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Canada Research Published by Raymond James Ltd.

Please read domestic and foreign disclosure/risk information beginning on page 30 and Analyst Certification on page 31. Raymond James Ltd. | 2100 – 925 West Georgia Street | Vancouver BC Canada V6C 3L2

Industrial September 23, 2013

Industry Report - ChangesBen Cherniavsky | 604.659.8244 | [email protected] Theoni Pilarinos (Associate Analyst) | 604.659.8234 | [email protected] Greg Jackson (Associate) | 604.659.8262 | [email protected]

A Comparative Analysis of Finning and Toromont: "There is a Difference" “I can’t see a difference; can you see a difference?” TV-viewers of a certain generation will remember this catchy advertising tag-line. It aired during the 1980s on a series of commercials that asked consumers to compare ABC laundry detergent with the ‘leading brand.’ The key message was: “There is a difference! Price.” (http://www.youtube.com/watch?v=phEtATUR5Uk) We can draw a loose parallel between this nostalgic ad and our current thinking on Finning and Toromont. As large, publicly-traded Caterpillar dealers, these two businesses appear seemingly identical. Yet one—namely Toromont—trades at a significant premium to the other—Finning. This begs the same question that advertisers behind the soap plug rhetorically asked consumers: “why pay more?” Their answer was a matter of value. So is ours: We believe that while Toromont’s superior long-term financial returns justify the premium that its stock now commands, there is currently more relative value in Finning’s shares. This is reflected in our Outperform rating on Toromont and our Strong Buy rating and increased target on Finning. This report explores in detail the issue of relative value between Finning and Toromont. In particular, we evaluate the historical performance of both companies to explain why the valuation gap between them has transpired and what we believe Finning needs to do to close it. Where segmented reporting permits, we have focused our analysis primarily on a comparison of Toromont’s Equipment Group, Toromont CAT, and Finning’s Canadian operations, Finning (Canada). Not only does this help limit the report’s scope to a manageable level, but it also provides us with the best apples-to-apples comparison of two CAT dealers operating in similar markets. Moreover, we believe that Finning (Canada) warrants particular attention since it accounts for the bulk of company’s revenue (50%) and most of its recent challenges. Some of the key observations that we make in this report are as follows: Over the past one, five, and ten year periods, Toromont’s stock price has generated respective compound returns of 11%,

6%, and 11%, compared to -8%, -2% and 3% for Finning and 4%, 0% and 5% for the TSX Index. This outperformance is consistent with the equally superior financial returns that the company has registered in terms of free cash flow, profitability, and return on assets. Toromont has also generally maintained much lower debt levels than Finning over time.

There are numerous variables that account for the above discrepancies. In this report, we have organized them into three categories: structural; operational; and cultural. Structural variables are those, such as geography, that are inherent to the businesses of Finning (Canada) and Toromont CAT and which both companies have very little ability to control.

Operational variables mainly relate to the end markets that each dealer serves and the implications this has for its respective operations. Specifically, we examine the unique challenges and opportunities of being a dealer to the mining industry compared to more conventional markets such as general construction. We see this as a major differentiator between Finning (Canada), which has sold nearly half of its new machines to mining customers over the past five years, and Toromont, which has sold only 15% of its new machines to this market over the same time frame.

Without taking anything away from Toromont’s excellent track record (or excusing some of Finning’s past mishaps), we believe that Finning (Canada)’s operations have become much more complex, and thus prone to error, as its mining business has grown over the years. Improving the related processes, parts flow, and overall asset utilization therefore represents a big opportunity to raise the dealer’s financial performance, in our view. To support this point further, this report reviews Finning’s South American operations as a template for a very profitable mining CAT dealership.

The third differentiating variable that we explore in this report is Cultural. Both Finning and Toromont have long, rich legacies of operating the leading dealership in their respective regions, which has engrained certain practices and behavioural biases in their operations. This is not necessarily a matter of one culture being superior to another, but simply an acknowledgement that different cultures can effect different results.

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Company Ticker(s) Current Target Price Div. Total Suitability Rating Primary Secondary Price Old New Yield Return Old New Old NewMachinery Finning International FTT-TSX C$22.68 C$24.00 C$30.00 3% 35% G G SB1 SB1Toromont Industries TIH-TSX C$23.32 C$26.50 C$26.50 2% 16% G G OP2 OP2 Note: Target prices are for a 6-12 month period; TR - Total Return, G - Growth, AG - Aggressive Growth, HR - High Risk, VR - Venture Risk; SB1 - Strong Buy, OP2 - Outperform, MP3 - Market Perform, UP4 - Underperform, UR - Under Review, R - Restricted.

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Table of Contents

The Same….But Different .................................................................................................... 4

Financial Analysis of Finning vs. Toromont ......................................................................... 4

One Part Structural; One Part Operational; One Part Cultural ......................................... 11

The Structural Differences ............................................................................................ 11

The Operational Differences ......................................................................................... 13

The Cultural Differences ............................................................................................... 22

Investment Implications and Recommendation ............................................................... 25



The Same….But Different

For stock market analysts and portfolio managers, peer group analysis is a routine exercise that compares and contrasts the investment merits of similar companies operating in the same market. In most cases, these comparables (or “comps”) are also competitors, each of which is defined by different branding strategies, product lines, and price points, in addition to a myriad of other distinguishing variables. With Finning and Toromont, however, investors are presented with the rather unique opportunity to compare two virtually identical businesses that never effectively compete with each other. This is a function of the exclusive territory rights that Caterpillar bestows upon its equipment dealers.

Taking this peer group analysis one step further, we are particularly interested in comparing Toromont’s Equipment Group (which we will refer to as Toromont CAT) with the Finning (Canada) operations. Here we have two CAT dealers who sell and service the very same product lines at virtually identical prices in the same currency against common competitors (sometimes) to identical customers in separate, yet similarly vast and rugged regions of the same country. Both companies are beholden to the same single supplier; they both operate rental units (aka The CAT Rental Store) alongside the equipment and power systems dealership; they both belong to public growth companies that have, over time, helped Caterpillar consolidate its dealership network; and they both boast long, rich histories in their respective markets.

We recognize that investors cannot selectively carve the equity of Finning (Canada) out of Finning International; nor can they invest in Toromont’s CAT business exclusive of its CIMCO operations. Both companies, however, provide segmented reporting that, to a limited extent, allows us to compare the operating units directly, apples-to-apples. In so doing, a telling observation comes to light: these two seemingly identical businesses have generated quite different financial results, particularly over the last five years. While it may be more reasonable to expect performance to vary between a CAT dealership in the UK or Chile and one in Ontario (due to differences in culture, currency, competitive dynamics, climate, economics, etc.), investors have, in our experience, struggled to reconcile the gap between Finning’s Canadian operations and Toromont’s CAT dealership. Herein lies the key question (and potential opportunity) for investors: what explains this performance gap and will it close over time?

Financial Analysis of Finning vs. Toromont

Before attempting to answer this question in detail, it is important for us first to define the performance gap itself. There are many ways in which we can run the numbers between these two companies. But in order to manage the scope of the exercise, we have narrowed our analysis down to a few metrics that, in our opinion, should matter the most to investors in the dealership business. As noted, we are primarily interested in comparing Finning (Canada) (which accounts for ~50% of the company’s total revenues) with Toromont’s Equipment Group (~90% of total company revenues). However, it would be remiss of us to overlook Finning’s other regions completely, or to ignore the relative performance of these two companies at the consolidated level. With this in mind, we present our comparative analysis as follows:

Share Price Performance:

Ultimately, it is the share price that investors care most about; everything else is simply a means to this end. On this front, our analysis shows that Toromont shares over the long, medium, and short run have consistently outperformed Finning shares and the market at large, while Finning has underperformed the market during all these time frames (see Exhibit 1). Toromont’s compression business had a material impact on the

With Finning and Toromont, investors are presented with the rather unique opportunity to compare two virtually identical businesses

We are particularly interested in comparing Toromont’s Equipment Group with the Finning (Canada) operations

These two seemingly identical businesses have generated quite different financial results

Toromont shareholders have consistently outperformed Finning shareholders and the market



company’s performance, which means that our analysis is not a pure reflection of any differences between the two equipment dealerships. Likewise, its divestiture in 2011 further complicates the exercise of comparing total share price returns (our calculations assume that Toromont investors sold their Enerflex shares at the time of their distribution and reinvested them back in Toromont). Nevertheless, we think share price performance is the most appropriate and telling place to start our story about Toromont versus Finning.

Exhibit 1: Finning, Toromont and the TSX: Historical Share Price Performance

10.6%

5.6%

10.5%

3.8%

-0.1%

5.3%

-7.6%

-2.1%

3.3%

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

1 Yr 5 Yr 10 Yr

TIH S&P TSX FTT

Source: Capital IQ, Raymond James Ltd.

Valuation:

While there are many ways to value equipment stocks, we have primarily relied on P/E multiples to drive our target prices for both Finning and Toromont. Notably, over very long periods of time the valuation ranges for these two stocks have been almost identical (see Exhibit 2). From time-to-time, however, gaps emerge. For example, in 2007, at the pre-crisis peak, Finning’s stock was commanding a premium of two to three points over Toromont. More recently, that situation has been reversed with Toromont now opening a wide valuation gap over Finning (see Exhibit 3).

Exhibit 2: Finning and Toromont: Historical P/E Multiples

Finning's Historical P/E Multiples

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 5 yr. Avg.* 10 yr Avg.* 15 yr Avg.*EPS (Cash) 0.49 0.76 0.82 0.86 0.86 0.92 1.31 1.55 1.49 0.77 1.06 1.56 1.90 2.00Stock price Hi 6.90 10.18 14.43 16.60 17.70 20.63 23.90 33.50 31.15 19.06 27.40 30.25 29.80 27.25

Low 4.93 6.05 9.83 11.50 14.43 16.13 18.05 23.10 12.09 10.15 16.54 18.55 21.81 20.69Average 6.11 8.51 12.20 14.30 15.76 18.17 19.80 28.58 23.77 15.12 20.47 25.79 24.94 23.59

FWD. P/E High P/E 14.2 13.5 17.6 19.4 20.5 22.3 18.2 21.6 20.9 24.8 25.8 19.5 15.7 13.6 21.3 20.9 19.6Low P/E 10.2 8.0 12.0 13.4 16.7 17.4 13.7 14.9 8.1 13.2 15.6 11.9 11.5 10.4 12.1 13.7 12.7Average P/E 12.6 11.3 14.9 16.7 18.3 19.7 15.1 18.4 16.0 19.6 19.3 16.6 13.1 11.8 16.9 17.3 16.3

EPS growth (%)* EPS growth 26.0% 55.7% 8.5% 4.5% 0.8% 7.0% 42.2% 18.1% -4.0% -48.3% 37.7% 46.7% 22.1% 5.2% 4.1% 8.8% 8.2%*CAGR for EPS … continued on the next page

Over very long periods of time the valuation ranges for these two stocks have been almost identical



Toromont's Historical P/E Multiples

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 5 yr. Avg.* 10 yr Avg.* 15 yr Avg.*EPS (Cash) 0.56 0.71 0.64 0.91 1.09 1.23 1.56 1.68 2.06 1.86 1.19 1.37 1.56 1.56Stock price High 10.38 12.91 13.00 16.62 20.76 25.52 27.10 30.00 32.88 27.79 31.74 33.25 24.95 24.40

