Description

Idea: Long NFI Group (NFI or “the Company”) which is the largest North American transit-bus manufacturer. We believe NFI is entering an upcycle in profitability driven by price/cost recovery, a mix-shift to EVs, and a wave of industry consolidation which will drive 29% upside to Adj. EBITDA in 2025 and 74% upside for shares in our base case. We believe there is over 150%+ upside here in our bull case.

Business Overview

NFI Group is a leading bus manufacturer focusing on North America through its New Flyer (transit), MCI (motor coach), and ARBOC (medium duty) brands. It also owns the leading UK transit bus manufacturer, ADL, which was acquired in May 2019. Transit buses are sold to municipalities (e.g. the MTA bus) while motor coaches are primarily sold to the private sector and usually sport nicer interiors (e.g. Greyhound). Buses are semi-customized.

It delivered 4,000 equivalent-units (“EU”, a standardized term for bus units) in 2023 split between transit buses (3,000, of which 1,800 are North America & 1,200 ADL), motor coaches (600), and medium-duty (400). As of 1Q24, transit buses had a delivered ASP of $535k, motor coaches were $625k, and medium-duty were $121k.

NFI reports in two key segments:

• Manufacturing (79% of 2023 revenue)

  • Within Manufacturing, transit buses are the main product at 77% of revenue in 2023 with motor coaches following at 18%, and medium-duty & pre-owned at 5%.

  • Normally the Manufacturing segment is ~80% of total Adj. EBITDA, but due to depressed margins, it contributed -$42mm of Adj. EBITDA in 2023.  

• Aftermarket (21% of 2023 revenue)

  • Replacement parts primarily for transit buses. This is a mix of OEM-certified parts and third-party.

  • Aftermarket drove all of the Adj. EBITDA in 2023 with its $120mm contribution leading to $69mm of consolidated Adj. EBITDA after -$42mm from Manufacturing and -$9mm from corp.

Our focus is on the transit bus sub-segment given it contributes around 60-70% of normalized EBITDA.

Transit Bus Industry Overview

The heavy-duty transit bus industry has an installed base of roughly 89k units in North America, of which the U.S. is 71.5k and Canada is 17.5k. With an average life of 15 years, this drives replacement demand of 5,900 units per year.

In the U.S., around 80% of the purchase price of a transit bus is eligible for federal grants if it meets Buy America specifications (70% of bus cost must be from the U.S.), with the remaining 20% funded by the state/municipality. As a result, demand for transit buses usually follows federal funding trends and only domestic players are favored.

Key players in the North American transit market for 2023 were NFI Group (41% share), Gillig (private, 38%), Nova Bus (owned by Volvo, 14%), El Dorado National (owned by Rev Group, 4%), and BYD & Proterra (3%).

NFI is a long because:

1. It is entering an up-cycle in EBITDA/unit driven by price/cost recovery and production improvements.

2. Federal funding for EV buses has led to a strong demand environment and a mix-shift towards higher per-unit profit buses.

3. This cycle is likely to overshoot prior mid-cycle levels of profitability as the industry has faced a wave of consolidation.

1)   NFI is entering an upcycle in EBITDA/unit driven by price/cost recovery and production improvements.

Production challenges and unprecedented increases in manufacturing costs since 2020 have resulted in industry deliveries coming in well below replacement demand over the past few years with low margins on delivered units.

We estimate 2022 deliveries were ~32% below replacement demand (4.0k vs. replacement demand at 5.9k), marking the trough of the cycle. Deliveries began to recover in 2023:

Source: APTA

Such shipments below replacement levels has led to an aging of the U.S. bus fleet to levels not seen in the past two decades:

Source: APTA

In addition to the pressure from low levels of deliveries, the industry has also suffered from price/cost headwinds due to the recent bout of inflation which was not fully passed through given the way most contracts are structured.

Buses have a one-year lead time between contract signing and the start of deliveries, which can have a multi-year shipment schedule. These contracts usually have a mechanism to allow for cost increases over the term of the contract, the most common index used is the PPI for bus and truck bodies. Such contracts would allow for re-pricing from the initial build date. We believe around half are structured with annual price increase caps set at 3% or 5%.

In an inflationary environment, the issue for the industry is then two-fold: a) the one-year lead time from order to shipment subjects the manufacturer to risk if they did not properly estimate or lock-in forward production costs and b) contracts with pricing caps subject the manufacturer to risk of being underwater over a multi-year timeframe.

