2023-06-29 12:24:45 ET
Summary
- Wabash National's record profits and sales have not gone unnoticed - the stock is up by almost 80% in a year.
- However, the stock also looks significantly undervalued, both relative to the sector and intrinsically.
- The valuation will hinge on the company executing on its new parts and services strategy and maintaining double-digit operating margins.
Investment Thesis
The record level growth in revenue and profits Wabash National Corporation (WNC) has delivered in the recent quarter and trailing twelve months has not gone unnoticed, given the stock is up almost 80% in the past year. However, it remains significantly undervalued both relative to the sector and intrinsically. The intrinsic valuation hinges on the company executing on its strategy to penetrate the parts and services market, while continuing to gain market share on the production end, in order to maintain double-digit operating margins. I assess the company is well-positioned and equipped to accomplish these objectives, hence give it a buy rating.
An Undervalued Growth Machine
Wabash is the leader of the $16.6 billion U.S. truck trailer manufacturing industry, with about 15% of market share, according to an IBISWorld research report . WNC is also one of the top-rated stocks in the construction machinery and heavy transportation equipment industry, according to Seeking Alpha's quant scores, coming in at number 6, with solid grades in all key categories, especially momentum.
WNC Quant Grades (Seeking Alpha)
The company delivered record sales of $2.5 billion in 2022, growing 31% over the prior year, and grew market share by 2 percent. It continued the growth trend in Q1 of 2023, with an all-time high in operating profit of almost $70 million and EPS of $1.04/share. For the trailing twelve months, sales is up 31%, EBITDA 120%, EBIT 210%, and EPS nearly 1,480%.
WNC Growth Grade (Seeking Alpha)
And the forecast is calling for even more growth. According to its Q1 filing, the company is looking to grow the top line by another 15% in 2023 to $2.9 billion and has raised its EPS guidance to $4.25/share - or 90% higher from last year's EPS of $2.25/share.
This growth has not gone unnoticed, evidenced by the stock price being up nearly 80% in the past year. And, yet, it still looks undervalued based on every key valuation metric relative to the industrial sector. The stock is trading at a mere 6x forward earnings, 5x cash flow, and has an EV/EBITDA ratio of around 4. That's 66%, 63%, and 56%, respectively, below the sector medians.
Evolving Business Model
Wabash's record growth in sales and profits is the culmination of a 4-year effort to transform the business. No longer just a trailer manufacturer, the company is turning into an end-to-end provider that offers everything from aftermarket parts and services to logistics technology solutions. (For a deeper dive into the company's specific offerings and innovations see Fade The Market's analysis here ).
The company, which rebranded itself to simply "Wabash" last year, is focused on providing value-added solutions, helping customers "solve unique transportation problems," and helping them reduce operating costs, according to its Q1 filing. Wabash also will look to utilize its "extensive dealer network" to market and sell products. Moreover, last year the company unified and expanded its parts and distribution capabilities by establishing Wabash Parts LLC. The company credited the entity as the primary driver of gross profit margin growth in Q1.
In addition to upping production capacity, Wabash sees growing and expanding the parts and services segment as "a key strategic initiative" for the company moving forward, as President & CEO Brent Yeagy made clear during the Q1 earnings call .
We have re-imagined our production capacity and are also acting to increase our recurring revenue exposure by achieving our rightful share in parts and services having already laid the groundwork through our parts and distribution joint venture.
When you take a closer look at the operating profit margins, it becomes clear why parts and services has become a major focus for Wabash.
After taking other expenses into consideration, this netted out to a company-wide EBIT of over 11%. The company's annual EBIT target for 2023 is 10.5%, which, if reached, would mark the highest annual level achieved since 2016.
It is worth noting, however, that the average quarterly EBIT margin over the past ten years has been 5.6% (as shown in the chart above). Penetrating the parts and services market will be pivotal to preventing a regression. The ability to maintain EBIT in double digits - for at least the next five years - will be decisive for the valuation, as we shall see.
Intrinsic Valuation
For the intrinsic valuation we will ask not what the top line and margins will be in Q2 or year-end or even 2024. Well, we will ask that too. But more importantly, we want to know what the average sales and EBIT margin will be over the course of the next ten years.
Let's start with the top line. The new trailer market in terms of units produced is expected to grow by only 2% by 2028 - from 306,000 trailers manufactured per year to 312,000, according to Wabash in its Q1 filing , citing ACT research.
U.S. Trailer Production Forecast (WNC Q123 Report citing ACT Research)
I take seriously the company's commitment to penetrating the parts and services market - which, first of all, means repeatable and consistent business that is divorced from production trends. In fact, when new production slows, customers require more parts and services. And with its rebranding and focus on improved service, the company could perhaps grab more market share on the production end as well.
The table below summarizes the assumptions behind the key inputs into the DFC model. They show the average annual rates or margins used in two phases: years 1-5 and years 6-10.
WNC DCF Model Assumptions (MH Analytics)
Sales Growth - The top line growth rate through year 6 will be based on the industry projection although the model assumes Wabash will continue to grow market share by 1-2% annually, which will offset some of the projected weakening in demand. Over the 10-year period, we end up with a CAGR in sales of around 5%.
EBIT Margins - We maintain EBIT at 10.5% in years 1-5, then gradually lower them toward the historical average. The margins used in the last five years will be: 9.5%, 8.5%, 7.5%, 6.5%, and 6%.
Capex/Sales - We build off Wabash's forecasted capex of around 3.5% of sales for years 1-5 before lowering to the company's historical average.
Tax Rate - We use the 21% federal statutory tax rate plus the Indiana state tax rate of 4.9% to get to 25.9%
Discount Rate - Finally, the discount rate is based on the 30-year average annual return of the S&P 500, including dividends, rounded up to 10 percent.
The DCF model projects that the fair price of WNC is $36/share, implying that the stock price is undervalued by 31% (based on the closing stock price on 6/28/23).
Risks
Risks include a slightly disproportionate amount of debt, with a D/E ratio of 98.2%, although the interest coverage ratio of 10 is above the industry average and the interest expense in the trailing twelve months is under 1% of sales.
The other risk is failure to execute on the strategy to penetrate the parts and services market, which will adversely impact EBIT margins, which are decisive to the valuation. The 10-year average used in the current valuation ends up being just over 9%. If the company EBIT only averages 6% in the next ten years, for example, then the stock would be fairly priced.
Other risk factors the company itself has identified include a dramatic downturn in transportation sector activity, supply chain disruptions, and spikes in raw material costs. These developments could prevent the company from meeting its strategic, operational, and financial objectives, which would in turn undermine the stock's value.
Conclusion
Wabash is one of the fastest growing companies in the heavy equipment manufacturing industry, a trend that will likely continue due to its evolving business model and strategic plan to penetrate the parts and services market. It is also well positioned to continue gaining market share in a very fragmented industry.
Despite skyrocketing by about 80% in the past year, the stock price remains significantly undervalued - both intrinsically and relative to the industrial sector. The intrinsic valuation hinges, however, on the company's ability to continue exploiting the higher-margins in the aftermarket in order to maintain double-digit EBIT margins. In the end, based on the assumption Wabash will execute on its strategy, I find the stock undervalued by about 30%. Hence, I give it a buy rating.
For further details see:
Wabash National: Geared For Even More Growth