Description

Rush Enterprises - Note that RUSH has ‘A’ and ‘B’ shares with the ‘B’ shares super-voting (20 to 1 vs ‘A’). The Rush family own 3.5 million B shares, or 38% of total ‘B’ shares. At present the B shares trade at a 5-10% discount, despite having equivalent economic interest. Mispricing between the two share classes has been the subject of the earlier recommendations on RUSH shares.

Like most industrial businesses, RUSH’s 2020 results are going to be down, although I think they will remain profitable given trucking is an essential service and parts of the supply chain are active. On the 4/23 earnings call, the company My guess is they earn something in the neighborhood of $0.50 to $0.80 EPS in the remainder of the year, in addition to $0.62 reported in March, for a total of roughly $1.10 to $1.40 this year. Note that on the 1Q call Rush guided for second quarter to a sharp drop in new truck sales (I’m guessing 30% drop from already low 1Q level), an 11% to 14% drop in aftermarket (so far, could get worse, I assume 14% drop), and a $12-$15 million quarterly reduction in SG&A, part of which will already be included in the second quarter. Using those assumptions, I calculate a second quarter pretax loss of $10 million, and roughly cash basis break even. All equal, as more SG&A cuts flow into the back half, that would move closer to pretax break even and a cash profit. That said, I would also expect improving revenues later in the year.

The recommendation is predicated on a return to normalcy in the years ahead. In the meantime, this is a business that should survive the downturn, given that aftermarket repairs represent about two thirds of profit, and should stabilize around second quarter levels, where the company is operating at modest profitability, inclusive of planned SG&A cuts.

The crux of the reason to own Rush is its predictable and cash generative aftermarket business, combined with steady share gains in this business over time, as well as a good long term opportunity to roll up other dealers and further leverage SG&A. The business has been well run by the Rush family for two generations and I’d expect that to continue. Further, I think heavy duty trucks and by extension truck service is less exposed to electrification risk than autos. That’s based on the cost of batteries and the time involved recharging on long haul trips (driver downtime), which become a significant incremental cost across a fleet of long haul trucks. As such I think ICE based trucks, and all the attendant maintenance, will be around for a long time.

On my sum of the parts detailed below arrive at a fair value of about $44 per share, which is 30% upside to the B shares (there was more going into earnings when I began writing this, and wouldn’t surprise me to see stock drift down again), but I also think the combination of a recurring revenue, cash generative business, and a lot of opportunity to consolidate other dealers, should lead to good longer term returns. Rush’s stated out year goal is $7 billion of revenue with a 5% pretax margin, which equates to EPS of roughly $7 per share. The company occasionally buys back shares, so I estimate the per share EPS will be closer to $8 when the company reaches that level. If you assume a 10x PE multiple, which is about where the stock traded at the last cycle peak, that would be an $80 stock, or a 135% return. The $7 billion sales target is only 20% above 2019 sales, and given historical revenue growth 23% over the last five years and more than 100% over the last eight years, I’d guess they reach that level in the next six years or sooner. An $80 stock with six years implies a CAGR of 15%, higher if they reach their target sooner.

Summary of Reasons for Recommendation

1)     In a normal environment Rush generates roughly 63% of gross profit from truck service and repairs (aftermarket), which is far less cyclical than the truck sales business. This is underappreciated by the market, and the current stock price undervalues the service businesses’ defensiveness and predictability.

2)     The aftermarket business is also cash generative, requiring minimal cap ex. Most of Rush’ cap ex is to maintain and replenish its lease fleet. Absent those charges the overall business generates somewhat more than net income in free cash flow.

3)     Rush’s financial metrics screen poorly due to the aforementioned lease cap ex, as well as floor plan financing, which is essentially working capital but shows up on the balance sheet as debt. Absent that funding (but including lease vehicle financing) Rush is leveraged less than 2 times.

4)     Significant improvements in the Navistar brand represent a multi-year tailwind for both new truck sales and service.

