Why you shouldn’t fall for the value trap that is TEX

September 11, 2018

Why you shouldn’t fall for the value trap that is TEX

A couple of weeks ago, I wrote about Oshkosh Corporation (OSK), a mid-cap stock in the Heavy Machinery industry that is trading at a steep discount right now, and that I think looks like a pretty interesting value-based opportunity. The entire industry is pretty depressed right now, and you don’t have to look much further than the biggest names in the industry, like Caterpillar (CAT) and Deere & Company (DE), which are both down nearly 20% since the beginning of the year, to see that even as the market is driving to new highs, this is an industry that is getting left behind, as trade war fears appear to be having a direct impact on investor’s opinions about the industry’s near-term prospects.

Paying attention to depressed sectors and industries is a technique that I like to use in tracking overall market activity, as I can often some excellent opportunities to work with stocks like OSK, where I think the long-term opportunity to buy a fundamentally solid stock at a major discount justifies any near-term volatility risk I may see in the industry. That doesn’t mean, however, that all stocks in a depressed industry are automatically going to offer the same kind of value-based opportunity. Managing risk as a value investor means thinking about the price you’re willing to pay for a stock versus the price the market is offering right now. If the company’s fundamental strength doesn’t imply the stock’s price should be significantly higher than it is right now, it doesn’t really matter how far off of historical highs the stock is right now; a smart investor will pass on the stock and focus his attention elsewhere.

I think TEX is a good example of the kind of “value trap” that investors can sometimes fall into. The challenge for some investors is working with stocks that trade a higher relative prices than other companies in the same industry. CAT, DE and OSK are all good examples; not only are these companies generally better known than TEX, with market capitalizations that are many times larger than TEX’s $2.8 billion, small-cap profile, their stocks also trade at much higher prices than TEX’s current price in the $38 price region. If you’re like a lot of investors, trying to work with limited capital, buying stocks like CAT or DE at prices above $140 is a lot harder to do. That can make a stock like TEX look like it might be a decent proxy for a larger company in the same industry. Unfortunately, that isn’t always the case. While TEX is down nearly 25% from its high in January of this year, it also looks like a stock with a significant amount of additional risk attached to it – risk that could see the stock drop down to levels it hasn’t seen in more than two years.



Fundamental and Value Profile

Terex Corporation is a manufacturer of lifting and material processing products and services that deliver lifecycle solutions. The Company has three business segments: Aerial Work Platforms (AWP), Cranes and Materials Processing (MP). It delivers lifecycle solutions to a range of industries, including the construction, infrastructure, manufacturing, shipping, utility, quarrying and mining industries. The AWP segment designs, manufactures, services and markets aerial work platform equipment, telehandlers and light towers. The AWP segment’s products are used by its customers to construct and maintain industrial, commercial and residential buildings and facilities, and for other commercial operations, as well as in a range of infrastructure projects. The Cranes segment’s products are used by its customers for construction and manufacturing facilities, among others. The MP segment’s products are used by its customers in construction, infrastructure and recycling projects. TEX’s current market cap is $2.8 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings  grew more than 92% while revenue growth was also impressive, posting an increase of about 18.5%. In the last quarter, earnings great by over 78%, while sales posted a gain above 11%. Far less impressive is the fact that TEX operates with a narrow margin profile of about 2.9% over the last twelve months, a measurement that improved in the last quarter to a little over 4%. That narrow margin is a red flag, especially when you consider it against the stock’s growth in earnings and sales.
  • Free Cash Flow: TEX’s free cash flow is very healthy, at a bit over $496 million. Since the third quarter of 2017, however, free cash flow has declined from about $1 billion, while debt has increased more than 25% over the same period. The stock’s Book Value has also declined in every one of the last five quarters.
  • Debt to Equity: TEX has a debt/equity ratio of 1.15. That number implies a high level of leverage, which of itself isn’t particularly alarming in the Heavy Machinery industry, however it has also increased in every one of the last five quarters – from only about .6 at the end of the first quarter 2017 to that current level.
  • Dividend: TEX pays an annual dividend of $.40 per share, which translates to a yield of almost 1.06% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for TEX is $12.86 and translates to a Price/Book ratio of 2.93 at the stock’s current price. At the end of the first quarter 2017, the stock’s Book Value per share was about %16.25 per share. Their historical average Price/Book ratio is 1.84. That suggest the stock is trading right now at a premium of nearly 38%, which puts the stock’s long-term target at only around $23.66 per share. That is a price level the stock hasn’t seen since the summer of 2016.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend from late January to its bottom in early May of this year; it also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock picked up some bullish momentum from May until August of this year, but has since dropped back to push near to its 52-week low prices. It is currently a little more than $3 away from the first resistance level shown by the 38.2% retracement line at around $41. This is the first level I would look for the stock to move above before a new legitimate upward trend could be considered. The stock is also only about $3 away from its 52-week low around $35; a break below that price at any point in the future would mark a continuation of the downward trend that began in January.
  • Near-term Keys: The stock is roughly the same distance from immediate resistance right now as it away from its nearest major support; that implies a short-term reward: risk ratio of 1:1 that just doesn’t justify trying to think about either a bullish or bearish trade right now. I also think that the stock’s value proposition is just not attractive at all, since the stock’s historical activity implies a fair price based on Book Value is only around $23. That really means that good value for the stock is really around the $18 to $19 level, which is more than 50% below the stock’s current price.