This article is part of our Rising Stars Portfolios series.
It's been a good first month for the Messed-Up Expectations portfolio. As of yesterday's close, the first three picks are up an average of 11.6%, while the S&P 500 was up just 3.3%. That's with two energy picks (one oil, one solar) and a gaming retailer.
Looking for additional companies to invest in, ideas come from all kinds of sources. For instance, I've long been aware of Spartan Motors (Nasdaq: SPAR), a specialty-manufacturer of truck chassis and bodies, building things like fire trucks, ambulances, motor homes, and package delivery vans. But it's a bit of a small player, with a market cap of only $180 million, which is smaller than I really want to get into right now. (However, as a messed-up expectation (MUE), it seems to be a possibility, with declines in free cash flow going forward currently priced in.)
Who else is there?
A larger company in the same specialty trucks space, though not competing directly with Spartan, is Oshkosh (NYSE: OSK), with its $2.9 billion market cap. This company builds specialty vehicles like fire engines for airports, cement mixers, personnel lifts, and truck-mounted cranes. But what it sells the most of is military trucks. Of the $11.7 billion of revenue the company brought in last fiscal year, before backing out intersegment sales, 61% of that was defense-related.
Oshkosh has been selling to the military for more than 80 years, so I don't expect this situation to change any time soon. But unlike General Dynamics (NYSE: GD) and its tanks or Lockheed Martin (NYSE: LMT) and its fighter jets, Oshkosh sells support equipment -- picks and shovels, if you will -- not the fancy weapon systems. Instead of selling tanks and jets, it sells trucks that haul supplies for all those weapons, such as ammunition and fuel. It sells troop transports, too, such as the M-ATV, an armored all-terrain vehicle.
Risky reliance on the military?
In other words, while its fortunes are tied to military spending, what it sells is not the big, flashy material that gets all the headlines. Rather, it's a lot of boring -- but necessary! -- vehicles that the military will keep buying. For instance, Oshkosh just received an order for $842 million worth of ambulances and palletized load system trailers, among other items. That'll be added to the defense backlog, which stood at more than $4.7 billion at the end of September.
The company could become the victim of budget cuts, especially as the government attempts to reduce the deficit, but I believe the wares it sells are less likely to get cut than brand-new weapons systems. Plus, with the Republicans taking control of the House next month, the likelihood of severe military budget cuts has gone down, in my estimation. If I'm wrong, however, then I'll have to reevaluate the decision to invest.
In addition to plenty of defense business, Oshkosh has other lines of products to provide a more diversified revenue stream. A large portion of its business, 26% of the most recent year's revenue, comes from its access equipment division, which sells aerial lift platforms -- these lift workers up at the end of a long boom arm -- and scissors lifts, among others. It just opened a Chinese manufacturing facility for this division, with management expecting the Asia and Australia region to be a "growth engine" for the foreseeable future.
So what's the opportunity?
Right now, even though the company just reported a "record-breaking fiscal year," Wall Street is pricing the company as if it's never going to grow again. In fact, at last night's closing price of $32.41 per share, the expectation is that Oshkosh will actually shrink its free cash flow (FCF) by 3.9% per year for five years, by 1.9% for the next five years, then hold steadily forever after that (at a 15% discount rate). That's a messed-up expectation if I ever saw one.
While FCF did drop significantly over the past fiscal year, it has a three-year growth average of more than 20% per year and a five-year average of nearly 26%. A good portion of that growth came from its October 2006 acquisition of JLG Industries (which builds many of those aerial platforms), and careful acquisition is part of the company's growth strategy going forward. But management is being smart and disciplined. They are continuing to pay down the debt taken on to acquire JLG before opening their wallets again in 2012 or 2013. I like that.
Tomorrow, the MUE Port will open an initial 2% stake in Oshkosh, about $340 worth. I expect that this will fairly quickly move up to a comfortable 4% stake, with the possibility of increasing it to my most confident level of 6%.
Come over to the MUE Port discussion board and share your thoughts on this company, or any of the others that are on the watch list or in the portfolio.
