Ritchie Bros. Auctioneers had one of the most compelling growth stories in recent years. The seller of construction equipment was believed able to grow earnings in good times or bad. So investors paid a dear price for the company’s shares, rewarding it with a premium valuation.
Then the Great Recession came, and, well, Ritchie Bros.’ earnings and sales retreated, pricking the balloon of its good-times-in-bad-times story. The company continued to miss expectations well into 2011. So investors now still have to pay a high price for the shares, albeit not quite the nosebleed levels of before.
This has left the analyst community divided. Some see the stock’s current price, at 35 times trailing earnings and a forward P/E in the low 20s, as a good time to get into a great company, compared with its historical valuations. Others – the ones whose arguments I find most compelling – appreciate what Ritchie Bros. has done and still may do, but can’t see outsized gains for those who buy at today’s prices.
Ritchie Bros., founded more than a half-century ago in British Columbia, is the world’s largest auctioneer of construction and heavy equipment, conducting sales in more than 25 countries. “Ritchie arguably is to the industrial auction business what Starbucks is to coffee,” said analyst Ben Cherniavsky of Raymond James Ltd., who has an “outperform” rating and a $27 target price. He notes the company has said in the past that its gross auction sales exceed those of its 40 largest auction competitors combined.
The key, said Mr. Cherniavsky, is that Ritchie Bros. has a “long-standing reputation for holding fair, clean, and highly efficient unreserved auctions … Sellers send their equipment to a Ritchie Bros. auction because they know from the past that enough buyers will be there to support a strong price; they also know that an unreserved auction means everything always sells at a Ritchie Bros. event.”
Despite that leading position, however, Ritchie Bros. has plenty of room to grow, say its advocates. It’s widely believed that about $100-billion (U.S.) of used industrial equipment changes hands each year, with 10 per cent of that sold at auction. Ritchie Bros., with gross auction proceeds of $3.7-billion in 2011, has just 3 per cent to 4 per cent of the used-equipment market.
That potential for expansion, combined with the company’s dreamy profit margins (gross margins of 85 per cent or more, net income margins topping 25 per cent), contributed to a valuation that was often twice any other in the construction-equipment industry. (Its valuation has also topped those of stock-exchange operators, and tech companies such as Apple Inc. and Google Inc., noted TD Securities Inc. analyst Cherilyn Radbourne when she initiated coverage on Ritchie Bros. in November, 2010. She has a “hold” on the stock and a $21 target price, right about current levels.)
In response to its recent challenges, such as missing its 2010 gross-sales guidance and reporting declines in earnings, the company is offering new services, such as fuller Internet descriptions and special warranties, and is instituting new buyers’ fees. Those changes are expected to help drive sales and profits as the worldwide construction industry rebounds.
The stock, however, is priced as if the turnaround has already occurred.
Its multiple of enterprise value (market capitalization plus debt) to EBITDA (earnings before interest, taxes, depreciation and amortization) is nearly 18, as high as its average levels in 2007 and 2008. Its forward P/E of roughly 22 is only a couple of points lower than its pre-recession levels.
“We have always considered Ritchie Bros.’ valuation to be more akin to a tech stock rather than a cyclical, given the blue-sky potential, and that as growth slowed, the multiple would compress,” said BMO Nesbitt Burns analyst Bert Powell, who has a “market perform” rating and a $24 target price, based on 22 times his 2013 earnings estimate.
That resetting of expectations means that Ritchie Bros.’ current multiple should be about as good as it gets, unless investors forget the recent past and return to their “blue-sky” views. It also means the best buys are to be found at Ritchie Bros.’ auctions – not in the shares.