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Finning International Inc
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Thank you for standing by. This is the conference operator. Welcome to the Finning International Second Quarter 2019 Conference Call and Webcast. [Operator Instructions] The conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Mauk Breukels, Vice President, Investor Relations and Corporate Affairs. Please go ahead.
Well, thank you, operator, and thanks to everyone for joining us. On the call with me today are Scott Thomson, President and CEO; Steve Nielsen, CFO; and Anna Marks, Senior Vice President, Corporate Controller. Following the remarks by Scott and Steve, we will open up the line to questions. An audio file of this conference call will be archived at finning.com.Before I turn it over to Scott, I want to remind everyone that some of the statements provided during this call and information on the slides is forward-looking. This forward-looking information is subject to risks, uncertainties and other factors, as discussed in our annual information form under Key Business Risks and forward-looking information and in our MD&A under Risk Factors and Management and forward-looking disclaimer.Please treat this information with caution as Finning's actual results, performance or achievements, could differ materially from current expectations. Except as required by law, we do not undertake any obligation to update this information.Scott, over to you.
Good morning. We are pleased to report our operating results for the second quarter. Earnings per share were $0.54, up 14% year-over-year. Revenues in Canada were up 18%, while SG&A costs increased by only 5%. This demonstrates our focus on reducing the cost to serve in competitive markets and improving operating efficiencies. EBITDA margin was 12.9%, and return on invested capital was 15.4%. In South America, product support revenues are back to normal run rates. In fact, they were up slightly from Q2 of last year. We are pleased with the improved margins this quarter and expect to see continued improvements through the second half of the year. U.K. and Ireland delivered a solid quarter, with return on invested capital of 14.5%. Revenues in Canada were stronger than expected due to higher equipment and part sales in the oil sands and more robust equipment sales in construction. The sustained improvement of the price differential between WTI and Western Canadian Select is a good development, with oil production in Western Canada up 14% year-over-year. Business with producers and contractors remain steady and competitive. While the size of the construction equipment market in Western Canada has declined, the demand environment remains somewhat stronger than our expectations at the beginning of the year. During the quarter, the growth in construction equipment sales was largely driven by market share gains, particularly in core construction equipment. Overall, we are seeing positive signs in Canada. There is a new government in Alberta that recognizes the need to improve the outlook for Western Canadian oil and gas producers. Progress has been made on Trans Mountain pipeline and LNG. And at the moment, we are collectively or actively quoting equipment packages for contractors who will be engaged in major projects. We are seeing significant interest in autonomous trucks and their introduction is going very well. We now have 14 autonomous trucks in Western Canada. One large oil sands producer is now operating 8 trucks in the production environment after operating a few 797 trucks in a test environment. Another customer, Teck, is operating 6 autonomous 793 haul trucks at the Highland Valley Copper mine in British Columbia. The Caterpillar autonomous trucks are interoperable, retrofitable and scalable. Miners around the world are choosing Caterpillar for their autonomous solution. For example, Caterpillar just announced the introduction of a fleet of autonomous trucks and ancillary equipments to Rio Tinto's "mine of the future program."Let me now turn to South America. Activity levels in Chile are encouraging. Global miners, such as Teck and Newmont Goldcorp, will be making significant investments in Chile. GDP is forecast to grow 3%, and the government is spending an additional 10% on infrastructure this year. Year-to-date, new equipment sales in South America were up 25%, driven principally by delivery of equipment to the mining industry in Chile. Our product support revenues recovered faster than we expected. We did incur some extra costs, such as people and freight, as we focused on restoring parts well in service to our customers as quickly as possible. Overall, we are pleased with the margins we achieved in Q2, particularly given the revenue mix shift to new equipment sales. We are now improving our processes and eliminating some costs with the objective of improving South America's profitability to 8.5% to 9% by the end of the year.In Argentina, the construction and Power Systems markets remain weak, and we don't expect business conditions to improve until after the presidential elections in October. We have taken steps to reduce the cost structure in Argentina and are operating at modest profitability levels. In the U.K., it is possible that there will be a hard Brexit on October 31. This situation is negatively impacting customer confidence. And in the near term, we expect to see slower demand in the general construction market. However, it is important to note that in the last 12 months, the top line in the U.K. has grown at 13% relative to GDP growth of just over 1%. The growth -- this growth has been driven primarily by Power Systems, which has generally not been impacted by the uncertainty around Brexit. In fact, our team has just secured a significant order from an existing customer for an expansion of their data center in the Dublin area. We expect continued Power Systems growth and increased infrastructure spend from the U.K. government, which will assist in underpinning 2020 revenue. I will close by saying we are pleased with the results and our ability to capture demand for equipment and product support across all regions. For the remainder of 2019, we expect our year-over-year revenue growth rate to be similar to the first half of the year, leading to a stronger consolidated top line in 2019 than we were expecting at the beginning of the year. Our priorities are to continue to improve South America's profitability to the second half of 2019 and generate higher returns on invested capital in all of our regions. I will now turn it over to Steve.
