$47.26
ALL NEW COMMENTS SINCE LAST UPDATE ARE HIGHLIGHTED
Overview
Headquartered at Westport, CT, Terex Corporation (TEX) is a manufacturer of equipment for the construction, infrastructure and surface mining industries. The Company is building a franchise under the Terex brand name. Its products are manufactured at plants in the United States, Canada, Europe, Australia, Asia and South America, and sold through a distribution network serving the global construction, infrastructure and surface mining markets. Terex operates in five business segments: Terex Construction, Terex Cranes, Terex Aerial Work Platforms, Terex Mining and Terex Road building, Utility Products and Other. The company’s website is http://www.terex.com/.
TEX is a play on an economic recovery, as its key end markets of construction, mining and road building are inextricably linked to an economic recovery. Analysts believe that the investment attractiveness of TEX will depend on (a) Extent of an economic recovery-which will drive sales growth of TEX’s key operating segments and (b) Ability to substantially improve segment operating margins from the current levels over the next 2-3 years.
Positives / NegativesEnd market recovery & market share gains are likely to propel sales and operating profit growth over the next 2 years. Some analysts have started becoming more positive on TEX’s mining, construction and AWP businesses driven by strengthening economy. They expect mid teen sales growth in these businesses over the next 2 years accompanied by expansion in margins to drive EPS above management’s estimated forecast. TEX also has set itself an ambitious target of increasing segment OP margins to 10% from the current levels of 5%-6% by 2006. Analysts remain divided on this issue. / Some analysts are a bit skeptical of improvement in business conditions over the near term. Over the longer term too they regard management’s intention to achieve considerable margin improvement as ambitious.
High cash generation will perhaps propel financial de-leveraging in 2005. Some analysts also believe that TEX has the highest FCF yield amongst peer group.
Analysts reckon that valuations should improve as business fundamentals improve and TEX meets its debt reduction target. Also some analysts believe that reduced acquisition activity (which dismayed investors in the past) could also expand valuations as investors become more comfortable with TEX’s organic growth.
Analysts concur that higher order activity seems to suggest improved business conditions. The analysts also believe that price increases and cost cutting will begin to bear fruit in 2005, leading to improvement in both sales and margins.
Sales
Our consensus model projects sales of $4.9 billion (26.2% y-o-y) and $5.4 billion (10.7% y-o-y) in 2004 and 2005 respectively.
Sales summary as projected by the consensus model
Table 1 ($$ mm)
3Q04A / 4Q04E / 2004E / 1Q05E / 2Q05E / 3Q05E / 4Q05E / 2005E / 2006ENet Sales / $1,252 / $1,268 / $4,900 / $1,203 / $1,496 / $1,357 / $1,444 / $5,426 / $5,604
Digest High / $1,252 / $1,368 / $5,000 / $1,203 / $1,496 / $1,357 / $1,444 / $5,611 / $5,700
Digest low / $1,252 / $1,132 / $4,764 / $1,203 / $1,496 / $1,357 / $1,444 / $5,168 / $5,508
Digest Average / $1,252 / $1,268 / $4,900 / $1,203 / $1,496 / $1,357 / $1,444 / $5,426 / $5,604
In 3Q04, Terex reported better than expected revenue growth of 38%. Revenue growth was helped by volume/pricing, which contributed 29% of the growth, currency 5% and acquisitions 4%. Backlog is up 100% y-o-y.
TEX operates five business segments:
Construction (33%): The segment includes mobile crushing and screening businesses, compact equipment, heavy construction and scrap handling. Demand is inextricably linked to end markets of commercial and non-residential construction, which is linked to the overall health in the economy. Revenue in the third quarter increased 36% y-o-y to $419 million. Excluding the benefits of currency translation, revenues were up 28%. Sales growth was driven by almost 50% growth in the compact equipment business and improvement in mobile crushing and screening equipment.
Cranes (21%): Crane segment sales totaled $269 million, up 14% y-o-y. Excluding benefits from foreign currency translation, sales still increased 9.3% y-o-y, helped by gains in tower cranes and boom trucks, which were partially offset by continued weakness in the North American crane market.
AWP (18%): The business primarily caters to the rental market. In the third quarter, sales increased 56% y-o-y to $236 million, benefiting from the replacement cycle and strong demand from rental customers.
Mining (13%): Demand is essentially linked to conditions prevailing in commodities such as coal, iron ore, metals, etc. In 3Q04, net sales of $160 million were up 71% from the prior year. Management attributed the better results to increased activity from surface mining customers, and strong demand for certain crusher and screener products.
