Scotia Capital Scotia Capital’s Michael Doumet thinks the pullback in equipment dealer stocks has been “too deep” and “too uneven,” believing a significant recession has been priced in.
“The market has become increasingly convinced that the economy is headed for a recession/slowdown,” he said. “For the equipment dealers, given the supply chain bottlenecks, extended backlogs, and recent management commentary that activity levels remain robust, it may take several months for clear signs of such a slowdown to emerge. To us, this creates an environment where beats are unlikely to be rewarded in full as investors look for 2023 consensus to reset/bottom out; the exception are margin/SG&A beats as those have positive implications regardless of the demand/revenue outlook investors assume for 2023 and beyond.
“That does not mean we do not see an opportunity in the sector. Typically, for a sustained rally to occur in the sector, history tells us earnings visibility will need to improve/reset (i.e. consensus will need to get closer to a “bottom”). That could take several months. And, in this environment, where recessionary risks are on the rise, TIH often proves to be the best name to hold. However, we believe FTT provides the better near-term opportunity as its outsized share price decline offers a potentially asymmetric bet as it is pricing-in a uniquely pessimistic scenario.”
Mr. Doumet said the recent weakness in commodity prices had led to “meaningfully” lower share prices and reduced earnings per share expectations for the equipment dealers.
“As a quick litmus test on what the market appears to be pricing-in, we back out forward EPS expectations from the current share price (using a mid-cycle multiple),” he said. “This approach suggests the market is pricing in a approximately 35-per-cent, 10-per-cent, and 25-per-cent EPS decline for FTT, TIH, and WJX versus consensus. These figures compare to the 2019-2020 EPS peak-to-trough (ex. CEWS) of 40 per cent, 15 per cent, and 50 per cent for FTT, TIH, and WJX, respectively. With this in mind, FTT’s share price decline appears too uniquely pessimistic. While lower copper prices and higher taxes will slow activity levels in Chile (the lower Peso may boost profits though), we remain constructive on Western Canada, a geography that produces a similar line up of commodities (oil, gas, potash, grain, etc.) as those that might remain in short supply due to sanctions on Russia. Product support and operating efficiencies have also been made by each of the dealers.”
Mr. Doumet lowered his earnings estimates and valuation multiples across his coverage universe, noting “while higher interest rates and lower commodity prices will slow activity, we question the steep decline in the share prices.”
His target prices also slide. His changes are:
- Finning International Inc. ( “sector outperform”) to $38 from $46. Average: $40.
- Toromont Industries Ltd. (“sector outperform”) to $120 from $126. Average: $120.50.
- Wajax Corp. ( “sector outperform”) to $25.50 from $29. Average: $25.63.
“Typically, it is best to wait out rising recession risks with the most defensive name, TIH,” he added. “However, the pullback in FTT has been so deep that we think a near-term upside adjustment is in store. Our thinking on FTT’s valuation is anchored to its mid-cycle valuation, a product of a 16 times P/E multiple on a mid-cycle EPS estimate of $2.30 per share. This view credits FTT’s enhanced product support growth, improved operating leverage, and capital deployment. Further, we think a positive (margin) surprise in 2Q22 could help alleviate the decline in its imbedded EPS expectations.”