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Toromont (TIH) Stock | TSX: TIH.TO

Covered by Stratosphere

The Certified Dealer

Toromont Industries Ltd. ("Toromont") is a Canadian industrial company. The company operates two business segments: Equipment Group and CIMCO. The larger segment by revenue, Equipment Group, includes a Caterpillar ("CAT") dealership and rental operation of construction equipment. CIMCO offers solutions for the design, engineering, fabrication, and installation of industrial and recreational refrigeration systems. The company operates primarily in Canada and derives a smaller portion of sales from the US.

Stratosphere Score

7

Growth

6

Valuation

10

Quality

4

Margins

3

Dividends

8

Balance Sheet

9

Investment Thesis

  • Toromont Cat is one of the largest Caterpillar dealers in the world. It has 120 branches across Canada, distributing the highest quality "picks and shovels" of the construction and infrastructure industries.

  • Toromont leverages a decentralized business model, empowering employees to make decisions in the collective best interests of the company and its customers.

  • Toromont's management team values capital allocation highly. The company has a goal of achieving 18% ROE (i.e., return on equity) on each business unit. This means each business unit leader comes up with the budget and target, who is then held accountable to deliver on the profit target.

  • The cyclical nature of the heavy-duty equipment Toromont sells exposes the company to lots of recession risk. Any investor in Toromont should understand the company's financial results will ebb and flow in some periods.

  • The global construction equipment industry is set to expand from about $140 billion in 2020 to over $175 billion by 2025.

Key Company Metrics

A set of metrics we constantly keep updated to monitor the investment thesis.

Competitive Advantages

Decentralization

Toromont is a decentralized company. The company has over seven different business units, each of which are managed by business unit leaders.

Each leader delegates responsibility "outwards", meaning employees are empowered to make decisions that are best for the business. These employees are closest to the customers and understand them best.

While the board of directors sets the tone at the top and manages the company as a whole, many key decisions are made by experts in each business unit who understand their customers. Few organizations operate in this manner, and the ones that do generally see lots of success. For example, Constellation Software and Waste Connections run decentralized operations with localized management. Their results have been nothing short of stellar.

Wrapped in Technology

Toromont invests heavily into digital tools to better serve its customers. These technologies help the company with forecasting future trends and understanding what parts of the business need improvement.

To stay on top of the curve, Toromont leverages three main tools:

  • Analytics and AI

  • Applications to remotely monitor equipment

  • E-commerce Sites

Toromont has dedicated data scientists working on algorithms to better understand and predict the market. This, in turn, can help the business improve its market coverage in addition to inventory management.

In terms of applications to monitor equipment, there is software embedded within each and every one of its machines to monitor the health of the equipment. This is a great move to better serve customers as servicing can be done more efficiently and accurately. In addition, as Toromont does take on risk when renting out its equipment, it can monitor its machinery without having to worry about theft or damage.

The base use of e-commerce is simple. Instead of relying purely on in-person dealerships, customers can order and have their equipment shipped to them in a matter of clicks. Recently though, Toromont has been using its e-commerce site in other forms.

As with any machinery, maintenance and dead parts are very common. The typical gesture with a machine that does not work is to sell it to a junkyard for some compensation.

Toromont, on the other hand, has used its e-commerce site to open online auctions for attachments and working parts from dead machines. This is a great initiative as it allows the business to still generate revenue from something that was intended to go to a junkyard.

The Certified Dealer

Toromont's business model is quite simple, yet advantageous to its own financial position. Toromont is effectively the middle man between the manufacturing world and the end user.

For five out of its six units, Toromont does not manufacture any products. These business units are known as certified brand dealers which source these products directly from manufacturers before they are re-sold to end users.

Through this retail model, Toromont is able to minimize the risk factor around production in an industry that is highly capital intensive. Because of this, Toromont is able to retain tons of capital that would have otherwise been used on manufacturing plants, equipment, raw materials, and plenty of other assets and expenditures. Overall, Toromont's costs associated with manufacturing products in its refrigeration unit are not significant.

With this model and Toromont's strong brand name given its leading Caterpillar dealer status, the company is in a strong financial position. Recently, the company has held more cash on its balance sheet than debt - a net cash position.

Opportunities Ahead

  • Infrastructure and construction spending is on the rise. The global construction equipment market size is expected to almost double by 2030, reaching over $235 billion in revenue. However, Toromont operates mostly in Canada. In Canada, infrastructure spending is increasing to support an ever-growing population. The Canadian federal government announced an infrastructure plan in 2016 (that is currently underway) worth $188 billion for 12 years. Toromont has certainly benefitted from this spending, and will continue to benefit throughout this decade. The growth of other Canadian private industries, like mining, waste, and industrial.

  • Toromont's competitive and financial positioning in the market set the company up for success. Toromont is in a net cash position despite having recently purchased Hewitt, a large $1 billion+ acquisition, in 2017. The industry tailwinds should also help propel the company upwards. For shareholders, this likely means continued high returns on capital, further dividend hikes, and share buybacks.

Risks

Competitors

Toromont does not manufacture a large portion of its products, meaning differentiation is a concern if other competitors are offering the same or similar products and / or at a lower price. While Toromont can introduce initiatives and implement strategies to better position itself in the market, it still looks similar to competitors, such as Finning International.

The main defining factors that encourage consumers to buy from Toromont are pricing and market presence.

Toromont's brand and regional advantages do not concern us significantly today. Additionally, its strategic course with prioritizing decentralization and using technology will help it gain the upper hand over competitors. However, the market is competitive and could turn away from Toromont's favour if its competitors expand into new markets more aggressively.

The Reliance on Cat Products

Toromont mainly carries Caterpillar products in its dealerships as the products hold tons of brand power and popularity.

This has worked to Toromont's advantage to date. However, Toromont is at the mercy of Caterpillar's pricing, production capabilities, and end-user demand.

In a scenario that any of these factors are impaired, Caterpillar's problems could quickly become Toromont's problems. There can be issues in the future with simply being a middle man. It would take substantial resources to pivot to another major manufacturer or supplier, or producing equipment in-house.

The Cyclical Nature of Products

Many industries that use construction equipment are cyclical industries that grow well during "boom" times. When the economy turns, these businesses are usually the first to cut spending dramatically as their margins are generally low and their operations require tons of capital. If these companies are not generating enough money, they are left with no choice but to cut excess spending.

While Toromont has fared well during periods of recent economic weakness, the company is still a cyclical one.

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