Thank you, Scott, and good morning, everyone. We are very pleased with the second quarter results. New equipment sales were up 24% year-over-year with double-digit growth in all regions. Product support growth in Canada continued to be solid and product support revenues in South America recovered faster than we had expected. Canada and U.K. and Ireland, both delivered strong operating performance. EPS was $0.54, up from $0.48 in the second quarter of last year and adjusted earnings per share of $0.30 in the first quarter of 2019. Canada's net revenues included $28 million of contribution from 4Refuel and were up 18% from the second quarter of last year. As expected, large mining deliveries in the oil sands drove strong new equipment sales in the quarter. We also achieved higher sales in construction, particularly in Alberta, despite the reduced size of the overall construction market compared to last year. We are capturing strong demand for our product support in oil sands and other mining. This includes parts, component rebuilds and machine overhauls. Product support revenues in Canada were up 7% compared to the second quarter of last year. In Canada, the shift in revenue mix to new equipment sales in the quarter reduced our overall gross profit margin. However, our initiatives to lower the cost to serve, improve efficiencies and increased market competitiveness are yielding better operating performance. SG&A, as a percentage of net revenue, declined by 220 basis points year-over-year. EBITDA increased by $39 million or nearly 40%. Operational improvements were the main driver of this increase. We also benefited from the contribution of 4Refuel and the adoption of IFRS 16. EBITDA, as a percentage of net revenue, was 12.9%, up from 11%, in the second quarter of last year. In May, the Alberta government announced a gradual reduction of the corporate income tax rate from 12% to 8% over 4 years. As a result, we recorded a $3 million benefit in the second quarter. We believe this is a constructive development for the economy in Alberta. In South America, new equipment sales were up 32% in functional currency, mostly from higher mining deliveries in Chile. Product support was slightly above the second quarter of 2018, but sequentially product support revenues increased by 35%. As Scott mentioned, restoring our product support revenues back to normal run rate so quickly required some additional costs and inventory. We continue to improve our processes, and we will eliminate these costs during the second half of the year. Our focus on increasing workforce productivity, improving efficiencies and reducing the cost to serve remains unchanged. For the quarter, EBITDA margin in South America was 9.8%. We expect continued improvement in South America's profitability through the second half of 2019. In the U.K. and Ireland, revenues increased by 11% in functional currency, driven by robust activity in electric and industrial power markets. While our sales to general construction segments were above last year, overall market activity and customer demand are being impacted by uncertainty surrounding Brexit. EBIT margin was 7.7% in the U.K. and Ireland, which is slightly below second quarter of last year, mostly due to the shift in the revenue mix to new equipment sales. Return on invested capital was 14.5%, up 130 basis points from the second quarter of last year. Our consolidated backlog was $900 million at the end of June, down from $1.2 billion at the end of March, as strong new equipment deliveries outpaced the order intake. However, we do have line of sight to orders that are expected to be added to our backlog during the back half of the year and support our 2020 revenues. In South America, we are actively quoting for significant mining orders. In the U.K. and Ireland, we have just received a large power systems order, as Scott mentioned, from our existing customer for data center expansion in Ireland. And in Canada, large infrastructure opportunities such as Trans Mountain and LNG Canada, both doing well for future orders.Free cash flow in the second quarter was a use of cash of $162 million, mostly as a result of elevated inventories and higher receivable balances due to timing. In Canada, higher equipment inventory support upcoming deliveries. In South America, we are in the process of eliminating excess parts inventories following the ERP system implementation. We expect to sell-through these inventories during the second half of the year, with about 20% reduction to our capital and rental fleet expenditures compared to last year. We continue to expect positive free cash flow in 2019. I will now turn it back to Mauk for the Q&A.
