This is my first attempt at writing a DD report. I hope it makes sense.
Just a few cautionary words:
- Grammar (and English in general) is not a skill of mine. There will be a few parts that you might have to decipher, good luck.
- I tried not to provide too much commentary and stick to the facts. I know you are spending your valuable time reading this and you probably don't want to listen to some random guy on the internet pontificate.
- For those of you who are easily offended/triggered, can't take a joke, or sarcasm isn't your taste, DO NOT click the spoilers.
Lastly, the following is just my findings, by no means is it a representation of all the information out there. It is just the baseline for me to have confidence in becoming an owner of the Company. Do your own due diligence or talk to a financial advisor to find what is best for you and your financial situation.
- Over the last 5 years the stock price has more than doubled.
- Toromont dominates market share over everything east of Manitoba in Canada.
- Customer base is heavily diversified, giving the Company many opportunities to expand into multiple industries.
- Dividend has increased for 31 consecutive years. It has been paid for 52 consecutive years
- The management team is extremely knowledgeable and have a good track record
Toromont Industries Ltd. (TSE:TIH) provides specialized equipment in Canada and the United States. The Company operates two business segments: The Equipment Group and CIMCO. The Equipment Group supplies specialized mobile equipment and industrial engines for Caterpillar Inc. (NYSE:CAT). Customers for this business segment vary from infrastructure contractors, residential and commercial contractors, mining companies, forestry companies, pulp and paper producers, general contractors, utilities, municipalities, marine companies, waste handling companies, and agricultural enterprises. CIMCO offers design, engineering, fabrication, and installation of industrial and recreational refrigeration systems.
The Company was founded in 1961 and operates out of Concord, Ontario. As at December 31, 2019, Toromont employed over 6,500 people in more than 150 locations across central/eastern Canada and the upper eastern United States.
The primary objective of the Company is to build shareholder value through sustainable and profitable growth, supported by a strong financial foundation.
Description of the 2 Main Business Segments
- The Equipment Group includes the following 6 business units:
- Toromont CAT: one of the world’s largest Caterpillar dealerships which supplies, rents, and provides product support services for specialized mobile equipment and industrial engines
- Battlefield Equipment Rentals: supplies and rents specialized mobile equipment as well as specialty supplies and tools.
- Toromont Material Handling: supplies, rents, and provides product support services for material handling lift trucks
- AgWest: an agricultural equipment and solutions dealer representing AGCO, CLAAS and other manufacturers’ products
- SITECH: provides Trimble Inc (NASDAQ:TRMB technology products and services. Trimble is a SaaS company that provides positioning, modeling, connectivity, and data analytics software which enable customers to improve productivity, quality, safety, and sustainability. Target industries: land survey, construction, agriculture, transportation, telecommunications, asset tracking, mapping, railways, utilities, mobile resource management, and government.)
- Toromont Energy: supplies, constructs, and operates high efficiency power plants up to 50 MW, using Caterpillar's leading power generation technologies. Toromont Energy operates plants that supply energy to hospitals, district energy systems, and industrial processes.
- Performance in this segment mainly depends on the activity in several industries: road building and other infrastructure-related activities, mining, residential and commercial construction, power generation, aggregates, waste management, steel, forestry, and agriculture.
- Revenues are driven by the sale, rental, and servicing of mobile equipment for Caterpillar and other manufacturers to the industries listed above.
- In addition, Toromont is the MaK engine dealer for the Eastern seaboard of the United States, from Maine to Virginia.
- MaK engine is a marine diesel engine manufactured by Caterpillar
- CIMCO is a market leader in the design, engineering, fabrication, installation and after-sale support of refrigeration systems
- Performance in this segment is dependent on the activity in several industries: beverage and food processing, cold storage, food distribution, mining, and recreational ice rinks.
- CIMCO has manufacturing facilities in Canada and the United States and sells its solutions globally.
- CIMCO services the ice rinks of 23 out of 31 NHL teams. So if you are watching a game and the ice is shitty, you know who to blame… the Ice Girls, obviously.
