Finning International Inc

TSX:FTT

Earnings Call Transcript 2021-Q2

[Operator]

Thank you for standing by. This is the conference operator. Welcome to the Finning International Second Quarter 2021 Investor Call and Webcast. The conference is being recorded. [Operator Instructions]I would now like to turn the conference over to Greg Palaschuk, Executive Vice President and CFO. Please go ahead.

[Greg Palaschuk, Executive VP & CFO]

Thank you, operator. Good morning, everyone, and welcome to Finning's second quarter earnings call. Joining me today is Scott Thomson, President and CEO. Following our remarks today, we'll open the line to questions. This call is being webcast on finning.com. We've also provided a set of slides that we will reference during our prepared remarks.The slides are posted on the Events and Presentation page of the Investor Relations section of our website. You can also view the slides on our webcast page. An audio file of this call and the accompanying presentation will be archived on our website.We'll also make several references today to our June Investor Day. Similarly, those audio files as well as the presentation are available on our website.We're happy to be taking this call today from our Surrey Branch campus in the Greater Vancouver area. We have closed our corporate head office at Great Northern Way in Vancouver and are transitioning to a hybrid model of working from home and working from our branches.Before I turn it over to Scott, I want to remind everyone that some of the statements provided during this call are forward-looking. Please refer to the Slides 10 and 11 for important disclosures about forward-looking information as well as currency and non-GAAP financial measures. Please note that forward-looking information is subject to risks, uncertainties and other factors as discussed in our annual information form and our key business risks and in our MD&A under Risk Factors and management and forward-looking information disclaimer. Please read this information with caution as Finning's actual results could differ materially from current expectations.Scott, over to you.

[L. Scott Thomson, President, CEO & Non]

Thank you, Greg, and good morning, everyone. On today's call, I will speak about our second quarter highlights, our positive outlook and how we are executing on the plan that we laid out at our Investor Day in June. Greg will then provide more details on our regional performance in the second quarter and our progress on reducing SG&A and delivering on our mid-cycle targets.Please turn to Slide 2. We are pleased with strong execution and results in the second quarter. All of our regions delivered outstanding performance, demonstrating operating leverage in a recovering market. I'm very proud of how quickly our teams were able to ramp up and capture market upside while keeping costs low and executing our strategy to drive product support.Market activity began to pick up in mid-February and continued strongly through the second quarter. We have seen a recovery in new equipment demand, which was widespread across all of our regions and was driven by the construction sector. Our new equipment sales were up 47% from Q1 2021, with the U.K. showing the strongest growth as we started delivering to HS2 customers.Our equipment backlog continued to grow in the second quarter to $1.4 billion by the end of June. Order intake in Canada and South America outpaced deliveries in Q2.In Canada, our order intake was the highest since Q3 2018. In South America, building on the recent mining deals with Codelco at the Radomiro Tomic and Ministro Hales mines, which we announced last quarter, we are pleased to have been selected as the auxiliary equipment supplier for Codelco's Andina mine, which is now included in our backlog. This order is valued at about USD 40 million for delivery in the first half of 2022.In addition, we will be providing 27 Caterpillar underground loaders to Codelco's Chuquicamata mine. Ten of these machines are included in our Q2 backlog. Our backlog in the U.K. and Ireland remains at near-record levels and includes GBP 54 million of equipment orders related to the HS2 project. We have begun to quote for 2022 HS2 orders and believe we are well-positioned to continue to capture significantly more than our typical market share of the remaining opportunities for Phase 1 with the assistance of our Quebec platform. In fact, we expect the machine opportunity in 2022 to be at least 50% higher than in 2021.This broad-based backlog build across all regions supports our confidence in the mid-cycle market as we can -- as we see -- continue to see economic recovery gaining momentum in the second half of 2021 and beyond in all of our territories. An acceleration in demand for equipment has placed an industry-wide constraint on the supply chain. Lead times have extended for some product lines, especially in construction equipment.We are working closely with Caterpillar and our customers to meet their equipment needs, including actively sourcing used equipment and offering equipment rebuilds and rental purchase options.We've also improved our supply chain capabilities, including visibility and planning with Caterpillar. At this time, we do not expect the supply chain challenges to materially impact large project deliveries that are currently in our backlog. Our product support revenue increased in all regions and all market sectors from the first quarter of 2021. Recovery in customer activity was a key driver, coupled with our strategy to accelerate product support growth in construction.We are offering more compelling product support solutions, including a broader scope of customer value agreements and flexible options for construction rebuild. In Canada, for example, the number of construction machines we are rebuilding has grown significantly this year, and we continue to see a lot of rebuild opportunities as customers are ramping up project work and lead times on new machines are increasing.Product support revenue in mining is also recovering in both Canada and Chile, and we expect continued improvement in the second half of 2021 and into 2022. We have recently seen a strong uptick in rebuild quotation activity in the oil sands. And in Chile, mining customers are resuming major maintenance work as COVID-19 restrictions are gradually lifted and customers are ramping up production to take advantage of the strong copper price.We are particularly pleased with the strong operating leverage in the second quarter, which demonstrates the progress we've made on our cost structure. Savings from our 2020 cost reduction program and continued productivity initiatives to further reduce fixed costs played a key role in achieving strong profitability in all of our regions. Our SG&A was up just 2% from Q2 2020 on 28% higher revenue.If we compare our results to the second quarter pre-pandemic, Q2 2019, we are confident that we are on the right path to significantly improve the earnings capacity of our business. While our consolidated revenue was still 15% below the pre-pandemic levels in Q2 2019, we were able to exceed Q2 2019 EPS by achieving higher profitability and lowering our finance costs. Our employees should be proud of these strong results.We are also realizing cost and capital benefits from our improved supply chain performance. Our working capital to revenue ratio of 24% was the lowest since 2012, down 430 basis points from Q4 2020. Our inventory turns continued to increase. Compared to the pre-pandemic performance of Q2 2019, our inventory turns are up 20% despite a 15% reduction in revenue. We have been using data and insights from connected machines to order the right inventory at the right time. This has allowed us to get ahead of the present lead-time challenges, which put us in a good position to deliver equipment to our customers on time and meet our mid-cycle revenue targets.We will continue to become more efficient and agile in how we serve our customers. This will not only improve the customer experience, it will also reduce our cost to serve and drive better working capital performance and stronger free cash flow generation. The market recovery is gaining momentum. As discussed at our Investor Day, we have seen significant return on capital improvements in all 3 regions this quarter as improved market activity that we had projected for the back half of 2021 started to unfold earlier, and we expect to see continued improvement in our return on invested capital going forward.In Q2 2021, our ROIC of 13.3% was up 370 basis points from Q4 2020 with a significant increase in all regions, driven by both improved profitability and higher invested capital turnover. This was a great quarter from an execution standpoint, and our outlook remains positive as the global economy recovers in 2021 and beyond. We have announced a 10% dividend increase, which marks our 20th consecutive year of dividend increases.Looking ahead, we are in a excellent position from a cost, inventory and capability perspective to capture the next phase of market growth. With the recovery maturing, I'm confident in the earnings potential of our business going forward.Now I will hand it over to Greg.

