Description

TTC sells outdoor power equipment (OPE).  The vast majority of this OPE is gas-powered mowers, but they also sell snow equipment and other OPE.  Sales to Pro customers account for 81% of revenue and 90% of operating profit.  Sales to residential customers accounts for the remaining 10-20%, and half of those sales are through the homecenters.  Focusing on the Pro business, ~40% of sales are for mowers and OPE sold to professional landscapers and ~18% of sales are for similar equipment sold to golf maintenance professionals.  The remaining 23% of sales is a bit different and is related to large machinery that’s sold into infrastructure markets – think trenchers and drilling machines. 

Credit is key in this business and TTC is involved with most of that credit extension – this is a centerpiece of the short case.  In addition to regular-way AR, there are two quasi-off-balance sheet financing vehicles that provide this credit.  The first is Red Iron – a lot of information is available about this one but you have to dig through the notes’ paragraphs.  Red Iron provides financing for the vast majority of US sales, primarily excluding the infrastructure biz and sales to homecenters.  TTC owns 40% of Red Iron and accounts for it in the equity method.  Through a partnership with HCFC, there’s another vehicle that provides similar financing but TTC doesn’t own any of that vehicle. But importantly, for both vehicles, TTC guarantees a large portion of this debt on behalf of customers and pays the vast majority of the interest on those loans (reduction to gross revs).  Note that this is floor plan financing, so the customer doesn’t pay off its loan until the product is sold to the final user – as such, outstanding credit is indicative of channel inventory.

Short Thesis Overview

• In the Pro business, channel inventory is sky high.  At the same time, demand is down.  TTC missed in Q1 and guided Q2 well below consensus, but guided to hockey-stick growth in 2H.  This is unlikely to occur, resulting in large earnings misses.
• Related, DSO’s, DSI’s, and financing through their off-BS vehicles is the highest it’s ever been.  They appear to be jamming through late quarter sales to keep them from missing numbers by a mile.
• TTC is viewed as a quality industrial compounder.  However, electric OPE continues to take share.  TTC is behind on that front and the electric OPE industry is more fragmented – lower quality.  Further, most of their growth is coming from lower margin pieces of the biz.  I expect TTC’s historical 20x+ multiple to trend closer to lower-quality peers’ mid teens multiple over time.
• I expect EPS this year to be $3.60-3.80 vs their guide of $4.20. I expect it’ll take time for the company to shed its “quality compounder” perception.  So at ~19x EPS (still below history but not cheap), there’s 25-30% downside.  If I’m wrong and this trades at 22x, 14% upside.  I think over time this will be a market multiple business (17x on the SPW today, which feels a bit high).

Thesis Detail

When including off-BS AR from Red Iron and the other financing vehicles, DSO’s have risen rapidly and are now over 150 days vs ~110 pre covid and ~120 days a year ago.  Meanwhile, DSI’s are at 168 days vs long-run averages of 110.  This is indicative of excessing channel inventory while demand is slowing, and perhaps continued channel stuffing. 

Deteriorating BS metrics has resulted in 35% FCF conversion for the past two years vs historical levels of 80%+.  They’ve continually missed their FCF guidance.

As mentioned, outstanding credit should be reflective of channel inventory.  When adding that outstanding credit to sales-adjusted on-BS inventory, we can get an estimate for total inventory in the system.  When looking at implied channel inventory vs sales, channel inventory appears very high.

We don’t need this analysis to show that inventory is too high – the company readily admits that there’s some excess inventory in the system, and sellside surveys show that ~70% of surveyed dealers say inventory is too high vs ~10% a year ago.  The point of this analysis is to highlight how high it is.  If this analysis is close to correct inventory as a % of sales is ~72% vs historical averages of 50-60%.  It seems that system inventory is 15-20% too high. 

Meanwhile, it seems that demand in the channel is getting worse.  This is from Constellation Data Solutions which tracks same store sales for OPE dealers that use their software.

Despite channel inventory that appears to be 15% too high and waning demand, TTC is guiding for flattish revenue in the Pro biz this year.  When taking into account growth in the infrastructure biz, it seems likely that they’ll miss this number by MSD+.  This matters bc the Pro biz is much higher margin than Resi.

Moving forward, I don’t expect a significant rebound in underlying demand for two reasons.

1. The equipment replacement cycle is 4+ years and this was a covid beneficiary.  For Resi equipment, the replacement cycle is double that.  In short, we’ll probably see a demand air pocket that lasts at least a couple of years.
2. TTC should continually lose share as electric takes share.  This is more pronounced in Resi, but over time, electric will take share in Pro as well.

TTC is expensive and there are clear comps that suggest this could trade for a mid-teens multiple over time if they shed the quality compounder perception.  

Catalyst

TTC likely to lower '24 guidance in Q2 or Q3.  '25 guidance should below expectations.  Due to multiple misses, I'd expect the multiple to come down over the next 12-18 months.