- For those of you who live in the GTA and have skated on The Barbara Ann Scott Ice Trail at College Park, the trail was created using CIMCO proprietary CO2 refrigeration technology.
CEO, Scott J. Medhurst has been with the company since 1988. He was appointed President of Toromont CAT in 2004 and he came into his current position as President and CEO in 2012. He is a graduate of Toromont’s Management Trainee Program.
CFO, Mike McMillan joined the executive team in March of 2020. His predecessor, Paul Jewer is retiring this year and has been working with McMillan during the transition period.
VP and COO, Michael Chuddy has been with Toromont since 1995.
On average, leaders have 29 years of business experience and have served at Toromont for 19 years. Seeing long tenures, good stock performance, excellent business planning and execution is usually a sign of strong leadership. In addition, insiders hold more than 3% (~$175 million) of the company’s outstanding shares. Medhurst owns more than 170 thousand shares, Chuddy owns just under 100 thousand shares and the former CEO and current Independent Chairman of Board of Directors, Robert Ogilvie owns more than 2 million shares, making him the 4th largest stockholder. High insider ownership typically signals confidence in a company's prospects. Compare this to Toromont’s main Canadian competitor, Finning, where insiders own less than 0.4% ($12 million) of the company (this number varies depending on where you look, I just took the highest one I found).
Recently insiders have been selling stock (Figure 1). I cannot speak to the reasons why insiders are selling but the remaining position owned by the insider is sizable and demonstrates that the executive still has confidence in the company. Some of the reasons insiders sell are: they don't believe in the company’s future, they need money for personal use, they are rebalancing their portfolio, among others. Figure 1: Buy and selling activity of insiders (the data is from MarketBeat, so take that for what it's worth).
On a somewhat unrelated but still related note, 50% of Toromont employees are also shareholders.
Toromont has five growth strategies (expand markets, strengthen product support, broaden product offerings, invest in resources, and maintain a strong financial position). I chose to focus on the following two strategies, as they seemed most prevalent.
- Expand Markets
- Toromont serves a wide variety of end markets: mining, road building, power generation, infrastructure, agriculture, and refrigeration. This allows for many opportunities for growth while staying true to their core competency. Further expansion into new markets doesn't require Toromont to build a whole new business model or learn the intricacies of the new industry because their products stays the same. Thus, the main concern is the application/selection of the products for the customer.
- Expansion is generally incremental. Each business unit focuses on market share growth and when the right opportunity presents itself, geographic expansion is archived through acquisitions.
- Strengthening Product Support
- In an industry where price competition is high, product support activities represent opportunities to develop closer relationships with customers and differentiate Toromont’s product and service offering from competitors. After-market support is an integral part of the customer's decision-making process when purchasing equipment.
- Product support revenues are more consistent and profitable.
Growth Through Acquisition
Rapid growth in this industry is generally driven through acquisitions. Toromont has gone through multiple acquisitions since the 90’s:
Acquisition of Hewitt Group of companies
- Acquisition of the Battlefield Equipment Rentals in 1996
- Toromont grew Battlefield from one location to 82 locations
- Acquisition of two privately held agricultural dealerships in Manitoba to form AgWest Equipment Ltd
- Acquisition of Hewitt Group of companies in Q3 2017 for a total consideration of $1.0177 billion
- $917.7 million cash ($750 million of which was finances through unsecured debt) plus the issuance of 2.25 million Toromont shares (equating to $100 million based on the 10 day average share price)
This acquisition allowed Toromont to make headway into the Quebec, Western Labrador, and Maritime markets, as Hewitt was the authorized Caterpillar dealer of these regions. Hewitt was also the Caterpillar lift truck dealer of Quebec and most of Ontario and the MaK marine engine dealer for Québec, the Maritimes, and the Eastern seaboard of the United States (from Maine to Virginia).
