Volvo Managing Surging Orders And Supply Challenges Well, But The Market May Already Have Moved On

 

Cyclical industries can be difficult to model in the best of times, and the last year and a half has been anything but that. With pent-up demand coming out of the pandemic and ongoing growth in e-commerce, orders for heavy-duty trucks should climb into 2022, leading to a revenue peak at some point in 2022 and 2023. Meanwhile, construction orders are generally improving everywhere outside of China and could get another boost from an infrastructure plan in the U.S., if that passes.

Volvo (OTCPK:VLVLY) is managing the cyclical uncertainties and more recent supply challenges well, and I believe the restructuring efforts made since Martin Lundstedt took over the CEO role in 2015 will continue to pay benefits. I also like the tech story here, as Volvo is well-placed to be a leader in truck electrification. Although I don’t think the shares are expensive, I do have concerns that the market is already pricing in the next peak and these shares carry above-average risk.

 

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Volvo Managing Surging Orders And Supply Challenges Well, But The Market May Already Have Moved On

Commercial Vehicle Performing Well In A Plateauing Market

Taken in isolation, things are going well for Commercial Vehicle (CVGI), as the company’s management has executed pretty successfully on cost-optimization and business restructuring efforts. The company also has some future growth opportunities that could drive long-term revenue growth above build rates, as truck and off-road vehicle manufactures add more electrical components and systems to their vehicles. The “but” is that Commercial Vehicle’s primary markets appear to be plateauing and it may be hard for the shares to get ahead as near-term revenue growth prospects diminish.

Holding cyclical stocks through cyclical declines can be a painful test of patience. I do believe Commercial Vehicle remains undervalued, but it’s tough to say how much of the impending decline in truck production is already priced into the shares. Investors with a longer term orientation may not care, but the next year or so could be more challenging for the stock.

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Commercial Vehicle Performing Well In A Plateauing Market

Allison Transmission Running Over The Bears

Whatever the future may look like for Allison Transmission (ALSN) and its role in a post-electric truck world, the company is executing remarkably well today. With solid growth in its core North American truck business augmented by improving demand from energy and mining applications, as well as share gains in trucks outside North America, Allison is posting exceptional incremental margins and forcing bearish sell-siders to trot out “we’re not wrong… we’re just early” calls.

I’m not in the “the sky is going to fall” camp with Allison, but it’s a tough story to model out given the likelihood that electric trucks eventually will grab share in strong core Allison markets like dump trucks, refuse trucks, and other vocational applications like drayage. I believe a key question is whether Allison can continue to gain share in overseas markets (where penetration is low) and whether they can fight off competition from other transmission alternatives like the Cummins (CMI)/Eaton (ETN) JV.

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Allison Transmission Running Over The Bears

Improving End-Markets And Market Share Not Enough For Cummins

Investors are definitely conflicted about machinery stocks these days, with mining and ag doing well, but a lot less enthusiasm for construction and trucking as investors worry about how the end of the cycle will play out. I didn’t see enough upside in Cummins (CMI) to want to dive in back in late May, and the market-lagging return since then doesn’t exactly have me regretting that call (though Cummins has done comparatively better than most heavy machinery names over that time).

I can’t say that I feel all that differently about Cummins now. The North American truck cycle looks like it has longer legs (into 2019), but that doesn’t really change the fundamental long-term valuation picture. Likewise with the long-awaited recovery in power gen and strength in markets like mining and oil/gas. Although the shares do look a little undervalued on a near-term basis and I like the company’s ongoing moves to invest in electrification products/technology, I just don’t see the upside to warrant taking a new position now.

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Improving End-Markets And Market Share Not Enough For Cummins

Seeking Alpha: Komatsu Looking For A Foothold

Six months ago, I thought investors could afford to wait on buying into Komatsu (OTCPK:KMTUY) (6301.TO), as this Japanese manufacturer of construction and mining equipment was likely looking at a multiyear process of demand repair. I don't think investors have really missed out on much - the roughly 8% drop in the ADRs since then is not catastrophic (certainly not relative to Joy Global's (NYSE:JOY) 31% drop), but investors would have done better in Caterpillar (NYSE:CAT), Volvo (OTCPK:VOLVY), Terex (NYSE:TEX) or by avoiding the space altogether.

Looking ahead, there's arguably a little more value in the shares but the outlook still isn't promising. There's a real threat that U.S. equipment demand isn't going to get much better and that growth in Europe won't offset weakness in Asia and particularly China and Japan. Komatsu does have an opportunity to stand out on a relative basis with its automation initiatives and internal cost reductions, but I'm not sure there's enough upside to make the wait a comfortable one.

