The longer a bull market lasts, the more extended price valuations become. The longer that condition continues, the harder it becomes for value-oriented investors to justify long-term investments in most of the stocks, industries and sectors that everybody else is talking about. I think this is a pretty good description of current market conditions, as valuations on stocks in a number of industries continue to push to new, higher levels that become harder and harder to justify.
The irony of current market conditions is that all of the major indices have managed to press to fresh, new all-time highs against the backdrop of a global pandemic and all of the societal and economic difficulties associated with it. To be sure, most of the move in the last few months is coming on the back of expectations that the long-anticipated “return to normal” is near as new vaccines are being added to the stable with those that have been distributed on an increasing basis, and which also means that vaccinations are being made more broadly available. That also implies that economic activity associated with the social activities that have been off-limits for the past year should start to increase.
One of the industries that you would expect to suffer during an economic downturn is Heavy Machinery. This is an industry in a sector, Industrials, that most analysts consider to be pretty cyclical; yet many of the largest companies in the sector – Caterpillar Inc. (CAT) and Deere & Co. (DE), for example – have followed the movement of the major indices to new, multiyear highs that would tempt you to believe that business is better than ever. That perception even extends to smaller competitors, like Terex Corp (TEX); this is a stock that has nearly quadrupled in price from its pandemic-prompted, bear market bottom at around $12 in the first quarter of 2020.
I think some of that action in these smaller companies comes from measures management may have to take to preserve capital and retain financial flexibility that larger companies may not have to take. In the case of TEX, slowdowns associated with the coronavirus pandemic prompted management to announce a suspension of its dividend, along with employee furloughs and reduced salaries for executives and cuts in production. The company’s earnings and Net Income through the last few quarters both reflect a significant impact from nationwide shutdowns and shelter-in-place orders, but also that they have not only survived that storm, but are in a good position to move with confidence into the future. That confidence is also manifest in the fast that after their latest earnings statement last month, management reinstated their dividend payout. What does that backdrop mean for the stock, which investors have been pushing to highs not seen since 2018? Let’s dive in and find out.
Fundamental and Value Profile
Terex Corporation is a manufacturer of lifting and material processing products and services that deliver lifecycle solutions. The Company has three business segments: Aerial Work Platforms (AWP), Cranes and Materials Processing (MP). It delivers lifecycle solutions to a range of industries, including the construction, infrastructure, manufacturing, shipping, utility, quarrying and mining industries. The AWP segment designs, manufactures, services and markets aerial work platform equipment, telehandlers and light towers. The AWP segment’s products are used by its customers to construct and maintain industrial, commercial and residential buildings and facilities, and for other commercial operations, as well as in a range of infrastructure projects. The Cranes segment’s products are used by its customers for construction and manufacturing facilities, among others. The MP segment’s products are used by its customers in construction, infrastructure and recycling projects. TEX’s current market cap is $3.2 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined more than -41.5% while revenues declined about -11%. In the last quarter, earnings were -32% lower, while sales were 2.76% higher. TEX operates with a historically narrow margin profile that has been negative over the last twelve months, but appears to have strengthened in the last quarter. In the last twelve months, Net Income was -0.34% of Revenues, but improved to 2.25% in the last quarter. Narrow margins are not unusual in the Heavy Machinery industry, and given the nationwide shutdown of business operations from COVID-19, the negative Net Income pattern may not be surprising. The shift to a positive number in the last quarter looks like a turn back to profitability; however, this is a pattern that bears watching.
Free Cash Flow: TEX’s free cash flow has been under pressure for the past year but appears to be stabilizing. Over the last twelve months, Free Cash Flow was $163.6 million – up from $71.8 million in the last quarter of the year, but significantly below the $1.3 billion level of the last quarter of 2019. The current number translates to a modest Free Cash Flow Yield of 5.04%.
Debt to Equity: TEX has a debt/equity ratio of 1.27. That number implies a high level of leverage, which of itself isn’t particularly alarming in the Heavy Machinery industry. Their balance sheet shows $665 million in cash and liquid assets against about $1.16 billion in long-term debt.
Dividend: TEX resumed its dividend payout after its last earnings report at $.48 per share, per year. At the stock’s current price, that translates to a dividend yield of 1.02%, which doesn’t sound too impressive; but the reinstatement in and of itself is a significant indication of management’s confidence moving forward.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target at about $17 per share. That means the stock is overvalued by about -65% at its current price, with a discount price sitting back at around $13 per share.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s upward trend from May of 2020 to its peak last week at around $50. It also provides the baseline for the Fibonacci retracement levels shown on the right side of the chart. The stock is dropping off of that recent peak, with expected support at around $44 per share. A push above $50 could have additional, momentum-driven upside to about $56 using the distance between the last resistance break and the $50 peak, while a drop below $44 would probably see about $5 of downside to next support in the $39 range.
Near-term Keys: The balance sheet for TEX has held up relatively well for the past year, considering the challenges the company has been dealing with. Gains in Free Cash Flow and improving flexibility in the form of increasing cash with very manageable debt are also a positive along with the reinstatement of the stock’s quarterly dividend. That doesn’t offset the fact, however that the stock’s increase in price has not been driven for the past year by fundamental strength but by the hope that eventually life will resume some semblance of the “old normal.” That is why the stock is significantly overvalued, and is likely to remain so for the foreseeable future. That also means the best probabilities lie with short-term trades. Use a bounce off of support around $44 as an opportunity to think about buying the stock or working with call options, with a near-term target price at the stock’s last peak around $50. A drop below $44 might be a good signal to consider shorting the stock or buying put options, with next expected support at around $39 offering a useful profit target on a bearish trade.