This is exactly the problem that has plagued the industry over the past few years. The Bus PPI growth far outpaced the 3-5% cap (in many contracts) from late 2021 to early 2023, meaning most contracts signed around this period were at quite poor margins upon delivery:

Source: Census.gov

NFI has stated that it typically secures pricing for “over 50%” of a vehicle’s component parts and includes an inflation adjustment within its contracts to account for price increases between bid and manufacturing. However, in NFI’s 1Q22 earnings presentation it admitted “heightened and rapidly moving levels of inflation in recent quarters has meant that actual costs have exceeded estimates for contracts bid prior to 2022.”

Indeed, when spreading NFI Group’s Manufacturing segment EBITDA / unit, we can see a decline from $57k in 2019 to a trough of -$55k in 2022 with a recovery to a still negative -$15k in 2023:

Source: NFI Group Company Filings

We believe NFI is now entering an upcycle for EBITDA / unit driven by price/cost recovery and improving production levels.

a)   Price/cost recovery

NFI started raising prices on new orders in late 2021 but was more aggressive through the past year. NFI’s heavy-duty transit bus pricing in the backlog has risen from $538k in 2021 to $738k in 2023:

Source: NFI Group Company Filings

A portion of this increase in backlog pricing is driven by the mix of EVs (~$400-500k higher ASP than ICE). We attempt to adjust for mix below, where we show our estimate of like-for-like backlog pricing on just non-EV bus units.

Source: NFI Group Company Filings, internal estimates

The key insight here is that the estimated non-EV backlog price was fairly stable throughout 2022, ending at $494k in 4Q22, but increased every quarter in the following year to end at $616k in 4Q23. Firm backlog covers around five quarters worth of deliveries, meaning this improving pricing in the backlog will start flowing in throughout 2024.

As an illustration of the latent profit improvement here, we show the price of transit buses in the backlog less the price of delivered units flowing through the P&L. This analysis attempts to adjust for any difference between the mix of higher-priced EVs in the backlog vs. reported P&L, so this is a like-for-like pricing uplift. Given costs are not inflating today like they were throughout 2022, this sets the stage for dramatic profitability improvements throughout 2024 and 2025:

Source: NFI Group Company Filings

Additionally, new order pricing is going to be higher than the average pricing in the backlog. Given NFI’s disclosure, it is difficult to parse out non-EV transit order pricing, but as a general indicator we can see the trend in total order pricing (includes transit buses and other products).

Source: NFI Group Company Filings

Various state contracts we have dug up also generally support ~$100k+ of pricing improvement since 2022 for diesel buses:(https://wwe2.osc.state.ny.us/transparency/contracts/contractresults.cfm?oc=6031200&ac=&v=&vo=B&cn=&selOrigDateChoiceOperator=0&txtOrigFromDate=&txtOrigToDate=&selCTDateChoice=0&selCTDateChoiceOperator=0&txtCTFromDate=&txtCTToDate=&selContractAmountChoice=0&txtContractAmount1=&txtContractAmount2=&b=Search&order=CONTRACT_END_DATE&sort=DESC).

As another illustration of the “automatic” ASP uplift over the next few years, we have roughly estimated NFI’s bus delivery & pricing schedule by cohort below. The key output is in orange, which shows delivered ASP (non-EV) should be up 11% in 2024 and 19% in 2025 (with more muted cost increases from the current level):

Source: NFI Group Company Filings an internal estimates

In addition to per unit variable margin increasing over the coming years, we expect production levels to improve leading to better fixed cost absorption.

b)   Improving bus production levels

After struggling with supply chain challenges throughout 2021 and 2022, NFI has been improving its production levels over the past year. This improvement is expected to continue, with the Company guiding to 5,000 deliveries for 2024 and 6,000 in 2025 – up from 4,000 in 2023 and 3,000 in 2022.

Source: NFI Group Company Filings

Supporting this increase in production levels is very healthy new order trends (LTM book-to-bill 1.2x on increasing deliveries) and an increasing backlog coverage (firm backlog stretches around 5 quarters worth of deliveries):

Source: NFI Group Company Filings

Note that NFI’s total backlog, inclusive of options, is much larger at around 10 quarters of coverage (2.5 years). Much of this is being driven by a multi-year increase in federal funding (discussed in the next section).

Of the total $2.08bn in Manufacturing COGS for 2023, roughly $272mm was D&A and other overhead. Additionally, the Company had $245mm in SG&A costs for 2023. Combined, there are $571mm of fixed costs that will be levered as deliveries increase – or roughly 21% of 2023 revenue.

Putting these factors together, in our base case, we believe NFI should be able to recover to at least mid-cycle (defined as five-year average pre-covid) EBITDA / unit in FY25:

Source: NFI Group Company Filings and internal projections

While this price/cost upcycle takes place over the coming years, NFI will also enjoy a mix-shift towards zero emission buses which carry higher per unit profitability.

