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Oshkosh: Attractive Valuation Combined with Bright Outlook

August 01, 2014 | About:

As the market sold off yesterday with the S&P 500 declined by 2% in a day, I observed that the industrial ETF is still above its 50 days moving average even though the RSI and MACD indicators both show some weakness.

(click to enlarge)5972751-1406906950214997-Gordon-Tam--CFA

By monitoring the sector and comparing dfiferent companies, investors can see a better picture about how their targeted companies perform relative to the market. As long as the industrial ETF can stay above its 50 days moving average, the bull trend is still intact. Hence, it is good for us to hunt for bargains within the industrial sector. One of my findings is Oshkosh (NYSE:OSK). According to my analysis, OSK has 35% upside potential, together with a wild card option if OSK wins on the bid of Joint Light Tactical Vehicle program for a potential $4 per share gain. It is rare to find a solid company, like OSK, selling for such favorable risk/reward profile.

Company Overview

(click to enlarge)5972751-14069077984856424-Gordon-Tam--CF

Source: Company Presentation

OSK designs, manufactures, and markets specialty vehicles and vehicle bodies worldwide. It has four divisions: access equipment, defense, fire & emergency, and commercial.

(click to enlarge)5972751-14069079531714075-Gordon-Tam--CF

Source: Company Presentation

Since the defense budget of the United States has shrink recently, the access equipment business becomes a bigger and bigger portion of the whole OSK business. (as shown in the above chart, the access equipment business is close to half of the total sales.) In addition, it is worth mentioning that the access equipment business demands around 14.5% operating margins as compared to the other business divisions' 3.5%-6% operating margins. The incremental share of access equipment relative to other divisions is definitely favorable for OSK shareholders.

Management Team

Charles Szews, the CEO of OSK, has joined OSK since 1996 with almost 18 years of tenures. Charles has taken various roles in OSK, including Chief Operating Officer, Chief Financial Officer, Executive Vice President. This broad range of managing experience should help Charles to gain an excellent understanding of the operation and the financial performance of OSK. I am confident to have Charles Szews to run OSK.

Insider Ownership

(click to enlarge)5972751-14069051409124677-Gordon-Tam--CF

Source: Proxy Statement

Based on the latest proxy statement, all directors and executive officers together own 2.45% of outstanding shares. This shows me insiders having a neutral view on the prospects of OSK.

Financial Strength

OSK has total debt of $900 million and total cash of $525 million. The net debt is around $375 million. With $578 million EBITDA, OSK has approximately 0.65x Net Debt/EBITDA. This gives plenty of financial flexibility for an industrial company, like OSK, to raise additional debt if needed so as to repurchase its undervalued stocks or pursue acquisitions to further propel growth.

5972751-14069083168439972-Gordon-Tam--CF

Source: Company Presentation

One of the important valuation metrics is free cash flow. As shown in the chart above, OSK has grown its free cash flow since 2006. With relatively low capital spending requirements, OSK is a business capable of generating free cash flow to its shareholders. With around 10% free cash flow yield, OSK deserves to trade at much higher valuation.

Valuation

OSK has initiated a strategy called MOVE. M stands for market recovery and growth. O stands for optimize cost and capital structure. V stands for value innovative. E stands for emerging market expansion. The MOVE strategy is expected to drive higher incremental margins across mon-defense business over cycle and explore drivers to create highest shareholder value. With the strategy in place, OSK forecasts that it can achieve its EPS target of $4-$4.5 EPS in 2015.

Furthermore, based on Yahoo Finance, the consensus 2015 EPS is expected to be $4.17 EPS. This results in less than 12x P/E multiple for OSK. Given 13.5% growth rate, the PEG is less than 1x, which implies undervalue for the expected rate of growth.

(click to enlarge)5972751-14069030952620337-Gordon-Tam--CF

According to the P/E chart of Gurufocus.com, the lowest is 5x and the highest is about 25x by excluding some extreme values. By taking 15x P/E multiple and $4.17 2015 EPS, my target price is $62.5, which implies 35% upside potential.

Bright Outlook

The following is an excerpt from Barrons.com:

Another reason is that the outlook for work platforms looks bright. Historically, nonresidential construction activity has tended to track residential construction activity with an average lag of 21 months, according to Mircea Dobre, who covers Oshkosh for Robert W. Baird, an investment bank. That suggests nonresidential construction is headed for a year and a half of healthy growth.

OSK looks undervalued not only based on its attractive valuation, but also a bright outlook for its access-equipment division, which is directly impacted by non-residential construction and the largest division within OSK. With an anticipated non-residential construction growth, it makes sense for investors to load up on OSK so as to catch the uptrend.

Another excerpt from Barrons.com shows the lottery ticket embedded in OSK:

Oshkosh is one of three bidders on the Joint Light Tactical Vehicle program, which will replace the Humvee with a more combat-ready truck. The Defense Department is expected to announce its supplier next summer. Some analysts see Oshkosh as a front-runner, given its experience in supplying military trucks. Dobre reckons a win would add $4 to the stock's value.

Given a good fundamental value investing in OSK, investors have a free call option for the further upside of $4 if OSK can win the bid on the Joint Light Tactical Vehicle program. The asymmetric risk/reward profile should not be overlooked by any prospective OSK investors.

Risks

First, industrial companies are very susceptible to the economy. If there is any economic slowdown or recession, OSK will be greatly impacted. Second, budget cuts or deferrals of orders in Defense could adversely affect the sales of OSK. Third, there is execution risk for the MOVE strategy. The financial performance of OSK might not improve as management has expected.

The Bottom Line

I believe that OSK is a rare find in today's market given its asymmetric reward opportunity.

Disclosure: I am not a securities broker/dealer or an investment adviser. You are responsible for your own investment decisions. All information contained should be independently verified with the companies mentioned, and readers should always conduct their own research and due diligence and consider obtaining professional advice before making any investment decision.

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