5)     RUSH shares are near their lowest levels of the last three years despite steady growth in aftermarket business. Prior to the Covid-19 crisis shares had already begun trading down on concerns around the outlook for new truck sales, however I believe those concerns overstate the importance of that cyclical business.

6)     Regarding Covid-19, Rush is an essential service, and continues to service trucks. That, in combination with a strong balance sheet, put the company less at risk of a liquidity event than other small industrial companies.

General Description and Background:

Rush Enterprises sells trucks through over 100 truck centers in 22 states, in addition to a 50% equity interest in Rush Canada, which owns 14 dealerships in Ontario. Rush has steadily expanded the number of dealerships over the years, more than doubling its owned dealerships since 2010. The company primarily sells Peterbilt (Paccar) and International (Navistar) Brand trucks, although it also carries Hino, UN, Ford, Isuzo and other brands at some of its dealerships.

Over the last fifteen years, Rush has transitioned from a highly cyclical business dependent on the new truck cycle to a far more defensive operation with strong recurring aftermarket and service revenues. This transition has come as a result of an expansion of Rush’s dealer base, combined with higher parts and service revenues per dealership. Despite this transition, Rush still trades like a highly cyclical new truck dealer, and therein lies the opportunity. Over time, as the market better appreciates the less cyclical nature of Rush’s service business, the stock should be awarded a higher trading multiple.

Rush’s large presence in Texas has made it susceptible to the ebbs and flows of the oil cycle. However at this point, oil represents less than ten percent of the company’s total business, per recent comments from management.

I’d note that while this business has some similarities to auto dealers, it has a higher proportion of aftermarket business, and I believe less secular risk from electric or autonomous vehicles. Given

Earnings/Valuation

I think it’s easiest to look at RUSH as three separate businesses – aftermarket, leasing, and new truck sales.

Aftermarket:

A key measure of Rush’s parts and service profitability is the ‘absorption rate’. This measures the gross profit from the parts, service and body shop departments divided by all the company’s dealership operating costs aside from vehicle selling expense and the carrying costs of new and commercial inventory. Since 1999 the company has focused on increasing the absorption rate, from 80% in that year to 120.2% in 2020.

As a rough approximation, 2019 gross profit from aftermarket was $665,173. Using the 120% absorption ratio implies operating income from aftermarket of $134,365, and an allocation of $530 million, or 70%, of SG&A. Note that this division has no allocated debt, so there’s no associated interest expense. Tax adjusted that’s net income from aftermarket of $100,774, or $2.70 per share, before cap-ex or depreciation. Rush spent $84 million in cap-ex in 2019 excluding lease vehicle cost, and roughly half of that was discretionary. That implies about $40 million of maintenance spend on the dealerships (new, used and service), implying more than $60 million of cash income from the aftermarket business, or more than $1.60 per share. Given the predictability and potential for longer term growth of this business, I believe it deserves a high teens multiple, implying a value of roughly $30. I’d note that in the present environment, most of Rush’ earnings will be coming from this segment.

Leasing, Finance, Insurance:

Leasing, F&I, gross profit was $66 million for 2019. Applying 10% of the remaining SG&A of $223 million (ie applying $22 million), as well as half of the $29 million total company annual interest expense, implies pretax income for these divisions of $30 million, net income of $33 million or $0.60 per share. Assuming a 10x to low teens multiple on this business implies value of $6 to $9 per share.

New Truck Sales:

This is the company’s most cyclical business, and generated $277 million of gross profit in 2019. Applying the remainder of SG&A and interest expense to this division implies pretax income of $47 million, or $1.25 per share. This division will clearly fall sharply this year, before gradually rebounding in future years. Given the cyclicality I think a 5x multiple is appropriate for this division, implying value of $6 per share.

Sum of parts

Aftermarket: $30

Leasing/finance/insurance: $8

New Truck Sales: $6

Total: $44 / share

Current RUSHB price $34

Upside: 30%

Catalyst

Emergence from Covid-19 recession

Roll up of other dealers

Improving cost management driving long term EPS goal of $7 before share repurchase, $8 including share repurchase