New Flyer Industries (NFYIF)

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New Flyer Industries (NFYIF)
(values in US dollars)
Recent Price: $12.79
Revenue: $741mil
Market Cap: $383mil*
EPS: $-5.93
Shares Outstanding: 29.9mil
P/E: --
Avg. Volume: 10,756
Dividend: $1.18
Book value: $12.90*
Yield: 9.23%
*Income deposit securities, including value of attached subordinated notes

New Flyer Industries of Winnipeg, Manitoba, is the largest manufacturer of heavy-duty transit buses in the United States and Canada. The company manufactures transit buses with body lengths from 30 to 60 feet and an array of propulsion systems including diesel, electric, gasoline-electric hybrid, and natural gas. The company also recently licensed Ballard Power’s fuel cell technology and is now in the process of designing a hydrogen-powered transit shuttles as well. New Flyer’s products are designed to meet the demands of public transportation authorities in the US and Canada. Buses are designed to run up to 16 hours a day, seven days a week, and designed to last for more than 12 years or 500,000 miles. New Flyer generally offers maintenance as part of the purchase agreement, so the company has an interest in making sure its buses are built to last.

The number of heavy duty transit buses in service in the US and Canada increased at a rate of 1.7% annually from 1993 to 2003, and transit bus ridership increased at a rate of 1.8% over a similar period. While new data is not yet available, analysts believe that the increasing price of gasoline has caused transit bus ridership to increase more rapidly in the past two years than in the pervious ten. New Flyer supplies transit buses to 19 of the 25 largest pubic transportation authorities in the US and Canada. The company believes it has delivered 20% of the transit buses currently on the road in the US and Canada, and that its annual market share as of 2004 was 36%. New Flyer estimates that 88% of the new buses sold in Canada and 80% of the new buses sold in the US over the past 8 years were replacement buses, which may indicate a continuing market for transit buses even if ridership ceases to increase. In fiscal 2006, approximately 7% of the company’s revenue was derived from the sale of aftermarket parts.

Since its IPO on August 19, 2005, New Flyer appears to have grown rapidly. Revenue in the first year after the IPO was C$570 million and in the second year was C$827 million, an increase of 45%. Distributable cash from operations increased 46% over the same period, and the company increased the dividend on its common shares twice for a total increase of more than 20%. From January 1st, 2006 through September 30, 2007 the company’s total firm order backlog increased from C$629 million to C$1.12 billion. Including optional orders, the company’s order backlog now stands at over C$2 billion.

Given the company’s rapid growth and positive cash flow, it is reasonable to ask why the stock is trading with a yield of over 9%. At least part of the reason for the high yield is the complex nature of the shares. Each New Flyer IDS (Income Deposit Security) includes both a common share in the ownership of the company and a share of subordinated debt. Debt generally offers a higher yield than equity, and investors often expect an additional premium for backing unconventional investments such as debt-equity composites. Another issue is that, despite its positive cash flow, New Flyer has reported a net loss in each of the past seven quarters. The loss has been non-cash, primarily due to fair value adjustments on class B and C shares, prepaid expenses, deferred revenue, and to losses on exchange rates. Because the company has several classes of shares and operates in two currencies, bookkeeping is complicated and the company has had to restate results on more than one occasion. Investor confidence is likely to increase when restatements are completed and when positive cash flows begin to be reflected in positive net earnings. Important risks to the company’s business itself include the possibility that funding for public transportation may be reduced or eliminated in the US or Canada, and that future product warranty costs may significantly impact earnings. In addition, a decline in the value of the Canadian dollar versus the US dollar could result in a lower dividend and maturity payments on the subordinated notes.

The complex nature of the New Flyer IDS makes it difficult to assign a fair value to the shares. One approach is to consider the debt and equity units separately.

The subordinated note is callable on August 19, 2012 and matures on August 19, 2020. The note has a maturity value of C$5.53. The call price in 2012 is C$5.8065, and declines by 1% per year until it reaches the maturity price. Subordinated notes pay interest monthly at an annualized rate of 14%. There really isn’t a comparable investment for valuation purposes, but if we assume 1) that we should expect an annual return of 9% from unrated subordinate debt, and 2) that subordinated shares will be called by the company at the first possible opportunity, a fair current value for the subordinated notes would be C$6.30.