Low 6.93 7.63 9.33 9.92 16.25 20.50 21.21 22.49 20.01 19.77 22.95 15.80 19.21 21.50Average 8.57 10.00 10.71 12.61 18.59 22.76 24.39 26.67 27.50 23.53 27.84 23.99 21.40 22.87

Forward P/E High P/E 18.5 18.1 20.3 18.2 19.0 20.7 17.4 17.9 16.0 14.9 26.6 24.3 16.0 15.6 19.5 19.1 19.3Low P/E 12.4 10.7 14.6 10.9 14.9 16.7 13.6 13.4 9.7 10.6 19.2 11.5 12.3 13.7 12.7 13.3 13.2Average P/E 15.3 14.0 16.7 13.8 17.1 18.5 15.6 15.9 13.3 12.7 23.3 17.5 13.7 14.6 16.1 16.1 16.1

EPS growth (%)* EPS growth 2.5% 27.1% -10.0% 42.6% 19.3% 12.8% 26.8% 7.7% 22.6% -9.8% -35.8% 14.7% 14.2% 0.0% -1.4% 9.3% 8.9%*CAGR for EPS


Exhibit 3: Finning vs. Toromont: Historical P/E Multiples

5.0x

7.0x

9.0x

11.0x

13.0x

15.0x

17.0x

19.0x

21.0x

23.0x

25.0x

Jan-

05

Apr-

05

Jul-0

5

Oct

-05

Jan-

06

Apr-

06

Jul-0

6

Oct

-06

Jan-

07

Apr-

07

Jul-0

7

Oct

-07

Jan-

08

Apr-

08

Jul-0

8

Oct

-08

Jan-

09

Apr-

09

Jul-0

9

Oct

-09

Jan-

10

Apr-

10

Jul-1

0

Oct

-10

Jan-

11

Apr-

11

Jul-1

1

Oct

-11

Jan-

12

Apr-

12

Jul-1

2

Oct

-12

Jan-

13

Apr-

13

TIH FTT

In the past several months, we have seen

the differential between TIH and FTT's forward P/E

increase markedly.


Capital Structure:

Another notable difference between Finning and Toromont has been in their respective capital structures (see Exhibit 4). Specifically, over the last ten years Toromont’s debt to total capital ratio has averaged 20%, within a range of 32% and -6% (i.e. positive cash balances). Comparatively, Finning’s ratio has averaged 45% over the same period of time, within a range of 52% and 35%. Here again we are not comparing apples-to-apples (Toromont’s ratio can’t be segmented for the Equipment Group alone nor does Finning provide segmented balance sheets for its three regions). However, we still think this comparison says something about the two companies’ respective philosophies towards debt.

While Finning has always been a more leveraged company, there has never been a time when it faced severe stress from the banks (not at least in the 15 years that we have followed it). In other words, even though Finning’s debt ratios have always been higher than Toromont’s, it has arguably never assumed too much debt. In fact, this analysis might suggest that Finning has maintained a more “efficient” capital structure while Toromont has taken on too little debt over the years and has arguably been too conservative with its balance sheet. We also believe that Finning’s relatively high leverage ratios add some context to the company’s tendency to incent and measure its

Over the last ten years Toromont’s debt to total capital ratio has averaged 20% compared to 45% for Finning



performance on a return-on-equity basis as opposed to ROIC which Toromont uses for the same purposes.

Exhibit 4: Finning vs. Toromont: Debt to Capital Ratio (2003 – 2012)

51.6%50.5%

46.0%

40.0% 40.8%

48.9%

40.5%

35.3%

42.0%

50.0%

44.6%

32.0% 31.0%29.7%

26.7%

16.2%

4.4%

-6.1%

16.9%

12.7%

24.8%

18.8%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

55.0%

60.0%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 10 yr AVG

FTT TIH

Source: Finning International, Toromont Industries, Raymond James Ltd.

Free Cash Flow:

Free cash flow is another area where it is impossible to remove the influence that Toromont’s compression and refrigeration businesses have had on the company’s financial performance. Still, we have included it in our comparative analysis if for no other reason than to show that there has been a significant difference in this metric between the two companies. Although they have both been net generators of free cash flow over time (which is an inherent attribute of the dealer business in general), Toromont has produced much steadier and more significant amounts on a per share basis (see Exhibit 5), allowing it to effect very meaningful dividend increases (see Exhibit 6). Comparatively, Finning has also managed to raise its dividend respectably, albeit by a little less than Toromont. Both companies have maintained relatively similar payout ratios (see Exhibit 7), meaning that their dividend growth has been generally in-line with their earnings growth. However, it appears that the extra financial leverage Finning has assumed over time has also played a role in sustaining its dividend policy. In other words, if Toromont was comfortable with Finning’s capital structure it could fund a significant dividend increase and higher payout ratio. Alternatively, if Finning had Toromont’s earnings to cash conversion cycle, its dividend could be much higher under the current capital structure.

Toromont has produced much steadier and more significant amounts of free cash flow per share



Exhibit 5: Finning vs. Toromont: Free Cash Flow Per Share (2003 – 2012)

$0.38

-$1.23

$0.55

$0.30

-$0.62

$0.13

$2.83

$1.50

-$1.29

$0.12

$0.54$0.42

-$0.32

$0.30

$1.94

$1.53

$2.63$2.70

$1.27

-$0.52

-$1.50

-$1.00

-$0.50

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

FTT TIH


Exhibit 6: Finning vs. Toromont: Dividends Per Share (1997 – 2012)*

$0.10 $0.10 $0.10 $0.10 $0.10

$0.15

$0.18$0.20

$0.22

$0.28

$0.36

$0.43 $0.44

$0.47

$0.51

$0.55

$0.10

$0.13 $0.14$0.16

$0.17 $0.18

$0.21

$0.26

$0.32

$0.40

$0.48

$0.56

$0.60$0.62

$0.66

$0.73

$0.00

$0.05

$0.10

$0.15

$0.20

$0.25

$0.30

$0.35

$0.40

$0.45

$0.50

$0.55

$0.60

$0.65

$0.70

$0.75

$0.80

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

FTT TIH

*for 2011/12 we include EFX dividends for Toromont




Exhibit 7: Finning vs. Toromont: Dividend Payout Ratio (2003 – 2012) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

FTT 21.0% 22.8% 23.8% 20.9% 23.2% 28.8% 57.1% 44.3% 32.8% 29.0%TIH 23.0% 23.9% 26.0% 25.6% 28.6% 26.0% 32.3% 48.1% 30.7% 30.7% Source: Finning International, Toromont Industries, Raymond James Ltd.

Revenue Growth:

At this point, we can start to do some apples-to-apples analysis of Finning and Toromont’s respective CAT dealerships. On a segmented basis, Toromont’s Equipment Group has generated CAGR in revenue of 5.6% over the past ten years. This compares to a 7.5% CAGR for Finning at a consolidated level, a 10.0% CAGR for Finning (Canada), an 18.6% CAGR for FINSA, and a -4.9% CAGR for the UK (see Exhibit 8). The lattermost region is widely recognized as Finning’s most mature and competitive market, an attribute that is reflected in these numbers. But the UK’s long-term CAGR has also been skewed down by a series of strategic divestures that were made over the period of time we have examined (Lex Harvey, Hewden plant hire, and Hewden tool hire). The fact that Finning’s revenue growth in Western Canada and South America has outpaced Toromont in Eastern Canada and Manitoba is unsurprising in the context of the robust economic activity that has taken place in these parts of the world. It is also, we believe, indicative of another important difference between these two companies—namely that Finning has been a much more revenue-centric organization over the years, particularly in mining, whereas Toromont’s guiding principles have been more about profitability and return on capital.

Exhibit 8: Finning vs. Toromont: 10-year Segmented and Consolidated Revenue CAGR

18.6%

10.0%

7.5%

5.6%

3.4%

-4.9%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

FINSA FTT (Canada) FTT (Consolidated) TIH (CAT) TIH (Consolidated) UK Group Source: Finning International, Toromont Industries, Raymond James Ltd.

Margins:

This is where we start to get into the guts of our analysis. Particularly over the past five years, there has been a lot of discussion about Finning and Toromont’s respective EBIT margins. Here is the evidence that suggests Toromont has maintained a more profit-centric mentality. Over the past ten years, its Equipment Group EBIT margins have

Finning’s revenue growth in Western Canada has outpaced Toromont in Eastern Canada

Toromont has maintained a profit-centric mentality



averaged 9.5% within a range of 6.9% and 11.9%. By contrast, Finning’s Consolidated EBIT margins have averaged 6.7% within a range of 5.5% and 8.1%. On a segmented basis, Finning (Canada)’s EBIT margins have averaged 7.3%, within a range of 4.1% and 9.8% (see Exhibit 9). Notably, the higher end of this range prevailed in the 2003-2007 period, when Finning (Canada)’s margins were slightly higher than Toromont’s Equipment Group. Since then the numbers have moved in the opposite direction with Finning (Canada)’s margins going down and Toromont’s going up.

Exhibit 9: Finning vs. Toromont: Consolidated and Segmented EBIT Margins (2003 – 2012) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 10 yr AVG

FTT (Consolidated) 7.1% 6.4% 6.1% 7.7% 8.1% 6.5% 5.5% 6.2% 6.4% 7.5% 6.7%

TIH (Consolidated) 7.7% 8.3% 7.5% 9.4% 9.5% 8.7% 8.4% 9.9% 10.7% 11.3% 9.1%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 10 yr AVGFINSA 10.7% 9.5% 9.3% 10.8% 9.6% 9.9% 10.3% 8.9% 9.1% 9.7% 9.8%

UK Group 6.3% 5.4% 4.3% 5.3% 5.2% 4.2% 3.2% 2.4% 6.2% 5.6% 4.8%

FTT (Canada) 8.3% 8.4% 7.3% 8.9% 9.8% 7.3% 4.1% 6.1% 5.8% 7.2% 7.3%

TIH (CAT) 7.1% 8.0% 6.9% 9.3% 9.9% 9.9% 9.7% 11.2% 11.2% 11.9% 9.5% Source: Finning International, Toromont Industries, Raymond James Ltd.

These margins must be considered within the context of revenue mix. It is a well-understood fact in the equipment dealership business that the highest margin activity is aftermarket support (aka parts and service). Therefore, the dealer with the highest mix of revenue from this activity should also have the highest margins. Remarkably, however, Toromont’s superior margins to Finning (Canada) have been generated despite having a consistently lower mix of the highest margin business (see Exhibit 10). We will explore this observation in greater detail below.

Exhibit 10: Percent of Sales from Product Support vs. EBIT Margins (5 Year Avg.)

