Commercial Vehicle Starting To Show Operating Leverage

| About: Commercial Vehicle (CVGI)
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Summary

Revenue and operating margins come in better at Commercial Vehicle as improving orders and operating efficiency kick in.

The company's upcoming analyst day in the fall is an opportunity for management to explain its strategy for growth outside of its traditional reliance on cyclical North Am trucks.

Mid-single digit revenue growth and industry-average FCF margins can support a fair value around $10.

This year has seen pretty solid improvement in the North American heavy truck market, with full-year order levels steadily improving along the way. That's good news for Commercial Vehicle Group (NASDAQ:CVGI) as although the company is trying to diversify its revenue base, North American Class 8 truck demand is still the key driver. Better still, a new efficiency-minded management philosophy is starting to produce real results and improving margins. In a market that no longer offers many cheap plays on commercial vehicles, Commercial Vehicle still offers enough upside to worth a closer look.

Delivering A Beat In Q2

Commercial Vehicle's second quarter numbers showed ongoing improvement and progress with the operational turnaround. Revenue rose 9%, with significant growth in the construction business (up 20%) boost mid-single digit growth in heavy trucks and other end markets. All told, that was good for a 6% beat relative to Street expectations (though the small number of analysts covering CVGI reduces the significance somewhat). Although Commercial Vehicle does not really break out its segment results, it sounds as though North American heavy trucks are still contributing about 50% of the company's revenue.

The top-line beat this quarter was nice, but I was more pleased with the ongoing progress in margins. Gross margin improved 150 bp from the year-ago level and 70 bp from the first quarter. Management tied this to an improved cost structure and better leverage from higher volumes. Operating income was more than four times larger this quarter than last year and up 67% from the first quarter. At just above 4% CVGI's operating margin isn't great, but it is getting better and SG&A expenses (excluding $2.5 million in one-time costs last year) rose at about half the rate of revenue.

Doing Okay On A Relative Basis

Finding good comps for Commercial Vehicle is not all that easy, as companies like Magna (NYSE:MGA) are more diversified and most of the rest are private companies. Relative to one of the closer publicly-traded comps, Grammer (OTC:GMEGF), Commercial vehicle seems to be doing alright. Grammer reported 3% revenue growth in its seating business for the first half, versus 10% growth at CVGI in the first half. It's worth noting, though, that at 8.6% Grammer's operating margins are still well ahead of those at Commercial Vehicle (3.5% for the first half) despite a smaller revenue base.

Beyond that, the comparisons get less valuable. Cummins (NYSE:CMI) reported 14% growth in its North American business and Allison (NYSE:ALSN) reported similar 13% growth in its North American on-highway business. I'd note that both Cummins and Allison enjoy better market share within their respective businesses and also are not quite as vulnerable to mix (CVGI is more leveraged to sleeper cab construction). That said, the company does have an agreement with Cummins to provide wire harnesses for the emissions solutions business in North American and China, so success at Cummins is not exactly irrelevant to CVGI.

I would note, though, that the company is still leveraged to improving fundamentals in the truck business. With ACT Research and FTR Associates now calling for 2014 Class 8 North American orders to grow to around 295,000, management at CVGI has lifted its order assumptions from 265K-280K to 280K to 300K.

A New Direction Later This Year

Commercial Vehicle enjoys good relationships with PACCAR (NASDAQ:PCAR) and Caterpillar (NYSE:CAT) and those are likely to play a significant role in CVGI's performance for the foreseeable future. PACCAR is one of the best-placed OEMs to benefit from rising Class 8 orders, while the company is picking up increasing business from Caterpillar in North American construction (seating products). While the North American construction market isn't doing great yet, it does give the company some positive leverage to that eventual recovery.

What happens next is a little foggier. Just comparing Commercial Vehicle to Grammer, I don't think its unreasonable to argue that internal margin improvements can still play a significant role in driving better results. Beyond that, shareholders will need to wait for the company's analyst day (CVG 2020) later this year. I would expect to hear more about management's goals for generating incremental revenue, both from a greater focus on emerging markets like China and other end-markets like construction, agriculture, and mining.

The Bottom Line

Commercial Vehicle Group is doing basically what I thought it would vis a vis my model, so not changes with respect to my valuation. I continue to believe that mid-single digit revenue growth (ahead of industry growth rates due to more sales from outside North America and a greater focus on new end markets) and mid-single digit free cash flow margins can support a fair value around $10, even with an elevated discount rate to reflect the cyclicality of the business.

Is $10 enough to make CVGI a buy? That's up to readers to decide, but I would note that not many companies with significant leverage to commercial vehicles trade at meaningful discounts to fair value and most of those that do are in stressed sectors (like mining). With end-market leverage and internal self-improvement potential, I'm not ready to exit CVGI just yet.

Disclosure: The author is long CVGI. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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