Merrill Lynch tempted fate, and fate won.
According to Merrill, a "lack of new ... orders for" heavily armored "MRAP" trucks for 2018 delivery would create an "air pocket" in Oshkosh's revenue stream. Sales could come in as much as 15% below the high point of Oshkosh's $2 billion in expected 2018 earnings. Deprived of this source of high-profit margin sales, Oshkosh's earnings would tumble.
Unfortunately for Merrill Lynch -- and fortunately for Oshkosh shareholders -- that may not be the way things play out.
Last week, Oshkosh investors got a dose of good news when the U.S. Defense Security Cooperation Agency informed Congress of a plan to sell more than 2,700 new Joint Light Tactical Vehicles (JLTVs) to Britain -- for $1 billion. And this announcement appears to have taken Merrill Lynch by surprise.
Armored, and with a V-shaped hull designed to divert explosive blasts from improvised explosive devices (IEDs), JTLV is Oshkosh's Pentagon-approved answer to the venerable military Humvee. It's smaller than a "mine-resistant, ambush-protected" MRAP, but a whole lot more maneuverable. And it's a whole lot more survivable than an unarmored Humvee, making it ideal for use in war torn locales where IEDs abound.
What it means to investors
Britain plans to acquire 2,747 JLTVVs "to meet current and future threats" faced by its warfighters. Oshkosh, which builds the armored trucks, saw its stock jump nearly 2% after the news came out. But was that a big enough jump to cover the opportunity? I don't think so.
Over the past year, Oshkosh booked $6.3 billion in sales, earning an average of 6.4% operating profit margins on each dollar of revenue. This new order of JLTVs for Britain, though, will boost Oshkosh's business by the equivalent of 16% of annual revenues. What's more, these will not be any old revenues, but the highest-margin revenues Oshkosh makes. According to data from S&P Global Market Intelligence, Oshkosh's Defense division, which builds the JLTV, earns profit margins of 9.7% on its wares. That's 50% better profit than Oshkosh earns as a whole, and nearly twice the 5.4% margins of products coming out of Oshkosh's smaller Commercial vehicles division, for example.
Result: At 9.7% operating profit margins, Oshkosh's upcoming $1 billion in JLTV revenue could generate north of $97 million in profit for Oshkosh -- roughly 25% of the profits Oshkosh earned last year.
With this new data in hand, it seems more likely than ever before that Oshkosh will succeed in achieving the 15% annual earnings growth targets that Wall Street has set for the stock. And with Oshkosh shares selling for just 10 times free cash flow today (and paying a tidy 1.2% dividend yield, let's not forget), I think Oshkosh stock remains attractively priced.
And yes, Merrill Lynch is still wrong to advise selling it.