Q4 2022 Finning International Inc Earnings Call
Thank you for standing by. This is the conference operator. Welcome to the Finning International Inc. 4th Quarter 2022 Investor Call and Webcast. As a reminder, all participants are in listen only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. Analysts who wish to join the question queue may press star then one on their telephone keypad.
Should you need assistance during the conference call, you may signal an operator by pressing the star and zero.
I would now like to turn the conference over to Greg Palischuk, Executive Vice President and Chief Financial Officer. Please go ahead.
Thank you, operator. Good morning, everyone, and welcome to Finning's fourth quarter earnings call.
Joining me on today's call is Kevin Parks, our President and CEO .
Following our remarks today, we'll open the line to questions.
This call is being webcast on SINNING.COM.
We've provided a set of slides that we'll reference during our prepared remarks. These slides are posted on the investor relations section of our website and an audio file of this call will also be archived on our website.
Before I turn it over to Kevin, I want to remind everyone that some of the statements provided during this call are forward looking.
These refer to slides 10 and 11 for important disclosures about forward-looking information, as well as currency and specified financial measures including non-GAAP financial measures.
Please note that forward-looking information is subject to risks, uncertainties and other factors as discussed in our annual information form under key business risks, in our MD&A risk factors and management and forward-looking disclaimer.
Please treat this information with caution as our actual results could differ materially from current expectations. Over to you, Kevin.
Thank you Greg and good morning.
When I started my career at Finning more than two decades ago, I knew I was joining a great company and I'm honoured to be asked to lead our amazing team of over 14,000 employees, particularly as we celebrate our 90th anniversary this year.
I cannot say enough about how our employees make it a pleasure to work for our company every day. We focus on keeping each other safe, while striving to deliver high levels of service to our customers and meaningful outcomes to our partners and communities.
Turning to our results, being on slide 2.
2022 was a strong year.
within an excellent job of controlling what we could effectively deploying all of our resources to our great teams to support growth in all of our regions.
We secured significant strategic wins.
drug strong product support and continue to improve our earnings capacity.
We delivered product support revenue of 4.6 billion, up 24% from 2021, and well-eared of pre-pandemic levels.
We did this while reinforcing our mid-cycle cost and capital model, which allows us to control SG&I as percentage of net revenue to 17.7%.
We also reinvested to compound our earnings and delivered record EPS of $3.25.
We achieved these results through relentless execution of our strategy and the fantastic hard work of our teams.
My transition to CEO is going well. Succession is an advantage and with my team we are very focused on execution and building an accurate momentum.
I've been talking to many of our stakeholders to ensure I understand their perspectives before we start to work on the refinement of our strategy.
I don't anticipate any hard turns, but rather a simplification and prioritisation of the current plans.
whilst ensuring all of our employees are empowered and engaged in our strategy.
We will be focusing on prioritised growth opportunities, performance through all market conditions and reinvesting in our business.
Looking ahead to 2023, please turn to slide 3.
Overall, we expect demand commission conditions in our end markets to remain constructive, supported by favorable commodity prices.
Activity levels remain strongly mining, energy and infrastructure.
We do however expect some softness in the construction markets in the UK and Chile.
We are mindful of the uncertainty in the global business economic environment.
and we will continue to reinforce our mid-cycle operating cost and capital model.
Our goal is to strengthen the resilience of our business through all market conditions.
The team will focus on productivity and optimizing working capital levels and we will also thoughtfully manage our capital expenditures and we will be prioritising further debt repayment which Greg will provide more details on in a moment.
2023 and started well.
and we expect to continue to grow in the first half of the year.
Despite strong deliveries in Q4, we have maintained our record backlog.
We continue to execute on our product support strategy and we expect to see growth in component remanufacturing, equipment rebuilds and product support contracts in 2023.
I am confident in our ability to continue building on our execution momentum and I look forward to seeing many of our investors in the coming months to update you all in person.
I will now hand you back to Greg to provide more colour around our results.
Thank you, Kevin. I'll talk about our fourth quarter performance in more detail, including regional results and outlook. I'll also speak to our capital allocation priorities for 2023.
Turning the slide 4.
Net revenue of $2.4 billion was up 34% from Q4 2021, led by mining deliveries in Canada and South America and strong product support growth rates in all regions.