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Komatsu Looking For A Foothold

Seeking Alpha: Allison Transmission Still Looking At A Multiyear Sales Effort Outside The U.S.

Orders continue to roll in pretty nicely for large commercial trucks, but major suppliers like Cummins (NYSE:CMI), Tenneco (NYSE:TEN), and Allison (NYSE:ALSN) haven't really been showing it in their share prices. Whether it is concerns about weak conditions in Latin America or valuations that got a little overheated earlier in the year, these shares haven't done much since I last wrote about Allison in March.

I thought back in March that valuation might be getting a little stretched, but with this stretch of relative underperformance, I'm getting more positive on Allison. The company will likely see some headwinds created by Ford (NYSE:F) and Volvo (OTCPK:VOLVY), but I like the company's opportunity to leverage its new TC-10 transmission into greater metro Class 8 share. Longer term, the key question remains whether or not the company can coax companies in Europe, Latin America, and Asia to adopt automatic transmissions despite the greater success. I think the process will take some time, but in the meantime Allison offers attractive margins and cash flow leverage, though the valuation is still not an obvious "gimme".

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Allison Transmission Still Looking At A Multiyear Sales Effort Outside The U.S.

Seeking Alpha: Allison Transmission A Stand-Out In Multiple Ways

In a vehicle parts/components sector that has seen many stocks rocket up over the past year, Allison Transmission (ALSN) doesn't look so appealing with its stock "only" up about 25% over the past year. That comes in spite of Allison owning exceedingly rare market share in its end markets and still having significant global under-penetration to fuel future revenue growth.

While it is true that Allison's cash flow is complicated by net operating losses carried forward and intangible asset amortization, the base operating margin and cash flow generation are still quite good for the sector. Although Allison is not a huge value today, and the EV/EBTIDA looks expensive without adjustments, upside from energy and on-highway markets could lead to higher expectations and the relative valuation (not to mention quality) makes Allison a name worth following.

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Allison Transmission A Stand-Out In Multiple Ways

Investopedia: Komatsu Looks Like A Winner, But Valuation Is Tricky

Most American readers will be well aware of the significant share and scale that Caterpillar (NYSE:CAT) enjoys in the construction and mining industries. What may be less appreciated is that Japan's Komatsu (Nasdaq:KMTUY) enjoys similar scale on a global basis, and has done quite well for itself in markets like China and Indonesia. What's more, Komatsu has made considerable investments in a variety of automation technologies that could set its equipment apart in the coming years. Valuation here isn't a simple exercise, but a multi-metric analysis suggests that Komatsu may well be cheap enough to merit serious investment consideration.

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Investopedia: Navistar In Early Stages Of Turning It Around

I don't know if the nearly 60% move in Navistar (NYSE:NAV) over the past six months is due to Wall Street's confidence in Navistar's turnaround efforts or investors simply looking around for a stock that seemed a little undervalued. In any case, it seems harder to argue that investors aren't already factoring in a pretty solid recovery for this struggling truck builder. An industry recovery in 2014 could certainly help, but investors shouldn't underestimate the challenges in rebuilding customer confidence and regaining the market position of years past.

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Investopedia: Investors Already Thinking Recovery For Cummins

Seeing as it is no simple task to find a company with the right mix of good management, competitive products, and attractive long-term markets, I understand why investors are slow to give up on companies that feature these attributes. All the same, it looks like the Street has already looked past this lull in Cummins' (NYSE:CMI) business. Not only is the stock up about 15% over the past year and within 10% of its all-time high, but today's valuation already presumes a pretty solid future outlook with respect to growth.

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Investopedia: Is Caterpillar Facing A New Normal In Mining?

For those investors who believed a year ago that Caterpillar (NYSE:CAT) had somehow outgrown its cyclicality, the past twelve months have been a painful reminder that it's never “different this time”. The real question now, though, is what the new normal will look like. Although there's good reason to believe that Caterpillar's power and construction businesses can do better, the longer-term outlook for mining isn't as robust anymore. There is certainly the risk that estimates head even lower, but Caterpillar shares are starting to look a little interesting in terms of value.

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Seeking Alpha: Terex Needs More Balanced Growth To Head Higher

It was almost a year to the day when I last wrote on material handling company Terex (TEX). I was positive on the stock at that time, and the stock did outperform over the past year (up nearly 27%). Like so many other industrial/heavy machinery names, though, I find myself asking if investors have been too eager to factor a strong global economical recovery into the numbers. While I still think Terex has a good business and a solid management team, a lot seems to be riding on businesses that have a lot of exposure to the still-feeble European economy.

