Description
Hi, guys --
I probably shouldn't be submitting this, since at the moment I'm rooting for lower prices ... but nobody listens to me anyway, so what the heck.
Rush Enterprises "which operates the largest network of heavy-duty and medium-duty truck dealerships in North America and a John Deere construction equipment dealership in Houston, Texas", is safe, cheap and potentially a multi-year multi-bagger. The stock is cheap because class 8 truck sales are going to be down in 2007 due to EPA regulations, and because there are some things about the business that aren't immediately obvious.
I've discussed the company a couple of times before:
http://www.valueinvestorsclub.com/value2/Members/index2.asp?select=symbol&textfield=rushb&Go.x=0&Go.y=0&Go=Go&UserName=
You'll notice that the stock has gone up a bit since then. I think it's entirely possible that we'll see similar gains in the future.
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Here's a little table of contents:
A: Is It Cheap?
B: What about '07?
C: ROE, Leverage, Safety, Cyclicality
D: Organic growth, MD & P&S
E: Pie in the Sky
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A: Is It Cheap?
1: The stock is cheap on a trailing basis.
After yesterday's earnings release, TTM EPS is 2.08, so Rush is trading at 8.5x earnings, which is cheap.
2: A lot cheaper after adjusting for excess cash.
The company is significantly over-capitalized. They've got about $5.60/share in cash. This isn't an exact science, but based on historical ratios, I think at least $5/share is excess. In Q2 '03, the bottom of the last cycle, they were able to operate (and, if memory serves, even make a small acquisition) with $4.7MM in working capital and a current ratio of 1.03. They now have $130MM working capital, and a current ratio of 1.26. In '03, PP&E/long term debt was 1.74 vs. 1.82 today, so they're less leveraged on a long term basis as well.
Let's ballpark the after-tax interest income from the excess cash at $0.15/share. On this basis, Rush is trading at 6.5x trailing earnings.
3: Yet still cheaper when you realize that the excess cash is obscuring the true value of the assets.
I'm too lazy to step through the calculations, but after accounting for excess cash & the associated interest, through the first 6 months of '06, Rush has an adjusted ROE of 32% and a staggering return on net tangible equity of over 100%. It turns out that, at the right time and in the right hands, Peterbilt dealerships can be surprisingly valuable. We'll get into why this is so later on.
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B: What about '07?
The EPA is mandating new, more expensive, harder to maintain and less efficient engines starting in 2007. This is going to crush heavy duty truck sales for a while. Estimates vary; most think shipments will be down 20%-40% from '06 levels. What's the impact on Rush?
I don't know how much Rush is going to make in '07 and neither does anyone else, it depends on how many trucks they sell. For what it's worth, current analyst consenus (per Yahoo!) is $1.69, but that's going to be going up. So right now the stock is trading at about 10x consensus trough earnings, and, oh, did I mention the $5/share in excess cash?
Here's a qualitative approach to getting comfortable with '07:
For the first 6 months of '06, the company's "absorption rate" was 105%. "Absorption rate" is this funky metric for how much of a dealership's costs are covered by the parts and service department. At 100%, a dealership would break even even if didn't sell a single truck. Since the absorption rate is greater than 100%, they've got negative leverage to truck sales at the dealership level. There's essentially no corporate debt, and they're sitting on tons of cash, so there's no financial leverage to truck sales. What you're left with is corporate overhead, which should more or less be covered by the other segments of the business -- leasing, construction equipment, etc. Worst case, if '07 truck sales are down 50%, I don't see how earnings go down more that 50% -- in other words, they should earn at least $1.10.
If they only make $1.10 in '07, the stock may well trade down. But even in this worst case, you're buying the stock at cash + 10x trough earnings, which I think is a great deal. Note that trough ROE would be around 14%.
Personally, I think they'll do a lot better than that. I expect current favorable trends in parts & services and medium duty sales to continue. I think '07 stands a good chance of coming in higher than '05, when they earned $1.80. Obviously this is all just making wild guesses and screwing around with spreadsheets, but my base case puts them at $1.85.
