August 7, 2024
Finning International Inc. Executing well
Our view: Q2 results reflected top-line ahead of consensus estimates while EBIT was modestly below. Finning continues to execute well amidst an evolving operating environment, and the outlook (supported by the $2.2B backlog) remains encouraging. While the lower mix of Product Support impacted margins (similar to TIH), H1/24 Net Revenue was +6% YoY on top of +25% YoY growth reported for H1/23. The upcoming SG&A right-sizing initiatives (a proactive measure) should support stronger earnings through the cycle. PT +$1 to $50, reiterate OP.
Key points:
Thoughts exiting Q2 – Results for Q2/24 reflected top-line ahead of expectations while EBIT was just shy of Street estimates (ahead of RBCe; see inside for details). Results reflected a higher mix of New/Used Equipment (+3% and +57% YoY, respectively vs. Product Support ("PS") +0.4% YoY), and this dynamic was the primary driver of YoY EBIT margin compression (Toromont's recent Q2/24 results reflected a similar dynamic). Despite the short-term margin pressure, the significant growth in Equipment deliveries should serve as a positive over the medium- to long-term as the larger installed base expands the company's PS TAM (should also release working capital in the short-term, which would benefit FCF as it did this quarter; see below). Management also highlighted they are in the process of finalizing plans to further reduce the fixed cost base and SG&A as a % of Net Revenue. This is a positive development (and a proactive step as opposed to a reactionary measure) as a rationalization of the cost structure should position Finning well to deliver stronger earnings through the cycle (currently operating with an absorption ratio above 100%).
Outlook puts/takes – By region, the outlook in Canada remains positive, with Finning anticipating strong energy sector activity/PS demand going forward. In South America, the outlook in Chile is strong, reflecting a "broad-based" increase in Mining activity driven by supportive copper prices and increased customer confidence. In the U.K. & Ireland, given the outlook for softer GDP growth in 2024, management expects demand for New Construction Equipment to remain soft, while the outlook for Product Support, Used Equipment and Power Systems in this market (including for Data Centre customers) was relatively more "upbeat". Also this quarter, Finning reduced its outlook for net capital and rental fleet expenditures to $220MM-$270MM (vs. $290MM-$340MM previously), citing market conditions (largely Construction softness).
Balance sheet/capital allocation update – Leverage exiting Q2 was 1.8x (generated $330MM of FCF in the quarter). Additionally, the company is holding nearly $3B of inventory on its balance sheet, which should position it well to deliver on its elevated $2.2B Equipment Backlog (+$200MM QoQ). Management reiterated that invested capital management and return of capital remain the priorities (~2.1MM shares repurchased in Q2, ~1.5% of the float), while the balance sheet is supportive of opportunistic M&A.