Description

Thesis: A rare opportunity by Mr. Market to cheaply buy a market leading, high double digit ROICs, commercial truck body assembler with fast growing TAMs in package delivery and EV trucks; led by an incredibly impressive CEO Daryl Adams with an excelent capital allocation mindset; a zero net debt balance sheet; and a 3 year 200% upside.

I've followed/owned this company for about 5 years and have had an amazing opportunity to watch Daryl Adams transform it from an underpeforming loser with substantial manufacturing problems and dead weight segments to a high performing and market leading power house.  While this company is certaintly a much more of a smooth sailing ship on a rising tide today than it was 5 years ago, it is important to emphasize that I believe a substantial part of the thesis is Mr Adams staying on and continuing to run the company through at least 2025, achieving the goals of $1.8b in revenues and $265mm in EBITDA growing at 25% CAGR. At today's price that is less than 4x 2025 EBIT

As such, this thesis is going to commit the cardinal sin of assuming historical performance will be indicative of future results and while I will focus on the future opportunities I believe describing Mr. Adam's history with this company will be my value add on this site, and then you can judge for yourself whether this is the right guy to capitalize on this amazing opportunity.

Description: 2021: ~$1b revenues ($992mm) which grew 47% off a low 2020 base, or 32% off a 2019 base (15% 2-year CAGR which I believe is a good trend of teens growth)/ $95mm EBITDA/$84mm EBIT

The revenues are split between two segments:

Fleet Vehicle & Services: $660mm revenues / $108mm EBITDA (18% 2 year growth/16.5% ebitda margins/15% EBIT margins).

To start off with, this segment has averaged about $150mm in capital last 3 years and has generated $50mm/$75mm/$100mm in EBIT during that time (33%/50%/66% ROICs). To me, thats personally incredible. However, when you realize FVS is not really a heavy manufacturing business but an assembly throughput business (i.e. main assets are working capital, not PPE) then these ROICs will begin to make more sense. 

So at the heart of it, FVS takes the chasis/underbody manufactured by an auto manufacturer (Mercedes, Izuzu, etc) and puts on specialty bodies on it. The trucks come in different sizes (Classes) and serve a wide body of customers (utility/retail/linen/parcel delivery) though of course Amazon accounts for 37.5% of revenues with UPS/FedEx a big part as well. The big raw material component is aluminum. 

FVS has substantial market share across all Class sizes, including a 100% for Class 2&3 and 50% for Class 4&5 (the bigger $/profit ones). 

Drivers of a $3.2b TAM (where parcel delivery is 75% of the pie)

- Growth in the size of major fleet cariers from 250,000 units in 2020 to 450,000 in 2025.(12% CAGR). The growth is from a 100k retiring/replacement cycle and 200k market growth. This is all per a comissioned "third party study". The growth is expected to come from a 7-10% CAGR in parcel delivery volume via growth in e-commerce through 2025. The company estimates that Covid had pulled e-commerce adoption curve forward by 2-3 years. 

- Out of the company's $750mm revenue bridge from $1,000mm in 2021 to $1,750mm in 2025 $258mm is estimated to come from organic growth of FVS or 8.5% CAGR. Out of the 410 bp expansion in operating margin forecasted by the company approximately 1/3 of 200 bp (or 65-70 bp) is coming from price increases. In general I do not believe this is such a high hurdle given the general secular tailwinds underpinning the company's end markets. If anything, I'd probably consider that conservative however given economic uncertainty I am ok with this. I wont fight you if you think its egregiously bullish. At 12/31 the company's backlog for FVS was up a 104% or $438mm to $859mm.

- The company estimates approximately 20% EBITDA margins for this segment for 2025 (2020 was 18.5%) which given continuous scale on newly acquired capacity, price increases and productivity improvements should not be a very high hurdle. 

Specialty Vehicles: $332mm revenues / $33mm EBITDA (62% 2 year growth/9.8% ebitda margins/9.3% EBIT margins).

