The Shyft Group: A Quality Business Poised To Benefit From Favorable E-Commerce Tailwinds (NASDAQ:SHYF)

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The Shyft Group (SHYF) represents an attractive investment opportunity within the last-mile delivery specialty vehicle manufacturing niche. Given its unique position as a leading manufacturer of walk-in van (WIV) bodies, the company stands to benefit from favorable e-commerce tailwinds as a result of the 2020 COVID-19 pandemic and the secular shift towards omnichannel retail and digital nativity. Despite Shyft’s swift recovery from the COVID-19-related dip and modest TTM multiple expansion, I believe Shyft’s share price still has room to grow for three key reasons, resulting in a compelling opportunity for prudent investors to buy a quality business that is trading 19% below its intrinsic value (23% upside).

Business Overview

Shyft is a niche market leader in the manufacturing and assembly of commercial and recreational vehicles. Shyft produces walk-in van and truck bodies used in e-commerce/last mile and grocery delivery, vocation-specific upfit equipment used in the mobile retail and utility trades, and luxury Class A diesel motor home chassis. Its vehicles, parts, and services are sold to commercial users, original equipment manufacturers OEMs, dealers, and governmental entities. Shyft operates two business units, spread across 15 manufacturing locations in the United States:

Fleet Vehicles and Services (FVS), which is marketed under the Utilimaster and Strobes-R-Us go-to-market brands, manufactures and assembles walk-in van and truck bodies for customers like UPS (UPS), FedEx (FDX), Amazon (AMZN), and PepsiCo (PEP). Walk-in vans feature an aluminum body assembled on a stripped truck chassis supplied with engine and drive train components. Truck bodies, which are also constructed out of aluminum, are installed on chassis with finished cabs and are designed with cargo lengths ranging from 10 to 28 feet. Typically, chassis are already owned by end-customers. Shyft holds these on consignment and manufactures bodies on top. In instances when Shyft directly purchases chassis, it usually does so from suppliers like Ford Motor Company (F) and Daimler AG.

The FVS business unit generated $485m of revenue (net of USPS pass-through) and $60m of adjusted EBITDA in FY19, accounting for approximately 75% of total operating revenue and EBITDA. It has grown at a CAGR of 16% since 2016 (50% YoY growth over the prior two years), excluding $65m and $91m of USPS pass-through revenue in 2018 and 2019. (Note: Adjusted EBITDA and Revenue are considered before intercompany eliminations.)

Specialty Vehicles (SV) engineers and manufactures luxury Class A motor home chassis, provides contract assembly of defense vehicles, and since the acquisition of Fortress Resources, LLC (Royal Truck Body) for $89.4m cash in 2019, is the largest service truck body manufacturer in the Western United States. The SV business unit generated $186m of revenue and $21m of Adjusted EBITDA in FY19 and $193m of revenue and $19m of EBITDA in 2018.

Effective February 1, 2020, Shyft completed the sale of its loss-making Emergency Response and Vehicle (ERV) business for $55m cash. The ERV business consisted of cab-chassis and apparatus manufacturing operations.

Approximately 97% of 2019 revenue was domestic to the United States. Essentially all of Shyft’s revenue derives from contracts with customers that are fulfilled over 2 to 12 months, depending on the product.

Velocity M3Image Source: Utilimaster

Management

The management team is led by Daryl Adams, CEO, and President, who joined the company in Q3 2014 as COO and was promoted to Chief Executive Officer in February 2015. Prior to joining Shyft (Spartan Motors at the time), Adams served as CEO of the privately held Tier One automotive supplier, Midway Products Group. Adams has been instrumental in leading Shyft’s multi-year turnaround plan, which he implemented at the beginning of his tenure. He has approximately $9.4 million of his personal net worth invested in the business and has consistently sought value-accretive projects (the acquisition of Royal Truck Body and the divestiture of the ERV business, for example).

According to Shyft’s most recent 10-K, executive compensation is based on a single adjusted EBIDTA performance metric, which is benchmarked against industry peers in the durable goods manufacturing industry.

Investment Thesis

Thesis 1: Global logistics companies will need to reinvest in their fleets to meet accelerating e-commerce demand.

If carrier companies intend to meet consumer demand for last-mile residential deliveries, then they will need to reinvest in their fleets. In its July 2020 e-Commerce Report, Goldman Sachs estimated that online shopping volume will grow by a CAGR of 19% until 2023. The report also noted that e-commerce penetration relative to domestic retail spending rose to more than 40% in May 2020, from 16% in the first quarter of 2019. This accelerating demand can already be seen in the earnings of companies that benefit the most from e-commerce: UPS, FDX, and AMZN all beat Q2 2020 earnings by at least 80bps.

As the proportion of e-commerce to national (and global) retail sales grows, so too will the need to purchase, maintain, and replace delivery vehicles. Prior to the COVID-19 pandemic, last-mile delivery was already the fastest-growing fleet segment for carriers, but with the emergent need for social distancing and “contactless” transactions, investment in this particular niche has become even more critical. Mike Antich of FleetFinancials notes that last-mile delivery is normally associated with stop-and-go driving, extended idling periods, and higher mileage – all of which take a significant toll on delivery vehicles. These vehicles are normally depreciated over a 10-year useful life, but as they are subjected to more frequent wear-and-tear and higher mileage, real depreciation will likely accelerate.

