Titan Machinery is a distributor/retailer of new and used agricultural and construction equipment in the Midwest. They currently own 48 stores with the majority of sales occurring in North Dakota, South Dakota, Iowa, and Minnesota. They recently were brought public in December 2007 by Craig Hallum Capital and Robert W. Baird. Since then, the shares have skyrocketed due to a strong spending season by farmers (due to soaring ag prices) and the company’s ability to acquire dealerships cheaply. Furthermore, over the summer, the stock was not only added to the Russell 2000, it also found its way on to the IBD 100. As a result, TITN is priced far beyond perfection and time and a sanity check should see the stock fall over 50% from current levels.

First, I will provide some background. Titan is a company in an extremely cyclical industry and generally very dependent on farmer incomes and commodity prices as over 80% of sales are into the agricultural market. I’ll not waste time explaining why the construction market is slow for them right now. The first half of 2008 saw farmer incomes explode and for the first time in years, they were awash with cash and there was a mini bubble of capex spending as they replaced old equipment. Titan was a beneficiary of this. They claim to be the largest regional dealer of CNH equipment in North America. Note: they do not have an exclusivity arrangement with CNH. As a result, same store sales in fiscal 2008 vs fiscal 2007 were up 16% and for the first quarter of fiscal 2009 they were up 37.4%! We have seen commodities come off sharply and they are likely to continue lower – I think the days of 38% SSS are gone and very likely to go negative over the next 2-3 quarters.

From the 1Q 2009 10-Q:

“The increase in revenue for the three months ended April 30, 2008 was due to acquisitions contributing to current period revenue and same-store sales growth.  Acquisitions contributed $43.4 million in total revenue, or 59.6% of the increase while same-store sales growth contributed $29.4 million, or 40.4% of the increase.  Same-store sales increased 37.4% over the prior year, which is indicative of the strong market for our products, particularly in the area of equipment sales.  We believe equipment sales were strong in the three months ended April 30, 2008 due to the growth in global demand for agricultural commodities and the positive impact this commodity demand has had on farm income. “

So , the other component of revenue growth besides SSS is acquisitions and that came in at 60% of the increase. Simply put, TITN is a rollup and those have a poor history. They claim to be able to buy at 4x EBITDA and extract value. The banks that brought them public believe that they extract so much value that they deserve a 10x multiple! In fact, one analyst arrives at his price target by assuming a doubling of EBITDA through acquisitions (using money from the secondary) in the next 2 years. This is highly doubtful.

Valuation:

EV = 400mm (including 80mm of cash raised in a secondary offering this past May – I am also including 95mm of floorplan)
Trailing EBITDA 21mm (19x)
Forecast EBITDA 29mm (13.8x)

While CNH, DE, and AG all possess multiples in the single digits, they also manufacture the machinery they sell. TITN is simply a distributor of machines without exclusivity in its regions and low barriers to entry for competition. I believe it should receive an EV/EBITDA near 5 based on other distributor models (car dealers/tech distributors) and certainly not a multiple higher than its suppliers. Using a high end of 8x and allowing for EBITDA to be 35mm for 2009 for no other reason than margin of safety, we arrive at an EV of 280mm or a stock value of $9. I happen to think that with commodities selling off and the unlikelihood of farmers spending as strongly as they did this past spring combined with further M&A activity unlikely at 4x EBITDA, that a strong case can be made that EBITDA can remain flat/fall year over year. The returns on capital of the business are extremely low and I think the market will understand that over the next quarter or two as same store sales growth becomes unsustainable.