Finning International Inc

TSX:FTT

Earnings Call Transcript 2020-Q4

[Operator]

Thank you for standing by. This is the conference operator. Welcome to the Finning International Fourth Quarter 2020 Conference Call and Webcast. [Operator Instructions] I would now like to turn the conference over to Amanda Hobson, Senior Vice President, Investor Relations and Treasury. Please go ahead.

[Amanda Fern Hobson]

Thank you, operator. Good morning, everyone, and welcome to Finning's fourth quarter earnings call. Joining us on today's call are Scott Thomson, President and CEO; and Greg Palaschuk, EVP and CFO. Following our remarks today, we will open up the line to questions. This call is being webcast on finning.com. We have also provided a set of slides that we will reference during our prepared remarks. These slides are posted on the Events and Presentations 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. 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 Slides 12 and 13 for important disclosures about forward-looking information as well as 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 under key business risks and in our MD&A under Risk Factors and management and forward-looking information disclaimer. Please treat 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, Amanda, and good morning, everyone. On today's call, I will share my views on 2020, speak about the execution of our strategic commitments and outline our views and expectations for 2021. I will start on Slide 2. As I reflect on 2020, it was a strong year from an execution perspective, particularly in the context of a difficult external environment. Our early investments and long-term strategic approach helped us navigate and have positioned us for success in the upcoming recovery. Our focus on safety and digital capabilities, in particular, as well as our capital allocation decisions are paying off and driving improved customer satisfaction and better financial results. Our total injury frequency rate decreased by 35% and our customer loyalty scores increased by 10% compared to 2019. Our focus on sustainability is increasingly evident to all stakeholders, and I encourage you to read our fourth annual sustainability report, which we will release at the end of March. We have significantly reduced our GHG emissions and are further reducing our environmental footprint with the implementation of our long-term network strategy in Canada and other initiatives such as efficiency upgrades to our branches, vehicle fleets and equipment. We will also make material commitments to reduce our GHG emissions further between now and 2027. Our employees should be proud of these accomplishments, which demonstrate continued adaptability and unwavering commitment providing essential services to our customers. This year required extraordinary determination, effort, support and flexibility from our employees. I am proud of how we operated in this environment and of the results we've achieved. Our investments in technology over the last 5 years allowed us to effectively navigate through the pandemic and set the stage for a strong recovery. Our robust IT infrastructure has enabled efficient remote work for all employees who can do their work from home. Machine connectivity has been essential in improving our inventory management and is providing us with a great foundation to grow product support market share. We are closely aligned with Caterpillar's aftermarket growth strategy, which is showing early signs of success. For example, in Canada, our parts market share in construction has grown materially since the end of 2019, driven by an increasing number of customer value agreements or CVAs and connected machines. The number of active CVAs in Canada's construction segment grew by 35% in 2020 with great momentum in the back half of the year and into 2021. The revenue we earn on our performance solutions per connected asset grew materially over the last year. Our digitally enabled value-added solutions and services allow our customers to improve their equipment, fleet and operational performance and this differentiates us from our competition. A great example is our integrated knowledge centers, which are staffed by experienced equipment experts with domain expertise. Together with the customers, we work to optimize equipment health and operational efficiency. Our mining customers continue to adopt economy as they expand their existing operations and plan for new mines. We have started delivering equipment to Teck's QB2 site in Chile to enable autonomous operations. In Western Canada, 2 autonomous operations, Kearl in the oil sands and Highland Valley Copper in BC continue to ramp up conversions. With only 7% of the ultra-class truck population in Western Canada presently autonomous, it's a great opportunity for both Caterpillar and Finning. Turning to Slide 3. Despite the many challenges of 2020, we stayed focused on what we can control and delivered on the commitments we set out at the beginning of the year. We have improved our execution in South America against a challenging market backdrop. We ended the year with 8.3% EBIT as a percentage of revenue, reflecting the benefit of a lower cost base from leveraging 1 common technology platform. I couldn't be more pleased with performance in South America during 2020 as EBITDA increased, profitability increased, return on capital increased, and the team delivered in excess of USD 200 million in free cash flow in an environment where revenue was down 15%. In Canada, we have made significant progress to reduce our cost base and improve employee and facility productivity. We are moving customer work to locations with lower operating costs. Our optimized triple R facility network directs the most technically advanced work such as machine rebuilds to what we call our distribution diamond, while freeing capacity in repair and response locations. This hub-and-spoke model is designed to improve customer turnaround and experience, drive productivity gains, leverage resources and technology and reduce our environmental footprint. Canada's 2020 SG&A was down 8% from 2019. And over the last 7 years, we've reduced Canada's SG&A by about 20%, and the composition of our workforce has shifted significantly to a higher proportion of revenue generated employees. We have more work to do to further address our cost to serve in Canada with a focus on leveraging back-office efficiencies and driving further supply chain and procurement benefits. In the U.K., we secured our first orders for the HS2 project. Our current backlog includes approximately GBP 65 million of initial equipment orders related to HS2 and we are confident there will be significantly more to come throughout 2021 and 2022. Backlog in the U.K. was up 19%, and order intake doubled from Q3. And finally, we've lowered our finance costs and significantly strengthened our balance sheet. Our finance costs were down 40% in Q4 and more than 20% for the full year compared to 2019. Our outlook for 2021 is positive. Please turn to Slide 4.Our key markets continue to recover. Commodity prices are expected to remain at constructive levels, and many of our customers have announced an increase in capital expenditures. In mining, production levels are expected to grow, driving demand for parts and service on a large and aging equipment population. Government stimulus spending on infrastructure and investments in other large projects in all of our territories, underpin our positive revenue outlook for construction. Led by strong recoveries in Chile and the U.K., we expect revenue growth in 2021, however, remaining below 2019 levels as the recovery in Canada will be a bit more gradual.In 2021, we expect to benefit from several profitability drivers as we continue to advance our strategic priorities. These drivers include operating leverage in a recovering market, which will improve our profitability and return on invested capital; product support growth in all regions as we are leveraging our digital capabilities to win customer business; significant progress towards our mid-cycle target of 17% SG&A; the execution of our global cost initiative is on track to deliver more than $100 million of annualized cost savings; and effective allocation of capital, redeploying the significant free cash flow we have generated in a balanced way among organic growth, return of capital to shareholders and high rate of return complementary acquisitions. We have improved our earnings capacity going forward, assuming an undisrupted market recovery and the successful execution of our profitability drivers, we expect 2021 earnings to exceed adjusted 2019 EPS of $1.65 per share. Our free cash flow generation in 2021 will depend on the recovery. We expect to generate roughly 50% EBITDA to free cash flow conversion through the cycle, in line with the average conversion over the last 8 years. We are in the process of increasing our inventory purchasing and will likely be modestly below 50% in 2021. However, we expect to deliver material free cash flow for the full year. Since we started this journey in Q3 of 2013, we have generated roughly $3 billion in free cash flow. With that, we've grown our dividend at an approximate 5% compound annual growth rate and repurchased $250 million of shares at an average price of about $23 per share. We have made 2 highly successful acquisitions in this time frame, the Saskatchewan dealer and Saskatchewan was paid back in full within 5 years of the acquisition and has generated $50 million in free cash flow in the 2 years since acquisition and delivered strong performance in 2020 with EBITDA growth of 14% from 2019. I'm extremely proud of what our team has accomplished. We now have all 3 regions in a strong cost and inventory position; and through 2020, it has been rewarding to see our previous investments paying off. I am convinced we have positioned the business for strong performance in the upcoming recovery phase. We have an engaged and action-oriented leadership team that has been executing well and is excited about our future. And on that note, I'll pass it over to Greg.

