Finning International Inc
TSX:FTT

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Earnings Call Transcript

Earnings Call Transcript
2019-Q4

from 0
Operator

Thank you for standing by. This is the conference operator. Welcome to the Finning International Fourth Quarter 2019 Conference Call and Webcast. [Operator Instructions]. And the conference is being recorded. [Operator Instructions]I would now like to turn the conference over to Amanda Hobson, Senior Vice President, Investor Relations and Treasury. Please go ahead.

A
Amanda Hobson

Thank you, operator, and thank you, everyone, for joining us. On the call with us today are Scott Thomson, President and CEO; Steve Nielsen, CFO; Greg Palaschuk, Incoming CFO; and Anna Marks, Senior Vice President and Corporate Controller.Following the remarks by Scott, Steve and Greg, we'll open up the line to questions. This call is being webcast on finning.com and an audio file of this call will be archived for 3 months on our website.Before I turn it over to Scott, I want to remind everyone that some of the statements provided during this call are 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 in our MD&A under Risk Factors and Management and Forward-looking Disclaimer. Please treat this information with caution as Finning's actual results 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.

L
L. Scott Thomson
President, CEO & Non

Good morning. We delivered solid performance in Canada and the U.K. in 2019 as a direct result of the work we've been doing over the past several years to strengthen our operations and be more resilient. In 2019, our Canadian operations achieved an adjusted EBIT margin of 8% on record revenue. This is the highest annual revenue and adjusted EBIT on record and the best profitability in our Canadian operations since 2007. We are pleased with improved execution in Canada as demonstrated by a stable gross profit margin in a highly competitive environment with disciplined cost management. In fact, Canada's fixed cost base is expected to be below last year as we entered 2020 with a sustainable 6% reduction in the workforce. Another important accomplishment is our market share growth in construction, which is up more than 300 basis points year-over-year. In the fourth quarter of 2019, Canada's EBITDA was up modestly year-over-year despite softer market conditions and lower revenue. In the U.K. and Ireland, the team has been successfully managing through a prolonged period of political and economic uncertainty. We are pleased that we were able to maintain profitability in 2019, despite the challenging market environment and a significant slowdown in customer activity in the fourth quarter, stemming from Brexit fatigue and the uncertainty of the general election.In South America, Q4 product support revenue was up 36% year-over-year driven by strong parts volumes in Chilean mining post the launch of the ERP system in Q4 2018. Improved product support was offset by disruption related to the social unrest in Chile. Chilean GDP was down about 3% in the fourth quarter. We saw a decline in customer activity due to business disruptions and an increased level of uncertainty related to potential implications of the government social reform. The devaluation of the peso had an impact on the quarter, particularly on our service revenue, which is invoiced in local currency. We estimate that the social unrest and subsequent devaluation of the Chilean peso reduced our EPS by about $0.05 in the fourth quarter. The combined impact of the unrest and devaluation on our EBIT margin in South America was approximately 150 basis points.I will now speak about the outlook for each of our regions. While the market environment in Western Canada continues to be challenging, particularly in coal mining and forestry, we don't expect the same rate of industry decline in 2020 as we saw in the fourth quarter. Our internal data is pointing to an approximately 5% new equipment industry decline in 2020, which compared to 20% decline experienced in 2019.There are many positive developments that are expected to drive GDP growth of about 2% across the western provinces. The infrastructure budget in Alberta is shifting to private partnerships, which will fund some large projects. The earthmoving work has started on Trans Mountain pipeline in Alberta, and with the latest Federal court decision, TMX is now in a better position to start construction on the British Columbia side of the border.While we expect other significant infrastructure projects in our territory to proceed in 2020, our assumption is that construction equipment markets will remain relatively soft. The biggest opportunity we currently see in Canada is growing our share of aftermarket parts in the construction market. We are focused on using technology to increase customer connectivity, equipment condition monitoring and the use of data analytics. This will create new business opportunities and improve the customer experience. Product support fundamentals in the oil sands are strong, and we expect steady activity levels to continue in 2020. We had a record year at OEM, and we are expanding our exchange business through a combination of process improvements and investments in capacity. Overall, we expect growing product support revenue and a lower SG&A run rate to drive continued improvement in Canada's profitability in 2020.In Chile, while the social situation appears to have stabilized, the potential impact of the government's social form agenda on the economy has created a lot of uncertainty. In the near term, we expect continued low GDP growth, reduced business confidence and soft equipment markets to weigh on our Q1 and Q2 results. Chilean GDP growth is expected to turn positive during 2020, which bodes well for our longer-term outlook.The good news is that the mining environment is improving, with copper production expected to be up in 2020. Our competitive positioning in this market is solid, and the China-U.S. phase 1 trade agreement is an important step towards a resolution of the 2-year trade tension. This is an encouraging development that reaffirms our constructive view on the outlook for Chilean copper mining.In Argentina, market conditions will remain uncertain until the new government approves an economic plan. With restrictive monetary policies and capital controls limiting our growth opportunities at this time, our focus continues to be on delivering product support to customers while managing exposure to the Argentine peso.In the U.K. and Ireland, construction equipment markets are off to a slow start in 2020. After having left the European Union, the U.K. is now in a transition period until the end of 2020. To help offset reduced business confidence, the U.K. government has committed to accelerating infrastructure investment. Recent announcements with respect to pending government budgets, health care infrastructure plans and confirmation that HS2 will proceed should drive modest GDP growth and have a positive impact on customer activity. Phase 1 of HS2 will provide meaningful upside to our U.K. business beginning in late 2020.As many headwinds begin to abate in 2020, we remain laser-focused on controlling the controllables and expect a benefit from the following profitability drivers. First, with the ERP behind us, we expect to see improved execution in South America. While some risk of social instability in Chile remains, the situation should normalize through the year. We estimate that these 2 headwinds reduce our EPS by about $0.25 in 2019. Second, a reduced cost base in Canada positions us well to continue improving profitability in a low growth environment. Third, we expect to see customer confidence recovering in the U.K. as uncertainty related to Brexit dissipates. And finally, we expect strong free cash flow generation in 2020 to reduce our finance costs and provide flexibility for share buybacks.And on this note, I will pass it over to Steve.