2)   Federal funding for EV buses has led to a strong demand environment and a mix-shift towards higher per-unit profit buses.

EV buses, termed ZEBs (zero emission buses) by the Company, have a low penetration of the fleet today at M-HSD in North America but are set to expand dramatically over the coming decade. While there are some limitations to the technology vs. ICE buses, demand is being driven by federal funding for low and no-emission vehicles.

In November 2021, the Infrastructure Investment and Jobs Act (IIJA) was passed which increased overall funding for the Federal Transportation Authority (FTA, the entity that oversees transit buses) from $13bn in 2021 to an average of ~$22bn over 2022-2026:

Source: NFI Group Company Filings

Within this broad increase in funding, the IIJA provisioned $5.5bn over five years specifically for the Low-No program, which is ~6x greater than the previous five years’ funding. These funds are specifically made available to help transit agencies buy U.S. built low-or-no emission vehicles (including related equipment and facilities). As part of the Low-No program, $1.1bn of grants were made available in 2022 (up from $182mm in 2021). For 2023 and 2024, the FTA announced $1.7bn and $1.1bn of Low-No grants, respectively. Canada and the UK have similar programs, although to varying degrees of magnitude.

This is driving orders for ZEBs. ZEBs have increased from 4% of NFI’s backlog (on a unit basis) in 2019 to 39% today. Deliveries have lagged so far, as seen below, however the Company is guiding to normalization in 2024 (30-35% of deliveries) and 2025 (40% of deliveries).

Source: NFI Group Company Filings

This industry shift is likely to lead to improved per unit margins overall for bus manufacturers. We believe ZEBs are priced $400-500k more than a traditional ICE bus. NFI has noted that they currently generate a lower % margin on ZEBs than ICE buses but a higher per unit dollar profit. While they have not quantified this specifically, we think the incremental EBITDA per unit is around $25k (roughly 5.5% margin on the incremental price of a ZEB vs. ICE). With this mix-shift, we estimate overall EBITDA/unit for NFI’s North America business will grow from $57k in 2019 to $69.5k in 2025:

Source: NFI Group Company Filings and internal estimates

In addition to the price/cost & EV-mix driven upcycle, we think there is a strong chance the industry will overshoot to the upside given a recent wave of consolidation.

3)   This cycle is likely to overshoot prior mid-cycle levels of profitability as the industry has faced a wave of consolidation.

The North America transit bus market has consolidated over the past decade, from six players to four today, and just two meaningful players for the U.S. market:

Source: NFI Group Company Filings, APTA, METRO Magazine

The first wave of consolidation occurred in 2013, when Daimler ended production at its Orion Transit bus division and NFI Group acquired NABI. Another wave of consolidation is transpiring today, mostly driven by the poor operating environment in 2021 and 2022:

• June 2023: Nova Bus (owned by Volvo) announced it was exiting the U.S. market in 2025 (closing a facility in New York), although it will remain in Canada.
  • We believe this will take out roughly half of Nova’s total North America capacity (per our conversation with a sales manager there) with a complete U.S. exit.
• August 2023: Proterra filed Ch. 11 and its assets were sold to Phoenix Motors (we assume de minimis operations for now, but this may rebound at some point).
• January 2024: Rev Group (ENC) announced it will be exiting transit bus manufacturing by the end of 2024.

Lastly, BYD is effectively out of the U.S. market given provisions put into the National Defense Authorization Act (effective 2022) which prohibited the use of federal dollars to purchase buses from state owned/controlled enterprises in China.

Resultantly, we believe the U.S. transit bus market has now turned into a two-player market consisting of NFI Group and Gillig:

Source: NFI Group Company Filings, APTA, METRO Magazine

We believe NFI’s U.S. transit bus share will go from ~41% in 2023 to ~52% in 2025 and its total North America share will go from 41% in 2023 to 49% in 2025. We assume total industry deliveries grow from 4,350 in 2023 to 5,900 in 2025 – our estimate of replacement demand. This translates to 2,900 North America transit bus deliveries for NFI in 2025, or right at their max capacity.

What’s more, NFI has traditionally focused on larger transit authorities while Gillig has focused on small-to-medium customers. NFI also does a few vehicle types that Gillig does not manufacture (fuel cell buses, 60 ft EV/hybrids). While Gillig has been encroaching more into larger accounts, we still think this consolidation sets the industry up for an increasing amount of single-source bidding activity.