[Greg Palaschuk, Executive VP & CFO]

Thank you, Scott. I'm going to provide more detail on our Q4 results, review our market outlook by region and discuss our strong balance sheet and associated capital allocation priorities. Slide 5 summarizes our consolidated fourth quarter results and provide key takeaways for 2020. Net revenue was down 12% in the quarter compared to Q4 of last year. Increased revenue in the U.K. and Ireland was offset by slower market activity in Canada and South America. Compared to Q3 2020, net revenue sequentially increased by 7%, with growth in all regions. All our operations achieved improved profitability compared to Q4 '19, driven by a lower cost base and stable gross profit margins, reflecting the resiliency of our product support business and ongoing operational improvements. Combined with lower financing costs and effective tax rate, we delivered significant year-over-year EPS growth despite the lower top line. EPS of $0.45 represented a 45% increase year-over-year. This included $0.07 of Canadian emergency wage subsidy. Adjusted EPS was $0.38, 25% higher than Q4 of '19. We have significantly strengthened our financial position throughout the year, and achieved EBITDA to free cash flow conversion well above 100%. In the fourth quarter, we generated $292 million of free cash flow, bringing our annual free cash flow to $870 million. I will now discuss the key revenue drivers of our Q4 consolidated results, which are shown on Slide 6. Lower revenue relative to Q4 '19 was mostly attributable to $150 million decline in new equipment sales. This was driven by Canada, where customer capital budgets remain constrained. Product support revenue was down $45 million or 5% from Q4 '19; however, it was up 4% sequentially. While we have seen a gradual ramp-up of customer demand for parts and service, the activity has not yet returned to pre pandemic levels in Canada and South America. We are encouraged by continued improvement and requests for proposal and quoting activity. Equipment backlog was up about 20% from September driven by higher order intake in the U.K. related to initial equipment orders for HS2; and in South America, driven by mining. Our Q4 consolidated order intake increased by 60% from Q3 and was the highest since Q3 of 2018. Moving to Slide 7. Our adjusted EBITDA was in line with Q4 2019. Adjusted EBITDA percent increased 130 basis points year-over-year. We saw a 260 basis point increase in gross profit margin, which was attributable to operational improvements, such as improved inventory quality and revenue mix shift to product support. SG&A cost decreased by 3% from Q4 '19. Savings from global cost initiatives were partially offset by higher LTIP expense, driven in part by a 33% increase in our share price during the fourth quarter; as well as a lower cost recovery in Canada, which I'll touch on in a moment. For the full year 2020, SG&A was down $115 million or 8% compared to 2019. Our Canadian results and outlook are summarized on Slide 8. In Canada, net revenue decreased by 20% from Q4 '19, mostly due to a 47% decline in new equipment sales. Q4 2019 revenue benefited from large mining equipment packages that did not repeat in Q4 2020, which meant our workshops who were less busy with equipment prep work compared to Q4 '19. Net revenue grew 6% from Q3 2020, driven by improved sequential activity in mining and power systems. Product support revenue was 6% below Q4 '19 due to reduced activity in all sectors. Compared to Q3 2020, product support revenue recovered 5%, driven by improved sequential demand in the oil sands and higher rebuild activity. Mined oil production reached record levels in November and equipment fleet operated at full capacity. We saw a strong pickup in activity at our OEM remanufacturing facility in Edmonton, building momentum through the quarter. Adjusted EBIT as a percent of net revenue was 7.7%, up 30 basis points compared to Q4 '19. Improved profitability on lower revenue was driven by a higher proportion of product support in the revenue mix, reduced cost base and operational improvements. SG&A decreased by 7% from Q4 2019, reflecting cost savings from improved processes and efficiencies. These savings were partially offset by higher service and overhead costs as new equipment prep activity was down significantly from Q4, and we continue to use the CEWS program to retain technicians. We recognized $13 million of this wage subsidy in Q4 2020, which is included in other income and excluded from our adjusted earnings. Including the wage subsidy, our reported EBIT as a percentage of net revenue was 9.3% in the fourth quarter. Support from the CEWS program has allowed us to preserve over 500 jobs and strengthened our financial position, and will enable us to make strategic investments early in this recovery cycle. This includes the purchase and capacity expansion of our facility in Saskatchewan, selected capacity expansion in Alberta and the construction of new ultra efficient facilities in Kamloops and Campbell River, British Columbia, which will be done in partnership with local indigenous communities. Shifting to the Canadian outlook. While current COVID restrictions are causing some short-term headwinds, we are seeing many positive signs in improved market activity in Western Canada for the full year, including an increase in oil sands production and capital expenditures. Strong price of copper and other metals and significant infrastructure programs planned in each province. With recovering oil prices and increasing budgets, we expect both new equipment and product support activity in the oil sands to continue to improve with higher fleet utilization, driving increased demand for maintenance and rebuilds. In addition, we're also seeing increased quotation activity for fleet renewal from both producers and contractors. The outlook for copper and precious metals has also improved. We're actively quoting on multiple RFPs for mining equipment and product support. For example, projects in the Golden Triangle area of BC, where there are several greenfield opportunities for us. We're also seeing an increase in order intake for construction equipment. We are encouraged by significant infrastructure investments being made by provincial governments. We have announced multibillion-dollar infrastructure stimulus packages to support economic recovery. We expect to benefit from public and irrigation modernization and expansion projects in Alberta and Saskatchewan, orphaned well abandonment program and light rail projects in Alberta as well as highway work in British Columbia. Moving to South America, and I'm on Slide 9. In functional currency, net revenue decreased by 3% from Q4 '19, mostly due to continued impact of COVID-19 restrictions on mining operations. While high copper prices are generating significant momentum for mining investments and driving a large uptick in quoting activity, day-to-day operations are still being impacted by COVID-19 restrictions. Chilean copper production was down 9% in December, with these ongoing restrictions being a key factor. Compared to Q3 2020, net