, the cost initiatives they are implementing will allow them to post flat EBIT in this segment even if the top line falls 5% to 10%.

Doing a straight normalization of all the divisions, we get to $510 million in adjusted EBIT, up from the $482 million in 2014. However, given the decline in the EUR and the near term headwinds in oil and gas (in AWP and cranes, although the adjustment in the field is done according to their customers).  Let’s assume that the $28 million of upside to normalized levels gets whipped out by the currency headwind (it may be slightly higher than this near term, but over time the weaker EUR should be a positive for Terex as it has 30% of the sales in Europe but over 50% of the cost base is in Europe. This should mean that while negative, the company’s improved cost position should allow for higher margins largely offsetting the initial translational headwind.  However, let’s assume that the 2014 adjusted EBIT number is a fair reflection of average cycle earnings (although I think the bias is to the upside).  Given the weak macroeconomic environment, the company has announced cost cutting initiatives of $202 million to be completed over the next two years, but for now we are not including any of these savings in our numbers. Before we move on to discuss the recently announced merger with Konecranes, let’s look at the Terex story standalone.  $482 million in EBIT, which using the most recent share count and interest expense (both have been falling as a result of share repurchases and debt repayments/refinancing) translates into about $2.35 in EPS (assuming 32% tax rate).  Once we add back the $50 million in goodwill amortization for the Demag acquisition (46 cents per share) we get to $2.82 per share.  Remember that this is before we give the company ANY benefit for the cost savings. The cost savings would add $1.27 per share if they were all delivered and retained.  However, to be conservative let’s assume that none of the cost savings materialize, so EPS is $2.35 or Cash EPS is $2.82.  While there are many reasons why a cyclical construction business should trade at a discount to the market, let’s be conservative and give it a 12x multiple. This would result is $28 per share in you use book EPS and $34 per share if you use cash EPS. Obviously, if they were to get the cost savings, then the standalone numbers would be much higher ($43.5 and $49.0 respectively). Remember this is using what we believe is normalized numbers. If the economy were to really start recovering (residential and non-residential and likely to continue to strengthen despite EM weaknesses, and the secular trend toward port automation by the port operators to save labor costs should continue despite a weak macro backdrop. Industrial cranes should also finally inflect, particularly in Europe, given

1. European capex/sales is at 30 year low.

2. Manufacturing now more competitive in Europe due to the EUR weakness.

3. Industrial cranes demand usually inflect when industrial utilization hits 80% to 82%, and it hit 81.8% in Europe last quarter.

Now let’s move to the merger. Terex announced in early August that it was merging with Konecranes, a finnish manufacturer of port cranes and industrial cranes. Konecranes shares many similarities with Terex’s MHPS division.  One of the differences is that Konecranes service business is much larger as a percentage of EBIT, being currently 2/3 of the business. The service business has been much more stable than the equipment business and the installed base of customers has been steadily growing. While some customers are still deferring service work, the service EBIT is as high as it was in 2007 despite the service base being 50% higher. This means that once the macro environment stabilizes a little, there should be significant upside to service revenue.  Konecranes equipment business is still at trough levels, given the hesitation by customers to spend capex given the global uncertainty. The equipment business did 46.7 million EUR in 2014 (lowest in 10 years) while it did 194 million EUR in 2008.  While it has some process equipment business that is sensitive to commodities (already very depressed) the bulk of the business is driven by port equipment and industrial manufacturing levels. As I mentioned earlier, industrial cranes demand has historically inflected at 80% utilization, and we are just crossing above that now.

The merger is a stock deal where each holder of a share of Terex will receive 0.8 shares of Konecranes. The new company will be listed in the US and Finland. Before the strategic benefit to the deal (significant synergies in this type of deal) there are two quick benefits to Terex shareholders:

1. Konecranes pays a significantly higher dividend yield, so PF for the deal, Terex will pay a 95 cent dividend or 5.6% yield at the current share price.

