Terex Corporation (TEX) Earnings Call Transcript & Summary

Great. Good morning, everyone. Welcome to this morning's fireside chat with Terex, and judging by the weather where John is at, I think we're going to need real fire here. I'm Jerry Revich from Goldman Sachs, and I'm pleased to have with me John Sheehan, Senior Vice President and Chief Financial Officer; and Randy Wilson, Investor Relations Officer. Gentlemen, thank you very much for joining us.

Thanks, Jerry.

Before we jump into the conversation, we are required to make certain disclosures and public appearances about Goldman Sachs' relationship with companies that we discuss. The disclosures relate to investment banking relationships, compensation received or 1% or more ownership. We're prepared to read aloud disclosures for any issue upon request. These disclosures are available in our most recent reports available to U.S. clients on our firm portals, that's gs.com/research/hedge.html. Okay. With the legal portion of the program out of the way, John, Randy, thank you so much for virtually commuting to join us here.

Absolutely. We're happy to be here.

And maybe as a starting point for the conversation, John, you folks, as a management team, have really done an outstanding job divesting assets, deleveraging the business. Can you update us on how you're thinking about strategic priorities for Terex entering this recovery?

Sure. So I think what I would do, starting off, Jerry, is big picture, right? When John Garrison came in as our CEO roughly 5 years ago, he came in with a mandate from our Board of Directors and with a focus of driving the operational execution and performance of Terex as a industrial company. And John, having been a long time industrial guy, his focus was -- is that -- has -- was and still is today, that industrial companies have to outearn their cost of capital through the cycle. They have to create value for shareholders and stakeholders, not destroy value. And so when John looked at the portfolio of businesses, as he came in, there were a number of businesses that, quite honestly, were not outearning their cost of capital, whether it be construction, our Material Handling and Port Solutions segment, subsequently, our Demag mobile cranes businesses. And so over the last 5 years, you are correct, Terex has divested of a number of businesses, a number of businesses where we believed that -- where either the business was not outearning their cost of capital or we believe that wasn't going to be able to get back outearning their cost of capital and therefore, we divested of the business. Today, Terex is a smaller company than it was when John took over, but our businesses are outearning their cost of capital. They are very strong brands, market-leading brands, and the operational performance of the business is stronger. In this -- at the same time that we were going through the process of, I'll say, culling the portfolio, we also focused on returning capital to shareholders. So between 2017 and 2020, we returned about $1.4 billion of capital to our shareholders, took our share count down from roughly 110 million shares down to the roughly 70 million, 72 million we are today. So we return -- as we divested businesses, we took the proceeds and we gave it back to our shareholders. And at the same time, we've also delevered the balance sheet. If you look at our -- what our -- our net debt-to-EBITDA over the last years, yes, we've always talked about a leverage target of net debt-to-EBITDA of 2.5x to 1x. But the reality of the situation is we're most of the time below that level, and we were at that -- below that level at the end of Q1. And if you look at our guidance, the outlook that we've provided for the full year and the EBITDA associated with that, it would suggest that by the end of the year, our leverage -- net leverage could be 1-ish times, maybe even less. So you are correct. We have a very strong balance sheet and probably the strongest balance sheet that Terex has had in its history. So our focus as a leadership team, as a company, is on driving operational performance of our businesses, having a strong balance sheet that provides us with financial flexibility, investing in our organic -- investing in the organic capabilities of the businesses so we can grow Terex for the future. That is absolutely the focus of our entire leadership team. And I give John a ton of credit -- John Garrison a ton of credit because he really has transformed Terex from what it was 5 years ago. I'll call it, a little bit of a private equity shop buying companies low and selling them high to being very operationally focused. And that's what we're looking at as a management team.

And John, in terms of the M&A part of the opportunity set, as you mentioned, the balance sheet has not been in this type of position at any point in the cycle, let alone entering the recovery. Can you talk about your M&A framework?