revenue increased 6%. Product support revenue for the quarter was down 4% year-over-year, but up 8% compared to Q3 2020. Similar to Canada, we expect the maintenance catch up trend to continue throughout 2021. New equipment sales were 10% below Q4 '19 with some mining deliveries deferred to Q1 2021. Order intake in South America increased by over 80% from Q3 2020 and was higher in all sectors. EBIT margin in the quarter was a very solid 8.3%, up 230 basis points from Q4 '19. Shifting to the South America outlook. We are optimistic about the recovery occurring in both mining and construction in Chile, while we remain cautious about Argentina. According to Cochilco, the Chilean copper commission, copper production in Chile is expected to increase to 7.1 million tons by 2029 from 5.8 million tons in 2020. Chile's mining project portfolio represents $74 billion of total investment potential and 49 potential projects; mainly in copper, gold, iron, lithium, industrial metals. We're actively quoting on multiple opportunities for new mining equipment, autonomy solutions and product support contracts for both brownfield expansions and greenfield projects. Of note, the Lithium Triangle region represents an interesting growth opportunity for us. The Lithium Triangle is an area between Argentina, Chile and Bolivia, that holds approximately 55% of the global lithium reserves. Global lithium production is expected to grow at an average annual rate of about 12% in the next 5 years, driven by battery industry demand and the transition to electric vehicles. We're actively quoting equipment packages to support the industry build out and are looking at additional value-added services we can provide to customers in the future. Looking at 2021, we expect mining product support revenue to continue to recover as customers are ramping up major maintenance and work preparing their equipment fleet to meet increasing production targets throughout the year. Turning to construction. The Chilean government announced $34 billion of public investment in infrastructure over the next 2 years to jump-start the economy. As a result, we expect to see improved activity, stronger order intake in the construction and power systems markets in 2021. We continue to monitor currently muted social activities headed into the elections in November 2021. While the overall business environment in Argentina remains challenging, we expect stability in gold mining, in oil and gas and some recovery in construction activity in 2021. We're actively managing key risks in Argentina, including peso devaluation. We are maintaining a minimal level of investment in our operations to manage risks and support our customers. Turning to the U.K. and Ireland on Slide 10. In functional currency, net revenue was up 4% from Q4 '19, driven by an 18% increase in new equipment sales attributable to power systems projects for data center and electric capacity markets. Product support revenue was up 3% year-over-year due to higher service and rebuild activity and related parts consumption in construction and power systems sectors. We are pleased with the results in the U.K. and Ireland. EBITDA as a percentage of net revenue was up 180 basis points from Q4 '19 to 3.7%. We achieved a higher gross profit margin as the quality of our equipment inventory improved significantly compared to last year, and our equipment product mix shifted to power systems this quarter. Effective cost control remained in place with government furlough programs wind down and our revenues recover. The number of U.K. and Ireland employees on furlough was about 3% in Q4. U.K. government's furlough program has been very successful in limiting business disruption and supporting our rapid recovery in the U.K. and Ireland. The Brexit resolution has removed uncertainty for our customers. And while economic activity in the U.K. and Ireland continues to be affected by COVID-19 mitigation measures, we provide services to industries that are deemed essential and current operations are not being impacted in a material way. The 2021 outlook for the construction equipment market in the U.K. is positive. Our order intake in the fourth quarter was more than double that of Q3, driven in part by initial equipment orders related to HS2. After some delays, we expect a strong ramp-up in HS2 construction in 2021 and remain well positioned to capture further equipment and product support opportunities for this project. We also expect continued strength in the data center market, where we continue to build a strong backlog and expect timing of these project deliveries to be phased towards the second half of 2021, similar to what we experienced in 2020. I'll now turn to Slide 11 and discuss balance sheet and capital allocation priorities. Net CapEx and rental fleet expenditures were about $100 million in 2020. In 2021, we are expecting net capital expenditures and rental fleet additions to be in the $170 million to $210 million range, with the range dependent on the pace of market recovery. Approximately 1/3 of the increase relates to strategic investments in our Canadian facility network noted earlier, which will enable a corresponding net reduction and lease assets in 2022. 1/3 of the increase relates to rental CapEx, which will be dependent on market conditions, with the remainder focused on supporting digital offerings where we have seen significant adoption and high IRR capacity expansion. Improved management of working capital and the strength of our business model resulted in 125% EBITDA to free cash flow conversion in 2020, which allowed us to reduce our net debt by $615 million and lower our financing cost by 20%. As of December 31, our net debt to adjusted EBITDA ratio was 1.4, down from 2.0 at the end of 2019. Our significant free cash flow and strengthened balance sheet support our capital allocation priorities, which start with investment in inventory and organic growth to capture the market recovery; then subject to Board approval, dividend growth, followed by opportunistic share repurchases, acquisition opportunities. Taking a step back and reflecting on 2020, while the year was difficult in many ways, the organization pulled together and executed exceptionally well with the passion of our people and the strength of our business model leading the way. Customer loyalty, employee safety and employee engagement, all improved from last year. Despite a challenging top line in 2020, we improved gross profit margins and materially reduced annual SG&A, while protecting our technical talent for the recovery. While we minimized our capital expenditures, our mission-critical investments in performance solutions and autonomy projects helped us win and execute HS2 and QB2, respectively. And the countercyclical cash flow nature of our business model allowed us to generate $870 million of free cash flow in 2020 at a time when liquidity was critical. Finishing with a strong backlog build and positive outlook was a great way to end the year, we're all looking forward to continued momentum in 2021. Operator, I'll now turn the call back to you for questions.