Operator, that concludes our remarks. Before we go through the Q&A, we request everyone on the line that you ask no more than 2 questions when it is your turn. Please go to the end of the queue if you have more questions. Can you open up the lines, please, operator?
[Operator Instructions] Our first question comes from Jacob Bout of CIBC.
Hoping you can comment on the sustainability of the new equipment sales and the drawdown on backlog what we saw in the quarter?
Yes, for sure. And Steve addressed it in the script. We definitely had backlog down in the quarter. And order intake was down in Western Canada. It was better than we were expecting, but it was down relative to last year. That all being said, we feel pretty good about replenishing that backlog. If you look at some -- the infrastructure program in Western Canada and some of the orders we have line of sight to, if you look at the U.K. and then when you look at the improvement in mining in South America, we feel pretty good about the sustainability of the revenue. And that's why we essentially upgraded our revenue outlook for the rest of the year relative to where we were at the start of the year. So hopefully that gives you some clarity.
But did you see that the -- that you think the second half revenue will be kind of in line with back half of 2018?
No, I think what we said at the start is, there is modest growth. We've seen 9% growth now first half of the year. And our expectation is, in the back half of the year, we'll have 9% year-over-year growth.
Second question here, just on the South American EBIT of 6.5%. And you said you're going to get to the 8.5% to 9% range by the end of the year. So we should be assuming that's kind of the run rate for 2020? Or how should we be thinking about that?
Yes. So if you look at the recovery that we're really pleased with the revenue and the revenue came back a little bit faster than we were expecting. I think last quarter we said, revenue run rate during the quarter. So you see our product support revenue are actually higher than last year, and we were really pleased with. And then to see the margin improve with the equipment mix, that's a pretty good outcome. It did come with an extra cost and capital, as Steve highlighted, primarily as you think about freight and some people costs. I think third quarter, you're going to continue to see improvements relative to the second quarter, and then fourth quarter, you'll get into that 8.5% to 9% range. And now we'll get back to kind of where we were. And so then the case is, how do you realize the benefits of the technology investments we have, and how do you capitalize on a much more positive end-market environment. And so we're going to continue to improve this business and get to returns of capital that are beyond our Canadian business. That's the objective.
Our next question comes from Cherilyn Radbourne of TD Securities.
So first question on Canada. Obviously, Canada had a good quarter. And with Kevin Parkes having been in the region for about 6 or 7 months now. I wondered if you could just give us a sense of where he may have identified opportunities to further refine the cost structure and the footprint based on his experience in the U.K?
Thanks, Cherilyn. I think to start, so Kevin has been in the role for 6 months. He's essentially been in Canada now for a year because he moved with family and everything in August. He's kind of got a year under his belt now. He's building on the work that Juan Carlos had done on the cost structure, for sure, and taking some of the lessons learned from the U.K., and you saw that in the first quarter, where we did the restructuring charge around some facilities optimization and some headcount reductions. And he's also taken a couple of learnings we had in the U.K. in terms of supply chain, and how we manage a very complex supply chain, but recognizing that a big part of our orders are in a subset of the equipment. And I think you are starting to see some of that impact come through in the numbers; you look at the SG&A reduction year-over-year, and as Steve mentioned, it was over 200 basis points. And frankly, I think there's more to come as we go through the back half of the year because those all haven't been implemented yet. So I'm really optimistic about the outlook for our Canadian business, particularly in light of an end market that wasn't as, I think, negative, as I thought at the start of the year. And then you layer on some of the macro I guess, silver linings that are out there with new government, Trans Mountain, LNG, a new truck with 794 that we're feeling pretty good about. And I'm looking forward to a good end of the year in 2019 and a strong 2020 from Canada.
Great. And then just moving to South America, you mentioned that the product support revenue had recovered somewhat faster than you thought. Just any comments on how much pent-up demand do you think remains in South America for product support?
Yes. I mean, it's a pretty fluid environment right now, I'd say. I think a lot of the noise on China and U.S., I think, does filter through the copper price and does somewhat impact sentiment, at least. That all being said, when we talk to our customers, there are significant plans to put capital into Chile. And you think about QB2 and the magnitude of that type of investment, you think about some of the interactions we're having with other customers like Codelco, Antofagasta Minerals, Collahausi, I mean, there is pent-up demand. We haven't had the replacement cycle here in Chile. And so my expectation is that subject to the macro, our Chilean business will grow at outsized rates over the next few years relative to our other regions. So I'm pretty optimistic about the outlook here.