Toromont had total assets of $1.51 billion before the acquisition, the acquisition added $1.024 billion in assets, nearly doubling the balance sheet (look at Figure 2 for more details about the acquisition). Figure 2: (all numbers are in thousands) The final allocation of the purchase price was as of Dec 31, 2018, Note 25 of 2018 Annual Report. $1.024 billion was added to the Toromont’s B/S
Large acquisitions like this one can be the downfall of a company. Here are some of the risks highlighted by management at the time of the acquisition:
- Potential for liabilities assumed in the acquisition to exceed our estimates or for material undiscovered liabilities in the Hewitt Business
- Changes in consumer and business confidence as a result of the change in ownership
- Potential for third parties to terminate or alter their agreements or relationships with Toromont as a result of the acquisition
- Whether the operations, systems, management, and cultures of Hewitt and Toromont can be integrated in an efficient and effective manner
In 2018, the Company started and successfully completed the integration of the Maritime dealerships acquired through Hewitt under Toromont’s decentralized branch model (bottom up approach). Under a decentralized model, regional leadership make business decisions based on local conditions, rather than taking top down mandates. A bottom up approach is an advantage in businesses like Toromont where the customer mix can vary vastly from region to region. It allows for decision-making that is better aligned with customemarket needs and more attuned to the key performance indicators used to manage the business. In 2019, the integration of the decentralized branch model was implemented in Quebec after its success in Atlantic Canada in 2018. Successful integration of Hewitt into the Toromont family shows the depth of industry and business knowledge possessed by the management team. Being able to maintain inherited customer relationships and ensure low turnover is no easy feat. Many companies have completely botched these kinds of acquisitions. One that comes to mind is Sobeys (the second largest food retailer in Canada) acquiring Safeway for $5.8 billion. Three years later, they wrote off $2.9 billion as a loss because they did not anticipate the differences in consumer habits in Western Canada vs Eastern Canada, among other oversights.
The result of the acquisition and Hewitt’s integration with Toromont’s existing business produced a 39% increase in EPS in 2018 and 14% increase in 2019.
Toromont pays a quarterly dividend and has historically targeted a dividend rate that approximates 30 - 40% of trailing earnings from continuing operations.
In February 2020 the Board of Directors increased the quarterly dividend by 14.8% to $0.31 per share. This marked the 31st consecutive year of increasing dividends and 52nd consecutive year of making a dividend payment. The five-year dividend-growth rate is 12.09%. Table 1: Information about the last eight dividends
Risks/Threats and Mitigation Dependency on Caterpillar Inc.
It goes without saying that Toromont’s future is heavily dependent on Caterpillar Inc. (NYSE:CAT). For those who don't know, Caterpillar is the world’s leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives. It has a market cap in excess of $68 billion. All purchases made by Toromont must be made from Caterpillar. This agreement has been standing since 1993 and can be terminated by either side with 90 days notice.
Given that the vast majority of Toromont’s inventory is Caterpillar products, Caterpillar’s brand strength and market acceptance are essential factors for Toromont’s continued success. I would say that the probability of either of these being damaged to an unrecoverable point are low, but at the beginning of this year, I would have said the probability of the world coming to a complete stop was very low too and look at what happened. Anything is possible. The reason this is a major consideration is because it's a going concern issue. Going conference is an accounting term for a company that has the resources needed to continue operating indefinitely until it provides evidence to the contrary. This term also refers to a company's ability to make enough money to stay afloat or to avoid bankruptcy. If there was irrevocable damage to Caterpillar’s brand, Toromont is no longer a going concern, meaning the company would most likely be going bankrupt or liquidating assets. The whole Company might not go under because the CIMCO, SITECH, and AgWest business units would survive but, essentially ~80% of the business would be liquidated.
In addition to the morbid scenario I laid out above, Toromont is also dependent on Caterpillar for timely supply of equipment and parts. There is no assurance that Caterpillar will continue to supply its products in the quantities and time frames required by Toromont’s customers. So if there is supply chain shock, like the one we just saw, there is the chance that Toromont will not have access to sufficient inventory to meet demand. Which in turn would lead to the loss of revenue or even to the permanent loss of customers.