For multi-national logistics companies, reputation and scalability are key to winning contracts. The walk-in van/truck body upfit industry is highly fragmented between many small regional players, but if a national distributor, like UPS, needs to replace a fleet (1,000+) of last-mile delivery vehicles, it has essentially two options: Utilimaster or Morgan Olson.

SHYF Market Stats & TAMSource: SHYF Investor Presentation

Thesis 2: The FVS and SV business units have historically earned high returns, but these have been obscured by the loss-making ERV business.

Skepticism of the company’s future is understandable: turnaround investments are almost always risky and rarely rewarding. Between 2015 and 2018, the company’s originally reported EBITDA and net profit margin averaged 3.6% and 0.6%, respectively – not exactly a cash cow – but I believe that historical filings grossly underrepresent the profitability of the FVS and SV businesses.

Despite Shyft’s apparent unprofitability, a breakout of revenue and EBITDA by operating unit for the period 2015 – 2019 reveals the following:

1) After adjusting for the one-time FY18/19 USPS pass-through contract, we can see that the FVS and SV business units have each grown by CAGRs of 16.3% and 7.0%, respectively.

2) The average 5-year adjusted EBITDA margins for the FVS and SV business units are 10.1% and 8.5%, but total FVS and SV adjusted EBITDA have each grown by CAGRs of 28.1% and 18.6% due to margin expansion.

3) Using the company-provided breakout of assets by operating unit, we can see that over the previous 5 years, the FVS unit earned an average EBITDA Return on Assets (ROA) of 35.9% while the SV unit has earned an average EBITDA ROA of 50.7%.

4) Shyft’s average 3Y Return on Invested Capital (roughly estimated) is ~14%, which is significantly higher than the company’s Weighted Average Cost of Capital (8.14%).

Source: Author Calculations | Data Source: Capital IQ

Thesis 3: Although many players are entering the electric vehicle last-mile delivery market, as a market leader, Shyft is well-positioned to capitalize on secular trends.

The trend in financial markets towards electric and alternative fuel vehicles has resulted in numerous startups and growth companies like Rivian, Hyliion (HYLN), Workhorse (WKHS), and Nikola Motors (NKLA) achieving lofty valuations – often in the tens of billions. But despite noise caused by new entrants in the EV space, Shyft has remained comparatively pragmatic. In fact, in Shyft’s presentation at the September 2020 Sidoti Virtual Investors Conference, CEO Daryl Adams disclosed that the company is fully capable of electrifying vehicles in all Classes (1 through 7); demand from carriers just is not there.

But despite apparent low customer demand, Shyft recently expanded assembly line capabilities to support the production of up to 5,000 Class 3-4 electric vehicle units per year, with production scheduled to begin in 2021. The company is also already producing Class 2 Velocity EV WIVs for two parcel delivery companies for route and performance testing. Given that in September, Governor Newsom announced via Executive Order that all new passenger vehicles sold in the State of California are required to be zero-emission, the scalability of Shyft’s production will likely be a key driver for future growth.

Shyft’s focus on the Class 3-4 segment of the last-mile delivery niche differentiates it from its competitors. At the 2020 NTEA Work Truck Show, Morgan Olson revealed its new prototype Class 2 WIV, the Storm. Although this WIV would directly compete with Shyft’s Class 2 Velocity/Reach bodies, there doesn’t appear to be any evidence on the Morgan Olson website that the company is producing EV bodies for higher weight classes. For now, Morgan Olson’s EV production appears to be restricted to Class 2 vehicles.

SHYF Supports EV WIV Production for Classes 1 - 7 Source: SHYF Investor Presentation

Valuation

Base Case: It should be emphasized that my base case model underestimates both forward revenue and EBITDA compared to the analyst consensus. I do not believe that consensus estimates properly reflect the impact of COVID-19 and the resulting chassis shortages among key suppliers. FVS revenue decreased by ~7.8% in Q2 2020, compared to the same period in 2019 (net of pass-through), while SCV revenue declined by ~36%. Q4 has historically been Shyft’s slowest quarter; therefore, it is doubtful that the company will generate sales to make up for losses experienced in the first half of the year. I have therefore accounted for a near-term downturn (-10%) in FVS and SV revenue for 2020.

Source: Capital IQ estimates

I estimate that FVS revenue will grow by 20% in 2021, eventually plateauing to 15% YoY growth in 2024. Annual FVS revenue is expected to reach $816m by 2024; or, assuming an average WIV price of $77k, annual unit sales of approximately 10,600 vans. Aggregate Company-wide sales are forecast to reach ~$1 billion by 2024.

Management has been vocal about their intention to improve Shyft’s adjusted EBITDA margin to >10% through the implementation of lean manufacturing and productivity improvements, as well as the company’s transition toward a more favorable product mix. The base case model incorporates management’s expectations. I estimate that Shyft will achieve a 10% adjusted EBITDA margin by 2023 and a 12% margin by 2024.

