Finning International Q1 2024 Earnings Call Transcript

There are 9 speakers on the call.

Operator

Welcome to the Finning International Inc. 1st Quarter 2024 Investor Call and Webcast. As a reminder, all participants are in a listen only mode. And the conference is being recorded. After the presentation, there will be an opportunity to ask questions.

Speaker 1

I would now like to

Operator

turn the conference over to Greg Palaszczuk, Executive Vice President and Chief Financial Officer. Please go ahead sir.

Speaker 2

Thank you, operator. Good morning, everyone, and welcome to Finning's Q1 earnings call. Joining me today is Kevin Parks, our President and CEO. Following our remarks today, we'll open the lines to questions. The call is being webcast on the Investor Relations section of finning.com.

Speaker 2

We've also provided a set of slides that we'll be referencing during our prepared remarks. The slides are posted on our website. An audio file of this call and accompanying presentation can will be archived. Before turning it over to Kevin, I want to remind everyone that some of the statements made during this call are forward looking. Please refer to slide 9 and 10 for important disclosures about forward looking information as well as currency and specific financial measures including non GAAP financial measures.

Speaker 2

Please note that forward looking information is subject to risks, uncertainties and other factors as discussed in our annual information form under key business risks and in our MD and A under Risk Factors and Management and Forward Looking Information disclaimer. Please treat this information with caution as our actual results could differ materially from current expectations. Kevin, over to you.

Speaker 1

Thank you, Greg, and good morning, everyone. Today, I would like to start by thanking our employees for their commitment to serving our customers, winning strategically important deals, diligently building execution momentum of our strategic plan and delivering a solid quarter. Our people are our greatest competitive advantage and we are committed to building safe and supportive workplaces. We are working hard to simplify our business and empower our teams to build customer loyalty. Turning to our Q1 results on slide 2.

Speaker 1

My team and I are particularly pleased with our strong new and used equipment performance that builds population of equipment and engines in our end markets and drives future product support business. We are also encouraged by the substantial backlog and the €700,000,000 of additional backlog since the quarter end. Following a period of record growth and a very strong Q1 in 2023, our product support is slightly down year over year. We consider this a transitionary phase due to some challenging market conditions and specific customer plans. If we look at our product support CAGR over the last 2 years, we have seen solid growth at 12% CAGR.

Speaker 1

Greg will provide more detail on our product performance in each region. The great progress we are making to grow used equipment and power system sales in all regions drives resilience and helped offset the impact of lower product support in the quarter. Used equipment revenue was up 48% year over year reflecting our significantly increased participation in a very active used equipment market. We recently launched fused equipment sales platform, specializing in selling as is where is used equipment globally and targeting mostly non cat high aero machines. Our Power Systems revenue was up 37% year over year.

Speaker 1

We added large orders from data center customers in the U. K. And Ireland and Chile to our quarter 1, 2020 4 backlog and secured significant new Power Systems orders post quarter 1. We're also demonstrating strong cost control with SG and A as a percentage of net revenue down 130 basis points from Q1 2023, which is a critical component of building full cycle resilience, while increasing our earnings capacity. Looking ahead, our positive outlook for 2024 is underpinned by robust end markets and strong commodity prices, large customer orders awarded in April which bolster our backlog and the continued disciplined execution of our strategic priorities.

Speaker 1

We are extremely pleased with the important strategic wins in each region in April, including multiple copper mines in Chile, the oil sands in Canada and data centers in the U. K. And Ireland. These awards represent over $700,000,000 of new equipment orders for delivery starting in the second half of this year, laying out a solid foundation for future product support opportunities. As previously discussed, with the electrification trends driving strong copper demand, Chile is mobilizing for growth.

Speaker 1

We are very pleased with the large orders in April, including with Codelco, whose order was valued at $380,000,000 where the fleet will be supported under a 10 year maintenance contract and this is an important strategic win for Finning and Caterpillar. The new agreement covers pork and Alco mines and marks the first time Caterpillar trucks will be deployed at 2 of those mines. Building equipment population and increasing our proportion of contracted revenue are key to our strategy and this wing is an excellent example. We are optimistic about the second half of twenty twenty four and we are confident in the direction of our business. We expect product support growth rates to improve in the second half of the year as we continue to book and execute rebuilds, grow contracts and hire technicians.

Speaker 1

We remain laser focused on improving our working capital velocity and unlocking invested capital to drive substantial free cash flow generation going forward with a number of key initiatives underway in all of our regions. These initiatives include increasing new equipment preparation velocity. We expect the new orders that we've taken to move through our backlog much faster than previously increasing inventory performance on time in full performance for our customers working closely with our customers on planning component exchanges and rebuilds and optimizing lower ROIC activities. We're constantly reviewing the pace of investment in our rental fleet to ensure we're achieving the growth goals and return on investment. Our focus is squarely on executing our strategic plan, which we laid out at our 2023 Investor Day.