Again, both of these threats have low a probability of occurring but either could single handedly cripple Toromont’s business. As of now, Caterpillar continues to dominate a large market share (~38% as per Gurufocus) in the industry against large competitors like John Deere, CNH Industrial, Cummins, and others.
Caterpillar's stock has been on a slow decline for a couple years but that is due to reasons beyond the ones that directly concern Toromont’s day-to-day operations. I would say if you don't believe in Caterpillar’s continued market share dominance, investing in Toromont is probably not for you. Shortage of Skilled Workers
Shortage of skilled tradesmen represents a pinch point for industry growth. Demographic trends are reducing the number of individuals entering the trades, thus making access to skilled individuals more difficult. Additionally, the company has several remote locations which makes attracting and retaining skilled individuals more difficult. The lack of such workers in Canada has caused Toromont to become more assertive and thoughtful in their recruitment efforts.
To combat this threat, Toromont has/is:
- Recruited 303 technicians to achieve growth targets
- Created 208 student apprenticeship programs
- Working with 19 vocational institutions in Toronto to teach about best practices and introduce the Company as a future employer to students
As a result of these initiatives and others, Toromont saw their workforce grow by ~8% 2019. Growing the workforce is one of the primary building blocks for future growth. Cyclical Business Cycle
Toromont’s business is cyclical due to its customers' businesses being cyclical. This affects factors such as exchange rates, commodity/precious metal pricing, interest rates, and most importantly, inventory management. To mitigate this issue, management has put more focus on increasing revenues from product support activities as they are more profitable than the equipment supply business and less volatile. Environmental Regulations Affecting Customers
Toromont’s customers are subject to significant and ever-increasing environmental legislation and regulation. This leads to 2 impacts:
- Technical difficulty in meeting environmental requirements in product design -> increased costs
- Reduction in business activity of Toromont’s customers in environmentally sensitive areas -> reduced revenues
Threats such as these come with a business of this type. As an investor in Toromont, you can't do much to mitigate these kinds of threats because it's out of your hands. Oil and gas, mining, forestry, and infrastructure projects are major drivers of the Canadian economy, so I think there will always be opportunity for Toromont to make money, regardless of government action. Impact of COVID19
While the company had been declared as an essential service in all jurisdictions that it operates in, Q1 2019 results were lower as a function of COVID19 reducing activity in many sectors that Toromont services. Decline in mining and construction projects lead to a decrease in demand for Toromont products in the latter part of the quarter. Revenues were trending for 5-7% growth for the quarter before the effects of COVID19 were felt.
Management cannot provide any guidance on how to evaluate the impact of COVID19 on future financial results. They are focusing on ensuring the continued safety of employees and working with customers and the jurisdiction they operate in to evaluate appropriate activity levels on a daily/weekly basis. Lastly, management is keeping a close eye on how this crisis has led to an increase in A/R delinquencies and financial hardship for customers.
The Executive Team and the Board of Directors have taken a voluntary compensation reduction. Wage increase freezes and temporary layoffs have been implanted on a selective basis. Management believes that expanding product offerings and services, strong financial position, and disciplined operating culture positions the Company well for continued growth in the long term. Competition
Toromont competes with a large number of international, national, regional, and local suppliers. Although price competition can be strong, there are a number of factors that have enhanced Toromont’s ability to compete:
- Range and quality of products and services
- Ability to meet sophisticated customer requirements
- Distribution capabilities including number and proximity of locations
- Financing through CAT Finance
- E-commerce solutions
- Financial health
Main Competitor in Canada: Finning International Inc.
Finning International Inc. (TSE:FTT) is the world's largest Caterpillar
dealer that sells, rents and provides parts and service for equipment and engines to customers across diverse industries, including mining, construction, petroleum, forestry and a wide range of power systems applications. Finning was founded in 1933 and is headquartered in Vancouver, Canada.