Keep it in EPS for about 36% year over year on solid revenue growth and discipline the operational execution.
89 cents of EPS was very strong, particularly considering that Q4 2022 saw 10 cents per share higher L-PIP expense compared to Q4 2021 due to our share price appreciation of 39% in the quarter.
Consolidated EBIT as a percentage of net revenue is 9%, led by strong profitability in South America at 11.4%, and in Canada at 11%.
These strong margins were achieved despite the high level of mining equipment and overall new equipment mix in Q4 and a high L7 expense in the quarter.
due to these factors, operating leverage in Q4 was lower than prior orders of 2022.
We generated $332 million of free cash flow in the fourth quarter and finished the year with net debt to EBITDA of 1.6 times down from 1.8 times at the end of September .
Given our organic growth opportunities, we invested in working capital to support our build-up of backlog and strong product support growth rates, resulting in the use of 170 million of free cash in 2022.
We are encouraged to see our service work in progress balances up 50% year over year reflecting strong activity levels and our inventory health.
is very strong and of a high quality.
Our equipment backlog remains at record levels, up 35% from the end of 2021, driven primarily by mining winds and a notable increase in power system supporter intake.
Now please turn to slide five.
New equipment sales were up 52% compared to Q4 of 2021 underpinned by strong mining deliveries.
Product support revenue is up 32% year-over-year, reflecting continued robust market activity in all sectors and strong execution by our regional teams.
Approximately half of the increase was due to price and half due to volume, including the acquisition of Hydroquip in the UK.
We're pleased to enter 2023 with a record equipment backlog of over 2.5 billion. Mining orders comprised over 40% of the backlog today, significant increase from a year ago. Power systems orders now represent 20% of our backlog with strong activity and order intake in our Canadian energy segment in 2022.
Turning to slide six for the details on our EBIT performance.
Our gross profit was up 30% year over year on strong volume and product support and new equipment.
As a percentage of net revenue, gross profit was up 80 basis points.
or was 80 basis points below Q4 2021 due to a higher proportion of new equipment sales in the revenue mix and lower margin mining equipment deliveries in Q4 2022.
We are pleased with the improved annual earnings capacity we've demonstrated for pre-pandemic levels with EBIT as a percentage of net revenue up 300 basis points, return on invested capital up 670 basis points, and EPS has nearly doubled from 2019 adjusted results.
Moving to our Canadian results and outlook, which are summarized on slide 7.
That revenue increased by 28% from Q4 2021, driven by strong market conditions in Western Canada. New equipment sales were up 56%, higher mining deliveries, contributing to most of this growth.
Product support revenue is up 30% on strong market demand and continued momentum in our product support growth strategy in all sectors.
Even as a percentage of net revenue was 11%, up 90 basis points from Q4 2021, driven by improved operating leverage.
S.GNA is a percentage of net revenue with down 198, 190 basis points year over year.
Our outlook for the Canadian business is positive given the strength in mining and energy sectors in Western Canada and we expect that to continue in 2023.
We expect constructive commodity prices and improved capital budgets from customers to drive investment in renewable aging fleets and product support opportunities in mining.
We're pleased to see our mining customers committing to comprehensive rebuild programs to extend the life of their assets, and we expect strong growth in rebuilds in 2023 compared to 2022.
In construction, demand for equipment, rental, and product support is expected to remain healthy supported by ongoing infrastructure projects.
While receiving signs of slow down and forestry and residential construction, these markets represent less than 5% of our Canadian business.
Power systems, high activity levels from our energy sector customers are driving a notable increase in our intake.
Our power systems backlog and activity levels in Canada are now at the highest levels since 2014.
Turning to South America on slide 8.
In functional currency, net revenue increased by 34% from Q4 2021, driven by strong mining activity.
New equipment sales were up 54% in functional currency on high mining deliveries in Chile, including catch-up of delayed backlog deliveries from Q3 of 2022.
Product support revenue is up 25% in functional currency, strong overall demand, and higher volume for new and expanded mining product support contracts.
South America's EBITDA, the percentage in net revenue, was 11.4% of 130 basis points from Q4 of 2021, driven by revenue growth, improved cost structure, and service productivity, as well as the favorable impact of Chile and Peso de Valuation.
Rogue in South America is 24.5%, the highest on record, up 420 basis points from 2021.
