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Value Investing for Mothers-in-Law: Forget What You Know About 'Margin of Safety'


It is tempting to think of the "margin of safety" as a machine-like certainty. But that's not quite accurate.

To defend against this vulnerability of thought, I flip the question around to frame it as "How do I not lose?" I still have my base-case scenario for intrinsic value (How do I win?), but I also start from the current valuation and figure out a range of bare minimum events which will backstop the current price so that I don't lose. Let's look at an example.

Commercial Vehicle Group (NASDAQ:CVGI) is the 400-pound gorilla in its niche as a supplier to commercial trucks and equipment manufacturers. It can provide pretty much every part that goes into a truck's or construction vehicle's cab. Its customers are the large Truck OEMs like Navistar (NYSE:NAV), PACCAR (NASDAQ:PCAR), Daimler (PINK:DDAIF) and Volvo (PINK:VOLVY) and the Construction/Agricultural Vehicle OEMs like Caterpillar (NYSE:CAT) and Deere (NYSE:DE). The industry has been in a funk since an emissions regulatory change caused a glut of vehicles to hit the industry just as the economy was slowing in the late 2000s. The industry has never really recovered, as fleets have been wary of making a lot of firm plans in an uncertain economy.

CVGI's management has navigated the economic waters pretty well, given the circumstances. It has avoided massive cash losses (though accounting losses were large) and been smart about acquisitions. Because of scale and operating expertise, they have a very strong competitive position.

Here are some of the ways I hope to not lose with CVGI at these price levels:

1. Cycles: At some point the economy will stabilize enough that truck fleets will be more confident in purchasing plans. Increased economic activity means fleets will expand, which means more trucks. Additionally, today's fleet is (by historical standards) "old," meaning that operators will eventually look to replace old inefficient and unreliable trucks with newer efficient and reliable ones. The economic cycle and the replacement cycle are somewhat distinct, so whether it is one or both that happen, it would be a boost to CVGI's results from current levels.

2.Taking market share: Because most trucks are customized products, it is important for a supplier to be able to deliver products exactly on time, lined up in production order, and with no defects. The supplier industry is very fragmented, with many of CVGI's competitors operating in just a fraction of CVGI's niches and sometimes with miniscule customer lists. As time marches on, OEMs look to simplify their list of suppliers. CVGI tends to grab some of this business each year (five or so percentage points of CVGI's base revenue).

3. Acquisitions: Though acquisitions can be treacherous, CVGI uses M&A to buy into new niches where, because of its scale, it can quickly spread the new expertise to its broader client list. It also uses M&A to avoid starting from scratch gain in new geographies.

4. Developing-world growth: Developing markets like China, India, and Brazil are not only growing their underlying need for trucks, but are also rapidly increasing the content levels of their vehicles. CVGI is bringing the same competitive strengths it has in the US to similarly fragmented foreign supplier markets.

5. Investor mood: Investors have been skittish with CVGI for years. Every quarter's earnings release is an exercise in breath-holding. As anything positive comes to pass, CVGI will eventually become less of a pariah to investors.

In total, management is targeting mid-cycle revenue of ~$1.6 billion in the next five years, which is around twice the current levels. In this scenario, EBITDA will likely approach $200 million versus a current Enterprise Value of ~$400 million (How do I win?). Even if only small pieces of its plan work, it should ensure that the stock price is (at the very least) not lower. A nice response to the question, How do I not lose? And I know you don't want a loser for a son-in-law.
Long CVGI (personally or in accounts where I have trading authority).
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