Geoff Gannon April 10, 2020

Miller Industries: A Pretty Good, But Very Cyclical Business that Sells its Car Wreckers and Car Carriers Through a Loyal Distributor Base

Miller Industries (MLR) has a lot of things to like about it. But, the timing of buying this stock now definitely isn’t one of them. Miller is in a very cyclical, highly durable capital good industry – it produces “car wreckers” and “car carriers” – that depends heavily on business confidence and especially access to capital. It is very easy to defer the purchase of a new wrecker or carrier. And it is very hard – impossible, really – to sell wreckers or carriers without easily available credit. To give you some idea of how important credit is in this industry – Miller Industries is currently promising lenders to its distributors (these are all technically “independent distributors”) that it will buy back up to $74 million of its own wreckers and carriers if the lender repossess that collateral from the distributor. Miller makes this kind of promise all the time. In recent years, it has not had to buy back any of its equipment. But, you see the problem. It might have to do so. And, the fact that distributors are using financing that depends on the lender getting a promise from Miller (the original equipment manufacturer) gives you some idea of how important credit is in this industry. The distributors – there are 80 of them in the U.S., and Miller estimates that about 68 of them don’t actually sell any wreckers or carriers other than Miller products – rely heavily on floorplan financing.

The industry is also very cyclical. In the last economic cycle, Miller’s sales peaked at $409 million in 2006 and bottomed out at $238 million (down 42%) in 2009. Gross profit dropped by the same percentage (42%). Operating profit – however – went from $33 million in 2006 to $7 million in 2008 (down 80%). Could the same thing happen in this recession?

Yes, it could.

So, Miller’s P/E, P/S, etc. ratios are all very suspect right now. Maybe price-to-tangible book value would be a better guide to the company’s valuation. The good news is that the P/E and P/S ratios here are low. But, that’s what you’d expect with a cyclical stock that everyone now knows is at the very top of its cyclical (the recession has already started as I write this, and Miller reported earnings less than a month ago that were its best ever – so, we can call this the official peak). The P/E ratio on those peak earnings is between 7 and 8. The P/S ratio is about 0.4 times. The company has a tangible book value of $21.60. As I write this – the stock is trading at $25.89. So, the P/B ratio here is 1.2 times. That makes it pretty easy to compare this company’s long-term history with its current stock price. Miller probably doesn’t convert all its reported earnings into cash. So, if stocks generally return say 8-10% a year – and we use that as the hurdle rate you, as an investor are looking for – then we need to see returns on equity from Miller (over a full cycle) that are at least 8-10% times 1.2 = 9.6% to 12%. Let’s call that a requirement for a 10-12% return on equity over a full cycle.

What has Miller actually done?

Over the last 16 years, Miller has averaged a 14.2% return on equity. That period starts right after a (comparatively mild) recession in the early 2000s. On the other hand, it doesn’t include the lower taxes Miller is paying now versus what it paid years ago. So, I’d say – yeah – Miller hits about a 14% ROE over a full-cycle which adjusted for today’s taxes might even be more like a 17% return on equity. Now, I do have to warn you about the word “average” here. I’m giving you an arithmetic average which is the least conservative way of calculating an average for a cyclical stock. The most conservative way would be to use the harmonic average. An arithmetic average weights things toward the highest ROE years. A harmonic average weights things toward the lowest average years. The harmonic average would be about 9%. However, taking into account the change in taxes – I’d still say it’s a 10-11% average. And that’s unfairly low for a cyclical company. The reality for Miller is somewhere between the harmonic and arithmetic averages. What you should really use is the geometric average to be fair. But, honestly, I don’t want to be fair. I want to look at the downside here. And the harmonic average tells me to expect a downside of more like 10%. Again, though – we need to remember this period included The Great Recession. So, over a full 15-years, I think we can say Miller should normally do better than a 10% return on equity. However, we also need to remember that Miller may do worse than ever in the next year or next few years. I showed you the drop in sales and earnings after the financial crisis. Buyers of Miller shares today should be prepared for a 50% decline in sales and an 80% decline in profits in this recession.