Speaker 1

We are growing our business in a moderating growth environment, demonstrating improved earnings power through driving product support, building full cycle resiliency by unlocking invested capital and delivering sustainable growth in used and power systems. We anticipate the execution of our strategy will have an increasing impact through the year with improving product support growth rates and substantial free cash flow. We are mobilizing all resources to build momentum, efficiently deliver our newly awarded packages and execute rebuild in a capital efficient way. We are pleased to increase our dividend by 10% and also renewed our share repurchase program. The dividend increase is well supported by our improved earnings capacity and demonstrates our strong commitment to returning capital to shareholders.

Speaker 1

Before I turn it over to Greg, I want to mention that we publish our 2023 sustainability report soon. We are proud of the work we're doing to improve safety, reduce our emissions and support our customers in achieving their decarbonization goals. We're building a strong and inclusive company, which has a positive impact on the communities in which we operate. I encourage you to take a look at this report when it's available on our website. With that, I'll hand it back to Greg.

Speaker 2

Thank you, Kevin. I'll talk more about our Q1 performance in detail. Turning to slide 3. In the Q1, our net revenue was $2,300,000,000 up 9% from Q1 2023, marked by strong growth in new and used equipment sales. Market activity was mixed, but solid overall, supported by strong momentum in commodities and growing demand for power solutions in all of our regions.

Speaker 2

Diligent execution of our strategic priorities including strong used equipment sales and cost control helped offset the impact of lower product support revenue in the quarter. EPS was down 5%, primarily reflecting shift in the mix to new and used equipment as well as lower margins in those segments. We've reduced risk levels in Argentina and are pleased that the business has returned to profitability in Q1, which was earlier than we anticipated. On slide 4, we show changes in net revenue by line of business compared to Q1 2023 and the composition of our equipment backlog by market sector. New equipment sales were up 25% led by Canada and South America where we continue to see strong demand in mining and power systems.

Speaker 2

Used equipment sales were up 48%, higher in all regions, reflecting execution of our strategic focus on used and our increased participation in this very active market. Product support revenue was down 1% with solid growth in South America offset by lower activity in Canada and the U. K, primarily due to a transitory phase impacting construction activity that I'll cover in the regional slides. Our equipment backlog was $2,000,000,000 at the end of March, maintained from December 31 levels. The new orders totaling over $700,000,000 are not included in the Q1 backlog.

Speaker 2

With the wins announced today, we expect to see continued trend of increasing proportion of backlog in Mining and Power Systems. Turning to slide 5, which shows our EBIT performance. Gross profit as a percentage of net revenue is down 2 60 basis points from Q1 2023, mostly due to the shift in revenue mix to new and used equipment sales. As expected, with improved availability, we're seeing lower margins in used equipment and rental compared to last year. Our resiliency actions offset half the margin decline in the quarter.

Speaker 2

SG and A as a percent of net revenue was down 130 basis points from Q1 2023 to 17.7 percent demonstrating operating leverage in the higher revenue environment and strong cost control. Moving to our Canadian results and outlook, which are summarized on slide 6. New equipment sales were up 39% from Q1 2023 with broad based strength across all market sectors and deliveries from backlog. Used equipment sales were up 37% year over year, driven by conversion of rental equipment for the purchase option to sales and stronger volumes across retail and wholesale channels. Product support revenue was down 4% year over year.

Speaker 2

In a transitory phase in construction with the wind up of several large construction projects and winter projects being deferred. Challenging operating conditions also led to reduced equipment utilization hours in most sectors in the Q1. Despite this, over a 2 year period our product support CAGR in Canada is 10%. In mining, we saw mixed activity by customer with a number of customers spending significantly more in Q1 and several spending significantly less due to adjustments in their mine plans. Overall, we are confident in product support growth going forward to deliver strong performance, achieving 16% growth in EBIT compared to Q1 2023 and generating positive free cash flow in the Q1.

Speaker 2

We're proud of their consistent and strong execution. Our outlook for Western Canada is positive with the Trans Mountain pipeline beginning operation in May 1. We're in a new area of steady growth in the energy sector. While the completion of major pipelines has slowed some construction activity in the near term, we expect to see increased activity in the energy sector and production growth. Turning to South America on slide 7.

Speaker 2

In functional currency, new equipment sales were up 20% from Q1 2023 on strong mining deliveries in Chile. Product support revenue was up 4% year over year, higher in all market sectors and increased activity in mining and power systems as well as demand for rebuilt and construction. Part sales were up 7%, partly offset by lower service revenue due to weaker Chilean peso relative to the U. S. Dollar compared to Q1 2023.

Speaker 2

In Chile, service revenues and costs are both in pesos. So the lower year over year peso reduces revenue growth, but ultimately the margin percentage is held and profitability is strong. We expect a weaker year over year Chilean peso to continue, which will impact service revenue growth rates in 2024, while at the same time supporting lower SG and A. EBITDA was up 3% from adjusted EBITDA in Q1 of 2023 and EBITDA as a percentage of net revenue was strong at 11%. Despite a large proportion of low margin mining equipment sales in the revenue mix.

