City bus fleets around North America are aging, which means New Flyer is poised to pick up many new orders in the next two or three years.
Fabrice Taylor, CFA, publishes the President's Club investment letter. His letter and The Globe and Mail have a distribution agreement.
The average age of a city bus on U.S. roads is eight years. The lifespan is 12 years. There begins the thesis for investing in New Flyer Industries, but there's far more to it than that – enough to make the company's dividend-paying shares look like a sound investment for the next few years.
New Flyer is the biggest heavy-duty bus manufacturer in North America. It has built about 40 per cent of buses on North American roads and, because of a recent acquisition, its market share of new production is about 50 per cent. It also has about a third of the lucrative after-market parts business. The company offers the broadest lineup of propulsion offerings, from electric trolleys to diesel, hybrid, natural gas and all-electric.
New Flyer is based in Winnipeg but has plants in the United States, which is important given the growing political compulsion toward "Buy USA" south of the border. It's especially important in the bus industry since the funding for transit comes from various levels of government.
A U.S. presence also adds to the investment theme on currency grounds. The loonie appears to be headed lower, so there is a modest hedge built into New Flyer shares for Canadian investors. About 85 per cent of sales are in the United States (but a good part of the costs are also south of the border).
As you can imagine, the heavy-duty (transit) bus industry was ravaged by the Great Recession, which partly explains the aging bus fleet. But ridership is stable and should increase modestly with rising employment. And improving government revenues will help fund more bus purchases. This is slowly becoming apparent in bidding activity.
The North American bus industry, meanwhile, has consolidated heavily. There used to be five players. Orion, a European manufacturer, exited the continent last year (and New Flyer bought its after-market business). Then New Flyer bought North American Bus Industries, reducing the field to three major participants with 94 per cent of the market. (The other two are California-based Gillig LLC and Quebec-based Nova Bus Inc.) Over time this should be good for margins, which are not close to their highest levels and therefore have room to improve.
Also in 2013, a Brazilian bus maker, Marcopolo SA, bought a 20-per-cent stake in New Flyer at a premium to the market price (the shares were purchased from the company's treasury). This provides financial stability and also creates the possibility of a takeover offer at some point.
On the financial front, the company has paid a dividend for 108 consecutive months since its initial public offering in 2005. The current yield is 4.5 per cent. Management has diligently paid down debt and improved financial flexibility. If anything the company could borrow more, so there is not much balance-sheet risk.
Management is also hard at work integrating acquisitions and applying more rigorous manufacturing practices to reduce costs and improve margins. It's also investing in research and development, particularly on the all-electric bus front. It's likely that in the future almost all buses will be electric or at least powered by something other than fossil fuels, so it's important to stay sharp in terms of the trends in propulsion.
To sum up, the industry is recovering from a very bad period. There are few players and demand is perking up. It has to – given the aging fleet. New Flyer is poised to capture a good deal of the recovering demand, which, along with a strong balance sheet and internal improvements, could lead to dividend increases in a year or so (the dividend hasn't been increased since the IPO).
The shares have sold off a little in sympathy with the market, and the company is working off some lower-margin orders that it won when business was more competitive. But next year should be a good one, and the ensuing two or three possibly better, which could lead to capital appreciation and a likely growing dividend to boot.
It's not sexy, but it's solid.
Disclosure: The author owns shares in New Flyer.