S
Steven M. Nielsen
Executive VP & CFO

Thank you, Scott, and good morning, everyone. Our fourth quarter results reflect a number of macro headwinds that impacted our revenue. However, our continued focus on cost resulted in a $6 million increase in EBIT compared to the fourth quarter of last year. And the inventory reduction helped us deliver strong quarterly free cash flow of $386 million. Earnings per share of $0.31 was below $0.33 in the fourth quarter of last year. The benefit of improved profitability in South America driven by product support growth was offset by the negative impact from the social unrest in Chile of about $0.05, $10 million of higher finance cost as well as higher long-term incentive plan cost due to an increase in our share price.In Canada, lower net revenue in the fourth quarter were mostly the result of reduced activity in coal mining, construction and forestry. Overall, the construction and equipment industry was down about 20% year-over-year in Western Canada. A slight decline in product support revenue from last year was attributable to stronger service revenue in the fourth quarter of 2018 due to a large-scale dragline maintenance project during that period. Part sales were higher year-over-year driven by mining. Canada's EBITDA was $17 million higher compared to the fourth quarter of last year driven by improved gross profits, disciplined cost management and the adoption of IFRS 16.In South America, we saw a significant increase in product support revenue year-over-year, reflecting a recovery in parts volumes as Chilean mining since the launch of the new ERP system. This was the main driver of a $22 million increase in EBITDA compared to the fourth quarter of 2018.As Scott mentioned, the social unrest that began in October and subsequent devaluation of the Chilean peso had a negative impact on our fourth quarter results. New equipment sales in South America were down 40% as a result of the disruptions and market slowdown as well as large mining deliveries that lifted our sales in Q4 of 2018. We expect low GDP growth, market uncertainty and reduced activity in nonmining sectors in Chile to persist through the first half of 2020.Argentina was modestly profitable in the fourth quarter. However, operating conditions remain difficult amidst continued restrictive monetary policies and capital controls. In the U.K. and Ireland, construction equipment market softened considerably in the fourth quarter with Brexit and political-related uncertainty causing economic stagnation by the end of 2019. Our revenue was down 17% compared to the fourth quarter of last year when our Power Systems business benefited from project deliveries to electricity capacity market. The decline in the U.K.'s EBITDA year-over-year was driven by lower revenue across most lines of business.Our inventory was down by $225 million in the fourth quarter for a total of $375 million reduction in the second half of 2019. We will continue to reduce our inventory in 2020 and improve our supply chain capabilities, which is expected to drive strong free cash flow generation and lower our finance costs.Our net capital and rental fleet expenditures are down 25% from last year, and we expect to see further reduction in 2020. We expect to demonstrate improved EBITDA to free cash flow conversion this year driven by reduced working capital requirements and continued financial discipline. Our average EBITDA to free cash flow conversion was in the mid-50% range in 2013 through 2016, and we expect to return closer to that level.In closing, as I move on to retirement, I would like to say that it's been a real privilege to lead the finance team at Finning over the last 5 years. I want to thank Scott for his support and my partners and the entire team for making it such a rewarding experience.I'll now turn it back to Scott.