Speaker 2

Our outlook for Chile in mining is optimistic, underpinned by growth, growing demand in copper, strength in copper prices, government approvals of large scale brownfield expansions and increasing customer confidence to invest in new projects. While the orders received in April are also strong evidence of the trend, we are seeing broad based increase in quoting and tender activity for mining equipment across customer base and their growth plans are advancing and with greater confidence. We also continue to see healthy demand for large contractors supporting mining operations in Chile and growing power systems activity in industrial and data center markets. In Argentina, while we see pockets of strong activity, especially in oil and gas sector, we continue to take a lower risk approach in 2024. Please turn to slide 8 for our results in the UK and Ireland.

Speaker 2

In functional currency, no equipment sales were comparable to Q1 of 2023 with higher power systems deliveries offset by lower volumes in construction due to soft market activity. Used equipment sales nearly doubled year over year as we work to increase our participation in the used equipment market. Product support volumes were reduced by lower customer activity levels and lower machine utilization hours. EBIT as a percentage of net revenue was down 120 basis points year over year, mostly due to a lower proportion of product support in the revenue mix and continued inflationary cost pressure. We are pleased with sequential improvement in the U.

Speaker 2

K. And Ireland and 4.5 percent EBIT margin given these tough market conditions. We expect demand for new construction equipment in the U. K. And Ireland to remain soft, reflecting low GDP growth projected in 2024.

Speaker 2

However, we expect to see growing contribution from used equipment and power systems and resilient product support as we continue to execute on our strategy. We've renewed our normal course issuer bid for repurchase of up to 14,000,000 shares. And our current NCIB which expires May 12, we repurchased 7,200,000 shares or 5 percent of our public float. Our balance sheet remains healthy with net debt to adjusted EBITDA at 1.9 times at the end of March, reflecting normal seasonal build of our inventory. We expect substantial free cash flow in 2024 as we sell through our inventory, start delivering new orders with improved cash to cash cycles versus prior backlog build and continue to execute our capital unlock and velocity plan.

Speaker 2

Operator, I'll now turn the call back to you for questions. Operator, just checking that you're there and we're ready to go to questions.

Operator

Thank you, sir. Pardon me, I was on mute. We will now begin the question and answer session. The first question comes from Jacob Bout of CIBC. Please go ahead.

Speaker 3

Good morning.

Operator

Good morning, Jacob.

Speaker 4

Maybe just talk us through some of the competitive pressures that you're seeing currently. I know with supply chain improving, a number of your competitors have been talking about competitive or pricing pressures. Is this broad based? Or is this kind of more on a smaller horsepower equipment?

Speaker 1

Yes. I think we've said this before Jacob. In my 30 years, we've always worked in a competitive environment. And for sure the pandemic changed the dynamics around that competitive environment due to different performance in supply chain. I think we're in a more normal position now.

Speaker 1

I think broadly in terms particularly in terms of construction equipment sales, I think supply chains have recovered. So most companies would have equipment to sell. But I think we're we would consider that we're competitive. We're always looking at acceptable premiums for our products and services. And our early market share in construction equipment that I've seen through the course of the 1st part of this year would be encouraging.

Speaker 1

And what I'm hearing from the team those in the U. K. Last week, which is a very competitive marketplace, what I'm hearing is they feel well supported by Caterpillar. They feel like I asked our Head of Sales, have you got the tools you need to be competitive in the U. K.

Speaker 1

Market right now? And the answer is yes. And we see more support coming from areas like Cat Finance with several financing programs in place to help kind of push orders through that are maybe in the decision making process due to capital constraints with our customers. But I wouldn't say that we're finding a dramatic shift in the competitive environment. And our margin decrease in this quarter was very much driven by mix.

Speaker 4

And maybe just looking back at the Investor Day talking about this full cycle resilience and this focus on earnings stability. I know driving product support was a big part of the strategy. But you look over the past two quarters and margins in product support have lagged. As you look at that, is there anything you could have done differently to mitigate either some of these weather related issues or utilization issues and so on?

Speaker 1

Yes. I mean, you live and learn all the time, Jacob. And so for sure part of resilience is better planning working more closely with our customers. I do think as it relates to this particular Q1, there were some distinct operational issues with our customers. General utilization of equipment was down in the on a broad base across our segments in construction.

Speaker 1

We had that major project transition particularly in Western Canada, which I've spoke to a lot of people in the past. We've never seen such a swing in major product activity. And then we have some very specific mining plans and mine changes to mine plans within our customers. And so we're seeing perhaps we could have been close to that with our customers to understand a little bit more about that. I actually think the biggest thing we underestimated if I'm honest Jacob is just how strong Q1 2023 was.