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

10% 15% 20% 25% 30% 35% 40% 45% 50%

EBIT

Mar

gin

Product Support % of Sales

FINSA

RMECVL

WJX

FTT (UK)

SQP

FTT - CAD

TITAN

TIH - CAT


Toromont’s superior margins have been generated despite having a consistently lower mix of the highest margin business



Return on Assets:

In order to compare the operating efficiencies of these respective dealerships we use a relatively rudimentary return on assets calculation in lieu of return on capital. This is simply a practical matter because the latter calculation can only be run on a consolidated basis, whereas segmented return on asset information is provided by both companies. Our analysis yields results that look similar to what we observed when we compared EBIT margins (see Exhibit 11). Specifically, between 2003 and 2007 Finning (Canada)’s average ROA was actually higher than Toromont’s Equipment Group (while the former’s UK dealership dragged down the company’s Consolidated returns). However, for the more recent five-year period between 2008 and 2012, Toromont’s average ROA has significantly increased, while Finning (Canada)’s has decreased. This again is indicative of issues that we will discuss in this report.

Exhibit 11: Finning vs. Toromont: Segmented Return on Identifiable Assets (2003 – 2012) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 10 yr AVG

FINSA 13.6% 14.1% 14.4% 15.3% 16.0% 13.7% 12.9% 12.1% 13.4% 13.0% 13.8%

UK Group 5.8% 4.9% 3.4% 3.8% 4.7% 4.2% 2.4% 3.4% 11.0% 10.1% 5.4%

FTT (Canada) 11.4% 12.2% 12.3% 15.6% 16.3% 12.0% 5.3% 8.9% 9.6% 10.6% 11.4%

TIH (CAT) 10.3% 10.8% 9.6% 13.4% 15.4% 15.2% 12.8% 17.0% 18.7% 19.3% 14.3% Source: Finning International, Toromont Industries, Raymond James Ltd.

One Part Structural; One Part Operational; One Part Cultural

There is, in our view, no single variable or “silver bullet” behind the performance discrepancies between Finning and Toromont that we have outlined above. Certainly, we must consider how Finning’s struggles in the UK market from 2003-2007 weighed on its share price and consolidated results over that period of time; similarly, the ERP derailment in 2011 clearly impacted Finning (Canada)’s numbers and, in turn, contributed to the gap that formed between it and Toromont’s CAT dealership over the more recent five-year time-frame. However, our theory extends far beyond these two simple (albeit important) factors into much more complex and convoluted matters. In the interest of simplicity, we have summarized the issues that we have identified into three basic components: structural, operational, and cultural.

The Structural Differences

The structural issues are those that we feel are inherent to the respective businesses of Finning (Canada) and Toromont CAT. Geography is the best example of this. Both dealerships cover vast, rugged territories (see Exhibit 12). However, Finning (Canada)’s is arguably more challenging to serve for a number of reasons. First of all, it is more sparsely populated with enormous distances separating its various branches. This adds complexity to some of its key performance indicators such as parts inventory turns, rental utilization rates, and overall supply chain management. Obviously, Toromont faces similar challenges in parts of its territory as well (Nunavut is almost twice the size of the Northwest Territories and equally as sparse). However, offsetting this are the disproportional benefits of operating in Ontario. This is particularly true in the “Golden Horseshoe” area, which is a densely-populated, highly-industrialized region in southwest Ontario where Toromont generates a significant amount of its revenues (at least half of the company’s CAT Rental Stores, aka Battlefield, operate within or close to this sub-region). Finning (Canada), by contrast, has no comparable “high velocity” parcel of geography within its territory. In fact, its most densely-populated region—namely, the BC Lower Mainland—presents additional structural challenges in that it is very close to

For the more recent five-year period, Toromont’s average ROA has significantly increased, while Finning (Canada)’s has decreased

Geography is the best example of a structural difference



the Port of Vancouver, which has historically made it a very contestable market for Asian OEMs, who have been known to “dump” their products into the region.

Exhibit 12: Geographic Comparison of Canadian Territory for Toromont and Finning

Sq KM Population Density (pop/km2)BC 944,000 4,400,000 4.66AB 661,000 3,600,000 5.45YK 482,000 34,000 0.07NWT 1,346,000 41,000 0.03Total 3,433,000 8,075,000 2.35

Sq KM Population Density (pop/km2)ON 1,076,000 13,500,000 12.55MN 568,000 1,200,000 2.11NFLD 405,000 514,000 1.27NV 2,038,000 31,000 0.02Total 4,087,000 15,245,000 3.73

"Golden Horsehoe"

33,500 8,800,000 262.69

FTT

TIH

Source: Raymond James Ltd.

Geography has blessed Toromont with another important advantage over Finning (Canada): closer proximity to Caterpillar. This provides additional benefits to the supply chain and further facilitates a higher velocity of inventory and asset utilization, at least for the operations that are concentrated in Ontario and southern Manitoba. Importantly, CAT has addressed this discrepancy between the two dealers’ regions. Specifically, last year in 2011 it announced plans to expand its Parts Distribution Centre in Spokane, Washington from 125,000 ft2 to 500,000 ft2. Going forward, Finning expects this new facility, which opened last year, to reduce shipping times of parts by four to five days, thus greatly enhancing its supply chain management practices throughout its branch network in Western Canada.

The difference in economic landscapes is another important structural variable to consider when comparing Finning (Canada)’s performance with Toromont CAT. It is no secret that Western Canada’s economy, particularly in Alberta, has been significantly more robust than Eastern Canada’s over the past five to ten years. As reflected in our earlier comparison of revenue trends, this has presented Finning (Canada) with an abundance of growth opportunities that generally dwarf what Toromont has had. That said, managing the rapid growth that Finning (Canada) has experienced also involves significant challenges, not the least of which include access to reliable and qualified labour. This is not to say that Toromont has been swimming in a sea of well-trained, low-cost technicians. It too has faced challenges on this front. However, in a relative context, it is fair to say that in regions such as Ontario, where the manufacturing base has suffered, equipment dealers do not face the same labour and cost inflation headwinds that exist in the West. Nowhere is this more obvious than in the oil sands, which provides us with a good segue into our discussion on mining.

Geography has blessed Toromont with another important advantage over Finning (Canada): closer proximity to Caterpillar



The Operational Differences

In this section we consider the ways in which the operations of Finning (Canada) and Toromont CAT differ from each other. As we will illustrate, these differences are mainly related to a key structural variable—namely, end market composition. Finning (Canada)’s territory is very mining intensive. As a result, its operational dynamics vary significantly from a more conventional construction equipment dealer such as Toromont. To put this important distinction in perspective, over the past five years ~45% of Finning (Canada)’s new machine sales have gone to the mining industry vs. ~15% for Toromont. Similarly, whereas Toromont derived over half of last year’s product support revenues from the construction sector, the mining industry dominated Finning (Canada)’s aftermarket business generating 65% of the related revenues.

Processes, Parts Flow, and the Intricate Complexities of a Mining Dealership

The unique intricacies of being a CAT dealer to the mining industry may not be strikingly obvious, but they are very important for us to consider when comparing Finning and Toromont. Put simply, it is a much more complicated business (not to mention a lot more cyclical!). With this complexity comes high barriers to entry and, in turn, fewer competitors. This, in theory, should lead to higher margins for the dealer (countless shady-tree mechanics can fix CAT 320 excavators, but how many of them would dare touch a 797 haul truck?). Yet, as we have shown, Finning (Canada)’s margins have been lower than Toromont’s over the past five years despite having much heavier exposure to mining.

This perversity is a function of many different factors. First of all, the sheer size and price of mining equipment plays a role. That is to say, bigger machines that are sold in larger packages have a lower markup for the dealer; hence a large mining truck order may generate outsized revenue numbers but with slightly smaller margins. Also, highly customized mining machinery is not as inventory intensive as general construction equipment, which means the dealer doesn’t need to be compensated for the same working capital costs. That said, the dealer does play an important role in “prepping” the equipment for delivery to the customer. Even for smaller machines “some assembly is required,” but for large mining equipment, which is highly customized, the process is exponentially more complex. Whereas it typically takes anywhere from 400 to 1,200 man hours for a dealer to prep large mining machinery, only 50 to 100 hours are typically required for the general product line. The dealer gets paid for this service. However, the margin is at risk of getting squeezed if the assembly process is inefficient, which is more likely to happen with mining products where complexity is very high and margin for error very low.

This is a challenge that dealers also face in the rebuild business. Increasingly, equipment owners, particularly in mining, are embracing rebuilds as a cost-effective alternative to ordering new product for replacement demand. Although the customer’s decision will always vary according to his needs, dealers have consistently told us that they would much rather rebuild an old truck than sell a new one simply because the related margins are much higher. But that assumes solid execution, which is not always the case. Indeed, rebuilding a mining truck is more complex than prepping it for delivery. Not only do you have to put the truck together, but you also have to take it apart—and you have to do this under the confines of a fixed price contract (in simple terms, the proposition to the customer is “it will cost you X dollars to rebuild this truck and Y dollars to buy a new one”).

Under these circumstances, databases, processes, and parts flow become paramount to the dealer. In the bidding stage of the contract, the estimator must be armed with extremely good information about the life of the truck and all of its parts in order to understand the task at hand and price it appropriately: What is the life expectancy of

The unique intricacies of being a CAT dealer to the mining industry are very important to consider when comparing Finning and Toromont

Whereas it typically takes anywhere from 400 to 1,200 man hours for a dealer to prep large mining machinery, only 50 to 100 hours are typically required for the general product line

Rebuilding a mining truck is more complex than prepping it for delivery



each part? Which parts have been replaced? When? And by whom? How many hours and what condition has the machine been utilized? etc. Moreover, all of this information gets highly scrutinized by a very sophisticated customer, who can be more informed with data and have an unparalleled understanding of mining equipment, as well as the dealer’s track record. Then, in the next phase—namely, execution—everything has to flow seamlessly for the dealer’s parts managers and technicians. If, for example, the wrong parts arrive at the right time or the right parts arrive at the wrong time (or even if too many of the right parts arrive at the right time), freight and emergency shipping costs, as well as excess inventory expenses, escalate and the margin on the work order begins to contract.

More significant is the risk that the whole project simply grinds to a halt while the technicians wait for such bottlenecks to be rectified. Rebuilding used mining equipment into “like new” condition is more of an integrated than modular process. As a result, if the right part does not arrive at precisely the right time labour can be stuck literally sweeping the shop floor. When this happens, the related costs get allocated to SG&A, rather than cost of goods sold (i.e. it becomes overhead or an unallocated labour expense), which further compromises the overall profitability of the job.

That Finning (Canada) has been experiencing many of these supply chain bottlenecks is vividly evident in their SG&A to sales ratio, which is significantly higher than Toromont (see Exhibit 13). We see this is a critical distinction between these two dealers and a big factor behind Toromont’s higher historical returns. Importantly, this is not strictly a matter of circumstances. That is to say, we do not believe that Finning (Canada)’s business is inherently confined to lower margins than Toromont simply because it is heavier into mining. On the contrary, as we pointed out earlier, it is far more intuitive to expect service margins in the mining business to be higher because competition is more limited (Wajax demonstrated this with its Letourneau product line). However, our key point is that in order for Finning eventually to realize higher margins, its execution will have to improve.

