Canada-based Finning International Inc. (TSX: FTT) is engaged in the selling, servicing and renting of heavy equipment, engines and related products in various markets worldwide. Its segments include: a) Canadian operations, which include British Columbia, Alberta, Saskatchewan, Yukon, the Northwest Territories, and a portion of Nunavut; b) South American operations, which include Chile, Argentina, Bolivia, and Uruguay; and c) the United Kingdom and Ireland operations, which include England, Scotland, Wales, Northern Ireland and the Republic of Ireland.

Revenue Mix

                                                                                                                      Business Segments                                       Geographic Segments

Investment Rationale

• Insiders are Bullish on Future Performance: Finning International shares have surged approximately 106.70% from its 52W low registered on 18th March 2020. We believe that insiders have played a crucial role in bringing the stock back to the race. Since free fall started in the stock from 10th February, insiders have raised their stake consistently for eight times, which implies that they have used the discounted price as an opportunity to increase their stake. Insider’s interests in the stock gave other investors’ confidence in the business of Finning International. 

• Consistent Dividend Payment: High yielding stocks with a proven track record of consistent dividend payment tend to be popular among the investors. At the last closing price, FTT’s shares were offering a dividend yield of 3.75%, which is approximately 1.04x of the benchmark TSX Composite Yield of 3.59% and around 6x of the Canada 10-year Government Bond yield of 0.61%. A higher yield that too with a history of dividend payment regardless of economic cycles is likely to keep Finning Internationals’ shares in the limelight of investor community. Also, the stock is offering an opportunity for the income-seeking investors to invest in the higher-yielding avenue, which can offset losses on their fixed-income investment.

• Hefty Cash Flow Yield: Free Cash Flow is a key concept for dividend investors because dividends are paid out of cash flows. It is superior to earnings because of accrual-based accounting smooths the data over a longer period of time and may not give an accurate representation of a company’s ability to pay dividends. In the case of Finning International, the company has decent free cash flow with a free cash flow yield of ~11%, which provide a greater margin of safety to existing and potential shareholders. Further, the company reported strong free cash flow conversion in Q2 2020, which resulted in a free cash flow of CAD 312 million, bringing year-to-date free cash flow to CAD 262 million.

• Notable Increase in Rental Activity Since May 2020: While Q2 was difficult and the pace of economic recovery in the regions the group operates remains uncertain. However, the company has seen signs of markets recovering since May, with notable increases in rental activity, machine utilization hours, and product support revenue run rates. With the recent recovery in oil prices, most oil sands producers have put their truck fleets back to work and are expected to be operating at pre-COVID-19 levels by the end of August. The price of copper has also improved, providing continued support and stability for copper mining in Chile. We expect these momentums to continue, which is likely to boost the demands of the company’s offerings.

• Shares are Hovering in a Bullish Zone: Shares of FTT are hovering in bullish territory, as its shares traded above the crucial long-term as well as short-term support levels of 200-day, 100-day and 50-day SMAs. Also, Price/200-day SMA ratio stood at 1.13x, which entails that the stock is hovering approximately 13.5% above the crucial long-term support levels of 200-day SMA, which is another bullish indicator, as the higher positive spread between Price and 200-day SMA implies stronger uptrend in the stock. Further, the Moving Average Convergence Divergence is rising and hovering above the 9-day SMA signal line, which is another positive indicator. The difference between 12-day and 26-day EMAs is positive, another bullish indicator.

Technical Chart (as on October 25, 202, after the market close). Source: Refinitiv (Thomson Reuters) 

• Risk Associated to Investment: The second wave of COVID-19 might affect the operations of oil & gas and mining industry players. Players from these industries are the key customers for the group. Hence, any such scenario would hamper the group’s performance.

2QFY20: Financial Highlights

 Source: Company Filings

• During the quarter under consideration, net revenue of CAD 1.3 billion was down 33%, including a 24% reduction in Canada’s product support revenue, as many customers parked equipment fleets and temporarily shut operations in response to low commodity prices and COVID-19 restrictions.
• The group’s SG&A expenditure declined by 12%, down in all operations, led by effective cost management and lower variable costs during the period under review.
• The Canada Emergency Wage Subsidy program allowed the Company to preserve a significant number of jobs and technical capabilities through a unique period of uncertainty. As a result, the Company recognized CAD 64 million of wage subsidy in Q2 2020 as other income. Without the benefit of this wage subsidy, the Canadian operations would have taken available alternative actions, which would have reduced SG&A by CAD 15 to 20 million in Q2 2020, an equivalent of approximately CAD 0.08 per share.
• Further, the company reported strong free cash flow conversion in Q2 2020 resulted in free cash flow of CAD 312 million, bringing year-to-date free cash flow to CAD 262 million and further strengthening the Company’s financial and liquidity position. As of June 30, 2020, net debt to Adjusted EBITDA ratio was 2.1x, down from 2.8 on June 30, 2019.
• The Company has accelerated existing strategic plans to drive productivity gains in Canada and South America, while maximizing flexibility and competitiveness to serve customers. As a result, the Company expects to reduce the global workforce by 8% by the end of 2020 from the end of 2019.

Top-10 Shareholders

Top-10 shareholders in the company held around 33.84% stake in the company. RBC Global Asset Management Inc., and Beutel, Goodman & Company Ltd. are among the largest shareholder in the company and carrying an outstanding position of 9.35%, and 6.11% respectively. The institutional ownership in “FTT” stood at 43.34%, and ownership of the strategic entities stood at 0.40% respectively

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): EV to EBITDA based Valuation Metrics

Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters)

Stock Recommendation: The group mentioned that the market had shown sign of recovery since May, with notable increases in the rental activity, machine utilization hours, and product support revenue run rates. With the recent recovery in oil prices, most oil sands producers have put their truck fleets back to work and are expected to be operating at pre-COVID-19 levels by the end of August. The price of copper has also improved, providing continued support and stability for copper mining in Chile. In the UK and Ireland, construction and power systems projects have resumed, and earthmoving work on the High-Speed Rail 2 mega-project, which represents a significant opportunity for the group. We expect, the demand for oil and gas and mining activities are likely to accelerate and would return to normalcy with improved demand from the re-opening of manufacturing and industrial activities.

Further, at the last closing, Finning's shares were offering a dividend yield of 3.75%. More importantly, its shares have recorded a relative strength against the benchmark TSX Composite in the past 3-months and 1-month and outperformed the index by 15% and 9% in the period mentioned above. Also, Shares of FTT are hovering in bullish territory, as its shares traded above the crucial long-term as well as short-term support levels of 200-day, 100-day and 50-day SMAs.

Therefore, based on the above rationale and valuation, we have given a ‘Buy’ recommendation at the closing price of CAD 21.89 on October 23, 2020.

1-Year Price Chart (as on October 23, 2020, after the market close). Source: Refinitive (Thomson Reuters)

*Recommendation is valid at October 26, 2010 price as well.

Disclaimer

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