Equipment Distributors: Q4/23 Preview
End-Markets Resilient Despite Macro Uncertainty
New/Used Equipment Margins Should Normalize on Improved Supply
TD Investment Conclusion
Q4/23 Estimates vs. Consensus: Finning will kick-off the Q4/23 reporting season
on February 6 after market close. Our Q4/23 EPS estimates (unchanged) are
in line with to slightly above consensus. We expect low-teens y/y EPS growth
from Finning and Wajax, and flattish EPS from Toromont, which is lapping an
exceptional prior-year margin performance. Given better new/used equipment
supply, we anticipate that backlogs will be stable to lower going forward
(absent lumpy fleet orders), which could cause some investor concern, but is
not necessarily a negative, as these businesses do not typically carry large/long-
duration backlogs.
Resilient End-Markets: Despite a dynamic macro backdrop, we expect new/used
equipment demand across construction, mining, energy, and power systems to be
stable to slightly weaker y/y in 2024, supported by public/private infrastructure
spending, healthy commodity prices, and opportunities related to the energy
transition, with power systems a particular area of strength. Higher-margin product
support revenue should benefit from a two-to-three-year period of strong new
equipment deliveries, which is positive from a revenue mix perspective. Rental
also tends to benefit during periods where customers are busy but not confident
enough to make fleet additions, and rental also carries higher margins, albeit with
greater capital intensity.
Improved New/Used Equipment Availability: Small- to medium-sized
equipment should be widely available, although certain larger machines and
engines remain supply-constrained. Improved new/used equipment supply could
weigh on rebuild activity, which attracts margins similar to product support, but
we believe that rebuilds have become well-entrenched as a cost-effective and
environmentally-responsible replacement alternative. Our biggest concern is
the potential for new/used equipment margins to normalize, as OEMs/dealers
compete more vigorously amid an environment of slightly weaker demand and
greater supply, although it is difficult to assess the extent to which margins
expanded above normal during 2022-2023. RB Global's latest market report
indicates that, for the three months ending December 31, used equipment prices
for large and medium-sized earthmoving equipment in Canada declined 5% and
11% y/y, respectively, vs. very elevated prior-year levels, which suggests to us
that the market is holding up rather well thus far.
Peak of Cycle vs. Extended Cycle: We see the potential for higher-than-normal
share-price volatility in 2024, as a peak cycle view competes with the potential
for a cycle of longer duration and less amplitude vs. prior boom-bust cycles.
Against that backdrop, we favour Toromont's strong track-record, lower relative
exposure to the volatility of the resource sector, and net cash position. We believe
that Finning has sustainably improved its earnings resiliency through the cycle,
but we think it will be harder for the stock to attract a secular re-rating against the
current macro backdrop. Wajax offers a healthy yield and modest valuation for
small-cap investors.