Terex Corporation (TEX) Earnings Call Transcript & Summary

Good afternoon, everybody, and welcome. My name is Ann Duignan. I'm the U.S. machinery analyst and delighted today to have John Sheehan, the CFO of Terex, with us. Since we are live on our webcast, I think we'll go right ahead with our questions.

John, I think it would behoove us, given the events of the last few days, to address maybe the elephant in the room first and just ask you what exactly your exposure to China is. And then we'll get moving right back on to the questions that we had designed for today. But perhaps we could get that question out of the way as a start.

Sure, Ann. So first of all, I'd like to say thank you to -- for you inviting us to participate in this conference. We have participated the last several years, and it's been a very positive experience for us. So thanks again for the invitation. In terms of our China exposure, China in total for Terex represents about 5% of our total revenue for the company or, let's say, not more than 5% actually. And the sales are principally through our Genie business. We do have a limited amount of Terex Utilities and Materials Processing crushing and screening machines in the country, but 90% plus of the revenue is for our Genie business. We manufacture locally in the China market in Changzhou, China. We've been there for a number of years with a fully localized cost-competitive manufacturing facility. Our Genie sales, since they represent the most significant portion of the segment, our Genie sales are to the rental companies in China. Our largest customer there is actually a state-owned rental company. And I would say is that we're obviously watching, or as everybody else is, the situation associated with the real estate firm in China. We don't see any real direct impact on our business, although obviously, on a longer-term basis, if there was some impact on nonresidential construction or -- residential/nonresidential construction in China that, that may have some impact. But again, China, while important, I don't minimize the value of the China market, it is only 5% of overall Terex revenue.

And maybe just to put that into context, I know as you say, it may not have an impact on your business overnight. But maybe just from an investor's perspective, maybe remind us maybe 5 years ago, how big China would have been as a percent of your total revenue? I know that may not be a fair question, but roughly, it's grown from maybe 0% of revenue to 5% in the space of like what time frame?

Yes. I would say is that 5 years ago, in 2016, 2017, China would have been on the order of magnitude of 2% -- 1% to 2% of our revenue to grow into the 5% today. So the business overall is definitely growing faster than the rest of the world. But again, our customers are the rental companies and servicing principally nonresidential construction and, to a certain extent, residential construction so that I wouldn't anticipate -- the demand environment for nonresidential construction in China will remain irrespective of whether this firm is meeting that demand or not.

A fair point. We may see a slowdown in the near term as things get reorganized or the company itself gets reorganized and...

Right. Fair.

Ends up in other hands reminds me of the housing crisis in the U.S. of last decade. I guess we should see if its technical or a secular or just scare tactics right now. So back to maybe the more fundamental questions. I thought it might be interesting to hear from you about the course of the last year, all of us have been through lockdowns and back to the office or whatever we've been through. But it did strike me as interesting, listening to CEOs and CFOs over the course of the last earnings season or 2 that -- what you guys have been through running companies has been unprecedented. And I'm just curious whether -- given your experience, whether indeed what you have experienced at Terex has been unprecedented over the course of the last 12 months. And is there anything you would do differently now, looking back at the shape of the recovery and the speed of the recovery and where we stand right now with supply chain issues, et cetera, et cetera, is there anything that you, as a management team, would have done differently in hindsight with the 2020 vision?

Yes. That's a great question. So I guess what I would say is that I do view the events of the last, call it, 18 months now with the whole pandemic as unprecedented or a bit of a black swan event. And therefore, the falloff in demand -- the overnight falloff in demand that we saw from our customers followed by the virtually overnight increase in demand we saw from our customers is unlike any other normal cycle that we've experienced. Quite honestly, the speed at which the recovery came was even faster than the -- during the course of the global financial crisis in the 2008-2009 time frame. And so if -- to your specific question, if I reflect back on the actions we took in 2020 and with hindsight, would we take those same actions, I think there's some that we would and there's some that we would not. So on the would-not side of it, if I start with would-not, is we cut into our workforce both on the -- in the production side really hard when the pandemic hit. We reduced our direct and indirect production workforce. We cut back on purchase orders with suppliers, all with the focus of preserving liquidity because we didn't know where the world was headed. And so we wanted to make sure that we had sufficient liquidity to operate through whatever was coming at us. And so what we've obviously discovered or seen as demand came back is the ability to then ramp up that supply chain again, the ability to hire workers has been quite challenging. So I think if we had to do it all over again and knowing how short term the demand falloff was going to be that we would certainly have maintained more of a production readiness, production continuity plan than we did. On the "I would do it all over again" side, though, I would also say that we used 2020 to reduce our SG&A cost structure significantly. And we have been very disciplined at adding costs back as our revenue has grown this year. That has allowed us to be able to reduce our SG&A percent of sales to below 12.5%. And our current guidance for 2021 is about 11.75%. So I would say is that I'm proud -- we're proud of the streamlining of our SG&A cost structure actions that we took during the course of last year, which helped us to preserve liquidity, but also is benefiting us this year as volume has been coming back. So obviously, hindsights 2020, if we had more continuity in our supply chain right now, it would be a good thing.