[Operator]

[Operator Instructions] The first question is from Cherilyn Radbourne from TD Securities.

[Cherilyn Radbourne, Analyst]

I wanted to start with a question on product support, which showed continued sequential improvement in Q4, but was still below pre-pandemic levels. Can you just elaborate a little bit more on how much pent-up demand do you think there is if the virus restrictions fall away? And do you think 2021 product support revenue can get back to 2019 levels?

[Greg Palaschuk, Executive VP & CFO]

Yes. Thanks for the question, Cherilyn. Yes. Certainly, the recovery continues to have good momentum, but it was a little slower than, frankly, we were expecting 3 months ago. I think we'd highlighted marginally lower revenue in Q4 versus last year, and ultimately, is a bit shy of that. In Canada, we have seen continued trucks going back to work. Ultimately, customers continue to manage the budgets and perform. So we do expect more catch up in Q1 and Q2. And then we started to see our OEM workshop ramp up and is back to 3 full shifts. And then in South America, you were pretty optimistic about the -- managing the curve in Chile throughout the summer. Ultimately, the second wave has come as what has in other regions. And so we continue to manage it day-to-day. And you'll have seen the copper production come off a bit in December as manage that as well as summer holidays. So that pent-up demand is still there, and we expect to see that throughout 2021 occur. It was just a little slower than we thought in Q4. And then in terms of 2019 levels, I think we'll have to see. We're confident that each region will focus on growth year-over-year, and we have to ultimately see how the year plays out.

[Cherilyn Radbourne, Analyst]

Okay. Fair enough. And then having proved the Canadian physical footprint quite a bit in recent years, could you just give us a bit more detail on what's driving the investments that are planned for 2021?

[Greg Palaschuk, Executive VP & CFO]

Yes, sure. Ultimately, the triple R model that we've been talking about for a little while here, that's been proven out really well in the U.K., is the hub-and-spoke model and building up the hubs really strong is an important feature of that. And then having the spokes be very standard templates that are very efficient or important. And so we really want to own and control our -- what we're calling distribution diamond or backbone. And so we want to own and control and expand Kamloop's a really important logistical hub to make the system work. And so we think that we need a really highly efficient facility there. And so that makes a lot of sense and will enable a lot of efficiency in some of the spoke locations. And then Campbell River, as an example, will be a template of the single R of the future. And it's a smaller footprint, but very efficient for turnaround activity. And so that's what's driving the CapEx. And we think it's a solid investment for the operating model.

[Operator]

The next question is from Jacob Bout from CIBC.

[Jacob Jonathan Bout]

Question here on backlog, up sequentially quarter-on-quarter, year-on-year. You talked a bit about HS2. What are some of the other big drivers there? I'm assuming that QB2 is in there well, but just interested in what you're seeing right now?

[Greg Palaschuk, Executive VP & CFO]

Yes. And you'll see it in our comments, I mean there's lots of requests for proposal activity going on across the Board. In the U.K., it's focused on data centers and HS2. And so those are pretty clear themes. South America is pretty broad-based, but mining is certainly leading the charge across the product spectrum. So within the quarter, would be in shovels, ancillary equipment and trucks as well. So it's pretty broad-based, and there is a solid 80% increase in South America, and that's pretty broad-based.

[Jacob Jonathan Bout]

Just on your comments on lithium, is any of that in backlog? And how big of an opportunity ultimately could that be?

[Greg Palaschuk, Executive VP & CFO]

Yes. Certainly emerging opportunity. While there's a huge amount of lithium, it isn't open pit mind like it is in Australia or the U.S., it is solution mining. So we are -- we've got equipment already working through contractors in Chile and Argentina. And we're quoting as we speak. These are $5 million, $10 million packages, not larger mining. But it's an emerging trend. It's growing. We'll continue to scope that out and likely talk more about it at Investor Day in June. But it's a real trend, and we're also going to look at other ways that we can participate beyond kind of dozers and graders and excavators.

