Terex Corporation (TEX) Earnings Call Transcript & Summary

Good morning, everyone. This is Courtney Yakavonis, Morgan Stanley's U.S. machinery analyst. Before I begin, I'd have to read some disclosures. For important disclosures, please see Morgan Stanley's research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So with that, thank you all for joining us this morning as we kick the day off with Terex. We're very fortunate to have John Sheehan, SVP and CFO; and Randy Wilson, Director of Investor Relations. So John and Randy, thank you so much for being here today.

Thanks for having us. We appreciate it, Courtney. So happy to have you back, too.

Thank you.

Well, no better way to kick it off than talking about the AWP cycle. You're talking about a multiyear replacement cycle for some time that should be starting the end of '21 time frame. How would you say that COVID has impacted that replacement cycle? And is the strength that we're seeing this year really just to catch up post COVID? Or do you think that replacement cycle has begun?

Yes. So what I would say is that the replacement cycle is a dynamic associated with our Genie business in our AWP segment. And our AWP segment has 2 businesses, Genie and Terex Utilities. And so the replacement cycle is really more associated with our Genie business. And quite honestly, I would say is that the COVID has not materially impacted our -- the replacement cycle. When you look at 2020, yes, our customers paused their capital equipment purchases, but they actually shrunk their fleets during the course of 2020 as a lack of capital spending and disposition of equipment. And so as a result, we're seeing a significant amount of growth in capital demand by the rental companies this year. We don't view that as really being replacement cycle-driven as much it is just simply the nonresidential construction demand that our customers are experiencing. So we don't believe that the replacement cycle has been materially altered, and we do expect that later here at the end of this year and into 2022, 2023 that, as a result of going back 8 years earlier, the amount of equipment that was purchased by the rental companies that the replacement cycle will kick in, in a significant way.

Speaking of the age of the fleet, how old would you say that the current fleet is? And when you're having discussions with your customers, are you starting to have those longer-term discussions about what their replacement needs could be out a couple of years?

Sure. We certainly are talking to our customers about what their capital spending plans are. Part of our conviction associated with the replacement cycle being alive and well is the fact of the discussions we've had with our customers. When you look at the age of the fleet, the fleet is aging. We used to reference one of our customer's externally reported age of their fleet, but they then stopped making that disclosure. So I would say is that it's difficult for me to specifically say how old the fleet is, but I would say that it is relative to the last several years that it is aging and that is what gives us conviction with respect to the replacement cycle. For some investors that may not be totally familiar with the replacement cycle, our customers are looking to maximize the return of their invested capital. And they've done a lot of analysis that demonstrates that 8 years plus or minus, it's not 8 years on the day, but that 8 years is really the sweet spot for minimizing maintenance costs and maximizing the residual value of the machine as the original owner of it. And therefore, replacing that machine after 8 years is the right time. So we remain fully convinced that the replacement cycle is alive and well as we move into 2022, 2023.

Great. You mentioned earlier that the replacement cycle mostly relates to Genie in North America. But can you talk a little bit about the international penetration rate within Aerial Work Platforms? APAC is only 5% below 2019 levels now, but -- and it's grown to be 15% of your business from only 10% a couple of years ago. So how big could that business grow over time? And can you just give us a sense of some of the dynamics in terms of pricing competition in your APAC markets?

Sure. So when you look at Asia Pacific for Genie, it has grown significantly, principally as a result of increased adoption in China. The China business has grown significantly -- the Genie China business has grown significantly for us and that has benefited us in terms of the overall exposure of the AWP segment to Asia Pacific. The other thing is that, when you look at India, another significant market in Asia Pacific, today, there's very little AWP or Access Equipment, Genie equipment that is used in that country, right? And we see India as the next significant growth market with respect to AWP equipment. So the Asia Pacific region will continue to grow. In terms of pricing, it would be -- it's fair to say that the China market is extremely competitive. However, we have fully localized manufacturing in China that is cost-competitive with our peers in China. And we're also not seeking to sell our equipment to every single rental company in the China market. We produce the same machine in the China market that we produce in Europe or the United States. We don't have a lower-priced machine. And we're selling on the same basis of the quality of the machine, the reliability of the machine, the residual value of the machine. And so customers that understand that -- and there are a lot of them that are focused on exactly the same dynamics that the U.S. or European rental customers are maximizing the return on invested capital of the machine. And so we've been very successful in China and expect to continue to do so. The rest of the Asia Pacific market is not tremendously different than the Western European -- Western, whether it be European or North American markets, in terms of pricing.

