Description

Background

• The Toro Company was founded in 1935 as a manufacturer of commercial tractor mowers and was quickly the #1 manufacturer of golf maintenance equipment and irrigation solutions in the world.
• There has been some recent management turnover, but with those positions filled internally. The CEO has been in his position since 2016 and became a director in 2022, prior to which he was the COO. The CFO was appointed in March 2023, and was previously the VP of construction after joining the company by way of the CMW acquisition in 2019.
• Total incentive compensation makes up 80% of executive compensation. The annual cash incentive is 19% of total compensation and is based on 50% adjusted EPS, 30% revenue growth, and 20% working capital to sales . Long term incentive is 60% of total compensation and is made up of the same performance measures, but on a cumulative basis over a 3 year period.
• Market cap of $9.4 B. Decent analyst coverage though primarily from boutique firms. Has corporate debt and a 10 year dividend history.

How do they make money?

Toro manufactures, markets, and sells turf maintenance equipment, irrigation systems, landscaping equipment, underground construction equipment, and snow maintenance and removal equipment to professional and residential customers worldwide under a range of brand names. Toro’s products mainly assist customers in maintaining outdoor spaces, but with a focus on niche applications.   

A significant percentage of Toro’s revenue comes from the park and land maintenance as well as the sports sector, including golf, soccer, baseball and multi-sport facilities such as schools. Toro sells products specifically for the golf industry, products specific to snow and ice removal, and is one of two suppliers of professional trencher and drill equipment used for laying water, gas, electric and fiber optic lines. Golf had been a much larger portion of the business historically, but has decline as the company has expanded into new end markets. Management estimates that 17% of revenue is tied to golf. The expansion of the breadth of their products has also helped to spread sales through out the year and reduce seasonality of traditional landscape equipment sales.

Toro has focused on expanding the professional segment which has led to expansion from 68% of sales to 76% over the past 10 years. The professional segment has higher margins and seemingly less volatile revenue.

The residential segment products are sold through home centers, hardware and other similar stores. Toro began selling their products at Tractor Supply in the Spring of 2020 and will begin selling at Lowes during 2024. At times, a single customer in the residential segment can be ~10-11% of total sales, but this is not the case every year. It is likely that large customer would be Home Depot (HD) who had been the company’s sole retail partner for a number of years.

The percentage of international sales has declined in recent years due to acquisitions with higher U.S. sales, but the company still employs a global manufacturing base. The manufacturing base generally handles final assembly of their products, but has also been expanded into strategic competencies such as injection molding.

The company believes that 90% of sales are driven by replacement demand. During an economic downturn customers could pause purchases, but it is believed that they replacement need would have to catch up later. This is driven by the fact that outdoor spaces need to continue to be maintained no mater the economic climate (grass continues to grow and needs to be watered). Also driving this is the focus on the professional segment, where equipment is used to complete work and sustain a business. The construction portion of the business may be more susceptible to economic downturns. However, the end customer in the niche construction industry that they service does not seem to be as cyclical as typical construction customers since they are typically in more utility-like industries.

Customers

End customers do not typically purchase directly from Toro, rather purchases are made through dealers, distributors, and mass retailers (primarily on the residential side). Toro has some customers they sell to directly, such as governments, rental companies, and large retailers.

Inventory financing for intermediaries (dealers, distributors, etc.) is primarily provided through their Red Iron joint venture[1] (TTC owns 45%) in partnership with Huntington Distribution Finance (owns 55%). Red Iron financed receivables to total sales of 61% during 2023. Toro also uses other third parties to assist customer in financing inventory. These financing arrangements include agreements for Toro to repurchase a maximum of $80 million or 12% of operating income, across all financing partners, of repossessed product in a given year.

End Markets

Golf (17% of revenue) has seen increasing popularity since COVID. The growth of golf rounds played has flattened out, but participation still remains elevated versus pre-COVID. From reading reports from industry trade groups and the like, the industry seems healthier than it has been in some time.   

Residential (25% of total sales) is driven generally by new homes built, consumer sentiment and replacement, and expansion of retail partners. Most recently, Toro expanded their retailer partnerships to include Tractor Supply which gives the brand further exposure to more rural customers.

The specialty construction and underground industry (23% of sales) is primarily driven by the Ditch Witch brand. There are a number of secular forces driving this market including the build out of 5G, hardening of the electrical grid (burying power lines), and general infrastructure build out aided by the inflation reduction act. For example, PG&E in California is looking to bury 350 miles of power lines in 2023, up from 180 miles in 2022, and continue increasing that number by 100 miles each year through 2026 in order to reduce wild fire risk and improve grid reliability. Toro is expanding their manufacturing footprint for underground construction equipment to capture increased demand going forward.

Grounds and landscape (37% of sales) are generally driven by replacement and expansion of the product lineup. This industry has high utilization of equipment as it is used to complete work that the professional is being paid for. Overall, the number of landscape companies is growing, which should translate into more sales and a growing install base for Toro. Also, engagement in outdoor sports and activity seems to be increasing at the current time.

Competition

Toro cites 50% market share in golf and 50% market share in underground construction, which are two of their three most important end markets (professional landscaping being the other). The Ditch Witch brand which serves the underground construction market is only 1 of two that serves the industry (Vermeer, private, is the other). The largest product category in their landscape business is the zero-turn mower where management believes that Toro has ~25% market share.