[Jacob Jonathan Bout]

My second question here, just on margins. How we should be thinking about 2021 versus 2020, lots of moving parts. You're talking about oil sands, higher product support with higher fleet utilization. But then you've got the offset here of the lower margin new equipment sales in U.K. and Chile. So if you put that all together, how should we be thinking about 2021?

[Greg Palaschuk, Executive VP & CFO]

Yes. We think we'll see more new equipment in the mix and more mining equipment. So that will put some margin pressure. But ultimately, as we continue with our other profitability drivers, we think we can continue to yield up. But we'll be mixing new with product support, but we think we can continue to make progress.

[Operator]

The next question is from Yuri Lynk from Canaccord.

[Yuri Lynk]

You're giving a lot more detailed financial guideposts for the year ahead than you did at this time last year, which is much appreciated. But just curious if you could expand on what's giving you the confidence to put out, say, an EPS number, where in the past, I think you've been pretty hesitant to do that.

[Greg Palaschuk, Executive VP & CFO]

Yes. Thanks for the question, Yuri. Certainly, we can see some trends in the market that we feel comfortable with. We've got really solid plans and feel like our execution is hitting another gear. And with the backlog starting to build, it just gives us more confidence. And ultimately, if you look at the back half of the year, we generated $0.75 of earnings. And so we think we can continue to build off of that. And so we're starting the year with a lower -- better balance sheet and lower financing costs. So we think it's a pretty clear buildup. And so we're putting it out there at this point.

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

Yes. I guess -- Gary, it's Scott. I mean as you think about the 7 year journey here, I mean, definitely, there's some uncertainty in the first quarter with the vaccine and activity, and we'll manage through that. But that's a little bit of uncertainty. But if you think -- take a step back and look where we are in all 3 regions, we've never been in a better place from a cost perspective, we've never been in a better place from an inventory perspective. And this is the first time we have a constructive backdrop from a commodity price perspective. And we're starting to see it come through in backlog and order intake. And so when you look at the back half of the year, all of the things we've been working on here for the last 7 years are going to start to demonstrate, right? I mean, similar to 2020 with the technology investments, which really paid off. I think you're going to see in the back half of 2021, getting through the vaccine, all of the cost and capital efforts we've made really pay off.

[Yuri Lynk]

Okay. That's fair. Just as we think about the SG&A, where you've made great progress on the $100 million in annualized savings. I believe at one point, you suggested that about 1/3 of that might come back depending on the pace of a revenue recovery. Given the kind of the wide range that you gave for where revenue might land this year, how do we think about some of that a $100 million in SG&A coming back this year?

[Greg Palaschuk, Executive VP & CFO]

Yes. So we'll continue to work away at the $100 million and continue to build on that our move towards our 17% target. We've added back about 100 techs in Canada and about 50 in South America through the back half of the year. And so that would be kind of, call it, about half of the add back. But the vast, vast majority are technicians that will go into cost of sales and ideally drive service revenue growth. And so we're still feeling good about the 100 and continue to drive initiatives across procurement working on the footprint, people productivity, leveraging our technology tool kit to keep driving that further.

[Operator]

The next question is from Michael Doumet from Scotia Bank.

[Michael Doumet, Analyst]

On just a follow-up on the last question for the SG&A. The mid-cycle SG&A guidance implies that you need to actually maintain or even reduce your SG&A for your Q4 SG&A run rate through the cycle. So what's your confidence level? I mean, particularly as you're going to have to do that while adding cost back to support higher activity levels.

[Greg Palaschuk, Executive VP & CFO]

Yes. I mean it's certainly a target that we're setting up. That's something that going to take a coordinated effort. And so we continue to execute through our plans. Between Q3 and Q4, there was a lift. Some of that was LTIP, some of it was the labor recovery point So I do think our run rate was -- is lower than what we saw in Q4. And so we'll see that through the first half of the year. And absolutely, we're going to need to continue that level of run rate while growing the business, and that's the challenge. And so there are additional fixed costs that are going to need to come out to keep up pace with variable costs. But we're up for the task, and that's what we think is going to add value. And so that's the point.

[Michael Doumet, Analyst]

Okay. Great. And then I just wanted to dig a little bit into the Canadian margins here. So Q4 revenues were up sequentially and mix actually looked favorable versus Q3 as well. And I'm assuming there were higher service costs in Q3 as well due to Qs. So what explains the margin compression from Q3 in Canada? I mean, is it purely seasonality? Or was there something else in the quarter?

[Greg Palaschuk, Executive VP & CFO]

Yes, there is SG&A pressure that we highlighted, labor recovery and cost allocations a little lower, which is always a seasonal thing in Q4. But typically what you'll have is some of the service work come off in November, December, and the workshops stay very busy prepping equipment as customers have budget to spend and we have model And so that dynamic was a bit different this year given the low level of equipment prep. So that puts a little bit of pressure on SG&A.

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

I think the other thing to note, too, I mean, we're trying to be really transparent here with backing out cues. But in reality, there's a population of the workforce here that isn't fully utilized. And so we should be taking credit for some of the Qs, right, in that margin. And we've done that purposely to be transparent with all of you, and we've taken it because we want to protect that technical workforce. But you think about a second wave in Canada, essentially, a lot of the market shut down kind of mid-December, right? And so you had a labor force that wasn't fully utilized.

[Michael Doumet, Analyst]

Makes sense. And if I could sneak 1 more in. I mean, there was quite a bit of CapEx spend in the prior cycle. So you've increased your spending levels in 2021, but I wanted to get your views on what you think the spending could look like for the next cycle and where the investments might be made?