[Greg Palaschuk, Executive VP & CFO]

Thank you, Scott. I'm going to provide more details on our regional performance in the second quarter, while highlighting our progress on reduced SG&A and delivering on our mid-cycle target set at Investor Day.Our consolidated second quarter results are summarized on Slide 3. Our results in Q2 of last year were heavily impacted by COVID-19. While we're still providing the comparison to Q2 of 2020, in some cases, we provided comparisons to Q1 of 2021 and other quarters as we believe these are more indicative of our performance.Net revenue was up 28% from Q2 2020 and up 16% from Q1 2021. Sequentially, our revenue growth was driven by strong recovery in new equipment sales and higher product support revenue in all regions. Strong operating leverage in a recovering market drove significant growth in adjusted EBITDA, up 83% year-over-year and up 26% sequentially. Savings from our 2020 cost-reduction program and ongoing productivity initiatives have been instrumental in achieving earnings performance in the second quarter.EPS of $0.56 was a record second quarter, with higher earnings in all regions and lower financing costs compared to Q2 of last year and Q1 of 2021.Slide 4 breaks out the increase in net revenue by line of business compared to Q2 2020. We saw strong revenue recovery in all regions. However, as expected, our net revenue in Canada and South America were still below Q2 2019 levels. Significantly higher new equipment sales were driven by improved demand in the construction sector in all our regions and large project deliveries. An increase in product support revenue reflected improved customer activity and our strategic focus to grow product support market share.Turning to Slide 5. Higher gross profit compared to Q2 2020 was driven by broad-based revenue recovery and improved margins in all lines of business. We have been successfully managing competitive pressures and maintaining our gross profit margin by focusing on growing market share and equipment models that have the most product support opportunity, improving deal execution, including procurement initiatives and using more robust data to drive inventory decisions, improve inventory health and enable pricing optimization.SG&A as a percentage of net revenue was 18.3% as our 3-month run rate continues to decline and demonstrated significant progress towards our mid-cycle target of 17%. If we compare our Q2 2021 SG&A of $313 million to the most recent mid-cycle quarter with a similar net revenue level, such as Q2 2018, you can see that we have reduced our absolute quarterly SG&A by about $30 million, while also absorbing 4 refuels SG&A.Further productivity initiatives that we highlighted at our Investor Day are in the categories of people productivity, facilities productivity and supply chain and are currently underway in all regions. With progress on these SG&A initiatives and revenue momentum underpinned by a growing backlog, we expect to see continued progress towards our SG&A target this year.Moving to our Canadian results and outlook, which are summarized on Slide 6. Net revenue increased by 25% from Q2 2020 and by 14% from Q1 2021, driven by strong demand for new equipment, especially in construction and higher product support activity in all sectors. Compared to Q1 2021, a seasonal increase in demand for new construction equipment in the spring contributed to higher revenue in the second quarter. As we had expected, our revenues were below Q2 2019, which was an exceptionally strong quarter for revenues in Canada, particularly in new equipment and product support.Product support revenue was up 18% from Q2 2020 and compared to Q1 2021, product support was up 4%, driven by improving demand in all sectors, coupled with our strategy to grow product support and construction. SG&A was up 3% from Q2 2020 on a 25% increase in net revenue, driving significantly higher profitability. Our EBIT as a percentage of net revenue was 9.3% in the quarter.Our outlook for Canada remains positive. Growth in the construction sector accelerated in the second quarter. This project work has been ramping up. We're seeing an increase in construction order, construction order intake and improved utilization of construction and heavy rental equipment.In the oil sands, customers remain disciplined on capital expenditures, driving improved demand for rental equipment and a strong uptick and rebuild quoting activity. Stable production and an aging equipment population are expected to support stable and growing product support activity in the oil sands for the foreseeable future.Quoting activity in hard rock and precious metal mining in Western Canada continues to be robust, and we are well-positioned to capture these opportunities, including the BC's Golden Triangle.Please turn to Slide 7. Net revenue was up 23% from Q2 of 2020 in South America and up 9% from Q1 2021 in functional currency, driven by market recovery in all sectors, new equipment and product support. Compared to Q1 2021, new