Gehl Company: A Hard Sell Without A Catalyst

| About: Gehl Co. (GEHL)

Until the housing market finds its footing, demand for Gehl Company’s (Nasdaq: GEHL) building equipment will continue to slide. Take the skid loader... please.

Auguring a rocky rest of 2007, Gehl (Nasdaq: GEHL), which makes compact equipment for residential and industrial markets, said last week with second quarter results that housing demand was worse than expected. Gehl’s order backlog as of June 30 was 40% below last year’s level and down 34% sequentially. Dealer inventories also grew by about ten days in the second quarter. The West Bend, Wis., company is now working off of large orders placed in the first quarter and expects its backlog to decline through the year.

As sales slowed, Gehl’s earnings fell to $0.71 per diluted share for the quarter, down from $0.75 in the same quarter of 2006. Revenues also were down, at $135.3 million, from $139.5 million. Because of its shallow backlog and weak North American housing market, Gehl cut back on guidance for the year, now looking for earnings of $2.05 to $2.25 per share, compared with previous guidance of $2.15 to $2.35, and compared with $2.26 in 2006. The company is now pegging sales at $465 million to $485 million, down from its earlier range of $475 million to $500 million, compared with $486 million in 2006.

Maneuverability is at the heart of Gehl’s business: it makes skid loaders, telescopic handlers and other compact earth-moving equipment used where space and utility are at a premium. Maneuverability is a quality Gehl needs badly, as well, for the company is trying to navigate the rotten foundation of an ongoing housing slump.

Although Gehl serves agricultural needs, its outlook is firmly tethered to residential and industrial demand. And the outlook there—barring those who believe in quick fixes—is daunting. From the Census Bureau for June: building permits for housing units were down 7.5% from May and were 25.2% below those of a year earlier. Housing starts were up 2.3% from May but down 19.4% from June 2006.

Perhaps more worrisome is the inventory of new and existing single-family homes. According to Robert McCarthy, an analyst at R.W. Baird and Co., U.S. inventories are about 1.2 million units above the five-year average, which could still stifle a rebound in residential construction activity. “We continue to remain cautious on near-term prospects for any improvement in U.S. residential construction activity, with corresponding benefits for related company construction equipment demand,” McCarthy said in a research note after second quarter results were released.

McCarthy, who has a neutral rating on the stock, lowered his price target to $33.00, from $36.00. In the wake of last week’s second-quarter earnings and guidance fallout, Gehl shares on Monday established a new 52-week low $23.67 before closing at $24.21. The 52-week high of $33.17 was established just over two weeks ago.

After such a precipitous fall, the stock value—near 11 times expected 2007 earnings—may seem like a dream instead of a money pit. Gehl Company has a solid industry record and is known for innovative products and upgrades to its equipment. It has a five-year earnings growth rate near 52%. In a capital intensive business, its net debt to total capital ratio is a healthy 7.1%, said McCarthy. Gehl does acknowledge in its annual report that its strategic plan depends on access to capital at attractive rates and terms.

And the company is benefiting—or at least somewhat staunching losses—from overseas sales. Gehl’s strategy is to grow from within and maintain focus on its strength: an extensive lineup of compact construction equipment and solid distribution network. Founded in 1859, Gehl moved actively into construction equipment in the mid-1980s and into international markets in 1991, forming Gehl International. Sales have more than doubled in recent years, helped by international demand as the company establishes alliances with certain European and Asian compact equipment makers.

But that’s not enough to offset the recent housing aftershock, as Gehl’s shares have been among the hardest hit in its sector. Caterpillar, Inc. (NYSE: CAT), the world’s biggest earthmoving machine, had a tough second quarter, too. But in a roiled market, investors seek stability, and many pundits, money managers and retail analysts have pushed them to large-cap companies. Caterpillar, with market capitalization of $51 billion versus Gehl’s $295 million, fits into more portfolios. Caterpillar is down about 9% since second quarter results were released July 20.

Separately, the pending $4.9-billion-dollar purchase of Ingersoll-Rand’s construction machinery unit—known for its Bobcat compact equipment—also has yet to play out on Gehl. The purchase, announced last week, is being made by South Korea’s Doosan Infracore Co., the largest South Korean maker of construction equipment.

Still, some analysts see upside from current levels based on 2008 performance expectations. Charles Brady, an analyst at BMO Capital Markets Corp., who carries a “market perform” rating on Gehl, left his price target at $30 per share after second quarter results were released. “On an EV/EBITDA basis, we assume Gehl can trade at 7.5 times our estimated calendar 2008 EBITDA of $52 million. Should the company fall short of our EBITDA estimate, our price target could prove too optimistic,” said Brady.

McCarthy’s $33 target reflects an 8.5 multiple of his 2008 EBITDA estimate. But he also noted: “Excess construction equipment industry capacity tends to result in a persistently difficult competitive pricing environment.” And: “Both the compact construction equipment and agricultural implement markets are populated by some significantly larger competitors with entrenched distribution networks.”

Gehl may be oversold at current levels, and hopes for improved business may see shares rebound. But without a catalyst, it is hard to build a case to buy the company’s shares. The housing market put Gehl on the skids, and only a housing recovery can pull Gehl out of it.

Disclosure: Author has no position in companies named

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