Well, I think that's a fair comment. I think, again, looking at it from an investor's perspective, none of us knew what the duration of the downturn was going to be. And I think given the size of your option, preserving cash would always be the #1 priority of any CFO or CEO running a company like yours, a cyclical company. So I think, indeed, given that none of us knew what the slope of the recovery was going to look like at the time, I'm sure that other CFOs would look back and agree with your assessment of where we are today versus where we were 18 months ago and where we've been. So with that in mind, it does bring me to, believe it or not, only question number two. So question number two in my list is given where we are today, could you rank order the following by concern, just -- and maybe quantify to the best of your ability, where we are today with material costs, freight costs, by your issues or the lack of ability to get supplies, labor issues internal to your own operation and other. I mean there's just a myriad of things that seem to present themselves on a daily or weekly basis. So I'm just curious, as of this moment, you could rank order those issues as concerns and, to the best of your ability, quantify those issues as we stand today.

Sure. So what I would say in terms of rank ordering is that I'd say number one issue is supplier continuity, the ability of suppliers to supply us with sufficient components for our manufacturing facilities to produce machines to be able to meet customer demand. And I rank order that number one and -- because of the fact that for -- really for 2 reasons. Number one is, if you don't have parts, you can't build a machine to have revenue. And I would also say is that during the course of the third quarter, we have seen a deterioration or a reduction in the ability of suppliers to be able to supply parts in line with the purchase order commitments that we had. As a data point, we had -- at the end of August, we had double the number of Genie machines in hospital, meaning parked outside the facility in the parking lot, waiting for parts to come in. We had doubled the number of machines at the end of August versus the end of June. And so our number one target right now is working with our suppliers to make sure that we're getting at least our fair share, if not everything that we've -- we ordered such that we're in a position to be able to build machines because we can't meet any customer demand if we're not able to produce machines. Number two, I would put actually material cost inflation as the -- as probably our second largest issue is we are certainly seeing material cost inflation from virtually all suppliers at the moment. And we are pushing back hard against those requests for price increases. But we also have to recognize that if we want to get components to -- and we want to be first in line to get the components we've ordered from our suppliers, we also have to be careful to not be saying no way are we giving you a price increase. The reality is we recognize that commodity costs have increased. Labor costs are increasing. And so we -- if we want parts, the reality is we are going to have to increase -- provide price increases to our suppliers. And we're seeking to minimize those and be reasonable about them. We're also keeping very close track of what the supply price increases we grant are so that as the world normalizes and commodity costs come down, that we recover those. In general, I would say mid-single-digit price increases is the type of requests -- suppliers probably start higher than that, but those are the types of -- in the 4%, 5% range is probably where we end up. It's probably more of an estimate than an empirically derived number there. And so material cost inflation is definitely a challenge here, especially in the second half of the year because of the fact that in our Genie business in particular, our ability to change prices and actually gain -- have price increases when we're pretty much booked out for the entire second half of the year unless we were going to change prices on booked business, which we've not historically done, means that pricing -- our price cost will be negative -- will be increasingly negative in the second half of this year. Third, freight costs have been an issue all year. I would just put freight and logistics in there combined, the ability -- first, you have to get the supplier to have components available for you. Then you've got to be able to ship them, whether -- or ship our machines around the globe. Also, we do produce in China for the European market. The ability to have available containers and ships to get the machines to the European market is definitely an issue irrespective of cost. And I would then rank labor last of your -- of the issues you identified or the concerns you identified. And I say it not because we have sufficient labor by any stretch of the imagination. We are hiring in virtually every facility we have around the world other than our corporate headquarters. But we -- the reality is, is that if we don't have more parts or availability of components from the supply base, then we do have sufficient labor today for the amount of parts we're getting. If the supply chain was all of a sudden to break loose and we had ample components from suppliers, labor would definitely be an issue. And we are putting in place, whether they be retention bonus opportunities or increased labor payroll cost, hourly labor cost payments, in order to be able to make sure we're retaining the team members we have and adding to those team members such that as the supply chain normalizes, we're in a position to meet customer demand. So those -- that's what I -- how I guess I would rank order the myriad of issues that we're dealing with today.

