Oshkosh Corporation (OSK) Earnings Call Transcript & Summary

All right. Great. Good afternoon, everyone. We're going to keep it rolling here. My name is Dillon Cumming. I'm the machinery construction analyst here at Morgan Stanley. And next up, we've got Oshkosh Corporation. So from the company, we have John Pfeifer, CEO; and Pat Davidson, Head of IR. So guys, thanks for being with us today.

Yes. Thanks, Dillon. Nice to be here.

Yes. So I start with a quick disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representatives. So with that, I want to pass it over to John for some intro remarks.

Yes, sure. I'll just provide an intro of the company and what's happening with Oshkosh Corporation today. First of all, for those of you who may not be familiar with us as a company, just real quick about our purpose. Oshkosh Corporation serves people in our communities all over the world who do the most difficult work and the most dangerous work that there is to do. So I'm talking about soldiers, firefighters, people who work at great height people and environmental services and soon to be last mile delivery operators with our newest business with the United States Postal Service. So we look at our mission in the world is providing those people with mobility, but more importantly, with productivity, with ease of use, intuitive use and with safety. Every firefighter has got to come home at night to their family after they serve their shift. And that's the purpose of who we are. So when we look at our position today and what's happening with the world, we look forward towards an era of accelerated growth. And I mean accelerated growth, meaning faster growth than we have seen in previous eras and faster than we see in industries around us. That might seem a little bit strange to say when we're in such supply chain disruption right now, which makes it really hard for all of us to operate, but when you look at the dynamics behind what's driving that, it's very, very compelling. So the first thing is we look at some of the markets that we serve and the underlying demand profiles mainly aged fleets in access equipment and Fire & Emergency segments where there's a huge need, multiyears going forward to replace aging fleets with new, more modern fleets of equipment. That's one thing. The second thing is, is we're a technology company as much as we are an industrial company. So we're driving technology into the end markets that we serve in the form of new products, delivering electrified product. You've seen us deliver electric fire trucks, electric defense vehicles, electric aerial work platforms, the electric postal fleets that we're about to put into the market. Autonomy is a big way for us to make a difference for our customers, making it easier for our customers to use the equipment so that they can get their job done and not worry about the equipment but have the equipment almost do some of the operation for them and they can just worry about the mission that they're there to do, whether that's 150 feet in the air or they're soldier on a battlefield. So that technological advancement that we're making is allowing us to deliver better solutions than ever before. That's an underpins our growth outlook for the -- through 2025. The final thing I'll talk about is we've got a really healthy balance sheet. We look at our ability to continue to generate cash and use about 2/3 of our cash flow to fund further growth initiatives. So that will come in the form of added capacities to support growth, new program and technology developments and programmatic M&A. So getting ourselves into adjacent categories where we think we can deliver a better solution than maybe is being delivered in that category today. Those are really what underpins what we see as a accelerated growth for our company. So we see $10 billion to $11 billion in revenue a 10% plus operating margins and taking our earnings per share to $11 to $13 in 2025, and we're very excited about the plan to make that happen.

Yes. And it's a good place to start on some of the longer-term dynamics around the company. You guys just had your first Investor Day in a couple of years, I believe. Just wanted to kind of start off by saying if you could talk through some of the more relevant targets you laid out and such on the margin side, right? What's the path to kind of cycle over cycle improvement looks like for Oshkosh.

Yes. So in terms of our ability to generate margins, a lot of the business that we're winning, whether it's the Postal Fleet or the Stryker program in our defense business whether it is putting electrified municipal fire trucks into the market and we go into production in 2024, some of the autonomous advancements that we're making in the aerial work platform or the access equipment environment. But the great thing about that is some of those investments in technology allow us to really not only solve customer problems, but when you're solving customer problems, you're able to drive better margins for your business. That's a big part of it.

Yes. Makes sense. And you mentioned the programmatic approach to M&A, which I think is actually an important thing to highlight for you guys because you haven't been as acquisitive more recently, right? You laid out about 25% to 35% of the cash flow profile going towards M&A. Just first of all, it actually gives you visibility that you can actually spend that notional dollar amount, right, because we haven't been acquisitive in the past. And what does the pipeline look like today?

