|Shares Out. (in M):||41||P/E||0||0|
|Market Cap (in $M):||965||P/FCF||9.5||0|
|Net Debt (in $M):||-2||EBIT||0||0|
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Summary and Thesis
At current levels we believe that we believe that Rush Enterprises (NASDAQ: RUSH.A / RUSH.B) represents a highly compelling risk / reward profile. In our view, RUSH represents a mispriced, deeply undervalued, unlevered, high quality business with aligned owner operator management and for which multiple sources of upside exist.
RUSH is the largest commercial vehicle dealership (Class 4-8 trucks, buses, etc.) group in the country. It is the commercial vehicle equivalent of automotive dealership groups such as AutoNation (NYSE:AN). RUSH was founded in 1965 by Marvin Rush and the family has run the Company since and continues to own close to 10% of the Company.
At current levels, RUSH trades at ≈5.5x 2015 EBITDA, ≈7.5x 2015 EBIT, and ≈9.5x 2015 unlevered fully taxed FCF (based on non-growth CapEx). Even under highly stressed scenarios RUSH is attractively valued. Assuming a 15% revenue decline from LTM levels and 50 bps of operating margin degradation (off an LTM base of 2.84%), RUSH trades at ≈6.5x EBITDA, ≈9.5x EBIT, and ≈11.5x unlevered fully taxed FCF.
The chart below highlights the substantial valuation gap that exists between RUSH and any relevant peer group. We note two items:
1) We have included Oil Services on the far left of the chart not because RUSH is an oil services company but because RUSH has been treated as one by the market over the past 9 months.
2) Automotive dealership groups are the best business model and valuation comparable for RUSH. On a blended EBIT and EBITDA basis, RUSH trades at a ≈40% discount to automotive dealership groups.
Figure 1: EV / 2015 EBIT
Our thesis for RUSH will explore the following points:
1) RUSH possesses identifiable reasons for mispricing
2) RUSH is a high quality business with strong management
3) RUSH possesses multiple sources of upside
RUSH possesses multiple identifiable reasons for mispricing
Misunderstood balance sheet
There are two forms of financing on RUSH’s balance sheet which are categorized as debt by GAAP accounting but which should not be included in the calculation of corporate net debt for purposes of calculating enterprise value. On a superficial basis RUSH appears to be levered at 5.5x net debt / EBITDA and to be trading at 9.0x EBITDA. In fact, RUSH has a fundamentally unlevered balance sheet and is trading at 5.5x EBITDA.
1) Floor plan financing – FPF is employed by RUSH to finance the inventory on its dealership lots, as it is as well by all automotive dealerships. FPF is fundamentally a working capital liability – interest bearing accounts payable – and not corporate debt.
2) Lease and rental fleet financing – RUSH operates a rental fleet of 6,500 trucks. The fleet is financed with asset backed notes which are structured to match the duration of the leases. Lease and rental is a financing or spread business (structurally akin to a bank) and the debt is fundamentally part of its operations and not corporate debt.
The interest expense for both FPF and lease and rental fleet financing must be treated as an above the operating income line expense – i.e. economic EBIT and EBITDA are net of both FPF and lease and rental fleet interest expense. For the latter, RUSH explicitly includes the interest expense (and depreciation) in COGS, whereas for the former we must make the adjustment ourselves.
Figure 2: Rush Enterprises Capital Structure
No direct comps in either the public or private markets and a resultantly underappreciated business model
As a general rule, we find businesses that lack direct peers tend to be mispriced by the market. While there are six publicly traded automotive dealership groups and some very large private groups as well (most notably the Van Tuyl Group which was acquired by Berkshire Hathaway in October 2014), besides RUSH there are no publicly traded commercial vehicle dealership groups and only one private competitor that approaches even half of RUSH’s size.
A highly favorable characteristic of the automotive dealership business model is the percentage of profit derived from parts and service. Parts and service is a much more recurring, much less cyclical, and much higher margin revenue stream than the sale of new and used vehicles. Vehicle sales gross margins are in the mid-single-digit range whereas parts gross margins are 25%-30% and service gross margins are 65%-70%. On average, automotive dealerships generate ≈41% of gross profit from parts and service. By contrast, RUSH generates ≈63% of gross profit from parts and service.
A critical implication of RUSH’s high percentage of gross profit derived from parts and service is the Company’s high absorption ratio. Absorption ratio is a critical metric used in automotive, commercial vehicle, and other equipment dealerships. Absorption ratio measures how much of a dealership’s fixed expenses (i.e. non-vehicle sales related expenses such as commissions and carrying costs of new and used vehicles) is covered by a dealership’s gross profit from parts and service. A dealership with a higher absorption ratio will – all else equal – be less cyclical than one with a lower absorption ratio.
