A Bumpy Ride For The Commercial Vehicle In 2011

by: Stephen Simpson, CFA

Arguably the nicest thing that can be said about Commercial Vehicle Group (NASDAQ:CVGI) for 2011 is that the company was not alone and performance could have been even worse. Although heavy duty truck production rebounded well in 2011, major truck and truck component manufacturers had a thoroughly miserable year. Down nearly 50%, CVGI's year was bad, but then so too were those of Accuride (NYSE:ACW) (down almost 60%), Navistar (NYSE:NAV) and PACCAR (NASDAQ:PCAR) (both down about 35%), and even the oft-popular Cummins (NYSE:CMI), whose stock is down about 20%.

With truck production in 2012 still looking fairly solid at this point, is a rally in truck-related stocks in the cards? Perhaps even more to the point, is Commercial Vehicle Group the way to play that rally?

Fancy Language For Simple Things

Commercial Vehicle likes to boast of offering “integrated system solutions” for commercial vehicles. That's Scrabble-speak for “we make seats, interior trim, wire harnesses, mirrors, and wipers for big trucks”. To be fair, though, Commercial Vehicle does have the distinction of offering the only total solutions for truck cabs and it is not as though seats or wiring are trivial aspects.

Commercial Vehicle sells into a range of vehicle types, but the North American Class 8 truck market is the driving force here – the company gets close to half of its revenue from this market. It's also a fairly narrow market in terms of the customers, and CVGI counts most of the usual suspects in its customer list – Navistar, PACCAR, Caterpillar (NYSE:CAT), Daimler (OTCPK:DDAIF), Volvo (OTC:VOLAF), and Freightliner.

That said, the company is not resting on its laurels. Management here understands what management at Cummins and Eaton (NYSE:ETN) realize, namely that truck growth potential in markets like China and India is considerable. To that end, CVGI has been actively trying to grow its business in China and Mexico and has a majority-owned JV in India.

Plenty Of Room For Trouble

Clearly truck build rates are important for CVGI, but that's not the entire story. For starters, this company has a legacy in private equity and has built itself through aggressive acquisitions. That has left the company with quite a lot of debt and almost no tangible net assets. Consequently, economic downturns are still an existential threat.

Margins are also a major talking point. CVGI is vulnerable to commodity inflation, as steel, aluminum, copper, and plastics make up a large percentage of the costs. The company has also been experiencing abnormally high operating leverage; while management is trying to improve full-cycle profitability, margins are still critically dependent on production volumes.

It is also worth noting that CVGI is vulnerable to less obvious shifts in its core market. As the years have gone on, short haul and less-than-truckload carriers like Old Dominion (NASDAQ:ODFL) have garnered more and more business, while long-haul carriers find that costs, employee preferences, and government regulations are all working against them. That matters to CVGI because they stand to make more money from the sleeper cabs that long-haul truckers need as opposed to the day cabs favored by short haul carriers.

Competition is more of a mixed bag for CVGI at this point. While CVGI does compete with public names like Accuride and Magna (NYSE:MGA), neither of these are as committed to the cab market as CVGI. For the most part, Commercial Vehicle competes with smaller entities and this is a mixed blessing as smaller companies are not always rational competitors and can be pushed harder by larger customers.

The Bottom Line

Commercial Vehicle really does not have a great track record of free cash flow production, so investors need to realize that bullish theses are at least somewhat predicated on a level and consistency of performance that hasn't been seen yet. Nevertheless, it's not hard to see what the company might achieve and there are definite signs of progress in that regard. Even assuming that CVGI cannot the profitability of the best parts suppliers, it is not hard to see a price target 50% or higher from today's levels.

CVGI is a highly levered, risky play on truck production growth and internal improvement. Investors with less risk appetite should probably focus on names like Cummins or Eaton, but Commercial Vehicle offers an interesting risk-reward trade-off for more aggressive investors.

Disclosure: I am long CVGI.