Finning International Inc. (FTT) Earnings Call Transcript & Summary

Up next, Finning International. We've got Kevin Parkes at the back of the room there. So CEO, used to be COO, and before that, managed the U.K. business. Kevin?

Thank you.

I guess as you fill up your cup glass of water. I will ask the first question. So great Q3. I think you've -- I think Finning has put up several good quarters, but last quarter, there was a little bit of a hiccup with Argentina. So I wanted to start there so we can move on, but it was a negative surprise and a lot of investors trying to size up what the potential impact to be short term, but also longer term, as I think Greg kind of talked about boxing in the business appropriately?

Yes. Sure. So -- we worked hard over the last -- and thank you, everybody, for attending the session. We've really taught over the last number of quarters to execute really well and effectively. We've been managing Argentina through the whole of that process. And the team have developed a really strong playbook for how to manage in Argentina. You're constantly wrestling with FX, taxation changes, access to dollars. And so we're really proud of the way that the team are running the business down there. And I'll come back to it. But long term, rightly or wrongly still remain optimistic about the future in Argentina. I guess -- I wouldn't kind of call it a surprising Q3. I think what didn't impact our results in Q3. But we don't like surprises and we're building strong credibility at Finning there. So we felt it responsible and incumbent on us to talk about the current challenges we're facing in Q4 as a result of the ongoing elections, and the subsequent devaluation that everybody has seen. We operate in Argentina, everybody could see the devaluation that happened. And so we felt it incumbent on us to talk about it. And message it to our -- to the street, to our investors. And so we -- it's not seen as too much of a negative surprise in Q4. There will be an impact in Q4, undoubtedly. The gap between the devaluation and the official rate is as large as it's ever been, and there's all sorts of taxation changes going on. We can't quantify that right now because we don't know, the runoff is on the 19th and it's still very split -- it's very hard to understand polls these days. I read yesterday that the right wing candidate was edging ahead again. But the process itself has been very challenging. And we'll manage through it. It's a small part of our business. It may have an outsized impact in Q4 but then we move on. And we move on with optimism. And what Greg means by putting it in a box is we have it in a box, and we're going to put it in an even smaller box, which means a relentless focus on things that we're really good at and they have international investment and they have long-term prospects, which is energy and mining. So the Vaca Muerta development is well underway. It's a very busy part of the business for us. The new pipeline will be constructed, which takes Argentina from being a net importer to a net exporter of gas. And there are as many copper and lithium projects at a more advanced stage as we talked about in our Investor Day, in Argentina than there are in Chile right now. And if you just read through the level of international investment in Argentina through this quarter, when everybody could see the challenges I think people are looking beyond this in media. And the 2 best ways for Argentina to put itself on a better path are agriculture and energy and on resources copper and lithium. So we play it. That's where we support. That's where we do most of our work. And so that's how we think about it. But it will be a tighter more deliberate scope of work, I guess, in Argentina moving forward.

Okay. Very good coverage of that topic. Maybe if we zoom out the lens a little bit and talk about the wider macro. I think you've used a specific word for each of the regions in which you operate in, and it doesn't sound like that's changed at all, but just what you're seeing at a macro level and yes at your Investor Day just a couple of months ago so I don't imagine a ton has changed, but...

Yes. So I mean I'm trying to simplify things at the company here. And we don't mean to sound too clever with some of the branding we put around, but it helps us communicate externally and internally. And so the way we described the company at the Investor Day a few weeks ago was mobilizing in South America. And what we mean by that is it's not gangbusters right now. There's not a huge amount of greenfield projects being developed. There's lots of mobilization for that potential, and there is brownfield expansion and efficiency going on. So it's kind of mobilizing behind an energy transition trend with, I guess, a more constructive outlook than in Canada. where we described that as just steady growth. And so whilst we're constructive on Canada, it is a more steady trajectory than we've seen in the past, and we like that. It's good for our business. But it is still growth. But there aren't any huge trends or macro themes to investment other than the most sustained production of oil and gas and general investment in infrastructure and power. And then in the U.K., we call it resilient growth, and you have to fight for everything. In the U.K., you have to find a way. There are opportunities to grow. We saw huge growth last year just we've won an infrastructure project. Obviously down this year because we don't have the same level of project deliveries. But it's finding a way to be successful and to generate the right return on invested capital that competes the capital in the broader organization. And you get there a different way in the U.K. by being more resilient by -- it's not a low margin business. It's a low product support business, which is a higher margin part of our business. We have to run that way more efficiently and way more capital efficiently to get to the same outcome. But nothing's changed from our Investor Day. The dark cloud -- the dark macro clouds that everybody speaks to are still there. And we don't necessarily see those materializing in our business. And in any scenario, we always are very clear that we have market share opportunities. So even in a declining market, we have the opportunity to grow.