Our next question comes from Michael Doumet of Scotia Bank.
So in Canada -- and Scott, you alluded to this -- just wondering whether the bulk of the restructuring was completed in the quarter? And maybe to what extent -- maybe additional cost restructuring could be reflected in subsequent quarters? And I guess, as we think about the company's ability to grow earnings in a slower-growth environment, do you think we've got all the pieces in place in Canada to reach the ROIC targets that you've presented at the investor presentation? Or do you think we'll need better operating environment, overall?
For that last one, I think we have it. I mean, if you look at -- the environment is in place for us to meet the type of targets we laid out. And if you look at year-over-year improvement on ROIC, I think last year it was 300 basis points, you're going to continue to see improvement this year. And then you're starting to get relatively close to that 20% mark. And so I have -- we have line of sight for that, and I feel pretty good about it. In terms of the -- your first question on the charges, you shouldn't expect any further restructuring charges in Canada. What we did in the first quarter was, Kevin had spent some time. He realized what he wanted to do. He made the facility changes, and he announced the headcount reductions. All of those heads have not come out of the business yet. I mean that was announced, and some came out in the second quarter, but there will be additional people -- the headcount will continue to come down in the third and fourth quarter.
And just can you give us a sense of magnitude on the headcount reduction removed in the quarter, I guess, versus your planned reductions that you have?
Probably about half, Michael.
Okay. That's helpful. Maybe just turning -- actually, just again on Canada, if you look at the age of the mining fleet in Canada, there's a considerable amount of trucks in the age, I guess, of 9 to 11 years old and ripe for rebuild. My question is, given the age of the installed fleet, how much longer do you suspect we can continue to see increased rebuild activity? And when do you suspect that opportunity will eventually normalize?
Yes, sure. So just to put that in perspective, there's a lot of conversation around both market share on new equipment and market share on product support, and this rebuilds opportunity is a big opportunity for us. So just putting it in perspective, our OEM business, which is what we do our rebuilds is a 350,000 square foot facility. It's grown at a 3-year CAGR of 16%, a 5-year CAGR of 10%. 2019 will be a record revenue year, and Q2 '19 was the biggest year we've had in OEM. And so that business is going really strong. And our expectation, given the aging of the fleet, is that we'll continue to be very strong as we go forward. Now I think there is a little bit of a dynamic going on in global mining around autonomy, right? And as you look at the benefits of autonomy, I think some miners are evaluating whether do we rebuild or do we go to autonomous fleets. I think the good news about the CAT system is you can retrofit your trucks to go to the autonomous system, if you want, but some miners may choose new trucks as well. And in fact, in this year, we think the number of 797s we announced in the last quarter, but I think we've increased our 797 population in the oil sands by about 10 trucks. And so I think it's going to be a combination, if you would have asked me a couple of years ago, I would have said it mostly on the result side. And I think that will continue strong, but I also think there will be more new equipment than I was probably expecting a couple of years ago.
Our next question comes from Yuri Lynk of Canaccord Genuity Group.
Scott, I wanted to just drill in on the South American margin targets of 8.5% to 9%. When we get there at the end of the year, I mean, how do we think about the puts and takes that go into that range in terms of any lingering ERP costs at that point, heightened competitive conditions, the state of your cost base? I'm just trying to get a figure -- feel for what that number might look like as we move forward? And which of these costs might abate a little bit as we go forward.
Yes. That's great. So if you look the 6.5% we did this quarter and getting to that 8.5% to 9% that we're talking about, that is -- that's not -- that's recovery, right? That's eliminating the costs and a little bit of the capital that we've had through, through the transition here. And so I think that's kind of getting us back to normal, and that's going to be aided a little bit. I mean, if you look at the third quarter of last year, I think our margin in FINSA was around 7% before SAP, and that was impacted a little bit by Argentina, which was a pretty negative or a big deceleration. Now as we go into the third and fourth quarter here, Argentina stabilized. It's modestly profitable. You've recovered on the Chile side, and you're back to 8.5% to 9%, which is kind of where we were a year or 2 ago. I do think there's a continued opportunity to go beyond that. And I think that the combination of the technology investments we've made, which will help our working capital velocity and will help on costs, a combination of the better end-market environment, where you have higher product support from miners and more market share. And I really believe we're going to capture more market share in South America because we have now both the 797 truck and the 794 truck. And historically, we've had about 50% mining market share in South America because we've got a very good competitor with a very good truck. But this 794 truck is the real deal, and it's getting a lot of commentary from miners around the world. We've got installation in Peru that's been very well received. So I think the combination of a great truck, a better macro environment and a cost base that were continually challenging will allow us to show pretty good results in South America over the next 3 to 5 years.
