Description
Investment Thesis:
A recent correction in OSK stock price has created a buying opportunity of a great company trading at a discount multiple of 13.5x versus recent multiple of 20x over last few years. $65 initial price target represents 35% upside based on 14x 2008 (sept) $4.50 eps power. This is a more in line multiple post JLG merger (closing 12/06) after trading at 20x for last several years due to a strong Defense spend backdrop. The crux of the investment thesis is a merger synergy story after an accretive acquisition JLG, that investors have been far too skeptical in penalizing OSK. We think the merger will be proven successful in higher accretion, diversifying revenue streams, and creating a stronger, more relevant company for investors. EPS accretion from 1) strong fundamentals at both companies core businesses 2) $75 merger synergies being achieved and exceeded 3) $300-400m of debt reduction creates further eps accretion
OSK and JLG’s end markets should remain strong for 2007 as the visibility of the backlog supports this. Of special note is the Defense portion of OSK. This business segment represents 60% of standalone ebit for OSK and 30% on a proforma basis commands a higher multiple. Management has indicated that the $8.6B procurement portion of the supplemental funding measure attached to the FY07 Defense Budget contains the highest relative funding level for OSK related programs in its history. While the $8.5B of the O&M supplemental budget could generate additional revenue for OSK as well. Recent timing issues on Defense spend have created some worry and we believe this will be short lived.
Investment Background:
OSK, a well regarded company and management team, has declined from $65 to $45 because of a surprise acquisition of JLG and perceived softer earnings in the most recent quarter. Investor skepticism has focused on acquiring JLG at this stage in the economic cycle. OSK has operated under both a conservative management team and balance sheet, successfully integrated 14 acquisitions over the last 14 years. OSK has traded at 20x eps over the last few years, yet the recent stock decline has brought this multiple down to 13x.
The concern and uncertainty has created a great investment opportunity to buy into a strong franchise and company with a decent merger synergy story as the stock has been displaced by recent events. The stock is pricing in low to no expectations from deal and a more uncertain business environment. OSK equity cap has been reduced $1.4B for a $3.2b acquisition.
Balance Sheet:
Oshkosh had an overly conservative balance sheet with zero net debt. Recently levered up for JLG acquisition to $3.2B of 7.7% debt. This debt will reduced with $300m annual fcf proceeds. Interest expense reduction of $246m to less than $200m by 2008 will add $.20 eps annually.
Company Overview:
OSK is a leading designer, manufacturer, and marketer of a broad range of specialty commercial, fire, and emergency and military vehicles. OSK manufactures trucks in 3 segments: Commercial – concrete mixers, waste trucks (33% revenues), Fire/Emergency – fires trucks, tow trucks, ambulances (27% revenues), and Defense – heavy and medium-duty tactical trucks (40% revenues). OSK controls most of its distribution network highlighting sales, service, and maintenance as a distinct competitive advantage.
JLG is the world leader in aerial work platforms and telehandlers. International remains a significant opportunity with the JLG acquisition. Currently represents 17% of Revenues. Service revenues are 15-17% of Revenues. The company has successfully integrated 14 acquisitions since 1996.
Valuation:
OSK was $65 with $3.00+ eps power this year, trading at 20x. JLG creates uncertainty and will reduce the multiple, as our price target assumes no multiple expansion (14x). OSK trades at 12x 2007 FCF and 9.6x 2008 FCF. OSK should trade at a premium to the following group.
2007 PE 2007 EV/Ebitda 2008 PE 2008 EV/Ebitda
OSK 13.4x 10.2x 10.4x 7.7x
CAT 11x 8.6x 9.5x
PCAR 15x 8.3x 13.5x
TEX 11.1x 8.3x 9.1x
IR 11.4x 8.5x 10.4x
Trend Fundamentals:
- OSK has beaten eps estimates all year. The street has gotten a little aggressive in forecasting eps and thus the amount OSK has beaten by has slowed this last qtr.
