REV Group: An Assessment

A smartphone is an addictive device which traps a soul into a lifeless planet full of lives"― Munia Khan

Today, we look at a small cap industrial concern that has faced challenging times in 2019, as have most in the space. Insider buying in September merited a fuller analysis which is presented in the paragraphs below.

Company Overview

REV Group, Inc. (REVG) is a Milwaukee based manufacturer of specialty vehicles and related aftermarket parts and services. The company was formed as Allied Specialty Vehicles in 2010 with the merger of four companies owned by private equity firm American Industrial Partners (AIP). The moniker was changed to REV Group in 2015 and the company went public in January 2017, raising net proceeds of $253.6 million at $22 per share. AIP still owns 54% of the REV, which has grown through sixteen acquisitions in the past twelve years - dating back before the formation of Allied. Shares of REVG currently trade below $11 and command a market cap of ~$660 million. REV Group operates on a fiscal year (FY) ending October 31st.

The company sells 30 specialty vehicle brands almost exclusively in the U.S. and Canada to government entities (45%), consumers (34%), private contractors (11%), and the commercial sector (10%). Its portfolio of vehicles are manufactured at 21 facilities and supported by 12 aftermarket service locations. REV Group holds a top two position in many of its markets, with 64% of its 3QFY19 net sales generated from products in which it held such share positions. Operating in a diverse range of specialty markets, management estimates the combined size of its total addressable markets at ~112,000 vehicles and $800 million for aftermarket parts.

Reporting Segments

The company disaggregates revenue into three reporting segments: Fire & Emergency; Commercial; and Recreational.

Fire & Emergency. As the title would suggest, Fire & Emergency produces three brands of fire engines and seven brands of ambulances. By unit volume, it is the largest manufacturer of fire and emergency vehicles in the U.S. with an extensive portfolio, including three classes of ambulances, as well as pumper trucks and ladder trucks, amongst others. This division competes with the likes of

.'s (OSK)

Pierce Manufacturing,

(SPAR)

, and Braun Industries.

Fire & Emergency was responsible for FY19YTD (3 quarters) net sales of $699.0 million (40% of total) and Adj. EBITDA of $35.8 million versus net sales of $706.1 million and Adj. EBITDA of $65.5 million in the prior year period.

Commercial. REV Group's Commercial segment consists of the manufacture and sale of shuttle buses, transit buses, Type A school buses, as well as terminal trucks and street sweepers. Brands include well-known names such as Collins Bus, Federal Coach, Champion, and World Trans, amongst others. This segment competes with

Daimler's (OTCPK:DDAIF)

Thomas Bus,

. (BLBD)

, Starcraft Bus,

Volvo's (OTCPK:VOLVY)

Nova Bus, and

Navistar International (NAV).

Commercial generated FY19YTD net sales of $514.5 million (29% of total) and Adj. EBITDA of $39.7 million compared to net sales of $447.9 million and Adj. EBITDA of $25.7 million in the prior year period.

Recreational. The company's Recreational division includes the production of Class A, B, and C RVs, towable travel trailers and truck campers under seven brand names. These include iconic monikers such as American Coach, Monaco Coach, Holiday Rambler, Renegade, and Lance Camper. Recreational competes with the likes of

(THO)

and

(WGO),

amongst others.

This segment accounted for FY19YTD net sales of $542.6 million (31% of total) and Adj. EBITDA of $39.4 million against net sales of $563.4 million and Adj. EBITDA of $38.7 million in the prior year period.

3QFY19 Results & Revised Outlook

These reporting segments combined for a very disappointing 3QFY19, which was announced on September 4, 2019. REV Group earned $0.21 per share (Adj.) on net sales of $617.0 million in 3QFY19 versus $0.38 per share (Adj.) on net sales of $597.7 in 3QFY18. These results missed Street consensus significantly - by $0.22 a share and $15.4 million, respectively. Equally disappointing: 3QFY19 Adj. EBITDA dropped 30% to $33.5 million as margins fell 253 basis points year over year to 5.4%.

Source: Company Presentation

REV Group's issues were labor, a major ambulance order delay, demand softness for its RVs, and tariffs.

Source: Company Presentation

The company has been keeping up with demand for its fire trucks by pushing its labor force with what management described as an "inordinate" amount of overtime. This strategy has birthed two negative consequences: higher labor costs and higher turnover as workers have options in a tight employment market. To offset these effects, REV Group embarked on a 36% footprint expansion at its main fire truck facility in Ocala, FL, requiring a contemporaneous 38% increase in labor. Finding good help has proven challenging, with the additional laborers currently characterized by management as "inefficient and unproductive". Until the new employees get up to speed, they have created a bottleneck in the production process, resulting in fewer deliveries. Management expects the logjam to alleviate in 2QFY20. In the meantime, backlog in the Fire & Emergency segment has increased from $606.5 million on July 31, 2018 to $775.7 million on July 31, 2019.

