Is TEX a big-bargain or a value trap?

One of the ironies of the stock market right now is that if you look at the major market indices, it’s easy to say that, right or wrong, investors continue to look for a V-shaped recovery in the U.S. economy. That’s the hope that, while the impact of COVID-19 on virtually every sector in the economy has been rapid and dramatic, the much-anticipated and hoped-for recovery might be proportional to the decline. For the stock market, at least, that is exactly what has happened, with the S&P 500 and NASDAQ both pushing above their pre-pandemic highs and the Dow Jones Industrial Average within spitting distance of its own. Even with a sharp, rapid decline at the end of last week, all three indices remain at levels that might make you think the worst of the decline is over, and the market is bound to get back to its normal, bullish ways.

The irony comes when you start to dissect the market movers from the laggards. It isn’t that surprising to see that most of the strongest stocks in the market since mid-March are among the largest, most easily recognized names in the American economy. These are companies that don’t just carry name-brand cachet but also have the resources, reflected in their balance sheets by healthy cash positions and limited debt, to ride through current economic difficulties that truthfully are forcing companies in every sector, and of every conceivable size and make up, to scrutinize their operations in the most critical terms, and take actions to ensure the business’ survival in the uncertain weeks and months to come.

Many of the laggards – the stocks whose price patterns haven’t matched, or have possibly even diverged from the broad index trend since the market found a bear market bottom in March of this year are smaller, less recognizable names. The size of these companies doesn’t automatically imply weaker or less disciplined management than their larger brethren; in most cases, it just means that their specialization may be narrower than the industry leaders, or that their target market may have a smaller global footprint. That may or may not put them at a disadvantage during an economic downturn; but it is a reason that a lot of investors tend to shy away from those stocks during economically uncertain time periods.

This dichotomy between industry or sector leaders and smaller, less established companies can be seen pretty easily in the Heavy Machinery industry of the Industrial sector. The largest companies in the sector – Caterpillar Inc. (CAT) and Deere & Co. (DE), for example – saw a healthy bounce along with the rest of the market from mid-March into April, and then extending that trend trend to fresh set of highs at the end of last week. Smaller competitors, like Terex Corp (TEX) rallied a bit into June, but have flattened into a narrowing consolidation range that still has them significantly below their late-2019 high levels.

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 both reflect a significant impact from nationwide shutdowns and shelter-in-place orders; at the same time, their balance sheet remains strong enough given their size to give them the financial stability and flexibility they need to ride through the current crisis, however long it lasts. While the stock failed to follow its bigger brethren higher from March to April, it is also consolidating in a narrow trading range near those multiyear lows. That could be an interesting, leading technical indicator for a contrarian investor, along with a bargain proposition that a dyed-in-the-wool value and fundamental investor might find too compelling to pass up.

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 $1.4 billion.

Earnings and Sales Growth: Over the last twelve months, earnings plunged more than -104% while revenues declined about -47%. In the last quarter, earnings improved a little more than 85%, while sales decreased -17%. TEX operates with a narrow margin profile that turned negative in the most recent quarter. In the last twelve months, Net Income  was 0.34% of Revenues, but deteriorated to -1.33% 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, but it is nonetheless a source of concern as it does act as a drag on the company’s balance sheet for as long as it persists.

Free Cash Flow: TEX’s free cash flow is generally healthy, at $115 million over the last twelve months. That marks a decline from $231 million in the quarter prior. The current number translates to a Free Cash Flow Yield of more than 8.24%.

Debt to Equity: TEX has a debt/equity ratio of 1.46. That number implies a high level of leverage, which of itself isn’t particularly alarming in the Heavy Machinery industry. Their balance sheet shows $426 million in cash and liquid assets against about $1.16 billion in long-term debt.

Dividend: TEX suspended its dividend earlier this year to preserve cash. It is unknown when or if the dividend might be reinstated; in the report management stated their dividend would be suspended for the remainder of 2020 but provided no additional details.

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 $28 per share. That means the stock is trading at a tempting discount, with 39% upside from the stock’s current price.

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 downward trend from July of last year to its lowest point in May. It also provides the baseline for the Fibonacci retracement levels shown on the right side of the chart. The stock rallied to a short-term high a little above the 50% retracement line at $22 in June, and has narrowed since August into a consolidation range between $19 and $22. A drop below $19 could see the stock fall to about $17.50 to find next support, or $16 if bearish momentum accelerates. A push above $22 should give the stock room to rally to the 61.8% retracement line a little below $24 with room to push to above $25 if bullish momentum picks up.

Near-term Keys: While the value proposition for TEX is enticing, I think there are enough questions right now how long it will take the company’s business to rebound from the effects  of COVID-19 on the company’s balance sheet to be wary. I would hold off on taking a long-term position in this stock. That said, it could offer some interesting short-term opportunities if the stock can break out of its current consolidation pattern. A push above $22 could be a very interesting bullish signal to buy the stock or work with call options, using $24 to $25 as a very attractive profit target. A drop below $19 could also act as a useful signal to consider shorting the stock or buying put options, with a target price somewhere between $17.50 and $16 on a bearish trade.


X