Terex Shares Are Priced Well for a Global Construction Resurgence

(This is a highly-abbreviated version of a full SumZero report republished with the author's consent)

Contributor: Jonathan Platt.
Firm: Cavoleph Partners. Hedge Fund.
Location: New York, NY.

Recommendation: Long Shares of Terex (NYSE: TEX)
Timeframe: 6 Months to 1 Year
Recent Price: $15.20
Target Price: $25.00
Strategy: Value

Quick Thesis:
Terex (TEX) is a leading global equipment manufacturer that is highly levered to construction and infrastructure activity. These markets are experiencing close-to-trough levels of demand and Terex ’s revenue and performance will improve dramatically as they recover.

The recent acquisition of Demag Cranes and the introduction of an aftermarket/service business offers additional upside and at the current share price of $17.75, Terex’s EV is just 6.5x 2012 EBITDA. This is an attractive multiple for a company at the beginning of a multi-year recovery. TEX also trades at a discount to its peer group for both PE and EV/EBITDA multiples.

Investment thesis:

1) Terex is a levered play on the recovery of infrastructure and construction activity.

Terex’s three largest segments, AWP, Cranes and Construction, are all highly correlated with construction activity and infrastructure development.

TEX has a significant level of operating leverage, and when demand and unit sales improve, asset utilization and pricing power will also improve. In 2007, Terex achieved operating margins of 12.3%. This contrasts with current margins of 4.2%. AWP sales have already begun to recover and margins have started to expand. The company’s backlog has also shown considerable improvement.

I believe that underinvestment in developed market infrastructure, along with the rise of emerging markets, will eventually lead to a strong multi-year recovery in infrastructure and construction activity.

2) Systematic underinvestment in US and EU infrastructure will eventually drive a prolonged period of spending.

Perhaps the most convincing evidence of years of neglect and underinvestment resulting in the current infrastructure deficit was provided when the eight lane Mississippi River Bridge collapsed in August 2007 during rush hour. Catastrophically, 13 people were killed and 145 were injured. While this may at first appear to be an unfortunate chance occurrence, an April 2010 release by National Transportation Research Group (TRIP) asserted that 25% percent of Americas bridges are structurally deficient or functionally obsolete. ... U.S. highway system has failed to keep up with the times. Over 50 years old in some places, the system has seen traffic almost quadruple since 1955 when it carried 65 million cars and trucks vs. over 246 million today.” – Raymond James (4-Aug-2010).

3) Non-infrastructure construction demand

This year, US construction indicators have shown general improvement with multi-family residential leading the charge. These markets should continue to recover as surplus inventory, created during the housing bubble, is gradually worked down.

4) The Demag opportunity

Management has been criticized for their timing of the Demag acquisition. However, I believe that over the long run Demag provides much needed diversification and a stable aftermarket/services business.

MHPS demand tends to be correlated with global IP and the Baltic Dry index, and thus, offers some diversification from Terex’s legacy end markets. Additionally, the services business, which makes up 31% of sales, offers a more consistent revenue stream and higher margins. This business can be leveraged across Terex’s other segments, decreasing earnings volatility and providing an incremental source of revenue.

5) Reducing expenses

On the 20th of April, Terex announced that the German domination process was approved. This means Demag can now be integrated into the broader organization and cost cutting measures may be implemented. A cost reduction target of $35m has been put into place - half of this is likely to come from SG&A.

Terex has meaningfully positive business trends, and at current price levels, offers significant value for money. My price target of $25.00 implies an upside of 40.8% - making this a good time to start building a position.

Valuation:

Due to changes in the company’s balance sheet , I believe TEX should be valued with EV/EBITDA multiples. Historically, TEX has traded at a median EV/FTM EBITDA multiple of 8.1x. If we exclude the unrepresentative levels witnessed from 2009 to 2012, we arrive at a median EBITDA multiple of 7.3x.

Based on my NTM EBITDA estimate of $689m (excluding currency, consensus of $687m), we arrive at an implied valuation of $25.76 per share. Currently, TEX trades at a discount to its peer group for both PE and EV/EBITDA multiples.

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