Monday, August 9, 2010

Commercial Vehicle Is Coming Back Slowly

Commercial Vehicle (Nasdaq: CVGI) has lived through a nasty double-whammy. First, the company took a hit from an overall cyclical decline in heavy duty truck construction that began back in 2007. This decline was largely a product of vehicle emissions standards that led fleet managers to make big purchases ahead of the change. To some small extent, this was no big deal - Navistar (NYSE: NAV) and PACCAR (Nasdaq: PCAR) suffered too, and only a few rare companies like Cummins (NYSE: CMI) made it through unscathed (due in part to less dependence on heavy duty trucks).

The second whammy hit with the Great Recession and the global decline in sales of ... well, almost everything, including trucks.

Without the expected uptick in sales and profits, Commercial Vehicle found itself in serious trouble - a big wad of debt (built in part from acquisitions and expansion) and not nearly enough cash coming in to pay it off or service it. Hence, a really ugly stretch for the stock.

Commercial Vehicle bit the bullet though, pared back some of its business and capacity, and now seems to be enjoying something of a recovery.

Revenue jumped almost 38% this past quarter, and the company managed to produce a sequential improvement in gross margin (12.5% versus 11.5% in Q1). The company slipped a bit on operating expenses, but still managed 30bp sequential improvement in operating margins to 2.8%.

Better still, management lifted its guidance for Class 8 truck builds by roughly 15% for 2010 and also raised the 2011 number, though not by as much.

So, what about the stock?

If you believe the company can get back to more normal levels of free cash flow margin, then the stock is worth about $11.50. That also includes a 13% discount rate (very high) and $100M in "excess" debt subtracted out of the valuation. That debt alone is worth nearly $4/sh in valuation and each 1% of discount rate is about $1.50.

So, at my conservative assumptions, the stock is probably a weak hold at today's prices. I am wondering, though, if 13% is a bit too severe of a discount rate. If the "right" number is more like 12%, maybe it is a "buy" for those willing to take a lower margin of safety.

Having ridden the recovery of this stock this far, I am probably not inclined to press my luck. I respect management's guidance, but it is hard to read the news these days and not get pretty concerned about demand for heavy equipment later in the year. Time will tell, but this could be a tricky stock to hold in a double-dip scenario.

Disclosure - I own share of Commercial Vehicle Group

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