equipment sales were up 14%, and product support revenue was up 8% in functional currency. Chilean mining customers have been lifting COVID-19 restrictions and returning to a more normal operation, driving higher parts and service revenues.In construction, product support activity also improved with the easing of pandemic protocols in both Chile and Argentina. EBIT as a percentage of net revenue was 9.8%. The team has done a great job to capture market recovery while operating with a lower cost base. SG&A was comparable to Q2 of 2020 on 23% higher revenue. Second quarter margin benefited from fewer larger mining deliveries than we expect to see in the second half of this year. We continue to closely monitor the political and economic reform process in Chile, leading to the general election in November of this year and the review of the mining royalty proposal.We expect that mining royalty rates will increase given the political and social situation in the country. However, it is becoming increasingly clear that given the latest debate in the Senate that the current royalty proposal will be modified.We have built our plans with a view that mining royalties will increase moderately. And currently, this appears to be the direction that the Senate is heading towards. Chile's government has expressed the hope that the royalties legislation would be considered more seriously and calmly as it progresses through the Congress' more conservative upper chamber. This process will likely extend into early next year.We believe that Chile will remain globally competitive copper producer. However, until the situation is resolved, international miners are unlikely to spend significant new capital. The electrification trend accelerating demand for copper globally and lower near-term capital deployed in new mines, we believe it will support the currently high copper price.The good news is that the existing mines will continue to operate. The equipment will need to be maintained, repaired and rebuilt, and we're seeing strong quoting activity as customers are looking to maintain and refresh their aging fleets so they can ramp up production and take advantage of high copper prices.Next, I'll turn to the U.K. and Ireland, and I'm on Slide 8. Net revenue nearly doubled year-over-year and was up about 50% in functional currency from Q1 of 2021. Our strong new equipment sales were driven by deliveries to HS2 customers, our system project deliveries to data center customers and a widespread demand recovery in the construction sector, including general infrastructure, coring and demolition.Product support revenue was up 37% year-over-year and 5% from Q1 2021 in functional currency, with significantly improved activity in all sectors. EBIT as a percent of net revenue was 5.3%, with great profitability from the U.K. and Ireland, which demonstrates improved operating leverage and strong execution by the team to capture growth opportunities.U.K. and Ireland continues to lead the recovery globally. The equipment markets are expected to be very active, driven by economic recovery and a ramp-up in HS2 construction activity. Robust demand for our power system solutions, particularly in the data center market is expected to continue. We have a strong backlog of power systems projects with deliveries planned for the second half of '21 -- 2021 and into 2022.Slide 9 summarizes our simple execution plan that we discussed at our Investor Day to drive product support, reduce costs and reinvest a compound and our associated mid-cycle targets for the period of Q3 of 2021 to Q2 of 2022. We are confident in our mid-cycle plan, and the quarter is a great example of our strong execution and momentum. As we discussed at our Investor Day in June, we expect to have about $250 million reinvestment capacity during this mid-cycle period.We have set up a competition for capital between business development and share repurchases. When it comes to business development, our current focus is on complementary bolt-on acquisitions that are highly aligned with our strategy to drive improved outcomes for our customers.In 2021, we expect to deliver strong annual free cash flow. However, the amount will depend on our backlog build and delivery schedule. We have a lot of quotes currently outstanding. Some of those are large and straddle yearend. The timing of those deals and general deliveries may impact 2021 EBITDA to free cash flow conversion, which we had previously projected to be modestly below 50% for the year.Over the next 12 months, we expect our net revenue to be in the range of $7.1 billion to $7.5 billion, driven in part by 8% growth in product support. Over this period, we expect to achieve our target of SG&A as a percentage of net revenue of 17% over annual EPS above $2 per share and demonstrate significant improvement in consolidated ROIC at more than 15%.Operator, I'll now turn the call back to you for questions.

[Operator]

[Operator Instructions] The first question comes from Yuri Lynk with Canaccord Genuity.

