Ritchie Bros. Auctioneers, Inc. (NYSE:RBA) is an industrial auctioneer specializing in selling heavy equipment in auctions on-site and online. RBA provides a variety of convenient services to make buying and selling equipment easier. The operation also includes in-house financing, shipping, refurbishing, and insurance. Those services enable bidders and buyers around the world effortlessly exchange equipment. RBA's business segments include construction, transportation, agricultural, material handling, mining, forestry, petroleum, marine and other industries. This report will cover the following objectives:
- Evaluate the potential implication of the acquisition of IronPlanet on RBA's competitive advantage;
- Examine the potential impact of the recent presidential election on RBA;
- Review the past and future industry specific trends and their impact on RBA; and
- Analyze RBA's financial performance in the third quarter, and its current valuation from a relative and absolute model perspective.
Horizontal Acquisition of IronPlanet For $758.5 Million in Cash
This acquisition provides RBA the opportunity to elevate the capabilities and scalability of the business in the form of revenue and cost synergies, and network effect. RBA's executive management expects annual cost synergies of $20 million by 2018, and tax synergies of $100 million once the transaction is closed. IronPlanet is a global brand with unique technology that provides online buyers and bidders a world class inspection system, "IronClad," before they finalize the transactions. This unique B2B technology gives the company an opportunity to earn commission revenues from the inspection process, and from the actual sale without physically moving any equipment. The acquisition of IronPlanet gives RBA the opportunity to benefit from extending its reach to customers outside their current geographic and demographic range. For example, RBA will be able to extend its reach to new geographic areas, such as Africa where RBA doesn't have physical equipment yards.
The primary rationale for the acquisition of IronPlanet is the fact that 50% of RBA's revenue in the last year came from online auctions and services. IronPlanet is the most dominant player in the online heavy equipment auction and inspection marketplace. The integration of IronPlanet's successful online platform, and creating a multi-channel selling point in a one-stop shop can turn RBA to an attractive value stock with significant growth prospects. RBA will have the opportunity to take advantage of the shifting technological forces in the industry to increase its customer switching cost, which correspond in a better competitive advantage and wider economic moat. Another benefit of the online marketplace is that you don't need to hold inventory on hand, which is the riskier part of the business since it's associated with high upfront costs.
Based on the following assumptions (2016 Q3 earning call slide):
- RBA's current market value is $3,990 million (as of 11/17/16);
- Projected PV of synergies $120 million;
- Gross market value of IronPlanet is $956 million (earning call slide); and
- The acquisition will be in cash only for $758.5 million, and the number of shares will remain at 108 million.
The expected price post-acquisition will be $39.88 per share ($3,990 + $956 + $120 - $758.5 = $4,307.5 million post-acquisition market value, divided by 108 million shares equals $39.88 per share).
It's important to mention that four years ago, RBA's previous executive management tried to develop an online platform by acquiring EquipmentOne, but was unsuccessful in efficiently integrating the company into their eco-system. Recently, it had to record an impairment charge against the asset, even though the segment reported its first positive quarter in the context earnings. According to the CEO, Ravichandara K. Sailgram, it took him over a year to make people believe in his strategy, and only now finally we start seeing some positive results from the EquipmentOne segment. As he emphasized in the earning call, "the first two years were a complete organ rejection, but after I [Sailgram] joined the team it took me a full year to make people believe in the multi-channel strategy." It took time for management to understand that the online sales process is completely different, and this learning curve may help them to integrate and utilize the acquisition of IronPlanet more effectively into their eco-system. EquipmentOne is analogous to the daily marketplace of Iron Planet. According to the earning call, RBA will be able to keep all the executive team from IronPlanet and utilize their 15 years of experience to integrate the two operations together. The company has identified that sales integration is pivotal for the succession of this acquisition.