Speaker 1

And I think we maybe could have managed that or communicated that a little better as we move through. But I feel confident as we move forward that product support growth rate will return to that kind of level. And we're getting closer to customers and increasing the number of unique customers we deal with to try and offset some of the lumpiness in our major customers.

Speaker 5

Helpful. Thank you.

Speaker 1

Thanks, Jacob.

Operator

The next question comes from Yuri Lynk of Canaccord Genuity. Please go ahead.

Speaker 6

Hey, good morning guys.

Speaker 2

Hi, good morning, Eric.

Speaker 6

Just looking at product support, those projects you mentioned rolled off in Canada, the U. K. Is a bit tough. So just wondering if you could put a little more meat on the bone in terms of where you're getting the comfort to call for improving product support growth rates throughout the year?

Speaker 1

Yes, sure. So a couple of areas. So we're seeing equipment mobilize. We've watched the equipment utilization as an improved in April. So kind of bounced back to more normal levels.

Speaker 1

We also see that through our rental fleet utilization. So we and in the U. K. Last week, I met with 3 customers and they all were consistent in saying it was a really terrible winter, but their activity levels just in the last 3 weeks have really started to improve. And so there's some customer sentiment out there and some activity levels around utilization hours and rental fleet utilization that gives us encouragement that the construction season is starting or be a little bit late.

Speaker 1

So that's 0.1 percent, so we just feel better. And I'm talking specifically about construction more so than Mining and Power Systems. The second area is execution capability. So to Jacob's question about what could you do differently, I do believe that our commitments in our Investor Day and some of the softness in Q1 has reinvigorated and made us double down revisit some of the basics in the plan things like customer coverage, making sure we've got the right propositions for our customers. So I think there's an execution quality that improves as we move through the course of the year.

Speaker 1

So we just get better at what we're doing and build on where we're at. And then I think more broadly as we look into the second half of the year, we still have the view that the macro improves, the pipeline capacity comes on in Canada which drives activity around the oil sands. And we're already seeing as Greg mentioned in his remarks mobilization of contractors around Chile as well support the large mining wins. So that would be a I think things are we're already seeing things improve coming out of the winter season. I think we're very, very focused on execution.

Speaker 1

And I think generally the macro starts to help us. And of course, we'll be lapping different comparisons in the second half of the year.

Speaker 6

Yes. For sure that makes sense. Maybe Kevin staying with you just trying to get your temperature here on the overall outlook. Last quarter you kind of characterized it as steady growth. You've removed that language from the MD and A.

Speaker 6

You've got these great awards in April. You seem to have better visibility on product support. So just overall, I mean, how are you feeling about top line growth in 2024 versus a few months ago when you last updated the market?

Speaker 1

No. As I just said, I would be happy I would be more confident than I was working through Q1. Our Investor Day targets remain. And so we're not moving off those. We believe that those moderated growth rates are still in play over that 2 year period.

Speaker 1

We said on the last call it's not linear. And for sure this Q1 was more transitionary than we thought it was going to be. But we still the optimism level has improved. Clearly, we're still seeing some restrained behavior and spending behavior. I think that improves as our customers get better line of sight to the utilization of their equipment.

Speaker 1

And of course, we're really excited about the commitment of capital from our major customers in all three regions around committing to large capital spend, which gives us that broader horizon of better activity level. So I would say in general, more optimistic than prior quarter. And our committed and stated goals on the Investor Day remain.

Speaker 6

Okay. Thanks for the color, Kevin. I'll turn it over.

Speaker 2

Thanks, Sherry.

Operator

The next question comes from Sherif Al Sabahi of Bank of America. Please go ahead.

Speaker 5

Hi, good morning.

Speaker 2

Good morning, Drew. I just wanted to get a bit more color. Looking at order patterns, you obviously have those big orders in April. Typically for the Q2, would we see orders ramp through the quarter? Or are they weighted towards April?

Speaker 2

Yes. So normally in the Q2, we'd have we're in selling season. So some of the construction live inventory on hand and sell through and we expect that to be pretty active this year. But otherwise, we know order intake on Mining and Power tends to be a little lumpier. Of course, we've had a number of wins right in April.

Speaker 2

But there are more out there that we continue to wait to hear on and continue to quote on. So, of course, we've highlighted $700,000,000 which is a very large amount for 1 month, but of course, we expect to close more deals in May and June. And as we highlighted, particularly in South America, kind of year on from the royalty review, copper prices in the mid-4s and we're seeing a lot of customers look at both refresh and expansion of fleet. And so nearly all mines have some form of tender going at the moment. So lots of activity and so we expect that to continue through the year and a bit lumpy, but certainly we've had some great wins in April, but we expect some more activity elevated particularly in Chile in May June.

Speaker 1

I'll just highlight another question, Sri. So our backlog in Canada is predominantly construction equipment now, which is encouraging. Order intake for construction equipment in the U. K. Was quarter quarter 1 versus quarter 1 was up considerably.