[Yuri Lynk]

Congratulations on a great quarter. It was nice to see.

[Greg Palaschuk, Executive VP & CFO]

Thanks, Yuri.

[Yuri Lynk]

Yes. So just to dig in a little bit on Canadian product support in the quarter, still below '19 levels, as you mentioned, I think it's actually below 2018. So that's probably an opportunity longer term. But is the strategy to offset some of the weakness in oil sands with construction? That's what it sounds like that's the way the market is evolving right now. And if that's the case, are there any margin differences between those 2 markets that should be called out when we think about product support?

[L. Scott Thomson, President, CEO & Non]

Yes. Thanks, Yuri. Yes, so there's -- as we highlighted, there's still room for revenue recovery in both new equipment and product support relative to pre-pandemic levels. The oil sands producers are in pretty good shape right now. With the prices where they are, differentials where they are and their current level of CapEx, they're really repairing their balance sheet quite quickly. And so we are expecting in the back half of the year, some improvement and some ability to spend more, and we'll anxiously look to see what 2022 capital budgets are, but we expect them to be up.So we can see some activity picking up, and we expect that to continue in the back half of the year. But as we talked about at Investor Day, it's an and thing. And we're also pushing really hard on growing construction product support. We're looking to grow that at twice the CAGR of the oil sands and the broader mining complex. And so we think that layer is on top. And so it's and thing. And I don't think we will comment on the margins, but it's not -- they're not completely different.

[Yuri Lynk]

Okay. Second and final one for me. Just on the CapEx guidance, $170 million to $210 million. Could you just tell us the portion of that that's going towards rental?

[L. Scott Thomson, President, CEO & Non]

Yes, that's something that we've broken out. It's usually about 1/3. Ultimately, the rental fleet is in good shape. We're seeing good utilization uptick, particularly on heavy rents at the moment. We're probably in a situation where we'd like to add a little more and where it's a bit constrained. And so I think we've ordered what we're going to order. You can see that there was a bit of a net build in the quarter. And so I think we're in a healthy position, and it's well within in range, but we won't be pushing to any upside on rental CapEx.

[Operator]

The next question comes from Jacob Bout with CIBC.

[Jacob Jonathan Bout]

First question is just on how you're thinking about the ramp in discretionary spending as things open up as we think about more travel, labor costs, a little bit more expensive? And then maybe comment on technician availability.

[L. Scott Thomson, President, CEO & Non]

Sure. Yes, it's something that we think about an awful lot. We're really keen to what we say sustain the gains of the model that we've got. And so there's no doubt that there'll be some discretionary costs that come back in. We're being very conscious on that. We're looking to bank as much of the improvements and efficiencies that we've seen, whether that's in the sales force or an administrative staff. One good example is just how we're going on hybrid and work. We plan to slowly bring people back to the office and be very flexible as we do. And so we're looking to sustain as much of the gains as possible. No doubt there will be some that come back. We've always said that our cost reduction program, about 1/3 of the costs would come back through other head count and some discretionary.So we think we're on track for that. And as highlighted in detail at Investor Day, we continue to work on efficiency with our next $50 million to help offset and then make further improvement.

[Jacob Jonathan Bout]

And the...

[L. Scott Thomson, President, CEO & Non]

And on the -- sorry, go ahead.

[Jacob Jonathan Bout]

No, go ahead. [indiscernible]

[L. Scott Thomson, President, CEO & Non]

You asked about labor availability. And it's something that we continue to work on. We added 30 technicians to our RRR network in Canada, for example, this quarter. They are in demand. And so we're very happy to be a premium employer and brand that can attract people, but it still takes effort to get them all in the right places. And so so far, so good, but no doubt that it's competitive out there. And it's something that we manage every week.

[Jacob Jonathan Bout]

Second question is on both around Chile mining product support. And you talk about how you expect to see ramp in product support in the back half of this year as COVID restriction ease. What are you seeing in third quarter so far? And do you expect levels to return to pre-pandemic levels given the political environment?

[L. Scott Thomson, President, CEO & Non]

Yes. So we expect continued momentum. You've seen it for a number of quarters in a row now. It keeps coming back. There's a lot of maintenance that needs to be done. This quarter was good evidence of managing that upturn very effectively. And so that momentum continues. And these operations are running hard. Production has been a little light for some producers while Codelco has been very successful year-to-date on ramping up production. And so we think it continues. People will push for production given prices. I don't think that the political piece will have an impact on operations near term. It will be more capital outlays in the medium to long term. So we think it's solid, and the business is obviously in good shape and progressing well.

[Operator]

The next question comes from Michael Doumet with Scotiabank.

[Michael Doumet, Analyst]

So first off, great quarter. My first question is on margin expectations. I think last quarter we talked about margin trends into the second half. And I think you indicated that mix is going to be somewhat dilutive, the cost and pricing would be an offset. What should we expect in terms of margins? And is there room to build on the Q2 margins into the second half?