The acquisition will also provide RBA the ability to have weekly unreserved auctions on a global scale, which can put positive pressure on volumes that will translate to expanded profitability margins and revenues. In regard to market share, RBA is already a leader in the industrial auction market, and if the transaction gets approved by the Department of Justice, RBA will be able to expand its market share and gain significant competitive advantage in this niche market. The deal is expected to close by the first or second quarter of 2017 (IronPlanet is one of the biggest online auctioneers in the heavy equipment segment).
The Election of Donald Trump for President and The Risk of Voiding Existing Trade Agreements
It is too difficult to say what the impact of the recent election of Donald Trump will be on NAFTA and other international trade agreements. Since RBA is a Canadian company, and the majority of its revenues is earned in the United States and Canada (approximately 85%), it is important to consider the risk of unfavorable future trade policies as a threat that can negatively impact RBA's operation. On the other hand, it is important to see some positives in the promises of Donald Trump to spend close to $1 trillion on infrastructure over his presidency. If this comes true, we might see an increasing demand for construction equipment, which is a segment that was already performing pretty well in the United States YOY, according to RBA's earning call. The Canadian prime minister Trudeau made similar promises, and his economic strategy will include increased spending on infrastructure instead of moving toward negative interest rates. Based on the statements made by both leaders regarding infrastructure spending, we can anticipate that RBA's top and bottom line will significantly benefit if they will fulfill their promises.
The Transportation, Agriculture, and Oil Industry
The company faces some difficulties in the transportation equipment industry. The freight business has declined due to oversupply, and declining demand (mainly driven by oil). RBA's management identified the trend and decided to take a very cautious approach by reducing the amount of inventory contracts they underwrite. Holding inventory is considered to be the riskier part of RBA's business model due to high upfront costs and commitments to a certain amount of inventory that might not meet demand. Instead, management is utilizing their EquipmentOne platform, which provides lower profit margins, but enables the company to facilitate smarter and safer operation.
In the agriculture sector, the Canadian market has a bright spot, but recent weather and harvest trends may impact buyers' behavior negatively in the future. According to the earning call, some of the issues that the Canadian Ag sector is facing are increased replacement cost of new equipment due to unfavorable currency fluctuations. This trend can create an opportunity for RBA to increase the number of auction participants that look for a cheaper used equipment on one of its platforms. The acquisition of Kramer Auctions, a Canadian privately owned company, will help RBA overcome some of the potential challenges and capitalize on the positive sentiment in the Canadian Ag market. Kramer Auctions is a leading Canadian agricultural auction company with a strong presence as a market leader in central Canada. In the United States, on the other hand, there is an excess supply of agricultural machinery, as well as weakening demand due to low commodity prices. Those trends in the United States put negative pressure on agricultural equipment prices and volumes.
Over the past two years, the oil industry suffered from a serious decline in oil prices and demand, but there is hope that President-elect Donald Trump will promote pro-oil policies that can help stabilize the industry. Stabilizing the oil industry can have significant benefits for RBA. First, it can help re-establish demand and prices for oil and gas exploration equipment. Second, it can increase demand for construction equipment due to the infrastructure work needed to build certain pipelines. Third, it can help stabilize supply and demand forces in the freight industry.
Financial Performance Analysis for Q3 (10-Q)
Gross auction proceeds for the quarter were $999 million, which is 12% higher from the same period last year. SG&A for the period came at $69 million, which is 19% higher from the same period last year. The increase in SG&A doesn't correspond to the goals RBA's management laid out in the second-quarter earnings call regarding more effective cost control policies that will reduce SG&A expenses. In the earnings call, the CEO claimed that the increase was due to some bonuses that were given in 2015, and in his opinion, the cost control policies that they are implanting will start paying off by the first quarter of 2017. From a GAAP perspective, the company had few one-time expenses. Those expenses included $4.7 million acquisition related cost and $28.2 million impairment charge against EquipmentOne.
The impairment charge against EquipmentOne is puzzling since it was the first quarter that the segment provided positive profit numbers, as well as an increase of 39% in volume and 5% increase in revenues for the segment. According to the CEO, this was an accounting decision that had to be made based on the previous assumptions, and has no impact on their [executive management] view for the future scalability potential of EquipmentOne by expanding to the European market.