L
L. Scott Thomson
President, CEO & Non

Thank you, Steve. We've been extremely fortunate to have had Steve's guidance as we navigated a volatile and unpredictable economic environment during the past 5 years. He's provided stability, thoughtful direction and sage advice. We wish him the very best as he enjoys his well-deserved retirement.We are very pleased that Greg will be taking on the CFO position, a role he is all suited for given its various global roles across the business since he joined us 2014. Greg's strong understanding of the market dynamics we face and his ability to find opportunity for growth and innovation are key to his new role as is the connection he has with our customers, shareholders, partners and employees.

G
Greg Palaschuk

Thank you, Scott. It's an honor to take on this role, and I look forward to working with this leadership team to execute our strategy and build value for Finning shareholders over the long term. I'm very passionate about building and executing business plans that deliver growth while being highly capital- and cost-efficient on a full cycle basis. We have a great business model, and one of its best characteristics is that when revenue growth rates decelerate, we generate significant free cash flow. Oftentimes, this coincides with opportunity for capital allocation choices. Today, we see that as the case, and we have spent significant time analyzing our expected free cash flow profile and the return to historical EBITDA, the free cash flow conversion rates. Based on this, we'll be moving forward with share repurchases. Going forward, I look forward to working with all of you on this call. And thank you, again, to Scott and to Steve.Back to you, Scott.

L
L. Scott Thomson
President, CEO & Non

I'd like to conclude by highlighting the important organizational changes at Finning since the beginning of 2019. Our 3 regional operators are new to their roles. And in March, we'll have a new CFO. All of these appointments were internal. These transitions have gone well, and even more will be accomplished by this team in 2020. All these leaders are progressive thinkers, highly aligned, energized and ready to execute on the plans we've laid out. Each leader is highly dedicated to Finning and has a long career runway. It's a new decade, a new team, and I'm highly confident in this team's ability to improve execution for the long-term benefit of the company and shareholders.I will now turn it back to Amanda for the Q&A.

A
Amanda Hobson

Operator, this concludes our remarks. [Operator Instructions]

Operator

[Operator Instructions] Our first question comes from Cherilyn Radbourne with TD Securities.

C
Cherilyn Radbourne
Analyst

If we set aside South America for just a second, I guess what I'm struggling with a bit in the numbers is that the revenue and revenue mix in Canada and the U.K. and Ireland are relatively similar in Q4 versus Q3. And yet the EBIT dollars were down a fair bit sequentially in both regions. I appreciate that most of your analysis has probably been on a year-over-year basis, but just wonder if you can shed any light on that.

L
L. Scott Thomson
President, CEO & Non

Steve, maybe I'll get to do the details. But at first, couple of opening comments. One, I think it's important to recognize in the numbers that revenue is down, but EBIT is up. And so take Canada, for example, you saw a 5% revenue decline. But our overall margin and EBIT contribution was modestly up. So as you look at the overall results, you have the benefit of recovery in product support in FINSA and essentially comparable profitability in Canada, slightly up, offset by weaker revenue and margin in the U.K.; incremental finance costs, given the free cash flow profile over the year; social disruption in FINSA and a movement in long-term share cost, given the significant decline in the share price in the fourth quarter last year and the improvement in the share price in the fourth quarter this year.

S
Steven M. Nielsen
Executive VP & CFO

Scott, I think you hit all of the relevant points. The one I would add is with the lower activity, we did have a decrease in the absorption of our labor on the throughput of lower revenues.