Toro competes against a number of different competitors. Many of their competitors are segments of a larger conglomerate like Husqvarna, John Deer, and others that focus a portion of their business on professional and residential grounds maintenance. One notable public competitor is a division of Stanley Black and Decker (MTD products) who owns the Cub Cadet, Craftsman, Troy-Built, and other additional brands. Management believes that they face more significant competition in their residential segment due to the lower barriers to entry.

The professional segment operates more through a distribution network (more than 150 of them) model that creates a higher barrier of entry for competitors looking to serve that market. 

Growth

Recent growth has been driven by net price increases as commodity costs increased. Steel is Toro’s largest commodity exposure. In a recent earnings call, management mentioned that they have generally been able to maintain price in the past and would only look to discount in special competitive situations.

Growth has been focused on the professional segment, which has led to a higher percentage of sales coming from that segment over the past several years. Over the past 10 years, sales in the residential segment have a CAGR of 4% while the professional segment has a CAGR of 10%. Outside of the normal replacement cycle for these machines, growth has been driven by acquisitions, expanding market share, and technology improvements. The percentage of net sales from new products introduced over the prior 3 years averages 35%.

Toro suggests that the replacement cycle for landscape contractors turf equipment is 3-5 years, and lease duration for golf equipment is 3 years. The Outdoor Power Equipment Institute suggests that residential mowers are replaced every 6 years on average. Golf course industry publications suggest that most equipment has an average replacement cycle between 5 and 8 years.[2]

R&D to sales has been about 3.5% on average and has not varied much from year to year. Recently, R&D spending has been focused on power conversion to battery, smart and connected products, and autonomous equipment. These elements then can be leveraged across their product lineup. Converting to battery power and expanding “smart” capabilities creates stickiness in the customer base and potential to expand their products with a customer. Batteries for one brand are not typically compatible with another brand without an adapter, but most brands allow for one battery to be used with a number of THEIR different products.[3] Also, with smart and connected devices, they all have to be the same brand to connect and operate in a cohesive manner. 

Recent autonomous and battery powered equipment could drive the next technology based replacement cycle. Autonomous equipment can assist professional purchasers reduce their labor costs. Industry research suggests that labor costs are ~80% of total maintenance costs for golf courses, whereas equipment is only 10%. Battery powered equipment will help reduce greenhouse emission and assist companies and communities with their climate goals. For example, running a lawn mower for 1 hour equates to the same emissions output as driving a car 300 miles.[4]

Most recently, the residential segment saw increased growth from adding Tractor Supply as a retail partner (generating significant sales growth from the sell-in to build up the retailer’s inventory) who will sell Toro residential products. Also, growth accelerated during the COVID period as more consumers focused on spending for the home. That growth has slowed and revenue has been declining for this segment during FY 2023 and has resulted in excess inventory (and associated lower cash flow).

Acquisitions

Acquisitions are more focused on the professional segment which typically has higher margins. The most recent notable acquisition occurred in January of 2022, Intimidator was purchased for $400 M which sells zero-turn mowers under the Spartan brand and integrated into the professional segment.

The other notable acquisition in the past several years saw the $700 M acquisition of Charles Machine Works (CMW), who manufactures and markets professional products that serve the underground construction market.

They have made small acquisitions that have been integrated into the residential segment, with most of them focused on automated machines and related technology.

Financial Strength

Overall financial strength is solid. The balance sheet is strong despite a recent $400 M acquisition. Cash to debt is 15%, maturities are wells spaced, debt to capital is below 50%, interest expense is above 10x and leverage is below 2x. Operationally, results have generally been strong, but cash flow was weaker in the past year due to increased inventory. Inventory build up was in part due to constrained component supply, which limited final product assembly. Supply chain disruption has eased resulting in more finished product inventory, but inventory remains high due to higher inventory of residential products as sales have declined and not kept pace with production completion.  

• As of FYE 2023 Toro had total debt of $1,032 million, leases of $132 million and cash of $151 million..
  • They have a $600 M revolver which was undrawn and typically is used for seasonal liquidity. 
  • The breakdown of fixed and variable rate debt as of the end of their fiscal year was 53% and 47% respectively.
  • The one covenant is tied to the private loans and are similar across different loans.
    • Maximum Leverage Covenant: 3.5x or 4x after an acquisition
    • Current Leverage: 1.6x
      • Management targets leverage between 1-2x
• Toro is rated BBB by S&P and BBB+ by Moody’s (upgraded on 2/28/2023).
  • Moody’s cites strong market positions, diversification of product and geography, and balanced capital allocation as financial strength positives.
  • Moody’s cites supply chain and inflation pressures, and seasonality as financial strength negatives.
• Bolt-on acquisitions are common. However, when Toro has completed larger M&A deals and leverage increases, they reduce debt for the next 2-3 years down to below 1x prior to looking for another larger acquisition. Over the past 5 years, the company has not breached the 2x leverage level.

Cash flow can be seasonal. Toro has lower cash flow from January to April as product is shipped to retailers, distributors and the like, with payments generally coming in from May to December for that inventory.

Capital allocation is generally balanced. They look for tuck-in M&A opportunities, with remaining capital returned to shareholders, which is often split somewhat evenly between share repurchases and dividends. Toro increased their annual dividend by 6% during the last year.

Risks

• Issues with water make people rethink having grass or have to switch to alternatives like astro turf.  
• Change in consumer interest and less interest in being outside and participating in sports.
• General cyclicality due to being in the capital equipment industry
• General seasonality. A continuation of less snow in the northeastern U.S.

Catalyst

Revival of spending from landscapers, greater apprecaition of the growth coming from the underground construction market, and an improvement in manufacturing utilization. Sell in to Lowes will help reduce some of the excess inventory.