[Greg Palaschuk, Executive VP & CFO]

Yes. Certainly, over -- on a mid-cycle approach, you can kind of look back over the last 7 years and take an average. You have which would add a little bit to that full cycle. But we think that's a reasonable benchmark. That's what we think about when we think about 50% EBITDA to free cash flow conversion. We'll continue to run the base business, continue to focus on digital initiatives where we're seeing good uptake and adoption. The rental fleet, we'll continue to invest in the appropriate parts of the cycle. And we've got a bit of facility spend here, but we think that's a bit of spend to save, and that should moderate over the next couple of years. So we think that's kind of the solid mid-cycle approach. It's balanced, and you can kind of look at a 5 to 7-year average, and that's probably what you should expect mid- cycle.

[Operator]

The next question is from Devin Dodge from BMO Capital Markets.

[Devin Dodge, Analyst]

Maybe start on the balance sheet. Leverage is on the low end of the historical range already. Arguably this is on trough EBITDA. You expect free cash to be free cash flow positive through the So leverage seems like it's going to be drifting even lower. So my question is, what do you think is the right amount of leverage for the business? And should we be expecting Finning to be a little more active on share buybacks or acquisitions in 2021?

[Greg Palaschuk, Executive VP & CFO]

Yes. Thanks, Devin. I mean, mid-cycle basis, I'd like to run the business at 2x debt to EBITDA. I think that's the appropriate level with some throughout the cycle and depending on what opportunities are in front of us. But yes, I mean we've been pretty clear with our capital allocation priorities, the organic investment. We still think that there's more capital beyond that. So we're -- we'll look at the dividend next quarter. We'll evaluate share buybacks as we go. And we'll continue to look at M&A. I highlighted lithium today as a spot where we'll be looking, and we think there's some interesting opportunities. There's a few other pockets like that, that we'll continue to find ways that we can gain wallet share. But the priority now is continuing to drive the business, focus on return of capital, but continue to evaluate.

[Devin Dodge, Analyst]

Okay. That makes sense. Maybe just on Just wondering, is that EBITDA growth that you realized in 2020, I think you said it was 14%, which is kind of impressive. Is just -- is that more weighted towards Western Canada just given the overlap with the dealer network and the opportunity for revenue synergies?

[Greg Palaschuk, Executive VP & CFO]

Yes, it's a balance actually. So Western Canada, we've had some really good cross sell, upsell, and so there's been growth there. Eastern Canada has been solid as well, and we've had actually really solid growth in Texas. So I'd say it's a balanced approach, but higher growth rate in Western Canada, given that's where the sale synergies lie.

[Devin Dodge, Analyst]

Okay. When you acquired 4Refuel, I think you were suggesting that Finning would consider selling some of the nonoverlapping portion of the business. We're clearly in an active M&A market. Do you think there's an opportunity to divest part of that business? Or are there synergies or scale benefits that we should be considering?

[Greg Palaschuk, Executive VP & CFO]

No. I think we're happy with the performance and encouraging that business to continue to grow and generate cash at the same time. So we're pretty pleased across the board.

[Operator]

Next question is from [indiscernible] from Bank of America.

[Unknown Analyst]

My question relates to Chilean copper. In the mines there, are you seeing -- through the cycle, do you expect it to be driven more by greenfield expansion or a larger maintenance and replacement cycle? And on that 80% jump in orders, is that primarily driven by greenfield demand or replacement demand?

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

It's Scott. I mean, I guess a couple of things, one, as Greg said, I think it's across the board in terms of types of product. And I would say the same thing for greenfield versus brownfield. You think about QB2 investment, which was the first major mining investment, $5 billion investment from which is now kicking off, and there's obviously the opportunity for QB3 behind that. But I think if you take a step back and you look at the copper price and the lack of investment over time, into all mining areas, but copper, in particular, and you look at what the forecasts are, the forecast that we're seeing right now are 5.8 million tons to 7.1 million tons over -- I think it's a 7 or 8-year period. And so the increase in production is going to be significant, and that's going to come from brownfield and greenfield. And I think the challenge, what you're seeing right now with copper price is there hasn't been a lot of investments. There's not a lot of supply. And that's obviously, with an increasing demand is causing those towards sorts of dynamics. So I expect that will rectify itself to more investment going into copper, which will be obviously beneficial for us.

[Unknown Analyst]

Makes sense. And then just as my second question, I understand that Keystone XL isn't expected to be a significant impact to your business. But could you expand on that on the broader implications for the industry?

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

Yes. No, good question. I mean, I think this has been a 10-year journey, right? And through that 10-year journey, I think the Western Canadian market has adapted with different alternatives. And also, there's been a a little bit of a reset on growth in the oil sands. And so as you look forward, there's no doubt in my mind that oil demand is going to be with us for a long time. And the oil sands is competitively advantaged, given the on and the low variable cost of productions. And I believe Western Canadian crude is now actually more important to the U.S. given the reduction in capital going into shale development in the U.S. So all projections I had seen out of Western Canada show production increasing over time. So again, that's a good thing for us. That being said, I think there is obviously an energy transition underway, which will take a significant amount of time, but that will impact new capital, foreign capital going into the oil sands and big new development. So the -- say 10% level is probably not in the cards, but growth in the 3% to 5% to 6% is in the cards. And so then the question is you have enough egress associated with that type of growth to keep the differentials tight. And then you go back to the 10-year journey. And when Keystone started, actually, there's a lot of other egress options now, right. As you think about Trans Mountain coming on, line 3 coming on, which add significant capacity. And so interestingly, Keystone goes away, but you have enough capacity. Once those 2 come online to get the oil out of Western Canada and into the U.S. So from an overall sentiment perspective, obviously, has an impact. I mean, there's no doubt. But from an actual on the ground, getting oil from Western Canada to the U.S., I think it's not that material.