Yes. So it's interesting. We have what's called an always-on view. So we're constantly looking at targets. But we're very focused as to where we look for M&A. And you've seen us -- I think it's if I talk about some of the programmatic moves that we have made, it will maybe allow me to articulate our focus in M&A. So we bought Pratt Miller, a technology company about 1.5 years ago. We bought a company called Boise Mobile, wildland firefighting and rescue vehicle company. It expands our ability to participate in that category of wildland fires, MAXIMETAL, which is a Canadian municipal fire truck company expands our ability to participate in the Canadian market, and smaller acquisitions which give us the ability to build out our autonomous capabilities. So when we look at M&A, we look at either building out technological capabilities or we look at getting into adjacent categories where we believe that with our purpose-built mentality and our technological capability, whether it's electrification, intelligent products, autonomy or a combination of those that we can deliver a better solution than what is being delivered today in that category. That's where we specifically look for M&A opportunities. I think postal is a great example. We saw substandard solutions in last mile delivery. We said if we develop a purpose-built vehicle that allows the postal carrier to be more productive and safe that can be transformational for that industry. That's the way we look at that M&A.

Yes, makes sense.

If I could just add to that. You mentioned Boise Mobile, that's an equity investment, right? And we've got some others as well, Microvast is one. So MAXIMETAL was an acquisition, Boise Mobile was equity going through our distribution network.

Yes. Yes. Got you. Maybe going back to the margin side for a second, I think we're going to probably ask about an update on the overall state of the supply chain in a second, but just contextualizing what you've been dealing with over the past year or so, both price cost and supply chain related relative to the margin goals you laid out. Is there anything structural about what you've seen in the current supply chain backdrop that makes you worried about that margin expansion over time? Or do you feel like it's still more transitory?

Well, it doesn't worry us because we know that we can price for the inflationary environment that we've been in. With us, the difficulty has been because we've got long lead times and big backlogs when you have to price for inflation, which we've done, it takes us a little bit of time to recognize the benefit because we have to work through our backlog to get there. So we're confident in our ability to do that, and that will start to materialize as we go forward over the next few quarters, the -- getting to full price on our -- in our P&L. I think the supply chain is a difficult environment for us. We're doing a lot to improve our ability to operate in a constrained supply chain environment. We believe that the supply chain environment will gradually get better over the next several quarters. We think it's probably going to take well into 2023 before we get to a little bit more of a normal state, but that's not necessarily what we're planning for. We're planning for how do we operate in a constrained environment better than we are operating today. So we're putting in -- we're doing a lot of redesign of certain components to be able to get better supply. Of course, we've been qualifying new suppliers. But we have been doing a lot of analytics work on connecting our supply chains well into the Tier 2, Tier 3 and Tier 4 to give us more visibility and more proactive capability to address problems before they disrupt our production. And so we think that that's going to make a big difference as we go forward in our ability to operate when we have suppliers that are under a lot of constraint.

Got you. I guess near term, kind of in that context, right, you mentioned you were still expecting some level of gradual improvement, but I imagine things are pretty kind of day-to-day in terms of what you're dealing with them on the supply chain side. Given the kind of more conservative bar you laid out last quarter with the supply chain. Have you seen anything near term that's made you more worried about that kind of backdrop that you laid out last quarter? Or how would you think about that?

I wouldn't say that we've seen anything that's made us more worried. We're -- we've seen a small improvement in supplier on-time delivery, but it's -- we're talking about maybe 2 months of data. So 2 months of data does not make a trend. So we like to see gradual improvement in supplier on-time delivery, we need to see that it's sustained and continued improvement going forward. So I would not say that we've seen anything that's made us more worried, but we still need to focus intently on continuing to make improvements in it because it's nowhere near where we need it to be.

Yes, makes sense. Maybe if you can kind of zoom out and think about the kind of construction rental backdrop for a second. Can you just give us an update in terms of your overall view around U.S. nonres construction. Obviously, a lot of kind of consternation in the market with regards to a recession next year or recession. What are you kind of seeing across your core construction markets? And where are you most optimistic or pessimistic kind of going into next year?