In the ambulance business, REV Group experienced a delay in the awarding of a contract from a large customer (FDNY), pushing initial deliveries into FY20. In this tight labor market, REV Group elected to pay its skilled ambulance employees to wait, which negatively impacted margins. Also, the ambulance industry is experiencing a shift toward remounts, where an existing ambulance module is mounted onto a new chassis. Remounts not only delay a new ambulance sale by several years, but also cut into the company's margin opportunity by nearly half compared to a new vehicle purchase.

The third headwind is a significant drop in demand for the company's Class A RVs, which comprised ~60% of its RV product mix. As a result, backlog in the Recreational segment has plunged 48% to $129.7 million YoY. In response, management has consolidated production at two plants down to one to reduce its Class A mix share to ~40%.

Lastly, tariffs have impacted some of the company's suppliers, causing disruptions that have impacted the timing of shipments.

These undercurrents will affect the 4QFY19 as well, forcing management to meaningfully revise its FY19 metrics lower. Specifically, the topline was guided to $2.4 billion, down from $2.5 billion; Adj. EBITDA was significantly decreased from $160 million to $105 million; and Adj. net income was dropped from $75 million ($1.21 per share) to $35 million ($0.55 per share), all based on range midpoints.

With its FY ending in less than two months, these drastic cuts were met with disdain on the Street, as shares of REVG plunged 32% over the subsequent two trading sessions.

Balance Sheet & Analyst Commentary

REV Group's balance sheet reflected $19.8 million of cash and equivalents and $416.8 million of long-term debt as of July 31, 2019. It has access to a revolving credit facility with $186.9 million remaining. Despite the revised guidance, the company anticipates paying down $50-$60 million of debt (from working capital improvements) in 4QFY19, which should bring its leverage, currently at 3.3, down to ~3.0 by October 31st. Its longer-term goal is a reduction back to 2.0.

REV Group returns money to shareholders in the form of a $0.05 quarterly dividend for a current yield of 1.7%. It also has a share repurchase program in place under which it has bought 700,000+ shares during FY19YTD. A little over $38 million remains on the buyback authorization.

Sentiment for vehicle manufacturers has been poor for a long time, so it is no surprise that REV Group receives little love from the Street. Currently, one sell and six hold ratings swamp the one buy and one outperform recommendations. Analysts' median twelve-month price target is just north of $10.00 a share.

In stark contrast to the Street's and the company's own dour outlook, CEO Timothy Sullivan purchased 50,000 shares of REVG at ~$9.58 on September 10th, 2019, bringing his total position to 1.85 million shares. It was the biggest insider purchase in the stock in one and a half years. The CFO also bought nearly $100,000 worth of stock on September 16th.

Verdict

REV Group has been approximately halved since its IPO. AIP, which brought REV Group public with the endgame of cashing out, divested of ~11.5 million shares in a separate 2017 offering at $27.25 a share. The private equity group has five partners or employees on REV Group's board - an arrangement that will be maintained until its ownership dips below 15%. It should be noted that if the company's fortunes turn around, AIP will likely return to unload another slice of its 33.8 million share position.

REV Group is plagued by the same fear-of-recession dynamics as the automobile industry. Ironically, its biggest current problem (a lack of efficient and productive labor) stems from a strong economy. Two other issues vexing management (tariffs and a delayed major order) are transitory. With the exception of weakening Class A RV demand, the company's business remains strong as it continues to win contracts, including a $80 million, 164 transit bus deal from Chicago's Regional Transportation Authority; the (now in motion) $160 million, 400 ambulance contract with the FDNY; and a $107 million, 145 fire truck deal with the City of Chicago FD. Even with the steep fall in RV backlog, overall backlog is up 2%.

There is no sugarcoating the 3QFY19 quarter, but CEO Sullivan's purchase signifies his belief that the pessimism is overdone, at least on a longer-term perspective. While not compelling enough to be a core holding, REVG would seem to merit a small watch item position.

But it is difficult to tell whether something is an opportunity or a trap when you are put on the spot."― Olivia Sudjic, Sympathy

Bret Jensen is the Founder of and authors articles for the Biotech Forum, Busted IPO Forum, and Insiders Forum

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

Additional disclosure:

I have a small 'watch item' position in this name