What should you do with a company whose highest revenue-generating segment gets hit hard by government-related issues, and the situation is not expected to get better anytime soon? You dig deeper to learn more.
The U.S. military's largest armored-vehicle supplier, Oshkosh (NYSE: OSK), saw its third-quarter earnings slump by an astounding 68% as defense sales slipped significantly in the quarter, sending the shares down by 13%.
With the government settling on a $900 billion cut in defense and domestic spending over a decade, and everyone anticipating further reductions later this year, we need to figure out what it could mean for Oshkosh and shareholders of the company.
The numbers
Sales in defense, Oshkosh's biggest segment, fell nearly 35% from the year-ago quarter to $1.1 billion. The primary factors were lower volumes of an MRAP armored vehicle and costs associated with the transition between two vehicle variants.
What's important to note here is that the company is moving away from a vehicle that has been a big revenue generator so far. Though Oshkosh is the only supplier of the new FMTV vehicles, it doesn't expect FMTV sales to be profitable before Q2 of fiscal 2012.
Sales in Oshkosh's access-equipment business, its second biggest segment, rose 44%, helped by strong demand and price increases. These factors had also helped rival Terex's (NYSE: TEX) second-quarter segmental sales jump by 108%. But for Oshkosh, taking defense-related sales into account, its segment's sales fell 18.4% from last year.
Low defense sales weighed tremendously heavily on the company and dragged total revenues down by 17% from the year-ago period to $2 billion. It also punished its bottom line by a steep 68% to $68.4 million in the quarter.
The "defensive" war
The U.S. defense budget cuts, including concessions stemming from scheduled and expected troop withdrawals from Afghanistan and Iraq, should affect all companies that have large government-driven orders. And there are quite a lot of them these days, including Oshkosh.
For instance, the delayed defense-spending bill slowed down General Dynamics' (NYSE: GD) defense bookings in its second quarter. Force Protection (Nasdaq: FRPT) has now recognized the need to look beyond Afghanistan for its business and is focusing on related strategies. The pain is hitting the military-industrial complex far and wide.
Now, companies will need to vie for a larger share of the smaller defense-budget cake, stiffening competition in the industry. And that's just to break even. Oshkosh, too, is now planning to focus more on its non-defense segments.
One point worth noting here is Oshkosh's debt reduction. The total debt-to-equity ratio has improved significantly year on year, from 126.5% to 68.5%. Interest coverage looks decent at 5.8. This may give Oshkosh further latitude to try new things and push away from a heavy reliance on defense spending.
In the coming months, though, Oshkosh expects lower sales in most segments. There could be another silent challenge looming here. Oshkosh's production and delivery schedules of military vehicles could be affected by tire supply constraints, which may in turn have an impact on the forthcoming quarter's operating incomes by as much as $25 million. That just adds to the pile of recent bad news for the company.
The Foolish bottom line
Oshkosh's defense segment will remain under pressure for the indefinite long term. The prudent choice for investors may be to wait till the new FMTV vehicles become profitable, while other segments start contributing higher positive margins. Till then, you probably should avoid this stock.