Got you. You've also -- you mentioned the facility in China. You've also been making significant investments in your Utilities business in Watertown. Can you just talk a little bit about the amount of capacity that you added to the Utilities business and some of the key drivers of that and how big you think that business can grow over time from the $400 million level today?

Yes. So the Utilities business is a really nice business, a strong business for us. They've grown that business high single digits revenue over extended period of time. One of the good things about the business is it has less cyclicality than our Genie business does. And so the 2 are very nice together. In terms of the business, you're right, Courtney, we did just make a significant investment in a new manufacturing facility in Watertown, South Dakota. We had maximized the production capacity in the 11, I'll call them, sheds in which we were producing equipment machines. And as a result, we were capacity-constrained. So we made the investment in the new facility in order to be able to continue to increase our share of wallet with our Utilities customers: the utility companies, independent power companies, forestry and tree care companies are our customers. And we expect that we'll continue to grow the business. As I said, it's a very stable industry, grows high single digits. And we have been able to increase our share of wallet, and we expect to continue to do so with that business. So it's one that we like very much and will continue to invest in.

Great. Maybe if we can talk a little bit about margins. You posted one of the strongest margin quarters in history. I think, in 2Q, your margins are about 200 bps better than they were in 2019 even though revenues were 20% lower. So can you just talk a little bit about the drivers of the improvement that you're seeing there?

Yes. So I guess what I would say there is I'd attribute it to really 3 factors. Number one is our Materials Processing segment. And over the last 5 years, our Materials Processing segment has been able to grow the top line of the segment very nicely from being just below $1 billion of revenue up to $1.4 billion, $1.5 billion of revenue. So through global expansion of the business, the business has grown. And at the same time, they've maintained their cost competitiveness and very strong cost control. And so as a result, the operating margins of the business have really grown by about 500 basis points from below -- just below 10% to 13%, 14%, 15% in any particular quarter. If you look at the last 4 quarters, Q3 of 2020 to Q2 of this year, this segment has been 13% or better operating margins every quarter, in the second quarter of this year at almost 16%. So that's, one, a huge driver of the increased 2019 to 2021 in Q2. Number two, we have been laser-focused on improving the profitability of our AWP segment, whether it be the new Genie manufacturing facility contributing to growth and profitability in that part of the business, or in Genie, we have been really focused on manufacturing efficiency, reducing our cost structure over the last year in order to enhance the profitability of that business. And so the Genie business was -- also improved its profitability significantly from Q2 of '19 to Q2 of '21 as a result of strict cost control. And then third, during the course of 2020, we used the reduction in revenue and the business environment to really attack our SG&A cost structure. And so if you look at our SG&A as a percent of sales this year, our target is 12.5% SGA to sales, and we expect now to be below 12% for the full year 2021. So the combination of those 3 factors, really, all 3 of them, the common denominator is strict cost control. We are really focused on maintaining our cost structure. This is a very competitive industry, and so we have to keep our eye on the ball of cost control every single quarter.

Good segue into supply chain constraints. You, along with the rest of the machinery complex, had some significant disruptions on the supply chain and logistics over the past couple of quarters. Last quarter, you called out about $75 million in deferred revenue as a result of it. Can you just talk a little bit about where the pressures were most acute and what steps you're taking to mitigate them?