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C: ROE, Leverage, Safety, Cyclicality
How is 100% ROTE possible? Well, if you think about the sales side (leaving parts & service aside for the moment), you'll realize that very little "E" is required. If you can get floor plan financing for the trucks, all you need is:
- A couple of acres at the edge of town.
- Some cinderblocks to build an office.
- HVAC & plumbing.
- Some furniture.
- A 24 karat gold signing pen.
-- call it $100k. If you net $2k/truck and can sell a truck a week, you've got 100% ROE. Say things slow down and a you only sell two trucks a month. That's still 50% ROE, which isn't bad.
Truck dealerships are like a lot of other things that require little equity, enable tons of leverage and have slim margins: When times are good, you get great returns, which times are bad you do OK, when you get caught leaning the wrong way you get whacked. That's what happened to Rush and the industry as a whole back in 2000; demand suddenly vanished and everybody was stuck with excess inventory that they had to slash prices to move. Could this happen again?
It could, but the risks are greatly reduced because of the EPA. There will be another emissions mandate in 2010, so at least until 2011, it's better to think of the heavy duty truck industry as "seasonal" (albeit with long seasons) than "cyclical". It was clear a long time ago that '06 would be a great year, '07 would be down, '08 & '09 would have to average out to at least pretty good, and that '10 will be a down year. Basically, it's a lot easier to forecast demand if you've got the government pre-arranging your slowdowns for you.
It's kind of like running a leveraged bond fund and knowing ahead of time that the Fed is going to raise rates 100 bps in the first half of '07 and again in the first half of '10: it's still _possible_ to screw up, but a lot lot harder. I wish I'd realized this back in '02 & '03 when I was buying tons of Rush, because I would have bought more.
This seems as good a place as any to address the floor plan financing, which was $375MM at last count. These are interest bearings notes with a 12 month term that finance Rush's truck inventory. For analytical purposes, I classify these not as debt but as accounts recieveable, and include the interest on them in cost-of-goods.
D: Organic growth, MD & P&S
In addition to being safe and cheap, Rush has at least a couple of years of decent organic growth baked in. They've been making a big push into medium duty trucks for the last few years. On a unit basis, the medium duty market is about the same size as the class 8 market, but medium duty trucks cost about half as much. The company's goal is to more than double their medium duty presence over the next few years, which should lead to something like 20% revenue growth. That might not sound like much, but it's an exciting opportunity because it allows them to leverage their existing asset base.
The parts and service business has shown steady growth over the last few years. Here are per-share revenues and gross profits from P&S:
________'02_____'03_____'04______'05_____Q1'06____Q2'06
Revs_____15.11___17.84___20.37___14.64____16.78___17.99
GP_______6.17____7.03____7.71____6.03____6.81_____7.42
-- you can see the dilutive effect of the '05 ATS acquisition on parts & services. I expect that the combination of business development, additional P&S business from medium duty trucks and continued optimization of newly acquired buinesses should enable >10% in P&S for at least the next few years. MD & P&S also reduce the company's dependence on the volatile class 8 market.
E: Pie in the Sky
Rusty Rush is talking big:
"He says his commitment to the company's board of directors is to boost company sales to a minimum of $5 billion over the next five years."
http://www.bizjournals.com/sanantonio/stories/2006/05/01/story4.html
Hmm ... Rush had 4% margins this quarter. If they can get to $5B in revenue with those margins, they'd be making $8/share. Given $130MM in cash, worst-case trough ROE of 14% and peak ROE's above 30%, it's clear that the company is financially capable (assuming nothing changes) of more than doubling revenues over the next 5 years. In reality though, their growth will be limited by available acquisition opportunities and subject to Paccar's veto.
One thing is clear: The company's going to be making a lot of money over the next 5 years. If they can invest it at returns anywhere close to what they've achieved historically, the stock will do incredibly well. If they wind up with $15/share in cash and $3 EPS, I'd be disappointed but that would be OK too.
Catalyst
The world doesn't end in 2007.