Sure. So -- and we have definitely pivoted, right, having returned $1.4 billion of capital to shareholders. We believe that the share count is rightsized. We also believe now is the time to begin -- having achieved the operational performance that our businesses are achieving, it's now time to start to grow Terex, to leverage the corporate cost structure that we have across a broader set of businesses. So we have introduced, in our disciplined capital allocation strategy, the fact that inorganic activity is a component of that disciplined capital allocation strategy, deemphasizing share repurchases. In terms of where is our focus, I'd say number one is that our principal focus is in the Materials Processing segment or the utilities businesses -- business. Both of those businesses are very strong performers, and we would welcome the opportunity to add bolt-on acquisitions to either one of them. By omission, what it really says is we're not focused on growing the aerial products or the Genie business and -- in that area. As certainly investors know, the rental industry is very cyclical, very volatile. And one of the benefits of our Materials Processing and utilities businesses, they're more stable. They don't have the same degree of cyclicality that our aerials business has. And so to the extent that we can grow the other businesses, reduce the volatility of the revenue and earnings of Terex, we also believe that, that will be a benefit to shareholders. So we haven't made much in the way of acquisitions for 5-plus years. So I think you'll see us start small and grow. It would not be our thought that the -- and the acquisition would be a third segment or a third leg to the stool, if you will, but rather adding on to the business segments -- the businesses that we already have.

And in terms of the valuation framework that you're looking at, can you comment on that? Are you marking it versus where your stock is trading at? Just a bit of context on -- just to sensitize us on how we should be thinking about valuation of these opportunities?

Yes. I think I would go back to John's framework, which is that industrial companies have to outearn their cost of capital through the cycle. So what we're looking at is what is the IRR of the acquisition. What would be the return on invested capital? Will the -- would an acquisition candidate be accretive to the return on invested capital for Terex? Or would it be a -- would it be dilutive? I think those are some of the things that we're looking at. Is -- there's obviously the simple accretion dilution to earnings, but it's really as much a focus on what does it do to our return on invested capital because that is the #1 metric that we're focused on, is the return on invested capital.

That's really interesting. So given where valuations are, it sounds like we're looking for assets that -- where Terex is essentially the best owner, right, because to get the type of IRRs you're talking about, you need significant savings.

Correct. And when you look at the Materials Processing segment or the specialized equipment businesses -- machinery, specialized machinery businesses that Materials Processing operates and would -- where acquisitions would be, there's a lot of private companies that have built up niche product areas that would be very good bolt-ons and can be acquired, brought into the company at reasonable valuations. I recognize that, especially right now, with where the markets are and all, that there's a lot of outsized valuations. Our focus is not to be overpaying for assets. We're not desperate. We're not -- look, we have a very nice portfolio. We love the company. We love our portfolio of businesses. So this is not something that we have to do. It's something that we can do to drive shareholder value.

Got it. And in terms of the pipeline in the U.S., we're hearing from companies in a range of industries saying that there's increased quoting activity, shall we say, because sellers are asking and trying to assess if they want to get a deal done before year-end, given the concerns about where tax rates are going for capital gains, are you seeing that in terms of conversations that you're having? Are you seeing any of your targets trying to move along quickly as a result?

Yes. So I guess what I would say is actually most of the activity that we've been -- most of the companies we've been talking with are outside of the United States. So I don't know necessarily that I'm able to confirm or deny that motivation. There hasn't been a ton inside of the United States at the current time to be able to say one way or the other. But I could understand that motivation.

Okay. Okay. And John, you spoke about how stable MP has been recently. And what's really interesting is the business has steadily moved from high single-digit margins to now healthy mid-teens margins. Can you just step us through what's enabled the team to deliver the improved profitability? Is it price costs, operating efficiency? Just help us get a flavor of what's driven that. And most importantly, is there room for a structural margin improvement to continue in that business beyond the cycle?