Table 2: A quick comparison between Toromont and Finning.
| ||Toromont Industries Ltd ||Finning International Inc. |
|Market Cap ||$5.84B ||$3.02B |
|Price ||$65.66 ||$18.49 |
|Dividend Yield ||1.87% ||4.36% |
|Number of Employees ||>6,500 ||>13,000 |
|Revenues (ttm) ||$3.69B ||$7.57B |
|Trailing P/E Ratio ||19x ||11x |
|Price/Book ||3.71x ||1.35x |
|Profit Margin ||7.71% ||3.54% |
|Places of Operations ||Manitoba, Ontario, Québec, New Brunswick, Prince Edward Island, Nova Scotia and Newfoundland & Labrador, most of Nunavut, and the Northeastern United States ||British Columbia, Yukon, Alberta, Saskatchewan, the Northwest Territories, a portion of Nunavut, UK, Ireland, Argentina, Bolivia, and Chile |
I am sure there are some people looking at this table and thinking Finning looks rather promising based on the metrics shown, especially in comparison to Toromont. Finning’s dividend yield, P/E, and price/book look more attractive. Their top line is 2x. Not to mention it operates worldwide and is the only distributor in the UK, while Toromont only operates in half of Canada.>! Before you go off thinking “I need to use my HELOC to buy some Finning,” as some people on this subreddit are prone to do, ask yourself: do you see any cause for concern in the metrics listed above? !< One glaring question I have is: why is Finning trading at half of Toromont’s market cap given that it operates internationally and has twice the number of employees and revenues of Toromont?
Q1 2020 Financial Results
Figure 3: Q1 2020 Income Statement
Overall operating income, net earnings, and EPS all decreased even though Toromont saw an increase in revenue for the quarter compared to Q1 of 2019.
- All of these decreases were contributed to COVID19, as the pandemic lead to increases in costs
Historically, Q1 has always been Toromont’s weakest quarter. Q1 accounts for ~20% of yearly earnings and is consistently the least profitable quarter. Toromont’s profit margin generally ranges from 5%-9% progressively increasing into the later half of the year. This is good news for investors with the thesis that the economy will return to "somewhat normal" in the latter half of this year. The majority of the earnings for 2020 are still on the table for Toromont to earn. If current conditions persist, or there is a second wave and lockdown later in the year, we will most likely see a regression in Toromont’s growth to last year’s levels or even lower.
Assuming the world does return to “normal,” many of Toromont’s customers (especially in mining and construction) may try to catch up for lost time with increases to their operational activity, leading to an increase in Toromont’s sales for the remainder of the year. Of course this is a major assumption but it’s a possibility.
Below is a comparison of the last eight quarters. You can see the clear cyclical nature of their business. Figure 4: Last eight quarters of earnings
Sources of Liquidity Credit
- Toromont has access to a $500 million revolving credit facility, maturing in October 2022
- On April 17 2020 they secured an additional $250 million as a one year syndicate facility
- Cash increased by 22.6 million for the quarter
- Cash from operations increased 13% Q1 2020 compared to Q1 2019
- The company also drew $100 million from their revolving credit facility
- $4 million dollars of stocks were repurchased during Q1 2020
Given their access to $750.0 million dollars of credit and cash on hand equaling $388.2 million, the Company should have sufficient liquidity to operate if COVID19 and its aftermath persist for an extended period of time.
Financial Analysis Analysis of Debt
Historically, Toromont has had very low debt levels. The spike in late 2017 was due to the acquisition of Hewitt. Management paid off the debt aggressively in 2018. At the end of December 2019 Toromont had $650 million of debt maturing between 2025 and 2027. As a result of COVID19 the company has taken on more debt. This additional access to debt accounts of the slight uptick in historical debt in 2020 (Figure 5). Figure 5: Toromont’s historical debt, equity, and cash
The long-term debt to capitalization ratio is a variation of the traditional debt-to-equity ratio. The long-total debt to capitalization ratio is a solvency measure that shows the proportion of debt a company uses to finance its assets, relative to the amount of equity used for the same purpose. A higher ratio means that a company is highly leveraged, which generally carries a higher risk of insolvency with it.