Road Building & Utility (15%): In the segment, Terex reported 58% growth in 3Q04 over the prior year to $190 million, but acquisitions (Tatra and ATC) added roughly 27% of growth. The company expects to see improving performance in this segment as these end markets recover.
Analysts assume at least modest revenue gains to continue in 2005. The company noted that businesses to which 35% of its revenues are linked (road building, heavy construction, utility, and North American cranes) are yet to accelerate and poised to do so in 2005.
Division wise consensus sales model
Table 2 ($$ mm)
2003A / 2004E / 2005E / '04 to '06 CAGRFY / FY / FY
Construction / $1,360 / $1,765 / $1,906 / 6.5%
Year over Year Growth / 14.4% / 29.8% / 8.0%
Cranes / $1,005 / $1,075 / $1,139 / 2.1%
Year over Year Growth / 42.1% / 7.0% / 6.0%
Mining, Road Building & Utility / $981 / $1,338 / $1,502 / 9.0%
Year over Year Growth / 16.1% / 36.3% / 12.3%
Aerial Work Platforms
/ $602 / $916 / $1,053 / 9.6%Year over Year Growth / 367.9% / 52.1% / 15.0%
Please refer separately saved spreadsheet for more details.
Margin
Our consensus model projects operating margins of 5.2% and 6.4% during 2004 and 2005, respectively.
Margin summary as projected by the consensus model
Table 3
Margins
/ 3Q04A / 4Q04E / 2004E / 1Q05E / 2Q05E / 3Q05E / 4Q05E / 2005E / 2006EGross / 13.9% / 12.3% / 14.2% / #DIV/0! / #DIV/0! / #DIV/0! / #DIV/0! / 12.5% / #DIV/0!
Operating / 4.8% / 4.5% / 5.2% / 4.6% / 8.9% / 7.1% / 5.7% / 6.4% / 7.9%
Net / 2.6% / 1.8% / 2.5% / 1.8% / 4.9% / 3.5% / 2.7% / 3.3% / 4.6%
In the third quarter, overall operating margin of 4.8% was slightly lower than the 5.0% reported in 3Q:03. The decrease is primarily due to higher steel costs in the quarter, which added an additional $31mn to the company’s costs, and negatively impacted margins by 2.5%.
Construction (33%): Operating margin was flat y-o-y at 4.9%, due to on-going margin pressure from steel price increases (particularly in the heavy construction equipment business) and unfavorable currency translation. However, the crushing and screening business remained strong and light business was solid. Analyst (CSFB) expects 8% operating margin in the segment by 2006.
Cranes (21%): Operating margins in the segment was the weakest, declining from 2.9% to 1.6% y-o-y, citing not just cost pressures but also competitive pricing pressure. To offset the impact of higher steel and tire prices, Terex will initiate a 4%-6% price increase effective November 1, and will also be adding surcharges for certain components. Analyst (CSFB) anticipates 7% operating margin in 2006, the bulk of which will be internal.
AWP (18%): In 3Q04, operating margin slipped one percentage point to 10.7%. TEX announced its intention to implement a 6% price increase on all AWP products shipped on or after January 1, 2005 in order to recoup the margin points lost due to steel price increases. Analyst (CSFB) expects operating margins in 2005 and 2006 to be 13% and 14% respectively, which according to him could be lower by 1-2% in each year if the pricing holds.
Mining (13%): Mining & Materials Processing was the only segment with improved operating margins in 3Q04, up from 4.7% to 5.6%. Analyst (CSFB) expects business to be booming and anticipates 7-8% margins going forward; with the shortages of trucks and shovels out there, and believes that pricing should not be an issue.
Road Building & Utility (15%): In the third quarter, segment operating margin was 1.6%, down 1% y-o-y. The lower operating margin reflects supplier cost pressures, higher commissions and lower profitability at Tatra. Analyst (Morgan Stanley) expects the business to turnaround in 2005.
Division wise consensus operating profit/margin
Table 4 ($$ mm)
2003A / 2004E / 2005E / ’04 to ’06 CAGRConstruction / $62 / $87 / $123 / 30.7%
Margins / 4.56% / 4.93% / 6.45%
Cranes / $33 / $30 / $43 / 56.2%
Margins / 3.28% / 2.79% / 3.77%
Mining, Road Building & Utility / $34 / $42 / $72 / 57.7%
Margins / 3.47% / 3.14% / 4.79%
Aerial Work Platforms
/ $70 / $102 / $141 / 22.9%Margins / 11.63% / 11.14% / 13.39%
Please refer separately saved spreadsheet for more details.
