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Morningstar | We Maintain Our No-Moat Rating for Terex as Industry Dynamics Suggest It Has Limited Leverage

After taking a fresh look at Terex, we are increasing our fair value estimate to $44 from $42.50 and maintaining our no-moat rating. The change is due to the time value of money and an increase of our stage II EBI growth assumption to 3% from 2%. Despite management’s enthusiasm for reaching a 10% operating margin by 2020, we anticipate a figure of approximately 8%, with a midcycle operating margin of 9% in 2022. We observe that Terex' transformation into a leaner organization is an ongoing effort that will ultimately be impacted by larger economic conditions and a highly competitive landscape.

Given long-established trends in the larger heavy equipment industry, we expect greater margins and moat formation in two of Terex’s segments—aerial work platforms and cranes. These products require a high degree of quality, as they can significantly affect worker safety. At the same time, maintaining uptime of these products is crucial in nonresidential construction projects, where delays can lead to significant cost overruns. Hence, the Terex brands, including Demag and Genie, should engender brand loyalty that creates intangible value. Yet Terex faces two main problems. First, the business for lifts and cranes is dominated by rental companies that tend to offer products from Terex’s competitors. The industry dynamic is such that the rental companies have significant bargaining power and own the customer relationship.

Second, Terex has very strong competitors in these businesses—Liebherr in cranes and Oshkosh’s JLG in aerial work platforms. In fast-growing China, the three major heavy equipment manufacturers, Sany, Zoomlion, and XCMG, make cranes. Moreover, there are numerous domestically produced aerial lift manufacturers. Moreover, there are numerous domestically produced aerial lift manufacturers. The presence of such competitors hinders Terex’s expansion into the fast-growing Chinese market.

We note that safety standards are already so high in the U.S. and Europe that the market requires all manufacturers in these regions to provide products with exceptional quality standards. This leaves manufacturers to compete on price and productivity-enhancing features. In the long run, this could lead to escalation in Terex’s research and development costs, which are now under 2% of revenue, compared with 4% to 5% at other major heavy equipment manufacturers.

Management’s ongoing efforts to streamline operations are showing some initial signs of progress. The sale of Terex’s material handling and port solutions segment along with the disposition of its compact construction business enabled Terex to focus on a core set of products where it can be competitive. We view this as a positive trend with clear benefits. Yet with so many moving pieces—business transformation, cyclicality, and elevated competition—forecasting Terex’s future is complicated and leads to a high level of uncertainty.