We believe this dynamic has a high probability to lead to increased through-cycle EBITDA/unit. Our Bull case contemplates manufacturing EBITDA / unit (excl. EVs and ADL) of $69k in 2025, or ~$10k above our Base case & 2019 levels. The Bull + case contemplates an EBITDA/unit $22.5k above the base case for 2025:

Note: We assume the same $25k improvement in per unit profitability of EVs across all cases. We assume the same EBITDA/unit on ADL deliveries in all cases. Finally, our valuation is built off 2025 in all cases – there is more upside than modeled if we were to base our figures off 2026 for the bull + case.

Valuation

We value NFI Group on 2025 Adj. EBITDA. Key assumptions across our cases are below:

Manufacturing

•  North America EBITDA/Unit for 2025

  •  Non-EV

    • Bear: $35.7k, 37% below 2019 levels ($56.6k).

    • Base: $59.5k, 5% above 2019.

    • Bull: $69.1k, 22% above 2019.

    • Bull +: $82.0k, 45% above 2019.

  • EV

    • Across all cases, $25k premium to the non-EV EBITDA/unit.

•  ADL EBITDA/Unit

  • We treat ADL (mostly UK and smaller RoW) separately from the North American business given the EBITDA/unit is lower. We use $25k EBITDA/unit across all cases. 

• Volume

  • Across all cases, we use 6,000 total units. Within this mix, we assume 2,900 North America transit buses and 1,700 ADL transit buses for a total of 4,600 transit bus deliveries. That compares with 5,218 transit deliveries in 2018 and 4,722 in 2019 (both PF for ADL). Additionally, we assume 900 motor coach and 500 medium-duty deliveries (1,036 and 358, respectively, in 2019).

The above assumptions translate to 2025 Manufacturing EBITDA as follows: Bear of $239mm, Base of $341mm, Bull of $383mm, and Bull + at $438mm.

 Aftermarket

We use $124mm of Aftermarket EBITDA in 2025 across all cases. This is 5% below our estimate for 2024 but 67% above 2019 contribution of $75mm.

 Total EBITDA

Along with -$8mm of corp, this translates to a range of 2025 Adj. EBITDA from $356mm in our Bear case to $458mm in our Base case and $555mm in our Bull + case.

At 7.5x our Base case 2025 Adj. EBITDA, we arrive at a $20.3 PT, or +75% from the current price.

 NFI Group has traded in a range of 7-10x fwd Adj. EBITDA (excluding 2022 and 2023 which are anomalies due to temporarily low fwd EBITDA) over the past decade.

Other investment considerations:

•  Upside to guided EBITDA
  • NFI guided to $240-280mm of Adj. EBITDA for 2024 and >$350mm of Adj. EBITDA in 2025. We think the 2025 guidance is very conservative as it does not take into account the improved pricing on orders received in the most recent two quarters (and are the largest increases over the past few years).
• Improving contract dynamics
  • Due to the issues faced by the industry over the past few years, the FTA gave guidance in February of 2024, called the “Dear Colleague Letter” which delineates the ability for transit authoritites to incorporate progress & advance payments in contracts. This should reduce the working capital burden of bus manufacturers. Additionally, in the letter, the FTA encouraged transit agencies to utilize contracts that allow for price adjustments and clearly laid out a mechanism for using federal funds to cover contract price increases.
• Battery cost deflation
  • We think there is a chance battery pack costs for heavy-duty vehicles start to deflate. So far pricing has lagged the movement lower in passenger EVs. We need to do more work here, but this dynamic could drive further price/cost upside.

Risks

• Further supply chain issues
  • NFI most recently experienced issues with its battery enclosure system that led to delays in ZEB deliveries in 1H23.
• New entrants
  • BYD is attempting to circumvent legislative restrictions on its ability to participate in Buy America bus bids by creating a local entity called RIDE.
  • Other players may cancel their exit from the U.S. market, or return, if we are right on the upcoming upcycle.
• Leverage
  • Net debt / EBITDA is elevated at 3.8x 2024 Adj. EBITDA. This will naturally get better as EBITDA improves – we estimate YE24 Net Debt at 2.2x 2025 Adj. EBITDA.

Disclaimer: The author of this memorandum presently has a position in securities of this issuer and may trade in and out of these positions without notice. This memorandum is for discussion purposes only and is not intended to be, nor should it be construed or used as, financial, legal, tax or investment advice or a general solicitation. This memorandum is as of the date posted, is not complete and is subject to change. The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates. Certain information has been provided by sources believed to be reliable, but has not been independently verified and its accuracy or completeness cannot be guaranteed and should not be relied upon as such.

Catalyst

Earnings beats in 2024 2025 and 2026