This is a decent segment for Shyft Group, though less important to overall EBITDA. It focuses on building high end truck bodies and chasis for large Class A vehicles including large motorhomes and buses (50%) and construction/commercial trucks (50%). This segment is a bit cyclical (high end RV buses at $400-500k a top are top of cycle purchases, though sees no sign of abating) which has been bolstered by Mr. Adams' purchase of Royal Truck Body and Duramag over last few years which focus on ... truck bodies. A very well respected brand that could double its current revenues from $50mm to $100mm by 2025. 

A nice cash flow generating 8-9% EBIT margin business, with 10-12% ROICs. A little bit more working capital intensive I'd imagine. A decent competitive position in chasis at 32% market share.

Growth is expected to come from a mix of infrastructure spend, gpd growth, consumer confidence (RVs), construction growth and EV adoption. In general I believe this should be a nominal GDP + 1-2% growth business given some secular tailwinds. At 12/31 the company's backlog for SV was up a 82% or $47mm to $104mm.

Margins are a bit lower and more volatile than FVS but with diversification into commercial/infrustructure truck body should be a little bit more tempered. 

Electric Vehicles:

Shyft Group might be the first company in the last 2-3 years whose stock dropped on announcement of introduction of EV segment. Especially more remarkable considering they have the most realistic chance of achieving their goals with an installed manufacturing capacity/supplier base; a world class customer list and have a 2,500 unit, including 500 EV, specialty truck assembly experience.

According to BloombergNEF2020 EVO and management’s estimates over 50% of global light and medium duty vehicles sales will be EV by 2040 which will be a $16b TAM for Class 3,4,5 vehicles (where SHYF currently has 50-100% market share). The company expects $50-$75mm investment, including $30mm in 2022 into this program, with a production ramp up into 2H of 2023 and a $150mm revenues by 2025. 

I am not an EV expert, however, this seems like a smart thing to do considering the world is clearly going toward Electric Vehicle mass adoption (though probably not as fast as everyone predicts). Class 1-5 vehicles tend to have shorter life spans of 3-15 years (larger have longer life spans) and eventually the replacement cycle will demand more and more EVs. Given the aforementioned competitive advantages and market opportunity at a $50-$75mm upfront investment seems like an incredible opportunity. 

2025 Revenue Bridge to $1,750mm

2021 Revenues: $992mm (with a $964mm backlog, up 101% from 12/31/2020, and 100% from 12/31/19)

+ $108mm Parcel Delivery (given aforemtioned secular tailwind factors does not take a herculean leap of faith to realize that e-commerce will continue to take market share and grow substantially from here)

+ $75mm Service Body 

+ $75mm Other Commercial (a $150mm 4 year organic growth revenue addition for non parcel business, my estimate of $500mm, at 6.8% CAGR seems very conservative so i am ok with this estimate)

+ $150mm EV ... this one is probably a leap of fait considering the segment just started but if anyone can pull it off its Mr Adams and I have never seen him be promotionally aggresive, so I would imagine these are rational, conservative targets)

+$350mm M&A/Balance Sheet:

Considering this is almost half of projected 2025 revenues I think its important to consider Mr. Adams history and the company's capacity to execute on this goal. Since taking over as CEO in February of 2015 (7 years ago) the company has made the following acqusitions:

2018 - $5.4mm - Strobes R-Us

2019 - $89mm - General Truck Body/Royal Truck Body ... gave the company an excelent foothold in US West

2020 - $18mm - Duramag 

$112mm in acqusitions in current business segments in last 4 years:

Additionally, prior to 2020 the company ran a mostly unprofitable Emergency Response (ER) vehicle segment ... i.e. firetrucks. To Mr Adams credit he has tried really hard to improve this business and took it from a money losing cash drain to a single digit EBITDA margin business. In 2017 the company paid $29mm for discounted assets of Smeal, a very opportunistic acqusition which likely paid for itself in working capital cash flows. Unfortunately, but rationally, Mr Adams just could not make the business work which was a drain on ROICs and resources, and sold it to the REV group in 2020 for $55mm. 

So since 2017 the company has made a net $84mm in strategic M&A which have taken the company's ROICs from mid single digits in 2016-17 to almost 18% in 2021. In general I believe Mr. Adams has the capital allocation chops necessary in purchasing strategic businesses. 

