Shares of off-road tire and wheel manufacturer Titan International Inc. (NYSE:TWI) rose more than 20% last week. It's not the sort of move that usually happens when a company reports a more than 25% drop in sales in the quarter. However, the market already knows the company is beleaguered amid difficult agricultural, mining, and construction markets, so investors are likely to warmly receive any positive news. Let's look at why the stock moved so violently.
Titan International's first-quarter results
Frankly, it's hard to get too excited about the headline first-quarter numbers per se. Net sales declined by 25.4% and adjusted net income attributable to Titan fell 66% to $731,000. Indeed, on the earnings release, CEO Maurice Taylor acknowledged that "first quarter sales were below our internal plan." With these negative considerations in mind, what is there to like about the earnings presentations?
I can think of four things.
First, although Titan reported just $0.01 in earnings per share, analysts had forecast a $0.04 decline. It's only a difference of roughly $2.9 million in net income, but it's a positive sign. Furthermore, Titan's management didn't provide guidance for the quarter -- a practice that, I believe, tends to accentuate stock price movements after earnings are given.
The stronger U.S. dollar also reduced the value of Titan's foreign earnings, with Taylor pointing out that "well over half of the decrease" in sales "was due to currency impacts from Europe, South America, Russia and Australia." In essence, the earnings were stronger than expected.
Second, while Titan customers' end markets in industries including agriculture and mining have been in decline due to falling commodity prices, the company has been busy trying to reduce its cost base. A quick look at its earnings numbers reveals how management has cut expenses and reduced its cost structure.
As the following table shows, Titan significantly reduced its cost of sales in the first quarter, thereby increasing gross profit margin. In addition, operating expenses were cut significantly, with CFO John Hrudicka saying the $12 million decrease "is a function of profit optimization initiatives, restructuring actions" and foreign exchange. Consequently, operating income rose strongly.
|Q1 2015||Q1 2014||Change|
|Sales ($ thousands)||402,100||538,900||(25.4%)|
|Cost of Sales ($ thousands)||359,300||484,000||(25.8%)|
|Gross Profit ($ thousands)||42,800||54,600||(21.6%)|
|Gross Profit margin||10.6%||10.1%||52 bps|
|Operating Expenses ($ thousands)||42,000||54,300||(22.7%)|
|Operating Income ($ thousands)||809||264||206%|
In addition, improvements in product quality meant warranty costs fell to just 0.63% of sales in the first quarter from 2% from 2010-2013 -- a pretty significant contribution to reducing the cost of sales.
Bottom in sight?
Third, Taylor made some bullish noises on the future when speaking on the quarterly earnings call. The remarks served to highlight the potential for a trough to form in the company's end markets:
We think we've seen the bottom. We think from now to the rest of the year. And so there's a little patch in 60 days some place on here. There'll be some adjustments from the OEs, but we're real positive. We're real positive. If you go out there and look at the -- the construction is starting to percolate a little bit more. You're seeing the farmers are hitting the field.
In truth, it's difficult to call a bottom in any market, and the agricultural machinery sector's prospects are guided by movements in crop prices -- a very hard thing to predict. However, with Warren Buffett taking a significant stake in Deere & Co. (NYSE:DE), it could be time to start feeling more optimistic. Deere is a Titan customer, and sales to agricultural customers declined 33% in the first quarter but still made up 53% of sales.
Meanwhile, construction/earth-moving customers made up 35.4% of sales in the quarter. Titan's construction/earth-moving sales fell 6.9% on a reported basis in the quarter, but when adjusted for currency effects they rose 3.6%.
Fourth, Titan's management has high hopes for its low sidewall, or LSW, tire/wheel assembly technology. Low sidewall wheels have a larger rim diameter and smaller sidewall compared to standard tires, and are believed to offer greater stability, therefore increasing productivity.
By expanding LSW options to customers, Titan's management believes it can generate sales growth in excess of industry growth. As Taylor outlined on the earnings call, "our LSW tires and wheels, which we've been preaching a long time. They're being offered now. They're going into the price books by our OEs. And we spent years trying to get that done, to offer these options."
All told, investors are buying into Titan's long-term prospects rather than the strength of its headline earnings in the first quarter. Costs have been cut and management has successfully raised margins. Meanwhile, LSW technology offers a unique cost-saving proposition to customers. Moreover, if the agricultural machinery market hits a bottom in 2015 , then end markets are likely to turn up for Titan.