[Greg Palaschuk, Executive VP & CFO]

Yes. Thanks, Michael. I mean, it was definitely a healthy quarter. Made a lot of good progress and some favorable mix in that. We have quite a large backlog, particularly in mining. And so in the second half, and particularly in South America, we've got quite a lot of larger mining deliveries, which will, as you mentioned, put some pressure on margins, but we'll continue to work on other areas to help offset that. And so back half of the year, more new equipment. We continue to work in every area to try and offset that and walk through that a bit at Investor Day. But I think solid progress, but more new equipment mix in the back half.

[Michael Doumet, Analyst]

Got you. Okay. And then could you discuss how equipment margins and product support gross margins are trending versus historical? I guess what I'm thinking here is, when I compare this mid-cycle versus the last mid-cycle, should I assume earnings growth will be largely explained by lower SG&A and lower interest costs? Or is there a case here for gross margin expansion by line of business as well?

[L. Scott Thomson, President, CEO & Non]

Hey Michael, it's Scott. So one, SG&A is obviously a big component of it, and you're seeing the benefits of that when you -- as Greg had highlighted, compared to 2019 or 2018. So that's a big component. But I also do think there's gross margin opportunity. And I think the gross margin opportunity is around a couple of things, just being tighter around what I would call as some leakage that sometimes occurs when you're growing a business, and we've spent a lot of resources on quoting tools, technology, incentive plans to make sure that we minimize that leakage and then also solution selling, right?And this CUBIQ platform I think is a real driver of not only market share but value added, I mean that's the obvious example, but there is lots of other examples to the business. Customers value agreement, solution selling, not just selling the piece of equipment. And I think the increase in sophistication of pricing, really tight on process and much more solution selling value-added services to the customer allows you to expand gross margin over time.

[Michael Doumet, Analyst]

That's great. And just, Scott, I mean, are you seeing that now? Or is that something you expect to see I guess in the next couple of quarters?

[L. Scott Thomson, President, CEO & Non]

I think you've seen it. I mean if you look at those numbers across every single business line, gross margin expansion, right, in a very competitive market and in a market where we are not increasing pricing being very sensitive to pricing for our customers who are in a tough spot still. And -- but I think the combination of solution selling, value-added services, a constrained supply chain, you're seeing the impact of that. And it's nice to see, right, across I think every single business line this quarter.

[Greg Palaschuk, Executive VP & CFO]

And I'll just add on inventory health. I mean, the inventory is in a really strong position and having the right inventory at the right age at the right time makes a big difference.

[Operator]

The next question comes from Ross Gilardi with Bank of America.

[Ross Paul Gilardi, Director]

Scott, I know you're making good progress with the electrified underground loader. And you mentioned I think the 10 units in backlog with Codelco. I'm curious more on the surface mining side, let's say, for example, like the cat ultra-sized trucks. How much urgency are you sensing from cats large mining customers for Caterpillar and Finning together to present more of like a comprehensive road map on how and when they're going to decarbonize that part of the product catalog, given some of these very bold emission target reductions that many of those same miners have presented to the market? Like is that a big deal right now? Or is that just something that's out there like a decade from now that they're not really that preoccupied with yet?

[L. Scott Thomson, President, CEO & Non]

Yes. Okay. There's a lot of layers to that question, Ross. So let me take it a couple of stages of time. One, thanks for noticing the underground. We're really pleased with the underground. You saw the Codelco underground. And actually just walking into this meeting, I understand we got into the PO for 10 pieces of equipment for another miner in underground in Chile. And so we're really pleased with that underground activity.And as you said, underground is the logical place to start on battery-powered equipment. And when you look at Cat's offering, they've got a battery-powered underground loader that we're really excited about. So I guess that's point one. Point two, as you think about ultra-class truck surface mining, I think there are some misconceptions out there. We talk about mechanical drive truck and electric drive truck. I mean both of these trucks are combustion engines, right? So there is no battery-powered ultra-class truck out there right now from anybody, right?That being said, as you think about the energy transition and what our customers need, they are increasing, looking towards a battery-powered or hydrogen-powered lower emission solution. And I do think the road map for that is longer term. It's not immediate. It's not next year. It's not the year after, but there is pressure on that. And I think the great news from our perspective is we're partnered with Caterpillar on that. And you saw Caterpillar's announcement last week when they did their results, they used the case study of the mine in Quebec where they are partnering with a customer to provide 0 emissions type equipment.So I guess my point is no one has figured it out yet. There is a lot of urgency around it and Caterpillar's very focused on it. And so I do think over the next couple of years, progress will be made. But right now, the option for a customer is -- in the ultra-class side is a combustion engine.Now I do think because of this transition, you probably see some customers wait a little bit on the capital expenditure to have big new fleet renewals until the transition and where the OEMs are heading is a little bit clearer. And does that result in a little bit of capital constraint over the next couple of years potentially. And for us obviously that's an opportunity on rebuilds and maintaining the fleet. So that's something we'll be very focused. So hopefully, I answered the different layers of your question there.

[Ross Paul Gilardi, Director]

No, that's great, Scott. That was -- you just at the very end, answered part 2 of my question. So do you think that is part of the reason why rebuild activity sounds like it's picking up yet again, even though the fleet is very old at this point that they're essentially trying to maybe buy some more time until they get more clarity on what's going to be available in the next kind of 5 to 10 years?