Sure. So when you look at our Materials Processing segment, it is a collection, I'll say, of specialized machinery businesses. It is not a single business. It is more or less 17 separate businesses. The largest portion of the segment is mobile crushing and screening, but there's many other businesses, whether it be Fuchs material handling or our Advance mixer -- front-discharge cement mixer business. We have several cranes businesses that come from the old Cranes segment, tower cranes, rough terrain cranes, pick and carry cranes down in Australia. So I think the segment benefits from what I'll call diversification, diversification of businesses, diversification geography. It is extremely well balanced from a geographic perspective, I mean, almost exactly 1/3, 1/3, 1/3, North America, Europe, Asia Pacific. And I'd say it also has really benefited from a strong leadership team, not just simply Kieran Hegarty as President of the segment with a small, I'll call it, segment leadership team. But he has done a very good job of instilling -- installing, not instilling -- installing strong general managers running each of the individual businesses. If I just use Fuchs material handlers as an example, business that really struggled until about 3, 4 years ago. We brought in a new general manager who's running that business for us, and he's doing a really great job. Our Advance mixer business 5 years ago, replaced out the general manager, and the general manager there doing a really great job. So I think the segment has benefited from the -- crushing and -- the crushing and screening business has definitely been migrating more towards mobile. That has absolutely benefited us. We are a #1, #2 player in mobile crushing and screening. And so the general industry trend towards mobile has really helped us. But all of our businesses in Materials Processing have performed really well. I'd say that's under the leadership of Kieran Hegarty and a very strong team of general managers.

So that's really interesting in terms of improvement at Fuchs and the mixer business. Can we just talk about operationally what's changed? Can we just expand on those points? And also, if you could just include the crane business in that conversation as well, John, because no crane manufacturers are putting up mid-teen margins. So can we touch on that as well?

Yes. So I would say taking them individually, the Fuchs material handling business, which is the primary area is with respect to the processing and support for processing of scrap steel, and that is definitely a cyclical business. There's no doubt about it. But the key to a cyclical business is to be understanding the industry, understanding where you're at in the cycle and adjusting your cost structure to the industry environment in which you're operating. And I'd say is that as we've become a more operationally focused company as we've been -- increased our data analytics, we understand much better today than we did, say, 5 years ago, where we are in the cycle of each business. I'd just use Fuchs here, where are we in the cycle of scrap steel and adjusting our cost structure to meet that -- to be in line with the commercial demand environment in which we're operating and how to ramp up and ramp down production in our facility in Bad Schönborn in Germany. So I'd say that's really been the benefit. And that's what to bring a good general manager who knows the -- knows manufacturing brings for you. And so that's, I'd say, Fuchs material handlers. If I look at the Advance mixer business, our Advance mixer business was probably a bit neglected, right? It's based in Fort Wayne, Indiana. And they were really marketing the mixers in a small radius in the Midwest. And we have -- under the leadership of the general manager, we have expanded the geographic base in which we're marketing the -- our mixers. We've introduced new products. What's the benefit of a front-discharge cement mixer is that you only need one single operator to run the mixer, both from a driving the vehicle or the machine and also then discharging the cement, right? Whereas in a rear discharge, you need at least a 2 man -- 2-person crew, excuse me. So that we have advanced the machines technologically, but we've also expanded the geographic reach in which we're marketing the business. And the combination of those things have really grown it. When you look at the backlog that we have in our Advance mixer business, let me just say, it's multiples of 100, multiples of a year ago, like more than double. I don't remember exactly whether it's 400% or 500%, but it's big. So the business is really flourishing right now. And again, I attribute that to a strong general manager who knows the industry in which he's -- the business that he's operating in, strong customer relationships and is flexing the manufacturing for the industry environment in which he's operating.

Okay.

Okay. Sorry, and you wanted to talk cranes. So I apologize. Yes. So I don't disagree that the cranes business is a very competitive one right now, right? Our -- the cranes businesses that are within our -- within our Materials Processing segment really are 3, tower cranes, rough terrain cranes and then pick and carry cranes, which are a form of rough terrain crane but can -- a small crane down in Australia, used principally in the mining industry. The machine can both work off-highway and can also go on the highway, drive on the highway. And I'd say of those 3 businesses, no doubt about it, the tower cranes business is the most competitive. And -- but we are -- I wouldn't say -- I would say that the overall margins of the cranes businesses are below the average for the segment as a whole. That's not new news to you, given your comments at the beginning. But the segment is -- the businesses -- the whole segment, Materials Processing segment is extremely cost-conscious, including our cranes businesses. And so they're nicely profitable, that's why we didn't dispose of those businesses when we sold our Demag mobile cranes business and shut down our North American mobile cranes business. So we like the cranes businesses. We've said previously that we're not going to build -- rebuild back cranes businesses. But what is our Materials Processing segment, it's a collection of specialized machinery businesses that outearn their cost of capital through the cycle, and the cranes businesses meet those criteria. Specialized businesses outearn their cost of capital through the cycle. So we like them, and we're continuing to operate them. But again, you're not going to see us get back into the cranes business and build out our cranes portfolio.