Speaker 1

And so we are seeing the construction industry starting to move. And so there's a couple of points of encouragement there. But we need to note that as our mining business mobilizes and we continue to grow Power Systems, those revenue streams are way more lumpy. And so they can be they can make dramatic changes within a quarter. And so just need to be conscious of that.

Speaker 2

Of course. And I realize there's a bit of a digestion with some of these larger project completions in construction. But looking ahead, do you see a project pipeline to fill the gaps as we head into 2025? Yes. You definitely see some more projects coming through with the Highway 1 expansion in British Columbia.

Speaker 2

But we do expect more private sector ramp up over the next couple of years versus some of the public works over the last couple of years. And so the activity that goes in and around the LNG upstream development as well as some oil capacity now in Alberta for that to grow, You'll see some effects around road clearing, well pad, construction, gas plant and gathering lines. So we expect to see more of that over the next couple of years, particularly if you start to see natural gas tick back up a bit more.

Speaker 1

Yes. I think Power Systems again gives us that's probably the most visible segment we have. And so we're seeing visibility well into next year and even beyond in Power Systems projects, particularly in the U. K, but also in Chile. And so that gives us some confidence that the revenues are robust in that segment.

Speaker 2

Thank you. And just looking specifically at the mining wins, are you seeing a share shift towards cap products take place with these orders coming in? Or is it more broad based strength across mining?

Speaker 1

No, definitely a market share shift. I think following a period of where our market share in Chile particularly was probably not where we wanted it to be in the previous cycle. We've talked about this previously around the electric drive truck and how that was essential to winning South America. I think you have a great electric drive truck now. We clearly know that with BHP Escondido last year, we went from 2 thirds to full cat site.

Speaker 1

We believe the Codelco win that we're announcing today, we won a high proportion of the available equipment there before the biggest opportunity in Chile as well. So I would say that the team in South America are doing an absolutely amazing job using the tools they have, the product they have, partnering with Caterpillar to make sure we have the appetite and the solutions to serve our customers. But without a shadow of a doubt, it's market share.

Speaker 2

Thank you. And just lastly, there's been some large M and A in the mining space that's been announced. Is that holding back capital spend at all? And historically has that typically held back CapEx in the space?

Speaker 1

I mean, of course, that there'll be some decisions that are considered when there's bigger M and A. But I don't think there's anything other than the Glencore tech that would impact us directly right now or the things are on the kind of are on the burner plate. So and I again, we've met with Glencore locally here in Canada. And the initial conversations suggest that they run a very decentralized model and that we're looking forward to working with them locally in Elk Valley for sure. So no, I don't specifically think that it's impacting us today.

Speaker 1

For sure, if some of this big M and A happens, there'll be a period of consolidation and review around fleets and performance and even individual assets. But what we're seeing is that even where assets change hands, they're typically being picked up and in some cases run more locally and we're enjoying some good success. Good example of that is just the coal business in Northern British Columbia where we've got some customers that are picking up and running with assets that run by larger miners in the past and not doing it very well.

Speaker 2

Thank you. I'll pass it on.

Speaker 1

Thanks, Shri.

Operator

The next question comes from Michael Zumac of Scotiabank. Please go ahead.

Speaker 2

Hey, good morning guys.

Speaker 3

Good morning, Michael.

Speaker 2

I was wondering if you could maybe isolate the impact from the completion of the major projects to product support in Canada? And also you talked about improved product support growth in the second half. Wondering how we should think about the Q2 bridge to that? Sure. Well, on the Canada side, obviously being 4% down, a portion of that's due to construction as well as some of the lower utilization hours.

Speaker 2

So I'd say that the decline part would be there, because on the mining side, as I highlighted, there's a couple of customers that were up quite significantly over a year. There's a couple that were reworking mine plants that were down significantly and therefore kind of flat. So from a construction perspective, I'd say the decline portion was pretty direct drive.

Speaker 1

And I would just add Michael that within the construction phase, we can very much point to the decline on increasing the number of unique customers we deal with to try and manage some of the lumpiness in our revenues. But we know a vast majority of the decline in Canada was less than 10 customers and we can name them and we can attribute them to those projects.

Speaker 4

Okay. Perfect. And then just in terms of

Speaker 2

the Q2 bridge, because look I'm looking at my model here and it's a pretty tough comp as well. So just thinking about that quarter versus maybe expectations in the second half?

Speaker 1

I think that we see the kind of product support run rate continuing Q2, a potential to improve slightly because of the activity levels in construction and some of the optimism around copper. But I think if we look at product support growth rates as I mentioned in my remarks, if you look back over 2 years to this point, we're 12% CAGR. And that's double broadly double our Investor Day targets. And so we think it's probably better we feel quite confident that when we get to the end of the year and run rate into next year, we'll be able to demonstrate that Investor Day target trajectory.

Speaker 4

Perfect. Very clear, Ken.