On average, well run automotive dealerships operate at 75% absorption ratios. By contrast, RUSH operates at almost a 120% absorption ratio. For illustrative purposes, let’s assume that a dealership has non-vehicle sales related expenses of $1mm. The average automotive dealership would generate $750K in gross profit from parts and service at that dealership whereas RUSH would generate $1.2mm in gross profit from parts and service at that dealership. Said differently, RUSH’s absorption ratio means that before it sells a new or used vehicle it is profitable at the dealership level.
Real and perceived energy headwinds
RUSH is based in TX and many of its stores are in the state. Based on commentary from management and our own analysis, we believe that 10%-15% of the Company’s business is exposed to the energy industry. The Company has quantified the potential impact to EPS from energy headwinds in 2015 by saying that assuming zero growth in other end markets, the EPS impact could be 20% vs. 2014 levels. Although 20% is absolutely a material amount, a few items require noting:
1) The vast majority of RUSH’s business has nothing to do with energy and tends to benefit from lower energy prices.
2) RUSH’s business has performed very well since oil prices collapsed. Specifically, RUSH has outperformed the industry in truck sales YTD despite sales of trucks into the energy industry declining to close to zero. Moreover, parts and service sales were up materially both y/y and sequentially in 1Q15 and 2Q15. EBITDA for 1H15 vs. 1H14 is +16%.
3) As the chart below highlights, since oil prices collapsed RUSH’s stock is down largely in line with oil services. Over the same time period, Paccar (NASDAQ:PCAR) – the owner of the Peterbilt brand for which RUSH sells ≈35% of all units – is up. In short, RUSH has already been severely penalized by the markets for its energy industry exposure.
Figure 3: Rush Enterprises Stock price vs. Oil Services and Paccar
RUSH is a high quality business with strong management
Impressive long-term growth
As the table below presents, over the past 10 years RUSH has achieved 3x-4x the revenue and gross profit growth of PCAR and the automotive dealership groups. Critically, RUSH has achieved such growth without issuing any equity and without assuming any net corporate debt, all while also facing significant headwinds. Specifically, 2005 was close to a peak year for commercial vehicle sales (due to regulatory spurred pre-buying) and commercial vehicle sales were down 13% in 2014 vs. 2005. By contrast, light vehicle SAAR was down 3% in 2014 vs. 2005.
The table also highlights RUSH’s severely lagging operating profit growth. That is a recent phenomenon which is the result of elevated investments made towards business expansion and optimization that have suppressed operating margins below normalized levels. We view the reversal of that dynamic as a substantial earnings growth opportunity for RUSH and will return to it later in further detail.
As the chart below presents, RUSH generates superior ROIC/ROTIC than any relevant peer group and, most importantly, higher than the automotive dealership groups:
Figure 4: Return-on-invested capital
Figure 5: Return-on-tangible-invested-capital
We note that the ROIC/ROTIC analysis is based on 2014 numbers which, for RUSH, embed significantly below normalized operating margins. At normalized margins, RUSH’s ROIC/ROTIC would have been 600/1000 bps higher.
Highly regarded company and management
We have followed RUSH for a long time and have spoken with participants across the industry value chain. The resounding message is that both the Company and management are highly respected.
Industry participants have consistently emphasized how RUSH has separated itself from competitors by establishing a national network of dealership locations. As a result of its scale, RUSH has capabilities that other dealership groups lack. Specifically, for example, RUSH directly sources certain parts rather than going through its OEM partners and forfeiting margins. More generally, RUSH can position itself to large fleets as the only dealership group capable of providing consistent and integrated services across multiple geographies.
RUSH possesses multiple sources of upside
Operating margin normalization
RUSH’s most significant source of upside is operating margin normalization. As previously referenced, over the past couple of years RUSH has made significant investments towards business expansion and optimization that have resulted in temporary margin suppression.
The chart below presents RUSH’s absorption ratio over time, highlighting the outstanding job the Company has done of improving absorption ratio over the past 10+ years:
Figure 6: Rush Enterprises Absorption Ratio
All else being equal, the 2,600 bps improvement in absorption ratio since 2003 should have translated into a 260 bps improvement in operating margin. Similarly, the 400 bps improvement in absorption ratio since 2011 should have translated into a 40 bps improvement in operating margin.
However, the operating margin expansion has not occurred. The following chart presents two figures: 1) RUSH’s operating margins over time (the dark blue bars); 2) RUSH’s central G&A over time (the light blue bars). While RUSH does not provide a separate line item for central G&A, using Company disclosures for the ‘Selling’ component of SG&A and the absorption ratio related (dealership level) G&A, we can back into an estimate of central G&A. By using the same methodology for all time periods the directional implications are sound: operating margins have been suppressed in recent years because central G&A has increased dramatically.