Exhibit 13: Finning vs. Toromont Consolidated SG&A as a % of Sales (2003 – 2012)

21.7%

23.2%22.5%

20.7%20.2%

21.2%

22.5%23.1%

21.7%22.4%

13.1% 12.9%13.2%

12.6% 12.4%

14.5%

16.2%

15.0%14.6%

14.2%

5.0%

7.0%

9.0%

11.0%

13.0%

15.0%

17.0%

19.0%

21.0%

23.0%

25.0%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

FTT TIH


We do not believe that Finning (Canada)’s business is inherently confined to lower margins than Toromont simply because it is heavier into mining



It was in pursuit of this ‘operational excellence’ that Finning (Canada) embraced its now infamous ERP platform two years ago. Without rehashing all the gory details, we feel it is worth mentioning this three letter acronym at this point in the report because it has been designed—at least in theory—to address many of the potential supply chain bottlenecks noted above. Specifically, in migrating from an old green-screen platform to this slick, new system Finning expects to see exponential improvements in parts flow, parts failure predictability, inventory management, and a host of other processes—including service order planning, bay utilization, warranty recoveries, quoting, etc.—that should effect much better execution in its mining rebuilds and overall service activities.

Bringing the ERP system into this part of the discussion also sheds some light on how lost Finning (Canada)’s business became during the most difficult days of its ERP implementation (3Q11-2Q12). With no system to guide parts ordering and flow, most of the company’s processes were totally in the dark and, as a result, many work orders literally stood still. While Finning (Canada) has since made great progress in restoring its operations from these depths of despair, its main focus to-date has been to prioritize its customers’ parts flow needs over its own internal parts requirements (i.e. for rebuilds and in-house customer service work). This means that it still has some systems work to do with respect to parts flow in the ERP recovery. Once this issue is resolved, the margins on the related revenues are expected to improve. Meanwhile, Toromont continues to utilize a modified and upgraded version of Finning’s legacy system (DBS) which, based on its reported performance, appears to be serving its (arguably simpler) needs very well.

Finning’s “Spine” of Support for the Mining Industry

The very complex flow of parts and information that is inherent in servicing the mining industry has had other profound influences on Finning (Canada) beyond its ERP system. For example, its entire network of bricks and mortar infrastructure was specifically designed with the intent to optimize efficiencies related to maintenance work, equipment prep, and rebuilds for mining machinery. Given the particularly challenging complexities of the latter two activities, Finning has centralized them in a large, specialized environment that is conducive to high volumes and repetitive processes. This is the rationale for its Centre of Excellence (COE) facility in Red Deer (see Exhibit 14). Supporting COE is also OEM in Edmonton, which performs the very technical component rebuild work that is an integral part of the process. These two facilities, combined with the new branch in Fort McKay (see our Jun-27-13 Brief “The Oil Sands Tour: Confessions of a Caterpillar Dealer”, price $21.52, for details), form a “spine” of support for Finning’s mining operations (see Exhibit 15) and the related customer base that is unrivalled by any of the other dealers in the market.

It was in pursuit of ‘operational excellence’ that Finning (Canada) embraced its now infamous ERP platform two years ago

Meanwhile, Toromont continues to utilize a modified and upgraded version of Finning’s legacy system (DBS)

Finning has centralized its equipment prep and rebuild work in a large, specialized environment that is conducive to high volumes and repetitive processes

http://researchclient/contents/67352/download



Exhibit 14: Finning’s Centre of Excellence (COE)

Source: Finning International Exhibit 15: Map of Finning’s Key Facilities in Western Canada

Source: Finning International

There is little doubt that Finning (Canada)’s strategy, as outlined above, has played a critical role in its ability to secure dominant (>80%) market share for CAT machines in Western Canada’s mining sector, particularly the oil sands. To be sure, the quality and scale of dealer aftermarket support carries more weight than any other variable in the buying decision among customers in this market (it’s all about uptime!). This, in turn, has been a big driver of the company’s robust new equipment revenue growth over the years. But it has also consumed an enormous amount of capital1 and fundamentally changed the economics of the business. Specifically, Finning (Canada)’s heavy investments in bricks and mortar have modified its model from being a pure capital-light distributor to more of a fixed-plant manufacturer. This is meant as an observation not a 1 We estimate that COE, OEM, and Ft. McKay have consumed >$400 mln of capex over the past eight years.

Finning (Canada)’s heavy investments in bricks and mortar have modified its model from being a pure capital-light distributor to more of a fixed-plant manufacturer



criticism. We see nothing wrong with this strategic shift provided that it yields positive and sustainable benefits for shareholders. The problem, however, is that such benefits—beyond market share and revenue growth—are difficult to discern in light of the financial metrics that we reviewed earlier.

We are thus presented with a bit of a paradox about Finning (Canada)’s business. The company’s capital expenditures on facilities and infrastructure have effected significant sales of new machines to mining customers in Western Canada and nurtured years of growth for the aftermarket business. However, nearly ten years since this strategy was first hatched with the opening of OEM, there is no overwhelming evidence to suggest that it has generated higher margins or enhanced returns on capital. On the contrary, these metrics, as we demonstrated earlier, have gone down over this period of time. The corollary is to question whether or not all the cash that Finning invested in these buildings would have been better suited back in the hands of the shareholders?

Before jumping to any conclusions, however, we must consider the consequences of such an alternative course of action. Indeed, it is hard to imagine Finning simply turning its back on all of these mining opportunities given CAT’s commitment to this market and the obligation that the dealer has to represent the manufacturer. With that in mind, there is a certain “go big or go home” argument to be made, particularly in the oil sands where a large concentration of “yellow iron” presents Finning with an opportunity to centralize processes and leverage economies of scale to overcome the challenges of prepping and rebuilding complex mining machinery. As a big, public dealer with access to significant capital and a broad product line, this is a competitive advantage that very few competitors (arguably none) can exploit.

Therefore, to suggest that Finning would be a smaller but higher return business if it had not invested in large-scale infrastructure runs the risk of throwing the baby out with the bathwater. This is because it assumes that the facilities themselves are the problem rather than how they are utilized. There is no doubt that all of Finning (Canada)’s extra floor space has added overhead, increased capital requirements, and translated into higher fixed costs, but with the right processes and the correct manufacturing disciplines, the company should be able to capitalize on the enormous opportunity that it has created for itself and realize dominant market share along with higher returns. In other words, we feel it has been the execution of the strategy rather than the strategy itself that has been flawed.

How Long-Term Service Contracts Can Throw a Wrench into Margins

The economics of long-term service contracts round-outs our discussion of a mining dealership’s various intricacies. These complex arrangements are structured in many different ways that make it difficult to discuss in a general context. However, in the simplest terms, they are designed by the dealer to guarantee parts life, availability, and/or complete equipment uptime for the customer. The idea, in theory at least, is to present a win-win proposition: The operator gets complete confidence in his fleet’s availability (or at least knows he will be compensated if something fails) while the dealer locks-up a long-term recurring stream of aftermarket revenues.

These long-term service agreements, which are a relatively common practice in the mining industry, can significantly influence equipment purchasing decisions. Certainly, in Finning (Canada)’s case, it is hard to imagine that they have not had a material impact on the dealer’s mining market share and the 12% CAGR in its customer support services revenue over the past ten years. Their impact on margins, however, is more difficult to discern. For one thing, the mark-up on the parts that are sold under these agreements is usually less than the margin that would be recognized on the sale of a similar part to a “walk in” customer at a general construction branch. This simply reflects a standard volume discount that is ordinarily offered to any large customer in any business. It also provides an element of price certainty that is necessary to get equipment purchasers to

Would all the cash that Finning invested in these buildings have been better suited back in the hands of the shareholders?

We feel it has been the execution of the strategy rather than the strategy itself that has been flawed

Long-term service agreements can significantly influence equipment purchasing decisions…



commit to a single parts supplier over a long period of time. Nevertheless, these discounts will skew aftermarket profitability down for the mining dealers that underwrite the contracts.

Other—more important—factors that will influence the margins on these contracts include parts failure predictability, labour productivity, and a host of other uncertainties that must be “priced into” the agreement when it is initially signed. In effect, the dealer will estimate and assume many of the long-term risks related to these variables in exchange for a pre-determined recurring fee (“pay us $X per year and we will make sure your trucks never stop running”). Normally, this should not be problematic since the dealer—together with the OEM, who also plays an integral role and will share many of the related risks—has an unparalleled understanding of the product and everything that is involved in servicing it. Here again robust systems play a critical role in the process by arming the dealer with useful data to manage some of the unknown variables related to these contracts.

Of course, no amount of knowledge or information can ensure perfect visibility on the performance of these machines, which is another way of saying that these contracts can and will sometimes go wrong. The risk of this happening is particularly high when a new product is introduced to the market. CAT’s 797 400 ton mining truck provides an excellent case in point. Although this truck represented game-changing technology for the mining industry, its ultimate success in the market was not achieved without considerable growing pains, much of which Finning had to bear. The 797 is now in its third generation (the F-series) and has been significantly reengineered. However, in the past, reliability and parts life—particularly with the transmissions—proved to be problematic. This left Finning vulnerable to some of the long-term contracts associated with this truck, which we believe has had an impact on margins as the product has matured. As noted, CAT was involved in “sharing” the risk, but it did not completely eliminate it. Furthermore, under these circumstances, the onus is often on the dealer to provide the OEM with the detailed information it requires to assume its responsibility in the agreement. If it cannot, the dealer may have to take the hit (the same is true of any standard warranty claim). Yet again, this raises the importance of having strong systems to track this process.

But equipment does not need to be revolutionary in order for it to be unpredictable. Even legacy products can end up being much more costly for the dealer to support than it initially assumed. This is particularly true in the oil sands where wage inflation and labour productivity have been ongoing challenges. Inefficient parts flow can also have an inimical impact on aftermarket contracts. For reasons that we outlined earlier, disruptions to any work order can be very costly to a dealer, especially if it incurs related penalties under a guaranteed uptime contract. There are a number of ways for Finning to mitigate these risks through covenants and/or conditions in the contracts (for example, provisions are often made for wage inflation). As noted, these are complex, customized agreements that we have grossly oversimplified for illustrative purposes. And by no means are we suggesting that the practice of underwriting these contracts has been unconditionally unprofitable for Finning or the sole source of its margin drag. Rather, our key point is simply to shed some light on the intricacies of these service contracts and how they can, under different circumstances, impact a mining dealer’s systems, operations, and profits.

How Does FINSA Do It?

While we have anchored the above discussion on Finning (Canada)’s operations, we must also mention Finning’s South American CAT dealer, FINSA. Its business is even more skewed to mining, while its margins and return on assets have been higher. This, in our mind, demonstrates that mining is not an inherently lower margin market to serve for a CAT dealer. On the contrary, it can be a very lucrative business.

…but these contracts can and will sometimes go wrong

Inefficient parts flow can have an inimical impact on aftermarket contracts

FINSA demonstrates that mining is not an inherently lower margin market to serve for a CAT dealer



While much of the discrepancy between Finning (Canada) and FINSA simply relates to execution, there are—like our comparison of Toromont CAT to Finning (Canada)—some important circumstances that have also played a role. Geography is not one that works in FINSA’s favour. In fact, the South American operations are even further from CAT’s supply chain than Canada. The climate, however, is generally more conducive to equipment usage and, more importantly, repair. For example, some of Finning’s equipment prep and service work can be done by its technicians outdoors, thus mitigating the same need for large scale (and heated!) bricks and mortar facilities. Similarly, where FINSA has made investments in its infrastructure, the related land and building costs have generally been lower. We believe these economics have played a role in the FINSA’s higher returns.