Speaker 2

And then just maybe moving to gross margins, look those were lower in Q1. And I think Greg you talked about lower used in rental. But from what I can tell, equipment and product score margins were firm year on year. So just wondering if you can maybe just clarify that for us. And then as it relates to passing price, retaining price cost spreads for the balance of the year, what are your thoughts?

Speaker 2

Yes. So on margin, it's proportion and mix with, as we said, lower margins in rental and used, which as we've said many times before, we don't expect the margins in the last 2 years. We would average those into the future. So those have come down to more kind of normalized levels. So that would be really the margin mix story within the quarter.

Speaker 2

And going forward, I think we are in more normalized rental and used margins, maybe a bit better in rental given some of the pickups that Kevin talked about as we get into the spring here. But on new and product support, we feel fine. I mean a large proportion of what's going through is mining equipment and data centers and those margins don't move as much. There wasn't a big windfall and there isn't a normalization going on. So we feel solid that new and product support are in the same zip code and rental and used are more normalized.

Speaker 2

Perfect. I'll pass the line. Thank you guys. Thank you, Michael.

Operator

The next question comes from Steve Hansen of Raymond James. Please go ahead.

Speaker 7

Yeah, guys. Thanks for the time. Greg, just following up on the rental market commentary, understanding margins have normalized here. Does that change any of the capital spending plans that you aligned at the Investor Day? I think 15 sites was talked about in terms of build out in Western Canada just by memory, but just any plans on the capital deployment there?

Speaker 2

Yes. Yes, certainly. I mean, when we look at the market some of the utilization factors are down across the industry. And we of course look at our fleet and see what our utilization levels are and want to manage those appropriately. So certainly we continue to have that as a priority area.

Speaker 2

Will continue to deploy capital at a reasonable rate probably down somewhat from a few months ago where we were thinking just to make sure utilization factors or profitability are in the zone that we want. So it's kind of more of a steady growth year as opposed to what we're thinking a few months ago might fit at higher level. But that's something we'll continue to monitor the market and evaluate.

Speaker 1

Yes. And we so we're I'm encouraged that the original cost on rent is back to where it was last year after a slower start and kind of clunky winter. That's pretty encouraging given the lack of major projects that we spoke to previously. But we did make some investments last year. So and we the lack of major projects has adjusted our sentiment for this rental season.

Speaker 1

So we'll just make the adjustments to make sure we're well positioned to meet our growth targets, but we're not out committed.

Speaker 7

That's helpful. Thanks. And just to follow on the U. K. Margin side, again down year over year, but a nice sequential uptick.

Speaker 7

Is that the new range that we should be thinking about here? I'm trying to understand the sustainability of that pattern on this latest print.

Speaker 2

Yes. It's a bit of a tough market out there as we said in the low GDP environment. It's a bit of a grind in construction, but power has got quite a bit of momentum. So good to see the sequential improvement as Kevin said being there recently. There's some improved sentiment, but still a bit of a slog through the year.

Speaker 2

So I'd look for some sequential improvement, but not huge moves.

Speaker 1

I think that I'd be surprised if the second half of the year was way more constructive than the first half. And obviously, we started to see the real slowdown back end of the summer last year. So a lot of optimism about the U. K. Had a great week there last week with employees and customers.

Speaker 1

And of course they're running into an election. Had a great few hours on the HS2 project. It might be absolutely amazing to see that come to fruition after so many years. And that work is well underway. So and that the actual we won't deliver product any more product to that, but that continues to work.

Speaker 1

So very encouraging week last week in the U. K.

Speaker 2

That's great. Appreciate the call. Turn it over. Thanks, Steve.

Operator

The next question comes from Devin Dodge of BMO Capital Markets. Please go ahead.

Speaker 3

Yes. Thanks. Good morning, guys.

Speaker 1

Hey, Devin.

Speaker 3

Technosphere Canada, look, I think it was a bit higher year over year. Product support was a bit lower. Just wondering if you have a sense for the drag this had on margins and earnings in the quarter? Or were you able to pull some levers to kind of neutralize that impact?

Speaker 1

Yes. So I mean, definitely had a drag in the quarter. Product support is a huge value creator for us. As I said in my remarks, Devin, we were really pleased that the additional new equipment and particularly used in Canada, which was up considerably helped mitigate that. We see that as we always felt the user play an important role in building resilience into the company and that has played through in this quarter, which is very encouraging.

Speaker 1

But for sure the product support trajectory has been a drag and we'll probably see that more normalizing. As Greg mentioned previously, we don't expect to use to continue at that trajectory and we expect product support to sequentially improve. So but nice to be talking about offsets and levers in Canada being able to deliver that earnings performance.

Speaker 3

Okay. Makes sense. And then the outlook mentioned a broad based increase in quoting tendering and award activity in Chile for mining equipment. Is there any way to scale that or provide a framework for how that sales funnel looks now versus whether it's 12, 24 months ago?