That does not, however, mean now is the wrong time to buy the stock. Sometimes, a cyclical stock is attractive as we are headed into a recession, as we are in a recession, or when we are almost about to emerge from a recession. That’s because it can get so cheap as people price in a recession that the stock is cheap relative to its full cycle earnings. Is that the case here?

Well, I estimated Miller’s range of possible ROE outcomes over a full cycle was something like 10% to 17%. The price-to-tangible book ratio is now 1.2. So, that gives us an 8% (10%/1.2 = 8%) to 14% (17%/1.2 = 14%) kind of normalized earnings yield. To put this in P/E terms – Miller might be trading at something like 7 to 12 times earnings. Basically, the “cyclically adjusted” P/E on this stock could be as low as a P/E of 7 or as high as a P/E of 12. Both sound reasonable enough. The long-term ROE on this stock is good enough too.

So, Miller might be cheap.

Is it safe?

Well, it’s in for a brutal time cyclically. And it does have some off balance sheet arrangements that could cause problems. Miller has promised to buy like $50 million of what are basically raw materials. I suspect, however, the company could get out of this. It’s not always the case that you need to honor purchase obligations in a situation like this. In general, I wouldn’t assume that just because a company has said it will buy $50 million of supplies it will always end up buying those supplies when its factories are shut down by government order. There’s also the $74 million in promises to buy back equipment it produced for distributors if they default. I don’t want to overstate that promise. Could it get triggered in 2020 or 2021? Absolutely. But, in normal years, it’s never triggered at all. On top of that, the lender would be selling the equipment back to Miller. So, Miller’s balance sheet would lose cash but gain finished equipment. That’s not good. But, it’s not the same as burning cash. And, I doubt Miller agreed to – nor do I think the lender even proposed the possibility of – Miller buying back repossessed equipment at rates above what they could easily be re-sold for (given enough time and an orderly market). The lender just doesn’t know how to dispose of car wreckers and car carriers. It’s not the kind of thing they could repossess and sell as well as Miller can. So, I think it’s a real risk Miller might actually have to buy some of its own equipment back in a bad recession. But, it’s not as big a risk as I’m used to seeing at a lot of companies.

Okay. So, Miller has a couple off-balance sheet items that might cause it a bit of trouble. What about on the balance sheet?

I can’t think of a better balance sheet you’d want to have than what Miller is going into this recession with. It’s a thing of beauty. Current assets are double total liabilities. Quick assets – cash and receivables – are 1.5 times total liabilities. Some inventory – which I didn’t include in quick assets – is finished goods. And, we know, Miller produces almost everything to order. So, that portion of inventory will get sold. The company also had a backlog of about 4 months as of the end of the quarter. That backlog consists only of what Miller consider “firm” orders. They could be a lot less firm in the face of coronavirus as it exists about a month since Miller talked about its backlog. But, my point is that some of that inventory can get turned to cash. And it doesn’t even need to. Miller has plenty of coverage of all of its liabilities using just its cash and receivables. Cash is about $24 million while debt is $5 million. So, Miller has less than $20 million in actual cash on hand. But, the receivable balance is very big. Only one distributor accounts for 16% of receivables. No other distributor accounts for even 10%. The company also has a $50 million credit facility that it has not drawn on. I won’t get into all the PP&E and such. But, that credit facility is unsecured. The PP&E consists of some land, a lot of plant assets, and then a bunch of equipment. A lot of this PP&E is from very new cap-ex – the company spent way more on cap-ex in the last 3 years than is required to maintain the business. So, overall, I think liabilities are low, liquid assets are high, and there’s some additional owned assets that aren’t mortgaged or anything. Plus, you’ve got a credit line. It’s also worth mentioning Miller’s SG&A is like 5-6% of sales (though this may be overly flattering, because I think some “sales” are pass through components at basically no gross profit). The U.S. workforce – which accounts for about 85% of Miller’s sales – is non-union. The European workforce is also non-union – but, probably a lot harder to lay off. Also, one of Miller’s European plants is in the U.K. and the U.K. is offering some assistance to companies that might make the fixed costs of running a factory a bit more sustainable.

