Douglas Dynamics: Strong Cash Generation Despite Current Headwinds

Dec. 29, 2021 4:27 AM ETDouglas Dynamics, Inc. (PLOW)2 Likes
Carles Diaz Caron profile picture
Carles Diaz Caron
775 Followers

Summary

  • The company has historically achieved astonishing sales growth rates.
  • The coronavirus pandemic crisis has strongly weakened the company's performance.
  • The company is deleveraging its balance sheet as it is generating strong cash.
  • Further price increases of its products should stabilize margins at more acceptable levels.
  • The current decline in the price of shares represents a good opportunity for the long term.

Autopista arado de nieve

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Investment thesis

Despite experiencing a decade of huge sales growth, the performance of Douglas Dynamics (NYSE:PLOW) has weakened since 2020 due to the coronavirus pandemic crisis. Both gross profit and EBITDA margins, as well as net sales, have suffered as a consequence of inflationary pressures, labor shortages, freight and transportation cost inflation, postponed orders, and unusual below-average snow seasons.

Despite this, the company has managed to generate positive cash during all this time, which is allowing it to pay down its debt pile. Interest expenses on debt are beginning to plummet, which is offering the company a lot of room for maneuver to continue paying its debt pile at a broader rate and is opening new opportunities to make new acquisitions that will ultimately allow the company to continue on the path of growth.

Also, the company still did not have time to increase the price of its products enough to offset inflationary pressures, therefore, profit margins should continue to stabilize in the coming quarters. For these reasons, I strongly believe the current share price decline represents a good opportunity for investors with a long-term view as the company's prospects are continuously improving despite current headwinds.

A brief overview of the company

Douglas Dynamics is a major manufacturer and upfitter of commercial work truck attachments and equipment in North America. The company was founded in 1948 and currently employs almost 1,800 workers, with a market cap of ~$900 million.

Douglas Dynamics BrandsImage source: Douglas Dynamics website

The company's operations are divided into two main segments: Work Truck Attachments and Work Truck Solutions. In the Work Truck Attachments segment, the company manufactures and sells snow and ice control attachments, salt or sand spreaders, brine sprayers, pusher plows, and snowplows. Over 86% of sales provided by this segment come from the sale of snow and ice control equipment. In the Work Truck Solutions segment, the company manufactures and sells snow and ice control products, attachments and storage solutions, cable pulling equipment, liquid application systems, dump bodies, and special-purpose truck bodies.

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Data by YCharts

Currently, shares are trading at $39.29, which represents a 23.62% decline from mid highs of $51.44 on March 12, 2021, and a 30.94% decline from all-time highs of $56.89 on February 25, 2020, just before the beginning of the coronavirus pandemic crisis. While it is true that the price currently reflects a weakened performance that is especially aggravated by the current coronavirus crisis, I believe that this represents a good opportunity for investors with a long-term vision, as the company generates good (and growing) amounts of cash year after year that allow it to pay down its debt pile.

Net sales are currently stagnant

The evolution of net sales is marked by an impressive increase year after year thanks to an aggressive acquisition strategy that has proved so far, in my opinion, to be successful. Nevertheless, this increase is being limited because the company has been losing maneuvering power due to the increase in debt as a result of these acquisitions but, because of its continued capacity of generating high amounts of cash year after year, I believe that in the long term net sales may continue to grow as the company is deleveraging the balance sheet, which is causing a steep decline in interest expenses that will allow it to continue investing in growth initiatives while paying down its debt pile at a faster rate.

Douglas Dynamics Net Sales

Source: 10-K filings

After net sales peaked in 2019, the company suffered a 16.01% decline year over year during 2020 as a consequence of the coronavirus pandemic crisis. The company closed all its U.S. locations in 2020 as a response to the coronavirus pandemic spread from March 18 to March 29, which also negatively affected net sales. In this sense, net sales declined by 27% year over year during the first quarter of 2020, 32% year over year during the second quarter, 6% year over year during the third quarter, and 1% year over year during the fourth quarter.

Although the recovery experienced during the last two quarters of 2020 suggested that the recovery was consolidating solidly, the results for the first three quarters of 2021 have been somewhat bittersweet. Compared to the same quarters of 2019, the company reported an 11% increase during the first quarter, an 11% decline during the second quarter, and a 10% decline during the third quarter. In this sense, these declines were, on average, considerably smoother than those experienced in 2020, so the trailing twelve months' net sales have improved from $480.2 million during the fourth quarter of 2020 to $546.7 million during the third quarter of 2021. Part of this increase, however, is due to the increase in prices that the company has implemented in recent months due to inflationary pressures, an increase that is still not enough due to the prolongation of the inflationary headwinds, so prices are currently being increased again, and that will likely increase net sales again during the fourth quarter of 2021 and beyond. Also, there have been three unusual below-average snow seasons, which have also affected the company's net sales during 2021. Lastly, backlog increased by 40% since the beginning of 2021 as dealers are postponing orders due to labor shortages.

The most positive point when it comes to the company's net sales is that the replacement of worn existing equipment provides the company a consistent and predictable source of income, which greatly reduces the potential volatility in share prices.