[L. Scott Thomson, President, CEO & Non]

Yes. I do think that -- I do think that's potentially the case. I mean, I think there's a lot of things going on right now, right, where you have balance sheets that need to be repaired. You have a capital-constrained environment. You've got this energy transition. And so that's all contributing to maybe a little bit of hesitancy on big new fleet renewals.The other thing that I would say is autonomy plays a major role in this transition, right? As you think about the energy transition, autonomy plays a massive role. And it is -- I think one of the reasons we're in those conversations with all of our customers, and we couldn't be more pleased with the progress, and we do believe Cat's got a competitively advantaged solution on that from retrofitability, interoperability, scalability, speed. And we've got, as you know, the 2 no longer pilots in Canada. I mean there's real operations that are up or running. And now in South America with Codelco and TAC, we're moving hard on those implementations. And I think that plays a large part in the energy transition as well.

[Operator]

And the next question comes from Cherilyn Radbourne with TD Securities.

[Cherilyn Radbourne, Analyst]

As you think about current activity levels, I'd just be interested in your thoughts as to whether we're seeing, on the one hand, a bit of a release of pent-up demand from last year. And on the other hand, maybe a bit of a pull forward as customers try to get their orders in early in anticipation of extended lead times and maybe some constrained availability for certain models. Just your thoughts on those dynamics.

[L. Scott Thomson, President, CEO & Non]

Yes, a little bit different by each region, but it's healthy in all 3. And so we're not seeing a particular pull forward. No doubt, I think customers are having an easier time making decisions. I wouldn't say we're seeing a lot of examples of people like accelerating at scale. So I think it's a healthy market.Order intake is strong. Backlog build is healthy, but I wouldn't say that we're seeing a large pull forward. And we really ramped up inventory purchases last fall. So we're having inventory arrive and go out the door quickly, and we've got some inventory to sell. Our inventory was actually up year-to-date quarter-over-quarter. So I feel like we're in a solid position, but I don't feel like that was a major theme for us.

[Cherilyn Radbourne, Analyst]

Okay. That's helpful. And then in terms of Argentina, that really hasn't been mentioned very much. Is that still just a pretty constrained place? Or is there a scenario where maybe that offers some upside?

[L. Scott Thomson, President, CEO & Non]

Yes, Cherilyn, it's Scott. Argentina has been difficult, as you know. And I think the good news is we've done a fantastic amount of great work to get that business repositioned from a cost and inventory perspective. And now it's unfortunately still a little dilutive to the overall South America earnings, but it's doing better than breakeven. And so we've still got some more progress to make that accretive, which you would expect it to be, given the profile to the overall South American business.I think just saying that because we didn't -- that also highlights how well Chile is doing, because I just -- even those results incorporate Argentina. Right now, Argentina is, I don't know, $150 million business. And until we get a little bit more comfort on exchange controls, on the devaluation, we're going to be pretty careful. That being said, we've got some really very important good customers like Barrick and Newmont, who are investing money there. And we're trying to support them from a product support perspective. And so it's something that's kind of day-to-day combat in all honesty around this team and making sure that we protect ourselves while at the same time service our customers.

[Operator]

[Operator Instructions] The next question comes from Bryan Fast with Raymond James.

[Bryan Fast, Research Analyst]

Just looking for more color I guess, can you elaborate on the increased market share regarding the HS2 opportunity? What do you believe has been I guess the key driver there?

[L. Scott Thomson, President, CEO & Non]

Hey Bryan, it's Scott. So listen, I think this story goes back 3 or 4 years ago. We engaged with a number of customers on the CUBIQ platform. We developed an extremely strategic relationship around how they wanted to run their operations. We became a technology partner to them as it relates to CUBIQ. And that positioned us well for market share on the new equipment side.And so this is not just one customer. It involves a whole bunch of contractors as well, but our market share is, I think we said significantly higher. It's kind of 3x higher than what would historically be the case. And the benefits to the customer around the CUBIQ platform are significant. And we've hopefully showed you some of that at Investor Day. And so beyond the kind of the regular sales excellence and engaging with the customer and all those things that we do day in and day out, the big differentiator here for that whole project has been CUBIQ.

[Bryan Fast, Research Analyst]

Okay. That's pretty clear. And then just one of the large Canadian contractors recently talked about a feasibility study for the blending of hydrogen and diesel fuels for some of the heavy equipment. I believe this is something you highlighted during the Investor Day, but would this also represent a longer-term opportunity for the 4 refuel side of the business?