Looking ahead, we expect a strengthening copper price to continue to support positive mining outlook in Chile. Our recent wins and continued investments in fleet replacement across our mining customer base are expected to drive mining sales in Chile this year. We also see continued strong demand for mining product support and technology solutions.
Construction activity in Chile is projected to decline in 2023, impacted by slowing economic growth and higher interest rates.
We continue to monitor the process for approval and revised mining royalty proposal.
We are encouraged by the latest moderation in the proposal. However, we expect the timing of investment decisions related to Greenfield and new expansion projects to remain uncertain until the new royalty proposal is finalized and approved.
We are pleased with our high quality, high return business in Chile and we are optimistic about growth opportunities in mining. We believe Chile will remain an attractive place to invest long term as electrification trends drive growing global demand for copper.
Please turn to slide 9 for our results in the UK and Ireland.
Net revenue was up 38% in functional currency on increased volumes across all lines of business.
Fourth quarter saw high power systems project deliveries, higher HSTU deliveries, and strong product support activity across all sectors compared to Q4 of 2021.
Keep it as a percentage if net revenue is 4.4%, which is slightly above Q421 levels.
UK and Ireland delivered ROAC of 17% in 2022, up 220 basis points from the prior year.
reflecting strong revenue growth and structural improvement in profitability, including the acquisition of Hydroquip.
In 2023, we expect lower construction new equipment sales in the UK compared to 2022. We have largely completed equipment deliveries to HS2.
In addition, slower economic growth rates are expected to impact broader construction activity.
However, we expect strong demand for product support to continue, driven by HS2 activity and high machine utilization.
We also have a solid backlog of power system projects for delivery in 2023. We expect demand for our power systems business in the UK and Ireland, including the data centre market, to remain robust.
As Kevin mentioned, we're seeing continued momentum to start 2023. We're seeing continued growth in the first half of the year compared to the first half of 2022.
underpinned by our record equipment backlog, very busy workshops, and growth and rebuilds driven by our strong execution of our product support growth strategy.
While we expect demands, conditions to remain constructive in 2023, we are mindful of the uncertain global business environment, including slowing rates of economic growth.
We are reinforcing our mid-cycle operating cost and capital model and reducing our 2023 capital expenditures budget by about 25% in 2022.
We expect our 2023 net capital expenditure and rental fleet additions to be between 190 million and 240 million. We will be allocating a higher proportion of capital to rental fleet and strategic investments in electric drive mining trucks for demonstration at customer sites.
In 2023, we will replace an higher priority on debt repayment and further reduction of our net debt to adjusted EBITDA ratio.
In summary, we're really pleased with the record results demonstrated in 2022. We have great continuity and momentum as we start 2023. We'll continue to work to improve the resiliency of their earnings capacity for our business.
Before I turn it over to the Q&A session, I'd like to invite everyone to attend our investor day and tour of our Chilean mining operations in Antiguasta during the week of September 25th.
We'll be providing more details on this event in the coming months. We hope that you can join.
In the meantime, Kevin will be doing additional marketing in the second quarter to share his views and plans for Finning's future. Operator, I'll now turn the call back over to you for questions.
Thank you. We will now begin the question and answer session. Analysts who wish to join the question queue may press star then 1 on their telephone keypad. You will hear a tone acknowledging your request.
If you are using a speaker phone, please pick up your handset before pressing any keys.
To withdraw your question, please press star then to.
We will pause for a moment as callers join the queue.
The first question comes from Jacob Bout with CIBC. Please go ahead.
Good morning.
All right, Jacob.
some softness in the UK in the Chilean construction markets. From a revenue perspective, would that be roughly about 10% of revenues and then...
How do we think about that from a mix, you know, new equipment versus product support? Will it be similar to the rest of your business or a little more skewed to new equipment?
Sure, so on the construction side, I mean, in it, it was one in 10, 15 year projects with HS2 and the level of deliveries is about 200 billion pounds over the last two years, so that piece won't repeat. There still is very solid business and particularly in quarry and aggregates and on the power side, so that...
can offset some of that. That would be the UK case side. You know, Chile would be somewhat similar. We're seeing declines in the market, but we'll obviously push for share where we can. So we won't give an exact number on that, but certainly on the construction side, which is a smaller part of that business.
we're seeing slower growth. We do think mining is more than picking up the baton in South America. And so from a mixed perspective, I think mining will more drive the equation there. And we expect continued momentum on both new mining equipment and product support in 2023.
