Douglas Dynamics (PLOW) is a relatively small manufacturer of vehicle attachments and equipment. The company has a market capitalization of just half a billion but surfaced on my radar as it announced the acquisition of Dejana Truck and Utility Equipment.
The deal will reduce Douglas´reliance upon snowfall, but it will increase leverage to fairly high ratios as well. While the overall valuation looks quite appealing, certainly in combination with a 4% dividend yield, I think that leverage ratios are somewhat elevated for a quality, but cyclical business.
That said, if shares would retreat a bit from the current highs, I would be compelled enough to buy shares given the strong market position, very fair valuation and decent yield. Further caution with the usage of leverage going forwards and a more ¨normal¨ snow season in the upcoming winter could alleviate some of the concerns as well.
The Business Overview
Douglas Dynamics is the market leader in snow and ice control equipment which can be attached to trucks. Strong brands, high loyalty and an extensive dealer network give the company a very strong competitive position in this area. The company owns brands such as Western Snowplows, Fisher and Henderson, among others.
The company believes that it holds a 50-60% market share for light duty truck mounted plows. The Henderson brand holds an estimated 20-25% market share for heavy truck mounted snow and ice equipment. The company expanded into the heavy equipment segment of the business when it bought Henderson in 2014 for $95 million, adding $76 million in annual sales.
This purchase gives Douglas Dynamics a nice starting point to expand the market share in both the medium and heavy duty segment. As always, the company will introduce its Douglas Dynamics Management System to these areas as well. This system has dramatically improved delivery times, increased flexibility, while it accelerated product development cycles as well.
A Track Record Of Growth
Douglas Dynamics has shown impressive growth over the past decade, but sales can be lumpy from year to year depending on the snow levels of each season. Sales have grown from $140 million in 2007 to $400 million on a trailing basis, indicating that sales have increased by a factor of three times. In 2012, when snowfall was very limited, sales fell a third compared to the year before.
While sales can be lumpy, which has an impact on margins, operating profits have been pretty decent. Operating margins have come in anywhere between 13 and 23% of sales over the past decade, currently coming in their high-teens. The gradual upward trends in sales and profits have been beneficial for shareholders as well. Since the IPO in 2010, investors have roughly doubled their money.
The Purchase Of Dejana Ahead Of A More Difficult 2016
The woes in the industrial sector and relative warm winter weather has an impact on the outlook for 2016. Douglas sees sales of $310 to $370 million this year, below the $400 million reported last year. Lower sales activity results in an EBITDA outlook of $55 to $85 million, as earnings are seen at $1.05 to $1.65 per share.
The wide range of the outlook indicates the inherent uncertainty which the business is facing. This also marks a big reduction from peak earnings of nearly $2 per share in 2015.
Despite the anticipation of a softer 2016, Douglas continues its acquisition spree following the closure of the Henderson deal last year. The company announced the $180 million purchase of Dejana Truck and Utility Equipment, as the deal tag excludes a potential earn-out of $26 million.
Dejana focuses on Class 4-6 trucks which increased Douglas´ exposure to the medium and heavy duty segment, making it less reliant on snowfall as well, thereby improving the overall diversification of the business. Douglas reported that Dejana generated sales of $145 million in 2015. The $21 to $24 million in adjusted EBITDA contribution will result in earnings accretion, but this effect has not been quantified.
The Pro-Forma Business
Douglas Dynamics ended the first quarter with $48 million in cash while it has $184 million in debt. This results in a net debt load of $136 million, although that number excludes a cumulative $17 million in pension and health related liabilities. The $180 to $206 million purchase of Dejana will increase the net debt load towards $316-$342 million.
The acquisition of Dejana will add some $145 million in sales, but the business is less profitable than Douglas Dynamics. Adjusted EBITDA came in at $21-24 million in 2015, for margins of 15 to 17%. This shows that the business is less profitable than Douglas Dynamics which managed to post margins of 20% last year.
Based on the stand-alone EBITDA projection of $70 million, and the contribution of Dejana, pro-forma EBITDA is seen at $91-$94 million. With a pro-forma net debt load of $316-342 million, leverage ratios are expected to increase to 3.4-3.8 times.
The pro-forma business will post sales of $485 million and EBITDA of $94 million, based on the estimates above. Stand-alone earnings of Douglas Dynamics are seen at around $30 million. Given that Douglas has D&A expenses equivalent to 3-4% of sales, Dejana´s D&A expenses might come in at $5-6 million. This suggests that EBIT is seen around $15-$18 million. If we assume a 5% cost of interest on a $200 million deal, the interest bill will increase by some $10 million per annum. This suggests that the after-tax profit accretion could come in at roughly $3 to $5 million per annum.
The calculation above suggests that pro-forma earnings could improve towards $33-$35 million in a difficult 2016. This could boost the midpoint of the earnings guidance from $1.35 per share towards $1.55 per share. It should be stressed that 2016 is expected to be a difficult year, as a return to normality could boost the profit numbers as well.
Douglas Dynamics continues its acquisition spree to the point where leverage gets quite high. While the business itself is very high quality, the issue remains that Douglas remains reliant upon snowfall conditions, not being within its own control.
The purchase of Dejana looks fair at a 1.2-1.4 times sales multiple (depending on the potential earn-outs). This corresponds to the 1.6 times sales multiple at which Douglas itself was trading ahead of the deal, and based on the 2015 revenue numbers. Part of the discount can indeed be explained by the fact that Dejana´s margins are slightly lower.
Overall I like the company, the quality of the business and the overall valuation. Based on my calculations, Douglas could post profits of $1.55 per share, for a 15 times earning multiple at $23 per share. The ¨good¨ thing is that this multiple is relatively low, even in a difficult 2016. If we take the 2015 numbers, the anticipated earnings multiple drops to just 11 times.
The only issue which I have is the fact that leverage is a bit high at 3.4-3.8 times EBITDA, as a 4% dividend yield does not allow for a very quick pace of deleveraging. A potential ¨better¨ snow season next winter, the improved diversification of the business and continued profits, should be able to alleviate most of these potential leverage concerns over time.
As a long term investor you should not worry too much about fluctuations in snow seasons, as the underlying trends remain positive. I like the acquisition strategy and focus on operational excellence in particular. It seems that the market likes this particular deal as well as a 5% upwards move over the past week added $25 million in value to Douglas on the back of a $200 million deal.
Following this upward move, after which shares are still not very expensive, shares are actually approaching their all-time highs. It should be said that as recently as the period of turmoil at the start of the year, shares still traded at just $17 per share.
As I never like to chase momentum runs higher, I will be patiently waiting for a potential dip. If shares re-tested the $20-$22 areas, I would be happy to initiate a position in this quality name.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.