Toro: To Watch the Grass Grow (NYSE:TTC)

Recovery is not here yet

The Toro Company (NYSE:TTC) shares continue to trade in the $80-$100 range they’ve been in since severely missing estimates and bearish indications a year ago when reported Q3 2023 earnings. This was the quarter where we started hearing about a decline in consumer demand for lawn mowers and landscaping equipment. Although the stock price returned to the top of the range a few times, it didn’t stay there for long, brought down by unimpressive earnings reports or missing seller reports like the one I mentioned in my article the last quarter when I downgraded Toro to Hold. The call looked moot for a while as the stock rebounded to near $100 as it became clear that Toro was working the big dealer channel. inventories discussed in the brief report. Ago 3Q 2024 earnings releaseit looks like it was right to avoid the stock as the company once again experienced a bigger than expected slowdown in lawn care sales, sending the stock back near the $80 level.

Toro also lowered guidance for the full year, though not as severely as the revision this time last year. The company also continues to make progress in destocking the dealer channel. In addition, Toro’s free cash flow regeneration is returning to normal, allowing for debt reduction and share repurchases. However, growth remains negligible, unlike the high single-digit sales growth we’ve seen throughout most of the 2010s. While there are no red flags to suggest further declines, it looks like the stock will be stuck in the same trading range for the next few quarters. Following the chart for a breakout will be like watching grass grow. Toro remains a Hold.

3Q results and outlook

Toro delivered $1.18 of adjusted EPS in Q3 2024. That was a nice improvement from $0.95 a year ago, but the company fell short of the hopes management said last quarter to beat 3Q record of $1.19/share set in 2022. Toro also revised down its guidance for fiscal 2024. The company now expects sales growth of just 1% and a slight operating margin smaller. As a result, EPS is now expected to be in the range of $4.15-$4.20, down from last year’s actual result of $4.21.

The residential segment was again the strong point of the results, with sales up 52.6% and operating margin returning to healthy levels of 12.2%. The company explains this increase by pointing to “aggressive destocking” last year. This was the beginning of the decline in demand for lawn care equipment and may also be related to Home Depot ( HD ) beginning to phase out the product. I’m still concerned about the sustainability of this growth going forward, as it’s unclear how much of this is the initial stocking of product at Lowe’s ( LOW ) versus continued selling.

The Professional segment, which accounts for about 75% of the company’s sales, again saw a slight year-over-year decline, but not as much as in last quarter’s results. Still, it’s disheartening to hear that driving strong sales of golf and land and underground construction quarter after quarter and not see this segment doing better. Landscaping and snow removal equipment is still the main business in this segment and remains sluggish. Specialty construction equipment was also cited as slowing this quarter. Toro continues to have a strong backlog of orders in the golf, grounds and underground construction markets, although it is working on a backlog in other areas. In hindsight, Toro would have benefited from adding manufacturing capacity for these products rather than buying another landscaping equipment manufacturer like Intimidator Group, which resulted in an impairment charge in 2023. Absence of impairment charge this year it was responsible for the nice recovery of the segment. operating margin.

Longer term, I think Toro can improve from the near-zero growth shown this year. The lawn care equipment market is cyclical and consumer demand should pick up in the next up cycle. As we mentioned in previous quarters, electrification could also be a driver of demand. It will continue to be a challenge to grow as quickly as the company did in the last decade. Growth through mergers and acquisitions will be more difficult to achieve than it was in the 2010s due to the larger size of the company.

Dealer channel update

Last quarter, we noted that Toro was making progress in clearing large inventories in the dealer channel. As a reminder, Toro records sales when it ships products to dealers. Dealers own the product and pay for it through floor plan financing from JVs between Toro and Huntington (HBAN) called Red Iron or HCFC in Canada. Earlier this year, short sellers became concerned that inventory was growing at these dealers, which would require Toro to reduce future sales so dealers could use this product. At the worst of the problem, at the end of fiscal year 2023, dealers financing through Red Iron had 200 days of outstanding sales, about twice the normal amount. We showed in the last quarter that it was down to 159, consistent with management’s comments that they were 40% of the way through eliminating excess inventory.

In the latest 10-Q, we note that, fiscal year to date, Red Iron financed dealer receivables totaled 135 days of sales. However, if we isolate the 3Q results, we see a positive trend with DSO up to 119, consistent with management’s comments in this quarter’s earnings call that they were 80% of the way back to normal stock levels.

Toro’s 10-Q also shows these values ​​for Huntington Commercial Finance Canada (HCFC). While these sales are a fraction of those funded through Red Iron, DSO remains higher and not down from last year’s levels. Canadian inventory may contain more snow removal products and we will have to wait another quarter or two to see this reduced inventory.

While I still believe that this reduction in dealer inventory is not the headwind suggested by the short seller report, it will still be ongoing for another quarter or two. I expect to wait at least that long before seeing accelerated sales growth that will move the stock.

Capital Management

As expected, Toro’s free cash flow is improving in the second half of the year, and year-to-date FCF conversion now stands at 82% of net income. For the full year, Toro still expects to achieve FCF conversion of at least 100%.

Given the new EPS guidance, Toro is therefore expected to have FCF of $428.4 million. The company paid down $40 million in debt under the revolving credit facility. It also bought back $109 million in shares and paid out $113 million in dividends so far this year. The fourth quarter dividend will use another $37 million in cash. That leaves room for an additional $169 million in buybacks in Q4, if desired.

ASSESSMENT

At $81.76, Toro is now trading at a PE of 19.6 times 2024 earnings. On a last-minute basis, the 20 PE was near the bottom of the stock’s 10-year historical range.

Given the slowdown in growth and reduced guidance, the 20 PE level now looks about right. Using the $4.175 midpoint of the company’s guidance, my price target for Toro is now $83.50.

Conclusion

While Toro addresses the issue of high dealer inventories raised by short sellers, the company is still subject to macroeconomic cycles, particularly in its core businesses of lawn care and landscaping. The company has also been a successful acquisition grower in the past, but its size now makes it difficult to find good opportunities to move the needle. The acquisition of the Intimidator Group, a maker of high-end lawnmowers for the Professional segment, was poorly timed in 2022. The capital could have been better applied to production facilities for golf and grounds and underground construction equipment, markets where Toro has identified them as strongly for several years.

I don’t see any big issues leading to a sizeable drop in the share price, but there aren’t enough positives to break out of the existing trading range anytime soon either. Without a large dividend to pay investors while watching the side stock trades, I would not commit new funds to Toro at this time.