The below is an extract of the latest deep dive released in our newsletter. In this write-up, we cover $TTC
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The Toro Company designs and manufactures its products / equipment / systems and sells through a network of more than 150 distributors, dealers, mass retailers, equipment rental centers, home centers, and online (direct to end-users) in more than 125 countries. Toro claims that its mass retailers (Home Depot, Tractor Supply, Ace Hardware) have over 8,000 locations and omni-channel solutions to serve customers whereas its dealer network exceeds 4,000 worldwide.
Its product offering is comprised of leading brands (see below) that serve golf courses, sports venues/fields, professional contractors, underground construction professionals, landscape contractors, agricultural growers, rental companies, government, educational institutions, and homeowners.
To facilitate sales TTC formed a joint venture with Huntington Distribution Finance (subsidiary of The Huntington National Bank, “HBAN”), namely Red Iron Acceptance (“Red Iron”) in which it holds 45%. Red Iron provides distributors and dealers of Toro a reliable source of inventory financing (Red Iron holds security on the inventory) in the US and usually no down payment is needed, whereas finance charges can be shared (or borne exclusively by TTC) among TTC and the distributor or dealer. Except Red Iron, TTC engages in such agreements with Huntington Commercial Finance Canada (“HCFC”) and other third-party institutions.
The benefit of these agreements is the reduction in the cash operating cycle for Toro, the transfer of credit risk to Red Iron and the like and it provides attractive financing solutions to distributors and dealers.
Why does the above matter to our analysis?
The current banking turmoil affecting regional banks cannot be ignored as any negative development with HBAN can distort the operating model of TTC. To understand its significance, in FY21 and FY22 the amount financed for dealers and distributors through financing institutions accounted for 69.3% and 72.2% of total sales, respectively (Red Iron FY21: 72.9%, FY22: 72.3% of US sales), whereas the receivable days would have increased from c. 22 days to c. 85 days if such financing arrangements were not in place.
The impairment of the investment in the joint venture ($45.7M) will be immaterial if it crystallizes. What will be distorting is a potential decline in sales and profitability if alternative source of financing at similar terms cannot be found promptly. The Company may have to finance an extended operating cycle through debt negatively affecting its profitability.
What are the mitigating factors?
Per HBAN’s latest 1Q 2023 presentation: a) it has the highest percentage of insured deposits among peers at 69% (SIVB was at 12%), b) it consistently grew deposits above peers despite the challenging environment, c) cash and borrowing capacity as a percentage of uninsured deposits is at 136% with the next best peer at 91%, and d) it has the 3rd best CET1 ratio.
Markets and Sales Mix
The Company has three reportable segments, professional, residential and other while it also provides a breakdown by product type (equipment and irrigation) and geographic market (US and International).
Source: 2022 TTC Annual Report
Professional segment products (think of reel, riding and walking mowers, all-wheel drive tractors, zero-turn radius riding mowers, heavy-duty walk behind mowers, walk and ride trenchers, vacuum excavators, utility locators, snowplows, sprinkler heads etc.) are primarily sold through distributors and dealers and address the following markets:
- Golf market (golf course turf maintenance & irrigation, water application solutions),
- Sports fields and Grounds market (sports fields turf maintenance & irrigation, water application solutions),
- Landscape contractor market (turf management solutions),
- Underground construction market which was enhanced by the acquisition of Charles Machine Works (“CMW”) in FY19 (products are utilized by specialty contractors to install water, gas, electric, telecommunication, fiber optic, and other utility distribution systems).
- Rental and Specialty Construction market (primarily sold to rental companies, large retailers and dealers),
- Snow & Ice management (snow removal products),
- Commercial Irrigation & Lightning, and
- Ag-irrigation market.
The below slide gives an indication on the weight of each end market.
Source: Investor Presentation The Toro Company, Q4’22, Note: Underground and specialty constructions were affected by the acquisition of CMW
Over the period FY13 to Q1FY23, the Professional segment depicted a CAGR of 10.7% reaching total sales of $3.6B and by FY22 it accounted for 76% of total sales compared to 69.8% in FY13. The segment also generated 84% of TTC’s earnings before taxes (“EBT”) in FY22 (ignoring ‘Other’ which includes corporate costs).
Source: TTC 10K filings, StockOpine analysis
Revenue growth over the years was driven by acquisitions, increase in volumes, and net price realization. For instance, in FY19 the acquisition of CMW was a key determinant of the 25.5% increase whereas in FY22 the growth of 17.1% was driven by net price realization (think of higher prices net-off promotions and incentives) and a 4.1% impact from the acquisition of Intimidator.
The Professional segment is a higher margin business than the Residential and it averaged at 18.4% over the period FY13 to FY22. The decline in FY19 is explained by the acquisition of CMW, however, the margins improved from 15.6% in FY19 to 17% in FY22 following the acquisition.
It shall be noted that Intimidator carries a lower margin but going forward an improvement should be expected in margins as material, freight and manufacturing costs normalize.
We are of the opinion that the Professional segment is more critical for the long-term success of the Company as it is more durable and less prone to economic cycles.
Q4’22 Richard Olson CEO (own emphasis) “And that's probably the key point is most of our products are used for essential tasks. They're not discretionary. So especially in the context of a business, many of our Professional customers are -- have delayed purchases through the early part of the pandemic, and they're already behind. And our products are consumed when they're used. So if they're being used then they're being consumed and they need to be replaced.”
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