The common share is more challenging to evaluate. As noted above, the NFI has shown negative earnings per share over the past seven quarters. However, losses have been non-cash, and the company has had positive distributable cash in each of those quarters. Let us assume that we can fairly evaluate the value of common shares based on distributable cash. Let us also assume conservatively that the shares should reasonably trade with a distributable cash yield of 10%, that distributions to class B and C shares will not change relative to distributions to common shares, and that excess distributable cash can be divided between common shares and class B and C shares in the same proportion as distributions. If this were true, a fair current price for the common shares would be C$6.45.

Pooling these two estimates and correcting for exchange rates, a fair current value for IDS shares would be US$12.88. Note however that this valuation is not adjusted for risk, or for what appears to be consistent growth in both revenue and backlog. If US and Canadian municipalities continue to increase investment in public transportation, this composite estimate is likely to be conservative.

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Analysts climbing aboard the New Flyer bus

Winnipeg bus maker a 'buy' as orders roll in

Nicolas Van Praet, Financial Post Published: Thursday, February 14, 2008

With the trucking industry in the tank as shipments slow along with the U.S. economy, investors looking for a place to park their money in four-wheeled transportation still have at least one option.

Think bus-making, the kind you ride to work or to the airport.

Canada, the United States and Mexico are in a robust segment of an order cycle in heavy-duty bus manufacturing that is expected to stay strong well into next year, according to analysts at Cormark Securities. And they argue the best way for investors to play this strength is through Winnipeg-based New Flyer Industries Inc., (NFI.un/TSX) which is winning market share and gaining revenue visibility.

New Flyer is the biggest maker of heavy-duty transit buses in North America, boasting a share of about 35%. Its backlog sat at a record 3,090 units on Jan. 9 and the company has bids on as many as 6,000 more buses worth $2.8-billion, representing more than a year of total industry output.

"We believe the announcement of further contract wins in [the first half of 2008] will continue to push the stock higher," Cormark analysts Ale-em Israel and Tom Kennedy wrote in a recent report.

What will drive New Flyer orders? In part, capability. The company makes a variety of buses of different lengths and propulsion systems, including diesel and electric. And although demand can rise and fall depending on ridership levels and government finances, many public transit authorities are renewing their fleets for the first time in years.

Pre-buying will also help, the analysts say. New regulations from the U.S. Environmental Protection Agency on bus emissions will be fully implemented in 2010, and New Flyer's management expects to see customers buy their buses before the rules kick in.

A similar thing happened with production of so-called class-8 big rig trucks in 2006 when buyers placed orders ahead of tougher standards to avoid paying for pricier trucks later on. That move benefited companies like Canada's Navistar, which boosted production at its plant in Chatham, Ont. to meet the heightened demand.

"We believe history will repeat itself " for New Flyer, the Cormark analysts say. "There currently exists a firm order backlog through May, 2009, and a significant number of additional orders that have yet to be announced."

One of those orders could be a deal to make 350 40-foot gasoline hybrid buses for the San Diego transit system, which has been awarded, but not formally confirmed by the bus maker, according to BMO Capital Markets analyst Peter Sklar.

Mr. Sklar is also bullish on New Flyer, but recognizes the stock price may be affected by the company's Q3 earnings restatement. Last week, New Flyer disclosed it would cut its consolidated net income for both the third quarter and year-to-date by $6.4-million to reflect the fair value of assets and liabilities as a result of the repurchase of Class C shares of New Flyer subsidiary New Flyer Holdings Inc. in July.

"Although this restatement involves highly complex accounting practices, it only involves non-cash accounting adjustments, and has no impact on adjusted EBITDA and distributable cash flow, (our primary valuation metrics),Mr. Sklar wrote in a note to clients Jan.29.

Scotia Capital analyst David Tyerman said in a note the same day that the restatement would not impact his valuation. New Flyer's income deposit securities are designed to pay out substantially all of the company's free cash in interest and dividends, and its large backlog should allow it to "produce strong and relatively stable free cash for a prolonged period," he wrote. Mr Tyerman rates New Flyer "sector perform" and has a 12-month target of $12 on the stock.

Compared to other specialty equipment manufacturers like Monaco Coach Corp. (MNC/ NYSE) or Spartan Motors Inc. (SPAR/NASDAQ), New Flyer presents an attractive buying opportunity, Mr. Israel at Cormark argues. On a fully-taxed basis, New Flyer is trading at 11.2 times Cormark's 2008 cash earnings estimate, he said in a recent email.

"This puts New Flyer on par with the group average, however, the company's balance sheet is much stronger and its firm order backlog provides significantly more visibility on earnings [than its rivals]."

Cormark rates New Flyer as one of its top picks, with a target price of $14. BMO Capital rates it "outperform" with a target price of $13.50.