Okay.
and maybe trying to square your comments about reduction in capex versus
H1-23 being a little stronger than H1-22.
Maybe just comment on your duration of backlog and then, you know, is the expectation a slow down in the back half of the year?
So from backlog perspective, it's quite evenly distributed. As we discussed last call, a lot of the backlog additions in the back half of this year for the back half of next year, that would include BHP and others. And so, you know, it's a great way to start the year when you've got your LTM sales in backlog and it's pretty distributed throughout the year, so we feel fully supported.
Morning guys. Morning.
Just wanted to follow up on that line of questioning.
So the back wall givenly distributed throughout 23 to so the bulk of it gets
recognized this year and the follow on to that would be
you know, when you were putting your outlook together, I mean, why not comment on the back half of the year? Or is it just that you don't have the visibility that far out?
So here is the cabinet. So we expect around 90% of the backlog deliver this year, but we are seeing some orders.
Moving to 2024 now.
I think that maintaining the backlog after the strong equipment deliveries is a really encouraging
But I've been around long enough to know that January is a reset month, particularly given there are macro uncertainties out there. So we've been very thoughtful about how we think about the second half of the year. I would say that our...
strategic focus around the initiatives around winning strategically important business, growing market share.
If you think about what Pat has said this week about supply chains improving as we move through the course of this year that gives us some optimism as we move through the year.
I would say that we come back to work this year encouraged.
but thoughtful about the second half of the year. But as every week goes past, we get more encouraged.
Can you just comment on the...
They'll look for product support for this year and whether you're expecting growth for the full year in 23 versus 22 and that'll be my two. Thanks.
Yeah, sure. So absolutely, we expect growth in 2023. We expect growth because we have market share opportunity. We expect growth because it's a key.
pillar of our strategy along with that of Casabella and we've got the lots of those organizations focused.
on executing there and I think I track record over the last two years.
reinforces our execution capabilities in that regard. So we remain relentlessly focused on that. It's a critical value driver in this company and we expect a strong year this year.
Thanks, guys.
Thanks, Eric.
The next question comes from Sharif Alshabasi with Bank of America.
Please go ahead.
Hi, good morning, and congrats on another strong quarter.
I guess just one thing is just given your positive outlook, how do you feel about your inventory levels? You know, they're a bit elevated, but do you think you will need to build inventory through the year to meet ongoing demand if it materializes continuously?
Yeah, we're certainly pleased to have been able to get our hands on inventory in a tight environment. You know, a really big driver of that is our ability to build an effective backlog. So when you've got two and a half billion of backlog of...
which we just highlighted 90% dedicated for this year and we're still selling. That's a good spot to be. So it's a highly committed set of inventories, so we feel really good about that. High quality aging profile is excellent.
And so we feel good about that dynamic and we feel like we've got sufficient to support that backlog. So we feel like we're in pretty good shape here.
Just to reinforce that, the quality…
of the inventory is a very high standard and the proportion of committed inventory is high too.
So for sure we have some safety inventory around us to be able to support our customers and we're confident we're going to be able to continue to support our customers and as a supply chain.
dynamic, continue to improve, you'll see some normalisation there for sure.
Understood. And then just with regards to the CapEx and rental fleet addition to decline, you mentioned adding our...
higher proportion going towards rental fleet additions. Is the overall level going into rental fleets declining or do you still see a strong demand there?
Yeah, so it would be, you know, it's a little more than half of our allocation this year, which is a bit of a shift in percentages from history. And so it would be up year over year and about half of the CAPEX allocation.
Thank you very much.
Thank you.
Once again, any analyst who has a question may press star then 1 on their telephone keypad.
The next question comes from Brian Fast
Please go ahead.
Yeah, good morning.
ok permits
I know you touched on it, but maybe can we just get an update on supply teams? It seems like things are improving. Is this widespread across all products or are there still pockets that are challenged?