Labour is another important variable. Like Western Canada, there has been an acute shortage of technicians in Chile. However, FINSA has generally managed this headwind better than Canada. In particular, through its very successful recruiting and training strategy—which involves the Think Big program and Finning Instituto Tecnico—the company has effectively created and monopolized its own labour pool (Finning does a lot of training in Canada too, but it is subject to union influence and generally done on a smaller scale through independent technical institutes such as NAIT and SAIT). There, are of course, other options for a machine technician to pursue after being hired and trained by FINSA, but employee loyalty is generally stronger in Latin America than it is in the money-soaked, Gold Rush infused town of Ft. McMurray.

Union dynamics are also different in South America. While FINSA technicians are represented by organized labour, there is generally less of the coercion and competition that arises in Canada from inter-union politics. Some of this has to do with the fact that the mines in Chile tend to outsource more of their labour to FINSA, which means that the customers don’t have a local competing workforce to placate (it also means they don’t poach the dealer’s trained labour to the same extent as they do in the oil sands). This outsourcing increases the appetite for the comprehensive maintenance and repair contracts (as opposed to a parts-only contract) which are structured differently in South America. Specifically, FINSA’s MARCs are more like “take or pay” agreements where the dealer invoices the customer on the number of hours that the truck is running rather than the number of labour hours that go into supporting the equipment. This changes the relationship between productivity and profitability.

There is one final important difference between Finning (Canada) and FINSA that is worth noting: namely, the systems. Whereas the former operation embraced the new Lawson ERP platform, the latter is still using the legacy (DBS) software—and getting higher returns from it. Of course, Finning (Canada) is still in a transition process to Lawson, where the related benefits have yet to come to full fruition (while the related costs have depressed recent returns). If Lawson achieves its targets, we expect it to be rolled out to Finning’s other regions, including FINSA. For the time being, however, this transition has been put on hold.

Toromont CAT: Canada’s Other Mining Dealer

Tying this analysis back to our comparison with Toromont, we cannot forget the fact that it has also been a mining dealer for a very long time (it is still servicing some 785 trucks that it sold to the Porcupine mine in 1994). Toromont’s mining exposure is considerably smaller than Finning (Canada), but it has been growing rapidly over the years (see Exhibit 16). This growth, of course, has slowed this year, but there are still many untapped mining opportunities in the dealer’s region (see Exhibit 17). Hence, when (if?) the market in Eastern Canada comes back to life, we expect Toromont’s overall mining exposure to expand even further. In the meantime, its parts and services revenue stream from the mining product that it has delivered over the past few years is poised to grow as those machines mature. All of this raises the question of whether or

Union dynamics are also different in South America

Toromont’s mining exposure is considerably smaller than Finning (Canada), but it has been growing rapidly over the years



not Toromont’s underlying fundamentals will change (i.e. become more complex) as its mining business gets bigger—and if this will have any corresponding impact on its margins and returns.

Exhibit 16: Toromont’s Installed Base of Mining Equipment

Source: Toromont Industries

Exhibit 17: Mining Opportunities in Toromont’s Region

Source: Toromont Industries

Having just expounded upon all the various intricacies that a dealer confronts in the mining market, it would be disingenuous of us to argue that there would not be any implications for Toromont’s business as its exposure to this specific market continues to expand. Take, for example, the electric drive Caterpillar 795 trucks that the dealer delivered to Detour Gold last year. In many ways, this product promises to be an earthmoving development (pun intended) for the mining industry, just like the 797 was 15 years ago (for details see our Jan-17-11 CAT Report “An Electric Drive to the One-Stop-Shop for Mining”, price: US$94.14). It is, however, a brand new product that Toromont sold with long-term service contracts attached. As a result, it faces the same unknowns—and potentially the same problems—that impacted Finning with the 797 truck.

This is simply a risk, not a certainty. In fact, there are a number of reasons to believe that these contracts will be unproblematic—and on the contrary very profitable—for




Toromont. First of all, in light of management’s exceptional long-term track record, we simply have to give them (and their systems/processes) some benefit of the doubt that they have structured (and will account for) these contracts appropriately. Equally important, as an electric drive truck, the 795 has a fundamentally different drive train from the mechanical drive 797. Put simply, it has far fewer moving parts, which means it is a much less complicated product to operate and support (i.e. with fewer moving parts come fewer potential problems, as well as less aftermarket revenue).

The 795, however, is an exceptional product. Generally speaking, there is a direct correlation between the size of equipment and the complexity associated with assembling and servicing it. As a result, Toromont has arguably faced fewer challenges with its mining operations compared to Finning. For example, whereas Finning (Canada) has sold and serviced over 200 of the massive 400 ton 797 trucks in Western Canada, the largest mining truck that Toromont has ever delivered (prior to the 795 last year) is the 150 ton 785. Similarly, there are almost 300 850 horsepower D11 dozers in Finning (Canada)’s market, whereas the biggest dozer Toromont has ever sold is the 400 horsepower D9. Finally, Toromont’s territory has many more underground mining operations than Finning, which further impacts the product profile and the related complexities (for example, underground equipment generally does not get sold with long-term service contracts).

There is another important distinction between the respective Toromont and Finning mining operations. Specifically, Toromont’s capital investments in bricks and mortar have been much more limited than Finning’s. This partly reflects the smaller scale of its operations (i.e. without Finning’s huge installed base of equipment it is difficult to justify the same kind of investments). But even if Toromont had 200 797s and 300 D11s rolling around its territory it is doubtful, in our minds, that they would put the same kind of capital into the business. For one reason, if they were to build an OEM or COE type facility, where would it go? Unlike Finning (Canada) where the vast majority of its mining equipment is concentrated within a radius of a few hundred kilometers around the oil sands, the mines in Toromont’s region are vastly dispersed, which would present major logistical challenges.

Moreover, with a closer proximity to CAT’s remanufacturing facilities, Toromont has historically leaned heavily on the OEM for much of its components needs (Toromont does have a component rebuild facility near its Concord head office, but it resembles only a fraction of the scale and capabilities of Finning’s OEM facility). We believe they will continue with this strategy as their mining platform grows. Indeed, the main reason that Toromont would be adverse to making a large scale investment in equipment prepping and rebuild facilities is, in our view, philosophical. That is to say, management has always subscribed to a more decentralized manufacturing and assembly model that involves lower capital investments and provides the dealer with more cost flexibility to manage cycles. The related trade-off, vis-à-vis Finning’s model, is that Toromont cannot centralize its most complex tasks in one facility where it stands to benefit from scale and repetition. But this is a moot point anyway since, as we have noted, the geography and size of the mining market in Toromont’s territory limit the merits of any such operation in the first place. The company circumvents this challenge by outsourcing many of its remanufacturing needs to CAT, which boasts a world-class manufacturing practice and unparalleled economies of scale. Thus far, this approach has served Toromont—and its shareholders—very well, which gives us very little reason to question it.

Toromont has arguably faced fewer challenges with its mining operations compared to Finning

Toromont’s capital investments in bricks and mortar have been much more limited than Finning’s

Toromont has historically leaned heavily on CAT for much of its components needs



The Cultural Differences

“Company cultures are like country cultures. Never try to change one. Try, instead, to work with what you’ve got.”—Peter Drucker

Throughout this report, we have made a recurring reference to the word “execution.” By this we are simply talking about a company’s ability to get the job done effectively and profitably. Speaking bluntly, and armed with the evidence we presented earlier, we believe that Toromont has executed its strategy better than Finning. As we have argued, there are many other variables to consider, beyond execution, that have made Finning’s job more difficult. However, in the final analysis, we cannot say that the discrepancy between Toromont and Finning’s results is all related to circumstances.

Before going any further with this rather sensitive topic, we need to recognize that there are countless committed and high quality people working at both Toromont and Finning, many of whom have dedicated most, if not all, of their careers to these respective companies. This observation has been drawn from our extensive contact with various members of their executive teams, mid-level management, and shop floor employees. It is hard for us to imagine that anyone could work for either of these two CAT dealers and not have considerable pride in their rich corporate legacies and the world class products they represent. Still, we feel that “there is a difference” between the culture at Toromont vs. Finning.

Analyzing company culture is not a particular area of expertise for us. Nor is it typically a topic that consumes a great deal of thought or discussion among analysts and investors (“where does it go in my model?!”). That said, we believe that culture has been a critical differentiator between Toromont and Finning over the years. At the start of this report, we suggested that Finning is a relatively revenue-centric organization, whereas Toromont tends to emphasize profits and return on capital. We have drawn these conclusions from our own impressionistic observations over the years as well as from feedback provided by employees, competitors, and customers of both organizations. The numbers substantiate these descriptions as well, with Finning having a considerably higher CAGR in its revenues, compared to higher margins and returns on capital for Toromont.

Our Observations on Finning’s Culture

In Finning’s case, the company has had a very long history of being uncompromisingly focused on “the customer.” Obviously, Toromont also keeps a laser focus on its customers (what successful company doesn’t?), but in Finning’s case we believe it indiscriminately became the company’s guiding principle—sometimes to a fault. One example that comes to mind is when oil sands producers turn to Finning to help manage their peak activity levels. In a customer-centric organization that emphasizes market share and revenue growth, there would be no reason to turn this business away. However, saying “no thank you” to some of these opportunities may, in effect, be the optimal decision if the intended outcome is to drive margins and ROIC sustainably higher.

As Finning has learned over the years, the work that tends to get outsourced to them in a mining boom is often both low-margin and ephemeral (i.e. it is the first work that the customer will in-source in a bust). The related problem is that it is very difficult for the dealer to create a cost structure that is flexible and nimble enough to scale up and down with the vagaries of the cycle. This is especially true in the oil sands where labour and other resources can be described as anything but flexible. In recognition of this challenge, Finning is starting to change its approach to these “peak shaving” opportunities by being more selective in the work that it assumes. However, this requires a shift in the culture as much as anything else and will therefore take time to effect.

We cannot say that the discrepancy between Toromont and Finning’s results is all related to circumstances

Finning has had a very long history of being uncompromisingly focused on “the customer”



The oil sands have been problematic for Finning’s revenue-centric mindset in another respect. Specifically, we believe that the sheer size of this opportunity has had an intoxicating effect on the company over the years, causing it to dedicate the vast majority of its energy and resources to chasing growth (at all costs) in this single segment of the market. In this process, Finning took its eye off of some of its bread-and-butter businesses such as general construction, forestry, and power systems and accordingly lost market share. To address this problem, and nurture a more balanced approach to the market, Finning has recently restructured its organization into independent business units—namely, general construction/forestry, power systems, and mining (see Exhibit 18)—each with its own financial statements and senior manager. The idea is to create more direct accountability in the organization and prevent one or two big wins in the mining business from obscuring a large number of small losses in other segments of the market.