Speaker 2

Yes. I would just say it's matured. As we highlighted in Investor Day, I mean most fleets are quite aged in Chile. So people have been evaluating decisions for quite some time. So it's gone more from the budgetary quote to competitive quotes to people making decisions and awards.

Speaker 2

I mean, even the words that we've recently got, there were some delays in getting those and decision making that still takes time. We're just seeing it more mature and more serious and nearly every mine is looking at some form of refresh or expansion to deal whether that's dealing with ore grades or some of the brownfields announced. So it's pretty broad based, but it's matured also.

Speaker 1

Yes. I would say, I think we'll be in a better position to answer that question on the next call. Devin, I think, obviously, even before the orders that we announced that came in after the quarter ended order intake for mining in South America was up 48%. And as these orders percolate through the system and miners start to calibrate that to supply chain and lead times. I think these orders will probably have miners think more about thinking ahead and where they're placing their capital and their capital program.

Speaker 1

And so I would imagine that we'll see more of those tenders and a clearer pipeline looking forward over the next few weeks here because there definitely has been a mobilization shift in the last quarter.

Speaker 3

Okay. Good color. Thanks for that. I'll turn it over.

Operator

Thanks, Kevin. The next question comes from Sabahat Khan of RBC Capital Markets. Please go ahead.

Speaker 5

Great. Thanks and good morning. I guess maybe just a bigger picture question on product support. Obviously, there was a bit of a push into product support during the lower equipment availability that threw off sort of the natural cyclicality of that business. But I guess presumably the product support mix maybe improved here after a bit of uptick in equipment sales in the first half of this year.

Speaker 5

Maybe can you share some perspective on how you view the product support trajectory over the next 6, 12 months? And where you think we are in that sort of longer term trajectory of product support based on the macro? Thanks.

Speaker 1

Yes. Sure, Samir. So I think I mentioned this previously. We expect the trajectory to remain at the lower end of or just off our Investor Day targets in Canada specifically. And order intake remains strong on new equipment and including power systems.

Speaker 1

And we have I don't want to walk past the fact that we are announcing a strategically important win in the oil sands on this call as well. So I think that product support mix might move 300 or 400 basis points up and down. But we expect all of the lines of business to be growing as we look forward. So we're very confident that if you that if we look back as we turn the year, the run rate into next year that we'll be on those Investor Day targets. And I would suggest that the activity we've seen in the last 3, 4 weeks here, general activity, particularly in Canada would support a more improved outlook, specifically in Canada, but also to a certain degree in the U.

Speaker 1

K. And Chile is doing fine in South America.

Speaker 5

Great. And then there was a bit of discussion earlier sort of around pricing and inflation. The expectations where the market had was pricing could generally be lower this year. But I guess given where inflation is at, can you just talk us through how your discussions with customers are going? Are you sort of managing to a certain margin?

Speaker 5

Maybe just how you're thinking about that given where demand seems to be in

Speaker 1

a good place. So how are you

Speaker 5

sort of managing that inflation and cost situation?

Speaker 1

Yes. So I think we've said previously that we see pricing returning to a more normalized level now. And pricing and margin are different things. And we work with our partner really closely to make sure we have

Speaker 2

the right

Speaker 1

value proposition to win share. As I said previously, I'd be very encouraged by the public or the publicly accredited market share data that we have around us in our businesses. So we'd be happy with the start that we've had. Expect a competitive reaction. Expect a more normalized competitive environment there.

Speaker 1

But also know that we have got the strongest partner in Caterpillar. We're very committed to growing our business. And as I said previously, I've traveled for a day with the Head of Sales in the U. K. Last week and I asked in the most competitive environment we have and asked him if he's got the tools to be successful this year.

Speaker 1

And the answer was yes. And to a certain degree, I was thinking about if there's any incremental we could incremental business we could win this year versus having a negative impact to the competitive environment. So we love the competitive environment. It's what we've done for years. We can be very creative.

Speaker 1

Cat Finance are an amazing partner in that regard. And so this why I describe when I walk around with sales people right now this is normal, right? This is normal. What we had experienced in the past was not normal. This is normal and we have to roll our sleeves up and get out there, participate in as much business as we can and be as creative as we can.

Speaker 1

And I think we have the sales team to do that.

Speaker 5

Great. Thanks very much for the color.

Operator

The next question comes from Cherilyn Radbourne of T. B. Cowen. Please go ahead.

Speaker 8

Thanks very much and good morning. Many of my questions have been asked. But in terms of the strength in used equipment sales that you saw in the quarter, is most of that equipment staying in territory? And just strategically, would you give up something on price or margin on a used sale to ensure that it does stay in territory?

Speaker 1

Yes and yes. So, yes, our best data suggests that it's an eightytwenty scenario, Cherilyn. So, 80 percent is staying within the territory. And for sure as we were doing we have this term in the company now, which is kind of product support by us. So we have a very strong bias towards equipment that would generate which generates population, which builds population, which generates product support activities for us.

