Description

Blue Bird Corporation (“Blue Bird” or the “Company”) was written up here last March by rab.  Since that time, the Company has delivered on its fiscal 2015 guidance and generated roughly $45mm in LTM adjusted free cash flow, corresponding to a 20% free cash flow yield to equity (on 24mm fully-diluted shares).  Fiscal 2016 free cash flow guidance, which at $30-35mm is modestly more muted due to higher cash taxes and some expansion capex projects, still implies a yield to equity of roughly 15%.  The business is trading at roughly 6x 2016 EBITDA and 8x 2016 EPS (consensus).  After rising as high as $14/shr in mid-2015, the stock has retreated back to under $10/shr.  I believe that it is worth another look.  This is a business with a strongly cash generative business model, significant macro wind at its back, and very high returns on its invested capital.  Due in large part to a lack of other pure-play comps in the public market, I believe that it is wrongly perceived as an asset-intensive heavy manufacturer.  This is not the case.  8x EPS for a well-managed, high return, growing business in the sweet spot of its cycle is too cheap.

Blue Bird is a leading U.S. manufacturer of school buses. The Company has annual output of over 10,000 units, which gives it roughly one third of the total domestic market. The U.S. school bus market is an oligopoly. Blue Bird’s two primary competitors, each of which also control roughly one third of the market, are Thomas (owned by Mercedes-Benz parent Daimler) and IC Bus (owned by Navistar).

Blue Bird’s origins as a bus manufacturer can be traced to 1927, when founder A.L. Luce began producing buses as an adjunct to his automobile dealership business. The Company continued to be controlled by the Luce family through the early 1990s, at which time a control stake was sold to Merrill Lynch Capital Partners (“MLCP”). Blue Bird continued to thrive under MLCP’s ownership, with its U.S. market share peaking at 42%. However, following MLCP’s divestiture of Blue Bird to the U.K.-based Henleys Group in 1999, a variety of market, manufacturing, and financial factors led to significant market share losses and, ultimately, a bankruptcy filing. Cerberus Capital Management (“Cerberus”) took control of Blue Bird through this bankruptcy process in 2006, and subsequently drove significant management and operational changes in the business. These changes led to an impressive turnaround, culminating with the Company’s return to the public markets in early 2015. Today, Cerberus continues to hold a 57% stake in Blue Bird.

Blue Bird is the only one of the three primary U.S. school bus manufacturers that is not vertically integrated. This has important ramifications for Blue Bird’s product competitiveness, as well as its financial model. Daimler and Navistar both have significant heavy truck manufacturing operations, while Blue Bird focuses solely on the design and manufacturing of chassis and cabins that are ideally suited for passenger transportation. As a result, Blue Bird is free to design its bus platforms with safety as an overriding priority. Daimler and Navistar, on the other hand, are forced to base their designs on chassis architecture that has been dual purposed for both passenger bus and heavy truck applications, where load maximization is a primary design driver. Safety is generally the top consideration for the municipalities that purchase school buses, and Blue Bird is consistently ranked by those municipalities as providing the safest vehicles.

A second benefit of Blue Bird’s lack of vertical integration is its drivetrain flexibility. Both Daimler and Navistar have in-house drivetrain operations, while Blue Bird does not. This gives Blue Bird the flexibility to pick and choose from multiple potential drivetrain suppliers and choose best-of-breed alternatives for any given application. In many cases, this provides the Company with a major time-to-market advantage and associated first mover benefit given the long lead times associated with drivetrain development. For example, alternative fuel options have become important to an increasing number of municipalities over the last few years. Blue Bird’s drivetrain sourcing flexibility helped it become first to market for propane buses, and over the last five years it has sold roughly 6x as many propane-powered buses as all of its competitors combined. Propane-powered buses, meanwhile, have been one of the highest growth subsegments of the passenger bus market, disproportionately benefiting Blue Bird. In addition, Blue Bird’s strategy of piggybacking on others’ drivetrain development efforts helps it avoid the R&D expense and heavy fixed asset investment required for in-house drivetrain development and production. This operating model has helped contribute to an annualized return on invested capital in excess of 40% for each of the last few years, an extraordinarily attractive level for a business that the public market currently mistakenly views as a heavy manufacturer.

There is a final advantage of Blue Bird’s sole focus on passenger buses that deserves mention. Daimler and Navistar’s dual-focus on both heavy trucks and passenger buses has led to the development of dealer networks for these competitors that also focus on both classes of vehicles. Over 80% of Blue Bird’s dealer network, on the other hand, focuses exclusively on buses. Dealers with a dual truck/bus focus often prioritize trucks over buses. Blue Bird’s network of dealers, with its more narrow focus, can provide a timelier, higher level of service, ultimately resulting in more satisfied customers.

The school bus industry is fairly cyclical, as the vast majority of school buses are purchased by local municipalities and, as such, are subject to the vagaries of local tax receipts. The collapse of the U.S. residential housing market hit the industry particularly hard. The dual headwinds of declining home values and increasing default rates led to significant reductions in property tax receipts. This reduction, in turn, drove a material decline in municipal capital budgets and, by extension, school bus purchases. Although the steady recovery of the housing market has led to corresponding improvement in demand for school buses, aggregate sales levels are still modestly below their long-term average and nearly 20% below the typical peak level. There is good reason to believe that the next few years may see a return to peak levels of aggregate production. The depressed sales levels of the last few years have led to a national fleet average age of nearly 12 years, versus a long-term average fleet age closer to nine years. Even accounting for a reasonable increase in overall fleet reliability, this dynamic strongly suggests a material level of pent-up demand that should help drive strong sales growth for a number of years to come.

Blue Bird shares currently trade for roughly 8x 2016 EPS and a modestly cheaper multiple of free cash flow. This is an unusually attractive level for a business with multiple demand tailwinds, 40%+ returns on invested capital, excellent cash generation, a strong management team, and a motivated control shareholder. Part of the disconnect between Blue Bird’s current trading levels and a realistic assessment of intrinsic value is its status as the only pure-play North American school bus manufacturer in the public markets. Many investors mistakenly assume that any heavy vehicle manufacturer must necessarily be an asset-intensive, low multiple business. Although Blue Bird’s implicit returns belie this assumption, it has been public for less than a year so the reality of its highly attractive economic model is not widely understood. Continued strong financial performance and incremental investor relations efforts should ultimately help further propagate the Company’s story, leading to multiple expansion and strong stock price performance.

Catalyst

* Market recognition that BLBD is not an asset-heavy manufacturing business, but has a high-implicit-return outsourced model; associated multiple expansion

* Continued, measured growth as aging national school bus infrastructure is renewed

* Continued improvement in US housing market strengthens local finances (i.e. property tax receipts), boosting upgrade cycle

* Continued focus on alternative fuel vehicles disproportionately benefits BLBD

* Sale of business