A Small Cap Industrial With A Wide Moat Advantage

Improving global economic growth is expected to serve as a tailwind for the industrial sector in 2014. Big boys including General Electric (GE), United Technologies (UTX) and Danaher (DHR) are well positioned to pick up revenue from the anticipated uptick in capital expenditures. Ritchie Bros. Auctioneers (RBA), which brokers the resale of large industrial equipment via on-site and online auctions is a decidedly under-the-radar entry point into the sector.

Given its $2.1 billion market cap, Ritchie Bros. Auctioneers might not be on the tip of your tongue, but it’s definitely got the attention of some major investors. Small cap experts Royce Asset Management and the venerated Primecap Asset Management (managers of Vanguard Primecap and Capital Opportunity funds) each own more than 7% of Ritchie Bros. outstanding shares.

Ritchie Bros.’ teeny market cap isn’t more a than rounding error at behemoths such as Google (GOOG), Johnson & Johnson (JNJ) and Berkshire Hathaway (BRK.B). Nonetheless, Ritchie Bros shares a telling characteristic with those mega caps: a designation as one of the 150 or so companies that has a large enough competitive edge to earn a wide-moat designation from Morningstar. (Full disclosure: Morningstar is an investor in YCharts.)

Small size aside, Morningstar considers Ritchie Bros.’ market-leading position in the extremely fragmented industrial-equipment resale market a dominant competitive advantage. From its Vancouver, Canada headquarters the firm has nearly four dozen auction sites in 25 countries. The U.S. and Europe dominate the brick and mortar sites, though the small cap is also on the ground in Beijing, Dubai and Narita, Japan. Buyers can also bid through Ritchie Bros.’ online platform. In the third quarter, an estimated 4.7 million unique visitors trawled the company’s online gateway (rbauctions.com); online bids generated more than one-third of company revenue in the quarter.

Morningstar makes a case that Ritchie Bros. is insulated from the usual cyclicality of industrial demand. When economic growth is pressured there’s more demand for used equipment, which is cheaper than new. And in periods of stronger economic growth demand for OEM equipment picks up so contractors effectively want to make room for their shiny new toys by culling the old stuff. Either way that’s inventory for Ritchie Bros. Auctioneers. All auctions are set without reserves, giving buyers control over pricing.

As shown in this chart, Ritchie Bros. has indeed managed steadier revenue and EBITDA growth since the financial crisis than you might expect from a classic cyclical industrial stock.

RBA Revenue (TTM) Chart

RBA Revenue (TTM) data by YCharts

That said, earnings per share growth still has a ways to go to return to its pre-crisis level:

RBA EPS Diluted (TTM) Chart

RBA EPS Diluted (TTM) data by YCharts

While it didn’t crater during the global financial pullback, it wasn’t immune either. In its third quarter financial release, management noted that it is still feeling the after affects of low OEM demand from 2008-2010. Contractors held onto their equipment longer than usual, and that means what has been hitting the auction platform of late has been older than normal. With OEM demand for industrial equipment picking up since 2011, Ritchie Bros. expects a trickle down effect will be fresher used equipment for sale going forward, which should generate higher auction fees.

Even during the global slowdown Ritchie Bros. managed its dividend growth with the consistency you’d expect from a mega cap:

RBA Dividend Chart

RBA Dividend data by YCharts

A current yield of 2.5% is well above the now sub 2% level for the S&P 500. One note of caution is that since the financial crisis, the dividend payout ratio has climbed from 40% to more than 60%. That said, strong cash flow growth has kept the cash dividend payout ratio below 30%. And while the average industrial stock with a fair value estimate from Morningstar current trades at a 4% premium to fair value, Ritchie Bros. recently traded at a 10% discount to its fair value estimate.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.



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