C
Cherilyn Radbourne
Analyst

Yes. I guess I'm just struggling with the sequential decline in EBIT in Canada and the U.K., Ireland because the revenue profile in Q4 versus Q3 was pretty similar in both regions.

L
L. Scott Thomson
President, CEO & Non

Yes. So I think there is -- oh, a sequential -- sorry, sequential decline in EBIT in Canada, sorry. So I was going year-over-year. So year-over-year, EBIT profitability and EBIT is modestly up. I think as you look for Q3 versus Q4, you have revenue down and margin modestly down, right, to the 7.4%. I think in the U.K., you have pretty significant revenue decline, with also some margin compression given the slowdown in the overall market.

C
Cherilyn Radbourne
Analyst

Okay. Can you help us think about the cost savings associated with the headcount reduction you referenced in Canada and just comment on whether you think you might have to give back any of those savings to maintain or increase market share in a competitive environment?

L
L. Scott Thomson
President, CEO & Non

So if you look at year-over-year, we're down about 6% headcount reduction. And so that's essentially a $25 million type fixed cost reduction. So I think we're entering 2020 with a pretty significant cost benefit relative to 2019. I don't see any scenario where we're adding cost to go after the market opportunity. I mean I think in this market, we've reduced costs and increased market share and improved customer loyalty. And so when you look at that Canadian business, I think it is probably the first time since I can remember where we've had a slight revenue increase with no increase in SG&A, I mean excluding the 4Refuel additions during the year. And so I do think that's a trend that we want to continue. It is a very good cost discipline on the SG&A side.

C
Cherilyn Radbourne
Analyst

Okay. That's my two. Got it. Before I pass it over, Steve, I just wanted to wish you all the best in your next phase.

S
Steven M. Nielsen
Executive VP & CFO

Thank you, Cherilyn.

Operator

Our next question comes from Jacob Bout with CIBC.

J
Jacob Jonathan Bout

Yes. Maybe my first question, just going back to your South American outlook. And I guess a couple of things here. How much of a bleed can we expect in the first quarter with the Chilean unrest? And then the second thing, just the impact of the coronavirus. When we take a look at the Chinese copper buyers, there is postponement of a number of shipments, specifically from Chile. So just wondering what the impact there is.

L
L. Scott Thomson
President, CEO & Non

Yes. No. So on the first question, I think the best way to look at is GDP probably, right? And when you look in the fourth quarter, GDP was down about 3% in Chile and the 2020 outlook is around 1.5% to 2% for the year, but that is third and fourth quarter primarily. So you see pretty low GDP, not negative but within the kind of 0% to 0.5% for Q1 and Q2 and then the improvement in Q3 and Q4. And I think that makes sense given that they have summer holidays right now in January, February, and then they have a referendum in April. So that kind of seems to hold together for me. Once you get through the uncertainty, you start to see more activity.In terms of the coronavirus, I think time will tell, frankly. We've seen a couple demand sources out of China ask Chilean producers to hold back on their deliveries. I think the other aspect of that is you've seen some closure of facilities in China as they deal with this virus. I think the good news on the latter is that, at least as it relates to CAT, CAT's gone back to work. So I think they opened up their facilities yesterday or the day before, which was a little bit of the delay coming out of the lunar new year holidays. But better than I was expecting. So I think that's the positive. So I think time will tell on the virus impact, Jacob. I think it's too early to determine right now.

J
Jacob Jonathan Bout

Okay. And then my second question just on the U.K. So you talked a bit about the HS2 phase 1. How should we be thinking about that as far as the timing and the dollar impact? And then maybe also just related to the U.K., the -- one of the opportunities you're seeing in Power Systems right now because it was fairly soft in the fourth quarter.

