The Toro Company: Quality Concerns

At the start of 2022, I believed that the risk-reward started to look compelling in the case of The Toro Company (NYSE:TTC), as the quality company has seen a strong performance since the outbreak of the pandemic.

Given its excellent long-term track record, accompanied by occasional M&A efforts, I liked the business but would like to see a greater discount before getting appealed and ready to be involved with the shares.

Shares quickly recovered and rose to triple-digit territory, as the latest setback has sent shares down quite a bit below that level, as I find it too early to go bottom fishing.

A Recap - Some Perspective

Pre-pandemic, The Toro Company was a $3.1 billion business, which posted adjusted earnings of $3 per share. A stock which traded in its eighties was granted a demanding multiple at 27-28 times adjusted earnings, all while leverage was relatively modest in the mid-1s.

Shares rose to $120 during the stock market recovery in 2021 but actually were down to $90 early in 2022. In the meantime, the company saw sales increase by 7% to $3.4 billion in 2020, while earnings were posted flat around $3 per share. Revenues rose in a spectacular fashion, up 17% to $4.0 billion in 2021, with earnings up to $3.62 per share, as the company saw more growth ahead in 2022.

With earnings seen around $4 per share in 2022, a resulting 22-23 times earnings multiple looked reasonable, certainly as net debt was cut to just half times EBITDA, as I regarded the company as being real quality. Moreover, some potential was introduced with a $400 million deal for The Intimidator Group, in a deal set to add $200 million in sales. Recognizing the quality, I was keen on finding an entry level around 20 times earnings, making me a buyer in the $80s.

Struggling - Some Concerns

In the end, I bought small in the lower eighties in spring 2022, yet sold out around the hundred mark later in 2022, as shares hit a high of $117 earlier this year. With shares mostly trading around the $100 mark this year, they have now fallen overnight to $87, marking no gains since I last had a look early in 2022.

In December 2022, the company posted its 2022 results with revenues up 14% to $4.51 billion, as operating profits rose by 11% to $575 million, with net earnings of $443 million working down to $4.20 per share, in line with adjusted earnings. Moreover, the company guided for 2023 sales to rise another 7-9%, while adjusted earnings were seen between $4.70 and $4.90 per share. With EBITDA reported around $650 million, a net debt load of $800 million was perfectly manageable.

After a very strong first quarter, in which revenues rose by 23% to $1.15 billion and earnings grew even more pronounced, the company maintained the full-year guidance, which frankly looked conservative given the first quarter strength displayed. Second quarter sales growth of 7% marked a dramatic slowdown, as the company actually trimmed the full-year guidance in a modest fashion, with sales now seen up 7-8%. The higher end of the earnings guidance was cut to $4.80 per share.

The bombshell report arrived in September, with sales down 7% to $1.08 billion as the company took a huge $151 million goodwill charge on The Intimidator Group. With adjusted earnings down from $1.19 per share to $0.95 per share, the company cut the full-year earnings guidance to $4.05-$4.10 per share.

This is attributed to a mix of macro and weather, as even a new partnership with Lowe's (LOW) could not bring any relief, as quite frankly, the operating performance and execution feel very soft. It was noteworthy to see that professional revenues rose by 1% to $896 million, yet it was a 35% decline in residential sales to $175 million, which was the pocket of weakness here. With inventory levels up sharply, net debt ticked up to $913 million, although it is still manageable.

And Now?

Trading at $87, we again find ourselves in a situation in which the stock trades at a reasonable 22 times earnings multiple, while leverage ticked up, but it should be manageable once inventory levels normalize as the business adjusts to changed circumstances.

While Toro is a long-term quality business, it is dealing with rapid changes like so many businesses related to the pandemic and weather creating longer and shorter-term impacts on demand, while supply chain disruption has been seen at times as well, making it a difficult environment to operate within.

I still believe that the business is long-term quality, despite current setbacks and while the initial share price performance to the earnings reports looks compelling, I am waiting for an entry point around $80, or even the seventies before pulling the trigger in this case.

After all, it is the shocking performance of the residential segment here, which raises the question on the prospects for this business, as well as the concerns as the company has some strives to make on electrification. Hence, some signs of stability are badly needed to get a reconfirmation of the long-term quality play, most certainly a successful transition to electrification.

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