Okay. And are you seeing any signs of customers pushing back any kind of cancellations, any delays in orders, any pull forward of demand in anticipation of higher prices going forward? Is there any reaction by customers? Or is everybody just in the same boat and they recognize that they're going to need new equipment, so it's kind of grin and bear it?

Yes. I would say is that we are not seeing customer cancellations even with the extended delivery times that we have. Customers definitely want equipment and are not canceling orders. We're not -- really both of our business segments at this point, we're pretty much sold out for 2021. And therefore, orders we would be taking are for 2022. We are -- any orders we are taking obviously have 2022 appropriate pricing built into them. And so I would say is that, especially with our rental customers at the moment, there's significant discussion going on with respect to 2022 pricing, and ordering will follow thereafter.

Okay. Well, that's a good segue into -- let's look at the various segments, and let's look at the Access Equipment or the AWP segment. Your backlog was up 182% at the end of June to about $1.4 billion. And you've guided for sales of up 22% to about $2.175 billion and an operating margin of 7.5%. Maybe you could just walk us through the assumptions for this year by region. I'm curious, we are hosting this event in -- it's a European-focused event. So maybe talk a little bit beyond just the demand side of the equation in North America, but also Europe. And we already talked about China, obviously. But maybe from an Aerial Work Platforms perspective, you could talk us through where you're seeing demand. And given that you said you're mostly sold out, is that true across all regions? And is there any upside or downside risk to your guidance for this year, probably not, given the comments you just made. But as we turn the corner and go into 2022, what do you worry most about, from a demand perspective, specifically with AWPs?

Sure. So I would say is from a demand perspective, the most significant growth that we're seeing is really -- or the largest demand we're seeing is in the North American market. Or at least against our expectations going into the year, I would say is that from a pure percentage basis, China is probably still greater than North America, but we expected that growth going into the year in the first place. The North American market has been certainly the one that's outperformed our expectations. That said, the European market also has significant demand this year. It's been a very strong market, definitely up double digits for us year-over-year. And we are effectively sold out for 2021 in the European market also. So really what I want to bring across Ann is, is that demand anywhere around the globe is really not our issue right now. Our issue is the ability to produce machines and to be able to deliver them to customers. With the increase in the number of machines in hospital at the end of August is you can't recognize revenue until you actually complete the machine and deliver it to the customer. So against our revenue expectations, the increase of machines in a hospital is certainly a concern that we are working through. The material cost inflation that we're experiencing in the second half of this year is also exceeding our expectations from that, which we were going into the second half of the year with, and is a challenge. I'd say lastly that when you look at what is the impact of having machines that you're not able to complete that reduces our manufacturing efficiency, takes more labor to bring the machine out to the parking lot, bring it back in, take it apart to put the parts in and be able to then complete it to deliver it to the customer. So our manufacturing efficiency also suffers. So there are certainly operational challenges that we've been working through in the AWP segment, which were those challenges, I would say, are greater than those that we were expecting going into the second half of the year.

Great. And maybe just before we wrap up on AWPs, again, I like your description of products in hospital. It sounds like you describe the net scenario where it's more than just semiconductor chips. I don't think AWP has been highly electronically -- with high electronic content. So maybe you could just remind us what specifically are the shortages that you're seeing right now or that -- I'm sure it changes every week. But what's causing more product to be in the hospitals this quarter versus maybe what you had expected?

Sure. So there are absolutely semiconductor chips and -- in sensors on our machines -- on our Genie machines. And we don't -- we are not a volume producer like the automotive OEMs are, although we're using pretty much the same semiconductor chip manufacturers as they are. And therefore, with our lower volumes, we are challenged to stay at the front of the pack in terms of supply. In addition to semiconductor chips, I would say that hydraulic equipment and resin-based products like -- and tires and so forth. But also recently, engine supplies has been a challenge. So I almost feel like at some point or another, over the course of this year -- other than steel itself, which obviously has its own issues in terms of cost, that many of the other components that go on the machine have been challenged to be able to have adequate supplies.

