Introduction

Douglas Dynamics (NYSE:PLOW) has seen its stock price get cut by nearly half since the start of 2021, piquing the interest of myself and other investors I know. This price decline isn’t totally unreasonable from a fundamental perspective, however, as sales and EBITDA has declined materially throughout 2023 after a battled 2022.

However, depending on what you infer is happening behind those numbers will dictate how you see today’s valuation – i.e., whether as an opportunity or a value trap. I’m more in the former camp, thinking that many of today’s sales and margins issues are non-recurring in nature and that they can get back to higher sales/EBITDA levels and thus, a higher stock price ahead.

Work Truck Attachments (WTA): Battling External Headwinds

Q1 2024 sales in their WTA segment increased ~24% year-over-year to ~$24M. What you’ll see, however, is that in Q4 2023, sales were down ~44%. Going through this, we can probably chalk up pricing as a slight tailwind. They noted it as pricing in Q2 for the WTA segment and in the Q3 10-Q, although nothing since then, so I’m assuming that any pricing benefits are marginal.

WTA is a fairly macro resilient business, but not entirely. They likely sell to some municipal end-customers here, but the biggest end-users here are professional landscaping businesses – who contract work for residential and commercial purposes – and on-staff maintenance crews at universities, for instance. So, to the extent that some end-customers serve discretionary needs like maintaining someone’s lawn/property, there could be a few situations where a worsened macro has resulted in some landscaping spend. And it’s also reasonable to think that some of the institutions they ultimately sell to have cut back on new equipment spend.

Indeed, we can see that while 2009’s sales were ~3% lower, their core equipment volumes declined 13.5%, offset by higher prices to cover inflation and new product introductions. Although, 2008 was a tougher comp given an elevated backlog, so net, perhaps something more high-single-digit is appropriate to adjust for the weather comp dynamic.

Now, PLOW is specifically selling to dealers, and as they called out in Q3 2023, dealers were working down their inventory levels from lower sales which effectively lowered PLOW’s sales below end-market demand levels. In Q4 and in Q1, they confirmed that this trend continued too, interestingly noting that “it’s going to take some of our dealers a little bit of time to work through existing inventory before they grab our new product lines.”

If we zoom out though across the past 2 quarters, what’s been causing the bulk of the decline isn’t macro, but lower snowfall levels. Obviously, if there’s less snowfall, equipment is getting used less, and consequently, there’s less wear-and-tear – i.e., the need to replace the equipment. This is what management is pointing to, which is consistent third-party reports. What’s merely happening today is that the comp is turning the corner.

It’s clear that there’s not a value proposition issue. To this end, attractively, since the value proposition is levered to the use case, the demand stream here is that outside of the snowfall randomness, there’s a recurring pattern every year of weather-driven demand – i.e., while to differing degrees, snow will fall every year, so to some relatively stable extent, there’ll always be demand.

I think it’s unlikely they’re losing market share too, where they compete against the BOSS brand (owned by Toro (TTC)), Buyers Product Company, and various other brands. PLOW claims they have 50-60% market share in the snow and ice (WTA) segment, so they’ve clearly been historically very competitive.

But from one angle, there hasn’t been anything that’s changed lately in terms of PLOW’s value proposition. And two, TTC reported lower shipments in Q1 (calendar Q4) of their snow and ice products, so they’re feeling directionally similar impacts, and also confirmed lower snowfall levels. While we don’t have data on their other competitors, their history would suggest minimal share loss. Adjusted for macro/weather by looking at pre-2023 results, their WTA business was growing – see post-COVID until 2022, and pre-COVID, which shows sales growth from ~$240M in FY17 to ~$380M in FY22, a ~10% CAGR, which was all organic. 2022 benefitted from inventory build and 2017 was depressed due to weaker-than-average weather, so this growth rate isn’t a perfect representation of underlying (controllable) growth.

As a separate point here, outside of some weather and price benefits, they’ve been growing their distribution. For instance, if we go back to 2018, they listed having 2,100 points of distribution, then 2,900 in 2021, which we know has subsequently increased to 3,100 today. However, in the 2022 10-K, they listed over 3,100, suggesting that growth in distribution points were minimal throughout 2023.

