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Sunday, October 21, 2007

Miller Industries (MLR)

Miller Industries (MLR, sec) They convert trucks into wreckers, tow trucks, recovery equipment, etc. They're the largest manufacturer. When they announced results for Q2 2007, they included this warning:

Mr. Badgley concluded, “With the completion of the most recent municipal and military orders and with no additional follow-on orders on these contracts to date, our order intake has moderated. We expect this to cause net sales for the remainder of 2007 to be lower than those achieved during the past several quarters. While we remain optimistic about our ability to secure additional follow-on orders, we cannot predict the success or the timing of any such orders under these contracts. We continue to be concerned about general economic conditions and the effect they could have on the towing and recovery industry, as well as the level of acceptance by our customers of the 2008 chassis with new engine emission requirements. Accordingly, we have taken appropriate steps to reduce our production levels and lower our costs for the remainder of the year in response to these uncertainties. We will continue to monitor our cost structure to ensure that it remains in line with business conditions.”
The results for Q2 were good, but this warning killed the stock. The price went from $25.50 down to $15.59. I had look at this two years ago at $18 and passed on it, figuring it might be worth $19, but feared potential competition from a lower cost manufacturer in Asia.

I looked at it a year ago (and here with a quick valuation of $22) at around $18 and passed again. Materials costs were rising, as one would expect nowadays.

Looking at Q2 results: The balance sheet has improved a bit (although it has the look of a business that's winding down somewhat). I see they expanded PP&E somewhat.

Once again, I see the same big issue of low margins and interest rate sensitivity. Q2 was a solid quarter revenue-wise. Gross margins were only 15.8%! SG&A ate up another 6.4%. Interest expense was only 0.8% of revenue so perhaps that's not going to be so much of an issue (if rates go up that much, I've got bigger problems to worry about). They earned 88 cents diluted in the first half.

I expect operating cash flow to be well above earnings, but it's not because of a huge drop in AP. Ok, fine. Operations produced a reasonable amount of cash, but capex was large: about half of the operating cash flow. That's not what you'd want to see if you suddenly worried about the business drying up. CVU had that same issue a couple years ago.

The other half of operating cash flow went into paying off debt, which has been cut in half since the end of last year. Good move. Senior debt is now lowered to LIBOR plus 0.75%-to-1.50% (100 basis points lower). Junior debt was with the CEO and was paid off.

Ok, so here's the question: If the company proved to be as solid and well run as they appear, where are they going to be 5 to 10 years from now in terms of free cash flow? Can potential Asian competition's low cost make up for a lack of industry experience, knowledge, and proximity to customers? I'm thinking that I overrated this somewhat. I wouldn't worry much if MLR's margins were higher and they could absorb some price reductions. But there's not a lot of freeboard above the waterline and if someone in Asia decided to make a lot of waves for a few years, MLR could be in trouble. But if I had to pick a valuation number, is $22 reasonable? I expect long term growth (even with Buffett betting on railroads). Heavy highway vehicles aren't going away. But I don't expect big growth. Let's call it $20.

In the short term, as far as military orders go, this blog post from the highly respected historian/observer VDH contains some interesting observations in Iraq:

The number of vehicles, arms, bases, and American infrastructure in Iraq is staggering. And the wear and tear on it all is evident everywhere. I wouldn’t be surprised that 30% of our equipment is worn out to the degree that it wouldn’t make sense hauling it back, and would be better off left to help transition the Iraqis. Humvees have sprung doors, broken glass, missing pieces, well in addition to the wear from sand and heat.
There's a lot of stuff that's going to need repair/replacement. I wonder if MLR might snag a big chunk of that business?

With the stock price at $15.59, I don't think it's cheap enough, unless I had to pick 50 stocks as a fund manager.

continue following

UPDATE Mon Oct 21, 2007:
Ok, perhaps because I'm bored and undisciplined, I bought back some shares of SDTH when it dropped this morning.

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