To provide a better picture of the performance in Q3, I excluded one-time expenses of $4.7 and $28.2 million from the reported EPS. On an adjusted Non-GAAP basis, EPS was $0.20, which is a 5% increase from the same period last year. In my opinion, the acquisition of IronPlanet will help increase the EPS growth rate to 7% in the long run based on the potential synergies, scalability, and network effect that it will provide.
On a GAAP basis, operating cash flow increased by more than a 100% to $126 million, which is not in line with the decrease in operating income based on comparable periods. The impairment charge in the current quarter may contribute to inflated earnings in the fourth quarter of 2016 or even in the next fiscal year on a GAAP basis. Since it's a non-cash expense, investors should take it into account when evaluating future solvency and profitability ratios.
Gross profit margins expanded to 88.55%, which is consistent with the average gross profit margins when comparing the last ten quarters. I expect margins to expand in the long run if the acquisition of IronPlanet is approved due to the increase in commission base revenue stream without increasing inventory levels. Operating income margins on a comparable basis expanded to 27.3% in comparison to the same period last year. Those margins are still below the average operating margins that RBA had in the past ten quarters, but if the cost control policies appear to be effective, the company can restore or even surpass its historical operating income margins. The company also acquired the Ritchie Bros. Financial Services (RBFS) unit in an equity-based transaction, and RBFS contributed $0.01 to EPS this quarter. From my perspective, this is more of logistical consideration. Since RBFS operated as an SPV, and its financials had to be consolidated with RBA, the parent company.
Regarding volumes, the number of consignors that sold equipment through the various RBA sale channels increased by 18%. The number of registered bidders increased 14%, and the number of buyers increased by 16%. Overall auction volume increased by 6% in comparison to the same period last year. The increased volume mitigates the impact of lower pricing power in some of the other segments.
From a relative valuation perspective, the company is on track to earn approximately $560 million in revenue for the year, which is a 10% growth on an annual basis. My expectations are that annual EPS excluding one-time items for the year will be at $1.33 (5% growth rate from $1.27 as of 12/31/15). Based on the EPS assumption and the current price per share of $36.99, the leading P/E ratio is currently at 27.8X. The current leading P/E is higher than my justified leading P/E ratio of 27X, which is based on the following assumption:
- Required return of 9%;
- Earning growth of 7% (the earning growth projection is based on the assumption that the IronPlanet acquisition will be approved by the Justice Department); and
- Dividend payout ratio of 53% ($0.68 dividend per share/$1.27 2015 year end EPS).
This is also above RBA's five-year average leading P/E that is 27.71X.
For my absolute valuation, I decided to use the two-stage DDM (Dividend Discount Model). This model is appropriate since RBA is a mature company with a stable payout policy, and RBA's management continuously emphasizing, including in the last earnings call, that growing dividends in line with earnings is their number one priority. Based on the following assumptions:
- Current dividend per share of $0.68;
- Dividend per share will grow at 7% per year (same as the earnings growth assumption) for next four years; and
- A required return of 9% (same assumptions for the terminal value at the end of year four).
The FVPS is $36.38, which is below the current market price per share of $36.99 (as of 11/17/16).
As we can see based on the two different valuation methods, the stock is currently slightly overvalued, and this might not be the optimal entry point. In the long run, RBA's growth prospects seem to be pretty bright assuming the acquisition will be approved. It has a solid track record of paying dividends, and it appears that management invests its resources in the right places by acquiring new growth opportunities. The potential risks and benefits that come with the recent election of Donald Trump should encourage management to prepare for any possible outcome. RBA is in an excellent position to capitalize on some potential opportunities, such as the increase in spending on infrastructure, and should mitigate the potential risks associated with Trump's statements regarding NAFTA and other trade agreements.
Disclosure: I am/we are long RBA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.