Yes. We've heard the hydraulics and the engine issues across our coverage. So that's pretty consistent. And interesting that they would also be contributing to your problems. Maybe switching gears a little bit for a moment. I do want to touch on materials and processing. The Utilities business, which for you guys are trucks with things on back of them that allow electric seller workers to go out and fix poles that might not be something that Europeans are as familiar with. But maybe you could talk about the Materials Processing business. I think it is the sum of a lot of different business units. But utility equipment has been the bright spark of that business. It's about a $400 million business, about 18% of the segment. And maybe you could just talk about that business as it lies today and where demand is and what exactly is going on in that business as we sit here today.

Sure. We like our Utilities business a lot. As you said, Ann, it's about a $400 million business. It is primarily 90% plus focused on the U.S. utilities market. The customer base is principally utility companies, whether they be electric utilities or independently owned electric utilities. To a certain extent, there's forestry companies. The dynamic in the U.S. is, is that utility lines are principally above ground. And therefore, if you're working on the -- if you're a utility company, you need to work on the utility line, you need to have an insulated bucket. So the boom and the bucket associated with the machine are made out of fiberglass such that the current -- the electric current wouldn't be conducted through the boom or bucket if it was to hit the electric wire and therefore keeps the electric worker -- electrical company worker safe while working on live electric wires. We do, as you indicated, mount the boom and bucket on the back of a utility truck that is then able to be elevated and work at height for the worker. The -- why do we like the business? We like the business because it is much less cyclical than, for example, our Genie Aerial Work Platform business, right? In general, utility companies are expanding their CapEx on a consistent basis each year. In 2020, through the pandemic, while we did see some contraction of spending by utilities, it was far less than by the rental companies. And so it's a much stable -- much more stable top line revenue business and one in which we produce in Watertown, South Dakota. We just built a new manufacturing facility to increase our capacity to be able to meet the growing demand of our customers. You know that the U.S. infrastructure does need significant upgrading, and I'll use the word renovation. And we believe that our products are uniquely positioned to be able to allow the utilities to work on the poles and the electric lines and keep their workers safe.

Maybe you could talk a little bit about who your primary competitors are in that business because it does seem like that's a nice little niche business with at least margins that are comparable with segment margins. So maybe you could just talk about the competitive dynamics in that business.

Sure. It's actually a very consolidated industry. We hold the #2 market position and have -- are very focused on competing for #1. In terms of the insulated market, there really is only one other competitor company by the name of Altec. And we believe that our equipment stacks up really well, both in terms of the functionality of the equipment, the reliability and quality of the equipment and our relationships with the utility customers. We are really focused almost exclusively today on the insulated market, as I said, the fiberglass boom and bucket. There are other competitors in the space that are producing equipment -- noninsulated equipment, but that's not an area that we're significantly involved in today.

Okay. That's good color, and I appreciate that. So that business would obviously benefit if we did see a significant increase in spending in infrastructure or spending on anything related to power generation or distribution. I would imagine that going forward, given climate change, given all the storms we've had in the U.S., whether it be fires or hurricanes, et cetera, et cetera, but there does seem to be a greater emphasis on transmission of the grid in the U.S. and investment in transmission. And I'm assuming that, that would be a benefit to a business like utilities.

No doubt about that, Ann. And you only have to look at what's happened in California over the last couple of years and the need for working on the California electric grid and infrastructure. But it's really the case across the United States, as we know the electric grid gets older and older every single day. And that's one of the reasons why the current U.S. administration is seeking to put into place a significant infrastructure spending bill, including on the electric grid, and Terex Utilities would be a significant beneficiary of that.

Okay. So now I really do want to switch to Materials Processing. And maybe you could give us an update on what's happening in that segment. Margins have been pretty solid through the course of the last several years and year-to-date. So maybe for an investor who might not be as familiar with Materials Processing segment and that part of the business, maybe you could give us just a quick high-level view of what product lines are in that business, how big is the market, where you're seeing the strength there by region, et cetera, et cetera. And then you probably do have a number of European competitors in that business. And where do you stack up in your major product lines versus your competitors in that business? I know that's lot of questions.