But anyhow, looking ahead, while they could decline further in the interim from further macro or weather pressures (although the Q4 to Q1 trend doesn’t suggest it’s rapidly degrading as most of this is seasonal), it seems likely to me that they grow over time. To this end, they could be posting mid-$300M in a few years. 2022, for instance, when they posted $380M in sales, was a relatively average weather year and macro state. Now, dealers were building their inventories, so all else equal, they shouldn’t get all the way back, and we’ve experienced macro pressures since, but with most of this weather-driven, should weather revert to these averages, WTA could be posting $340-$350M today. Assuming 4% growth this gets me to ~$370M by ~FY26. To be conservative, it’s probably best we think about this being an FY27 achievement, as they point out it’ll take a few seasons to get back to normalized spend.

Margin-wise, Q1 segment EBITDA margins were (18.7%), down from (~53%) in the prior Q1 and down from 11.1% on $55M in sales in Q1. Their contribution margins have likely grown versus last year from higher prices as we noted earlier. Concurrently, it’s likely their cost inflation has moderated as they’re no longer calling it out. And consistent with this, they were calling out improved supply of components throughout 2023.

What’s causing today’s margin increase, however, was operating leverage resulting from higher sales volumes. And this is understandable too when we think of the embedded costs here – they’ll of course have variable costs like product costs (components) and freight, but they’ll also have various fixed costs such as D&A, back-office employee (salaries), respective R&D and advertising costs, and then lease/rent. So, there’s a reasonable amount of leverage in the business.

Concurrently, they’ve initiated a cost takeout initiative to which are partly boosting this, an understandable cost move given the reduction in sales. As noted in the 8-K, they’re restructuring WTA with a focus on reducing centralized headcount. They expect it to generate $8-10M in annualized savings, with ~75% realized in 2024. So, in Q1, they may have taken out something like half a million or so of costs versus last year, but not too much.

Added up though, if they get to $370M in sales, I don’t see why ~20% margins are unreasonable. They posted 20.5% on $380M in sales in 2022, but their contribution margins have likely increased versus last year. Plus, they’ve historically posted mid-20% margins with fewer sales, suggesting their contribution margins have yet to normalize to historical levels (although I’m not assuming they get back to this point). And this embeds a mix recovery too.

Assuming then that they can do 20% EBITDA margins on $370M of sales, that would give me ~FY27 sales/EBITDA of ~$370/$74M.

Work Truck Solutions (WTS): Working Through Backlog

Q1 2024 sales for their WTS segment increased ~14% year-over-year to ~$72M, up from $63M in the prior quarter, although down from $79M in Q4. While it’s hard to quantify, price has been a tailwind here as they note on the call, specifically for their municipal contracts (HENDERSON business whose primary customer is local governments). Essentially, what’s happening is that orders in their backlog which were priced higher are incrementally continuing to flow through.

But volumes were higher too. The only challenge here though is that it’s hard to get a good read on their true real-time demand because Q1 sales benefitted from backlog reduction. For instance, they ended Q4 2023 with $296M in backlog, down from $369M at the end of 2022. Now, what contributed to Q1 would’ve been the delta versus Q4, although they don’t provide the Q1 backlog, so we don’t know for sure what the backlog reduction was in Q1. But net, they’ve noted they’ve been reducing their backlog and thus, it’s likely they worked it down in Q1 too.

For context here, what’s been happening is that there’s a chassis shortage, so for both Henderson (class 7 and 8 trucks) and Dejana (class 3 through 6 trucks), they’ve only able to get a limited supply of chasses from the OEMs – e.g., Ford – which in turn limited the number of upfitted trucks they could deliver. They’re able to work down their backlog today/throughout 2023 and into today as chassis supply has improved.

But in any event, end-market demand is hard to read for the above reasons. My sense though is that it’s largely stable. I’d estimate that the backlog reduction may have contributed something around $10M in Q1, implying that they had maybe ~$62M-ish in new orders. Last year, they posted $63M in sales in Q4, although they were also growing backlog in that period, so true demand was higher. So, on an adjusted year-over-year basis, it’s probably flat-to-down, although considering that PLOW also raised prices between the two periods, orders are more likely down volume-wise.