- JLG reported strong Q107 eps and guided higher for the year by .12 to 1.84-1.94
- JLG order book is up $100m sequentially from the July Qtr, the slowdown in residential construction is having little negative impact on their results
- Defense backlog and other business has high visibility for next few years The company reported a slight drop in Defense backlog in the Sept Quarter but it is estimated that this will pick up next quarter and show more improvement in the 2nd half of 2007. The $15-17b 2006 Supplemental Budget shows one of the best allocations for OSK in recent history. Total backlog was down 1.5% to $1.9B.
- 2007 DoD Supplemental budget should be higher than 2006
- Municipal spending remains strong
Catalysts/Story:
1) Merger synergy story – Market and shareholders were surprised about JLG acquisition at this point in the cycle. OSK management is very conservative and has a history of successfully integrating acquisitions. They have estimated $75m of synergies over 3 years. This equates to 2.5% of revenues and is below the historic 5% synergy number. Combined procurement power is $4b plus additional G&A overhead overlap savings. JLG G&A overhead spend alone is $77m annually. Continued weakness in steel prices could add to RM savings ($1B combined purchase of steel and fabrications). Our view is this is low, conservative, and will be front end loaded. Reminds me of CX- RMC, initial skepticism on deal allowed entry point in stock.
2) JLG merger makes OSK more diversified and a better company. OSK recently traded at 20x eps based on history of beating estimates and exposure to a strong defense market. JLG will diversify them. OSK did due diligence and was able to gain confidence in JLG order book. JLG recently beat quarter estimates and raised annual guidance. Accretion from this deal is most likely understated, JLG adds $1.00+ to eps power by FY 2008. OSK goes from EBIT concentration of 60% defense to 30% post deal.
3) The new company becomes a more relevant, larger company that the equity market will have to pay attention to. OSK standalone was $3.5b company with only 3 sellside analysts covering it. The new company will have an enterprise value of $7b and become a more important name with the capital equipment sector.
4) JLG has an alliance with CAT for Telehandlers that should accelerate with OSK. This should allow for meaningful market share gains in Europe (Recently rolled out in July). Cal 2007 $350m revenue is conservative target. CAT is excited by this alliance because neither OSK nor JLG threatens their core business of earth moving equipment. This alliance should allow OSK to gain more sales from CAT at the expense of TEX whose subsidiary Genie competes with JLG. Longer term potential exists to leverage JLG and OSK products through the CAT dealership network.
5) Deleverging potential. OSK balance sheet prior to the merger was debt free. OSK is debt financing this transaction by adding $3.2b 7.7% cost of debt. FCF will reduce debt and create eps accretion and upside for the equity. $300m of fcf will save $21m interest expense and add $.20 per share annually. Debt to ebitda will be reduced from 4.8x to 3x by FY 2008. Debt paydown story while wait for merger synergies to kick in. Management has dismissed the potential of doing an equity follow-on offering to paydown debt.
6) Recent concerns over a slowdown in Iraq and Defense spending should largely be viewed as a timing issue. Dec orders should pick up from Sept and additional improvement should be seen in the 2nd half of 2007. The 2006 Supplemental Budget of $15-17B shows the best allotment of orders for OSK in recent history.
