Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Buoyed by big contracts to outfit the military with new all-terrain MRAPs, Humvee-replacing Joint Light Tactical Vehicles, and medium and heavy trucks, Oshkosh (NYSE:OSK) stock has run off to the races -- up 45% over the past 12 months. It has crushed the returns of the S&P 500 and become one of the best-performing stocks on the planet.
But how long can that last?
This morning, Bank of America's Merrill Lynch brokerage unit predicted an imminent crash in Oshkosh shares. Downgrading the stock from neutral to underperform, Merrill's analysts took a hatchet to their price targets, cutting the stock from $75 to $60 a share -- and predicting Oshkosh shares will not rise, but fall 13%. Here are three reasons why.
1. Oshkosh's military muscle
Much of the enthusiasm surrounding Oshkosh stock over the past few years has centered on the company's booming defense business. Sales have fallen 1.5% over the past 12 months at Oshkosh's flagship access equipment division (responsible for 46% of all sales) and are down 2.8% at its commercial equipment division (Oshkosh's third largest).
But in its defense, Oshkosh sales have surged 31% year over year, and operating profits are up 130%. Last quarter alone, Oshkosh announced better-than-50% sales growth in its defense segment, "due to the ramp-up of sales to the U.S. government under the Joint Light Tactical Vehicle program and higher international Mine Resistant Ambush Protected All Terrain Vehicle sales." Credit for this astounding growth goes to the company's booming business building armored trucks for the military -- a business where Oshkosh has basically swept the field and beaten back competition from Navistar, General Dynamics, and even defense industry behemoth Lockheed Martin.
2. The Pentagon's military ambush
But here's the thing: Merrill Lynch believes defense could actually be Oshkosh's Achilles' heel, and that the stock could begin to suffer from a lack of Pentagon orders as early as next fiscal year. In a note covered this morning by StreetInsider.com (requires subscription), Merrill warned of "a potential air pocket" forming due to "the lack of new [MRAP] orders for FY18 delivery."
Merrill believes that sagging orders for Oshkosh's monstrous armored "M-ATV" trucks will cap defense segment sales at perhaps $1.7 billion next year -- within Oshkosh's guidance, but as much as 15% below hoped-for sales of $2 billion. And given how much more profitable defense products are for Oshkosh (9.7% pre-tax margins) relative to sales of, for example, access equipment (8%) or commercial equipment (5.4%), a shortfall in defense sales would have a big impact on Oshkosh's profits.
3. Can Oshkosh be saved?
Admittedly, Oshkosh is a diversified industrial manufacturer, and that diversification may help to mitigate the harm from a sputtering defense business. Oshkosh's fire and emergency vehicle division, for example, boasts respectable 8.3% profit margins and growing sales (up 9% over the past year, according to data from S&P Global Market Intelligence), and the access equipment business is even more profitable, even if its sales are weaker.
Regardless, Merrill Lynch seems to be losing confidence in President Trump's promised trillion-dollar infrastructure plan coming to pass anytime soon and giving a lift to Oshkosh's access equipment sales. Customers could decide to buy replacement access equipment for their fleets "eventually," says Merrill, but it's "unclear" precisely when such sales might materialize -- and the analyst expects customers to defer buying "until there is further visibility on infrastructure spending outlook."
What it means for investors
In Merrill Lynch's opinion, this all adds up to bleaker prospects for Oshkosh going forward, and a strong argument in favor of selling Oshkosh stock today. Is Merrill right about that?
Let's consider: At $5.15 billion in market capitalization today, and with a much-reduced net-debt load of only $415 million, Oshkosh stock boasts a debt-adjusted market cap (enterprise value) of less than $5.6 billion.
Relative to the stock's $209 million in trailing-12-month earnings, that works out to a valuation of roughly 27 times earnings. And relative to analysts' projected 14.6% long-term earnings growth rate for Oshkosh, yes, that does seem a bit steep. With the added prospect of an imminent slowdown in high-margin defense sales, I can see why Merrill Lynch is worrying about the stock's prospects.
On the other hand, Oshkosh generates quite a bit more free cash flow than its income statement currently reflects. S&P Global figures show cash profits of $513 million generated over the last 12 months, which is more than twice Oshkosh's reported net income. Valued on this free cash flow, the stock sells for an enterprise value just 10.9 times its cash profits -- which is arguably cheap for a stock growing profits at nearly 15%.
Long story short? Depending on how you look at it, Oshkosh stock is either terribly expensive, or still somewhat cheap. While I agree Merrill's concerns over a slowdown in defense spending have merit and are worth keeping an eye on, I am not convinced there's a compelling need to sell Oshkosh stock just yet.
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