[L. Scott Thomson, President, CEO & Non]

Yes. Thanks for mentioning that, Bryan. I should have highlighted that when Ross talked about the energy transition. I mean, another great example of Caterpillar's ingenuity and leadership is the 3500 engine, the dual gas blending engine where you can do diesel and natural gas. And this may have been a little bit under the radar, but you may have noticed that Caterpillar signed an MoU with Certarus around natural gas distribution into primarily the Permian, their customers, they all service customers in the Permian.And we are now have just set up a couple day event here in Calgary or Edmonton, I can't recall which one, sorry, in the next 1.5 months, where we're going to bring our oil field service customers onsite with Certarus, with Caterpillar to show them the 3500 engine dual gas blending and inserting hydrogen. And that hydrogen, what we're seeing is 20% type blend on hydrogen into that 3500 engine. Now -- and here's an example of Cat leadership. I mean, no one has the DGB engine like Cat does. I mean, the market share for Cat and that engine is off the charts. And what we're seeing with our customers in oilfield services, they're still losing their per strength, but this whole transition from diesel engines to dual gas blending engines is win-win, right? You get lower prices because of the gas price, similar performance. And then the optionality down the road, and this is again, piloting stage, so for hydrogen blend. So another great example of Cat leadership in this area.

[Operator]

The next question comes from Sabahat Khan with RBC Capital Markets.

[Sabahat Khan, Analyst]

Just a follow-up on the HS2. I think you indicated that you are quoting for 2022. Can you maybe share the competitive dynamic there I guess in having been a partner to them and being involved in '21? Is there any sort of a [ leg up ] relative to competition? Or is it sort of like a jump ball in terms of securing more business there?

[L. Scott Thomson, President, CEO & Non]

Yes. Thanks, Sabahat. So I think we said we expect 2022, which we're quoting on now to be similar market share and 50% more orders for 2021. And obviously, I mean, everything is competitive. And when you win the type of market share we did in Phase I, obviously, that is -- creates a reaction in a competitive environment, and we deal with that every day. Again, I come back to CUBIQ and the platform and the differentiator. And our competitors don't have that. And that's really important as we think about execution of that project for all of our customers.

[Sabahat Khan, Analyst]

Okay. And then I think Greg mentioned the $250 million of potential investments and the internal competition for that. I guess is it largely just ROIC-based? How are you thinking about allocating that money? Or is the competition purely sort of whoever can bring the highest sort project gets the capital? Just wanted to get an idea of how you're prioritizing the investments.

[Greg Palaschuk, Executive VP & CFO]

Yes. The way we look at it is discounted cash flow per share. So it's really about the net asset value of whatever business we're looking at versus what the share buyback can do to your DCF or NAV per share. So that's at a high level how we look at it. Ultimately, we're looking for solid businesses that can be accretive near term, and we'll check that versus a share buyback. And when the share price with the business plan that we've got, that we have a lot of confidence around, that's really compelling that we don't feel like we get full credit for. Share repurchases are pretty attractive. And so it takes a pretty high bar for acquisitions to get passed.There needs to be a lot of synergies and very accretive or needs to have a really high NAV impact over the medium term. So that's how we'll do the balance. As of today, share buybacks win in most cases, but we're looking at some smaller bolt-ons that have some pretty attractive returns that might get above the threshold.

[Operator]

The next question comes from Devin Dodge with BMO Capital Markets.

[Devin Dodge, Analyst]

Maybe at the Investor Day, I think you were highlighting that the vast majority of equipment sales included some form of customer value agreement. So in the current environment, where you're starting to see some stresses on the supply chain, lead times are extending out, I think product availability, it probably depends on specific components and equipment, but it's probably less than optimal generally. How should we be thinking about the risk of we'll say higher logistics or even component costs? I'm just trying to get a sense if these potential costs are shared with the customer or Finning bears all this risk? And maybe what levers are available to Finning to mitigate maybe this cost inflation?

[Greg Palaschuk, Executive VP & CFO]

Yes. Thanks, Devin. So I think we're managing quite well. We've done this through many cycles, and we're managing our metrics around availability of parts really well. And so while no doubt there are certain spots where there's longer lead times, I think we've got higher safety stock in some of those and really collaborative with Cat and feel like we're managing through that well.So we feel like currently we're in a good spot. Wider gaps happen to emerge. There are some degrees of freedom in the CVAs on timing and whatnot that will allow us to work with customers to execute at the appropriate time and with a little wiggle room. But also in many cases, there's annual resets on pricing and whatnot that allows for some sharing of that risk if there was higher costs and whatnot. But for now, we think it's really manageable and a day-to-day challenge, but we think we're managing through really well.

[Devin Dodge, Analyst]

Okay. Okay. Good color there. I believe there are currently a few mediation processes underway in Chile between the unions and the miners. I think there's one at Escondida as well. Just not much visibility into how this unfolds. But from Finning's perspective, is there some deferred maintenance work at these sites that could be done to mitigate the impact of a potential strike at least for a brief period?

[L. Scott Thomson, President, CEO & Non]

Yes, thanks, Devin. So I guess a couple of things. One, I think we'd highlighted there was a lot of labor activity in Chile. And so status update. I think we've worked through any challenges we've had, which is good. So we've got some stability on the labor side, but some of our customers are still working through that. And Escondida is obviously the highest profile case. I think that will come to a head here, August 10th or 11th. And so they are in mediation right now and going back and forth.We've been through this before. So as you recall, I think in 2017, there was a 7 week strike in 2018. We went right to the kind of the cost, but before they came to a solution. And in both of those cases, we were very well ingrained with the customer and trying to help them mitigate the impacts and work through it.It's similar to right now. And so we're standing by to help Escondida to the extent we can. I think if you look back at those examples, it wasn't a material impact to us from a financial perspective, and I expect that to be the case here as well. And hopefully, there's an opportunity to help Escondida and show them what an important strategic partner we are for them in times of challenges, and we'll stand by and do that with them.