I anticipate that in purchasing $350mm in revenues, the company will likely spend between $300mm to $450mm (though maybe with EV segment expansion those revenues may be more expensive). It currently has $37mm in cash, $377mm in borrowing capacity and anticipate between 2022 and 2025 to generate over $400mm in FCF (combined) meaning that the company has plenty of M&A capacity. Given that the company purchased $19mm in shares in 4Q21 and reathorized a $250mm share buyback (or 25% of market cap at current prices) I do not anticipate dilutive actions.

Summary: I believe that $350mm in acquired revenue, while not a low hanging fruit, should be a very achievable goal, especially if, given current supply environment, opportunistic acqusitions arise. 

Operating Margins/Mr Adams

The company has guided for 15% EBITDA margins in 2025, from 2021's 10.9%. The company anticipates 210 bp to come from price, mix and productivity improvements at 25-50 bp a year. An additional 200 bp is anticipated to come from operating leverage on the OPEX/SG&A base. This should result in $265mm in EBITDA of which I anticipate $210mm+ will come from FVS reaching a 20% EBITDA margin. The $55mm (from $33mm) of SV is a bit more of a wild card since its a bit more cyclical and will likely house the EV segment which could be rife with cost over runs. But overall considering Mr. Adam's considerable history in operating improvements at SHYF this is likely an achievable goal.

*long winded point with anectodes 

in the mid 2000s, a fund I worked for owned shares at Wabtec (WAB) which I was responsible for covering. At the time the company had about an $800mm market cap and had an outgoing CEO who had hired Al Neupaver, a former nuclear submarine captain, as their CEO. I had the pleasure of watching Al transform the company through major operating improvements and strategic moves (including one with GE) to a $20b company at his exit in 2019. It was an incredible run, and I've always looked for CEOs that fit that mold. In 2017, sitting across a conference room table from Mr. Adams knowing almost nothing about Spartan Motors (which it was called at the time) at the end of 30 minutes I was sold. He reminded me of Al almost to the t. Patting myself on the back here, but he did not dissapoint and has delivered and then some. Even at $30 (though the stock was at $54 not that long ago) this is still a 300% return since then. He was hired by the family that has mismanaged the company to low single digit margins to turn the ship around. Coincedentally I knew a PE guy who was incredibly sad in that Mr. Adams had chosen the SHYF opportunity vs working for one of their core portfolio holdings with major carry opportunity. Mr. Adams saw what what we see today. From 2017, in addition to the aforementioned M&A, mr Adams had a lot of low hanging fruit to pick off. For example, the company had 3 different purchasing managers for 3 segements that did not co-ordinate on scale. Unbelievable. Introducing lean manufacturing techniques and most importantly lean culture, as well as some automation has improvement EBITDA margins from 5.6% in 2015 to 10.9% in 2021. 

Another important anectode I wanted to share is that in the first two weeks of Mr. Adam's tenure he was at an RV conference and his biggest SV customer pulled him into an RV and behind closed doors told him that he was firing them for just terrible performance. Mr Adams begged off for 3 more months to fix things. About 2 years later that customer switched their chasis business exclusively to SHYF's SV segment. As far as anectodes go, this is a good one.

In general, I believe Mr. Adams (60) is both an incredible competitive advantage and a serious risk to this story given his importance. Mr Adams owns about 400,000 shares or $12mm at current prices. Additionally Mr. Adams has about 350,000 in RSUs/PSUs with 260,000 not yet vested (about 20k a year) which is approximately another $16mm. This would equate to approximately 2% of overall market cap or $23mm of what I call Value At Risk. This is a fairly substantial amount. Mr Adams gets compensated about $5mm a year with $800k base, $1mm ish bonus and $3mm in long term equity awards. Awards seem to be targeted toward EBITDA (65% weighting) and Free Cash Flow (15% weighting) goals. Overall for a $5mm comp for a $1b market cap company is excellent. However, Mr. Adams is clearly world class and in theory could make much more at a Fortune 500 company. 

Overall I believe the current goals in front of Mr Adams present roughly a $100mm wealth creation opportunity (between current shares owned and awards for next 4 years. In theory that should be enough of an incentive to retain Mr Adams. I do not believe he would have issued a 4 year goal plan if he didnt have the intention to stick around and see it through. It is more likely he would use SHYF as a platform to become an industrial power house a la Wabtec/Neupaer. 

