Oshkosh (OSK) is a specialty vehicle producer. The firm has been around since 1917, and services a wide range of customers and applications. Currently the largest customer is the U.S. Department of Defense (DoD), which accounted for over 76% of sales in the most recent quarter, and traditionally about 30% of sales. Oshkosh builds mine-resistant vehicles and both medium and heavy-duty vehicles for various branches of the military. DoD has been a major customer for over 80 years. Defense is also, by far, the most profitable of Oshkosh's business divisions.
The company also has several non-defense related segments. The largest of these is Access equipment, which effectively represents Oshkosh's 2006 purchase of JLG Industries. JLG provides aerial work platforms (think electric pole repairs, although they are used for many jobs) and telehandlers (long-armed fork lifts). Access generated about 30% of sales in the most recent quarter, and is usually more around 40%.
Fire and emergency, notably the Pierce (fire truck) and Medtec (ambulance) brands, account for about 15-20% of sales. Some other specialty vehicles, like airport rescue and snow removal, fall into this segment. Last is the Commercial business, which consists of primarily trash trucks and concrete mixers. Commercial historically contributes about 15% of Oshkosh's total revenues.
Less than a year ago, this looked like a firm in serious danger of insolvency. The company paid $3.2 billion, primarily financed by debt, to buy JLG in 2006, and then watched as construction plummeted, severely crippling demand in the Access segment and for concrete equipment. This snowballed into a full-fledged recession, strapping municipal budgets and leading to push-out of emergency vehicle orders. To make matters even worse, Oshkosh lost out early in competitive bidding on a new military Humvee vehicle in 2008. In fiscal (Sept.) 2009, Oshkosh earned just under $208 million in operating profits but faced debt interest burden of nearly $213 million, not to mention outstanding debt exceeding $2.5 billion dollars! The situation was dire, and Oshkosh stock reflected that fact, trading at levels under $5 at one point.
Fast forward to last July, when the company turned things around in a big way. Oshkosh won the government's lucrative mine-resistant ATV (M-ATV) contract, which ramped up immediately to 1,000 units a month, providing a huge boon to the company. In the most recent quarter, Oshkosh's sales ballooned 83% year-over-year to $2.4 billion, allowing management to aggressively pay down debt. Next quarter should see similar results. In fact, the M-ATV contract alone is estimated to be worth anywhere from $6 to $12 billion dollars in total revenue for the company over the next several years.
The good news kept coming. Just a month later, Oshkosh prevailed over BAE Systems (OTCPK:BAESY) and Navistar (NAV) for the government's Family of Medium Tactical Vehicles (FMTV) business. While this is a much smaller opportunity (initially $300 million with a potential value approaching $3 billion), it is both incremental to growth and proof-positive that Oshkosh has its “mojo” back with the federal government. While the FMTV is currently under a stop-work order while the Government Accountability Office (GAO) reviews protests from the losers, Oshkosh management seems quite confident the decision will hold.
With these two contracts, we have an investment with outstanding near-term growth opportunities. Currently, the remaining businesses are weak, but as construction demand improves and municipal budgets free up, I expect to see returning strength to them as well (although it might be another year off). Oshkosh can also boast of a solid competitive position. The company is a long-standing contractor with the government, and the non-defense businesses are all rather niche, with limited competition and limited market sizes that tend to discourage new entrants.
Put it all together, and MagicDiligence believes Oshkosh stock could be worth as much as $57 a share – a significant increase from the current $38 levels. That makes the stock a solid Magic Formula choice, and I have placed a positive, “buy” rating on it.
Oshkosh does not quite make the cut for the Top Buys portfolio... at least not yet. Financial health is still a concern here. The debt has been whittled down to $1.8 billion, and interest coverage has increased to an acceptable 7 times. However, it will still take several years, even with the two new contracts, to get debt down to manageable levels.
Also, relying on these kinds of contracts is risky business. If M-ATV orders fall below expectations or are diverted away from Oshkosh for any reason, we are right back in danger territory. The valuation is reasonable, with an MFI-adjusted earnings yield of 12% (12.7% against forward 2011 estimates), but not so cheap as to unduly discount the risks. MagicDiligence would like to see Oshkosh get down into the low $30 range before really getting excited.
Disclosure: Steve owns no position in any stocks discussed in this article.