Terex Corporation (TEX) Earnings Call Transcript & Summary

I'm Courtney Yakavonis, Morgan Stanley's U.S. machinery analyst. And next up, we have Terex. But before we begin, please note that this webcast is for Morgan Stanley clients and appropriate Morgan Stanley employees only. The webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to Morgan Stanley sales representative. So as many of you know, Terex is a global manufacturer of Aerial Work Platforms, Materials Processing equipment and cranes. And I'm very pleased to have with us today John Sheehan, CFO; as well as Randy Wilson, Director of IR. So John and Randy, thank you so much for being here today.

We're happy to be with you, Courtney. Absolutely.

So we'll just jump right into Q&A. But for those of you who are on the webcast, please feel free to submit a question via the Ask A Question box on the portal today. So John, maybe you can just start off talking a bit about the transformation that Terex has gone through over the past several years. And just comment on Terex' ability to manage this downturn versus prior downturns, given some of the changes that have been made in the portfolio.

Sure. Thanks very much, Courtney. And for those investors who might not have day-to-day contact or research on who Terex is, is that Terex was historically a serial acquirer and disposers of businesses. To be honest, I'll call it, a small PE shop. And in the 2016 time frame, our Board of Directors determined to move away from that strategy to one of operational excellence and execution of the industrial businesses in which we own and the company changed CEOs to John Garrison, who is our current CEO. As John came in, and John is a longtime operator of industrial businesses, John's philosophy was, is that industrial companies must outearn their cost of capital through the cycle. And while in 2016, not every one of our businesses did, we went -- we embarked on a process to either get our businesses to be outearning their cost of capital or on a trajectory where we knew definitively when we would get there. As a result of that, Terex did in the 2017 -- beginning of 2017 time frame dispose of our Material Handling and Port Solutions business. We did dispose of the remainder of our Construction businesses. And then in 2019, we disposed of our Demag Mobile Cranes business and shut down and sold the assets in our North American small cranes businesses. Today, I'm pleased to report that all of Terex' businesses outearn their cost of capital through the cycle. Yes, I know 2020 is a different kind of year given COVID-19, so maybe I should phrase it slightly differently to say, our businesses, coming into 2020, all outearned their cost of capital. And as we get to post-pandemic, they will definitely outearn their cost of capital again. We have been instilling a focus on operational excellence in our businesses, a culture of accountability, do what we say we're going to do. And through the transformation and the effects of COVID-19, the revenue of Terex has shrunk, but the profitability, the operating margins of our businesses have increased. And when you look at Terex' balance sheet today, we have a much stronger balance sheet than Terex historically had. Yes, we are a high-yield credit from a credit rating agency perspective, but when you look at our balance sheet, we have available to us over $1 billion of liquidity. That's over $400 million of cash on our balance sheet at June 30, a $600 million revolver. We have no significant debt maturities before 2024, 2025. So we have a very strong balance sheet and we are progressing through this very uncertain economic environment -- pandemic environment from a position of strength. And so I think that Terex is very well positioned, coming out of the backside of this pandemic into 2021 to grow and thrive.

Great. As a result of many of the actions you talked about, your decrementals were very strong in the second quarter for Aerial Work Platforms when you talked about the profitability there. Can you just talk about some of the more temporary cost actions that you did take to over this time period? And how should we be thinking about incrementals in this business when aerials finally do start to turn?

Sure. So when talking about the cost reduction actions that we've been taking during the course of 2020, I'd like to divide the discussion up separately between cost of the actions we've been taking that impact our cost of goods sold and those that impact our SG&A. On the cost of goods sold side, we took significant action, proactive action at the very end of the first quarter, very beginning of the second quarter to rightsize our production cost structure to the customer demand environment in which we were going to -- we were operating. As we talked about in our Q1 earnings call, in the second half of March for Aerial Work Platforms alone, we had approximately $175 million of customer orders that were canceled. And as a result -- or pushed out. And so as a result, it was imperative that we took action to rightsize our production workforce. So we had layoffs in both our Genie and Terex Utilities businesses to reduce the manufacturing workforce to the size of the production demand required. We cut off purchase orders with suppliers for components into our facilities to maximize liquidity and not be paying for parts that wouldn't be used in production for an extended period of time. And so we were able to rightsize our production cost structure to recognize that customer demand had fallen off significantly. We continue to monitor customer demand very, very closely and are only producing product to customer demand requirements. We're not building inventory on our balance sheet. In fact, today, our Genie business has inventory levels that are equivalent with those of 2016. And that -- if you go back and look, that was the last time that we had a pronounced downturn in the business. So we've taken substantive action this year to reduce Genie production, reduce our inventories, rightsize our manufacturing cost structure to that of the customer demand. That has had a big impact on our ability to meet and exceed the 25% decremental margins that we expect for our businesses. Go ahead. I just -- I want to -- let me come to the SG&A side, if you don't mind. I know it's a long answer. I apologize. On the SG&A side, those costs are much more sticky and salaried workforce and -- are more fixed in nature. We took very aggressive action in the first quarter. All of our salaried employees across the globe had reductions in their compensation between 5% and 20%, depending upon their level. We canceled our merit increases for 2020, and we reduced the bonus opportunities for team members. But those actions are temporary. Over the long run, we have to pay our team members at market. Even Randy Wilson, we have to pay at market sooner or later. And so we have been on a cost -- SG&A cost reduction initiative here during the course of 2020, such that as we move into 2021, we're rightsizing our SG&A cost structure to the size of the business. And John Garrison talked -- has talked for -- since 2016 about our objective for SG&A is 12.5% of sales. We -- and that in 2019, we exceeded that target, exceeded from the perspective of being lower. In other words, we were at 12.1%. This year, we're going to be in the 14% plus range because revenue fell off so fast. And so we are on a path to drive our SG&A back such that at the revenue levels that we will see for 2021 that we achieved that 12.5% SG&A to sales target. My apologies for the length of that answer.

