Investors have been getting more and more nervous about companies tied to heavy vehicle sales in markets like agriculture and construction. To some extent, then, I think the Street was looking for an excuse to approach Titan Machinery's (Nasdaq:TITN) earnings with a skeptical eye. While equipment sales remain robust, margins have weakened and the company's aggressive expansion plans may be coming at too high of a cost if the ag sector has indeed seen its best days.
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Fiscal Q1 Results a Mixed Bag
In a healthier market, I suspect Titan's earnings report wouldn't have led to a double-digit percentage decline in the stock. The company not only grew revenue at a nearly 33% clip, but also surpassed expectations once again. While earnings did come in below the average estimate, investors have been known to ignore two-cent misses before in favor of impressive top-line growth.
As mentioned, revenue rose 33%. Construction was the real growth driver this quarter, with a sales growth of 85% year-over-year. Ag still did pretty well too, however, as sales rose 25% over the last year.
While top-line growth is not a problem, the margins are. Gross margin held steady, as better parts and service sales (which carry higher margins) offset lower equipment margins. Operating income rose just 16%, though, as acquisition costs chewed into profits. Profits were also hurt by the lower margins of the construction business, but it's worth noting that 11% segment profit growth in agriculture is not really that good either.
SEE: Analyzing Operating Margins
Mixed Messages in North American Ag
Figuring out the North American ag equipment market is no simple task. On one hand, CNH (NYSE:CNH), which is the company for whom Titan is a retail dealer, AGCO (NYSE:AGCO), and Deere (NYSE:DE) all had decent quarterly results from North American agriculture. Yes, Deere's top-line growth in ag was just 11%, but North American sales were up 18% and ahead of expectation. What's more, Deere's management (notoriously conservative) did increase their expectations for full-year ag equipment sales in North America.
That said, everybody seems anxious about the market and willing (if not eager) to call the end of a bull cycle that is admittedly getting on in age. That sets up the risk that Titan is going to be left with dealerships full of equipment and few buyers - a circumstance that proved more than a little problematic for companies like Rush Enterprises (Nasdaq:RUSHA) and Penske Automotive (NYSE:PAG) when their respective markets faced that situation.
SEE: Digging Deeper Into Bull And Bear Markets
Opportunities in Europe and Construction Are Real, but Not Risk-Free
Certainly Titan is not tied solely to the North American ag cycle. The company has been growing its construction equipment business, and companies ranging from Caterpillar (NYSE:CAT) to Terex (NYSE:TEX) still seem relatively constructive (pardon the pun) on this market. That said, CNH is weighted more heavily towards smaller equipment and that does not typically carry the same margin structure.
As for Europe, it is indeed true that there is a large base of old and outdated equipment, particularly in Eastern Europe. It's also true that Europe is a strong area for CNH. All of that said, we're still talking about a dealership business - an industry with notoriously low operating margins and ever-present inventory and inventory financing risks.
SEE: Signs That It Might Be Time To Sell
The Bottom Line
I don't think Titan shares are particularly expensive today, and in fact they may actually be pretty cheap if the ag sector finds a soft landing and the construction sector continues to recover. Still, investors want to dislike almost anything tied to heavy machinery these days and swimming against that tide may be painful in the short-term, as this stock could easily sell down to wash-out levels.
Although I do fear that Titan may be too aggressive in acquiring dealerships and spending far too much of its cash expanding during the waning days of a bull cycle, I do think this is a name worth watching. Titan is still not a well-followed stock and aggressive investors may want to think about playing the inevitable rebound.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.
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