The first thing to note is the decline in SPAR’s revenues from the 2007/08 period to 2009-current. It appears at first glance that the company’s revenues declined by approximately 1/2. This is in fact exactly what happened. But recognize that the 2007/08 period was an anomaly, resulting largely from a defense contract that occurred in those years (in which the company provided the chassis for Mine Resistant Ambush Protected, or MRAP, vehicles. Note the impressive show of manliness in the Wikipedia entry here). If not for this contract, revenues would have been roughly flat throughout the period.
But wait, there is something interesting here. Roughly flat is an interesting thing for the core revenues of a company that provides heavy duty machinery like SPAR. Consider one of its core product markets: fire trucks. Fire trucks are sold to municipalities, and althougha municipalities haven’t suffered the collapse predicted by Meredith Whitney, many (most?) have suffered (and still are) from a perfect storm of falling housing prices (and thus decreasing property tax revenues), increasing labour costs (thanks to sweetheart deals negotiated in good times by public unions), and declining support from the state and federal governments (which are suffering from their own budgetary demons). One would expect that the sale of new fire trucks (and chassis to other fire truck manufacturers) would be hit as these capital expenditures are pushed off into the future.
One would expect this, but one would be wrong. This didn’t happen. In 2009, fire truck sales increased 22.7% from the prior year, and then 2010 saw an increase of 14.7%.
In fact, it appears to me that the company’s core revenues (which I define here as revenues less the MRAP revenues) have performed quite well despite extremely challenging economic headwinds. Here’s another fact: motor homes, perhaps the definitive discretionary product, provided a boost to the company in 2010 with sales increasing 150% from 2009.
I should note also that, while I ignore MRAP revenues as unique, these vehicles can be expected to provide ongoing parts and assemblies revenues as they age.
So while the company’s core revenues do not appear to be nearly as cyclical as expected, the company does another interesting thing that we usually hope for with cyclical companies (but often do not see): it has almost no debt. As at the recent 10-Q, the company had just over $5 million in debt versus cash and equivalents of $30.5 million. This is great.
Let’s return for a moment to the company’s sales of fire trucks. As discussed above, these sales have confounded our expectations by increasing despite the economy. But the interesting thing is, revenues could (and should) be much higher in years to come. As the company noted in its 2010 Q4 conference call (emphasis added):
Another data point is the existing national fleet of fire trucks is also aging. Approximately 54% of the fire trucks in service today are more than 15 years old. And to give you a point of perspective, that means they don’t have antilock brakes. Imagine driving a 30,000 to 40,000 to 50,000-pound vehicle on rain, snow, little bit of ice and you don’t have antilock brakes, a pretty precarious situation. And last, remember that fire departments are often the first responders to any serious event. Again, on also a positive note, in talking with the market groups bid activity is up in Q1 versus Q4 of last year. And while those are not orders, that’s also a big step in the right direction.Though this doesn’t give me a warm fuzzy feeling about firetrucks on the road, it does give me confidence in the existence of untapped potential for this market.
Putting aside the company’s sales to the various levels of government, let’s look now at its sales to private industry. With the acquisition of Utilimaster in 2009, the company took a big step into the private sector, acquiring considerable expertise in the service and delivery vehicle market, including walk-in vans and hi-cube vans:
Utilimaster, which was established in 1973, designs, develops, and manufactures products to customer specifications for use in the package delivery, one-way truck rental, bakery/snack delivery, utility, and linen/uniform rental businesses. Utilimaster serves a diverse customer base and also sells aftermarket parts and assemblies. The majority of its revenues are in the service and delivery market, which includes walk-in vans for the package delivery, bakery/snack delivery and linen/uniform rental markets. Its remaining revenues are attributable to commercial truck bodies, along with aftermarket parts and assemblies.In Q3 2011, Utilimaster launched its new commercial product known as “Reach” which the company developed through an alliance with Isuzu (and will be sold through Isuzu’s 280-strong dealer network). The Reach has 35% greater fuel efficiency than Utilimaster’s other products, which cuts CO2 emissions in half. Additionally, it has keyless entry, which although this might leave you chuckling as a selling point, is evidently a big deal for companies like Fedex and UPS which currently operate vehicles that lack keyless entry. From the Q3 2011 conference call (emphasis added):
Keyless entry systems for a major package delivery customer that will take or cut the time it takes for drivers to access cargo, thus increase the number of packages or staff they can make on a day. As a point of reference, UPS recently disclosed that keyless entry, as they call it, will save them over $70 million annually. The simple technology which has – it’s been available in passenger car for decades marks an important shift in the delivery and service market, driving down costs, increasing capacities, while providing a return to fleet operators and Utilimaster as well.The short story is, this is a big opportunity for the company, but even disregarding the Reach, Utilimaster appears to have been a smart acquisition, with Delivery and Service Vehicles segment revenues increasing 73% YoY in Q2 2011 and 122% in Q3. This segment has grown to 51% of SPAR’s revenues, and the backlog is growing, suggesting a bright future (and this is not including the ramp up as the Reach is deployed).
So where does this leave us? Given the role of the MRAP in the company’s financials in 2007/2008, as well as the recent sale of its Road Rescue division and purchase of Utilimaster (and the important role it is playing for the company now), I think this is one of the (rare) situations where historical financials can be safely ignored. The company has undergone a transformation, and while past performance may give some insight into management’s capabilities, for valuation’s sake we should be focusing more on the recent performance.
First, let’s just consider management’s capabilities. Over the last decade, ROE averaged 15%, ROIC averaged 13.7%, and CROIC averaged 6.5%. While ROE and ROIC are decent, CROIC is weak and I prefer companies that are able to generate significant free cash flows with relatively little capital employed. Thankfully, it appears that things are starting to turn around, with 2009 and 2010 CROIC averaging an impressive 16.4%.
Ok, now for valuation. This is somewhat trickier given the shorter time period, so any forecast we make necessarily has less grounding than we would like. In my model, I assumed top line growth for three years and moderating thereafter. I derived free cash flow using expectations based on the culmination of the company’s restructuring efforts and its margins for the past two years. I then estimated the current intrinsic value for a few scenarios. The result is that SPAR looks very cheap, and this is despite the fact that it has enjoyed a run-up of 30% YTD (as of the time of writing).
What do you think of SPAR?