Qualitatively, the macro has probably hurt them a little. They’re selling to both professionals like they are in WTA, and then they have a bigger municipal business here from their HENDERSON business where local governments purchase fleets to clean up roads and highways, etc. Municipal budgets have been rather strong as of late, so while they could have softened a little versus last year with some softening in housing prices, I don’t sense any material pullback in spend, consistent with Alamo Group’s (ALG) comments. Indeed, they even note that their municipal customers are generally not macro effected.

Then there’s also the Dejana business, which isn’t tied to snow and ice but to various industries – i.e., anyone with a fleet of vans, essentially, carrying assorted tools that need organization. Here, I can imagine some impact given the general economic trends in the U.S. I.e., It’s conceivable that some customers have deferred new vehicle spend or upgrades out of either budgetary constraints, or general uncertainty.

Competitively, I find it unlikely they’re losing share. They compete against a number of different players including Monroe Truck, Godwin Manufacturing, Alamo Group (ALG), and also against TBEI which is owned by Federal Signal Corp (FSS). But all considered, there are a variety of competitors.

To this end, FSS’s Environmental Solutions segment grew ~24% and saw an increase in the backlog. The issue though is that TBEI is just one piece in there, so we don’t know exactly what’s comparable. Same for ALG – their Industrial Equipment segment grew 23% in FY23, and management noted snow equipment as a grower. However, like PLOW, it’s hard to get a read because while snow equipment grew, they also talked about it in the context of a “strong” backlog.

Like WTA, though, if we zoom out, this is a business that historically has grown – we can see post-COVID and then pre-COVID. Per the 10-K, they saw softness in municipal in 2018 attributed to insufficient chassis supply, but between both 2018 and 2019, they saw a net increase in demand, and this was all organic too. So, this doesn’t suggest to me that they were losing market share. It’s harder to infer from the post-COVID data as sales were pressured by chassis and component shortages, but as noted earlier, their backlog was growing, signaling that orders were indeed growing.

One thing that’ll help in 2024 is that they’re introducing a new product – the DynaPro dumb body line is getting a “landscape” body, which was introduced in 2023. This, to my understanding, extends their product line – i.e., it’s not a new version of an existing product. Indeed, they noted in Q3 2023 that Dejana was previously sourcing these products from other vendors when they did the upfitting work. So, this is going to be an incremental revenue source for them and contribute in 2024 and onwards.

Margin-wise, Q1 EBITDA margins were 8.4%, up from 4.5% last year, although down from 11.1% in Q4 (sequentially). What’s benefiting them are improved contribution margins thanks to improved pricing. Like other backlog-affected businesses, the price of the delivered trucks/products are getting closer to normalized contribution margins as inflation slows – i.e., previously priced orders aren’t affected by rampant cost inflation post-order.

Labor has seen some inflation since the end of 2022 – confirmed by FSS – but core raw materials like steel are down. They, of course, source various other components, but given the general direction of various raw materials, this is probably true across the board. And as noted earlier, the increase in component supply that they’re seeing would be consistent with stabilizing (or declining) market prices.

Also contributing was operating leverage with sales up ~14%. After all, this is a manufacturing business, so like WTA, there’s labor utilization benefits, back-office expense leverage, ad/marketing expenses leverage, and other various fixed costs like plant overhead. And that goes for their upfitting facilities too, although these will carry less equipment.

Putting it together then, the $72M of sales isn’t a perfect run rate, because there’s some seasonality. However, WTS won’t entirely follow typical seasonality today because of the backlog situation. I.e., Sales would typically decline from a stronger Q4 into Q1 (as they did), however they’re offsetting some seasonality with backlog reductions. So, for simplicity, a $300M annual run rate makes sense to me (assumes less than average seasonality).

Looking ahead, they’re not expecting chassis supply to improve much in 2024 – “stable to slightly improving” – but they should continue to see pricing benefits for maybe another quarter or two as they continue to work through their backlog. Beyond these variables, I’m OK assuming they grow from here, particularly as the backlog will continue to support sales for the time being. It sounds like the chassis situation should normalize to a higher level on an annual basis such that they can sell more per period, but I’m not sure. That would assume that true end-market demand is higher too. But consistent with pre-COVID growth, between price, new product intros, and geographical expansion, it’s reasonable to me that they can grow low-single-digits. At 3% growth, we’d be looking at FY27 sales of nearly $328M.