So when we -- and I'll talk about North America primarily, when we look at our demand and our construction markets, we see a lot of robust demand be honest. We have not seen any kind of tapering off of demand. Our backlogs are solid. They're bigger than they've ever been, and our order rates are solid. And when we talk to our customers, that serve the construction market, they still see really strong equipment utilization rates, which is their primary metric. So we see a really, really healthy environment. When you look at nonresidential construction metrics, the forecast are still very favorable for growth in the near term on nonresidential construction. The other thing that I think we look at and our customers look at is you look at 2 big bills that got passed recently, one, the infrastructure bill, about $1 trillion and the other the -- I think we're calling it the CHIPS Act, both of those will put added demand on construction markets, whether it's building a bridge or a mobile base station to expand broadband access or schools, which are all part of that spending you need our equipment to do all of that. So that's yet more pressure on demand for the future that has not really manifest itself yet because they haven't started to spend the money.

Yes, absolutely. And maybe we have an unfair question because it just got passed, but the Inflation Reduction Act, obviously, some kind of components in there for manufacturing. But you expect that to kind of benefit your business as well?

We do, especially the postal fleet. The postal fleet, we designed a purpose-built solution that comes in either an internal combustion option or a zero-emission battery election battery electric option. And the postal service started with about 10% ratio of battery electric to internal combustion. They then increased that to 20%. They have since increased that to 50% battery electric, which is great for everybody. All constituents want more electric, certainly good for us. And one of the reasons we're able to do that is because in that bill was a few billion dollars to allow the postal service to build out their recharging infrastructure. There are tens of thousands of post offices in the United States, and you have to put the charging infrastructure in place to have an electric fleet. So that helps them do that a little bit faster, which is why they're more confident to keep increasing the ratio of battery electric versus internal combustion.

Yes. Makes sense. Maybe we can kind of go back to rental budgets for a second. A lot of the equipment rental companies have been noting that they've had to begin negotiations earlier than normal kind of lock in build slots, right? I think some of them have actually been saying they've had to have discussions about 2024 already, right. In terms of your own kind of negotiations, how would you kind of characterize the timing and intensity of those negotiations and the overall time frame of those negotiations relative to prior years?

Well, there's nothing about the current demand environment that's normal. It's an unusual time. It's unprecedented. We have never had a time in our past where we've been talking about demand for 2024 with our customers as early as 1.5 years in advance. Usually, we get into the fourth quarter of a year, and we talk about the coming fiscal year and how much demand is going to be in order rates and so forth, and we lock them in. Now we're already talking about 2024. We're not even talking about 2023. We're really booked a year out already. So it's a very unusual period of time. Our customers understand that they need equipment. They want to refresh their fleets. They want to do it in a prudent manner, but they also want to do it in an expeditious manner. So we're doing everything we can to make that happen. And -- so it's an unusual time in terms of we're not talking about annual contracts for 2023 right now. We're talking about reserving production slots for 2024.

Yes. It's definitely compelling in terms of the cycle length. But I guess one of the things that we wonder about as well is, as you mentioned, the desire to refresh the fleets right? All of the IRCs and NRC related have been 2 years of high end, right, kind of managing fleet agents within more normalized windows. How acute is that desire to get those operating rates back into kind of normalized average age because imagine they're incurring higher maintenance costs, et cetera. How acute is that desire?

Yes. So as fleets age, of course, you have higher maintenance costs. That's a cost that our customer base doesn't like, but you also have the risk that the residual value of the aged fleet will start to drop off. And as that residual value starts to drop off, it really can be disruptive to the economic equation that our customers have. They want to sell the fleet while it still has a healthy value in the used market versus waiting too long. So they want to make that happen before they see those residual values drop off. But the other thing that I think everybody recognizes is there's a lot of new safety features on equipment today. There's new convenience features. There's new connectivity options. We have electric product today that we didn't have in the past. And customers of our customers they want to ramp newer equipment. And I think that, that's also an understanding and one of the drivers for refreshing fleets.

