Description

I recommend an investment in ALTG at a price $15.35 per share. ALTG is a high-quality business led by a fantastic owner/operator that is trading at a 16.0% trailing Levered Free Cash Flow Before Growth Capex yield and at just a 7.6x forward EV/Economic EBIT multiple.

Alta Equipment Group [NASDAQ: ALTG] is a dealership of heavy equipment such as aerial lifts, forklifts, cranes, haulers, and earthmovers. The company’s crown jewel asset is its pool of 1,150 highly skilled mechanics who support customers out of 71 physical locations across the Midwest, Northeast, and Canada. Each dealership location is a regional monopoly protected by exclusive territorial rights from the OEM partner, a list that includes Hyster-Yale, Volvo Construction Equipment, JCB, and Manitou. There are two segments: Material Handling (industrial warehousing) and Construction (non-residential).

ALTG generates revenue in five ways: (1) new and used equipment sales, (2) parts sales, (3) service revenue, (4) rental revenue, and (5) rental equipment sales. The company employs a classic razor-blade business model. The company populates its territories with equipment by selling at low gross margins. As the years go by, that equipment is put under immense stress and typically requires substantial maintenance to keep it working properly. Parts/service revenue provides recurring high-margin revenue and is thus far more valuable than either sales or rentals.

CEO Ryan Greenawalt is a true owner/operator who owns 18% of the business ($89 million) after buying out his father in 2017. ALTG’s management provides investors with detailed quarterly financial appendices which help reconcile reported earnings to “owner earnings.” This level of disclosure and transparency with shareholders is impressive given that the company lacks an internal investor relations department.

My investment thesis is based on the company’s robust free cash flow generation coming from the parts and services annuity stream. Furthermore, the company is the consolidator of choice by their OEM customers which should provide a long runway of attractive acquisition opportunities. 

Investment Thesis

(1) GAAP Obscures Robust Free Cash Flow Generation and Built-In Parts/Service Annuity Stream

ALTG reported GAAP Net Income of just $6.3 million and EPS of $0.20 in FY 2022 but is far more cash flow generative than it appears.

ALTG screens on FactSet/Cap IQ as more indebted than it actually is due to the existence of floor plan facilities, which also has the effect of artificially inflating invested capital and thus deflating ROIC. These floor plans are first lien secured facilities provided by OEMs such as Volvo and Hyster-Yale. They are meant to help dealerships finance large batches of inventory purchases at low carrying costs in order to get product out into the market. The principal on these floor plans has no maturity date and is only due when the specific equipment is sold. At the end of FY 2022, ALTG had $211.5 million of “Floor Plan Payable: New Equipment.” I do not view them as a component of total debt given the lack of a contractual maturity date in the absence of a sale event. According to filings from both ALTG and Hyster-Yale, the facilities are non-recourse to ALTG. From my understanding, the company can return the inventory at cost to the OEM in the event that it is unable to sell it.

After incorporating pro-forma contributions from the $86.7 million of acquisitions completed during 2022, adding back growth reinvestment associated with the rental operation, and removing OEM-backed floor plan facilities from debt and invested capital – on pro-forma 2022 numbers ALTG generated $124.5 million Economic EBIT, $79.0 million Levered Free Cash Flow Before Growth Capex, and ~17% pre-tax ROTC.

Furthermore, the market underappreciates the organic revenue growth visibility at ALTG. I estimate that $2.1 billion of cumulative equipment has been sold into ALTG’s field territories over the past four years (FY 2019 to FY 2022). This equipment typically comes with a 3-year OEM warranty, which means that it will only start generating meaningful parts/service revenue in the fourth year of operation. Assuming a post-warranty useful life of 10 years (10.0% maintenance capital spending required per year), I built a waterfall of expected parts/service revenue growth based on the identifiable field population vintages. This exercise implies that ALTG is “guaranteed” a 10.1% organic parts/service revenue CAGR based solely on equipment it has sold since FY 2019. This gives zero credit to parts/service revenue growth from any equipment sold prior to FY 2019. This idea of having built-in – yet delayed by a few years until the 3-year warranty expires – growth gives me a high degree of confidence when underwriting a 12% organic parts/service CAGR in the base case valuation.

(2) Powerful M&A Reinvestment Runway as Preferred Dealership Consolidator for OEMs

ALTG has completed 16 acquisitions since it went public in March 2019, allocating $345.5 million to purchase $445.7 million in sales and $52.5 million in Adjusted EBITDA. ALTG typically generates significant revenue synergies from its dealership acquisition targets by improving the existing parts/service aftermarket operation. The company has paid an average of just 4.6x EBITDA on its deals.

Volvo Construction Equipment and Hyster-Yale have designated ALTG as a “preferred consolidator” of mom-and-pop dealerships and retain the contractual right to block sales to unwanted buyers such as private equity. This dynamic has allowed ALTG to roll-up dozens of dealerships over the past decade while paying artificially low multiples (4-5x EBITDA) due to a structural lack of bidding competition. Primary research contacts at both Hyster-Yale and Volvo Construction Equipment involved in overseeing dealership networks noted that they preferred to have best-in-class dealers like ALTG continue to grow larger as a percentage of the overall dealership footprint.

At just ~10% penetration of the dealer footprint for Volvo and Hyster-Yale today, ALTG has a long runway to continue acquiring small dealerships. Neither sell-side consensus nor management guidance incorporate any acquisition-related growth which should allow ALTG to routinely exceed expectations. I underwrite $70 million per year of acquisitions at 5x EBITDA in my base case, resulting in $35 million per year of incremental enterprise value creation. This deal pace results in ~15.8% penetration of the Volvo/Hyster-Yale dealership footprint by FY 2026.

