Titan’s first quarter showed mixed results, but the stock ended up a little bit and slightly above tangible book value per share. The top line surprised to the upside, but flow-through was weak, given weaker farm equipment used pricing and international segment expenses. We continue to see risk to the implied second-half guidance on the margin front, given agriculture headwinds and negative construction seasonality in the fourth-quarter.
Construction may be profitable in the fiscal second and third quarters, because of strong same-store sales growth (guidance raised to 15%-20%, with growth of 24% in the first quarter), coupled with cost reductions and seasonality. International will likely remain a headwind because of European operation center start-up costs, but a potential subvention fund for Bulgaria and Romania could lead to upside to Titan’s international guidance. Inventory reductions remain the most acute facet of the story and our major focus.
Inventory will not come down until the second half, and we believe late-model, used equipment inventories remain stubbornly high (~$350 million); this is partially because any potential tax incentive increases would not likely occur much later in the year (post-elections). Management said the majority of new equipment on order is interim tier-4 compliant machinery, and so it is comfortable that it can work these levels down, but there could be risk to retail sales when the channel transition fully occurs. Tier 4 final equipment is less attractive to customers because of the higher prices, though that could provide some cover for weaker used prices at some point.
Management guides same-store sales down 10% to 15%, and equipment sales will be down more than that, given steadier performance in parts and service. New equipment sale will be down more than used equipment sales, we believe, as farmers become more hesitant to trade in used equipment because of lower pricing and tax incentive uncertainty.
Agriculture same-store sales surprised to the upside in the first quarter, only down 1%, but equipment was down more than that. Easier comparisons (late planting last year caused underutilization) helped lead to better-than-expected sales, but the second-quarter comparison is tougher. We anticipate steep same-store sales declines throughout the rest of the year in agriculture and next year as well, as the retail channel changes over to the higher final tier-4 machinery.