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Data by YCharts

The PS ratio currently stands at 1.643, which means the company generates net sales of $0.61 for each dollar we have invested in shares, each year. This data does not tell us anything by itself, although it does help us to measure the optimism or pessimism of investors in the face of the current headwinds and the forecasts in the short and medium term for the company. In this sense, we can see that investors are willing to pay less for the company's revenues than during most of the time since 2017, and this has caused the current drop in share prices.

Now, it will be very important to evaluate the performance of the company's operations in order to make sense of this data, and see whether this is a sign that we are in front of a good opportunity or not. Now that we have seen the evolution of net sales throughout history and the current coronavirus pandemic crisis, we must see the company's profit margins and, later, the company's current debt position.

Margins are declining as prices can't offset inflationary pressures on time

Since 2014, profit margins have experienced a slow but steady decline which lasted until the coronavirus pandemic hit the world. During all these years, the company made enormous efforts to acquire new companies, which in the end has led to a huge increase in sales, as we have seen. Until now, the continued growth of the company has kept investor optimism alive, but the company appears to have (almost) reached its borrowing limits (within acceptable levels), so I strongly believe that sales growth rates will be greatly reduced until the company completes the current deleveraging process. Even more, I think there is a great risk that they may stagnate or even slightly decline as the company is addressing its debt issue, which is requiring much of the cash it generates through operations. As for margins, I believe the company will be able to invest more in profitability optimization initiatives very soon as interest expenses are declining fast, which will free up a lot of cash in the coming quarters.

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Data by YCharts

The company is currently facing macroeconomic supply headwinds and inflationary pressures for which it is implementing rolling shutdowns. In the meantime, material prices kept rising during the past twelve months. There are also important shortage issues as truck OEMs slowed down the production of new trucks. The company also had to increase entry-level wages due to labor shortages. The cost of commodities, primarily iron ore and coal as steel is the main raw material used for the manufacturing process of its products, has also increased dramatically during 2021.

Iron Ore Commodity PriceSource: Trading Economics

As we can see in the graphic above, the price of iron ore has skyrocketed since November 2020 by which time it was already at much higher levels than in the period between the second half of 2014 and the first half of 2020. Even so, starting in August 2021, prices began to fall drastically to levels that are still too high compared to recent history. A very similar price evolution can be seen when it comes to coal, which is widely used for the manufacture of steel.

Coal Commodity PriceSource: Trading Economics

Even with the current decline, profit margins remain depressed since the company has not had enough time to pass the inflated costs of goods sold to its customers, so this problem should be solved in the medium to long term as the prices of the raw materials stabilize and the company fully updates the price at which it sells its products to offset the increase of costs.

The company increased prices for the second time, since the inflationary pressures began, as it entered the fourth quarter of 2021, which should help some margin stabilization. Also, the snow season for the fourth quarter seems to be very positive and could offset current headwinds at an acceptable level. Therefore, I believe that margins should start to stabilize in the medium term and this will allow the company to continue generating positive cash as in all years. Now, it is very important to take a look at the current debt position of the company, but before that, let's look at the acquisitions that led the company to borrow at current levels.

Acquisitions

In the 2013-2016 period, Douglas Dynamics made three major acquisitions that allowed the expansion of sales experienced during those years.

In May 2013, the company acquired TrynEx, a truck-mounted salt and sand spreader equipment manufacturer which operates under the SnowEx brand. The company also owns the brands TurfEx and SweepEx, which manufacture turf application and industrial attachment products. The acquisition cost was valued at $26 million.

In December 2014, the company acquired Henderson Products, a manufacturer of customized, turnkey snow and ice control solutions for heavy-duty trucks with trailing twelve months' net sales of $76 million, for ~$95 million.

In July 2016, the company acquired Dejana Truck & Utility Equipment Company, a leading manufacturer of storage solutions for trucks and vans and cable pulling equipment for trucks with trailing twelve months' net sales of $145 million, for $206 million.

Debt is at high levels as a consequence of acquisitions

Due to the three major acquisitions carried out from 2013 to 2016, the company has accumulated a large debt pile and entered a new phase marked by a deleveraging process. This is not a bad sign in itself since sales have increased enormously during all this time. Instead, I simply see it as a new stage that, with the passage of time, will materialize these acquisitions, that is, the company will increasingly enjoy the benefits of the acquired companies without having to face the interest on the debt thanks to which they were acquired. Despite this, the management currently remains willing to continue acquiring more companies if the opportunity presents itself as stated during the third quarter's earnings call conference, which could again increase the amount of debt.

Chart
Data by YCharts

As we can see in the chart above, net debt declined consistently from slightly over $300 million after the three major acquisitions to $205 million in 2020. During the last quarter, net debt stood at $286.1 million, which represents an 8.74% decline year over year, as the company uses debt to respond to seasonal orders. A view of the quarterly net debt will help us better understand the company's debt structure and how it has successfully deleveraged the balance sheet since its peak in 2016.