That's perfect. Maybe moving to supply chain. So Supply chains really tight in 2022, they've loosened up this year, maybe not back to normal levels. I think the way you characterize it is that looser supply chains would be a net positive for Finning? Is there -- I mean I understand why it could be a net positive. But on the margin side, anything else that could offset that positive? Maybe you can also explain why the net positive as well.

Yes, sure. And so I guess you're getting a good run of Caterpillar, Dave is here. I'll just catch a little bit of Mike's presentation before. I mean, for sure, there will be a level of competitive intensity that comes from having 2 products on a fence and having to compete for that business. I've been in the business 27 years now and I have been selling acceptable premiums for 27 years and trying to grow market share. And so that's what we do. We don't sell the cheapest product on the marketplace. We work with Caterpillar to be competitive. We have to be competitive. And we have very strong ambitions to grow our market share, not double our market share but grow our market share. And so there may be some moderation or for sure, we've been helped by -- it's been a tailwind, right, having a lack of supply and price increases. But we don't necessarily see that being something that investors should worry too much about in terms of pressure on the new equipment side. And it's less competitive and certainly less improved in mining and power. It's still very long lead times and to a certain degree, consistent with what Mike said, it's a very mixed bag in construction. So some products are readily available today, some are still pretty long lead time -- for longer lead times than we would have been used to in the past. So yes, that's the downside, right? The upside is we can provide better customer service, and now I'm talking about equipment and parts. So we can fix machines faster, and we can provide better customer service. We can grow our market share because we have more to sell faster. And even if we're not growing market share if the market is populating the market, right, so the more stuff we have available, the more we can sell into the marketplace. It helps with capital velocity. So our capital velocity has been somewhat hampered by the need to create buffers in our inventory to support our customers and to continue to support the growth trajectory. And it helps with cost to serve. So we have a higher proportion of what we call expedited or emergency fees and charges to satisfy customers because we're pulling parts and labor. So over time from different places because we're having to make things happen. And so margin pressure, for sure, to a certain degree, but we've been managing that for years, upside lots. And so I don't describe in improving supply chain as a headwind for this company. We're a distributor. You can't -- net-net, pre-pandemic, that wouldn't make sense, whenever the distributor would be hampered by a better supply chain.

Makes sense. Tough to argue against. Maybe just a hard pivot here. So we've talked about the macro for quite a bit. You hosted the Investor Day in September, I think there was a lot of good details you outlined what the primary growth drivers were and you -- the time line that you provided was through 2025. So I thought good detail there. So maybe in your words, since we have you here, what you thought the main takeaways should be for the Investor Day?

Yes, so just touching on the time line there, Michael. So I've been, as I mentioned, in the company quite a while now, and I was a big part of the leadership team that put the previous strategy together, which it can't be disputed and it worked pretty well post pandemic. And so number one, I don't think I have a luxury of a long-term learning curve. Number two, I think that we're -- our current strategy is working well, it needs refining, not reinventing. The other thing is, I believe, in the second half of the decade, there's a lot to consider in terms of the energy transition and so we made the decision that a short chart burst refinement in the strategy would be the right way to go. And we put that kind of, I guess, to short 2.5-year time line on it. And essentially, it's focused around more of the same. So our product support growth is the headline. We're explicit around a range of product support, which is moderating as we move forward, but it's still growing. That was the first message and how that growth, that structural growth in product support over a well-managed cost base, has driven real value creation in the company's earnings capacity and how that's structurally different than it was in the past. So we wanted to land that message that this is a product support business essentially. And so we talked a lot about that. The second part of the Investor Day was all around South America and the opportunity that exists. And primarily on Chile, we're very clear about that. I think we have half the slide on Argentina. And so the opportunity around the energy transition, the metals and the resource development, the copper, lithium, nickel that needs to be produced to support the energy transition and how Argentina and Chile also are very well placed to participate and benefit from that. And equally, that we have -- and you were there, Michael, you saw -- we call it [indiscernible], you saw lithium plants going up. You saw [ Terex ] cranes, you saw copper mines in full swing, brownfield, not a huge expansion. but Teck -- in ore grade, they're a new mine last 1.5 weeks ago, I think, in QB2. So we feel like South America, the risk reward profile, particularly in Chile right now is rebalanced and in a good place. The third thing was about a growth platform. And so yes, we're probably a more bigger mining organization than some of our peers, and we're very heavily focused on product support. But as you just heard from [indiscernible] there's rental, there's [indiscernible], there's a little opportunity to grow. And we feel that our opportunities to grow are around power systems, development, rental and used. Their businesses we know very well. There are customers that we know very well. We can grow organically without having to do M&A, although M&A is always a possibility for the right opportunity. And so we wanted to evidence that we have a platform, which we can grow incrementally at the right kind of returns. And then the final piece of the presentation was around resiliency. So we know very clearly that we have opportunity to become more cost and capital efficient to be -- to improve our free cash flow conversion. And that's been the biggest -- I think we're kind of proving out the growth credentials. But the resilience is the missing piece for me. And growing up in the U.K. for 22 years in that part of my career, you have to be resilient every day. And so I know their playbook. It's not a perfect science as it relates to the other geographies, but we know what we're going to do.