The debt-to-equity ratio is at 47% and debt-to-capitalization ratio is 32%, Toromont has $388 million in cash that could be used to pay down debt by nearly 50% and bring the net debt-to-equity to 23% and net debt-to-capitalization to 18%. As mentioned before, management is holding on to cash to insure sufficient liquidity during these times.
The implication of these ratios is that Toromont does not take on large amounts of debt to finance growth. Instead the Company leverages shareholders equity to drive growth.
For comparison, Finning has a debt-to-equity ratio of ~100% (it differs between WSJ, 99%, and Yahoo Finance, 101%). The nominal amount of their total debt is ~$2.2 billion, which gives them a long-term debt to capitalization ratio 62%. Finning carries $260 million in cash. Figure 6: Toromont’s debt-to-capitalization and debt-to-equity ratios Profitability Ratios
Return on equity (also known as return on net assets) measures how effectively management is using a company’s assets to create profits.
Toromont’s return on equity is generally around 20%. Go to Figure 6 to look at the ROE for the last 4 years. In comparison, Finning has had a ROE of ~11% for the last three years, about 3% in 2016 and a negative ROE in 2015 (as per Morningstar).
Return on capital employed (ROCE) tries to find the return relative to the total capital employed in the business (both debt & equity less short-term liabilities). Toromont’s ROCE (ttm) for March 31 2020 was 22%. This means for every dollar employed in the business 22 cents were earned in EBIT (earnings before interest and tax). Finning had a ROCE of 11% as of December 2019. Liquidity Ratios
Working capital is the amount of cash and other current assets a business has available after all its current liabilities are accounted for. In the last ten years, Toromont’s working capital has fluctuated between 1.6 at its lowest (2018) to 2.8 at its highest (2016). At the end of 2019 it was at 1.8. Meaning current liabilities equate to 60% of current assets.
Interest coverage ratio is used to determine how easily a company can pay their interest expenses on outstanding debt. Toromont has an interest coverage ratio 15x (as per WSJ). Finning on the other hand is at 4x. At this point I feel like I'm just beating up on Finning. For those of you who made it this far, I have to admit something to you. This whole post is just a facade to ask you a question that has never been asked on this subreddit before: Should I buy BPY.UN? It keeps going down and I'm worried if I buy it, it will keep going down and I'll lose money. I don't want to lose money. Although if you go through my post history, you'll see I've been looking at/buying penny stocks.
Key Performance Measures
Below is a chart with key financial measures for the last four years. A few things I want to highlight:
Figure 7: Summary of key financial measure for the last four years
- Toromont had large capital expenditure last year (most of it went to increasing inventory) so they have the choice to keep capital expenditure down this year and preserve cash
- From the start of 2018 (aka end of 2017) to the end of 2018 Toromont stock was down about 3% while the TSX Composite was down more 12% and S&P was down 7%. This stock has a history of out performance not only on the upside but also on the downside. I'll go into a bit more detail in the next section.
Price Chart Comparisons
I don't do technical analysis. To those who do, good luck to you because let's be real, you'll need it.
This section is just to get an idea of past performance and evaluate the opportunity cost of investing in Toromont compared to a competitor or a board based index fund.
I thought it would be easier to look at pictures as opposed to reading a bunch of numbers off a table.
For the sake of not creating a picture album of screenshots, I just looked at charts for the last 5 years. If you're interested in looking at different time intervals you can do so on google finance.
Figure 8: Five year price chart of TIH v. FTT
- Toromont Industries Ltd v. Finning International Inc.
These are the only two Caterpillar distributors on the TSX, making them direct comparisons. If I was looking for exposure to this industry, I would be choosing between these two companies (on the TSX anyways). There isn't really much to evaluate here. It's like they saying: “A picture is a thousand words,” or in this case, it's 128%. If you have time, go look at the graph from August 1996 to now. I can safely say it hasn't been much of a competition. Toromont has outperformed by ~2500% in stock price appreciation alone. If you're a glass half full kind of person, I guess you could look at this disparity as Finning having enormous upside. LOL
Figure 9: Five year price chart of TIH v. VFV
- Toromont Industries Ltd v. S&P 500 Index
If I'm not buying individual stocks, I’m buying the S&P 500 and to a lesser extent a Nasdaq index fund. This gives me a second look at the opportunity cost of my money. The story is not as bad as the Finning comparison. If you had bought $100 dollars of Toromont stock 5 years ago, it would have turned into $207 today, whereas the same $100 dollars in VFV would have became $157.