I haven’t talked about the business. In normal times, I think I’d like but not love this business. Miller is the leader in the field. Starting in the 1990s, they acquired the best known brands of car wreckers, car carriers, and auto transports. Sales of these things are made to governments and the like. But, the real customer base is professional towing companies. These are companies that clear accidents on the road (using light duty wreckers), that move heavy equipment, that pick-up overturned trucks and buses, that carry cars long-distances to dealerships, etc. Companies that need these services include insurance companies, auto auction companies, rental car companies, etc. But, the important thing to think about is towing companies buying these products through distributors. Purchases are made on credit. And distributor inventory is owned using floorplan financing. This industry is super sensitive to credit. It’s super cyclical.

But, as we saw, over a full cycle – ROE is acceptable. And, for the most part, that ROE was achieved without use of much debt. Miller hasn’t given out any stock options in recent years. It has invested super heavily in expanding its manufacturing base. A lot of this is modernization – not just capacity increases. The vast majority of dealers have been selling Miller products for over 10 years. Many dealers have been with the company for over 25 years. All the top executives at Miller – including the Chairman and the Co-CEO have been with the company since at least the 1990s (20-30 years). A few have been with the company even longer. Insider ownership is not high here. The biggest shareholders are mutual fund owners (focused on small caps). Miller claims it focuses on competing on relationship with its dealers, customer service, quality, innovation, and having a known brand – not primarily on price. Their actions suggest that. They spend a very low amount of R&D versus sales. But, it’s not terrible versus gross profit. And they built a dedicated, free standing R&D facility. They employ 50 engineers out of 1,310 people total (engineers are 4% of the workforce). So, I do believe the things they say.

One final point – I mentioned a “pass through” of sales at like no gross profit. I’m very, very suspicious that this company’s sales make it seem bigger than it is. Why is that? Well, the way this business works is that Miller builds the body of a wrecker or a car carrier. However, what distributor wants to hold inventory consisting of the body of a car carrier or the body of a wrecker and tell the customer – we can put this together for you with a truck chassis later? Nobody wants that. What they want is a wrecker or carrier affixed to a truck chassis already. Miller doesn’t make that part of the product. But, it can just buy a truck chassis and combine it with what it does make. So, that’s what Miller does. For a variety of reasons, I don’t believe Miller can get better pricing on a truck chassis than others could and don’t think there’s room for making profit on buying a chassis and selling it with a wrecker or carrier body. I think all the gross profit is in the body. So, you’ll see things like a 15% gross margin at Miller and a 5% SG&A as a percent of sales expense. I think all that stuff is a bit misleading. The chassis is a meaningful part of the final cost – and Miller doesn’t make it and isn’t in a position to buy it at a wide enough spread to make retail type margins. So, what I’m saying is that I think Miller’s profits all come from just the body portion of the sales – but, accounting rules require sales be shown as the combination of the body and the chassis. I think this overstates sales and causes the gross margin at Miller to look oddly low. Again, what matters is really ROE. And, as we’ve shown, Miller has achieved an acceptable ROE over a full cycle.

I’m not sure this company is cheap. I do think it’s safe. I’m really not sure now is a good time to buy the stock – but, timing isn’t really my thing. It’s not an amazing business over a full cycle. But, it’s good enough to be real interesting. For a cyclical stock and a manufacturer – I’m surprised to say I kind of like this one.

But, I don’t like it nearly enough to suggest buying it anytime soon. Still, it’s one I’m willing to revisit.

Geoff’s Initial Interest: 50%

Geoff’s Revisit Price: $14/share