The turnaround story at Commercial Vehicle Group (CVGI) is moving along at a painfully slow pace, but is moving along. New senior management (both the CEO and CFO have been at the company less than a year) has a lot on its plate, ranging from shifting the R&D process to a more customer/application-specific approach to enhancing productivity to positioning the company for growth in large markets like agriculture and Chinese heavy vehicles.
All of this takes time, and not all of the factors necessary for better results are within management's control. While I wouldn't overlook other quality stories leveraged to commercial vehicles, like Cummins (CMI) or Eaton (ETN), I'm still willing to wait and see if new management at CVGI can deliver better results as the truck and construction cycles turn around. I think reasonable fair value (considering the risks and cyclicality) is around $9.50 today, but simply de-risking the story to a point where Commercial Vehicle would be on par with companies like Allison (ALSN), Cummins, and Eaton would add over $2 per share to fair value.
Mostly Positive Results For The Fourth Quarter
Commercial Vehicle's fourth quarter revenues were about 3% lower than the third quarter's, but still up 6% on a yoy basis. That was about 4% below the average sell-side estimate, but as there are only two sell-side analysts following the stock, you have to take that with a grain of salt. Even so, looking at the double-digit growth for large truck OEMs (and significant CVGI clients) PACCAR (PCAR) and Volvo in the fourth quarter, it's hard not to be a little disappointed with the results.
On a more encouraging note, the company's margins are getting better as early restructuring and cost reduction efforts take hold. Gross margin improved two points from last year and slightly on a sequential basis, while the incremental gross margin improved significantly. CVGI cut SG&A expenses by almost one-third from last year's level, leading to a significant reversal in operating income and better than 100% growth from the third quarter. Management's comments on the call suggest that this is not the new normal (not yet, anyway), but it is still a meaningful positive step forward.
Strong Truck Orders Can't Hurt
One of management's long-term priorities is to make the company a more diverse component supplier, but for the time being, North American trucks make up more than 40% of revenue. January Class 8 orders were up 51% on a year-over-year basis, marking four straight months above 20,000 and the best result (almost 35,000) in almost three years.
Commercial Vehicle operates a volume/utilization-sensitive business, and a high ongoing level of orders would offer upside for 2014 numbers. Of course, the details will matter - if those orders go to companies where CVGI doesn't have as large a presence or the orders are for trucks that have less CVGI content (the company makes more from long-haul sleeper cabs), it won't help as much as you might hope.
A Lot Of Restructuring Work Still To Do
It's not exactly fair to compare Commercial Vehicle to Cummins, one of the best-run industrials around, but I do think a look at other heavy vehicle suppliers supports my view that the company has a long way to go to improve its operations. Eaton's vehicle segment margins are in the low-to-mid teens (13.7% in the fourth quarter), Allison's are in the high teens, Cummins' are in the low teens (excluding distribution and power gen), and so on.
Commercial Vehicle has over a dozen manufacturing facilities scattered around the world, and further consolidation may be a necessary step in establishing the right level of capacity and the right cost structure. Management is also turning to steps like developing a central procurement system and giving more authority/responsibility to product line managers as a way of improving both margins and accountability.
China, Construction, And Agriculture Remain Big Opportunities
Diversifying away from North American trucks is an important part of CVGI's long-term story. The new CEO came to the company from Caterpillar (CAT), and the two companies already have an agreement in place for seating products in new North American construction equipment. The company also has an agreement with Cummins to supply wire harnesses for trucks in both North America and China.
Management knows they need to be driving this process. Every commercial vehicle company talks about China as an important market, and CVGI's management has made it clear that establishing a bigger presence with Chinese vehicle manufacturers is a major priority in the coming years. The company is also looking to increase its share with agricultural equipment manufacturers like Deere (DE) and improve its market share in the construction business by developing more products specifically for that market (instead of trying to sell products designed for trucking markets to construction equipment manufacturers).
It Is Going To Take Time For The Benefits To Show
This turnaround is going to take time, and the rewards are going to be seen over the long term. While I believe that CVGI is going to generate long-term revenue growth in excess of 7% and future FCF margins in the mid-single digits, the uncertainty of those cash flows (and the cyclicality of the markets it serves) leads me to discount them back at a higher-than-normal rate. Even so, I believe these shares should trade closer to $9.50 on a DCF basis.
The Bottom Line
There is plenty of execution risk with this company, but management seems to have identified numerous avenues to better performance - whether in the form of additional revenue, less dependence on particular markets, or better margins. I still believe that management deserves the benefit of the doubt and that success with their various initiatives can make CVGI a much stronger company with a much healthier stock.