Just in Q4, they did ~11% margin on $79M in sales, so if they get to ~$82M a quarter like I’m assuming, an 11% margin is certainly achievable assuming cost inflation is passed on. And it’s likely they’ll pick up some additional pricing. Indeed, their margin target is for double-digit to low-teens on a full year basis. So, simply assuming 11.5% margins on ~$328M in sales, they’d post ~$38M in EBITDA by FY26.

Valuation: Interesting

In terms of capital allocation, they’ll spend about 2% of sales annually on maintenance-related capex, fixing and upgrading facilities and equipment. The rest of free-cash-flow will be funneled to shareholders via debt repayments (which I’d prefer at these levels) and dividends.

That said, they have a desire to do M&A, specifically within WTA and specifically into non-snow and ice products to diversify their business. They haven’t done an acquisition since 2017, which came after the large acquisitions of Henderson in 2014 and Dejana in 2016. And notably, both of these acquisitions were completed when today CEO Bob McCormick was CFO.

I’m OK assuming the deals will be average financially. On the one hand, they paid around 10x net income for Dejana at the time of the acquisition (and less when you back out the acquired cash), which has likely grown since. But on the other hand, they paid ~25-30x earnings for HENDERSON. HENDERSON’s also likely grown since, but they’ll need to grow for a long time to make this a materially above-average IRR. So, I’m simply assuming that M&A will be average.

Finally, one notable risk today is that despite their profitability and interest coverage, they’re very close to breaching their covenants. As they point out, they were at a 3.3x ratio by quarter end, with the covenant threshold set to go back to 3.5x by year end. Their leverage ratio should improve by year end should demand trend as expected, but any operational hiccup could result in a breach. As a consequence, it’s possible they’d see a rate hike by the respective bank.

Added up, at today’s price of ~$22/share with 23.1M basic S/O, that’s a $508M market cap. Net of $2M of cash (seasonally low) and $243M of total debt, that’s an EV of ~$749M.

Putting together my earlier conclusions on what I think PLOW could be posting in FY27, I get an implied sales/EBITDA level of $698M/$112M. Subtracting out D&A at 1.25% of sales ($8.7M), SBC at 0.7% of sales ($5M), $14M of interest expense, and a 25% tax rate, this spits out net income of ~$63M in FY27. Add back D&A and back out capex at 2.5% ($17M) and I get ~$54M in FCF.

What multiple to assign this? I think ~14x FCF multiple, implying low-to-mid-single-digit long-term growth. In my opinion, this also adjusts for the natural cyclicality in their long-term earnings as weather trends will continue to oscillate and thus, impact their sales/earnings. But within their control, they should continue to eke out sales growth between price and new products, which should be further boosted with operating leverage.

Net, that would equate to a market cap of $756M in FY27 – add in, say, $100M of free-cash-flow generated in the interim that’ll likely be sent to shareholders via dividends and the adjusted market cap is $856M. Discounted back to today, that’s a market cap of $585M, or ~$25/share. Versus the $22 they’re trading at today, this then amounts to an interesting valuation assuming those economics are achieved, which largely rests on the weather cooperating.

Conclusion

All considered, I think PLOW offers a compelling risk/reward at today’s levels. There are some risks that I worry about like weather, which is an uncontrollable variable – it doesn’t have to be the case that today’s 2023’s weather patterns average higher. Or if they do, that they get back to 2022 levels. And I also worry about the uncontrollable landscape they operate in – i.e., being connected to third-party OEMs who are, and have historically, disrupted workflows/production rates. And then finally, there’s the debt risk.

On the other hand, what we’re modeling isn’t all that unreasonable, and from a base rate perspective, historically unlikely. The weather levels we’re modeling are what they’ve averaged out at historically, the underlying value proposition they offer is durable, and competitively, they’ve shown they can compete. As such, while sales can get worse in the interim, I think investors could earn attractive IRRs at this level.