I described the supply chain as dynamic and it's different by product and a little different by geography as well because of the specification of certain products. And obviously there are additional challenges to ask.
shipping times to our Chilean business. So it's a very dynamic environment. We've got everybody focused on using all the resources available to maximize the opportunities and support our customers. So we have resources and capabilities and our role is to manage the
the dynamics of the supply chain and support our customers. I think ultimately it will get better as we go through the course of the year, but I think you can see from our revenues and our earnings, Brian , that we're not complaining about supply chain, we're using the likes of the organisation to push through it.
Thanks, it's helpful. And then let's see what's the appetite like for external growth opportunities, similar to hydroquipment and for refueling, or do you see the opportunity to expand those platforms?
Yeah, I think for sure with Hydroquip we've added to that business since we bought it as we have with 4eFuel. So they're two excellent platforms. As I mentioned previously, I'm still in listening mode really with our stakeholders and we're about to embark on a prioritisation of the strategy.
which will communicate later this year, which will give some indication as to how we see the growth levers in the company, whether they're organic or inorganic. But we really like those two platforms. There's growth in those platforms, both organically in the regions they operate, but also...
I don't want you to take away that the business is on pause, it absolutely isn't. We're fully focused on execution around our core business and the acquisitions that we've made and we're going to embark on this pretty quick.
review and enhancement of the strategies that's working today and I would be very surprised if there wasn't more in an organic opportunities coming out of that work.
Great, thanks for the color. That's it for me.
Thanks Brian .
The next question comes from Sabahat Tan with RBC Capital Markets.
Please go ahead.
Great. Thanks and good morning. We've been getting a lot of questions on this space and the future evolution of product support and what a recession maybe does. Does the mix increase? Does it decrease given some of the trends we've seen in that business recently? Is there any commentary based on your current visibility?
on how you expect the mix of product support to evolve as maybe the backdrop evolves somewhat.
Sure, well as you can tell it's been a bit of a unique relative to history mix situation where product support is growing faster than new and pretty healthy upcycle conditions. So that's been a bit unique. I do think it depends on how supply chains normalize.
through any potential down cycle. But the, you know, the common denominator is that the product support business is an excellent business. As you can see, we're seeding a lot of equipment in the field, which is great. And these are high intensity product support applications, and so we feel like we're doing a good job of increasing the population.
And when that equipment goes to work at mines or infrastructure projects, generates product support full cycle. So we're pleased with that dynamic.
So it'd be kind of dependent on how supply chains normalize, but we'd expect product support to continue to play a very
significant role even through a challenging market.
I guess to add to that, product support is more resilient than new equipment.
And so, you know, that's hence one of the reasons why we've been focused on growth in that area. But that said, you know, we are pleased as well with the refresh and somewhat additional population that we're seeing going into the, particularly into the mining business but also into the energy sector as well.
Great, and then just my second one. Obviously the weakness on the construction side in Chile. It's been called up by you guys and the OEMs as well. I guess we just think over the next 12 to 24 months. I've seen a lot of the issues that have caused that slow down and those make sense. But if the commodity markets stay strong.
Is there potential for that construction site in South America to potentially pick up? Is it a pause or do you think it's maybe just a bigger cycle that's flowing down on the construction site there?
Yeah, I mean, I think it's just been a bit of a slow down here. When you, you know, interest rates go as high as they have down there, and the cost of new equipment has increased and the pace has devalued. It's, you know, it's a challenging decision to make new. So we've seen high utilization hours on existing fleets.
We've also seen the current government delay some decisions which doesn't catalyze a lot of extra new equipment. So we think with some clarity that we think is coming across mining but also broader infrastructure and maybe some normalization of rates here. I think that can see a bit of a pickup. So it's not a sharp slowdown but it's not a growth area. You can see a line of sight to that improving over the next.
Yeah and I think the only thing to add to that is in the UK, when we're suggesting slow down the UK you have to remember that we're coming off a huge high of delivering a massive infrastructure project as well so when I spend time talking to the teams in the UK, I think the Madam Prime Minister asked me to share the thuke and at the same time worked at the UN should be Calculator for National Security for a virtual conference where it goes out
It doesn't feel like they're working in a slow down environment right now but it's moderated on last year for reasons of the huge project we delivered.
Great, thanks very much for the call.
This concludes the question-answer session. I would like to turn the conference back over to Greg Palastzczuk for any closing remarks.
Thank you, Charisse. Thank you everyone for participating in the call today and have a safe day.
This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.
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