Institutional investors can be a notoriously fickle and impatient lot and Commercial Vehicle (NASDAQ:CVGI) shares have certainly fallen out of favor since the summer of 2014. Commercial Vehicle wasn't the only commercial vehicle-exposed company to see its stock slide, Cummins (NYSE:CMI) and Allison (NYSE:ALSN) also saw declines (albeit not as steep), but it looks as though the Street was unimpressed with Commercial Vehicle's mid-September Analyst Day and is less bullish on the long-term self-improvement prospects.
Admittedly, management's guidance that 2015 and 2016 will be years of investment instead of significant margin improvement was a little sobering. Likewise, I can understand if investors are worried that management is banking on agriculture equipment, a sector that many now expect to be in a multiyear bear market, as a major source of future growth. All things considered, though, not a lot has changed in my long-term fundamental outlook for the company and I continue to believe that $10 is a credible medium-range destination for the shares.
Improved Performance Continues
In my opinion, Commercial Vehicle continues to deliver pretty good quarterly improvements that support the idea that the new senior management has made some significant changes for the better at the company.
Sales were up 14% in the third quarter, which was in line with Cummins (not a good comp from a product standpoint, but with similar end market exposures) and not that much below Allison. Sales to the North American truck market climbed 18%, while construction rose 10%. Ag-related sales were up 92%, but keep in mind that this is a tiny segment for the company today. I'd also observe that Germany's Grammer AG (OTC:GMEGF), one of the only real comps for CVGI, barely saw any sales growth in its seating business in the third quarter due to weakness in markets in Europe and key emerging markets like Brazil.
Margins are still very much a work in progress. Gross margin continues to improve, though, with a nearly four-point improvement from last year and a roughly quarter-point sequential improvement. Operating margin improvement has stalled a bit (adjusted OPM of 4.6% this quarter versus 4.2% in the second quarter), but the trend is still positive if not as steeply positive as investors should want.
Mixed News From The Analyst Day
Back in mid-September, CVGI's management team hosted a fairly comprehensive review for investors and analysts. This was, I believe, the first time that CEO Richard Lavin really presented the totality of his vision for CVGI and with that came some good news and some not-so-good news.
On the positive side, management is saying a lot of smart things about emphasizing innovation and product differentiation, as well as working more closely with key OEM customers. Management also made it clear that while select M&A transactions would be considered if they meaningfully contributed to the company's efforts in product development, manufacturing, and/or distribution, M&A is not going to be the driver of the company's growth plans.
Management also put out growth targets that were in line with or better than my preexisting expectations. They are targeting 6-8% annual sales growth out to 2020 (I was at around 6%), with 13% to 17% EBITDA growth. Greater diversification is also a priority, with management looking to take its agriculture business from a minimal contributor today to about 10% of sales in 2020.
Now for the not-so-good news. The next two years (2015 and 2016) are going to be years of "investment and building", with accelerated capital spending and perhaps not as much margin leverage as investors had been hoping to see. This makes sense to a point; the company has come up with a plan for improving product development, manufacturing efficiency, and the go-to-market strategy, and it's going to take time, energy, and money to implement it.
Along similar lines, there is a lag between the announcement of new business (like the announcements the company has made with respect to Caterpillar (NYSE:CAT) and Cummins) and the actual physical production of those products. That lead time is often around two to three years, which should see CVGI ramping up these progress toward the end of 2016. All told then, the destination is going to be the same (if not better), but it will take a little longer to see the big improvements.
That plan to generate more business from agricultural equipment is also one that I suspect has some investors worried. The outlook for ag equipment companies like Deere (NYSE:DE) has certainly soured over the past year or so, with many analysts and investors expecting a multiyear downturn.
I understand why the Street may not be excited about a growth plan that depends upon adding an incremental $100 million or so in sales from a sector facing tough times, but I think the worries may be misguided. It is not as though companies like Deere, CNH, or AGCO (NYSE:AGCO) are going to see their sales drop to zero; they're still going to be manufacturing and selling machinery, and they're still going to be introducing new models. Grabbing a $100 million piece of a $3.5 billion pie over six years just doesn't strike me as exceedingly ambitious.
A Credible Vision
Commercial Vehicle's management team believes they have a plan in place that can transform CVGI into a top-quartile manufacturer of components like seating, trim, and wire harnesses for commercial vehicles ranging from Class 8 trucks to tractors to construction equipment. That's all well and good, but now they have to execute that plan, and do so by serving notoriously cyclical end markets.
I said previously, management's growth guidance was pretty consistent with my expectations. I am tempering my near-term margin improvement estimates a bit, but I'm also slightly increasingly my long-term sales and margin targets on the basis of management's presentation and stated goals. At the bottom line, I'm still looking for long-term sales growth of around 6% (likely double the underlying markets) and a FCF margin in the mid-single digits - somewhat above the norm for components companies, but conservative if management can indeed make this a "top quartile" company.
The Bottom Line
With my model changes pushing out the margin improvements a bit, my FCF-based fair value goes down about $0.50 to $9.50. That's enough potential to make hanging on worthwhile. Given the nature of the industry, though, as well as the lack of coverage on this stock and the risks that go with turnaround/improvement stories, it won't surprise me if this remains a volatile name that gives investors multiple opportunities to trade or trim/rebuild positions.
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.