Perfect. And I'm going to hit a couple of the topics that you just mentioned, but I'll start with the product support. So product support has been, I don't think this gets talked enough. For Finning, since 2020, 2021, there's been a lot of product support growth. And I think in the last 3 years, you've been able to achieve more product support growth than you have in the decade prior to that, combined. Presumably, some of that is pricing, but I get asked this question often, what drove this particular inflection point, '21, '22, '23? And just trying to get a sense for how much of it was market-driven versus what you would describe as execution-driven?

Yes. So the first thing I would say is, I mean, we -- in our investor deck, we went back to 2016. So we've grown in all 2 years since 2016 product support. The CAGR since 2016 is 7%, which I would class as a healthy kind of CAGR despite 2016 being down and 2020 being down never more than 10%. Hence, why we describe it as [indiscernible] resilient part of our business. But certainly, that growth trajectory has increased post pandemic more like 15% since 2021. And the markets have improved. For sure, there are a couple of tailwinds there from a market perspective in terms of activity constraint spend through the 2020 where we had a bit of catch-up. Price increases, as you mentioned, certainly helped in terms of that CAGR number. But I would say that if you look at our product support growth over that period of time, similarly with Caterpillar and others, it was primarily focused on a very clear and explicit strategy to grow services at a double-digit rate for 10 years, 2016 to 2026. Caterpillar call it double services. We call it grow product support. But a complete alignment of 2 big organizations around a common goal where the whole organization was focused around it. The tone from the top is very clear. We were all committed to the right coverage, the right propositions, the right capacity and capabilities in our organization. And 3 examples of that I would point to. One is CVA. So an absolute relentless focus on contract. I mean, a contracted and recurring revenue stream with our customers, we call it CVAs. It's basically a service agreement. And so now everything we sell goes with a service agreement, and we have very strong renewal rates after the first contract. And of course, we have component contracts in mining. So making sure we boxed off as much of that. So we talk about having more product support revenue contracted than costs. That's a good model to try and get after. I'm not saying we're there yet, but it's a focus of ours. The second part is rebuilds. So again, for sure, I'm very transparent. There would have been a tailwind there in terms of availability of new equipment. Potentially a further tailwind in terms of when the equipment became available, the cost increase, the price increase of that equipment. When we look at rebuilds, we look to build propositions that broadly 2/3 the cost of new to get like new product. And so 2 things happened. Obviously, prices increased, but we've doubled down on our efficiency of the rebuild cost to get into that kind of range of commercial proposition, which customers like. And I would suggest that more than half of the rebuilds we're doing right now with net new customers that never rebuilt before. And I believe it to be -- to have a level of stickiness moving forward. So we're encouraged about that. We've also built capacity to turn the rebuild running faster. I mean if you rebuild the machine in 6 weeks versus the 12 weeks, it's lower cost rate. it's less hours. So if you do it in a really efficient way in your bigger locations and you move the equipment to the capacity rather than trying to do it in the smaller location that helps too. And the third area is the digital capabilities. So whether it be absolute digital capabilities like e-commerce or integrated procurement or whether it just be data collection and the use of that data to better guide your salespeople to where they should be or the fact that customers are using their equipment more effectively and efficiently because of the digital information they have around so I'd point to 3 big changes in how we approach that as a strategy versus the market tailwind.

4 Perfect. And I guess on that, I mean, how is it -- what's the strategy behind? And you talked about this here just now with some of the details that you provided, but growing product support more quickly, but also doing it to reduce the cyclicality of product support in particular. So choosing the type of business in particular. So is there a difference in maybe how that's being done now versus previously?