Okay. That's helpful. And then maybe just taking a step back, I mean, you've gone with SAP in South America. It's been a few years since your last ERP in Canada. Correct me if I'm wrong, but I don't think you went with SAP in Canada. So just what's the broader strategy around the company's ERP system longer term?
Yes. I think -- so we're going to do this. So we're going to get it right. We're going to get all the process improved. We want to get the cost of working capital benefits. I think one of the big learnings for me is the lot of the improvement comes from process and thinking to get a lot of the cost out by just having better processes. And some of the digital investments we've made, centrally, I think have allowed us to continue to take some of the cost out in our Canadian business without having to make big systems changes. And so for the -- in the near future, I think what you've seen in South America is probably the last of big technology deployments in spending for a while.
Okay. So you're okay running different systems in different regions. It's -- you just roll it up at the...
Yes.
Our next question comes from Derek Spronck of RBC Capital Markets.
Just around your market share, you indicated that you're gaining market share in certain competitive markets. What do you attribute that to? Is that partly due to the improved service offering? Or is that a price-led market share gain? Any color around that would be helpful.
Yes. And so to put it in perspective, it's pretty significant, right? I mean, it's 400 or 500 basis point improvement year-over-year. And so we're pretty pleased with that. And I -- we've thought a lot about what is driving that. I think it's a combination of a whole bunch of things. One is, last year, we were constrained a little bit on lead times; and our market share, I think, I've told this group, didn't suffer. We kind of remained flat. But clearly, if we would had more equipment, we would have been doing better on market share. And now that we have the inventory on the fence, you can see that that's helpful. I think part of it is, some of the tools that we've given our sales force. We've given over the last 2 years our sales force some tools that help them do their job better, quoting tool, which I think I've talked to many about as an example. Part of it is due to some of the work we've done in digital around pricing. I think we're being a lot more thoughtful around how we price the product. And then partly, listen, Teck's got a great product. It's a great, great product. And for people that have high applications, like high-intensity applications, it's hard to beat from a total cost of ownership. So all in all, I'm feeling pretty good about the construction market share and the construction end markets despite the fact that they have declined somewhat year-over-year.
Okay. That's great. And just moving on to the -- I know you've touched on this before, but the LNG, Trans Mountain Pipeline opportunity. Is that a -- you indicated it's a near-term opportunity. Is near term potentially 2020? And in any way to kind of frame the potential size of that opportunity?
So I think we've said, on the LNG, the whole opportunity is about $500 million to $700 million, and we're going to start to see some of that come through in 2020. So that will start, in earnest, in 2020. On the TMX, we're trying to still size up the TMX order -- the opportunity. My view is it's a $100 million to $200 million type opportunity for us, that's probably, again, 2020, 2021. That being said, we're starting to see some orders now as contractors get more confidence in that going through.
Is it a pretty competitive market for that bid? Or do you think that it can be won somewhat rationally?
So always competitive, but it's not -- this is a different type of situation than dealing with one customer, you're dealing with multiple customers who have multiple contracting opportunities. So it's not like dealing with one big oil sands customer or one big mining customer. So we feel pretty good about our opportunity of profitably growing into that business.
And would it be -- I know you haven't won it, but by and large, it sounds like it would be relatively margin-neutral to a sustainable margin that you're running at?
Yes. Again, listen, I think it's a competitive market out there, but we've got a great product. And so I wouldn't be expecting margin erosion if that's your question.
Our next question comes from Michael Feniger of Bank of America.
You addressed before your inventory levels, especially with the excess parts in South America. I guess I'm just curious, Scott, on the new equipment side, you mentioned the quoting activity in Canada, your comments about miners in Chile. On the new equipment side, do you have to -- did you think you have to build inventory and place some orders now to be in position for that 2020?
