2023-10-10 04:36:58 ET
Summary
- Commercial Vehicle Group's stock is down due to general economic fears and the market's distaste for small- to micro-cap stocks.
- However, recent news and data don't support the conclusion that CVG's fundamentals have deteriorated. This mismatch between expectations and reality makes the stock a buy before Q3 earnings.
- Based on my 2024 EPS estimate of $1.33 and a 10-12x multiple, I think the stock has 70-110% upside potential over the next 12-18 months.
- In this report, I'll discuss Q2 earnings, recent company and industry news, and the thought process behind my price target.
It’s been a few months since I initiated coverage on Commercial Vehicle Group, Inc. ( CVGI ) with a buy rating and a $20 price target. Since then, the stock has fallen 26% despite reporting Q2 2023 earnings that surpassed expectations, announcing the opening of its electrical manufacturing facility in Morocco, and despite recent positive industry news regarding class 8 heavy-duty truck orders and production. I think the primary reasons the stock has fallen so much are general fears of economic weakness which would hurt class 8 truck production, and the market’s current distaste for small-cap and micro-cap stocks.
In my previous report, I made a model that laid out the case that the stock is worth $20 if the company hits management’s 2027 guidance of $1.5 billion in revenue with a 9% EBITDA margin. This model still holds up and I think there is 200-300% long-term upside for the stock, but over the next 12-18 months I think the stock has 70-110% upside based on my estimate of 2024 EPS.
There are risks involving economic weakness, however, these risks have not unfolded over the past quarter. Unless economic data over the next month is very poor, I think the stock will rally after Q3 results are released in November. In this report, I’ll provide an update on Q2 earnings, an update on company-specific and industry news since my last report, and my thought process regarding my 12-month price target.
Q2 Earnings Update
Commercial Vehicle Group reported strong results in Q2, which surpassed both revenue and earnings expectations. The stock popped 40% after these results were released as consolidated revenue was up only 4.5% year over year but operating income rose 156%. While the increase in operating income contributed to the 40% rise in the stock, most excitingly the business transformation story continued well as new business wins year-to-date totaled $124 million. This puts them on pace to achieve their goal of $180 million in new business wins in 2023. 80% of the business wins year-to-date were in the higher growth, higher margin electrical systems segment which will make up the majority of the long-term value of the business.
CVG New Business Win Update (Q2 2023 Investor Presentation)
On a segment level, revenue in the Vehicles Solutions segment rose 7% primarily due to increased pricing, and gross profit rose 134% due to the increase in revenue, cost reduction initiatives, and lower costs of goods sold due to a decrease in raw material costs.
In the Electrical Systems segment, revenue rose 34% year-over-year due to both price increases and volume increases and gross profit rose 42.8% primarily from the increase in revenue.
Revenue in the Aftermarket Accessories segment rose 14.5% year over year and gross profit rose 171.6% primarily due to price increases.
In the Industrial Automation segment sales fell 68.4% due to decreased demand from a large customer, presumably Amazon.com, Inc. ( AMZN ) given Commercial Vehicle Group’s ties to Amazon fulfillment, as they continue to control costs along with other mega-cap tech companies. The operating loss for this segment was $2 million, however, $1.2 million of that loss was attributable to a one-time, non-cash inventory write-off. From the Q2 earnings call , the segment has cut away many fixed costs and is operating at breakeven despite the loss in revenue.
LinkedIn Post on CVG and Amazon Ties (CVG LinkedIn)
In general, Q2 earnings revealed that the company’s story is continuing as planned. While it is slightly concerning that a large portion of the increase in earnings was due to price increases, the continued volume growth and the continued business wins for the electrical systems segment are very encouraging.
The stock rose so much on these earnings both because they surpassed expectations and because management’s commentary didn’t mention that there was any slowdown in class 8 truck production. However, the stock has since fallen to about where it was before these earnings were announced as the recession narrative and lack of excitement for small-caps has led to there being a dearth of buyers for stocks like Commercial Vehicle Group.
Recent Company and Industry News
All company news since Q2 earnings doesn't show any indication that the business has slowed. The company announced that its new electrical manufacturing facility in Morocco has opened . This facility will allow the company to keep up with growth in electrical wire harness demand and will lead to more business wins as long as demand holds up. While demand holding up is largely dependent on economic conditions, it is less sensitive to changes in GDP than is the vehicles solutions segment as electrical systems demand is being bolstered by investments in sustainable energy solutions and infrastructure spending.
The company also announced that a member of its board of directors, Roger Fix, is retiring and not standing for re-election at the next annual meeting. Melanie Cook , who had previous roles at GE involving cooking products and industrial communications, is replacing Roger Fix as a member of the board. Cook’s experience with electrical appliances and utilities could be applicable to the electrical systems segment and could help drum up new use cases for Commercial Vehicle Group’s electrical technology.
There has not been an update on the CEO search, however, I would expect some sort of update upon the release of Q3 earnings.
The electrical systems segment is the more important segment going forward, but the vehicle solutions segment still generates the majority of the company’s earnings. If class 8 heavy-duty truck production declines greatly due to economic weakness, then Commercial Vehicle Group’s earnings will decline. As long as orders remain strong and cancellations remain low, truck production and Commercial Vehicle Group’s earnings will be high.