Speaker 1

And so we would have a very creative view on that type of equipment and where the second life is and how we ensure that the second life is within our in a territory that provides us part of support opportunities. I think if I told you that walking around Edmonton site 3 weeks ago seeing machines with U. K. Customers' logos taken off and you could still see the U. K.

Speaker 1

Logo customers was an extremely important moment for me. I've been asking the teams obviously working in the U. K. And Canada for many years to align those our approach in those two markets. We're very lucky to participate in a very active used equipment market in the U.

Speaker 1

K. And so our first priority is is to make sure that that stays in the territory. If that territory is in a different continent, but it's in a finning territory. We're working hard to make that happen in the first instance. Where we're not then we would look to participate actively in that deal and partner with our other cat dealers in North America to make sure that that opportunity stays within the family.

Speaker 8

Okay. That's good color. And then in terms of the inventory level, obviously, pretty elevated. So I assume that bringing that down is a priority for the rest of the year. Is there any way you can kind of give us some guidepost on what you're looking for in terms of free cash flow for the year?

Speaker 2

Yes. Absolutely a big priority for us. Obviously, we've got some more equipment came in for the selling season. We do think the backlog build that we're talking about today moves through the system much faster on a cash to cash cycle than the last backlog build over the last couple of years. So we do think we'll convert that at a faster pace.

Speaker 2

As we highlighted a lot of these orders will start delivering pretty early in Q3. We have moderated some of our orders given the improved availability on certain product lines And we continue to work on all the items we listed at our Investor Day around warehouse automation and velocity. So and continue to work on some of those low ROIC activities. So we think all of those contribute. And so we highlighted $450,000,000 of capital unlock and that continues to be the plan.

Speaker 2

And we think you'll see more and more of those catalysts here in the second half of the year.

Speaker 8

That's my cue. Thank you for the time.

Speaker 2

Thanks,

Operator

The next question comes from Maxim Sytchev of National Bank Financial. Please go ahead. Hi. Good morning, gentlemen.

Speaker 1

Hi, Max.

Operator

I just had a couple of very quick ones. In terms of when we look at the oil sands, sort of customer behavior because on the one hand obviously as you mentioned WTI good spot and takeaway capacity is improving. Is there anything structural from the client behavior, which is sort of different from how they behave sort of previously? Or it's really just sort of a tactical intermittent dynamic that was sold over the last couple of quarters? Thanks.

Speaker 1

Yes. No, I'd say the latter Max. I think there's some as you can probably read there are some specific plans in place. I think the oil sands is moving to a transitionary phase as well. There's a lot of talk of expansion and mine development.

Speaker 1

There's pivots between mines slowing down and mines ramping up. And so I would suggest that it's not structural. And we remain optimistic about the long term fundamentals particularly given WTI and the incremental pipeline capacity. So it really is more a function of the mine plans today and the specifics today and everything points to a more constructive and consistent outlook in the oil sands.

Operator

Okay. Okay. That was great. Thank you. And then lastly just going back on used obviously, very strong performance.

Operator

And I'm just wondering in terms of what have you changed when it comes to go market strategy, processes, people maybe some of that stuff if you can provide any color there? Thanks.

Speaker 1

All of those things Max. So it starts with people and talent. So we have dedicated leadership that wake up every morning and think about used and they have a team that wake up every morning think about used and act on used and work with all of the regions to participate more effectively in that market. It's process as you mentioned rest of the dealership to work to improve and rest of the dealership to work to improve them to work on. So they come from a different DNA in a different space.

Speaker 1

It's a close relative, but it's a different DNA and we're empowering them and giving them space to do what they need to do to participate in a very active used equipment market. We see that moderating because I think there's a sense that coming out of the pandemic and supply chain improving there's maybe a little bit of overshoot in terms of customers buying equipment. And we see them that kind of calibration happening right now and we're just really happy to be participating in that more than we have done in the past. But used equipment looks and feels very different than it did 12, 18 months ago at Finan. And as I mentioned in my remarks, we've even launched an independent used equipment platform or marketplace called fused equipment that's helping us to participate in the non cat side of the business as well.

Speaker 1

So that's important well to have those capabilities. So looks and feels very different. Been really excited by the trajectory over the last couple of quarters, building this for the previous 6 quarters before that. And hopefully, we've got really strong hopes that we can build a sustainable business there that can contribute more to Finip.

Operator

Very helpful. Thank you so much.

Speaker 1

Thanks, Max.

Operator

This concludes the question and answer session. I would like to turn the conference back over to Greg Palmscher for any closing remarks.

Speaker 2

Great. Thank you. That concludes our call. Thanks for everyone for participating and

Speaker 1

I hope you have a safe day.

Operator

This brings me to an end today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.

Earnings Conference Call
Finning International Q1 2024
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