[Operator]

The next question is from Bryan Fast from Raymond James.

[Bryan Fast, Research Analyst]

I'll take the flip side of Devin's earlier question on 4Refuel. It has performed well for you in your current regions. Is there a possibility we see an expansion of that offering into other regions like the U.K. or it seems density of the region would be, I guess, contusive to a product like that.

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

Thanks, Brian. It's an interesting platform because it has -- I mean, we have high expectations for it, but it exceeded our expectations. And when you look at 14% EBITDA growth through pandemic and $50 million of free cash flow, and then the IRR and the base investment is really high. So that's good. But the interesting thing about it is it is a platform for distribution, right? And as you add more capacity, the IRR increases pretty significantly. And so we're going to be thoughtful about it, but adding organically through incremental capacity does have pretty high returns. And as Greg said, that's a little bit of the capital uptick relative to 2020. As you think about where it may fit in other areas, the U.K. is a good fit, right? I mean as you think about HS2 and all of those machines, and you noted our success on HS2 to date, we're going to have a big population of machines there. And you think about customer share of wallet and the ability to provide additional services, that's a really logical fit. And we're in the early stages of thinking that through. I think South America, a little bit more challenging and a little bit more challenging just because of some of the safety issues with distribution of fuel that I think we have to be pretty conscious of. And then I guess the last thing is, in terms of the strategic rationale when we did this, it's also delivery of other services, not just fuel, also beyond fuel. So oil changes, oil filters, all in the pursuit of increased share of wallet, increased intimacy with our customers, increased service revenue. And so, so far, so good, 2 years in, $50 million of free cash flow, 14% growth in EBITDA, high IRR. I don't think we could be more pleased with the allocation decision -- capital allocation decision.

[Bryan Fast, Research Analyst]

Sounds encouraging. And then maybe just on the parts side of business, have you been experiencing any disruption in-sourcing parts? I'm just trying to get a sense of, I guess, supply channels have recovered at this point?

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

Yes, it's a great question, and it's been -- we're spending a lot of time on that, but it's not on the parts side, so much it's on the equipment side. On the parts side, I think what's been fortunate is just great alignment between the dealers and on growing services revenue. And so you think about strategy of doubling services over a period of time, obviously, making sure supply chain is operating well is critical. So even through the pandemic, we saw almost no interruptions, and our on-time in full delivery to our customers has gone up pretty significantly. And I think that's actually been a driver of our increased customer loyalty. So no concern on product support. I think where there is something we have to be really cautious about is lead times on new equipment. And this isn't -- I mean, cap all over it. You can hear Jim respond to it in his call, and he feels good about it. But I guess the only thing we just have to watch carefully is, as the whole world reflates here, you see what we're seeing from an order backlog perspective, I suspect others are seeing that as well. And so I think it's going to put a pretty big demand on supply chain. And so getting real good alignment with on what we need, when we need it and how far in advance is key. And that's what we've been spending a lot of time on in the last 3 months. And frankly, you're going to start to see the impact of that in the first quarter as we go back to more seasonally typical free cash flow patterns in the first quarter with inventory additions coming on, on the back of some of these order intake and backlog improvements that we've highlighted today. So, so far, so good, but something we're keeping a close eye on.

[Operator]

The next question is from Sabahat Khan from RBC Capital Markets.

[Sabahat Khan, Analyst]

Just a question on kind of the seasonality that we should think about through 2021. You indicated that H2 seems to be the one that will be a bit stronger. But I guess through H1, with Q1 being compared against a non COVID corridor, should we expect H1 to also be getting sequentially better with Q1 being maybe less growth than Q2? Just any color there would be helpful.

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

Yes. Listen, I think we've got a lot of conviction around on the back half of the year. And when you look at the performance in 3Q and 4Q without Qs in a pandemic, dealing with the second wave and knowing that we'll be through at some point here, we get a lot of confidence on that EPS projection. I think where we're less confident is in the first quarter, frankly. And I'm not trying to say anything different than what we've said. I mean we're still seeing improvement. We're still seeing a recovery. But it's such an uncertain environment that Q1 isn't going to see the ramp relative to the back half of the year. And that's just going to be dependent on vaccines and how we get through that. In terms of that vaccine issue, you look at the U.K., it's leading the way. Right? I mean, I think 20% of the population in the U.K. has been vaccinated now. I mean, it's unbelievable. They're doing such a good job. So they're going to come out of this early. I think I'm really pleased with Chile. I think Chile right now is in the second wave, and it's primarily impacting for the mining region, and that's why you saw Chile copper production down 9% in December. But I also believe from a vaccine perspective, they're going to come through this quicker than Canada. In talking to some people that are associated with hospital boards down there, we think March, April, May is going to be a good time to get through that. So I feel pretty good about the outlook I think the Western Canada and associated with our guidance here on gradual, is the vaccine rollout has been a little bit slower than I think all of us on the phone are hoping. So that's the area that we just have to keep an eye on. That's the area that we've guided to a little slower recovery because of that issue. And to your point, the second half is going to be a little bit stronger than the first quarter.

[Sabahat Khan, Analyst]

Okay. And then just during the quarter, it looks like in Q4, the user equipment really performed well across both Canada and South America. Do you think that was maybe just given the caution in the backdrop, folks were lying on used equipment a bit more? And do you expect that maybe reverses towards, I guess, with new equipment maybe picking up next year, that reversed a little bit. Just want to get a bit more color on the drivers there.