No, it was a long question. So I appreciate the answer. Maybe just when you talked about inventory levels, you obviously had started under producing pretty aggressively in the back half of last year. So are you thinking second half of this year, you'll be producing to retail? Or is there still some underproduction left to happen? Or does it really depend on new negotiations in the back half of this year?

So I would say is that for Q3, the current quarter we're in, we are absolutely producing at a level below customer demand and reducing inventory levels. We're not producing quite as low as we were in the second quarter. But I would just say, the year-over-year production decline is substantial. And we'll talk more about that, obviously, in our Q3 earnings call next month. I would expect that by the end of the third quarter, that we would be pretty close to where we wanted to be in terms of inventory levels for our AWP segment. As I mentioned a few moments ago, we are approaching, if not lower than, the 2016 levels for the Genie inventory levels, for the Genie business. And so we will, as we go through the fourth quarter and our discussions with customers about their capital expenditure needs for 2021, we will then size our production for the fourth quarter and into 2021 and adjust our production accordingly.

And when you have that comment about still underproducing in the third quarter, is that primarily in North America? Or is that globally?

It's -- well, I guess I would say is it's globally from the perspective that really, the reduction in customer demand that we're seeing is globally, with the exception of China, right? So the European market is mirroring the United States market or the North American market. And so the comment -- and most of our European business these days is strongest from our Changzhou, China facility. So it's a global comment.

Okay. Great. Maybe since we're on AWP, if you can just talk a little bit, John Garrison, obviously, took over as President of that business. What changes, if any, is he making? I believe, you mentioned that he's over on the West Coast. But anything that he's enacted since taking over? Or is it more just continued execution of the same plan?

I would say is that what -- the Genie business is a great business. It's a great brand, high-quality product. Customers want our product. We have an excellent market share. What 2019 and now 2020 have demonstrated to us, though, is that the -- we have to reduce the cost structure for our products -- the manufacture of our products. Whether it be the manufacturing footprint, the design of the product, the -- those -- the -- we need to be more cost-efficient in the manufacture of our product. I think we produce a really high-quality product that the customer appreciates, loves. But we also need to make sure that the features and the benefits of that product are those that a customer is willing to pay the value associated with placing them on the machine. And to the extent they are not, then we have to question the value of that addition. And I think that the Genie culture is one that is extremely entrepreneurial, very product focused. And so that at times, it can be that the love of the product can cause the cost of the product to maybe outstrip what the customer is willing to pay for it. Working with AW -- with the Genie team is very focused on making sure that we're producing product that meets customer demand, but is efficient in terms of the cost of the manufacture of that product.

Got you. Maybe you can also just comment, obviously, you guys have been working on connectivity of your equipment. What are you seeing in terms of utilization levels? I think you commented that the business had stabilized in the second quarter, but coming out into July, August and September, is that continuing? Anything you would say relative to seasonality that you feel comfortable commenting on?

Yes. I think that there's sort of 2 aspects to that question that you just asked. One was with respect to customer utilization, right? And you're correct, there are telematics on our machines. And what that telematics demonstrates to us is that equipment is being used by customers at utilization rates that are pretty darn close to what they were a year ago, despite the pandemic that's going on. However, that also doesn't translate into automatically that customer orders for new equipment are at 2019 levels. As you know, our bookings in the second quarter were down significantly year-over-year. And while certainly, customer bookings have improved since the second quarter, and they continue to improve, I would say is that our customers are still taking a very cautious approach to their capital expenditures. And as a result -- and watching how the world develops, whether it be with respect to the pandemic and the impact on the global economic environment or with respect to the U.S. election. And those factors, I would say, have created some degree of hesitancy in terms of new customer bookings. That said, right, is the replacement cycle from our perspective is alive and well. And so that as we go into 2021, as the pandemic is behind us, whether it be growth capital for new projects or the replacement cycle, we do believe that 2021, 2022, 2023 will be good years for our AWP business.

Got you. Maybe you touched a little bit on the rental CapEx and the rental budgets. Obviously, 2 of your largest customers have spoken to very significant cuts this year. Do you think those cuts are really sustainable beyond 1 year? Or how long can we stay at these low CapEx levels given the replacement cycle that you alluded to?

Yes. I think that we've talked extensively, as our peers have and not just Genie but also JLG, about the replacement cycle that the optimal period for a customer to replace their machine is 8 years. That minimizes the maintenance cost on the machine, it maximizes the residual value of the machine. And so when a customer is looking to maximize their return on invested capital, 8 years is the sweet spot. Now that said, it doesn't mean that they have a calendar and on day -- 7 years and 364 days, like a switch goes off and they have to dispose of the machine. They certainly can sweat that asset for a longer period of time. But the residual value does continue to erode. The maintenance cost will increase. And therefore, I think you measure that the extension in that period of time or what period of time they could extend for, you measure that more in months than you do in years. And since 2013, '14, '15 were really good years from a growth capital perspective for the rental companies, that would mean that 2021, '22, '23 -- and look, maybe it's not January 1, 2021, but it's certainly within 2021, you should start to see the replacement demand increase and increase through 2022 and 2023. So when you combine that dynamic with the fact that in post-pandemic, there will be a return to more normalized levels of construction activity, we believe that the outlook for the Genie brand for new machine sales will be healthy in the next, say, years.