Some of Finning’s work order practices provide us with a final example of how a customer-focused culture can sometimes effect unintended negative outcomes. Specifically, without the best systems and controls in place, the company’s technicians have had a great deal of discretion to expand work order scope without proper customer authorization. While this may be done with the best service intentions in mind (i.e. to expedite the job, provide preventative solutions, and/or fix problems that customer may have been unaware of), the practice often leads to disputes over the bill, many of which Finning concedes to the customer. The new ERP system that Finning installed in 2011 was designed, in part, to address these issues by creating more structure around managing work orders. But the initiative back-fired on two fronts. First, it proved to be very difficult for Finning to get its people to accept the new discipline that was built into the system (i.e. the culture rejected the system on the grounds that it was “too rigid.”). Second, in order to recover some of the goodwill that it lost during the botched implementation process in 2011, Finning was forced to make additional concessions to its customers in the market. Notwithstanding the irony of this outcome (the ERP was supposed to lead to fewer concessions, not more of them), we expect these practices to abate as Finning’s new systems become more embedded in the operations.

Exhibit 18: Finning (Canada)’s Organizational Structure

Andy FraserPresident,

Finning Canada

Dave Primrose EVP, Mining,

Construction & Forestry

Joel Harrod SVP, Power

Systems

Cristian Chavez VP, Operational

Excellence

Gary Agnew VP, Customer

Solutions

Mona Hale VP,

Finance

Mike DaviesVP, Human Resources

Kevin Tatlow SVP, Construction

& ForestryGordon Finlay

VP, Coal & Metals

Randy McDonald General Manager, Mining Equipment

Management

Brian Shaw General Manager, Drills, Shovels & Mining Systems

Brent Davis VP, Oil Sands

Source: Finning International

Finning has recently restructured its organization into independent business units each with its own financial statements and senior manager



A proper analysis of the role that Finning’s culture plays in the company’s performance must extend well beyond the handful of examples outlined above (for more details see our Jan-23-12 Report “Focus on Canada: Resurrecting the “New Finning””, price $27.18). Suffice it to say here, however, that changing some components of employee behaviour remains a top priority for management—albeit one that has been complicated by other variables, including a downturn in the market, the integration of the Bucyrus product, and the departure of the company’s previous CEO. We must also emphasize that there are some very strong and positive components of Finning’s culture that need to be preserved through this process. After all, we are not talking about wholesale change of a broken organization. Rather, in a word or two, we simply believe that more “discipline” and “accountability” need to be embedded in the existing culture. Our initial impression of Finning’s new CEO, Scott Thomson, is that he recognizes the importance of this issue very well and will address it early in his tenure. If he and the rest of the management team can effect the right kind of behavioural change, we believe all stakeholders will be better off. But again, this is an exercise that will take time to effect.

Our Observations on Toromont’s Culture

Compared to Finning, our analysis of Toromont’s culture is a little less complex because the company’s impressive track record is a clear manifestation of its very effective culture. Still, the question remains how does Toromont do it? Here again, it is a challenge to distill our thoughts on culture down to a handful of observations and anecdotes. But at a very high level we believe the key ingredients to Toromont’s long-term success can be summarized as follows:

Emphasis on financial literacy, especially return on capital—Toromont has always put great emphasis on investing in its people. In addition to aligning itself with community colleges to promote the recruitment of technicians, the company has also established a very effective management training program that is used to identify and develop future leaders. During this two year rotation, employees touch every part of the business and are schooled in the importance of systems, product knowledge, and customer service standards. The program also puts a heavy emphasis on financial literacy and measuring the KPIs for the business. A particular focus is placed on return on capital as a defining feature of incentives and compensation for the organization, right down to the branch manager level.

Strong controls—A very disciplined organization cannot exist without strong controls, which, in turn, requires modern and robust systems. As opposed to Finning’s “big bang” investment in technology, Toromont has taken a more gradualist approach to its systems, modifying, upgrading, and investing in its legacy DBS software over a long period of time. As a result, the company now has a very powerful and functional ERP system that provides management with excellent insight into, and powerful control over, the day-to-day performance of the business.

Empowerment—Armed with good training and strong systems, Toromont’s employees are largely cast free to act as independent business owners and operators. This has engrained into the culture a very successful balance between entrepreneurship and accountability. Talk to people at the dealership who go back to the days when it belonged to the Crothers family and they will likely say that the employees were “liberated” by Toromont’s management practices after they bought the operation in 1993.

“Skin in the game”—Getting employees to act like owners also requires them to have “skin in the game.” Accordingly, Toromont creates strong incentives for its people to own the stock. This philosophy extends right up to senior management and the Board, where a heavy emphasis is put on buying the company’s stock with “out of pocket after tax money” rather than incenting with options. Notably, this has effected a significant difference in stock ownership levels between Finning and Toromont’s top executive and

Changing some components of employee behaviour remains a top priority for management

Toromont’s impressive track record is a clear manifestation of its very effective culture

Toromont’s employees are largely cast free to act as independent business owners and operators




Board members (see Appendix), although more continuity among the ranks of the latter organization has clearly played a role.

Productive paranoia—In his latest best-selling book Great By Choice management guru Jim Collins studied companies that rose to greatness within environments of unpredictable and uncontrollable change and volatility. According to his research, one of the many defining features of these “10x companies” (i.e. companies that beat their industry indices by at least ten times over fifteen years) was a culture of “productive paranoia” which—albeit without replicating Collins’ rigorous empirical study and analysis—we believe aptly applies to Toromont’s management practices and culture. Specifically, we summarize Collins’ concept of productive paranoia using the following excerpt from his book:

“10Xers remain productively paranoid in good times, recognizing that it is what they do before the storm that matters most. Since it is impossible to consistently predict specific disruptive events, they systematically build buffers and shock absorbers for dealing with unexpected events….Certainly, 10X leaders took risks, but relative to the comparisons in the same environments, they bounded, managed, and avoided risks.”

The rather glowing description of Toromont’s culture that we have outlined above is not meant to suggest that the company and its people are perfect or infallible. Nor would we want Finning to see this as a call for it to defenestrate its own rich and uniquely strong culture in an attempt to recreate what Toromont has built over its many years of existence. Rather, in the spirit of Peter Drucker’s sage advice (quoted earlier), we think Finning should work with what it’s got to drive more discipline and accountability into its current organization. Likewise, there are areas where Toromont—despite its great track record—could still improve and evolve into an even better operation.

Toromont’s management is the first to admit this, as a number of recent initiatives demonstrate. For example, last year the company made certain changes to incentive and reporting structures that are designed to optimize the performance of its Battlefield rental operations. Similarly, Toromont has also embraced a more segmented organizational structure that—akin to what Finning has done—will make it more difficult for regional managers to bury any of the “sins” that they may commit with the general construction product line in the larger scale mining operations. Specifically, independent operating units, each with its own senior manager and financial reports, have been established for Toromont Construction Industries, Toromont Resource Industries, Toromont Power Systems, and Battlefield the CAT Rental Store. Changes like this suggest to us that Toromont’s track record of continuous improvement and operational excellence isn’t over yet.

Investment Implications and Recommendation

Having dispensed with this detailed comparative analysis of Finning and Toromont, we are left to answer the single, pressing question: which stock should investors own? The short answer to this question is that we believe both companies will generate respectable returns over our forecast horizon (i.e. we suggest investors buy both or either). However, if asked to recommend only one of the two stocks, we would tell investors to buy Finning over Toromont at the current prices. This is reflected in our Strong Buy rating for the former vs. our Outperform rating for the latter.

Our bias towards Finning over Toromont at this point in time is based primarily on the bottoms-up analysis that we have presented in this report. This is not to suggest that top-down variables related to macro forces have been omitted from our investment thesis. On the contrary, we continue to pay very close attention to the current state of the infrastructure and construction markets and, in particular, the related demand for

The concept of “productive paranoia” aptly applies to Toromont’s management practices and culture

There are areas where Toromontcould still improve and evolve into an even better operation

Which stock should investors own?

Our bias towards Finning over Toromont at this point in time is based primarily on the bottoms-up analysis



and supply of heavy equipment (for details see our most recent Machinery sector Brief “2Q13 Post Mortem”). But in the final analysis, we can’t make this the distinguishing feature of our call because at present both Finning and Toromont generally face similar industry conditions.

An important caveat to the above is that, in a regional context, we believe the long-term outlook for construction activity in Western Canada and Chile remains more promising than in Ontario, Manitoba, and Newfoundland. Likewise, recognizing that all resource markets are soft, we prefer Finning’s relative exposure to copper and oil vs. Toromont’s exposure to gold and nickel. Nevertheless, if our call is based primarily on bottom-up fundamentals, not end market outlooks, it might surprise some investors that we are recommending Finning over Toromont. Indeed, shouldn’t the performance discrepancy that we outlined earlier in this report lead to the opposite conclusion?

Even after considering the underlying differences in these two CAT dealerships, it is difficult to deny that Toromont has demonstrated a stronger track record. But that doesn’t necessarily mean that it is the better stock to own right now. Although we are recommending Toromont’s shares (with our Outperform rating), we believe that Finning’s risk-reward profile looks more attractive. The main reason is that we see significant potential for multiple expansion on Finning’s stock if it can address some of the operational and cultural issues we have outlined above and improve its execution. For reasons that this report has discussed, Finning’s margins in Canada may never reach Toromont’s level, but if the company can leverage enough change to generate higher ROIC, better free cash flow, and steadier earnings through a cycle, we believe its multiple will expand. On the other hand, if Finning fails to improve its performance, the valuation downside is, we believe, limited by the fact that the stock is already trading near an historical low and at an unprecedented discount to Toromont.

Importantly, we are not suggesting that Toromont’s shares are overvalued. The company’s strong performance and superior balance sheet clearly warrants a premium multiple. However, we see less opportunity for its multiple to expand from here, at least without Finning following along. In fact, as (if?) Toromont evolves into more of a mining dealer there is, in our view, a risk that its returns might deteriorate as the operations get more complex. This, in turn, could lead to some valuation downside over time. Given the company’s excellent track record and impressive culture, we believe this risk is fairly limited. Still, it is something for investors to consider when we evaluate the relative risk-return profiles of these two stocks.

To put a final point on the current valuation gap, we refer back to Exhibits 2 and 3 of this report. There we can see that over the past 15 years, the weighted average forward P/E multiple for Toromont’s stock has been 16.1x, which is almost exactly the same as Finning’s weighted average P/E multiple of 16.3x. The variance around these averages has also been quite similar over time, although the respective multiples have never tracked each other perfectly. For example, at the peak of the last cycle (2007), Finning’s stock was trading at roughly a three-point premium to Toromont. More recently, that situation has reversed and Toromont now commands nearly a four point premium.

Taking this report full circle, we return to the question: why pay more? The answer, we believe, lies in the superior returns that Toromont has been able to generate over a long period of time. In other words, notwithstanding its premium price, we believe there is still value in Toromont’s stock and we encourage investors to buy it and rate it Outperform. However, we see even more value in Finning shares. Accordingly, we rate the stock Strong Buy and have increased our target price to $30.00. Using a target P/E multiple of 13.0x our 2014 EPS estimate—one point above the 5-year average low P/E—we are still assuming that it will trade at a discount to Toromont ($26.50 target; equal to 5-year average P/E of 16.0x) but that the spread will slightly narrow as Finning performance improves in its Canadian operations.