L
L. Scott Thomson
President, CEO & Non

Yes. I think the Power Systems side was more of a [ faith. ] So one, the U.K. was very soft in the fourth quarter. I think GDP was 0.1%. So it was a -- and I think the combination of the uncertainty associated with the election and Brexit played an impact on that. I think as it relates to our Power Systems, though, it wasn't -- it's -- you can't look quarter-to-quarter. I think you have to look year-over-year. And when I think about some of the investments that are being made primarily in Ireland with Facebook, Amazon, Microsoft and our position on the data center side, I feel really good about that business.As we look forward to the U.K., I think as you get past the general election and now more certainty around what's going to happen with Brexit, that should increase confidence, recognizing that there's still a transition period. And our expectation was that the government was going to make some announcements around infrastructure, which we saw yesterday around HS2. That is a very promising and I think a good development for us. And I think it's not only the HS2 issue, but it's the ripple effect on confidence in the economy. What we saw was a lot of contractors were holding back in the third and fourth quarter waiting for what the government was going to do around HS2. So to see HS2 announced, I think it is pretty positive.In terms of how HS2 will impact us, we have $1 billion business there approximately and HS2 has the potential, assuming we get the type of market share that we're hoping for to be a $250 million to $300 million type opportunity for us. And that starts late 2020. And so there's a -- it comes pretty quickly. And it's -- it is over a period of time, but the actual equipment -- the earthmoving, it happens over a few years. And so starting like 2020, I think you'll see something come through. We'll see some things come through on the revenue line.

Operator

Our next question comes from Michael Doumet with Scotiabank.

M
Michael Doumet
Analyst

So there are more apparent headwinds today versus sort of back in November when you provided us with your 2020 flattish revenue guidance. So as we think about sort of incorporating those headwinds, would you be willing to share a range of revenue expectations for the full year, Scott?

L
L. Scott Thomson
President, CEO & Non

I'll tell you the variables. I'm not going to give you a range, but I'll tell you the variables that we're dealing with. I mean I think on the equipment side, we're definitely seeing a decline in industry activity. I think that decline or the magnitude of that decline will depend on some big projects that are out there or big variables that are out there. So HS2 is one thing. If that comes through as we expect in the fourth quarter, that's really helpful. I think in Canada, the pipelines and the activity that happens on those pipelines is quite important, and we're seeing some quoting on TMX right now, which is positive. But obviously, there's a pace to that. And then in Chile, it's around the social unrest and when that stabilizes and when you can start to see GDP growth in the region. So that, to me, are the -- those, to me, are the variables around revenue on the equipment side.On the product support side, we see continued positive growth. I mean I think in Canada, you saw year-over-year in a quarter slight down, but that was not on the parts side. The parts side was actually up. You saw a little bit of weakness on the service side because we had some big dragline outages in Q4 2018. And so when we think about the aftermarket and construction and OEM at high levels, we're going to see continued product support in Canada.And then in Chile, we believe we're going to see continued product support as well. Part of that is the easier comps, given we're through our ERP situation. But part of that also is copper production increasing year-over-year. And so that should be helpful.So hopefully, that gives you a sense of the type of variables we're dealing with.

M
Michael Doumet
Analyst

Yes. No. It definitely does. And then maybe just shifting over specifically to South America. Just thinking about the margins there into 2020, I mean it certainly sounds like a tale of 2 halves with the political landscape. I mean should we be thinking of that as a gradual margin improvement? And what type of exit margin should we be thinking? I mean is it possible that we see historical or return to historical margins by the end of the year?

L
L. Scott Thomson
President, CEO & Non

Yes. I mean I think the way we're approaching this is, we have reworked the U.K. business, and we've reworked the Canadian business because of the growth pressure, sort of the revenue pressures. And those 2 businesses are in very good shape from a resiliency perspective. And hopefully, you'll see that when you look at the annual results.The FINSA business or the South America business has seen a pretty significant re-rating on the revenue side. And you just have to look at the GDP or the GDP situation to come to that conclusion. So we need to continue to be much more disciplined on how we manage the cost base there and working capital. And 2019 was an interesting year because we dealt with the Argentina situation, and we reduced our headcount there by about 25% and our footprint significantly.Overall in South America, we reduced our headcount I think by 7% year-over-year on an annual basis. So that's sort of cost focus in our South America business is going to continue throughout 2020 and not only cost, but on the working capital side as well. And that will underpin some of our free cash flow that comes out of that business in 2020. And so I do think you're going to see a gradual profitability improvement in our South American business through the year. And the question in my mind is the social unrest and how you get through the -- back to a growth phase in Chile around GDP.

