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Finning builds a strong growth case for investors

Some analysts are forecasting the share price of Finning, international dealer of Caterpillar equipment, will reach new records in the coming months.

Yves Logghe/AP

Finning International Inc. is known for selling Caterpillar-brand heavy construction equipment, but it's the repair and maintenance of those bulldozers and dump trucks that investors are hoping will dig up bigger profits.

The Vancouver-based company sells, rents and repairs Caterpillar equipment to customers in the resources and other industrial sectors in Canada, South America, the United Kingdom and Ireland.

Finning shares are trading near all-time highs, which has some investors nervous, particularly as the mining industry remains in the doldrums.

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But some analysts are forecasting Finning stock to reach new records in the coming months as the company expands its higher-margin product support business and relies less on the mining sector for growth.

"I wouldn't be afraid of the recent increase in the stock," says M Partners analyst Tom Varesh. "The higher-margin product support revenue that they are going to generate will lead to earnings growth, even if revenue growth is flat."

Finning plans to increase its product-support sales to about half of its total revenue in 2014, up from about 47 per cent of its record $6.8-billion in revenue recorded in 2013. Product-support revenue rose 12 per cent last year as miners looked to repair aging equipment instead of buying new.

That's still profitable for Finning, whose margin on repairs and services is estimated to be about 40 per cent, compared with about 10 per cent for new-equipment sales, according to analysts.

The company's latest mantra is to drive higher returns from invested capital and shift its focus away from mining, which today represents about 34 per cent of sales, down from 43 per cent in 2008.

Mr. Varesh is a believer in the strategy and recently increased his 12-month target price to $37 from $32.

He is one of 10 analysts with a "buy" on the stock, while two recommend it as a "hold," according to S&P Capital IQ. The average price target among analysts is $33.13.

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Finning shares reached a 52-week high of $30.31 on the Toronto Stock Exchange in late February, closing in on its record high of just below $34 in the fall of 2007, just before the global recession hit.

Analysts also see the stock as cheaper than its closest competitors. Finning is trading at 14 times earnings, compared with 16 times for Toromont Industries Ltd. and nearly 17 times for New York-listed Caterpillar Inc.

"It's in some nice growth territory," says Cantor Fitzgerald analyst Peter Prattas, citing in particular expansion of the oil and gas sectors in Western Canada.

About half of Finning's revenue comes from Canada, 37 per cent from South America and 13 per cent from the U.K. and Ireland.

Analysts also expect the company to increase its dividend, now yielding about 2 per cent, as it continues to aggressively pay down debt and increase cash flow.

"You don't buy it for the dividend today, but you buy it for the prospect of an increasing dividend," Mr. Prattas says.

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Still, some analysts are cautious about Finning given the stock's recent run-up. The shares have risen by almost 40 per cent over the past six months.

"We have been surprised by how much Finning's multiple has expanded recently," TD Securities analyst Cherilyn Radbourne said in a recent note. She has a "hold" on Finning and a $29 price target.

"We believed that the new strategy would be more of a 'show me' story, particularly given the uncertain macro backdrop. We would prefer to upgrade the stock on a pullback or an improvement in commodity market fundamentals."

Desjardins Securities analyst Benoît Poirier also has a "hold" on Finning, citing a "cautious outlook." However, he recently increased his price target to $31 from $29.

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