Figure 7: Operating Margins and Centralized Costs
We believe that normalized margins for RUSH are ≈4.0%. In addition to thorough analysis of the Company’s historical performance and commentary from Company management, third party data points buttress our view. Penske Automotive (NYSE:PAG) cited structurally higher operating margins for commercial vehicle dealerships vs. automotive dealerships – with the former in the 4.0%-4.5% range – as a key reason for PAG’s entry into the commercial vehicle dealership business in late 2014. Moreover, our research confirmed that many well run private dealerships generate operating margins significantly in excess of 4.0%.
RUSH should continue to grow organically through market share and wallet share gains as it further leverages its position as the sole national commercial vehicle dealership network. RUSH’s largest organic growth opportunity is within parts and service where the Company continues to invest to expand its reach and capabilities. RUSH estimates that it currently has ≈4% of the total parts opportunity (vs. vehicle sales market share of 5%-7%) but believes that it can address well more than half of the total parts opportunity. In the most recent quarter – despite the severe energy headwinds faced by the Company – RUSH generated +4.0% same-store parts and service growth and on a YTD basis same-store parts and service growth is +6.0%. The Company’s goal is to double parts and service sales by 2020.
On the acquisition front, RUSH should continue to find attractive tuck-in acquisitions as the Company has over the past decades.
As discussed, RUSH’s balance sheet is fundamentally unlevered. By contrast, the publicly traded automotive dealership groups are levered, on average, at 2.5x net debt / EBITDA. At 2.5x net debt / EBTIDA RUSH could assume ≈$450mm in debt and repurchase ≈50% of the Company. While we don’t anticipate that RUSH will repurchase half the Company, RUSH has the balance sheet capacity to commence a more significant repurchase than the $40mm program currently in place.
Sources of upside – earnings implications and valuation implications
We believe that a combination of margin normalization, topline growth, and share repurchases will substantially increase RUSH’s earnings and intrinsic value per share.
The chart below presents RUSH’s EPS under various scenarios. We note that there is a ≈$20mm ($.50/share) delta between D&A and non-growth CapEx:
Figure 8: EPS Waterfall
The table below presents value per share under various earnings scenarios at peer multiples:
Figure 9: Valuation Waterfall
We identify 3 primary risks to the investment:
1) Energy - Although RUSH has communicated the expected impact of energy industry weakness, conditions could worsen and/or derivative effects could be negative.
2) Truck Cycle - Class 8 truck sales were ≈10% above long-term average levels in 2014 and should be ≈15% above long-term average levels in 2015. Sales in all years from 2007-2013 were below long-term average levels. A meaningful retrenchment in Class 8 truck sales could negatively impact earning.
3) Leverage – An unlevered balance sheet represents inefficient capital allocation and limits the equity upside from topline growth or operating margin normalization.
We believe the risks are largely or wholly discounted by the current share price. To illustrate: we do not believe that LTM revenues are above normalized levels and we believe that LTM operating margins are below normalized levels. However, let’s assume that for whatever reason normalized revenues are 15% below LTM levels and normalized EBIT margins are 50 bps below LTM levels (which would put normalized EBIT margins slightly above average EBIT margins for 2008-2010, a period with a very difficult macro backdrop). At an 8x EBIT multiple – which corresponds to 10x unlevered fully taxed FCF – value per share is $20.00.
Therefore, while we recognize that there are risks present in the investment, we believe that at current levels the risk of permanent capital impairment is low. Moreover, we believe various equity shorts can be used to effectively hedge out energy and truck cycle risks.
 RUSH has two share classes: A shares with 1/20th of a vote per share and B shares with 1 vote per share. The B shares are less liquid than the A shares and trade at a ≈10% discount to the A shares. The valuation metrics referenced in this write-up are based on a share price mid-point between the A and B share prices. For further commentary on recent developments regarding RUSH’s dual class share structure, we point investors to the RBC note from August 6, 2015 (published following a non-deal roadshow with the Company) and to the Company’s 8K filed September 4, 2015. Both the RBC analyst comments and the Company’s 8K make clear RUSH’s efforts and desires to collapse the dual class share structure.
 We believe our estimates are conservative, though in line with management’s implied guidance (see 10Q for details). Specifically, our estimates incorporate back-half 2015 weakness. Therefore, despite 1H15 EBITDA +16% y/y, we expect 2015 results to fall short of LTM levels. On an LTM basis, RUSH trades at ≈5x EBITDA, ≈6.5x EBIT, and
 Many oil services companies will generate minimal or negative profitability in 2015. To arrive at a peer group valuation multiple, we had to make certain adjustments based on normalized margins and 2015E revenues.
 On an LTM basis, RUSH trades at a ≈45% discount to automotive dealership groups. See footnote 2.
 I.e. the analysis assumes a situation where the improvement in absorption ratio is a result of increased gross profit from parts and service and that absorption ratio related expenses remain flat.
 I.e. although it is possible that our calculation of central G&A does not accord precisely with the Company’s internal calculation of the figure, on a directional basis we believe our analysis is correct.
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