Operator

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

D
Devin Dodge
Analyst

So given the big working capital recovered in Q4, we're a bit surprised to see that you weren't buying back any shares. Was this just a case that you wanted to retain some cash in the business maybe as a hedge against 2020 being potentially a bit soft? Or were there other considerations we should be thinking about?

L
L. Scott Thomson
President, CEO & Non

Our cash was back-end loaded in the fourth quarter and a little bit more than historically has been the case because of some of the challenges we were facing during the year. And we wanted to make sure the balance sheet was in good shape heading into -- or in a volatile environment. And so now that, that free cash flow has come in, and we have a lot of confidence around returning to historical EBITDA, the free cash flow conversion rates. We feel comfortable repurchasing shares once we come out of block out here. And we'll start to do that as we're -- coming out of this quarter and progressing through the year.

D
Devin Dodge
Analyst

Okay. That makes sense. And I apologize if I missed this, but can you give us a sense to how you're feeling about your inventory position across your businesses? And how we should be thinking about working capital in 2020?

L
L. Scott Thomson
President, CEO & Non

Yes. So I'm feeling -- I think Steve gave the comment around reductions in inventory in the back half of the year. I think it was around $350 million. I'm feeling really good about our Canadian situation. I mean I think we went from a '18 industry that was growing at 20% to a '19 industry that was declining 20%. And in the mid part of this year, we had some excess inventory, but the team did a great job working through it. And we've got inventory on hand, but nothing that concerns me in Canada. So I feel really good about the Canadian situation.In South America, as we worked through the ERP issues, we find ourselves with probably about $100 million, maybe a little bit more of excess parts in the South American side, and that's been exacerbated a little bit. We thought we're going to work through most of that in the back half of 2019, but with this social disruption that impacted us a little bit more than we would have thought. And so as we enter 2020, we have essentially excess inventory in South America that will provide a good underpinning to our free cash flow performance in 2020.

Operator

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

R
Ross Paul Gilardi
Director

Scott, how should we think about the backlog? I mean your backlog is obviously down a fair amount again in the fourth quarter, but it's only 10% of sales. And given your product support business, the size of it, I'm just trying to understand how you factor it into your thinking. And when do you -- do you have any visibility on when we see stabilization in the backlog? And can you break it out at all by region? And what it would look like? I know you don't ordinarily do that, but if you could at least qualitatively help us, that would be great.

L
L. Scott Thomson
President, CEO & Non

Yes. Sure. So the backlog has come down. I think frankly, the backlog is a little less relevant right now as availability from CAT has improved pretty significantly. And so what we look to is order intake. And I think the good news on the order intake side is we've seen a little bit of a pickup in the fourth quarter relative to the third quarter on the construction side.I think the other thing that gives me comfort is looking at some of these big projects that we're bidding on right now, TMX as an example. There's quite a lot of equipment that needs to go to work there, and that is in our plans for 2020.That all being said, we're expecting continued weakness in the equipment markets. And I think I said in my opening comments around 5% type industry decline in 2020. On the parts side, that's not really factored into the backlog. That's the regular product support that has I think shown a good resiliency and ability to grow through any kind of macro headwinds. So I feel good about that.

R
Ross Paul Gilardi
Director

And maybe you could just help a little bit on the -- I'd love to hear your thoughts on just the state of the mining cycle, particularly for the big equipment in Western Canada and Chile, irrespective of the recent headwind. I mean where are we? Because I mean it felt like just 6 months ago, you could have still argued that we are in the nascent stages of recovery, and then we just rolled right over. Like, what are the -- like the structural issues that are really preventing this market from recovering much at all? And like any sense, it's like what is replacement demand these days versus what it used to be? I mean I know those are big questions to answer, but anything probably...

L
L. Scott Thomson
President, CEO & Non

And a lot of -- and I know, Ross, you cover CAT as well, and a lot of what CAT said on their call has resonated with me in terms of kind of the mining outlook. We're seeing really good product support in mining in both regions, in Canada and South America. And I think part of that is the rebuild opportunity. I think autonomy has an opportunity in Canada to increase the new equipment demand, and we're looking at as an example, Kearl, where we have 13 trucks running autonomously. And I think they've said publicly that they're planning on ramping that up to 20 next year and then moving fully autonomous at some point in the future. And so I think there's some opportunities there for new trucks. In South America, I think the good news is something like QB2, right? I mean, QB2 is a $5 billion or $6 billion investment. And for us, that's material. We'll see some of that come through in 2020. I think it starts in the second and third quarter for us in terms of deliveries.But frankly, this social unrest in Chile has caused people to wait a little bit. And we've had a number of RFPs in process, where I think the customer is going to continue to go forward with it, but they're also -- not hesitating, but waiting a little bit to see what happens here over the next couple of months from a stability side and a GDP side in Chile. So hopefully, that gives you some context.

