Finning International Inc T.FTT

TD Notes

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Equipment Distributors: Q1/22 Earnings Preview

Commodity Price Backdrop Very Supportive
OEM Supply-chain Issues Unlikely to be Resolved in the Near Term

TD Investment Conclusion

• Finning, Toromont, and Wajax are seeing end-market strength virtually across the board and entered 2022 with very strong backlogs. Finning's Q4/21 backlog of $1.9bln was up ~140% vs. $800mm in Q4/20; Toromont's Equipment Group had a record backlog of $1.1bln, triple that of the previous year; and Wajax's Q4/21 backlog of $419mm was up ~130% y/y.

• The Fed tightening cycle and the war in Ukraine have prompted investor concern about a period of stagflation or even a recession, but in the resource sector, which we see as the primary driver of earnings cyclicality for the equipment distributors, we perceive considerable support for commodity price-strength in the near term. Notably, many commodities need a period of sustained higher prices to stimulate the supply response necessary to support decarbonization and the energy transition (copper, nickel, lithium, etc.) and the Russia-Ukraine conflict has created incremental demand for secure sources of supply for various commodities (oil and natural gas, nickel, uranium, potash, etc.)

• OEM supply-chain performance deteriorated in H2/21 and we anticipate limited improvement in 2022. Tight OEM supply and limited opportunity for inventory restocking in 2022 should facilitate the pass-through of inflation-driven OEM price increases, and, despite a tight labour market, our covered companies seem to be achieving sufficient levels of technician intake to support growth. We believe that other inflationary cost pressure (fuel, insurance, etc.) can be partially mitigated by new operating efficiencies emerging from the pandemic.

• All else being equal, we expect supply-chain bottlenecks to lengthen the duration of this cycle, which we see as having two main areas of potential benefit for the dealers: 1) higher product support activity, as customers will have to maintain their existing fleets and 2) greater demand for used equipment, rental, and rebuilds as other means of satisfying new equipment demand, which is positive for mix, as rental and rebuilds are higher-margin revenue streams (although rental is more capital-intensive). Used equipment is in tight supply and commands very strong pricing to the extent that it is available.

• Our Q1/22 EPS estimates are roughly in line with consensus for Finning and Wajax, and we see the potential for another upside surprise from Finning. We are an outlier to the downside on Ritchie Bros., but the company's new earnings definitions have increased forecast difficulty and reduced comparability between analysts. We have raised our Q1/22 EPS estimate for Toromont, but not quite to the level of consensus, which we see as potentially having overreacted to an exceptional Q4/21 margin performance from the company.

• Our sector stance is Overweight. Among the large market-cap stocks, we see the best upside in Finning. We also rate Wajax as BUY.