Just a quick aside, you can see the volatility in Toromont’s stock is much higher compared to the VFV. VFV has a relatively smooth trend upwards while Toromont trends upwards in a jagged path. This is the risk of single stocks, they move up and down more erratically, leading inventors who don't have a grasp of the business or conviction in their pick to panic sell or post countless times on Reddit asking why their stocks keep going down. “I bought the stock last week and it's done 3% already, do you guys think it’s going bankrupt? I thought stonks only go up???”
Figure 10: Five year price chart of TIH v. ^TTIN
- Toromont Industries Ltd v. S&P/TSX Capped Industrials Index
The S&P/TSX Capped Industrials Index isn't my favourite comparison for Toromont because its constituents cover many industries ranging from waste management (WCN), to railways (CNCP), to Airlines (AC, lol, had to mention it. I miss the days when there were double digits posts about AC. I wonder where those people have gone, because I can tell you where AC stock has gone... absolutely nowhere).
Regardless, I used TTIN because I deemed it a better comparison to Toromont than the entire TSX. The story is on par with the other two comparisons. Toromont’s out performance is significant.
I just threw this bonus chart in here because when I saw it, I was like BRUHHH (insert John Wall meme)… It's completely unsustainable but that's impressive given the vast differences between the two.
Figure 11: Five year price chart of TIH v. ZQQ
- Toromont Industries Ltd v. NASDAQ-100
Now, of course, past performance does not dictate future results and all that good stuff, but it really gets you thinking about how the rewards disproportionately favours winners compared to the overall market. People are generally happy getting market returns (i.e. the just buy VGRO people)
but being able to pick even a few winners really pays. This reminds me of the Warren Buffet quote: “diversification is protection against ignorance.” The context of the quote is that if you are able to study a few industries in great depth and acquire a wealth of knowledge, you can see returns astronomically higher than those who diversify across the board market. The problem then becomes you put yourself at risk of having all your eggs in one basket. Look at what's happening with Wirecard in Europe right now. This is why the real skill in investing is managing risk.
Analyst Price Targets and Estimates
The prince targets set for by analysts range from $63-$81. The average price target is ~$72, with the majority of targets within the 70-$71 range. Given the current price of $65.66, there is a ~10% upside. These price targets haven't changed much due to COVID19 even though revenues and EPS forecasts have been downgraded for 2020. The consensus estimate on 2020 revenues is $3.36 billion, down from the actual revenues of $3.69 billion in 2019 and the consensus EPS for 2020 is $3.01 down from actual EPS of $3.52 for 2019 and $3.10 for 2018. The fact that revenues and EPS forecasts have been downgraded, yet price targets remain untouched, for the most part, indicates that the effects of COVID19 are expected to be short-lived. Figure 12: Earnings and estimate ranges for Toromont. Note: EPS numbers in this graphic are diluted EPS numbers.
Assuming P/E ratio stays the same as it has been for the last 12 months (~19x) and EPS goes down to ~$3.00 (as per analyst consensus), the implied price would be $57.
Using the last 12 months of revenues, the EV-to-Revenues ratio is at 1.56x. Assuming that ratio stays the same and with revenues estimated to be ~$3.36 billion, enterprise value (EV) comes out to $5.2416 billion. Using Q1 2020 figures for shares outstanding (82.015 million), cash ($388.182 million), and debt ($745.703 million), the implied price for a share is $58.94*. \
Note: Enterprise Value is equal to market cap plus total debt minus cash.) Dividend Discount Model
The dividend discount model (DDM) is a method of valuing a company's stock price based on the theory that its stock is worth the sum of all of its future dividend payments, discounted back to their present value.
