Commercial Vehicle Still Early In A Major Business Repositioning
Summary
- Commercial Vehicle reports fourth quarter earnings on March 10; better results in the commercial truck space and strong growth in warehouse automation suggest upside.
- Commercial truck production rates should be much higher in 2021, and CVG should see very strong demand in the warehouse business, while electric trucks will be more about order wins.
- Supplying "picks and shovels" for warehouse automation and shifting toward value-added components for emerging markets like electric trucks should drive higher sustainable margins, but execution is vital.
- Mid-single-digit long-term revenue growth and FCF margins in the mid-single-digits can support a mid-teens fair value, and electric trucks and warehouse automation should offer revenue growth upside.
So far, so good for Commercial Vehicle Group’s (NASDAQ:CVGI) (or “CVG”) attempt to significantly restructure the business away from its low-return, commoditized truck components legacy and toward new opportunities in higher-value electrification projects, including BEV trucks and warehouse automation. The third quarter saw 65% of the company’s revenue come from non-truck sources, and while that number will likely jump around on the cyclicality of the truck business, early execution on this new strategy has been good.
CVG shares have doubled since my last update, and they could still have plenty of room to run. Initial progress with electrical commercial vehicle projects has been positive, and warehouse automation remains a red-hot market. So much of the modeling here is speculative as the company targets fast-growing, relatively new markets where they don’t have much experience, but as an emerging “picks and shovels” supplier to both electrical commercial vehicles and warehouse automation, there’s definite appeal. Keep in mind, though, that this is a small fish swimming in murky, turbulent waters and these shares do carry well above-average risk.
Waiting For Fourth Quarter Results
CVG is a late reporter in the cycle, so we won’t see fourth quarter earnings until next week, but given the trends and themes in the commercial vehicle and warehouse automation spaces, there’s no reason not to expect a pretty good quarter relative to expectations.
Commercial vehicle suppliers like Cummins (CMI) and Dana (DAN) reported better than expected revenue in the fourth quarter, and while PACCAR (PCAR) had a noisy quarter, it did meaningfully raise its guidance for North American Class 8 truck deliveries in 2021 (up 15% at the midpoint, or up 22% year-over-year).
Suppliers of automation solutions to the warehouse end-market likewise reported strong results, with Honeywell (HON) reporting 37% year-over-year growth and a 70% year-over-year improvement in backlog, while Cognex (CGNX) reported 40% growth for the full year of 2020 and alluded to strong growth in the fourth quarter as well.
Sifting Through The End-Market Themes
For CVG’s commercial truck business, 2021 should be a year of strong recovery, with the industry likely seeing some capacity constraints in the effort to serve a rush of orders after a sharp downturn in 2020. The outlook for 2022-2023 is definitely murkier, though, as analysts, companies, and investors debate just how close we are to the next peak in Class 8 orders.
Specific to CVG, I think this cyclical upswing is an opportunity to put meaningful new policies into practice. Management has talked about looking to maximize the value of its Global Seating business (as well as related components like interior trim, panels, and structures), and this upswing should give the company the opportunity to selectively prioritize the more profitable business opportunities.
If management is serious about running this long-underperforming business more efficiently, there’s really not much reason to sacrifice margin for volume just to maintain inadequate returns on sub-optimal business. In other words, harness the “good volume” and let the “bad volume” go elsewhere, and don’t run beyond the limits (and incur unrecoverable costs) just to make low-return customers happy.
For the EV business, I do expect to see some opportunities for CVG in 2021, including recent contract wins in 2020 (five in total, two of which are described as “large”). Several companies, including Daimler (OTCPK:DMLRY), PACCAR, and Volvo (OTCPK:VOLVY) are launching new electric truck models this year, and companies like Dana have been logging meaningful BEV projects into their backlog. I don’t expect 2021 to be a meaningful year for CVG from a BEV truck revenue standpoint, but I would expect to see more contract wins if the strategy is on track.
Last and the exact opposite of least is the warehouse automation opportunity. CVG has done an excellent job of leveraging the First Source Electronics acquisition into the warehouse automation market, where it sells control boxes and subassemblies. At the risk of radical oversimplification, these subassemblies are the essential “behind the scenes” electronic components that basically make the systems run. They’re not as sexy as Cognex’s machine vision systems or Teradyne’s (TER) cobots, but the warehouse won’t work without them.
As warehouses look to install more automation, and increasingly sophisticated automation systems, the demand for sub-assemblies and control boxes grows with it. That gives CVG good exposure to the rapid growth in warehouse/logistics automation, and I expect strong growth in 2021. I also expect potential M&A here, with CVG looking to add capabilities in adjacent products/systems.
The Outlook
Modeling CVG is tricky now, as you have to model a cyclical commercial vehicle market that may well lag this cycle (in revenue growth terms) as management pares away less profitable business, an electric truck opportunity that’s small now, but will likely grow meaningfully over the next five years, and a warehouse automation opportunity that’s growing gangbusters today, but should see more competition as well (the sub-assembly business doesn’t really have high barriers to entry).
Ahead of fourth quarter results and guidance (and with the risk that entails), I’ve substantially increased my 2021 and 2022 revenue assumptions on a stronger/earlier recovery in commercial trucks and both strong end-market growth in warehouse automation and better execution from CVG.
Even so, I’m only looking for 4% long-term revenue growth, as I expect a shrinking legacy truck business will offset the growth opportunities in electric trucks and automation. There’s definitely upside potential here. The EV opportunity could be much larger than I model, likewise for warehouse automation, and management is looking to pursue other growth opportunities like molded plastic components (with expertise gained from the truck interior business and machinery already in place).
On the margin side, I expect more profitable electric truck and warehouse automation business, as well as a reduced willingness to accept low returns in the legacy truck business, to drive FCF margins into the mid-single-digits over time. Again, while the EV truck and warehouse automation opportunities are meaningful, this isn’t a high-tech value-added play on those trends, so adjust expectations accordingly.
The Bottom Line
Even if those foundational assumptions seem conservative, they still support a mid-teens fair value today. As I said in my last article, if CVG management’s new plan works, “the shares will be worth considerably more”, and we’re starting to see some of that already.
If this really is a new dawn for the company, one where investors can reasonably expect better gross and operating margins on a sustained basis, there could be a lot more in store from here. This is a high-risk opportunity, and one very dependent upon management execution, but the plan is working so far and aggressive, risk-tolerant investors may still find a lot to like here.
This article was written by
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