Although I thought the valuation of Miller Industries (NYSE:MLR) was getting a little stretched in the spring of 2015, I'm still a little surprised that the shares have fallen close to 20% despite a generally decent performance. Perhaps that's the price of toiling in obscurity (as Miller is uncovered) or maybe investors were spooked by the surprisingly weak gross margin in the first quarter and the generally unimpressive margin trajectory seen this year. After all, if Miller can't generate good margins when volumes are high and input costs like steel and aluminum are low, isn't that a problem?
I am inclined to think that things are fine at Miller. Given that the Tennessee plant is running two 10-hour shifts a day, I don't think lack of demand is the problem, and the eventual smoothing out of plant construction and reorganization should help. I think Miller is undervalued, but I'm also looking for levels of cash flow production in the future that have been difficult for the company to maintain in the past. Investors should also note that the liquidity and float are too low here for this to ever be a well-covered stock on the institutional side.
Results Seem More Erratic Than The Real Underlying Business
There's only so much an outsider can ever really know about how well a business is doing; if all of the people who claimed they knew Enron was a fraud actually had known, it would have unraveled quite a bit sooner. Anyway, I offer that disclaimer because Miller is small enough and rare enough that it is hard to corroborate trends and construct meaningful comps. All of that said, I think the underlying health of the towing/wrecker market is stronger than Miller's somewhat erratic results would suggest.
Since I last wrote on the company, MLR has reported three quarters (with fourth-quarter results due in a month). First-quarter sales were better than I'd forecast (about 6% above my estimate) and up almost 22% from the year-ago period. Second-quarter sales were even stronger, rising 24% and beating my target by more than 8%.
Then, to take a quote from a classic episode of The Simpsons, "What happened here? Lightning hit the transmitter?". Third-quarter revenue rose less than 7% from the year-ago period and came in below my expectations. In truth, I don't think this was a bad quarter; the company shut its Tennessee facility for a week, and adjusting for that, the result would only have been about 2% below my target. I'd also note that it is common for the third quarter to be relatively weak.
Oshkosh's (NYSE:OSK) implied performance has been broadly similar. I say "implied" because Oshkosh almost never talks about its Jerr-Dan towing business; it's reported as part of "Access - Other". First-quarter sales in this line item were up 17% in the first quarter, up more than 7% in the second quarter, and down 4% in the third quarter. Encouragingly, that line item was up 18% in the December quarter, and that may indicate a solid result for Miller on the way.
What Is The Ceiling For Margins?
I'm more concerned about the margin trajectory for Miller. The first quarter saw gross margin fall a point from the prior year and miss my target by nearly two points. Second-quarter gross margin snapped back (improving yoy by 140bp and beating my target by 60bp), and then, third-quarter gross margin was back down 90bp yoy and about 140bp below my forecast.
While high levels of volume and production are normally a good thing for margins, I wonder if Miller has found itself bumping up against some capacity constraints. There gets to a point with production capacity where you're pretty much operating as effectively as you can, and pushing for more actually starts to hurt margins (more overtime, supply/inventory management challenges, and so on). I wouldn't think that Miller would be running the Tennessee plant on two 10-hour shifts and expanding operations in Pennsylvania if the business pipeline wasn't strong, so I would be cautiously optimistic that navigating this process will open the way to better margins.
Gross margin has been bouncing around between 10% and 11% for almost three years, but the company has managed 14% to 17% in the past. I'm not forecasting a return to that level, but I can't really see a reason to assume that the margin structure here is permanently broken.
What Drives The Business?
Miller and Oshkosh's Jerr-Dan aren't the only games in town when it comes to North American wrecker bodies (they don't make the trucks, just the towing equipment/decking that goes on the chassis), but they do largely dominate the market. Quebec's NRC competes more in the heavy duty side of the North American market and doesn't appear to be nearly as large (getting reliable sales info in this industry is not easy).
In any case, this is a broadly cyclical business, as towing companies need to have decent access to capital to buy new wreckers and dealers need access to showroom financing, and there's some modest correlation with the health of the economy and more vehicles on the road. I'm looking for Miller to generate around 5% long-term growth as there should still be some catch-up/fleet refresh spending in the next few years and the company continues to try to expand its European operations.
Beyond that, though, it's not a dynamic revenue growth story. Miller tried the over-the-road trailer market, but the Delavan joint venture didn't go well. Progress in Europe has been slow, and while a market like China would theoretically be pretty exciting given the increasing number of vehicles on the roads, I'm not sure how realistic that is for a company that spends a mid-single-digit percentage of revenue on SG&A. I wouldn't rule out the possibility of growth investments here in the future, but I'm certainly not counting on them.
With that, I think basic "blocking and tackling" drives this business. Numerous banks have reported good demand for business loans, and the small/mid-sized business segment looks healthy. Miller offers a range of brands, sizes, and price points for customers, and while industry magazine reviews and Internet message boards are only worth so much, it seems like Miller's brands are well regarded and have strong resale value. I'd also note that MLR has a broader product offering, though Jerr-Dan overlaps at all but the highest/heaviest end of the market.
Re-Calculating The Value
In addition to the aforementioned 5% long-term average annualized revenue growth, I'm looking for modest gross margin accretion (up into the mid-12%'s) and a relatively steady SG&A spending. This is a pretty tightly-run ship, and I don't expect that to change meaningfully. I'm looking for FCF margins to average out to around 3.5% over the long term, which is about 70bp higher than the trailing average. Discounting those cash flows gives me a fair value of over $25 today, but I'd note that keeping GM flat over the entire forecast period would drop the fair value to around $21.
The Bottom Line
Miller could be an acquisition target, but the very low SG&A spend here would suggest to me that the upside from a deal would have to come from expanded sales opportunities (a larger company like Dover (NYSE:DOV) or Terex (NYSE:TEX) could conceivably grow the ex-US business faster) and/or meaningful anticipated manufacturing and sourcing synergies. Given the company's healthy balance sheet, Miller could look to do some small deals but it doesn't sound like a management priority to me.
Owning a stock like Miller can be frustrating, as it's never going to get much (if any) attention. Then again, so long as the company generates good cash flows, pays its dividend, and runs the business well, GARP investors probably don't care about how much attention it gets.
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.