Numbers:
|
Proforma OSK-JLG: |
|
|
OSK |
|
$ 48.50 |
|
|
|
|
|
Shares |
73.8 |
$ 3,579 |
|
Debt |
|
$ 3,300 |
|
Cash |
|
$ 22 |
|
Net Debt |
|
$ 3,278 |
|
Enterprise Value |
|
$ 6,857 |
|
|
|
|
|
|
|
|
|
(FY Sept) |
|
|
|
EPS: |
|
|
|
2005 |
$ 2.18 |
22.2x |
|
2006A |
$ 2.76 |
17.6x |
|
2007E |
$ 3.50 |
13.9x |
|
2008E |
$ 4.50 |
10.8x |
|
|
|
|
|
EBITDA: |
|
|
|
2005 |
$ 307 |
22.3x |
|
2006A |
$ 371 |
18.5x |
|
2007E |
$ 660 |
10.4x |
|
2008E |
$ 880 |
7.8x |
|
|
|
|
|
FCF: |
2007 |
2008 |
|
Net Income |
$ 258.3 |
$ 332.1 |
|
D&A |
$ 144.0 |
$ 150.0 |
|
WCAP |
$ - |
$ - |
|
Other |
$ - |
$ - |
|
Capex |
$ (115.0) |
$ (120.0) |
|
|
$ 287.3 |
$ 362.1 |
|
|
12.5x |
9.9x |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OSK Standalone: |
|
OSK Proforma: |
|
|
|
|
|
|
|
Revenues |
Ebit |
|
Revenues |
Ebit |
|
28% |
23% |
Fire/Emergency |
15% |
15% |
|
38% |
61% |
Defense |
30% |
30% |
|
34% |
16% |
Commercial |
15% |
15% |
|
|
|
Access Equip |
40% |
40% |
|
|
|
|
|
|
Risks:
Slowing economy
Merger integration issues
Defense budget and Supplemental budget slowing
Municipality spending
Weakening of end markets for cement, waste, commercial
Catalyst
1) Merger synergy story – Market and shareholders were surprised about JLG acquisition at this point in the cycle. OSK management is very conservative and has a history of successfully integrating acquisitions. They have estimated $75m of synergies over 3 years. This equates to 2.5% of revenues and is below the historic 5% synergy number. Combined procurement power is $4b plus additional G&A overhead overlap savings. JLG G&A overhead spend alone is $77m annually. Continued weakness in steel prices could add to RM savings ($1B combined purchase of steel and fabrications). Our view is this is low, conservative, and will be front end loaded. Reminds me of CX- RMC, initial skepticism on deal allowed entry point in stock.
2) JLG merger makes OSK more diversified and a better company. OSK recently traded at 20x eps based on history of beating estimates and exposure to a strong defense market. JLG will diversify them. OSK did due diligence and was able to gain confidence in JLG order book. JLG recently beat quarter estimates and raised annual guidance. Accretion from this deal is most likely understated, JLG adds $1.00+ to eps power by FY 2008. OSK goes from EBIT concentration of 60% defense to 30% post deal.
3) The new company becomes a more relevant, larger company that the equity market will have to pay attention to. OSK standalone was $3.5b company with only 3 sellside analysts covering it. The new company will have an enterprise value of $7b and become a more important name with the capital equipment sector.
4) JLG has an alliance with CAT for Telehandlers that should accelerate with OSK. This should allow for meaningful market share gains in Europe (Recently rolled out in July). Cal 2007 $350m revenue is conservative target. CAT is excited by this alliance because neither OSK nor JLG threatens their core business of earth moving equipment. This alliance should allow OSK to gain more sales from CAT at the expense of TEX whose subsidiary Genie competes with JLG. Longer term potential exists to leverage JLG and OSK products through the CAT dealership network.
5) Deleverging potential. OSK balance sheet prior to the merger was debt free. OSK is debt financing this transaction by adding $3.2b 7.7% cost of debt. FCF will reduce debt and create eps accretion and upside for the equity. $300m of fcf will save $21m interest expense and add $.20 per share annually. Debt to ebitda will be reduced from 4.8x to 3x by FY 2008. Debt paydown story while wait for merger synergies to kick in. Management has dismissed the potential of doing an equity follow-on offering to paydown debt.
6) Recent concerns over a slowdown in Iraq and Defense spending should largely be viewed as a timing issue. Dec orders should pick up from Sept and additional improvement should be seen in the 2nd half of 2007. The 2006 Supplemental Budget of $15-17B shows the best allotment of orders for OSK in recent history.