To account for acquisitions required to support growth, capital expenditures are expected to remain between 2.5% – 3.0% of revenue (1.5% hist. 3Y average) in the base scenario.

My base price is approximately $25 per share, or a 22% upside, derived from a (WACC) of 8.14% and a terminal growth rate of 3%. To control for growth in the SV business unit, SV revenue is set at a constant 7% (3Y Average) beginning in 2021.

Source: Author Calculations | Data Source: Capital IQ

Bull Case: My bull case also reflects a near-term downturn in FVS and SV revenue related to the COVID-19 pandemic; however, sales will experience a sharp rebound in 2021.

  • Sales are expected to grow at a CAGR of 25% until 2024 due to accelerating demand for WIVs on EV chassis.
  • COGS as a % of revenue is adjusted in 2020 to reflect near-term chassis shortages, but will recover to 78% by 2024 due to productivity and supply chain improvements.
  • SG&A margin is set at 10% in 2020 to keep fixed costs and overhead consistent but will quickly recover to 7.5% by 2022.

My bull price is approximately $37 per share, or an 80% upside, also derived from a WACC of 8.14% and a terminal growth rate of 3%.

Bear Case: The bear case also reflects a near-term downturn in FVS and SV revenue related to the COVID-19 pandemic; however, the recovery is expected to take significantly longer.

  • Shyft is expected to lose market share to Morgan Olson or to a highly scalable competitor (Amazon, Rivian, etc.), resulting in revenue growth that is significantly lower than in the base or bull scenarios.
  • Gross margin is heavily impacted by chassis shortages in 2020, with fallout expected to last until 2024.
  • SG&A margin is set at 12% in 2020 to keep fixed costs and overhead consistent but will recover to 8% by 2024.

My bear price is approximately $14 per share, or a 30% downside, also derived from a WACC of 8.14% and a terminal growth rate of 3%.

Assuming a 25/50/25 Bull/Base/Bear probability weighting, the probability-weighted share price is about $25 per share: a 23% upside.

Source: Author Calculations | Data Source: Capital IQ

Key Risks and Uncertainty

Prolonged effects of COVID-19 may adversely impact Shyft’s value chain, both through chassis shortages (suppliers) and through order pauses/cancellations (customers).

While this is certainly a concern, order backlog for the FVS business unit at Q2 2020 – which is a semi-reliable indicator of short-term demand – remained strong, increasing by 18% to $287m compared to the same period in 2019. Further risks remain related to chassis availability and the conversion of backlog to sales (supply-side). In 2018, Shyft was adversely impacted by chassis shortages due to international tariffs, and uncertainty remains as to whether the company will experience similar supply shocks following the COVID-19 pandemic.

In Shyft’s Q2 2020 earnings call CEO Daryl Adams noted that unlike in 2018 when Shyft relied upon OEMs to supply chassis, the company’s recent transition towards Class 3 vehicle manufacturing means that chassis are now procured directly from Ford and Freightliner (Daimler AG). By sourcing chassis from original manufacturers with whom Shyft has long-standing relationships, rather than from third-party OEMs, Shyft can weather some (but not all) of the supply-chain shocks that may affect its industry.

Amazon, which makes up a significant portion of Shyft’s revenue, may attempt to vertically integrate its supply chain through the development of their own delivery vehicles.

Amazon is notorious for acquiring or directly competing against key suppliers. Concerns relate to Amazon’s investment in Rivian and its order to purchase 100,000 EV vans by 2024. Should Rivian’s production appropriately scale to meet demand, the loss of Amazon as a customer, as well as the emergence of a new multi-billion-dollar competitor in the last-mile EV space, may negatively impact Shyft.

Operating Model Summary

Source: Author Calculations | Data Source: Capital IQ

Final Thoughts

Given the company’s expanding margins, high rate of revenue growth in the FVS business, and advantageous position as a leading manufacturer of walk-in van/truck bodies, I view The Shyft Group as a compelling long position for investors looking to capitalize on the secular theme of e-commerce. Key information that I will be looking for in Shyft’s upcoming Q3 2020 earnings release include, A) whether the company continues to sustain the ~20% gross margin that it earned over the prior four quarters, and B) how the rate of backlog-to-revenue conversion has changed as a result of the economic reopening.

On a final note, my operating model assumes that over the next five years Shyft will need to engage in a limited number of acquisitions to maintain market share (these are factored in capex). Historically, Shyft’s management team has done an excellent job pursuing value-accretive investments, but something to consider going forward is whether acquisitions are done for the sake of growth (value-accretive) or for maintenance (value-destructive/capex). If Shyft can prove that it’s capable of growing sales organically to meet growing e-commerce demand – without the need for acquisitions – I would be even more optimistic about the company.

As it stands, based on current information, I view Shyft’s fair value to be ~$25 per share. I would bump that up to ~$30+ per share if the company demonstrates a swift recovery from the COVID-19 pandemic and high rates of organic growth (beginning in 2021). I believe that anything below $16 per share (June/July trading range) is deeply underpriced.

Disclosure: I am/we are long SHYF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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