Chart
Data by YCharts

As we can see in the chart above, the company's capacity to generate positive cash year after year allowed it to get rid of a sizeable amount of debt. Ultimately, this is allowing the company to decrease interest expenses, which is freeing up a lot of cash.

Chart
Data by YCharts

Therefore, the company will have, from now on, more and more resources to face the current headwinds and to continue on the path of growth via investments and new acquisitions. Also, the debt position is increasingly more manageable, so its reduction will be easier and easier as interest expenses keep decreasing.

The dividend is safe

The company has steadily increased the quarterly dividend from $0.1825 in 2010 to the current quarterly dividend of $0.285, which represents an increase of 56% in the entire period.

Chart
Data by YCharts

Next, I am going to assess the company's ability to cover the dividend in order to analyze its sustainability. To do this, I will calculate what percentage of the cash from operations is destined for the payment of dividends and interest expenses. I like to calculate it this way since in this way it can be assessed if the company has the capacity to cover the dividend payout and interest expenses on the debt through actual operations.

Year 2012 2013 2014 2015 2016 2017 2018 2019 2020
Cash from operations (in millions) $15.62 $32.25 $53.75 $56.47 $69.92 $66.35 $58.18 $77.30 $53,366
Dividends paid (in millions) $18.23 $18.70 $19.60 $20.17 $21.45 $21.97 $24.38 $25.18 $25.93
Interest expense (in millions) $8.39 $8.33 $8.13 $10.90 $15.20 $18.34 $16.94 $16.78 $20.24
Cash payout ratio 170.46% 83.81% 51.59% 55.02% 52.41% 60.75% 71.03% 54.29% 86.50%

Source: 10-K filings

In the table above, we can see that the company's cash payout ratio looks pretty conservative. In the last decade, interest expenses have increased dramatically, which is limiting not only dividends but also potential investments to continue growing the business as well as improving its profitability. Therefore, it is important to bear in mind that the increase in dividends will be seriously limited until the company finally manages to get rid of a large part of its current debt pile. Due to the speed at which it is achieving this, I anticipate that the investor can expect additional generous increases in the medium and long term.

Chart
Data by YCharts

Currently, the dividend yield stands at 2.91%, one of the highest ratios in the last four years. Personally, I consider this to be a good yield when considering the speed at which the company is eliminating interest expenses, as this will allow for large increases in the dividend in the foreseeable future due to the great weight that it had had in the payout ratio until now.

Risks worth mentioning

The company's net sales highly rely on the timing and location of snowfall. For this reason, potential drops in snow levels in those regions where the company operates can cause serious drops in the company's sales and margins. This is an important risk to take into account since it adds a component of cyclicality to the company's operations.

Also, we must not forget that we have not yet reached the end of the coronavirus pandemic and we also do not know how it will evolve in the future. New variants of the coronavirus could emerge as the recent discovery of the Omicron variant reminded us. For that reason, one must be prudent when buying stocks in times of high volatility, as further disruptions due to the coronavirus pandemic could prolong the current global problems related to supply chains, inflationary pressures, increased transportation costs, labor shortages, and shutdowns. A good option for these volatile times is to save a bullet in order to average down in case the stock price continues to decline, although this is a more personal decision for the investor.

Lastly, I would like to mention that an M&A strategy as aggressive as Douglas Dynamics' is a risky strategy, as a bad acquisition can drag a company astray for many years. For this reason, it is very important to realize that Douglas Dynamics is a company that offers enormous opportunities for growth, but that these opportunities are accompanied by the risk of the company stumbling over the wrong stone.

Conclusion

Overall, I don't see any serious problem for the company in the medium and long term. After facing countless headwinds with a heavily indebted balance sheet: a global pandemic, shutdowns, labor shortages, inflation in transport prices, and increased cost of raw materials, the company has managed to consistently generate positive cash and has continued to pay its debt pile. The current pressures on profit margins are due to a short-term problem, which is that the company has not yet had time to update its prices to the rate at which the cost of goods sold increased.

The company is currently updating its prices to offset inflationary pressures, which should stabilize profit margins as early as the fourth quarter of 2021. Furthermore, the dividend is covered relatively easily while interest expenses are being reduced at a very good rate thanks to the deleveraging process.

For these reasons, I consider that the current drop in the price of shares represents a good opportunity for those investors with a longer-term vision since the current dividend yield on cost of 2.91% should continue to grow over the years as the interest expenses have a lower and lower weight in the payout ratio and the company continues to grow through new acquisitions.

This article was written by

Carles Diaz Caron profile picture
775 Followers
Subscribe for an average ~25% return per year according to Tipranks. I am a long-term Dividend Growth Investor always looking for new opportunities in the stock market since 2015. In order to find good deals in the stock market, I look for companies that are going through a bad time and carefully assess the chances that the financial situation will return to the path of profitability and growth. My objective is to find stocks that can be bought and held for many years and try to get them for the lowest price possible during temporary headwinds. For me, the most important aspects when analyzing a stock's turnaround chances are that the company's products are essential to a big portion of the population, healthy and stable profit margins, a sustainable debt and dividend, and a long-term trend that suggests the products and services offered will continue to be essential for the decades to come.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

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