Price/Guidance/Valuation

Speaking of Wabtec, one other thing I learned during our ownership of the company, is that Mr Market loves to puke up high class industrial assets on short term concerns. In fact, it was one of my first industrial co dip buying when the company missed earnings and dropped 25% in a day. My other notable dip buy was with Shyft Group in 10/31 when a Trump trade war supply chain issue forced the company to shut down ops for 2 weeks and they obviously missed the quarter. The stock dropped 40% in one day from $10 to $6. It then went up 9x to $54.50 in next 3 years. A few weeks ago a company issued excellent 2022 Guidance:

*16%(5% to 25%) revenue growth 

*$130mm in EBITDA ($120mm - $140mm) at 11.6% margins (10.9% in 2021)

these were all above the street and they sounded upbeat about tackling inflation/supply chain stuff especially given the lessons learned in 2018. They also announced a $30mm R&D investment in the EV segment (which obviously ate into core guided EBITDA making the real number $100mm in 2022) which caused the algos to sell it off 25% to $33 which it immediately bounced back to above $40 next two days. A few days ago a DA Davidson note went out and indiscriminately shot the entire Transportation segment in the face (seen snipets, havent seen all of it). This, to me, is giving us the opportunity of a gift of a lifetime at $30 per share not unlike 2018.

In the short term (given the current trading multiples) the company is either 30% undervalued if the market is reading its $100mm vs $130mm core guidance (I believe in pricing off core earning power, not one time depressed earnings). Vice versa you could say its valuing the company at 7.5x NTM EBITDA giving zero credit to 25% CAGR next 4 years.

So I am basing a 3 year Base Case Valuation at $90 for year end 2024 in that the company will achieve Mr Adam's goal of $265mm of EBITDA and will trade at its most recent FTM median of  11.5x EBITDA (or 6.7% FCF yield on $210mm) with approximately $100mm in excess cash. I believe I explained my reasons and beliefs on why this achievable and I believe this is a probable and likely outcome. Its possible that an interest rate regime change may compress multiples though I believe mid single digit FCF multiples are always a good deal.

Today, at $30 or $1050mm market cap I believe mr Market is telling us that the market is assigning a 7-8x multiple on sub $170mm 2025 EBITDA which is pretty close to a bad scenario price target. I believe assigning 7x to $150mm 2025 EBITDA and discounting that price by 10% cost of capital will get you to about $20 as my bad case scenario. Basically nothing works, economy is in shambles, and the company is scrapping by on replacement biz with modest growth. 

Best case: $300mm in 2025 EBITDA at 13x with $200mm in cash at $120.

I use to spend a lot more time on valuations trying to justify every half a turn multiple and ever bp increse in growth or margins but at the end of the day its an art and maybe the right price target is $75 and maybe i am too lenient with my bad case. Maybe its $15. But I feel pretty good about these numbers and my history with this stock and management team and I believe buying an excellent asset at a 55% discount to its most recent high is an excellent opportunity.

Risks

I obviously assumed everything is honky dory economically by 2025 however I am not dismissive that in next 12 to 24 months it could be some turbulent waters. Aluminum ie energy prices are likely to stay elevated. The company may not be able to pass those costs on. Enough inflation could create some real demand destruction in end (e commerce) markets and kill the growth story. So I think the economic risks are real. As are lasting effects of supply chain break downs.

Can't state this enough that this is Mr Adams' company and if he leaves so would the multiple premium and potentially lowered goal targets. 

The company's strategy depends on M&A and with $350mm of revenues the deals will get bigger than previous "tuck ins" which create additional risks to targets and valuation premiums.

Amazon accounts for 25% of overall revs for the company. You can imagine the miriad of risks this represents. The ever hanging over question: "Why can't amazon just do this in house itself?" is ever present especially with FVS earning high double digit ROICs. 

*pardon my grammar really wanted to get this out before Monday (not due to requirements but current price)

Catalyst

- substantial progress/announcements on EV platform

- a substantial M&A transaction

- continued growth in backlog/expansion of margins

- clearing up of supply chain and inflation uncertainties