Michael, it's Steve Nielsen. No, equipment availability is good. And typically, on the big orders, we have those in advance. We place the orders. We usually have deposits that we share with CAT. So no, typically, we don't. Right now, our inventory surplus in Canada is largely matched either backorder or specific orders, and we expect that to sell-through by the end of the year. So no. So as we talked about going into next year, we don't expect a significant inventory build to support that increased activity.
And then just secondly, you've obviously mentioned the quoting activity and the conversations going on in Chile. I'm just curious, is this more replacement of the aging fleet? Is this more some big mine expansions where the conversations are happening? I was hoping you could just give a little bit more color on kind of what you're actually seeing there and the conversations. You gave great color on the OEM rebuild in Canada. I was just curious how these conversations are playing out in Chile and what type of projects we're talking about.
Yes, Michael, it's a combination. Right? So if you look at the last 5 or 6 years in Chile, there hasn't been a lot of new equipment sales. And despite the fact that our new equipment revenue is up significantly in the quarter, it's off of a low base. And so if you look back, we've had 1 or 2 large orders. The one big order comes to mind 1.5 years ago because there hasn't been a lot. And so now as we're looking forward and engaged with customers, it's a combination of rebuilding a fleet that's aging and greenfield mines. And the obvious greenfield mine that is in the press is QB2, QB3. But there's also a union, which is the Goldcorp Newmont (sic) [ Newmont Goldcorp ] and Teck opportunity. Antofagasta Minerals is looking at expansion. BHP is looking at expansions. Codelco is looking at expansions. Collahausi is looking at expansions. And so it's -- and these things take time, right? So it doesn't mean it's going to hit in the back half of '19, but it is a more productive environment. And I think that's -- we'll be pretty consistent on that. The Piñera government has been pretty focused on getting through the regulatory process. The Piñera government has been pretty focused on supporting the mining business. And the Piñera government has been pretty focused on spending on the economy. And so not only mining but 10% infrastructure spend, and this all takes time to come through. But I think you're starting to see -- and you see it through the top line now in Chile. You're starting to see that take hold a bit in our Chilean business.
[Operator Instructions]Our next question comes from Ben Cherniavsky of Raymond James.
Good quarter. That was nice to see. I mean, you've obviously already provided a lot of commentary, Scott, about the outlook and operations, et cetera. But this is clearly a notable change in your tone and message from at least the last 2 or 3 quarters. Can you speak to what the specific factors were in the inflection point? I mean you mentioned some of the projects that are moving forward, but they aren't really anything new in terms of developments, nothing that was not on the agenda 3, 6 months ago. So is this just overall better execution that's raising your confidence in the outlook? Or what would you attribute the change in the tone to?
Yes. No, it's a good point and a good start. Here, as you think about what we're saying, we're saying modest growth, right, and I was expecting a pretty significant reduction in our Western Canadian business, Alberta, in particular, and that has not played out -- in the construction segment, and that has not played out to the extent that I was thinking. I think I was talking 30% type reduction in industry activity, and it clearly hasn't. It's reduced, but it clearly hasn't been that significant. I think the second thing is oil sands' growth, oil production is up 14% year-over-year. And at the start of the year, when there was all of this noise around curtailments and the outlook. That made for a pretty uncertain environment. So I was a little bit cautious there. And then in Western Canada, third thing is execution, and I think the team is doing a great job executing. So the combination of those 3 things give me comfort that the outlook for the back half of the year is a little bit better than I thought. In Chile, I think, again, that's a little bit of execution and a little bit of outlook. We're 6 months now into more conversations with our customers around potential opportunities, and I'm feeling pretty good about that. Second, our revenue came back faster than I was thinking from a product-support perspective. And so I was thinking it hit revenue run rate during the quarter, not for the whole quarter. And so that makes me feel a little bit better about the outlook as well. So I think it's a combination of execution and macro. And there's still, by the way, there's still clouds out there, right? I don't want people to think I'm not being thoughtful about Brexit and the China-U.S. type rhetoric because those do impact the way our end markets think about deploying capital. And I think we're still in that situation of controlling what you can control, control costs and control inventory because the environment -- the economic environment seems to change every day on us.
Yes. I guess that was going to be my next point was just the -- so recognizing that -- well, nobody knows as better than the sell-side analysts, but just recognizing the difficulty in forecasting the future and what the risks are to 6 months from now as having one of us asked the question, well, in the second quarter, you were really optimistic and what's changed. So I mean, I think you put it well where you just said focusing on what you can control because there's still a lot of uncertainties out there. So you're managing that. But having said that, you're still adding inventory and managing for growth. So what's the balancing act that you're trying to achieve as you sort of weigh all the different variables and increasing uncertainty out there?