The average dividend growth rate is 12% for the last 5 years is 12%. There is no way Toromont can increase the dividend at this pace in the long term, thus, I chose a long term dividend growth rate of 5%. This is the assumed rate in perpetuity. The required rate of return will equal WACC, 6.85% (averaged from 2019 Annual Report). The dividend over the last year is $1.16 (two payments of $0.27 in 2019 and two payments of $0.31 for 2020).
The fair value equals $65.84. Figure 13: DDM calculation.
There is no doubt that Toromont trades at a large premium. The current P/E is 19x and the CAPE ratio (Shiller P/E) is 26x. The fair value of the Company as per Morningstar research is in the mid $60 range.
Based on all valuations I did and analyst price targets, I would start buying in the high $50 range or maybe the very low $60 range, but my belief in the company has to do with long term thematic trends and how the Company operates, rather than today's price. Although I have to admit, the price does look more attractive now than it did in the beginning of June when the stock hit new all time highs. It seems like the only companies hitting new all time highs these days are tech companies, so it's refreshing to find a non-tech company achieving the same feat.
Toromont is not going to double next year or the year after that. It is a relatively low margin business, with slow growth and a cyclical business cycle. I like that the Company has strong financials, low debt, and good management. They don't take shortcuts or unwarranted risk. Future growth will mostly be driven through acquisition, but management is cautious with acquisitions and don't overextend themselves. One of the biggest problems Finning has been facing for the last couple years is political and social turmoil in South American countries which is affecting their mining clients and thus affecting revenues/margins.
The Q2 earnings are reported on July 22 202. We should have a clearer picture on the prospects of the Company from management. Hopefully we have a better idea of the COVID19 situation by then too. Regardless, I think the company is in a position where its services will always be in demand so short term fluctuations are not something that shake my confidence in this pick.
Limitations and Further Areas of Research
By no means is this an exhaustive due diligence report. This is enough for me to feel confident in the business and its trajectory. Limitations/further areas of the research include:
- Looking into the growth of each sector Toromont services and extrapolating that growth to calculate Toromont’s future growth opportunity.
- As per IBIS Research the heavy equipment rental market in Canada is ~$8.3 billion. It grew 1.1% yearly for the last 5 years.
- The US market is estimated to be $47 billion, with an average growth of 2% for the last 5 years
- Sorry but I couldn't get my hands on future projections as each report is $750
- More research into competitors
- I chose to include Finning only for simplicity’s sake. But there are many other competitors like:
- United Rentals (NYSE:URI) provides similar services to Toromont/Finning in 49 U.S. states, 10 Canadian provinces, Puerto Rico and four European countries. The only thing being they aren't distributors for Caterpillar.
- Rocky Mountain Dealerships Inc (TSE:RME) sells, leases, and provides product and warranty support for agriculture and industrial equipment in Western Canada
- Holt Cat, N C Machinery, Ziegler CAT (none of these companies are publicly traded)
- Further analysis can be done on the B/S and accounting treatments.
- The effects of automation in the industry
- Distributors in the US have started working with industrial automation companies to provide autonomous construction equipment on rent to contractors
- Sunstate Equipment Co.'s partnership with Built Robotics
- I was not able to do a discounted cash flow, which would be critical to finding the intrinsic value for Toromont and having true confidence in the company and its trajectory.
- Further analysis of CIMCO and prospects of future growth
- Based of the financials, CIMCO seemed like a small part of the business, which is why I mainly focused on the Caterpillar dealership side
These are not all the limitations or areas of further research, they are just the glaring one that came to mind.
>! I know I took a few shots at people in this post. It's all in good jest. If you're offended well.... maybe you should be. I don't know, you have to figure that out on your own or you could make a post on Reddit asking random people on the internet whether you should be offended or not. !<
Remember I'm not an expert, I'm just a random guy on the internet.
I am long Toromont. This information is not financial advice. Please do your own research and/or talk to a financial advisor. All data provided is current prior to the market opening on June 29, 2020. Inconsistencies in data can be due to many reasons, the foremost being that data was spruced from multiple different websites.