Markets & Finance

Getting a Lift from the Recovery


By James Sanders Like most manufacturers of construction-related equipment, JLG Industries (JLG) has been hit by the economic downturn. But the company's focus on keeping a healthy balance sheet -- and controlling its costs -- has left it in excellent financial shape. And it's primed to take advantage of an expected cyclical rebound in the rental and construction markets. That's why Standard & Poor's has assigned the stock its highest investment ranking, 5 STARS (buy).

Founded in 1969, JLG is the world's leading producer of mobile aerial work platforms. It's also a top manufacturer of variable-reach material handlers and telescopic hydraulic excavators, which it markets under the JLG and Gradall trademarks. JLG sells its wares mainly to rental companies and distributors, who in turn rent or sell the products to a diverse array of customers in the industrial, commercial, institutional, and construction markets. JLG has manufacturing facilities in the U.S. and Belgium, with sales and service locations on six continents.

S&P believes that the company is well-positioned for a sustained earnings upturn. Why? It's quite likely that JLG's customers -- especially its major customer, United Rentals -- will spend heavily to replace aging equipment fleets in the foreseeable future. And the company should benefit from its recent expansion into the European markets for aerial work platforms and telescopic handlers -- which are less mature, and larger, than those of the U.S.

BIGGER BUDGET. We at S&P also see JLG's main U.S. market beginning to show signs of improvement. The most recent construction spending and manufacturing data indicate that outlays in both the commercial and private sectors have increased, orders for manufactured goods are stabilizing, and inventories are being rebuilt. In addition, United Rentals, which accounts for about 20% of JLG's annual revenues, recently said it has significantly increased its equipment budget for 2003. As a result of these developments, and the low interest rate environment, we feel the stage is set for JLG to resume domestic growth.

Although economies in the European Union remain weak, it's still a growth market for JLG. The company has boosted its growth prospects in the region with the recent opening of its Belgium facility and the introduction of a new telescopic-handler line specifically designed to meet European standards.

While JLG's annual revenue growth has averaged 20% over the past five years, it posted declines in fiscal 2001 (ended July 31) and the first half of fiscal 2002. Those results can be blamed on overall weak industry conditions brought about by the global economic slowdown. For the remainder of fiscal 2002, we see flat revenues when compared to the third and fourth quarters of fiscal 2001, as demand for JLG's products continues to stabilize. However, for fiscal 2003, we believe that sales will significantly increase, mainly driven by expanding market share in Europe and the likely fleet replacements by several of the company's larger customers.

MORE EFFICIENT. JLG should also benefit from cost-cutting resulting from its focus on improved manufacturing processes. The company has been able to cut its overhead requirements by approximately $20 million annually through facility closures and consolidations, and workforce and inventory reductions implemented during fiscal 2001 and the first half of fiscal 2002. That has help lower its break-even point to $600 million in revenues from $700 million at the end of fiscal 2001. We believe these moves to rationalize costs have made JLG more efficient and will result in a boost to margins in fiscal 2003.

Another strong point for JLG: its ability to generate healthy free cash flow by strengthening its balance sheet. Since the end of fiscal 2001, the company has reduced its debt load by $93 million, which includes $43 million in off-balance-sheet financing, and cut its debt-to-total-capital ratio to 46% from 53%. In addition, JLG has reduced its working capital by decreasing its accounts receivable and inventory levels. The company plans to keep paying down debt and has targeted a debt-to-total-capital goal of 35% to 45%. We think that target is readily attainable over the next 6 to 12 months.

For fiscal 2002, we see JLG's earnings declining approximately 16%, to $0.68 per share from $0.81 in fiscal 2001. However, assuming that economic and industry conditions continue to improve, we expect that EPS will more than double in fiscal 2003, to $1.41, as JLG expands its market share in Europe and begins getting fleet-replacement orders from its larger domestic customers.

HIGHER TARGET. The shares currently command an estimated price-earnings-to-growth (PEG) ratio of 1.15, or a p-e of approximately 10 times S&P's fiscal 2003 EPS estimate. This represents a favorable discount to a PEG of 1.62, or a p-e of 14.2 times 2003 estimates, for its industry peers. In addition, our discounted cash flow model (DCF), which assumes the company will generate free cash flow at initially high, but decelerating, rates, implies that the shares are also trading below their intrinsic value.

Where should JLG be trading? After taking a weighted average of the results from our various valuation models, we believe that the stock can achieve a price target range of $18 to $20 over the next 6 to 12 months. That's a significant premium to its closing price of $14.60 on Mar. 8. Analyst Sanders follows industrial machinery stocks for Standard & Poor's


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