Thesis: Oshkosh Corp is an equipment maker about to experience a severe cyclical downturn in its biggest segment. The company’s valuation currently reflect near top of the cycle valuation and the cash flow profile of the business is likely to deteriorate very rapidly in the coming years. The equity value has a 80% downside to my target price over a two year period.
Oshkosh manufactures specialty access equipment and vehicles for the municipal markets as well heavy duty defense trucks for the U.S. and foreign militaries. The company reports in four segments. Access equipment (51% of sales) was formed from Oshkosh’s largest and most recent acquisition of JLG Industries in 2006. Defense (25% of sales) produces tactical wheeled vehicles for the military and security forces globally. The Commercial segment (13% of sales) offers concrete mixers and batch plants, refuse collection and field service vehicles and truck-mounted cranes. Fire and Emergency (11% of sales) focuses on firefighting and snow removal vehicles. These segments have no or limited synergies and these businesses are best discussed separately.
ACCESS EQUIPMENT SEGMENT:
Oshkosh acquired JLG in 2006. JLG manufactures aerial work platforms and telehandlers used in a wide variety of construction, agricultural, industrial, institutional and general maintenance applications to position workers and materials at elevated heights. Access equipment customers include equipment rental companies, construction contractors, manufacturing companies and home improvement centers.
The business is highly cyclical and has historically been linked to non-residential construction demand in the US as there is not much used of access equipment for residential. The business is primarily (about 70%) domestic, so important to understand that market first.
US Construction Activity
The US construction spend as a % of GDP had been declining for a few decades and nosedived after the 2009 recession to settle at a lower level.
So even as US GDP had surpassed the 2008 highs by 2010, US construction has not reached its previous peak of 2006.
Breaking down this total construction spend into its Resi and non-resi components shows that a very slow residential recovering is largely to blame, which partly reflects the scale of the overbuild in the 2006 period and also the effect of other factors like demographic trends, etc. See below for breakdown (in $b)
So non-residential activity only collapsed after the overall economy went into a recession and has recovered since then to its previous highs. See below for the components of the non-resi spend (in $b).
It’s a busy chart but most of the Non-res rebound has come from 4 of the components, Manufacturing, Lodging and Commercial from 2011 onwards and Office from 2013 onwards. The rest of the categories have largely shown little to no growth. See below to illustrate that fact (in $b)
Lodging is a cyclical sector and we are experiencing peak supply growth right now as occupancy rate is just starting to go negative which usually signals peak cash flows for the industry as well as the end of approvals for further capacity additions.
For Offices, conversations with Ashtead (one of the largest rental companies for construction equipment) reveal that last few years have seen a number of approvals for new headquarters, which is borne true by the data shown above. This upcycle in office construction lasted from 2005-2008 in the last cycle and 1998 to 2001 in the cycle before. It’s currently lasted from 2013-2016 and we are unlikely to see a further major inflection upwards in the data. 2016 should still be decent but activity will likely start declining after that.
For Commercial, going into its sub-components shows the biggest improvement has largely been in Multi-Retail and Warehousing, and again the square footage added in those segments has slowed recently as supply growth exceeds demand growth. This is borne true by recent declines in the Construction Backlog Indicator
Meanwhile for Manufacturing, which had registered by far the largest increase in non-residential spending growth, the main growth component over the last few years had been energy related which turned negative in 2015 leading to a contraction in the manufacturing activity for the first time in 6 years. I expect the downturn in manufacturing activity as a result of commodity related downturn to exacerbate going forward causing manufacturing related construction to roll.