The Rebound At Terex Should Have Legs (NYSE:TEX)

While the 2023 outlook for many industries is getting more frightful, the recent trading in Terex (NYSE:TEX) and other heavy machinery names has been pretty delightful, with Terex up more than 65% from its summer lows and leading in trailing 6-month performance over other machinery names like Caterpillar (CAT) (up 15%), Deere (DE) (up 36%), Metso (OTCPK:OUKPY) (up 18%), and Oshkosh (OSK) (up 2%).

Relative to many other industrials, demand for equipment used in markets like aggregates, agricultural, environmental (recycling, et al.), forestry, mining, and so on should hold up better, particularly given strong backlogs to start the year. While I do see some risks around private non-residential construction, overall, I think Terex is well-placed, and I don’t think the stock is necessarily played out yet.

The 2022 Analyst Day Was More Evolutionary Than Revolutionary

I wouldn’t characterize Terex’s December 13 Analyst Day as a major event for the company, but it did underscore the progress made in making Terex a more profitable (and more consistently profitable) company, and I do believe management did a good job of highlighting the Materials Processing business – a segment that I think a lot of analysts and investors struggle to assess and benchmark.

Management’s commentary on the remainder of 2022 wasn’t much different than the sell-side had already expected, but the same is not true for the 2027 targets. Management laid out a target of $6 billion-plus in revenue, comfortably above the $5.43B sell-side average, and I believe this number does not include potential M&A over the next five years. Terex management’s margin targets likewise provided an upside to sell-side expectations, with an OPM range of 13% to 14% against a 12.3% average estimate before the meeting.

While the targets for both Materials Processing and Aerial Work Platforms were above sell-side expectations, there was more upside relative to those expectations in the Materials Processing business.

I’m not so surprised by that, as I think the sell-side has often struggled with this segment. Some of that may be due to the lack of easy comps – it’s much easier to benchmark Terex’s Genie Aerial Work Platform business against very similar businesses at Oshkosh (OSK) and Linamar (LNR:CA) and it’s a discrete, easy-to-follow, easy-to-model business (albeit less profitable and more volatile).

Materials Processing, in contrast, is more of a hodgepodge, including a very large aggregates business (crushing and screening equipment), lifting (cranes), material handling (purpose-built equipment like timber and waste handlers), cement mixers, and “environmental” (shredders, screeners, and conveyors). Companies including Astec (ASTE), Deere, FLSmidth (OTCPK:FLIDY), Manitex (MNTX), Metso, and Sandvik (OTCPK:SDVKY) compete in parts and pieces of the segment, but there are a lot of moving parts here, with multiple end-markets to track. So it’s understandable that this business may go a little underappreciated.

Even so, it’s clear this is the main driver going forward. While Terex is still invested in improving Genie and maximizing the value there (including leveraging longer-term opportunities in areas like construction and utilities), Materials Processing already generates around 60% of Terex’s profits, and management is looking to expand this with M&A into adjacent products/markets.

Relatively Better End-Market Exposures

Here, of late, I’ve been trying to give more attention to the end-market exposures for multi-industrials and how those exposures line up with the outlook for 2023. In the case of Terex, I’d say it’s rather positive on balance, but with a few risks to note.

I am relatively bearish on construction activity in 2023 (both residential and non-residential), but construction fleet operators have not been able to get the equipment they need due to supply issues and production shortfalls in 2022. With that, companies (Terex included via its aerial work platforms business) are heading into 2023 with robust backlogs that should support business throughout much of the year.

With the production/shipment delays, the equipment fleet is now overaged, and that should be a positive for Terex. In aerial work platforms, for instance, the average fleet age is now around 55 months – above the 40-50 target range. I do think weak activity will lead to weaker orders in FY’23, and likely weaker results in FY’24, but Terex’s exposure to non-resi construction equipment is still more positive than not for the next 12 months.

I’m more bullish on the company’s leverage to infrastructure spending and the aggregates market. The Infrastructure Investment and Jobs Act should start kicking in more noticeably in 2023, supporting several years of projects and demand growth for aggregates (and equipment to mine/process aggregates), as well as demand for cranes and material handlers. Likewise, while I’m not particularly bullish on non-resi construction in ’23, the CHIPS Act and Inflation Reduction Act should support a range of projects where Terex can have positive leverage through aerial work platforms, cranes, material handling equipment, and utility equipment, including factory construction and power gen/grid modernization projects.

While Terex doesn’t have as much exposure to oil/gas or mining capex as I might like (and almost no ag exposure), I think the leverage to infrastructure construction, aggregates, utility, and environmental (recycling projects) will serve the company well over the next couple of years.

The Outlook

Many industrial stocks have been weak in anticipation of the manufacturing PMI heading below 50, which it ultimately did in November. While that is concerning for near-term short-cycle industrial demand, machinery stocks like Caterpillar, Deere, and Terex have historically outperformed in the year after such an event. Beyond this, I think the fundamentals still support Terex as well.

Assuming that Terex hits its own $4.3B revenue target for 2022, I’m expecting close to 7% compound annual revenue growth for the next five years on the back of infrastructure spending, as well as demand from end-markets like aggregates, cement, environmental, non-residential construction, and so on. I don’t expect that growth to be sustainable, but my long-term growth rate is still in a healthy 4%-5% range.

I expect EBITDA margins of around 11%-12% over the next two years, but over 12% in FY’24 and possibly over 14% in FY’25. I expect good cash flow leverage over the next five years, with a longer-term weighted average free cash flow margin in the mid-single digits. Discounting those cash flows back, Terex looks priced for almost a double-digit long-term annualized return from today’s price.

Multiples-based valuation approaches are common with stocks like Terex, but setting the “right” multiple is difficult given the cyclicality and the challenge of predicting cyclical peaks and troughs. Evaluate Terex like a “regular” industrial, though, and the margins and returns I expect for FY’23 (10.5% operating margin, almost a 23% ROIC, et al.) should support a forward multiple of 8.75x, or a fair value of close to $60 on my FY’23 EBITDA estimate. I’d also note that when Sandvik acquired Schenck Process Group (a screening/feeding company) earlier this year, it paid 10x, so I don’t think a nearly 9x forward multiple is totally crazy.

The Bottom Line

It can be tough to buy stocks after they’ve already enjoyed a good run, and I certainly do still see risks here. Construction activity could be even weaker than I expected and could drive a sharper downturn in equipment demand than I expect, and projects in areas like power gen/grid modernization could be slower to materialize. Still, on balance, I think Terex has more room to appreciate given its leverage to better end-markets for FY’23.