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Terex Needs More Balanced Growth To Head Higher

Seeking Alpha: Cummins Getting A Lot Of Benefit Of The Doubt

With the stock up almost 40% from its October 2012 lows and less than 10% from its 52-week high, it seems safe to say that investors are feeling pretty good about Cummins' (CMI) recovery prospects. Though I have little doubt that anything is changing in regards to the company's top-notch quality, I do wonder if investors are too quick to assume that emerging market growth is just going to go back to where it was. I would love to accumulate these shares at attractive prices, but today's valuation already assumes a pretty optimistic scenario.

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Cummins Getting A Lot Of Benefit Of The Doubt

Seeking Alpha: Commodity Prices And China Make Caterpillar A Yo-Yo

Reading Caterpillar's (CAT) release and listening to the call, I get the sense of management basically shrugging its shoulders and saying "heck if we know" when it comes to the year ahead. I can't blame them in the least, as listening to all manner of conference calls this earnings season has turned up a wide array of feelings, impressions and outlooks for the economy both now and for the rest of 2013. For better or worse, the near-term outlook for Caterpillar is likely to be dominated by commodity price trends, while the long-term value seems only so-so right now.

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Commodity Prices And China Make Caterpillar A Yo-Yo

Investopedia: Navistar Is Terrible Today, But That May Not Be Relevant

There was absolutely no reason to think that the fiscal fourth quarter was going to be a good one for truck builder Navistar (NYSE:NAV), and it certainly was not a good one. The real question for investors, though, is whether this company can hit its new product launch targets, streamline its manufacturing process and rebuild the share that management missteps destroyed over the past couple of years. This continues to look like a binary stock to me - if management can direct a real turnaround, the shares will thrive from here, but survival (and success) are far from assured.

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Investopedia: Westport Is Still All About Tomorrow

Whether it's truck and engine company executives like those at Navistar (NYSE:NAV) and Caterpillar (NYSE:CAT), environmentalists, or energy policy pundits, it seems like there's a broad agreement that the U.S. needs to do more to make use of natural gas as a vehicle fuel. With high-quality partners like Volvo (OTC:VOLVY) and Cummins (NYSE:CMI), Westport Innovations (Nasdaq:WPRT) continues to look like a promising play on that trend. That said, while these shares could indeed have substantial upside from here, the LNG/CNG engine market is still in its infancy and there are no guarantees that customers will go in the direction of Westport's technology.

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Seeking Alpha: Is Komatsu A Better Way To Play The Eventual Heavy Machinery Rebound?

As I recently lamented in an article on Cummins (CMI), U.S. investors don't let quality heavy machinery/industrial names like Cummins or Caterpillar (CAT) linger long in value territory. This leaves investors with a few choices - pony up and pay current prices (even if the risk/return tradeoff isn't great), avoid the sector altogether, or go shopping for less traditional names. I'm a fan of that last approach, and just as I think Atlas Copco (ATLKY.PK) is a solid industrial name overlooked because of its thinly-traded ADR listing in the U.S., Komatsu (KMTUY.PK) looks like a name at least worthy of further discussion.

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Is Komatsu A Better Way To Play The Eventual Heavy Machinery Rebound?

Seeking Alpha: Does The Market Love Cummins Too Much?

For a market that got very nervous very quickly about industrial companies, particularly those with sizable emerging market exposure, Cummins (CMI) is actually faring quite well. Investors seemed encouraged by the company's recent quarterly report, as well as a big (albeit not totally unexpected) win with Navistar (NAV). The question I have is whether Cummins, for all of its great qualities as a company, is still a bit too popular for investors' long-term good.

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Does The Market Love Cummins Too Much?

Seeking Alpha: Relief Will Only Carry Caterpillar So Far

Earnings from heavy machinery specialist Caterpillar (CAT) certainly gave investors a little relief, but they shouldn't underestimate the risks to growth over the next 12-18 months. While this company certainly does have solid long-term prospects, the possibility of long-term gain isn't always enough to assuage the short-term pain that can go with wholesale institutional abandonment of a sector.

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Relief Will Only Carry Caterpillar So Far

Seeking Alpha: Cummins - If The Good Are Struggling, Where Does That Leave The Rest?

A strong second half is looking less and less likely for the industrial sector. Class 8 truck orders have been declining, Europe is not getting better, and emerging markets continue to weaken. Now we have Cummins (CMI) warning that management no longer expects 2012 revenue to grow from 2011 levels.

While I have expressed some reservations in the past about Cummins' valuation and the risk of engine market share loss to internal programs, I have never questioned the quality of the business, or its status as a leader. So then, if Cummins is now of the opinion that there will be no revenue growth this year, where does that leave truck manufacturers and other heavy equipment producers?

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Cummins - If The Good Are Struggling, Where Does That Leave The Rest?