Finning International Inc. $54 – Toronto symbol FTT

FINNING INTERNATIONAL INC. $54 (Toronto symbol FTT; Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 89.5 million; Market cap: $4.8 billion; SI Rating: Above average) is one of the world’s largest dealers of heavy equipment made by Caterpillar Inc., such as tractors, bulldozers, pavers and trucks. Major customers include the mining, forest products and construction industries. Revenue grew at a compound annual rate of 11.8%, from $3.2 billion in 2002 to $5.0 billion in 2006. Most of that growth is due to higher commodity prices, which have spurred strong demand for heavy equipment from mining and oil exploration firms. Profits from continuing operations were $1.68 a share (total $132.3 million) in 2002 and $1.68 a share ($132.0 million) in 2003, but rose to $2.27 a share ($240.7 million) in 2006. (These per-share figures do not reflect a 2-for-1 stock split planned for May 2007.) Cash flow per share rose from $5.99 in 2002 to $6.55 in 2003. It fell to $6.37 in 2004, and to $5.95 in 2005, but grew to $6.71 in 2006. In Canada, Finning operates mainly in Western Canada, the Yukon, the Northwest Territories and Nunavut. The Canadian operations accounted for 52% of its 2006 revenue. Finning also operates in the UK (28% of revenue) and South America (20%). In the past few years, Finning has built up its overseas operations, mostly through acquisitions. While we usually have a skeptical view of companies that use acquisitions to fuel growth, acquiring established businesses in foreign countries is often easier than starting an operation from scratch. A big area of growth for Finning is South America. Political stability and economic freedom have helped spur new copper and gold mining developments in Chile and Argentina. Revenues at Finning’s South American businesses have doubled in the past five years, and its growing reputation among customers should help it win more contracts. In the UK, however, Finning has had trouble expanding profits. As part of a new restructuring plan, Finning recently sold its struggling UK forklift business. The company recorded a $32.7 million after-tax loss on the sale. Finning has now teamed up with Caterpillar to improve the performance of its remaining UK operations. Caterpillar will adjust some of the prices of its equipment to make this business more competitive. It will also redesign some of its products to better suit the needs of UK construction firms and other customers. Finning now aims to expand its service operations, which generate higher profits and steadier revenues for it than equipment sales. Services currently supply a third of its revenue. Along with services, Finning is also expanding its parts business. Many Caterpillar machines share the same engine parts and other components, which makes them easier to repair. To help capture a larger share of the parts market, Finning recently acquired an Edmonton company that recovers parts from used Caterpillar equipment. Finning is in a strong position to profit from several major projects in Canada. It’s already a key supplier to the Syncrude oil sands development, and the 2010 Winter Olympics in Vancouver. It should also win more contracts as work begins on several new pipeline projects over the next few years. Finning’s strong balance sheet should help it overcome any short-term setback. Long-term debt is 0.5 times equity, so it can comfortably afford to take on more debt to fund acquisitions or expansion. The stock trades at 18.1 times the $2.98 a share it will probably earn in 2007. It also trades below its revenue of $56.46 a share, and at 8.0 times its 2006 cash flow. Finning has a long history of steadily increasing dividends. The current rate of $0.64 yields 1.2%. Finning is a buy.