Titan Machinery Delivering Giant-Sized Growth

By Stephen D. Simpson, CFA | April 13, 2012 AAA

Titan Machinery (Nasdaq:TITN) highlights some of the risks and rewards of highly-valued growth stories. While the stock did very well in response to blowout earnings, the stock had actually languished over the past year with some pretty unnerving dips along the way. Although the company's cash flow situation is going to be a hang-up for some value investors, this remains an interesting company all the same.

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Closing the Year With a Bang
Titan Machinery certainly delivered the goods when it came to fiscal fourth quarter results. Revenue jumped 65%, on a 66% increase in equipment sales. Growth was strong in both equipment categories, as agriculture sales rose 58% and construction sales rose 120%. While Titan has been a busy acquirer, same-store sales growth was up a robust 41%.

What was more impressive, though, was the margin improvements the company appeared to make. Gross margin rose only a bit (about 10 basis points), but operating income jumped 87% as the company saw good operating expense leverage. All in all, the company's earnings exceeded the average estimate by nearly 60%.

Can the Good Times Last?
So far, this has been a solid spring for both agriculture and construction. Warm weather has picked up construction equipment demand and large OEMs like Caterpillar (NYSE:CAT) and Deere (NYSE:DE) are seeing some solid interest as well. Titan is a CNH (NYSE:CNH) dealer and while CNH's leverage towards smaller, lower-margin construction vehicles has been challenging for CNH, it seems to be less of a problem for Titan.

Agriculture is also doing well. Not only are there still tax incentives in place to encourage equipment buys, but CNH is offering machinery with new engines that are more fuel efficient. Moreover, lenders seem a little more willing to underwrite loans, and plantings have been strong.

The issue, though, is sustainability. North American farmers have been buying a lot of equipment and that won't go on indefinitely. Deere, for instance, has been somewhat conservative in its outlook for North American growth, and that seems to be backed up by Titan's guidance for 3 to 8% same-store agriculture sales growth in the next fiscal year.

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International Growth Is a New Twist
It looks like Titan is turning to Eastern Europe as a new growth driver. While operating a business in both the U.S. corn belt and Eastern Europe could strain the company's resources, the growth potential is intriguing. Not only is CNH a strong player in Europe (and Eastern Europe), but the age of agricultural equipment in many of these markets is measured in multiple decades.

I am a little worried about management distraction, diseconomies of scale and financing risks, but expanding into the Eastern European ag equipment market could be a very solid long-term move.

The Bottom Line
One of the problems with Titan is that there aren't a lot of other companies to compare it to. There are a few large private ag/construction equipment dealerships (which the company dutifully notes in its 10-K), but the comparisons made to companies like Tractor Supply (Nasdaq:TSCO) don't really work. Moreover, this company doesn't share the same model as construction equipment rental firms.

Compared to auto dealerships and commercial vehicle dealerships, Titan has pretty solid operating margins. Unfortunately, cash flow modeling is problematic at this point. That said, I think that structural free cash flow (a measure which excludes working capital items like inventory) points towards solid long-term potential value.

Now, I realize that ignoring inventory levels at a dealership/retailer is like trying to sell a burning house and asking people to ignore the flames, so I definitely believe investors must keep careful tabs on trends in inventory turns. That said, I can fair value into the high $30s and maybe a little beyond, though this is a stock with above-average risk due to its debt load, aggressive growth plans and inventory risks.

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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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