Sure. That was a lot of questions, but I love talking -- being able to talk about our Materials Processing segment. Our Materials Processing segment is not one single business, but rather a collection of specialized equipment manufacturing companies, call it as many as 17 or 18 of them. And the segment is extremely well diversified with about 1/3 of its revenue in North America, 1/3 in Europe, 1/3 in Asia Pacific. So one of the real benefits of the segment is diversification, diversification of businesses and diversification geographically. In terms of the businesses that make up the segment, the largest portion of the segment, close to 60%, is crushing and screening equipment. Our focus in crushing and screening is on mobile crushing and screening. There's stationary machines where the machine stays in a single location, and the aggregate comes to the machine to be processed; or mobile crushing and screening, which we produce, where the machine goes to the job site and processes the aggregate at the job site. The mobile crushing and screening equipment has been growing in demand over the last years, and we've been a beneficiary of that. The growth is the result of the fact that the strength, the power of mobile crushing and screening machines has been increasing. And so as a result, customers are finding it increasingly efficient to use mobile crushing and screening equipment versus stationary. We market our crushing and screening equipment under 2 brands, principally 2 brands; Finlay and Powerscreen. And the business is headquartered out of Northern Ireland. In addition to our mobile crushing and screening franchises, we have a front discharge cement mixer business by the name of Advance, servicing the United States, most predominantly in the Midwest of the United States. We have Fuchs material handling equipment, which is for the processing of scrap metal in recycling yards. We also have environmental chipping, shredding businesses for demolition waste as well as for lumber and trees. And then we have several cranes businesses, smaller cranes business as a pick-and-carry crane business in Australia and a rough terrain and tower cranes businesses that operate out of Italy. We have a #1 market share in mobile crushing and screening equipment and really a 1 to 3 -- #1 to #3 market position in all of the MP businesses. You asked about how do the businesses go to market. The vast majority of the businesses go to market through distributors, exclusive distributors of our equipment. And the end users tend to be individual contractors that purchase the equipment either through a rent-to-own or directly purchasing the equipment from the distributor. As a result, our MP segment has a stronger price realization opportunity than our AWP segment does. And as a result, the price cost relationship in Materials Processing is also better than in our AWP segment. So when you look at the segment, over the last 5 years, the segment has grown from just under $1 billion of revenue with a 9% to 10% operating margin to this year being a $1.4 billion segment with almost 14% operating margins. So we like the business a lot, and our team has been -- has done a great job of growing the business and then driving that increased revenue through operational efficiency to the bottom line with increased margins.

That is great color. And I'm assuming because that business is more levered to non-U.S. operations that it's probably seeing less pressure in terms of input costs, probably greater opportunity for incremental profits as we go forward. So as we look at 2022 and beyond, how should we think about incremental profits for the Materials Processing business on a more normalized basis? Is it greater than AWP? Is it about the same? Is it less? But I would imagine it's a pretty high fixed cost business just based on geography. So maybe you could just talk about incremental profits for both segments on a more normalized basis.

Yes. So as we go into 2022, our focus with both of our segments is to be price cost neutral, we say, on a cumulative basis, including the cost increases we've experienced in 2021, which we have not necessarily recouped 100% of. The pricing, as I said a moment ago, the pricing in the Materials Processing segment is, I'd say, easier to realize than in the AWP segment, where the rental companies, especially the national rental companies, have significant price power. We are absolutely focused on being price cost neutral and then benefiting from higher volumes, hopefully, as supply chain normalizes, those higher volumes then allowing us to deliver 25% incremental margins on that increased volume through manufacturing efficiency and disciplined spending on SG&A.

And as I wrap up, just a follow-up to that because I do have to move on to the next company that I'm hosting. But would it be fair to say that if we were to look at the 2 businesses that Materials Processing would have a little bit more fixed cost in it than AWPs? I think the AWPs is a little bit more of an assembly operation and Materials Processing maybe a little bit more vertically insulated. Is that a fair assessment?

So I think it is absolutely correct that as you measure the production of AWPs in hours. We measure the production of Materials Processing equipment in days. So it is absolutely a longer TAT time for manufacturing and a more -- I'll use the term fixed cost business, yes.

Okay. And I'm going to have to leave it there. I'm...

Good.