Spartan Motors SPAR
January 12, 2003 - 5:16pm EST by
2003 2004
Price: 11.50 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 145 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Spartan Motors manufactures custom heavy duty chassis for Recreational Vehicles (RVs) and Emergency Vehicles (EVs) such as ambulances and fire trucks. They also sell fully completed EVs. Operational improvements and the disposition of a money losing subsidiary have resulted in Spartan becoming a cash machine. It has a 25% ROE, no debt, and FCF exceeding Net Earnings (all numbers exclude discontinued operations). Furthermore, sales and earnings will likely increase nicely in 2003. It has a PE of 12 and will implement a regular dividend in 2003, substituting for the special dividends Spartan has periodically distributed. Liquidity is decent with 50,000 shares traded daily. Spartan is a story of a company showing nicely improving results during difficult times as a result of executing well.

In 1997, Spartan bought two Fire Apparatus companies, Luverne Fire Apparatus and Quality Manufacturing, and acquired a large interest in Carpenter Industries, a manufacturer of school bus bodies. Only the Luverne acquisition was reasonably successful. The Carpenter acquisition was a disaster. In September 2000 Spartan began the liquidation of Carpenter (completed in Q4 2001) and it is not included in the financial results of this report. Once this decision was made, management was able to spend more time on its other groups and the increased attention has paid off. In November 2002, Spartan announced the consolidation of Luverne and Quality into a new company doing business as Crimson Fire under the leadership of the Luverne President, Jeff Laut. In his four years at Luverne, Laut (who is a volunteer fireman) has taken it from losing money to a ROIC exceeding 20%. Improved manufacturing methodologies played an important part of this turnaround and the plan is to institute these practices at the former Quality, which is still very labor intensive. Spartan has committed to Crimson Fire being at an ROIC of 20% by 2005. Spartan also owns Road Rescue which designs and manufactures advanced care ambulances, especially medium-duty type vehicles.

Management believes that its major weakness is in marketing and distribution. One of the rationales for the consolidation of the fire apparatus divisions is to improve their distribution. Previously, Spartan has met resistance when trying to sign up new distributors who were reluctant to sign up for Luverne (for example), knowing that Quality would be competing against them. The 2003 marketing budget will be increased by 25-30%. The custom chassis market for RV and EV is fragmented. Spartan is one of the larger independent manufacturers. It estimates that it has about 5% share of its markets.

RV industry unit shipments are typically leading indicators of the US economy. The RV industry accounts for about 75% of Spartan's sales. Especially encouraging is the dramatic improvement in Spartan's 2001-2002 Earnings (poor-mediocre years for the RV industry) compared to results in 1999 (a record year for the RV industry). Compare also Spartan's 2002 results to the results in 2000 when revenues were about the same. Execution makes a difference.

RV Industry Unit Shipments (Source: RVIA)
Full Year 2003E 2002E 2001 2000 1999
Shipments (000) 323 307.4 256.8 300.1 321.2

(in Millions; continuing operations)
Full Year 2003E 2002E 2001 2000 1999
Sales $ 295 257 226.3 251.4 284.6
Net Earnings 14.0 12.0 6.0 4.9 6.9
Free Cash Flow 14.0 13.0 19.5 11.7 10.9
EPS 1.08 0.96 0.57 0.43 0.55

Spartan's guidance for 2003 is for Revenues of $290-$300 Million with Gross Margin % of 17.5% (slightly lower than 2002 due to expected mix changes and increased price competition), 10% Operating Expense, 38% Tax Rate, and $12.9 million diluted shares. Capital Expenditures in 2003 will be a more normal $2.2-$2.6 Million (slightly higher than depreciation), down from 2002 CapEx close to $5 Million, which funded a new factory for Road Rescue. At year-end 2000, Spartan's Long Term Debt was $24.5 Million. That was paid off by the middle of 2002. Spartan is projecting a year-end 2003 cash balance of $20 million, assuming it doesn't increase R&D even further or institute a stock buyback. Management has mentioned that both are possibilities.

Spartan's exposure to its major customers (Newmar and Fleetwood in 2001 and 2000) has been declining. Sales to major customers were 26.7%, 37.3% and 43.7% of total revenues in 2001, 2000 and 1999, respectively.

Through 2001, most employee stock options had a strike price below 10. Due to the rapid rise in Spartan's share price over the past couple of years, (up from $1.50 two years ago), there was a big rise in the fully diluted stock count. Most of the existing options are now already in the money. There might be another 5% increase in fully diluted share count over the next year.

Management is disappointed with the PE at which Spartan is being valued. Senior management is spending a lot of their time in Nov 2002 - Feb 2003 doing road shows with the financial community.

Management compensation has been stingy in terms of base, bonuses, and options. The CEO is the son of one of the founders. Insiders own about 15% of the stock, which is enough to keep them focused but not enough to prevent effective oversight. Management is focused on three metrics: Productivity, Cash Flow, and Working Capital. They attribute their recent improved performance to operational improvements, particularly reduced waste and improved inventory management. To help keep them focused, Spartan in 2001 implemented a bonus system similar to Stern-Stewart's EVA model where bonuses are based on Net Operating Profit minus a capital charge. Generally, 25% of the bonus is "banked", reducing the emphasis on short term results.

I believe that positive surprises are more likely than negative ones. The most likely risk is a sustained rise in gasoline prices as a result of setbacks in Iraq or attacks on international oil supplies. This would cause a slump in RV sales. Spartan's 2003 estimates assume a moderate increase in RV shipments, but not the boom year the RVIA is predicting. Spartan is assuming a 2% annual growth rate in their Fire Apparatus market. While money is tight at the local government level, money for Emergency Vehicles is likely to be less constrained than for other purposes. As of last October, Spartan's Fire Truck Apparatus production schedule for Q1 2003 was the highest in Spartan's history. If the Homeland Security Act funding for Emergency Vehicles is ever released that will likely flow into production several due to normal governmental and manufacturing lead times. Based on my experience in manufacturing, I would guess that there is a lot of low-hanging fruit at Crimson Fire that Laut can rapidly pick, generating additional cash flow. In addition, Spartan has been a leader in developing a mid-engine chassis design that allows an RV to store ATV's, canoes, and even a small car while still allowing the RV to tow another car behind it. If consumer reaction is positive, this could be an additional upside surprise.

Assuming that none of the above surprises happen, and considering the high ROE and FCF, I am comfortable betting my money on a share price of 18 within 2 years. This is generated by using a PE of 15 on Net Earnings two years from now of $1.20. At the current levels, there's fairly low risk unless something catastrophic happens geopolitically, and the chances of a good surprise is non-trivial.


a) Smart use of Free Cash Flow (perhaps to buy back stock)
b) Consolidation of subsidiaries into Crimson Fire generates improved results
c) RV market achieves the levels that the RVIA is forecasting
d) Congress approves Homeland Security Act, jumpstarting Emergency Vehicle Sales
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