Class 8 truck orders were recently released for September, which marks the start of order season. Orders were up 68% month-over-month which is largely due to seasonality as orders are usually low in August before order season begins, but it indicates that the season is starting on the right foot. This is very important for class 8 truck production in 2024 as the majority of the truck backlog was set to be built in 2023 so if orders were weak, the backlog would not be replaced and 2024 production would be low. The order number is low relative to September 2022, but 2022 was a record year for truck production. For the purposes of earnings for a company like Commercial Vehicle Group, orders don’t need to reach levels from 2022.
North America Class 8 Truck Orders (ACT Research)
Eric Starks, executive chairman of FTR, a freight research firm, commented that the recent September order numbers are positive and said that “despite the weakness in the overall freight market, fleets continue to be willing to order new equipment. We did not anticipate matching the level of orders that we saw this time last year, but increasing orders confirm our expectations of replacement demand in 2024”.
At a higher level, economic data seem to indicate that the economy will continue to be strong through the rest of the year. Non-farm payrolls in September 2023 beat expectations handily which resulted in the unemployment rate remaining unchanged at 3.8%. These types of data points along with others are reflected in the Atlanta Fed’s GDPNow real GDP growth estimate for Q3 which remains quite high at 4.9%. Demand for goods will be bolstered over the next 12-18 months if the unemployment rate remains low and as some spending shifts away from services and back to goods.
Atlanta Fed GDPNow Real GDP Growth Estimate (Atlanta Fed)
Price Target and Valuation
In my previous report, I made a model to demonstrate that Commercial Vehicle Group’s intrinsic value is about $20 if the company achieves management’s 2027 revenue and EBITDA guidance. This model still holds true; however, it makes some aggressive growth assumptions about 2023 and 2024. Growth from 2025-2027 should be higher than that of 2023-2024 as revenue from the electrical systems segments becomes a larger part of total revenue in later years.
An estimate of 2024 EPS shows that the stock has a significant upside as the company reports earnings for the next few quarters given the negative expectations that are baked into the stock and given the generally positive economic data that has come out since Q2.
I expect revenue to grow 3% for the full year 2023, and 4% in 2024. In 2024 I assume: Commercial Vehicle Group’s operating margin is 5.5%, the company pays an interest expense equal to 1% of revenue or $10.5 million, has a tax rate of 25%, and has 32.65 million fully diluted shares outstanding. These assumptions lead to a 2024 EPS estimate of $1.33. The stock is currently trading a bit under 6x that estimate.
I think a reasonable forward earnings multiple for Commercial Vehicle Group is 10-12x based on its past valuation, its peer group, and the emergence of the high growth/high ROIC electrical systems segment. Using this multiple range would put the stock between $13 and $16 providing 70-110% upside.
I am especially bullish for Q3 earnings because there is no indication that the business has slowed despite the stock dropping like it has. In fact, I only see indications that business strength has continued given the recent class 8 truck order news from ACT Research, the recent positive economic data, and given open market purchases from the CFO in late September. His purchase totaled $31 thousand which isn’t huge, but I don’t think he would have done this if there was any indication that the business had slowed, at least up to that point.
Even if earnings surpass expectations, the market will react based largely on guidance. Management typically doesn’t give specific earnings guidance but reiterates what ACT Research forecasts for truck production. All of the latest news and forecasts from ACT so far this year have been largely positive and I expect management's commentary to support this positivity. All of these positive data points along with the negative sentiment from the market that is pricing the stock at under 6x 2024 EPS, should lead to upside upon release of Q3 2023 earnings.
Risks
The main risk is economic weakness which I discussed above and in my previous report. Historically Commercial Vehicle Group has been very cyclical and has performed in lockstep with GDP and class 8 heavy-duty truck production. Even though the less cyclical electrical systems segment is becoming a larger part of the business, the majority of the company’s earnings still come from the vehicle solutions segment. The economy has remained strong despite the pervasive recession narrative this year but if that changes, Commercial Vehicle Group’s earnings will drop.
Another risk that has recently come up involves union workers at Mack Trucks that have recently gone on strike after voting down a contract agreement that negotiators had with the company. If this strike is prolonged, it will have a negative effect on class 8 truck production and thus a negative effect on Commercial Vehicle Group’s earnings.
Finally, Commercial Vehicle Group is in the Russell 2000 index and is a micro-cap stock. In the short term, if the funds that track the small-cap index continue to see outflows, the stock will be indiscriminately sold by portfolio managers even if fundamentals improve. Longer-term this is less of a concern, but investors should be aware of this when considering the stock over the next few quarters.
Final Thoughts
The current opportunity in Commercial Vehicle Group’s stock exists because of general recession fears and because of weakness in small to micro-cap stocks even as recent news and economic data would suggest that the company’s fundamentals are not deteriorating. Based on the model in my previous report, I believe that the stock’s intrinsic value could be about $20 per share if the company hits management’s 2027 revenue and margin guidance.
However, over the next 12-18 months, I think the stock could trade between $13 and $16 based on my 2024 EPS estimate of $1.33 and a 10-12x multiple. I think that Q3 earnings will show that the business is still performing as expected, which should cause the stock to rise closer to my target range as the fears that have taken the stock down are assuaged.
For further details see:
Commercial Vehicle: A Buy Before Q3 Earnings