Got it. Really appreciate the deep dive of your teams for the performance there. And if we could just shift gears to the Aerial Work Platform business. Can we talk about the margin opportunity there? A decade ago, when we were in the last recovery, you folks were nicely in a double-digit margin range, even reached mid-teens margins. I know the utility segment was added since then. So maybe on an apples-to-apples basis, it would have been 13% margins. But can you talk about whether you see runway to returning to profitability levels in that cycle? Or is there something particular to that recovery that might not be repeatable?

Yes. I think that if I go back to some of the comments I made in our last earnings call, number one is we absolutely believe that the -- our Aerial Work Platforms segment or our businesses are double-digit margin businesses. Absolutely, in the latter part of 2018, '19 -- and the very beginning of '19, we fell off the wagon. We had missteps, principally surrounding a misread of the market and building too much inventory that really, really plagued us during the course of 2019 and especially in 2020 when demand fell. But the business is absolutely double digit, and we are in the process of restoring that business, that segment to double-digit margins. If you look at 2018, the segment was about $3 billion, slightly less, $2.95 billion, I think, and it had a double-digit margin, 10.2%. Here in 2021, we're at $2.1 billion of revenue and a 7% operating margin. So if you just take that differential in revenue, call it, roughly $800 million at a 25% incremental margin, you will be actually above 10.2%. So -- and in fact, in order just to get back to 10.2%, and I'm not suggesting that we're satisfied with 10.2% because that -- you were pointing out, 10 years ago, it was much more profitable. But all I'm demonstrating is we don't even need a 25% incremental margin as the business gets back to industry levels to be double digits. So we have restored, as you know, in 2020, we did a ton of work to rightsize the inventories to the customer demand environment in which we're operating. In 2021, we are manufacturing in line with customer demand. So that -- and what does manufacturing in line with customer demand mean? It means that we're actually -- the year-over-year increase in the manufacturing -- the amount of production is huge. In the first quarter, year-over-year, the production for our Aerial Work Platforms segment was up 34%, right? I'm not saying we were producing more. We were producing in line with customer demand. But because we were so far below customer demand last year, the increase in production was 34%. So the business is absolutely double digits. It's a highly competitive industry, right? The rental companies have consolidated, and it's a very competitive industry. We have a very strong commercial team that has the right tools to work with and sell our products to the rental companies, and we are on the path to restore the segment to double-digit operating margins.

And John, what about beyond that? So -- and to me, the SG&A reductions that you folks deliver and not producing to retail, it's -- to your point, it's very easy to see 10% margins. But can you comment on prior cycle levels? Is -- are prior cycle levels of profitability on the table or not?

Yes. Look, I'd say we're on a journey back with our Aerial Work Platforms segment. So we believe the earnings power of the segment is as strong as it's ever been. But the industry has become much more competitive. So I can't sit here today, Jerry, and tell you that in 2024 -- 2022, '23, '24, whatever, that we're going to be 14%, 15%. I think that what we need to do is we need to restore the business to double-digit operating margins as the customer demand environment continues to increase, right? The industry dynamics for Aerial Work Platforms is really good right now, whether it be the nonresidential construction demand, infrastructure, discussion surrounding infrastructure bills or the replacement cycle. So all of the commercial signals are very strong for the segment right now. And so what we're really focused on is taking advantage of the current customer demand environment to increase the profitability of the segment, restore the segment to double-digit operating margins. And I think we'll bite -- we'll eat the elephant in bites. In other words, I think that if we get too far out over our skis and say, "Oh, we need to get to 15%. I want to get to double digits," then I can talk about 13%, 14%, 15%.

And John, I'm wondering, can you talk about how you view product vitality for your AWP product lines in North America, Europe? And what's in the pipeline?

