We might call The Toro Company (TTC, Financial) the very model of a Buffett Munger company, with its ability to consistently grow its bottom line and a valuation of less than 1, indicating it is currently undervalued. Although it appears the two gurus don’t own any Toro stock at the moment, the company should get the attention of investors who follow the legends at Berkshire Hathaway (BRK.A) (BRK.B, Financial).
Toro is the company that makes those ubiquitous mowers, snowblowers, and more. Its products are a staple on thousands of golf courses, landscaping projects, and even residential lawns. While America is its home turf, so to speak, it’s increasingly appearing on golf and landscape projects internationally.
Source: Investor Presentation, December 2014
Toro comes up on the Buffett Munger screener at GuruFocus.com. For investors, its essential history can be summed up with this graph of share price (green line) and EBITDA (blue line):
History
1914: The Toro Motor Company founded in St. Paul, Minnesota.
1921: Starts working on mechanized replacement for horse-driven mowers on golf courses; subsequently becomes well known for golf course equipment.
1946: Expands by targeting the consumer market, with equipment for mowing at home.
1952: Opens the world’s first agronomic R&D facility (which will soon have more than two dozen scientists) to research turf and turf care.
1956: Becomes the first lawn and garden company to advertise on television.
1971: Renamed The Toro Company.
1978: Begins trading on the New York Stock Exchange.
1989: Acquires Lawn-Boy brand.
1996: Acquires James Hardie Irrigation Group.
1997: Acquires Exmark Manufacturing; net sales surpass $1 billion.
2000: Sells its outdoor lighting and gas handheld product lines.
2005 Acquires Hayter Limited, which makes mowing products for the sports fields and municipal markets.
2013: Sales go over the $2 billion mark for the first time.
2014: Celebrates its 100th anniversary by ringing the NYSE bell on May 28; acquires BOSS professional snow and ice management business.
History based on information provided at the company website and encyclopedia.com.
Toro’s Business
The Toro Company designs, manufactures, and markets the following:
- professional turf maintenance equipment and services
- turf irrigation systems
- landscaping equipment and lighting
- agricultural micro-irrigation systems
- rental and construction equipment
- residential yard and snow removal products.
It advertises and sells its products under these brand names: Toro®, Exmark®, Irritrol®, Hayter®, Pope®, Unique Lighting Systems®, Lawn-Boy®, and Lawn Genie®.
Toro operates with three reportable business segments, which made the following contributions to net sales in fiscal 2013:
Source: Investor Presentation, December 2014
Geographically, about 71% of net sales in fiscal 2014 came from the United States, and about 31% from international sales.
Source: Investor Presentation, December 2014
The company is based in Bloomington, Minnesota and had about 5,000 employees at the end of fiscal 2013.
Competition
The company describes its markets as highly competitive. Yahoo! Finance lists its three major competitors as Deere & Company (DE, Financial), Honda Motor Co., Ltd.(HMC, Financial), and privately-held MTD Products Inc.
According to Toro, companies in its space compete on the basis of product innovation, quality and reliability, pricing, product support and customer service, warranty, brand awareness, reputation, distribution, shelf space, and financing options.
It attributes its strength in the markets to "...total solutions and full service packages with high quality products that have the latest technology and design innovations. In addition, by selling our products through a network of distributors, dealers, hardware retailers, home centers, and mass retailers, we offer comprehensive service support during and after the warranty period." (10-K, 2013)
Takeaways: Toro brings in more than $2 billion per year with lines of products connected with managing customers’ relationships with the earth. Its most important lines are landscape/grounds and golf. Competition is strong but apparently manageable, and international sales offer new opportunities.
Growth
Here’s how Toro has grown its top and bottom lines over the past 20 years, with Revenue per Share (green line) and EBITDA per Share (blue line):
Aside from the dip that occurred with the financial crisis of the last decade, it has had steady growth in both revenue and earnings (EBITDA).
TTC plans to continue growing, organically and through acquisitions (as well as strategic partnerships and joint ventures. It plans to pursue those goals both domestically and internationally.
Tactics for achieving that growth include:
- Spending at least 3% per year on research & engineering; new products (introduced in the current or two previous fiscal years) have generated at least 35% of sales for the past six years.
- International markets represent growth opportunities; one example is the acquisition of a micro-irrigation manufacturing company in China, where demand for food crops is growing rapidly.
- It has had a series of three-year productivity improvement initiatives; the current initiative, Destination 17, aims for 5% or more organic growth each year, operating earnings of at least 13% by the end of fiscal 2017, and operating capital below 13% by the end of fiscal 2017.
