Fit for Heavy Lifting 

09/08/2009 2:12 pm EST

Focus: GLOBAL

Tom Slee

Retired- Financial Advisor, Money Manager, Gordon Pape Enterprises LTD

Top Caterpillar dealer Finning will profit from the machine maker’s metamorphosis, writes Tom Slee in Internet Wealth Builder.

The sputtering Canadian economy is rapidly becoming a divide between haves and have-nots. There is nothing inherently wrong with that; all recoveries are uneven. However, this one is particularly patchy. For instance, energy and services are doing relatively well, [whereas] industrials, autos, and machinery remain a wasteland.

Fair enough, but that divide could easily become an investment trap. Right now it's very tempting to focus on oil companies and banks and neglect other sectors. That could be very costly. There are investment opportunities right across the board. Take the still-struggling heavy equipment companies, for instance. Some of them are starting to show signs of life. Their stocks could surprise us.

Founded in 1933, Finning International (TSX: FTT) is now the largest distributor of Caterpillar (NYSE: CAT) heavy machinery products in the world. With a western Canadian base, the company [provides] sales, rentals, and customer support services in six different countries. With almost 13,000 employees, it operates through three main divisions: Canada, South America, and the UK, which includes Hewden, Britain's largest equipment rental company.

As with all heavy equipment dealers, this is a difficult year for Finning. First-half revenues of $2.5 billion were down 14.6% from 2008. Net income of $93 million fell 33% from the same period last year. For once, because of the unprecedented worldwide economic collapse, FTT's geographic diversification failed to provide a buffer.

It's not a happy picture, but no worse than you would expect during the deepest recession for 70 years. The important thing is that Finning remains profitable, and prospects for its major customers are now improving. The mining industry is surprisingly robust, and energy producers are expected to start expanding once more as oil prices move higher. Finning, meanwhile, has been implementing cost-cutting measures that should result in $150 million worth of annual saving, and these are going to take effect as we head into 2010.

The most promising development, though, is at Caterpillar in the US. CAT is introducing its new "Lane" strategy, a production methodology that will simplify equipment designs, produce more robust machines, reduce the number of models, and allow for faster deliveries. For dealers like Finning, that means an improved product line, reduced inventories (perhaps by as much as 50%), far less working capital, and much wider profit margins.

Earnings of slightly more than C$1.00 a share are expected in 2009, followed by a rebound to C$1.35 or more next year. The stock should start reflecting the improvement long before then. There is a quarterly dividend of 11 cents a share for a yield of 2.6%.

Finning International becomes a Buy for investors seeking long-term growth who are able to assume some risk. I have set a $23 target and will revisit the stock if it dips to $13. [The shares closed at C$16.03 in Toronto Friday—Editor.]

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