We believe Finning’s stock will get rerated upwards if it can address some of the operational and cultural issues we have outlined above and improve its execution

There is still value in Toromont’s stock, but we see even more value in Finning’s stock




Appendix: Finning vs. Toromont Executive and Board Member Share Ownership

Tenure-adjusted value of Name Director Since # shares owned Value of shares owned shares (value/ # yrs)

Doug Whitehead 1999 158,299 $3,591,804 $256,557Andrew Simon 1999 35,000 $794,150 $56,725Ricardo Bacarreza 1999 28,000 $635,320 $45,380John Reid 2006 20,000 $453,800 $64,829Kathleen O'Neil 2007 14,000 $317,660 $52,943Bruce Turner 2006 11,090 $251,632 $35,947James Carter 2007 10,000 $226,900 $37,817Michael Wilson 2013 10,000 $226,900 $226,900David Emerson 2008 7,300 $165,637 $33,127Chirs Patterson 2010 4,175 $94,731 $31,577

Total Director $6,758,534% of mkt cap 0.17%

Average Director $675,853 $84,180Median $284,646 $49,162

Name Title # shares owned # of DSUs Value of shares/DSUs ownedSmith CFO 21,679 $491,897Villegas COO 27,169 $616,465Fraser Pres. FTT Canada 15,184 $344,525Marchese Pres. FINSA 20,173 $457,725

Total Exec $1,910,611% of mkt cap 0.05%Average Exec $477,653

Tenure-adjusted value of Name Director Since # shares owned Value of shares owned shares (value/ # yrs)

Ogilvie 1986 2,015,896 $47,877,530 $1,773,242Hill 1988 222,000 $5,272,500 $210,900Franklin 1994 117,700 $2,795,375 $147,125Medhurst 2012 61,185 $1,453,144 $1,453,144MacCallum 1985 60,000 $1,425,000 $50,893Galloway 2002 23,500 $558,125 $50,739Chishom 2011 12,000 $285,000 $142,500

Total Director $59,666,674% of mkt cap 3.27%

Average Director $8,523,811 $546,935Median $1,453,144 $147,125

Name Title # shares owned # of DSUs Value of shares/DSUs ownedOgilvie Exec Chair 2,015,896 - $45,740,680Medhurst CEO 61,185 $9,981 $1,614,757Jewer CFO 26,507 $28,555 $1,249,357Casson Pres. TIH CAT 135,523 $14,007 $3,392,836

Total Exec $51,997,629% of mkt cap 2.85%Average Exec $12,999,407

Avg (excl. Ogilvie) $2,085,650

FTT

FTT Executive Managers

TIH Directors

TIH Executive Managers

Data as of December 31, 2012. Data only includes shares purchased in the market or earned in lieu of cash compensation; options or PSUs not included.




Finning International FTT-TSX Rating: Strong Buy Suitability: GrowthCurrent Price (Sep-20-13) C$22.68 Target Price (6-12 mos) Old: C$24.00 New: C$30.0052-Week Range C$27.30 - C$20.37 Total Return to Target 35%Market Capitalization (mln) C$3,908 Dividend/Yield C$0.61/2.7%Shares Outstanding (mln, f.d.) 172.3 Current Net Debt (mln) C$1,98810 Day Avg Daily Volume (000s) 488 Enterprise Value (mln) C$5,896

EPS 1Q 2Q 3Q 4Q Full Revenue EBITDA P/E EV/EBITDA Mar Jun Sep Dec Year (mln) (mln)

2012A C$0.39 C$0.47 C$0.49 C$0.55 C$1.90 C$6,622 C$711 11.9x 8.6x Old 2013E 0.45A 0.48A 0.52 0.55 2.00 6,640 737

New 2013E 0.45A 0.53A 0.52 0.55 2.00 6,640 737 11.4x 8.0x Old 2014E NA NA NA NA 2.30 6,800 792

New 2014E NA NA NA NA 2.30 6,800 792 9.9x 7.4x

EBITDA Segmented Segmented Segmented Margin (%) Revenue

(mln): Canada

Revenue (mln): U.K.

Revenue (mln): FINSA

2012A 10.7% C$3,278 C$901 C$2,444 Old 2013E 3,081 843 2,717

New 2013E 11.1% 3,081 843 2,717 Old 2014E 3,175 850 2,775

New 2014E 11.6% 3,175 850 2,775 Source: Raymond James Ltd., Thomson One

Toromont Industries TIH-TSX Rating: Outperform Suitability: GrowthCurrent Price (Sep-20-13) C$23.32 Target Price (6-12 mos) C$26.5052-Week Range C$24.54 - C$18.61 Total Return to Target 16%Market Capitalization (mln) C$1,799 Dividend/Yield C$0.52/2.2%Shares Outstanding (mln, f.d.) 77.2 Current Net Debt (mln) C$16710 Day Avg Daily Volume (000s) 110 Enterprise Value (mln) C$1,967

EPS 1Q 2Q 3Q 4Q Full Revenue EBITDA P/E EV/EBITDA Mar Jun Sep Dec Year (mln) (mln)

2012A C$0.22 C$0.33 C$0.43 C$0.59 C$1.56 C$1,507 C$223 14.9x 8.8x Old 2013E 0.23A 0.35A 0.41 0.55 1.55 1,527 225

New 2013E 0.23A 0.35 0.41 0.55 1.55 1,527 225 15.1x 8.7x Old 2014E NA NA NA NA 1.65 1,581 238

New 2014E NA NA NA NA 1.65 1,581 238 14.1x 8.3x

EBITDA Margin (%) 2012A 14.8%

Old 2013E New 2013E 14.8%

Old 2014E New 2014E 15.0%

Source: Raymond James Ltd., Thomson One



Company Citations Company Name Ticker Exchange Currency Closing Price RJ Rating RJ EntityAgnico Eagle Mines AEM NYSE US$ 29.44 3 RJ LTD.Baffinland Iron Mines Corp. BIM TSX NC Caterpillar Inc. CAT NYSE US$ 87.84 2 RJ LTD.Cervus Equipment Corp. CVL TSX C$ 19.75 2 RJ LTD.Cliffs Natural Resources CLF NYSE NC Detour Gold Corp. DGC TSX C$ 10.60 2 RJ LTD.Enerflex Ltd. EFX TSX C$ 14.07 3 RJ LTD.Goldcorp GG NYSE NC HudBay Minerals, Inc. HBM TSX C$ 9.06 3 RJ LTD.Newmont Mining Corporation NEM NYSE NC Osisko Mining Corp. OSK TSX C$ 5.65 3 RJ LTD.Rainy River Resource Ltd RR TSXV NC Rocky Mountain Dealerships Inc. RME TSX C$ 11.54 3 RJ LTD.Stillwater Mining Co. SWC NYSE NC Strongco Corp. SQP TSX C$ 3.86 3 RJ LTD.Titan Corp. TTN NYSE NC Wajax Corp. WJX TSX C$ 37.34 3 RJ LTD. Notes: Prices are as of the most recent close on the indicated exchange and may not be in US$. See Disclosure section for rating definitions. Stocks that do not trade on a U.S. national exchange may not be registered for sale in all U.S. states. NC=not covered.



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are only permitted to sell those positions five days after the rating has been lowered to Underperform. The Analyst and/or Associate or a member of his/their household has a long position in the securities of Caterpillar Inc. The Analyst and/or Associate or a member of his/their household has a long position in the securities of Finning International. The Analyst and/or Associate or a member of his/their household has a long position in the securities of Toromont Industries.

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Ratings and Definitions Raymond James Ltd. (Canada) definitions

Strong Buy (SB1) The stock is expected to appreciate and produce a total return of at least 15% and outperform the S&P/TSX Composite Index over the next six months. Outperform (MO2) The stock is expected to appreciate and outperform the S&P/TSX Composite Index over the next twelve months. Market Perform (MP3) The stock is expected to perform generally in line with the S&P/TSX Composite Index over the next twelve months and is potentially a source of funds for more highly rated securities. Underperform (MU4) The stock is expected to underperform the S&P/TSX Composite Index or its sector over the next six to twelve months and should be sold.

Raymond James & Associates (U.S.) definitions

Strong Buy (SB1) Expected to appreciate, produce a total return of at least 15%, and outperform the S&P 500 over the next six to 12 months. For higher yielding and more conservative equities, such as REITs and certain MLPs, a total return of at least 15% is expected to be realized over the next 12 months. Outperform (MO2) Expected to appreciate and outperform the S&P 500 over the next 12-18 months. For higher yielding and more conservative equities, such as REITs and certain MLPs, an Outperform rating is used for securities where we are comfortable with the relative safety of the dividend and expect a total return modestly exceeding the dividend yield over the next 12-18 months. Market Perform (MP3) Expected to perform generally in line with the S&P 500 over the next 12 months. Underperform (MU4) Expected to underperform the S&P 500 or its sector over the next six to 12 months and should be sold. Suspended (S) The rating and price target have been suspended temporarily. This action may be due to market events that made coverage impracticable, or to comply with applicable regulations or firm policies in certain circumstances, including when Raymond James may be providing investment banking services to the company. The previous rating and price target are no longer in effect for this security and should not be relied upon.

Raymond James Latin American rating definitions Strong Buy (SB1) Expected to appreciate and produce a total return of at least 25.0% over the next twelve months. Outperform (MO2) Expected to appreciate and produce a total return of between 15.0% and 25.0% over the next twelve months. Market Perform (MP3) Expected to perform in line with the underlying country index. Underperform (MU4) Expected to underperform the underlying country index. Suspended (S) The rating and price target have been suspended temporarily. This action may be due to market events that made coverage impracticable, or to comply with applicable regulations or firm policies in certain circumstances, including when Raymond James may be providing investment banking services to the company. The previous rating and price target are no longer in effect for this security and should not be relied upon.

Raymond James Euro Equities, SAS rating definitions Strong Buy (1) Expected to appreciate, produce a total return of at least 15%, and outperform the Stoxx 600 over the next 6 to 12 months. Outperform (2) Expected to appreciate and outperform the Stoxx 600 over the next 12 months. Market Perform (3) Expected to perform generally in line with the Stoxx 600 over the next 12 months. Underperform (4) Expected to underperform the Stoxx 600 or its sector over the next 6 to 12 months. Suspended (S) The rating and target price have been suspended temporarily. This action may be due to market events that made coverage impracticable, or to comply with applicable regulations or firm policies in certain circumstances, including when Raymond James may be providing investment banking services to the company. The previous rating and target price are no longer in effect for this security and should not be relied upon.



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Suitability Categories (SR) Total Return (TR) Lower risk equities possessing dividend yields above that of the S&P 500 and greater stability of principal.

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Rating Distributions

Coverage Universe Rating Distribution Investment Banking Distribution RJL RJA RJ LatAm RJEE RJL RJA RJ LatAm RJEE

Strong Buy and Outperform (Buy) 61% 51% 43% 47% 34% 25% 0% 0% Market Perform (Hold) 39% 43% 57% 32% 23% 10% 0% 0% Underperform (Sell) 0% 6% 0% 21% 0% 3% 0% 0% Raymond James Relationship Disclosures Raymond James Ltd. or its affiliates expects to receive or intends to seek compensation for investment banking services from all companies under research coverage within the next three months.

Company Name Disclosure Agnico Eagle Mines Raymond James Ltd - the analyst and/or associate has viewed the material operations of

Agnico Eagle Mines. Raymond James Ltd - within the last 12 months, Agnico Eagle Mines has paid for all or a material portion of the travel costs associated with a site visit by the analyst and/or associate.