Takeaways: Toro is well established in its niches, and has used its positions to deliver strong revenue and earnings growth; it also has proven plans in place to maintain that growth in the future.
Management
Chairman & CEO: Michael J. Hoffman, age 59, CEO since 2005 and Chairman since 2006. He started at Toro in 1977, with positions in service, sales, and marketing.
Chief Financial Officer, Vice President, & Treasurer: Renee J. Peterson, age 52, joined Toro as CFO in 2011. Previously she held senior finance positions at Eaton Corporation and Honeywell International.
Board of Directors: Eight independent directors plus Chairman/CEO Hoffman; the independent directors are or have been associated with the following companies: Jostens, Inc., Qwest Communications, Medtronic, Inc. (MDT, Financial), Hormel Foods Corporation (HRL, Financial), Idearc Inc., The Mosaic Company (MOS, Financial), Target Corporation (TGT, Financial), and Arctic Cat Inc. (ACAT, Financial).
ISS Governance QuickScore: 4, a middling score ("A decile score of 1 indicates lower governance risk,while a 10 indicates higher governance risk."). The company receives receives red (warning) flags for Takeover Defences, Meeting and Voting Related Issues, and Termination Controversies; it receives one green star, for Use of Equity.
Takeaways: The Chairman/CEO appears to have spent most or all of his career at the company, so he should know it well, while the CFO is relatively new but brings experience at other companies. The board appears to have at least corporate diversity and a reasonable governance score from ISS.
Ownership
Gurus: 11 of the gurus followed by GuruFocus hold stock in Toro: Jeremy Grantham (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), Jim Simons (Trades, Portfolio). Bill Freis, Ken Fisher (Trades, Portfolio), First Pacific Advisors (Trades, Portfolio), Diamond Hill Capital (Trades, Portfolio), Chuck Royce (Trades, Portfolio), Columbia Wanger (Trades, Portfolio), Mario Gabelli (Trades, Portfolio), and Joel Greenblatt (Trades, Portfolio). Bill Freis has the largest holding, at 2,879,015 shares.
Institutional Investors: NASDAQ.com reports about three quarters of TTC shares belong to institutional investors, organizations or companies that invest on behalf of individuals (such as pension plans and mutual funds). Of those 284 institutions, Vanguard Group holds the biggest position, at 4,287,248 shares.
Short Interests: A very modest 1.5% of shares are borrowed by investors who expect the company’s stock price to go down. That level has been quite consistent in the post-2008 era:
Insiders: According to GuruFocus, insiders own a healthy 4% of Toro’s shares. Looking at individuals within the company, Yahoo! Finance reports the only with a sizable holding is CEO/Chairman Michael Hoffman who owned just under three-quarters of a million shares on December 4, 2014.
Takeaways: Strong ownership positions taken by gurus, institutions, and insiders (as well as the light position among shorts) suggest confidence in this company’s future. In addition, it suggests the share price is not likely to spike up or down.
Toro by the Numbers
Takeaways: The most striking number is the ROE, Return on Equity, at 45.31%; the stock price currently sits, roughly in the middle, between the 52-week high and low; the dividend while modest puts the payout ratio at 26% and the company indicates it wants the payout to range between 30% and 40% going forward, suggesting more dividend increases in the near future.
Financial Strength
The Toro Company receives strong 8/10 ratings for both Financial Strength and Profitability & Growth:
To follow up on that, we’ll look at the company’s long-term debt and its free cash flow, using the GuruFocus 10-year financials.
The company had long-term debt of $224 million at the end of fiscal 2013 (October 31), and on a trailing twelve month basis it’s up to $347 million. Along with noting the company had sales of more than $2-billion in fiscal 2013, here’s how the long-term debt looks in historical context:
The following chart shows the Debt to Equity ratio is roughly in the middle of the range it’s established over the past 20 years:
This chart shows the sometimes bumpy free cash flow for 20 years.
Takeaways: Long-term debt has gone up, but not significantly in light of its $2 billion in sales. The Debt to Equity ratio is comfortable, and while free cash flow hasn’t grown smoothly, it generally has maintained its upward path. All of which backs up the good financial strength rating shown above.
Valuation
The stocks that make it through the Buffett Munger screener -- and only a very few do -- have demonstrated earnings predictability and are considered either undervalued or fair valued.