Sure. So I guess, number one I would say is that the supply chain disruptions, supply chain constraints that we're seeing are significant. That said, I would give a shout-out to our global supply chain teams because they are working their hearts out every single day to make sure that we have components to be able to build machines for our customers, and they're doing a great job this year under really challenging circumstances. I would say to you, Courtney, that the supply chain situation at Terex is not and I think in the industry, I don't think we're unique here, is definitely not improving and we're continuing to face challenges every single day. Perhaps I would even put them in the category of increasing challenges every single day. The impact, I would say, is that the supply chain challenges go across all of our businesses or probably are most acute in our Genie business, where the supply chain is most global. The Genie business also has much faster production time. The machines come on to the line and roll off the line much quicker, and therefore, a shortage of parts affects them much more significantly than, say, Materials Processing segment where the machines take a longer period of time to produce, measured in days versus hours. So in terms of the impact, when we're not able to have all of the parts to produce the machine the first time through the line, that creates inefficiency in our manufacturing processes and additional costs when we have to take a machine off the line, put it in the parking lot and then bring it back in. That's inefficiency that reduces our manufacturing efficiency or absorption. So now I would say, though, is that when you look at the amount of production that we had, for example, in the second quarter of this year, it really -- versus the second quarter of 2020, it was 2.5x higher. So it's not like the supply chain hasn't ramped up. It has ramped up. The problem is the demand has ramped up so much faster that we're not able to be able to procure parts in order to be able to meet that demand. That said, the production in the second quarter of this year was only 60% of Q2 of 2018. So there's a lot of -- we have plenty of production capacity. Our constraint is getting parts from suppliers. And we expect that the issue will continue throughout the remainder of 2022.

You mentioned that you're starting to see it -- or the pressure has increased slightly. Where is that? Is that on semiconductor chips? Is that on steel-related parts?

Yes, yes. And hydraulic equipment, I'd say, is a third area. Resin-related products, another one. But also I have to highlight global freight and logistics. The -- again, with our Genie business and the global supply chain, the availability of freight, whether it be containers, shipping, to be able to move machines we do produce in the -- in China for the European market in particular. So that logistics is also an issue that is affecting us.

Do you have any sense of when you'll start to see some relief? And how long does it take before we see these impacts reflected in your P&L?

So I guess I would say is that -- 2 things there. I probably will hesitate to speculate on when the relief is going to occur. Back during the first half of this year, first quarter, we were saying that -- and I think our peers, too. I'm not saying anything -- I don't believe I'm saying anything different than our peers, which was that, back earlier this year, we were saying the second half of the year. Now I believe we would say 2022 that the issues will continue throughout the remainder of this year and into 2022. So I don't think it's something that's going to -- we're going to overcome in the next couple of months. And what -- the supply chain constraints manifest themselves in delay of the ability to recognize revenue or the ability to deliver a machine to our customer, and therefore, be able to recognize revenue. So look at our backlog at the end of Q2 was 20% to 25% higher than pre-pandemic levels yet our revenue forecast is 20%, 25% lower than pre-pandemic levels. That -- so what's the biggest impact on the supply chain constraints is the ability to produce machine, and therefore, produce -- deliver it to a customer and recognize revenue. It also manifests itself in manufacturing inefficiency, higher cost for manufacturing machines.

You mentioned that 20% of your backlog is spilling into 2022 right now. I believe you had said most of it was still at 2021 pricing because it's that deferred. Can you talk to us a little bit about, given that these constraints are likely to last into 2022, how you think about pricing heading into next year, also in light of the inflation that we've seen on the steel side and from some of the raw materials.

Yes. I mean they're really -- the supply chain, if you will, supply chain or the dynamics of procurement today really have 2 issues. One is the supply chain constraints that we just discussed significantly. The other is material cost inflation. It started with steel earlier this year. But quite honestly, whether it be resin-based products or freight and logistics, we are seeing significant material cost inflation across almost every cost category in our business. And as a result, we have been talking to our customers and being transparent with our customers about the cost increases that we're experiencing. We can't be and we won't be the shock absorber for material cost increases. We've got to be able to pass those along to our customers. In both our AWP and MP segments, we have increased prices, quite honestly, more than once this year. And we do expect that for 2022 that we would be price/cost neutral on a cumulative basis and that is certainly our objective. Our objective is not to expand our margins on the back of higher material costs. It's simply to be able to recover the costs that we're experiencing from the increases in material costs. So our discussions with our customers have been about the cost increases that we're experiencing in our business and the need to be able to recover those costs through pricing in 2022.

Maybe can you just address how that's going to impact your incremental margin framework? You mentioned that you expect to be price/cost neutral in 2022, but you've also had a target of a 25% incremental. So maybe if you can just talk a little bit about the second half of this year because the first half was so much higher than that 25% and then the setup for 2022 to reach that.