Yes. Makes sense. Maybe just can kind of come back to price cost for a second. It's probably not a topic that you love to talk about. But can you just remind us how impactful those pressures have been year-to-date? What you expect to kind of play out in the back half of the year and then thinking to next year, right, with regards to the aerial's order book, in particular, how do you kind of price -- how do you approach price cost with that in mind?

So we've approached price cost a little bit differently depending on the end market that we serve. We serve about a dozen end markets, and we're organized in 4 operating segments or divisions. And so we have 4 -- 3 of our 4 businesses are commercial-oriented businesses where we have the opportunity to make price adjustments based on inflation and one is defense and in defense, we deal with more fixed-price contracts. So in our commercial businesses, we've all seen rampant inflation. I think if you go back 1.5 years ago, it caught many of us by surprise because it wasn't forecast by many economists, the inflation rates we're dealing with. So we've had to work through a period of catching up our price with the actual cost, input costs that we're seeing. We pay very close attention to the Producer Price Index. It's gone up by 15% or 16% during that period of time. And so we put price -- we've been -- the good news for us is we're the leader in essentially every end market that we serve. And we therefore have some ability to price and get prices to stick. We are very transparent with our customers. We're very prudent about it. We -- they understand that we've got significant inflation. So nobody likes price increase, but you have to do it to keep yourself financially healthy. So we have been able to do it. We've been able to protect ourselves. There's been a bit of a lag in terms of the benefit because we burn through price-protected backlog first before we get to full price. And the good news is, is you'll start to see much better margins flow through the P&L as we go through this quarter and next quarter and should be in a much better place as we exit this year with regard to realizing the full prices that we put into place. But we have to do business a little bit differently going forward because we make long lead time items and because we have big backlogs, bigger backlogs than we've ever had before, so we've had to, in some cases, change terms and conditions where if we're taking an order for a product that's not going to be shipped for 1 year or sometimes longer, well when -- at the time of shipment, it will be shipped at the price list at that time versus the price when the order was taken. And that helps. It's a prudent way to do it. We think it's a fair way to do it, and it helps us where we're not getting behind on price just because we got big backlogs and long lead times.

Yes, absolutely. In terms of kind of the overall cost backdrop for you guys, you do have more exposure to play but we've seen some moderation in some cost indices on the hot-rolled side, and then spot freight rates, for example. Have you seen similar levels of moderation across our cost footprint?

The most moderation we've seen is in hot rolled coil steel, a little bit in aluminum. Not much in plate. Plate has been a bit stubborn and we buy almost as much plate as we buy hot-rolled coil. Now there's a lot of expectation that plate will follow hot-rolled coil that is that we have yet to see that. We hope that's the case. But -- so that helps us for sure. But a lot of the inflation that we see comes through engineered components from our supply base because they have to pass their cost on them. And so we see a lot of inflation in everything from engines to motion products, rubber hoses even wire harnesses. And we haven't seen a moderation yet in that area of our cost base of our input costs. So some good news on the raw material side, but still dealing with supply components that have inflationary environment.

Yes. Makes sense. I wanted to ask a few questions on defense. I think it is one of the more attractive growth opportunities for the company. Starting on the international JLTV side, last quarter, you did call out some opportunities in Eastern Europe from the Ukrainian-Russia conflict. It sounds like it was minimal. But in arguably, we're operating in a kind of higher threat environment now post Russia-Ukraine now. So how does that create opportunities not only for your broader business but also for the international JLTV?

Yes. So for international JLTV we've had a lot of inquiries, no surprise from Eastern European countries. A lot of Eastern European countries have dramatically increased their defense spending. Some have even doubled it as a percent of GDP. And they're doing it for obvious reasons. They want to be protected against the type of thing that happened in Ukraine. And we have -- we make products that help them do that. In fact, the product that we make, the JLTV and a lot of different variations that we make it in is the exact type of vehicle that you need to defend against that type of an invasion. So that has really pushed up a lot of inquiries. Those countries will get either supplied directly by the U.S. Department of Defense or in some cases, they'll come to us directly. But either way, the order ultimately comes to us. So we expect that, that's going to put upward pressure on demand over the next several years. You have to remember, though, when you talk about an Eastern European country versus the U.S. DoD, the U.S. DoD buys thousands and thousands and billions of dollars of these vehicles, where an Eastern European country might buy dozens or hundreds of vehicles. Still good business, still nice growth, but just keep it in perspective versus what the U.S. DoD.