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

Yes. In South America, we've had some excess equipment that we've done a really good job of shifting. And so they've had a pretty solid year for used and I wouldn't expect it to necessarily grow off of that base. In Canada, we've got a few initiatives driving increased volume there, that with how it's working. And we do expect new to be more primary in 2021, but ultimately we'll continue to drive used. We're seeing solid margins. And where there are potential product gaps or equipment lead times stretching it, we'll try and fill that with some use proposition. So I think solid. But certainly, for 2021, we're seeing more opportunities on the new side.

[Sabahat Khan, Analyst]

Okay. If I could just squeeze 1 on the lithium commentary that you had earlier. It looks like for now, you indicated that the mining share was there in the $5 million to $10 million range, smaller than typical mining. Do you think that as the market develops over time, you could get something similar to what you see elsewhere in mining? Or is it more related to having to develop some capacity or certain capabilities to be able to get that similar order size in that market?

[Greg Palaschuk, Executive VP & CFO]

Yes. I mean it's not open pit mining, so it's going to be hard to compete with copper. But certainly, it's a solid opportunity and an area where if we got into additional services that that could scale up. And so we're encouraged. We think it's a growth area. But yes, we don't expect it to copper on the current platform, but we'll continue to review the opportunities, and it's just such an interesting fit with our portfolio.

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

I think the one thing, I mean, just keep in mind, too, as you think about this energy transition, I mean, as I said, I'm very optimistic on the oil sands and thinking that it's going to be a competitively advantaged. Energy source for a long time. But inevitably, you are in the energy transition over time. And you think about how Finning is positioned, we've got natural gas in Western Canada that is as big as the Marcellus, right? I mean, that is a massive opportunity for us. And then you look at the South American footprint, and you see 30% of the world's copper in Chile and 55% of the world's lithium in that triangle of Argentina, Bolivia and Chile. And so from an energy transition perspective, we couldn't be better positioned. Recognizing that energy oil and fossil fuels are going to be with us for a long time as well.

[Operator]

The next question is from Maxim Sytchev of National Bank Financial.

[Maxim Sytchev, MD & AEC]

Just wanted to focus a little bit on the e-commerce and technology capabilities. So Scott, when we talk about parts transacted online, wondering if you don't mind maybe commenting what that means from a margin profile and maybe ease of service. Just do you mind maybe sort of painting kind of like an operational/financial picture on that?

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

Yes, sure. So as you think about the 2 -- with our 3 big initiatives, but 2 of them, I'll focus on for this conversation that we embarked on 5 years ago, one, it was connecting all our machines and getting an e-commerce platform that was appropriate for our large customers and our small customers. And so as it relates to the e-commerce piece, we've gone from 10% of our nonservice parts online to 40% online. And that's a -- it's a massive advantage for us because you just have more options for the customer. And so that doesn't mean the branch network is going away. It's an omnichannel approach, and that's really important because some customers will want to use the branch network, some people will want to use online distribution. It has really helped through a pandemic, right? I mean, the fact that we've been able to have these options for our customers. I think I talked about supply chain availability, but I think that's also been a big driver of the customer loyalty improvement and the resiliency of the product support business. So that's great. And then if you get to the economic piece of it, it should be accretive, right, because you're actually providing a better service to your customers, some more options. So there's not a a financial discounting aspect to that, and you're doing at a lower cost. And so you should be able to reduce the cost structure. Now there's a period of time here where you're duplicating costs, obviously, but I think we're through a lot of that. And as we think about this triple R network going forward, the hub-and-spoke network off the distribution diamond, that's obviously a big part of how we design that network will be with e-commerce in line. So I think, Max, is kind of all good from a customer perspective, from a cost perspective and then ultimately from an efficiency perspective. Just 1 quick comment on the connected machines because I think that was the second part of the journey. We've done from 10% of our machines connected to 70% of our machine connects over that same period of time. I think one of the reasons we've been able to manage this pandemic so effectively on the inventory side is because of the connected machine data usage. And that's really allowed us to have insight into machine utilization, which has allowed us to adapt from an ordering perspective. And it comes back to me saying, we've never had our inventory in such great shape. So that's a good connection. And then the second connection is around product support and back to what we've continually said is when you connect a machine, when you put a customer value agreement around it, and when you create that instrument relationship with the customer, you drive higher parts market share. And it's hard to see in this year when you're dealing with a pandemic where product support is off. But when I see our product support aftermarket share, it's improving materially. And that bodes well for when you get back to a normalized revenue market. And then that all connected aspect of this then plays into the e-commerce, too. If you have that relationship, that digital footprint relationship with your customer, you can also have more dedicated marketing offerings. You can have more disciplined approach to maintenance. And so it's one part of the digital journey, we're trying to bring our customers along with us, that is, it's good for them and it's good for us.

[Maxim Sytchev, MD & AEC]

Yes. No, 100%. And maybe just -- I don't know if you want to potentially quantify this, but I mean how much revenue are you driving right now from that connectivity and condition monitoring revenue generation?

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

Yes. So I mean, that's obviously very -- yes, I'm not going to disclose it, is answer one, as Amanda looks at me. But I think the key here though is there is value here, right? And you look at this HS2 situation that we have, and this gets to the third pillar of our digital strategy that we rolled out 5 years ago, which was value-added services, performance solutions. And one of the real drivers of our outsized market share on HS2 is the technology solution we've wrapped around the equipment, which provides insights to the customers, which improves their productivity, which makes them more efficient. And there is a revenue stream associated with that, for sure. I think for us, though, we think about amplifying the parts of -- the traditional parts and services business, right? I mean if you can wrap technology around the equipment and you can drive significantly incremental market share on the new equipment side and significant incremental market share on the parts side, that is a great outcome for Caterpillar. It's a great outcome for Finning. And at the same time, do it in a way that you obviously get value for the investments that you're making in. And that's how we're thinking about 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.

[Amanda Fern Hobson]

Thank you for joining us today. This concludes our conference, and have a safe day.

[Operator]

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