Toro Company stock looks attractive at current levels (NYSE:TTC)

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Investment thesis

The Toro Company (NYSE: tax included) experienced strong demand which boosted the customer order, exceeding its production capacity in FY21. This led to a larger than normal order backlog of approximately $1.58 billion at the end of the fiscal year. year 2021. However, in the first half of FY22, the company’s volume growth was hampered due to supply chain constraints. Over the past quarter, the company has seen some improvement in the supply chain, which should benefit the company’s volume growth in the second half of FY22. To offset the current inflationary costs on the market, the company began raising prices for its product line, which contributed to sales growth in the second quarter of FY22, as well as additional revenue from the acquisition of the Intimidator Group. The company’s sales growth in the second half of FY22 is expected to be driven by higher price realization, a strong backlog and revenue from the recent acquisition. Due to inflationary costs and the acquisition of the Intimidator Group with a lower initial gross margin, the company’s Y/Y margin growth is expected to be affected. However, in the long term, the company intends to improve its capabilities and create synergies in its business portfolio to bring its margins back to historic levels.

Last quarter results

Earlier this month, The Toro Company announced mixed financial results for the second quarter of FY22, with sales below expectations and earnings above expectations. Sales for the quarter were $1.25 billion (up 8.7% year-on-year), which was below the consensus estimate of $1.27 billion. Adjusted EPS for the quarter was down 5% year-on-year to $1.25 (vs. consensus estimate of $1.23). Revenue growth was driven by net price realization in the Professional and Residential segments, partially offset by lower volumes. The acquisition of Intimidator in January contributed $60.5 million to net sales for the quarter. Adjusted operating margin for the quarter decreased by 190 basis points to 13.7% due to higher material and manufacturing costs and higher indirect marketing expenses, partially offset by higher pricing and productivity improvements. These headwinds resulted in a 5% year-over-year decline in Adjusted EPS in the quarter.

Revenue Growth Outlook

In FY21, the company experienced unprecedented demand within its professional and residential segment, which reduced inventory levels in the field and resulted in a customer order that exceeded production capacity. of TTC. Additionally, supply chain constraints hampered the company’s production capacity. This translated to an order backlog of approximately $1.58 billion at the end of FY21, compared to $370.9 million in FY20. Backlog was greater than the the company’s normal order book. However, due to supply chain constraints in the first half of FY22, the company’s volume growth was affected. The company is seeing some improvement in the supply chain, which should benefit the company’s sales growth in the second half of FY22.

Toro Company Backlog Growth

Toro Company Backlog Growth (Company Data, GS Analytics Research)

In the second quarter of FY22, professional segment net sales increased 11.8% year-over-year to $925.8 million, driven by net price realization and incremental revenue of 60.5 million from the acquisition of Intimidator Group in the first quarter of FY22. This growth was partially offset by lower volumes in certain product categories due to product availability constraints. Residential segment net sales increased 1.5% year-over-year to $319.7 million due to net price realization and increased shipments of zero-turn ride-on mowers. This growth was partially offset by lower sales of walk-behind mowers and portable power products, primarily due to delayed spring weather conditions in many parts of the United States.

Within the professional segment, the company anticipates that demand in the underground construction market will strengthen as investment in public and private infrastructure becomes a priority across the world. In addition, the golf market is strengthening, which should support sales growth in the Professional segment. As end-market demand strengthens, the segment’s backlog should begin to improve. The company also invests to grow its business inorganically. The recent acquisition of the Intimidator Group in the first quarter of FY22 provides TTC with an opportunity to expand its product line and geographic reach. The company incorporates the Intimidator Group with its zero-turn mower space, as the Intimidator Group designs and manufactures Spartan Mowers, a professional line of zero-turn mowers. Apart from this, the company is implementing price increases in its business portfolio to offset the current inflation in the market. The realization of strong prices in the second quarter of FY22 boosted the company’s net sales. Improved volume, incremental Intimidator Group revenue and higher price realization are expected to drive professional segment revenue growth in the second half of FY22.

Residential segment sales were impacted in the second quarter of FY22 due to late spring as retail demand for walking mowers and portable power products declined. However, the company expects to regain lost sales in the third quarter of FY22 as the season’s warmer weather arrives in North America. Additionally, pre-season bookings for products related to the winter season are expected to give Q3 FY22 momentum.

In short, the company’s volume growth is expected to increase due to growing backlog, strong demand and easing supply chain constraints. Improving sales volume along with strong pricing should drive the company’s net sales growth in the second half of FY22. As a result, management has raised its net sales guidance for FY22. from 12%-14% to 14%-16%.

The company launched its three-year “Drive for Five” employee initiative in the fourth quarter of FY21 to align and engage its workforce across the company to achieve common goals. The goal of this initiative is to increase annual net sales to $5 billion through organic growth while improving profitability by the end of FY24. One thing to keep in mind is that t is an employee initiative, which means that it is a set of internal objectives rather than guidelines. However, it does provide us with information about the company’s future plans. The company strives to increase sales and margins both organically by investing in manufacturing capacity and improving efficiency and inorganically. Additionally, the company has stepped forward to bring new innovations within its residential segment by launching its battery-powered robotic mower in May 2022, which is expected to be available to consumers in spring 2023.

Margins to improve sequentially

The company’s adjusted gross margin fell 260 basis points Y/Y to 32.5% in Q2 FY22. The decline is mainly due to higher material, freight and manufacturing costs. Additionally, the acquisition of the Intimidator Group in the first quarter of FY22 with an initial gross margin below the company average further depressed margins. However, this decline was partially offset by higher realized prices and productivity improvements. This resulted in a 30 basis point increase in gross margin, which was better than the company’s forecast of a flat gross margin for the quarter. Adjusted operating margin in the quarter fell 190 basis points year-over-year to 13.8% due to gross margin pressure and higher indirect marketing spend, partially offset by leverage net sales and lower incentive spending.

including VAT Adjusted gross margin and Adjusted operating margin

Adjusted Gross Margin including tax and Adjusted Operating Margin (company data, GS Analytics Research)

Going forward, the Company’s gross margin in the second half of FY22 is expected to be higher than the first half due to higher price realization. In addition, the company is working on improving its internal operational productivity, which should support the improvement in the margin in the short and long term. This should somewhat offset the impact of including the Intimidator Group at a lower initial gross margin. However, given the inflationary cost environment and the acquisition of the lower margin Intimidator Group, the company expects adjusted gross margin to be lower in FY21 and adjusted operating margin to be lower. in line with FY21. In the longer term, the company is working to return its profitability to historical averages by improving manufacturing efficiency, increasing productivity and through synergies within the organization.

Evaluation and conclusion

TTC shares are currently trading at 19.32x the FY22 consensus EPS estimate of $4.09 and 16.39x the FY23 consensus EPS estimate of $4.82. This figure is lower than its historical five-year PER of 25.08x. In the near term, the company’s sales growth should benefit from the strong order book, the easing of supply chain constraints and the realization of higher prices. While near-term margins are expected to be under pressure due to inflationary costs and the Intimidator Group’s lower initial margin, they are expected to improve sequentially in 2H FY22 compared to 1H FY22. In addition, margins are expected to improve over the long term as the company strives to improve manufacturing efficiency, increase productivity and realize synergies. The cheaper valuation and business growth prospects make The Toro Company a good buy.

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