Yes, absolutely. And then on the USPS contract, you laid out about $1 billion kind of per annum revenue opportunity once the program has full production. If you does kind of remind us what the path to hit that $1 billion run rate is. And then when you think about last mile and more broadly, right, you kind of called that as a growth opportunity for the company. What's the next opportunity for Oshkosh once you get past USPS?

Yes, sure. So the -- we call -- the post office calls at the next-generation delivery vehicle, that's the vehicle that we designed, a purpose-built vehicle. When I say purpose-built, that's really what we do. So the -- what I mean is a typical last-mile delivery offering that you see in the market today is a third-party chassis with a box on it that they call a last mile delivery vehicle. We designed from the ground up, it's our own chassis, our own chassis design, a purpose-built vehicle that's designed with the postal carrier in mind, allows them to be really productive, allows ease of use of the vehicle and it allows maximum safety. So a huge innovation for a last-mile delivery operator. We go into production in September about 1 year from now, we go into production. You start seeing these vehicles hit the streets in the fourth quarter of next year. We'll ramp production through 2024 and get pretty close to full production in 2025. Again, this is an innovative, disruptive vehicle in that market. It's better than anything you see in your communities today. When we all go out and about later today or tomorrow, we'll all see last mile delivery vehicles all around us. You might see a transit van that is doing last mile delivery or you might see the a chassis with a big brown box on it doing last mile delivery. This is a -- what we have designed is disruptive to that because it's so purpose-built for the operator. So we've got lots of opportunity and are working aggressively on opportunity to expand that business beyond the U.S. Postal contract. But first priority is getting the U.S. Postal contract in production, on time and getting it up and running, and we'll continue then, therefore, and expand that business. We're very optimistic about it. We think it's a great segment for us to be in. And we think there's a lot of opportunity for us to make a big difference in that segment.

Got you. We've got a few minutes left. I want to open it up to the audience for a second and see if there are any questions. Maybe just kind of go back to the JLTV again, just really on the domestic side of the equation, you obviously have the that you're going through right now, but you were confident enough to include that kind of in your long-term targets when you had the Investor Day. Can you just talk about why that was the case? And then as you've kind of gone through the recompete, have you seen anything from competing bids that's when you worried? Or how would you kind of characterize that.

So I'd call us confident, but you never know that you win it until you actually win it, right? So we're a humble company with a humble culture, but we're confident that we are doing and have done over the last 7 years and have done in this proposal, what needs to be done to continue to be the supplier of the JLTV. And so they'll evaluate the vehicle with 3 fundamental criteria. Number one is manufacturing capability. Our capability to deliver a quality product on time to the Department of Defense, the U.S. Army, the Marines are the big customers. Number two is cost, they always evaluate your cost position. And number three is technology insertions. They want -- this contract is $7 billion to $9 billion, it takes the program into the 2030s. They want to know that when they award the contract that the company that does it can continue to drive technological innovation throughout the life of the contract. So that's why we introduced and showed the Department of Defense a couple of months ago, the eJLTV. That's an electric joint like tech wheeled vehicle. So we electrified the product. It gives the army silent watch capability. A lot of times, they're using these vehicles to -- for surveillance, gives them silent drive capability. So in some dangerous situations, they can operate the vehicle and actually run it perfectly silently. It also gives them the ability to export power. They don't have to tow a generator around they can export power where it's needed in environments, which is a great advantage. So we introduced that so they could see the technological insertions that we can deliver to this vehicle in the future. So as we do all that, we're the incumbent manufacturer, Nobody knows how to make it better than us. And we've got technological capability to continue to add to the vehicle. That's what gives us confidence that we think we're the best choice for the Department of Defense. But again, we will keep our fingers crossed until January when they make their final decision.

Yes. Makes sense.

And that confidence is why we put it into our...

Yes, absolutely. Look, we're at the top of the time to hold and wrap it there. John and Pat, appreciate the time, and thanks for coming out.

Thank you. Appreciate it.