In late February, Terex (TEX) board member Paula Cholmondeley directly purchased more than 3,500 shares of the $3.6 billion market cap construction machinery company's stock for $33.10 per share. In general, we believe that insiders should avoid buying shares of their company's stock, since they are already sensitive to company-specific risks and could therefore benefit from diversifying their wealth.
Therefore, when insiders buy, they must have a level of confidence that goes beyond the general bluster that "this will be a great year for us." On average stocks bought by insiders do narrowly outperform the market. Cholmondeley, for example, bought more than 5,000 shares of Terex in June 2012 at prices around $18.25. Although this purchase has earned a high return, of course this is not a typical result of insider activity.
Terex is best known for its work platforms, which include Terex and Genie products, but the company also provides cranes, excavator vehicles and other construction equipment. It's perhaps unsurprising that the stock price tends to be very responsive to changes in the broader market, since demand for its products is so dependent on construction: the stock's beta is 3.6. The past couple years have been good for Terex's business: the company reported a 13% increase in revenue last year, following 47% sales growth in 2011. Costs have been higher as well, but in those two years, operating income has gone from a loss of $74 million to a profit of nearly $400 million. Earnings have similarly flipped from being negative (adjusting for a gain on disposition of assets) in 2010 to $0.93 per share in 2012.
Even after that improvement, the current stock price represents an earnings multiple of 35 on trailing earnings. So the market is depending on Terex to continue growing its earnings, and to do so at a high rate. The company is capable of that, though its exposure to the overall economy creates significant macro risk. In addition, Terex experienced a decline in revenue last quarter compared to the fourth quarter of 2011 (with multiple segments seeing lower sales) and also missed earnings. The stock price fell on the news; Cholmondeley may have bought the stock believing that the market overreacted to the poor quarter. In addition, the most recent data show that 13% of outstanding shares are held short.
Management outlook in the company's 10-K filing was quite strong, with internal earnings estimates having a midpoint of $2.55 in earnings per share (EPS), which would make for a current-year price-to-earnings ratio (P/E) of only 13. The current sell-side consensus is for $2.62; however, some analysts may not have updated their forecasts since the fourth-quarter numbers were released. The sell-side has been even more bullish for 2014, with the forward P/E falling to 9. In comparison, Manitowoc (MTW), which also has a large crane and construction machinery business, carries trailing and forward P/Es of 24 and 10, respectively. It did not have any problems in the fourth quarter, with revenue up 9% compared to the same period in 2011 and earnings rising strongly. The market leader in construction equipment, Caterpillar (CAT), is in a very different situation: Its financial performance was very poor but the stock is cheap in terms of its trailing performance, with a valuation of 11x trailing earnings.
We like the overall trend in Terex's financials over the last two years and it's good to see this insider purchase, but the poor quarter gives us pause. It's possible that this is an anomaly as Manitowoc's good numbers signal that the industry is not collapsing. But given how much growth the company needs to deliver this year to justify the current stock price, we don't think the stock is a safe purchase right now. We would need to see Terex get back on track to meet management and Street expectations before considering it to be a growth stock.