Operator

[Operator Instructions] Our next question comes from Ashish Gupta with Stephens.

A
Ashish Ravi Gupta
Research Analyst

Maybe first, just a follow-up on Ross' question about the equipment demand in South America. I guess just -- so I guess I was a little surprised that the social unrest is limiting the mining equipment purchases there. But I guess because I was thinking most of that production would be for export markets like China. But I just was wondering, is that your impression? I just wanted to clarify that -- make clear that the social unrest is impacting mining as well, if not more of like an economic issue.

L
L. Scott Thomson
President, CEO & Non

No. And I don't want to confuse people. So we saw a significant decline in equipment revenue year-over-year in Chile. That wasn't all related to social unrest. We had a lot of deliveries in the fourth quarter of 2018 associated with some large mining orders. And when you look at the impact, I think we said that was $0.05 of EPS and 150 basis points. Only a small part of that was revenue, to tell you the truth. The other aspects of that was the productivity in our facilities, given people couldn't get to work and the devaluation and the impact on service.And so when I was answering Ross' question, I was talking more about RFPs quoting replacement cycle on big mining equipment or new mining projects. And like I said, the good news is we have QB2, but our expectation is that there's going to be a few more of those, given where Chile sits on the supply side for copper. But I think when you have some of this uncertainty in Chile and then also with China demand, it just -- I think the producer is just positive. And I think that's what we're seeing from a quoting and RFP perspective right now.

A
Ashish Ravi Gupta
Research Analyst

Okay. Great. That's really helpful. And then going back to the increasing parts market share through the connected -- connectivity and ability to sort of think about predictive maintenance. I'm just wondering, up until this point, the -- as you've not necessarily lost share, but as you try to think about recapturing share, how much of that is a function of the price of the -- economic decision on the second or third buyer versus just making contact with those customers since you have the predictive ability now?

L
L. Scott Thomson
President, CEO & Non

So I mean I think we've made a huge step forward as a company over the last 3 years on connectivity. I think we've gone from 20% of our fleet connected to 80% of our fleet connected. And we know that -- and we can see it through our numbers, that if you have a connected machine and you have a customer service agreement with it, we can get more parts market share.I think there's a big opportunity in both Canada and South America, in particular, on the construction side to increase our market share. And part of that is figuring out how to optimize the value and the price. There's a great opportunity and a high-margin opportunity, and we should be very thoughtful about how we trade-off that price volume. And so long as it's accretive to the overall enterprise, and I think we've shown that what we've done, it is, we should be willing to go after that.I think we're well placed now with the connectivity and our sales approach to capture this market share. I don't want to leave any impression that we've lost market share, though. I think that was your comment. We haven't lost market share on any aftermarket at all. We just now, with all these connected machines, see the amount of market share that we can actually capture. And so I do think that's a big opportunity for us in those 2 regions over the next few years, and it's consistent with CAT's strategy to double their services revenue. And so we're well aligned on that approach.

Operator

Our next question comes from Ben Cherniavsky with Raymond James.

B
Ben Cherniavsky
Managing Director & Head of Industrial Research

Just I guess some of it's already been discussed on the impacts of the free cash flow. But if you go back a year, I think the expectations were from more free cash than you generated this year. I think we could sort of debate what significant means, but I know that was how you framed it, and there were expectations it would be up year-over-year. So -- and of course, those are -- we look at it on a consolidated basis, but can you maybe break out where you fell short? South America, I think you've already reviewed. But are there other headwinds, just in terms of inventory or working capital management that didn't quite transpire the way you expected this year? Or for that matter, did you end up on your CapEx allocating more capital to places you hadn't originally anticipated?