Yes. So number one is that I think our investors understand this. But just to say it, we sell the same Genie products around the globe. We do not have a different product that we market in, say, the Asia Pacific region from that which we market in North America or Western Europe. Why? Because our focus with Genie is on the quality of the product, the strength of the platform and its operating history, low maintenance and, as a result, the strength of the residual value of the machine. And so from a product vitality perspective, we have been very focused on bringing to market hybrid and electric Genie products, especially within the scissor area. In fact, in North America, here, there is a greater demand for our electric and hybrid products than there is for diesel engine products at the moment. So we are -- have been introducing environmentally friendly, ESG-friendly products. I would say to you that we have -- we were not the industry leaders in bringing electric products to market because the reality is, is the rental companies, they really wanted a product, which was cost competitive with the combustion engine. And so we worked very hard to bring cost parity between our electric product and our combustion engine product before we were bringing it, introducing it to our customers. We were able to achieve that in the second half of last year and therefore, brought the products out to our customers. So I'd say from a product vitality perspective, the vitality of our Genie product range is excellent, and it's really focused right now on electric and hybrid products across the globe.

And I want to come back to the electric product opportunity in a moment. But before we do that, can we just talk about your product lineup in China? There have been a broad range of low-end competitors. And I'm wondering, how would you define your focus market segment within China? And is there an opportunity to essentially put out a more basic product than you folks produce in Western Europe to take advantage of demand for lower-specification products?

Yes. So we produce all of the product for our customers in China in our manufacturing facility in Changzhou, China with Chinese manufactured components and with a full Chinese workforce. So we believe that our Changzhou, China manufacturing facility is completely cost competitive with any manufacturing facility of our competitors in China. There's no -- we do not see any differential there. So that, as a result, our focus really has been on providing a quality product with a strong residual value to our customers in China. We made a decision several years ago that we were not going to have a, call it, a Western market standard and a China or Asia Pacific market standard. We were going to sell the same machine because we did not want to dilute the brand equity, the quality, the residual value of the Genie product. And that is -- so we don't have an intent for introducing a lower-range, lower-quality, second-tier, whatever you want to call it, machine in the China market. Our focus -- and there are absolutely customers in the China market who understand the value of the importance of the residual value of the machine and are very strong customers of ours. What I would say to you, Jerry, is that our product offering is probably stronger, not probably, our product offering in China is stronger on the boom side than it is on scissors. There's -- the boom is obviously more technologically challenging, and so we're able to compete there more effectively, whereas the pricing for scissors, less technologically sophisticated, has really fallen. We don't sell our products at a loss. And so to the extent that there are Chinese competitors of ours that won us by market share, have at it. We're not going to sell it loss -- at a loss.

Good. Okay. And can we go back to the comments about more than half of your scissor sales in North America are now hybrid and electric than diesel. That's really an interesting comment. Where would that have been a year ago? And what are the economics for you? Do you get more profitability per unit? Obviously, the percent margin, because of the battery costs, I know, are going to be lower. But what about profitability per unit? Can you comment on that, please?

No difference. As I was saying, is that we did not bring the -- we did not bring our electric product to market until we were able to match the cost of our combustion engine product because the reality is, is that our customers don't want to pay more for the electric product. They are very price sensitive. The rental industry is a very cost-competitive industry where the rate per day, week, month, whatever is measured in very small differentials. And so what we found with our customers is they would very much want an electric or hybrid product, but they weren't willing to pay more for it, just like with respect to the ANSI-compliant products. We introduced the ANSI -- we learned from the ANSI compliant -- I can sell in these, call it, fiasco, right, is that we introduced ANSI-compliant products before the original legislation or regulation was to go into effect. And our customers were willing to buy the ANSI-compliant products, but they weren't willing to pay more. And then the regulation got pushed out. And here we were, we had converted to ANSI compliant, which is more expensive, but customers won't -- weren't willing to pay for it. So what we said is we're not going to introduce an electric product until it is cost compliant -- cost competitive with the combustion engine product. And so our price isn't different, the cost isn't different, the profitability is the same.

No. No, that's really interesting. Well, unfortunately, we've run out of time. As you can tell, we can keep going. John, Randy, thank you so much for joining our conference. And thank you very much, everyone, for tuning in.

Thanks, Jerry.

Thanks, Jerry. We appreciate your support.