Toro qualifies as a 5-Star (5 out of 5) stock, which means it has shown highly consistent earnings growth, or put another way, is among the top few dozen out of the thousands of stocks evaluated by GuruFocus. Here’s a chart that shows the consistency:
Note how revenue (green line) and net income have steadily risen since bottoming out at the end of fiscal 2009 (October 31, 2009). Backtesting by GuruFocus has shown that the higher the predictability, the stronger the future price performance and the lower the likelihood of losses.
Turning to price, we evaluate it in terms of both the earnings growth (using EBITDA) and the stock’s P/E (Price to Earnings ratio). This gives us a metric we can apply across all industries and sectors, a metric known as PEPG or PEG. We calculate it by dividing the P/E by the average annual EBITA growth over the past five years.
After close of trading on December 16, 2014 TTC had a P/E of 20.30 and average annual EBITDA growth of 22.70% over the past five years. Dividing the former by the latter, we get a ratio of .90, which makes Toro an undervalued stock. A stock with a PEG ratio of 0.00 to 1.00 is considered undervalued, more than 1.00 and less than 2.00 is considered fair valued, and anything above 2.00 is considered over valued.
One of the tools companies can use to generate consistent earnings is share buybacks, and TTC has used its ability to do that. This graphic from the company’s December 2014 Investor Presentation illustrates its share buyback history:
Note that many market observers only consider buybacks a good idea when shares are undervalued or at a reasonably fair valuation.
Earnings also matter when it comes to dividends. In its Investor Presentation, the company advises it aims to return 30% to 40% of the average three-year earnings per share to shareholders. Currently, it pays $1.00 annually, which works out to a forward dividend yield of 1.6%. And now that it has increased dividends for five consecutive years (at an average of 15.6% per year), it qualifies for Dividend Challenger status at the The DRiP Investing Resource Center.
Takeaways: Toro offers investors a high level of earnings consistency, at an undervalued price (based on the PEG ratop). In addition, it pays a modest dividend that can be expected to grow with revenue and earnings, as well as a strategic share buyback program.
Opportunities & Risks
As with many other big American companies, the rapid growth of middle class populations in countries such as China, India, and Brazil (but not so much Russia, anymore) means the opening of vast new markets. Urbanization creates a need for municipal grass cutting equipment and snow removal equipment; increased prosperity means additional golf courses, more lawns and larger lawns.
At home, the economy has yet to get back to full steam. Assuming that does happen, the market for infrastructure equipment, everything from landscaping equipment to drip irrigation, should see a spurt of growth as governments and institutions, as well as many companies, reinvest in their maintenance equipment.
A solid history of continuous improvement initiatives suggests the company will continue to squeeze more out of each revenue dollar. The following chart shows the how earnings have grown under the six improvement initiatives launched since fiscal 2001:
Risks
If we look at quarterly revenue (green line) and earnings per share (blue line), we get a sense of how seasonal a business Toro runs:
That in turn gives us an idea of the seasonality and sensitivity to weather conditions.
Sales in the Professional segment depend significantly on the opening and closing of golf courses; while strong expansion in emerging markets is a promise, there’s no guarantees of how quickly that will happen. And, how will changing demographics affect the size of the golf market domestically?
More than 10% of residential sales in fiscal 2013 were made through one retailer: Home Depot. Consequently, loss of floor space or other changes at that one retailer could have a material effect on sales and net income.
Sell a product with lots of moving parts, especially sharp ones, like lawnmowers or snowthrowers, and there’s always a chance someone will get injured or worse, leaving the manufacturer saddled with liability claims. To take bad case example, consider the recall woes of General Motors and other auto manufacturers.
See Toro’s 10-K for 2013 and December 2014 Investor Presentation for more about opportunities and risks.
Outlook
Considering the opportunities and risks of The Toro Company, I come away optimistic about its future. With a proven management team, a solid history of top and bottom line growth, as well as ample financial and human resources, it should be able to execute the ambitious plans it has for the future.
Conclusion
In the short-term, TTC provides an opportunity to buy into a quality company at a good price -- based on the PEG ratio; it’s undervalued, making it appropriate for closer inspection by investors looking for capital growth. A strong history of earnings, backed up with share buybacks, suggests more growth ahead (barring black swan events).
Investors looking for immediate income won’t find much to attract their attention, since the current yield sits at 1.6%. However, the dividend has grown rapidly for the past five years, and with dividend growth tied to earnings growth, it should provide an attractive yield in a few years (presumably with capital appreciation while waiting).
Investors who want good dividend yields, and capital appreciation while they’re waiting (a reversal of the normal strategy), should take a look at The Toro Company.
