Description

I'm resubmitting this idea since you guys _didn't listen to me last
time_. The original write-up is at:

http://www.valueinvestorsclub.com/Members/view-thread.asp?id=676&more=dtrue

You'll note that it consists mostly of negatives and vague hopes for the future; maybe that explains the lukewarm reception.

What's changed since then? A few things:

1: The timing of the turnaround in truck sales has become clearer.
2: The company has divested its unprofitable non-core businesses.
3: Rush has expanded its truck dealerships by about 10%.
4: Paccar is being forced to sell its holdings in the company.

1: Timing

Soon. Barring general economic collapse, truck sales have to turn around pretty soon, because -- Hey! -- Trucks wear out.

Let's use broad generalizations and round numbers to get a sense of where the industry is at before considering what it means to Rush. There are 2MM class 8 trucks out there. They last about 10 years. This suggests that equilibrium demand for new trucks is 200k/year -- way more than the 140k delivered the last couple of years. (For what it's worth, I've seen estimates of steady-state demand as high as 230k.)

But are we in equilibrium? Demand for trucking services is a function of GNP (not GDP, because imports have to be moved too). Demand for trucks (new or used) depends on the utilization and age of the trucking fleet. We all understand why utilization is important. Fleet age is important, too, because the reliability required of over-the-road (as opposed to vocational) trucks forces the owners into 3-5 year trade cycles.

I'm no better at forecasting GNP than anyone else, but there is evidence that the weak truck sales of the last few years have brought us close to equilibrium. Trailing 3 quarter class 8 fleet utilization has averaged 88%; 92% is regarded as peak utilization, so the trucking fleet is about the right size. Fleet age is at it's highest levels in a decade, since the end of the early 90's recession. The bumper class of '99 is now four years old; the truckographics of the the over-the-road trade-in cycle dictates that they be replaced over the next couple of years. In addition, higher used truck prices confirm that the backlog of older trucks has been absorbed.

And if the heavy-duty truck market isn't in equilibrium, it's getting there real fast. Q1 was atrocious; only 25k trucks were shipped. Annualized, that's 100k/year. For context, class 8 sales averaged 134k in the 70's. Unless we're permanently returning to 1960's levels of economic activity, sales have to go up pretty soon.

Personally, I think we've hit the bottom. Any further weakness just
adds to pent-up demand that will have to be satisfied sooner or later.


2: Ditching the losers.

Rush has discontinued the Farm & Ranch retailing business and the Michigan John Deere franchise. Withdrawing from distracting money-losing segments is obviously a good thing, but it also serves to highlight the strength of the core business. In Q1, Rush posted $.06 from continuing operations despite the terrible industry environment. If you make some minor adjustments (e.g., the business is mildly seasonal with the second half of the year being stronger, they have excess cash that they could use to reduce debt, etc.) it's easy to see them making $.30/year even if things never get any better.


Let me harp on that a bit. Business has been bad for the last 3 years. Q1 was just terrible -- the worst since who knows when. But the company isn't entirely dependent on truck sales. They're profitable even in trough periods thanks to their annuity-like parts and service business, which has doubled revenues over the last 5 years. New and used truck sales will be all over the board depending on economic conditions, but you still have to keep 'em running. Once we clear away the failed diversification efforts, we can see that Rush is trading at about 13x what it could make in a state of permanent recession. If the economy is able to at least stagnate, they can do better.

To get an idea of how much better, we can look at Q3 2002, when the industry benefitted from customers buying ahead of the EPA emissions regulations. 42k trucks were sold -- less than my estimate of replacement demand. Rush posted EPS of $.20/share. I estimate that the discontinued operations lost $.03-$.04. So Rush should be pulling down something like $1 share even in so-so years.

3: Continued expansion

Rush's recent acquistions in Mobile and Central Florida are significant because they give the company a foothold East of the Missippi and demonstrate its ability to continue its growth strategy even in a downturn. Rush now has a national presence from one coast to the other, and their footprint is 50% bigger than it was at the last peak.