Earnings Per Share
TEX’s third quarter EPS of $0.65 (up 94.4% y-o-y) was above most of the broker’s estimates and consensus. The out performance was due to a surprisingly lower tax rate in 3Q04, which benefited earnings by $0.16 per share in the quarter. Higher steel prices negatively impacted EPS by $0.40.
The management raised its 2004E EPS guidance from $2.25-$2.45 to $2.40-$2.50 because of lower expected tax rate. Most of the brokers have also raised their 2004 EPS estimate due to the same reason.
Management reiterated its 2005 guidance of $3.40 - $3.60 which, according to the analyst (Lehman Brothers), sounds somewhat back end loaded as it will take time for volume and pricing improvements to impact bottom line.
EPS Table
Table 5
3Q2004A / 4Q2004E / 2004E / 1Q05E / 2005E / 2006EZacks Consensus / $0.46 / $2.46 / $0.56 / $3.48 / $4.91
Digest High / $0.65 / $0.52 / $2.54 / $0.56 / $3.53 / $5.06
Digest Low / $0.65 / $0.38 / $2.40 / $0.40 / $3.40 / $4.75
Digest Average / $0.65 / $0.45 / $2.47 / $0.46 / $3.47 / $4.95
Management EPS guidance / $2.40 - $2.50 / $0.34 - $0.50 / $3.40 - $3.60
Digest Average Y-o-Y Growth / 93.1% / 53.4% / 70.3% / 34.6% / 40.7% / 42.5%
Please refer separately saved spreadsheet for more details.
Target Price/Valuation
Target price of TEX ranges from $42 to $58 with an average of $51.00.
One of the analysts with the highest target price (CSFB) has a positive rating on the stock and has based the target price on 16-17x 2005 EPS of $3.50.
Another analyst with the highest target price (Smith Barney) has a positive view on the stock and derived the target price from the average of EV/sales, EV/EBITDA and P/E calculations based 2005 sales, EPS and EBITDA estimates.
Analyst (RW Baird) with the lowest target price and a neutral view on TEX has based the target price on 12x P/E FY2005E EPS.
Please refer separately saved spreadsheet for more details.
Long-Term Growth
Terex is a leading producer of mobile cranes and road building equipment. It also produces large capacity earthmoving trucks for heavy construction and mining industries. Terex’s long-term growth is inextricably linked to recovery in key end market demand, which in turn is linked to recovery in the economy and industrial activity. Moreover Terex is also using its cash flows to repay its debt, which is expected to reduce interest cost and underpin EPS growth. Its acquisition of Demag and Genie also provide it with significant opportunities to gain market share as well as higher margins through synergy gains and improvement in operating efficiencies.
Consensus estimate of $2.47 during FY2004 implies a growth of 70.3%. These assumptions factor in a modest recovery in end market demand. In the longer term, some analysts reckon that with sustained cyclical economic recovery, margin enhancement through better volumes and efficiencies and interest cost reduction through debt reduction, Terex could have an earnings power of $4+.
Analysts expect long-term EPS growth rate for TEX to be 7% (Smith Barney) and 15% (Lehman Brothers).
Individual Analyst Opinions
POSITIVE RATINGS
Morgan Stanley- Stock is rated Overweight with a target price of $45. The analyst views Terex as a deep value play in the recovering industrial equipment segment. The analyst believes that despite weak near term performance, the company can significantly improve margins as price increases and cost cutting begin to bear fruit in 2005.
Smith Barney- Stock is rated Buy, High Risk with a target price of $58. The stock is rated High Risk due to its small market capitalization, low trading volume, and high operating leverage amid very cyclical end markets.
CSFB- Stock is rated Outperform with a target price of $58. The analyst believes that the markets Terex serves are just recovering—and the margin issues with regard to steel are easily solvable, even if some of the others may be a bit thornier.
NEUTRAL RATINGS
R W. Baird- Stock is rated Neutral (downgraded on 10/28/2004) with a target price of $42. The analyst is confident that TEX will gain better pricing but also expects materials costs to be net negative through 1H05. The analyst believes that his targeted valuation balances TEX’s significant peak earnings potential with the current uncertainty surrounding the internal accounting review and historical valuation discounts to its larger public competitors.
Merrill Lynch- Stock is rated Neutral. The analyst believes the current stock price already discounts a better outlook for cash flows going forward and 2007 peak earnings estimate. The analyst also believes that the current accounting disclosures increase the risk associated with the stock.
Lehman- Stock is rated Equal weight with a target price of $52. The analyst continues to believe that TEX has significant leverage to recovery in commercial construction, cranes, mining, and road building and utility end markets.