Solid sales as margins continue to improve
The Toro Company (NYSE: tax included) reported 2nd quarter 2022 results and raised the forecast for the year. The company now expects sales to grow 14% to 16% this year, up from the previous estimate. from 12% to 14%. The Professional segment, which represents approximately 3/4 of the company’s turnover, continues to be the engine of growth with the acquisition of the Intimidator group, as I mentioned last quarter. The Residential segment had a more difficult quarter with a cold start to the spring season this year. Still, the company noted on the earnings call distribution partners remain positive on retail demand and strong pre-season snow bookings should provide momentum in the second half. Longer term, the company continues to innovate, with a robot lawn mower launch planned for next year.
Encouragingly, sales growth is supported by demand and not just price inflation. In addition, margins continue to improve after bottoming out last year. Gross margin was hit hard in the second half of fiscal 2021 due to inflation, but increased sequentially in the last two quarters. Thanks to good control of operating expenses, the operating margin and net income held up better than the gross margin and returned to long-term average levels.
With this satisfying first-half performance, Toro raised its FY2022 EPS guidance to $4.00-$4.15 from the $3.90-$4.10 range they had previously guided. . Analyst consensus is in agreement with management at the time of writing. However, I think the EPS numbers are still conservative based on management’s comments on the individual lines of the income statement. Based on this, FY2022 EPS looks more like $4.25. That would put Toro’s forward P/E at 20.3, a value it has rarely seen since 2016.
Orientation is always conservative
As noted above, the mid-term sales growth forecast is now 15%, 2 percentage points better than the previous one. This is supported by both price and volume as the order book indicates continued strong demand. Gross margin is now expected to be higher in the second half of fiscal 2022 than in the first half, which will translate to an average gross margin for the year “slightly lower than 2021”, as stated in the call. I’m using a gross margin of 33.5% in my model, compared to 33.8% for FY21. This is a huge improvement from the 32.2% I assumed for FY2022. last trimestre.
The CFO went on to say that the company continues to expect “similar adjusted operating profit as a percentage of net sales to fiscal 2021.” For modeling purposes, I interpret this to imply an operating margin of 13.1% for both years. This strikes me as particularly cautious as it suggests that no operating lever enjoys the best gross margin outlook. However, the company plans to increase travel and entertainment spending as well as R&D.
This also factors in more normalized spending in the second half as we plan to engage more directly with our customers, as well as the continued prioritization of strategic research and development investments.
Source: Renee Peterson, Chief Financial Officer, Toro 2Q 2022 Earnings Call
These activities can lead to future growth if done intelligently, but the SG&A line should be carefully monitored in the future to ensure that these costs are not exceeded.
Toro now expects $36 million in interest charges this year. That’s higher than last year due to the added debt to acquire Intimidator, but lower than my last quarter estimate. The expected tax rate of 21% is unchanged from previously.
Combining all of these estimates and using an updated share count, I get an EPS estimate of $4.25, above the high end of the company’s range.
Toro’s free cash flow in the first half of 2022 was only slightly above breakeven at $7 million. This is due to building up working capital in an inflationary environment. In the first half of 2022, working capital consumed $212.5 million of cash, compared to a release of $11.2 million in the first half of 2021. Additionally, the company spent $403 million on Intimidator Group, paid dividends of $63 million and repurchased $75 million of stock. The company issued $400 million in net debt and drew down its cash balance to cover dividends and redemptions.
For fiscal 2022, the company still expects a free cash flow conversion of 80% to 90% of net income. The company currently has a high inventory of work in progress to help manage supply chain issues, but expects to resolve this issue by the end of the year. They also have inventory of finished goods to move due to the slow start of spring. Based on the 80% conversion level, Toro would have approximately $360 million FCF available in fiscal 2022. This covers the dividend of $129 million, completed buybacks of $75 million and $100 million dollars of debt from the Intimidator deal that is due within a year. I expect the company to hold the remaining $56 million in cash for a few quarters as the supply chain normalizes, but the CFO mentioned the possibility of additional buybacks at the end of the exercise. Debt of $1.1 billion is now about 1.5 times my last EBITDA estimate of $715 million. Leverage increased from 1.0x last quarter due to the acquisition of Intimidator, but remains within the company’s target range of 1x to 2x.
At $4.25, Toro has a forward P/E of 20.3. Historically, the P/E has been above this level since 2016.
Toro has been a more diversified company since then, having added to the professional segment by purchasing Boss snow removal equipment and Charles Machine Works trenching and excavation equipment. This makes the company less sensitive to downturns in the housing market like the one that took over 63% of the stock price between 2007 and 2009.
On the other hand, recent acquisitions and the constitution of working capital are temporary brakes on the return on capital. Yields have started to rise again, but remain below pre-2020 levels.
Toro is not a high dividend payer, but it has steadily increased the amount paid by about 10% per year on average, following the growth of the share price. The dividend yield has traded in a narrow range, but the stock’s recent pullback has taken it back from the low end of the yield range to the high end.
Toro has been hit by margin compression in 2021, but margins appear to have bottomed out and sales projections have been revised higher. Management still seems cautious with its FY2022 EPS guidance which I believe is underestimated by about 4% at the midpoint. The shares are trading at around 20.3 times forward earnings, which is now the lowest since 2016. Although the stock has traded lower since my buy rating last quarter, the strong book of orders, pricing power and continued contraction in multiples have made it even more of a buy since then.