Speaking of peaks -- maybe it'd be fun to speculate on how much they're likely to make at the next. The last one was in 1999, when Rush made $1.17/share. But they also underwent a major expansion that was backloaded to the end of the year, increasing SG&A while getting minimal contributions from the new centers. On the other hand, 1999 was an all-time high for truck sales. How likely are we to see those kind of numbers again?

The source of volatility in new truck sales is the large existing fleet. Let's stick with our simple 2MM-trucks/10-year-life/200k-steady-state model. Let's say we're in equilibrium, building 200k trucks a year. What happens if the fleet expands by 1%? If we start with 2MM trucks, 200k of which wear out, and we want to end up with 2.02MM trucks, we obviously need to build 220k, or a 10% increase in builds for a 1% increase in fleet size. So new builds are very sensitive to changes in the rate of change of the fleet size. (Derivatives, anyone?)

1999 was unusual for a lot of reasons, including irrational pricing from some major vendors, a driver shortage that led to fleets using new trucks as a retention tool, the belief that we were in a New Era, and so forth. But the economy has a grown a bit since then, and will presumably continue to grow a bit. Things don't have to get as far out of whack for us to get close to '99 build rates over the next few years.

I indicated above that I think Rush can get close to last-peak earnings even with below-trend truck sales. I even think they're likely to hit last-peak earnings with _equilibrium_ truck sales. And if we see some economic expansion, they'll do better than that. But an even more important source of upside is the finance & insurance part of the business. In '99, F&I was 1.7% of revenues; in 2002, it was a measly 0.07%. This might not sound material, but F&I is really high margin -- shucks, you've already sold the guy the truck, now all you have to do is get him to sign a couple of papers. Given Rush's low margins -- net from continuing ops was 1.15% in 2002 -- if the F&I business ever came back, it would mean beaucoup bucks.

I'm too much of a sissy to go on record with a prediction of Rush's peak earnings, but if the planets line up right, it could pretty impressive. In any event, I think they stand a darned good chance of earning their market cap back by the end of 2006.

4: Forced liquidation by major stockholder creates opportunity

A quick look at other industry participants --

http://finance.yahoo.com/qd=c&c=pcar+cum+cat+nav&k=c1&t=6m&s=rushb&a=v&p=s&l=on&z=m&q=l

-- shows prices rallying in anticipation of the turn in truck sales. Then why is Rush so cheap? Because Texas law prohibits manufacturers from having a stake in their distributors. Paccar owned 14% of Rush. Now they're being forced to sell.

Paccar has been dribbling the shares out over the last few months. As a 10% owner, they are prohibited from selling more than 1% of Rush per quarter. They don't seem interested in arranging any block trades -- and at these prices, who can blame them? I've tried to discuss their plans, but they're keeping their cards close to the vest. They've allowed as to how they're doing what they're doing because that's the way they want to do it, and they'll keep right on doing it until they do something else, so the timing and volume of their disposition is opaque. But you don't have
to be a stock market genius to understand that buying in a forced sale can lead to outsized gains. At the limit, they could either keep on selling 10,000 shares a week for years, or suddenly dump it all at once. Either way is fine by me.

----

Negatives:

Rush has some debt, so I'm not sure that they'd make it through a re-
run of the Great Depression. A lot of their debt is floating-rate;
stagflation would be bad, too.

The stock is illiquid, but it's possible to put together a meaningful
position -- Rutabaga Capital Management, for instance, has become a
10% holder over the last year. Hey, any Rutabaga guys out there?

I'm still not crazy about executive compensation, which includes some
healthy option grants. Management did make some mistakes at the turn
of the century. But both of these things are true of most companies.

---

To sum up: We've got a pretty good business that's about to enter a
cyclical upswing whose price is being depressed by forced sales from
a major shareholder.

Catalyst

Cyclical turn will dramatically increase earnings.