Why Does this Opportunity Exist?

 (1) Small De-SPAC with Low Free Float

ALTG went public via SPAC in February 2020 and did not receive a road show. The 3-month average daily volume traded is just $3.7 million, making it difficult for larger institutional investors to build positions.

(2) GAAP Obscures True Owner Earnings and Leverage

ALTG does not screen well as GAAP financials fail to reflect true owner earnings before growth reinvestment. Floor plan facilities are incorrectly listed as debt by FactSet/Cap IQ instead of non-recourse working capital, making ALTG appear more leveraged than it actually is.

(3) Misunderstood as a Sub-Scale Rental House or Auto Dealership

ALTG’s financials look similar to those of the publicly traded auto dealers. However, the heavy equipment dealer model is more competitively advantaged due to high off-warranty switching costs.

Competitive Dynamics

ALTG is a competitively advantaged business. It has strong barriers to entry related to exclusive territorial rights within its designated geographic areas and benefits from high customer switching costs in the aftermarket parts/service vertical.

The competitive landscape includes: (1) dealerships affiliated with other OEMs: Caterpillar, Komatsu, John Deere, (2) equipment rental houses: United Rentals and Ashtead Group (operates as Sunbelt Rentals in the U.S.), and (3) independent repair/maintenance shops. Since exclusive territorial rights create legal barriers to entry and ALTG’s economics are driven primarily by high-margin parts/service revenue – it is independent repair shops that potentially pose the biggest competitive threat to ALTG. 

The six publicly traded auto dealerships are the most comparable businesses and thus serve as key reference points. While the auto dealerships generate slightly higher gross margins on parts/service revenue, ALTG is more heavily weighted towards parts/service. The average auto dealership generated just 12.2% of total revenues from parts/service while ALTG generated more than twice that at 28.1%. In terms of gross profit, the average auto dealership had 34.2% attributable to parts/service while ALTG had 46.1%.

ALTG has a superior parts/service franchise compared to the auto dealers because heavy equipment customers almost always return to the dealership for repair and maintenance work, even after the warranty has expired. This insight was derived from speaking with several ALTG customers. In contrast, returning to the dealer after the warranty expires is very rare in the auto industry. I was able to dig up data from several sources that triangulate towards ~75% of off-warranty auto customers choosing to utilize independent repair shops as opposed to the dealer.

There are two reasons why heavy equipment users return to the dealer even after the OEM warranty has expired, both related to switching costs. First, on the supply side, mechanics need proprietary OEM computer hookups be able to diagnose mission-critical issues like engines/hydraulics. Second, on the demand side, customers value reliability, customer support, and speed of service far more than price.  

On the supply side, both ALTG employees and customers indicated that heavy equipment today has highly sophisticated internal telematics. Proprietary OEM diagnostic hookups are needed to diagnose issues related to the engine, hydraulics, and other mission-critical internal parts. Repair shops that are not affiliated with the OEM are physically unable to plug-in and work on these machines.

On the demand side, an independent repair shop could theoretically do minor repairs for less money than the dealership, However, the big difference between heavy equipment and personal automobiles is that the stakes are so much higher with heavy equipment. These machines are the primary income generators for those who own them. If there is any sort of equipment downtime, that is quantifiable lost money for the customer who might also be on the hook for cost overruns or paying wages to idled workers. 

Cyclicality of Heavy Equipment Industry

The heavy equipment industry is cyclical and tied to macroeconomic conditions. Unfortunately, ALTG does not provide historical data from 2008 or 2009, so it’s difficult to see how the company might fare in a recession scenario. However, using publicly available data from Volvo Construction Equipment, we can see that net sales of construction equipment in North America fell 46.1% in 2009.

That said, parts/service – not outright sales – is the key driver of ALTG’s economics. We can look at data from the public auto dealerships to see how this revenue bucket has held up in prior recessions. AutoNation [AN] and Penske [PAG] only saw a 1.4% and 6.5% decline in parts/service revenue in 2008 and 2009, respectively. ALTG’s more mission-critical parts/service operation should hold up even better in a recession scenario.

Recommendation | Valuation 

My base case 3-year price target is $26.99 per share (75.8% upside), equivalent to a 3-year IRR of +22.0%. The asymmetry of outcomes is favorable here with a 159.8% 3-year upside (38.7% IRR) in the bull case and just a 31.4% 3-year downside (-10.1% IRR) in the bear case.

In terms of valuation multiples, ALTG deserves to trade at least in line with the six publicly traded auto dealerships (Lithia, AutoNation, Penske, Asbury, Group 1, and Sonic) at 6.7x NTM Adjusted EBITDA. In fact, ALTG’s heavy equipment dealership business model is far more competitively advantaged due to the switching costs imposed on customers even after the equipment has fallen off warranty. As a result, I underwrite a 7.5x NTM EV/Economic EBIT multiple in my base case which is equivalent to the multiple that ALTG trades for today (note: “Economic EBIT” for ALTG is far more punitive than “Adjusted EBITDA” for the auto dealers because the former reflects maintenance capital spending in the equipment rental vertical). In my bull case, I underwrite just a single turn of multiple expansion to 8.5x EV/Economic EBIT.

Catalyst

Continued consolidation of regional markets.

Parts and Services growth which leads to accretion in margins.

Great management team led by owner/operator.