[Devin Dodge, Analyst]

And congrats on the good quarter.

[L. Scott Thomson, President, CEO & Non]

Yes, thanks, Devin.

[Operator]

The next question comes from Maxim Sytchev with National Bank.

[Maxim Sytchev, MD & AEC]

Scott, and I guess, maybe, Greg, if you don't mind to potentially chime in. I mean one of the things that -- I mean, I know that historical investors looked at Cat sort of from incremental, decremental margin perspective. But we kind of like that approach. And [ we know ] historically, like it's been quite volatile, and it's only now that we're seeing obviously there was a positive incremental margin build in 2020 than in 2021 and potential for 2022. So do you mind maybe like highlighting what you think is kind of structurally different right now? Is it the fact that the footprint is sort of properly sized for the revenue opportunity, the SG&A, kind of all of these combined? So -- because I think that's obviously could be a potentially pretty exciting part of the investment thesis as incrementals are really coming through.

[L. Scott Thomson, President, CEO & Non]

Yes, thanks, Max. I mean, as you know, you've been following this for a long time, and we've had lots of conversations. I mean, this has been a pretty heavy lift from a cost perspective to get the organization in a place where we were -- maintained our competitiveness. We're able to continue to grow our market share and at the same time service our customers and grow profitability.And I think the encouraging thing is you're starting to see that. And so if you look to 2018, which was a similar revenue base, you see the impact of those reductions. And I think now you're seeing the impact on the competitiveness too if you look at the market share in terms of these new big mining deals and some of the progress we're having in South America around Codelco and Teck just highlights, I think the progress we've been making.And I feel really confident we're going to get to 17% on that SG&A to sales. And I think there's more, right? And I don't think it's people productivity. I think a lot of it is supply chain redesign facility productivity as Kevin and the team that we're replicating across the whole company implements this per strategy. I mean, this is probably one of the biggest changes definitely during my time around how we operate our business. You have the right work done in the right place by the right people. And that sounds easy, but it's a huge change management exercise. And Kevin's taken that on as well into the implementation of that. And that will bring even more cost and productivity efficiencies.And then -- and so when Greg was asked the question around costs coming back into the system. I mean, of course, there'll be some discretionary cost in travel, et cetera. But I continue to believe that there's a lot more fixed cost opportunity here. I've given you just one example. I could go to the warehouses. We've got 3 or 4 warehouses in Edmonton that Alex and the team are addressing.I could go to e-commerce and look at the progress we've made on e-commerce. Now 50% of our parts online are e-commerce, but we haven't yet thought about the backend and how do we reduce the cost base to reflect that. And so you kind -- as you get into this and you get the company thinking about it in a low-cost kind of fashion, more opportunities come. And I think as you look forward here, you'll continue to see that. So that's point one.Point 2, and it comes to Michael's comment on gross margin. We've been a very difficult spot around commodity prices and reacting to our customers and trying to help them through that, which we've done, and that's created obviously some gross margin pressure, which we've offset through the SG&A.As we look forward and we talk about things like CUBIQ, we talk about things like customer value agreements, we talk about things about more sophisticated pricing and focusing on how we sell and linking that to the supply chain. You start to see enhancements in the gross margin as well. And I think that is really exciting. And we're in the early days of that, you're starting to see that through the business through HS2, the HS2 project and through some of the results you're seeing this quarter, and that will continue as well.So I do think there's a structural change here that allows us to increase the earnings capacity of this business going forward. And I haven't even talked about the ROIC side because, as you know, I think about ROIC and supply chain and the fact that sales down, but inventory turns up by 20%. And when you combine those 2 things, increase profitability with more velocity in the supply chain, good things happen. And so you look at FINSA right now, 17% ROIC in an environment where you have COVID. I mean, that team has got both the supply chain and the profitability working together, and that's going to continue to increase. And so I'm really encouraged about where we are from a cost inventory and capability perspective right now.

[Greg Palaschuk, Executive VP & CFO]

And I'll just add on one piece is just -- I mean, that was the Investor Day framework. It's been quite some time since we've had a sustained up cycle, and we're pretty confident, given consensus GDP and commodity prices that we're in kind of a multiyear version of this. '18, '19 was kind of 3 or 4 quarters together. So it's been a while since we've had a sustained up cycle, and we think that will be really helpful for our -- and we've got early momentum.

[Operator]

This concludes the question-and-answer session. I would like to turn the conference back over to Greg Palaschuk for any closing remarks.

[Greg Palaschuk, Executive VP & CFO]

So thanks, everyone, for joining today. I appreciate your attendance, and have a safe day.

[Operator]

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.