2. Konecranes carries very little debt on its balance sheet so as part of the deal, $1.5 billion of stock will be bought back to bring the combined company to 2.3x net debt / EBITDA. Given the massive recent selloff in the shares of Terex, this translates into buying back 79 million shares at current prices. So Terex has 108 million shares outstanding, which turns into 87 million shares (0.8 shares of new shares for each old share).

So assuming that the shares that are bought back are the Konecranes shares (if I was Terex I would buy the Terex shares back because they trades at over 10% discount). As per the merger presentation / documents, before the buyback, using the 2014 actual financials, the combined company did $371 million in Net income.  We discussed earlier how we believe for Terex 2014 was a good proxy for average cycle earnings. As for Konecranes, we believe 2014 below average cycle, maybe to the tune of 15% given the growth in the installed base of service contracts and the trough level of the equipment business. However, to be conservative, let us assume that it is a fair reflection of average cycle EBIT. Terex’ MHPS business is not as well managed as the Konecranes business, with lower margins and significantly lower service earnings.  It was due to the opportunity to run Demag (the vast majority of Terex’ MHPS business) better, that Konecranes tried to buy Demag when Terex bought it in 2011.  We believe the synergies are very significant because beyond purchasing, SG&A, logistics, etc, there is a big opportunity to increase service earning on the MHPS side.  

Terex and Konecranes management guided to $119 million of after-tax synergies, quite a reasonable number given a revenue base of $10 billion. If we simply take the $371 million of 2014 combined net income, add the $119 million in after-tax synergies and subtract $105 million for additional interest expense due to the buyback, we have an adjusted net income number of $385 million. Remember, this does not include the $137 million of after tax cost savings that Terex has guided to. There is also a smaller cost savings plan that Konecranes standalone has been guiding to but this is less than 20 million after tax. In any event, we are not including either of these cost savings plans. In terms of the share count we have $145.2 million (58.4 million Konecranes shares plus 86.8 million Konecranes shares issue to Terex shareholders) before the stock buyback. The $1.5 billion share repurchase at the current Konecranes price (as I mentioned earlier Terex should buy back its own shares more aggressively now given the discount to the deal price), buys back 79 million shares, which leaves us with PF share count of 66.3 million. The $385 million in PF net income divided by the 66.3 million shares gives us $5.80 per share in EPS. The $50 million in non-cash amortization would now add 75 cents due to the lower share count, so cash EPS is $6.56.  If we wanted to be less conservative and add in the cost savings from Terex of $137 million after tax or $2.07 per share, we would get to $7.87 in EPS or $8.63 in cash EPS.  Obviously adding in the Konecranes savings would increase the numbers further. The point here is that at the current share price of $16.90, you get a 5.6% dividend yield and own the stock at 2.6x cash EPS or 2.0x cash EPS including the Terex cost savings. Given that this number is slightly below average cycle, this makes very little common sense. Terex was already cheap when they announced the transaction and the stock went from $22 to $27, but the latest selloff due to global concerns and Konecranes guidance of flat earnings (remember we are using 2014, so flat earnings is what we have), plus incremental tax selling has taken the stock to a level where it should never be. Clearly, people seem to be forgetting that by taking the stock down another 37% since the day after the deal was announced allows the company to buy back that much more stock with its $1.5 billion share repurchase program. With a majority of the business in the US and Europe, with close to 25% of the business being service, which is pretty stable, with a 5.6% dividend yield, this stock has no business trading at 2x cash EPS.

Catalyst

1. High likelihood of new high caliber CEO announced as Terex CEO’s contract is ending
2. Closing of the deal which will allow Terex stock to screen with dividend yield above 5%
3. Industrial crane markets improving as industrial utilization is crossing 80%
4. AWP markets re-accelerating as excess equipment from oil and gas has now been absorbed (URI commentary of latest conference)
5. Crawler Crane market finally improving due to inflection in downstream chemical projects in the US gulf coast finally breaking ground while tower cranes improve with non-residential construction