Caterpillar Inc. Raymond James Ltd - the analyst and/or associate has viewed the material operations of Caterpillar Inc..

Cervus Equipment Corp. Raymond James Ltd - the analyst and/or associate has viewed the material operations of Cervus Equipment Corp.. Raymond James Ltd. has provided non-investment banking securities-related services within the last 12 months with respect to Cervus Equipment Corp.. Raymond James Ltd. has received compensation for investment banking services within the last 12 months with respect to Cervus Equipment Corp.. Raymond James Ltd. has received compensation for services other than investment banking within the last 12 months with respect to Cervus Equipment Corp.. Raymond James Ltd. makes a market in the securities of Cervus Equipment Corp..



Company Name Disclosure Detour Gold Corp. Raymond James Ltd - the analyst and/or associate has viewed the material operations of

Detour Gold Corp.. Raymond James Ltd - within the last 12 months, Detour Gold Corp. has paid for all or a material portion of the travel costs associated with a site visit by the analyst and/or associate. Raymond James Ltd. has managed or co-managed a public offering of securities within the last 12 months with respect to Detour Gold Corp.. Raymond James Ltd. has provided investment banking services within the last 12 months with respect to Detour Gold Corp.. Raymond James Ltd. has received compensation for investment banking services within the last 12 months with respect to Detour Gold Corp..

Enerflex Ltd. Raymond James Ltd - the analyst and/or associate has viewed the material operations of Enerflex Ltd..

Finning International Raymond James Ltd - the analyst and/or associate has viewed the material operations of Finning International. Raymond James Ltd. has managed or co-managed a public offering of securities within the last 12 months with respect to Finning International. Raymond James Ltd. has provided investment banking services within the last 12 months with respect to Finning International. Raymond James Ltd. has received compensation for investment banking services within the last 12 months with respect to Finning International.

HudBay Minerals, Inc. Raymond James Ltd - the analyst and/or associate has viewed the material operations of HudBay Minerals, Inc.. Raymond James Ltd - within the last 12 months, HudBay Minerals, Inc. has paid for all or a material portion of the travel costs associated with a site visit by the analyst and/or associate. Raymond James Ltd. has received compensation for investment banking services within the last 12 months with respect to HudBay Minerals, Inc.. Raymond James Ltd. makes a market in the securities of HudBay Minerals, Inc..

Osisko Mining Corp. Raymond James Ltd - the analyst and/or associate has viewed the material operations of Osisko Mining Corp.. Raymond James Ltd - within the last 12 months, Osisko Mining Corp. has paid for all or a material portion of the travel costs associated with a site visit by the analyst and/or associate.

Rocky Mountain Dealerships Inc.

Raymond James Ltd - the analyst and/or associate has viewed the material operations of Rocky Mountain Dealerships Inc..

Toromont Industries Raymond James Ltd - the analyst and/or associate has viewed the material operations of Toromont Industries. Raymond James Ltd - within the last 12 months, Toromont Industries has paid for all or a material portion of the travel costs associated with a site visit by the analyst and/or associate.

Wajax Corp. Raymond James Ltd - the analyst and/or associate has viewed the material operations of Wajax Corp..

Stock Charts, Target Prices, and Valuation Methodologies Valuation Methodology: The Raymond James methodology for assigning ratings and target prices includes a number of qualitative and quantitative factors including an assessment of industry size, structure, business trends and overall



attractiveness; management effectiveness; competition; visibility; financial condition, and expected total return, among other factors. These factors are subject to change depending on overall economic conditions or industry- or company-specific occurrences.

Target Prices: The information below indicates target price and rating changes for the subject companies included in this research.

Valuation Methodology: We value Finning on a comparative basis to historical P/E multiples.

Valuation Methodology: We value Toromont on a comparative basis to historical P/E multiples.

Risk Factors General Risk Factors: Following are some general risk factors that pertain to the projected target prices included on Raymond James research: (1) Industry fundamentals with respect to customer demand or product / service pricing could



change and adversely impact expected revenues and earnings; (2) Issues relating to major competitors or market shares or new product expectations could change investor attitudes toward the sector or this stock; (3) Unforeseen developments with respect to the management, financial condition or accounting policies or practices could alter the prospective valuation.

Risks - Finning International a) Several sources of foreign exchange risk could affect either favourably or adversely Finning’ financial performance. Finning sources most of its products from the U.S., and records the results of its U.K., Chilean, Argentinean and Uruguayan operations in Canadian dollars. As a result, changes in any of the aforementioned country’s currencies directly affect the company’s performance. To mitigate the foreign exchange risk, Finning uses a combination of derivative strategies; b) our financial forecast assumes that Finning will continue to be able to identify appropriate markets in which to expand. Failure to do so would likely have negative implications on the company’s earnings; c) Finning’s business is reliant on agreements with several equipment manufacturers and distributors, the most significant being Caterpillar; d) Finning’s operations are also influenced by commodity price fluctuations, however, we believe that the company’s broad operations in the forestry, metals, petroleum and thermal coal sectors help minimize commodity-related risks; and e) interest rate fluctuation may adversely or favourably affect the company’s ability to raise capital in the form fixed or floating rate debt.

Risks - Toromont Industries a) Toromont’s future growth is sensitive to the general level of economic activity and the company’s ability to identify suitable acquisition candidates and/or appropriate markets in which to expand; b) Toromont’s business is reliant on agreements with several equipment manufacturers and distributors, the most significant being Caterpillar; c) Toromont sources products and generates revenues from the United States. As a result, fluctuations in the C$/US$ exchange rate directly affect the company’s financial performance; d) Toromont’s operations are also influenced by commodity price fluctuations, especially natural gas; e) demand for the Caterpillar/Toromont products and services may be significantly impacted by fluctuations in commercial and industrial construction, infrastructure spending and the level of economic activity; f) labour agreements could subject the company to greater risks of work interruption and impair Toromont’s ability to achieve cost savings; and g) interest rate fluctuations may adversely or favourably affect the company’s ability to raise capital in the form of fixed or floating rate debt.

Additional Risk and Disclosure information, as well as more information on the Raymond James rating system and suitability categories, is available for Raymond James at rjcapitalmarkets.com/Disclosures/index and for Raymond James Limited at www.raymondjames.ca/researchdisclosures.

International Disclosures For clients in the United States:

For clients in the United States: Any foreign securities discussed in this report are generally not eligible for sale in the U.S. unless they are listed on a U.S. exchange. This report is being provided to you for informational purposes only and does not represent a solicitation for the purchase or sale of a security in any state where such a solicitation would be illegal. Investing in securities of issuers organized outside of the U.S., including ADRs, may entail certain risks. The securities of non-U.S. issuers may not be registered with, nor be subject to the reporting requirements of, the U.S. Securities and Exchange Commission. There may be limited information available on such securities. Investors who have received this report may be prohibited in certain states or other jurisdictions from purchasing the securities mentioned in this report. Please ask your Financial Advisor for additional details and to determine if a particular security is eligible for solicitation in your state. Raymond James Ltd. is not a U.S. broker-dealer and therefore is not governed by U.S. laws, rules or regulations applicable to U.S. broker-dealers. Consequently, the persons responsible for the content of this publication are not licensed in the U.S. as research analysts in accordance with applicable rules promulgated by the U.S. Self Regulatory Organizations. Any U.S. Institutional Investor wishing to effect trades in any security should contact Raymond James (USA) Ltd., a U.S. broker-dealer affiliate of Raymond James Ltd.

For clients in the United Kingdom: For clients of Raymond James & Associates (London Branch) and Raymond James Financial International Limited (RJFI): This document and any investment to which this document relates is intended for the sole use of the persons to whom it is addressed, being persons who are Eligible Counterparties or Professional Clients as described in the FCA rules or persons

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described in Articles 19(5) (Investment professionals) or 49(2) (High net worth companies, unincorporated associations etc) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (as amended) or any other person to whom this promotion may lawfully be directed. It is not intended to be distributed or passed on, directly or indirectly, to any other class of persons and may not be relied upon by such persons and is therefore not intended for private individuals or those who would be classified as Retail Clients.

For clients of Raymond James Investment Services, Ltd.: This report is for the use of professional investment advisers and managers and is not intended for use by clients. For purposes of the Financial Conduct Authority requirements, this research report is classified as independent with respect to conflict of interest management. RJA, RJFI, and Raymond James Investment Services, Ltd. are authorised and regulated by the Financial Conduct Authority in the United Kingdom. For clients in France: This document and any investment to which this document relates is intended for the sole use of the persons to whom it is addressed, being persons who are Eligible Counterparties or Professional Clients as described in “Code Monétaire et Financier” and Règlement Général de l’Autorité des Marchés Financiers. It is not intended to be distributed or passed on, directly or indirectly, to any other class of persons and may not be relied upon by such persons and is therefore not intended for private individuals or those who would be classified as Retail Clients.

For institutional clients in the European Economic Area (EEA) outside of the United Kingdom: This document (and any attachments or exhibits hereto) is intended only for EEA institutional clients or others to whom it may lawfully be submitted. Raymond James International and Raymond James Euro Equities are authorized by the Autorité de Contrôle Prudentiel in France and regulated by the Autorité de Contrôle Prudentiel and the Autorité des Marchés Financiers. Proprietary Rights Notice: By accepting a copy of this report, you acknowledge and agree as follows:

This report is provided to clients of Raymond James only for your personal, noncommercial use. Except as expressly authorized by Raymond James, you may not copy, reproduce, transmit, sell, display, distribute, publish, broadcast, circulate, modify, disseminate or commercially exploit the information contained in this report, in printed, electronic or any other form, in any manner, without the prior express written consent of Raymond James. You also agree not to use the information provided in this report for any unlawful purpose. This is RJA client releasable research This report and its contents are the property of Raymond James and are protected by applicable copyright, trade secret or other intellectual property laws (of the United States and other countries). United States law, 17 U.S.C. Sec.501 et seq, provides for civil and criminal penalties for copyright infringement.

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INSTITUTIONAL EQUITY SALESHEAD OF SALES

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TORONTO (CAN 1.888.601.6105 | USA 1.800.290.4847) LAURA ARRELL (U.S. EQUITIES) 416.777.4920 SEAN BOYLE 416.777.4927 JEFF CARRUTHERS, CFA 416.777.4929 RICHARD EAKINS 416.777.4926 JONATHAN GREER 416.777.4930 DAVE MACLENNAN 416.777.4934 ROBERT MILLS, CFA 416.777.4945 DOUG OWEN 416.777.4925 NICOLE SVEC-GRIFFIS, CFA (U.S. EQUITIES) 416.777.4942 NEIL WEBER 416.777.4931 CARMELA AVELLA (ASSISTANT) 416.777.4915 ORNELLA BURNS (ASSISTANT) 416.777.4928

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LONDON JON DE VOS 0.207.426.5632 ADAM WOOD 0.207.426.5612

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TORONTO (CANADA 1.888.601.6105 | USA 1.800.290.4847) PAM BANKS 416.777.4923 ANTHONY COX 416.777.4922 OLIVER HERBST 416.777.4947 ANDY HERRMANN 416.777.4937 ERIC MUNRO, CFA 416.777.4983 JAMES SHIELDS 416.777.4941 BOB STANDING 416.777.4921 PETER MASON (ASSISTANT) 416.777.7195

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