L
L. Scott Thomson
President, CEO & Non

Yes. Sure. Good question. So I mean definitely, if you look at '18 and '19, the EBITDA -- free cash flow to EBITDA conversion wasn't where it had been in previous years. I think '18 was more because it was growth, both on the capital side, frankly, and on the revenue side, investment in inventory. In '19, where the miss came was in South America. And that was coming out of the ERP. We invested in parts and components to take care of our customers to the tune of $100 million to $150 million. And that was the major cause of the miss.If you look at rental and capital, I think we reduced that 25% to 30% year-over-year. And as you look forward to 2020, that's going to continue to come down. There was -- in Canada, the miss was mostly timing and that there was a strong push at the end of the year to go through that inventory that was a little bit elevated at the start of the year. And that didn't hit us in the overall free cash flow performance, but it did hit us in the financing cost as we went through the year because our -- and that would obviously have an impact on EPS. I think that's a much different situation as we look into 2020, partly because we're coming into the year in a much better situation in Canada. We have a decelerating equipment environment. And so that -- the business model works. It will generate free cash. So I feel very good about getting back to our historical EBITDA to free cash flow rates in 2020. Steve, did you want to add something?

S
Steven M. Nielsen
Executive VP & CFO

Yes. The one thing I'd also add is, as we came through the ERP and the remediation, we restored parts flow and, therefore, product support revenues, but it did cause a ripple on the timing of conversion to free cash flow. So we also had a delay pushed out from '19 to '20 on the [ sales ] to cash.

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Ben Cherniavsky
Managing Director & Head of Industrial Research

Great. But going -- but Steve, going into '20, you would have known that, right? Those issues would come up in the fall of '18?

S
Steven M. Nielsen
Executive VP & CFO

Yes. And so that ripple from the fourth quarter to the first quarter was a bit greater than we expected in South America as we were focused on restoring the revenue flow than the invoicing. So we expect to have that come from fourth quarter to first quarter, strengthening the prospects for free cash flow this year. So as -- just as product support revenues have been recovered, that monetization will come pretty rapidly in the first part of 2020.

B
Ben Cherniavsky
Managing Director & Head of Industrial Research

Fair enough. My second question, Scott, could you maybe talk a little bit about how your digital strategy is playing into opportunities like the one in the U.K. with the high-speed rail and how you're sort of using that? Or if you're using it to position yourself to get a more significant piece of the business that you might have not otherwise got?

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L. Scott Thomson
President, CEO & Non

Yes. Thanks, Ben. That's a great question. So I mean the digital strategy was threefold, right? It was -- one was the connectivity, which we've talked about. Second was the e-commerce which was -- has been successful or kind of growing that business at 35% to 40%. And so that's been helpful from a cost to serve perspective. And then the third portion is -- are there value-added services you can provide to customers to both increase customer intimacy, increase market share and hopefully increase revenue through subscription-based services.I think where we've seen more success on that is in the integrated knowledge centers in both South America and Canada, and that is connecting mining equipment and then driving insights back to customers. And we've seen a, particularly in South America, which is probably a couple of years advanced than our Canadian business, increased availability of the fleet, which I think has helped a lot in terms of market share and positioning us for future bids.The point on HS2 is our technology platform that we've been developing in conjunction with one of the main contractors in HS2. And that technology platform allows us to connect not only CAT machines but also mixed fleets and then drive insights off of those mixed fleets back to the customers to increase their productivity. And it's not only around machines, frankly. It's around their whole operations. And so it will help them think about where to dig, how to move the earth, where to move the earth, when to move the earth, thinking about fuel efficiency, thinking about operator performance. And I think that's positioned us well with this customer in particular, but also with the whole HS2 consortium. And so one of the reasons I feel good about us capturing our fair share or better in HS2 is because of the work we've been doing on the digital front in the last 3 years in the U.K.

B
Ben Cherniavsky
Managing Director & Head of Industrial Research

It's interesting to see how that will evolve. Thanks for the extra perspective on that. And Steve, congratulations on your retirement, all the best. We never got our ski day and now that you're not working, maybe we can make that happen.

S
Steven M. Nielsen
Executive VP & CFO

Let's do that. Thanks, Ben. I appreciate it.

Operator

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

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Amanda Hobson

This concludes our call. Thank you, operator, and thank you, everyone, for joining us today.

Operator

You may now disconnect your lines. Thank you for participating, and have a pleasant day.