Well, that, I think, comes back to the first question that Jacob asked around backlog? And how confident do you feel about the backlog. And I think we have some pretty good clarity into some orders in all 3 regions that will help to replenish that backlog and gives us confidence on the inventory that we have being able to use that. In terms of big lumpy orders, those don't typically come into inventory, right? I mean, you work with the customer to know when they want to deliver, and then you work with CAT to make sure we can meet those delivery schedules, but you don't put the 797 or 794 trucks on your balance sheet. And so really, when we're talking about backlog, you're talking about the general construction sector. And we feel, although uncertain environment, given what we see in terms of new orders and what we see in our backlog, we feel pretty good about the inventory we have.
Okay, that's helpful. And just to follow up, if I could, in the past -- I suppose in the past 2 or 3 quarters, at least, I think it was fair to say you had -- and I don't think this has changed, but you got a real focus on the core operations and getting it right. To the extent that, that may have put additional M&A on the back burner, do you feel like you now sort of have a license to move forwards and look at new opportunities? Or are you still really focused on the core at this point?
Yes -- no, we've got a lot more to do on the core business. I think it was a good quarter, but there's a lot more that we need to do to get to where we want to be, both in Canada and in South America from our return-on-capital perspective. So I think there's a lot more to do there. And then on the M&A front, we just did 4Refuel. I think the early returns are positive, but we've got to prove that out. We've got to prove out that strategic story of revenue synergy story and the shareholder value creation story. So that's my focus right now, those 2 areas.
So never say never, but we should not anticipate M&A this year.
Never say never, but my focus is on 4Refuel and the core business.
Our next question is a follow-up from Cherilyn Radbourne of TD Securities.
Just wanted to follow up on a somewhat related question and that's share buybacks. Scott, you had always indicated that those were more likely to fall in the second half when free cash flow would turn positive. I guess I was somewhat surprised that you didn't act in the second quarter. Maybe you can just kind of comment on your confidence around delivering positive free cash flow for the year and your thoughts on share buybacks here?
Well, I'll ask Steve talk about the free cash flow, and then I'll come back to capital allocation.
So, Cherilyn, to be succinct, we're very confident in generating free cash flow for the year. As I mentioned, we do have some excess inventories that built up in parts in South America and new equipment to support the stronger-than-expected sales, but we both expect both of those situations to monetize through the back half of the year. When we look at the buyback, we hit our net seasonal or within the year peak demand for capital right in the second quarter. So we've been mindful of that. Also, we were mindful of making sure that the recovery in South America was achieved. So Scott, if that...
Yes, yes. On the capital allocation front. I mean, I think we've been pretty consistent through the last 5 years, as don't spend the cash until you have the cash. And so I think in the back half of the year, we'll generate significant cash. It's a very uncertain environment. There's different ways to allocate capital. I think for the last 5 years and the way we've done it, there's a pretty good road map to how we think about it, a combination of internal investments, dividend increases, share repurchases and M&A through synergistic acquisitions. So stay tuned as we get to a place where we have cash to be able to allocate it.
Our next question is a follow-up from Michael Feniger of Bank of America.
Scott, I might have missed this, so apologies. I know you provided the second half margin outlook for South America. You guys made progress there. How are you thinking about the margins in the back half in Canada with some of the puts and takes you have going on in there with mix but also some of the restructuring?
Yes. So on the Canada, while I'm going to keep the ROIC kind of conversation, and last year, we increased ROIC by, I think, it was 300 basis points, '18 over '17, and I continue to believe we're going to see improvements in ROIC in '19 versus '18 and 100, 150 basis points, that's the kind of area that's in my mind. And you don't hold me to that, but my point is, we're going to see continued improvement in '19 versus '18. On the South American margin, we're at 6.5%, which was a significant improvement over 2Q. I think you're going to see a significant improvement in Q3 over Q2, and then you're going to get into that Q4, about 8.5% to 9% range. Hopefully, that's helpful.
This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Breukels for any closing remarks.
Well, thank you very much, operator, and thank you, everyone, for listening. We look forward to speaking with you again after next quarter.
This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.