Yes, sure. So I mean, I'll give you an example of that. A customer wants 100 technicians to help them with their site, their job sites, whether it's a mine or whatever. And we say, do you want them for 10 or 20 years, right, not 10 weeks, okay? So the fact that the markets are a little constrained in terms of labor and supply -- product supply, permitting, ESG license, capital license is a -- we think it's a net positive for us because we're able to grow. So we don't want to accelerate product support growth. We've been -- there was questions at Investor Day, Michael, you were there. We've heard all this great stuff anyway, you're only saying 6% to 7% product support growth. Well, we don't want to grow much faster than that because it's expensive and it's not sustainable. And then we'll -- we don't help with the cyclicality. We overbuild capacity. We overengineer. We over buy inventory. And we want to build a sustainable business. I've made a statement to our business that we're never going to lie off a frontline person again. We don't know how we're going to do that yet, but we're very committed to it, right? Because -- and to do that, you have to build out -- it's not about what you've done in the past, it's about how you build in the future. And so one could say that we're artificially restraining or no, we absolutely restraining our ability to grow in product support. I'd rather have 7% a year for the next 10 years or 6% a year for the next 10 years, than 26% next year, 36% the year after and then minus 20% the year after that. It's been something that. And like I said before, product support is the most resilient part of our business. If there's an area of our business, we should be able to build sustainability is product support. It's only declined twice since 2016. And one of those was a pandemic never more than 10%. So if we can manage the pandemic resiliently, which I think we did, we can manage anything going forward. If we build appropriately in front of us.

That's really good color. So switching to the use on the rental side. It looks like you're -- while you raised your CapEx on the rental so you're looking to grow that a little bit faster. I guess the question is, let me there's 2 questions. The -- how you view the total addressable market? And two, why you think this opportunity to accelerate use in rental exist now?

Okay. So on the first point of capital, we didn't necessarily raise capital just on rental. Ultimately, we haven't -- we've kept some equipment longer in the fleet. We've got some mining opportunities that we're exploring. And so there's a lot. It's not just rental as you kind of you define it as the market defines as kind of rental services so maybe United kind of world. We're not even -- we've not done that yet. In terms of going forward, why do we think that's -- why do we think it's a good time? Well it's a mega trend. Rental penetration is growing in North America. And when we talk about rental, we're talking about Canada, not the U.K. or South America. Right now, we do have rental operations there, but our main focus to prove out the model is in Canada. And so rental penetration will continue to grow in North America as it is in lots of other things, asset light or asset sharing type economies. It's a big addressable market. We think it's $5 billion to $6 billion in Western Canada alone. The opportunity for rental actually is bigger in Alberta than it is in Ontario, different mix, different products, but there's a lot of rental services that go to support the resource sector. And so -- and we're looking for opportunities to grow organically with the right returns in the markets that we understand and we know. And so we want to grow our addressable customer base. So we think it's a good opportunity. We're going to be really thoughtful about it. It has to contribute to the company and has to generate the right levels of return. And we think we can. Now is it the returns of the dealership business? No. Is it accretive to cost -- weighted cost of capital and a growing segment? Yes. So we'll figure our way through that.

Perfect. When I -- at the IR day, it did feel like you were laying out a growth agenda mostly and you talked about capital efficiency. But where my perspective was -- had [ lesser ] was on costs and margins. I don't know if that's on purpose, but versus, I guess, previous IR days where there was a lot more focus on cost to margin. So maybe that speaks to the business where it is today. But as investors, how should we think about the overall opportunity on costs and margins?

Yes. So we deliberately -- there's only so much you can consume, right, in Investor Day. And so we were trying to be pretty targeted and deliberate about our messages, which were about product support growth, growth of growth platform and resiliency now, it doesn't mean we don't have any cost opportunities by any stretch. We still have cost opportunities, particularly in how we run and administer our service business. So we're making some technology investments this year in terms of 1 of them was called case management, which is cradle to grave management with the customer when we're in service. So everybody has visibility to what's going on in that rather than if somebody has a day off, they'll be knowing what happened yesterday. And then the other one is workforce management, so making sure we're allocating the right skills and capabilities to the right jobs with the right parts, okay? And so there's a big opportunity in terms of -- every labor hour we can't sell is a cost to us, okay? As is if you have 6 people administering it versus 4 and so there's opportunity around that. The second area of opportunity is around warehousing and distribution. As I mentioned before, we've got a lot of emergency charges and an extra charges to execute in our supply chain right now. We have gone from 8 warehouses to 5, we'll get to 3 in Canada. We're already at 3 in the U.K. And we have 2 and you saw some examples of investment in Antofagasta which will reduce our labor intensity in the warehouses. So I think there's some opportunities around how we manage our warehouses, now we get the parts to the end customer. And the final one and interesting, I just caught the end of the presentation there. I mean I'm an operator, I'm in favor of decentralization. I think it drives accountability, empowerment, entrepreneurism. And I think that reduces the need for such a big head office or central functions. I think we'll need some centers of excellence, particularly as it relates around finance and some aspects of HR. But I think there's opportunities there, IT, but I think there are opportunities for us to be much leaner in the center as well. So these are 3 examples of where we're not satisfied on cost right now, but we -- the reason why we deemphasized it a little bit at the Investor Day was to draw attention to the invested capital opportunity.

Perfect. Thanks very much, Kevin.

Okay.