Yes, yes. I would say is that the second half of this year is going to be tougher than the first half of this year. Material cost inflation has accelerated as we've gone through this year as well as the supply chain constraints are accelerating or increasing, as I said earlier in this conversation. So that from a short end -- in some of our businesses, particularly on the Genie business, the ability to continue to raise prices here in the second half of the year is more challenging. And so I'd say that there is probably a short-term dynamic where material -- the price/cost would be increasingly negative for that business. That said, as I said a few moments ago and to be very clear about it, our objective is that for 2022 we will be price/cost neutral on a cumulative basis, and therefore, that we would recover the cost increases that we're seeing in steel, resins, hydraulics, freight, labor. And so that it still is our objective and would expect to be at a 25% incremental margin for 2022.

Great. And then just, lastly, you haven't really mentioned labor being an issue. Is that something that you're seeing, others are seeing, significant absenteeism? And if you wanted to increase your capacity, if you did get the supply chain constraints resolved, you'd be able to add a third shift?

Yes. I would say is that labor is certainly at a premium. I would say especially in the state of Washington, where we have significant manufacturing and also in Northern Ireland. And quite honestly, labor in Northern Ireland is probably as much of a constraint, if not maybe even a little bit greater than supply chain. And I'd say that given the -- on the AWP side, given the supply chain constraints, I wouldn't say that labor has been a big issue because we don't have enough components to be able to produce more. And so we're not at this current time looking at a third shift in, quite honestly, any of our businesses. And I would say is that we, like almost every other company in the United States at the current time, are hiring. And so we will continue to be creative in bringing new team members into the business in order to be able to maintain and grow our production in order to meet customer demand.

Okay. Great. We'll leave the margin and cost conversation there. Maybe switching over to MP. You mentioned earlier that, that's traditionally been the more stable part of your business. You made a couple of small acquisitions recently to bolster some of your product lines there. Can you just talk a little bit about the outlook, the various markets within MP and which business lines you view as most attractive right now?

Yes. The beauty of our Materials Processing segment is their diversification, right? It's not one single business. It's really 17 or 18 small businesses, a collection of specialty manufacturing businesses. And so therefore, that diversity of businesses allows them to have, at any point in time, some that are doing well and overcoming the challenges in others. From a global diversity perspective, they are almost perfectly symmetric in terms of North America, Europe, Asia Pacific, each being about 1/3 of the business. So the diversification of the business has really benefited our Materials Processing team. The crushing and screening business, which is about 60% of the segment, has been performing extremely well. You know that with our Powerscreen and Finlay brands, they're really #1 in terms of mobile crushing and screening. We're really focused on the mobile side of crushing and screening. And mobile has really been supplanting stationary as the primary method of crushing and screening. The differential being whether you bring the machine to the aggregate or you bring the aggregate to the machine. And there's a lot of efficiency associated with our mobile crushing and screening equipment, and that's what's been driving the demand in that business. On top of crushing and screening, we're also significantly expanding in recycling through our Evotec (sic) [ EvoQuip ]. And that business really focused on demolition and waste recycling businesses has also been a significant driver, especially in the European market.

We have about 1 minute left. Maybe you can briefly talk about electrification and some of the ESG trends that you're seeing. You mentioned some of the environmental businesses within MP, but also how your Utilities business is advancing some of the electrification of the grid and also just what your electric product lineup within Genie is today.

Sure. So I would really just probably the best thing to do in the minute is some quick facts, right? 1/3 of the revenue of our Genie business is battery-driven, right? Very focused on driving hybrid and battery-driven technology for that business. So number one. Evotec -- the EvoQuip brand for waste and nonresidential recycling and demolition recycling. And then also in the Utilities business, right, very focused on driving growth in the infrastructure grid. That's critically important here in the United States. And our Terex Utilities equipment allows workers to work at height on electric equipment in insulated bucket trucks that keep them from being -- keep them safe while conducting their work. So we're very focused on electrification.

Great. Well, thank you so much, everyone, for joining us this morning. Thank you, John and Randy, both for being here. And I hope everyone has a good rest of the conference.

Thanks very much, Courtney.

Thanks, Courtney.