Oshkosh exceeds earnings expectations and receives upgrade

Every day, Wall Street analysts upgrade some stocks, downgrade others, and begin coverage on a few more. But do these analysts even know what they’re talking about? Today, we’re taking a look at a top-tier Wall Street pick…

After a year of declining stocks, Oshkosh (NYSE: OSK) Investors finally had a good day yesterday. The company reported a significant increase in profits and a significant increase in forecast, which led to a share price increase of over 2.5%.

Today, Mr. Market appears to be setting Oshkosh up for another bull run, with analysts at Merrill Lynch expressing excitement about Oshkosh’s growth prospects while other analysts at RBC Capital raise their price targets on Oshkosh stock.

Here’s what you need to know.

Five dice labeled “Buy” and “Sell” on an LCD screen with price charts and numbersFive dice labeled “Buy” and “Sell” on an LCD screen with price charts and numbers

Five dice labeled “Buy” and “Sell” on an LCD screen with price charts and numbers

Image source: Getty Images.

Modernization of Oshkosh has the details. This morning, Merrill Lynch upgraded Oshkosh stock to Buy and set a price target of $85, implying a potential gain of over 16% for investors who buy the stock at today’s price.

Oshkosh’s growth streak, Merrill says, has not yet peaked, and the analyst believes earnings could continue to rise into 2020 or even 2021. Defense backlogs are growing, and the company’s access equipment and fire and emergency response units, which are more dependent on the economy, also appear to be growing steadily.

According to Merrill Lynch, Oshkosh “provides little earnings momentum in a slow-growth engineering world.”

And also rising price targets

And Merrill Lynch isn’t the only analyst interested in Oshkosh. Canadian investment bank RBC Capital — which had already rated Oshkosh as “outperform” ahead of Wednesday’s announcement — confirmed it was raising its price target on Oshkosh shares to $90.

Like Merrill Lynch, RBC based its optimism on “increased revenue and margin targets” at Oshkosh, as well as “surprisingly strong” order growth. RBC also points out that Oshkosh is buying back shares, which should result in rising earnings being concentrated in a shrinking number of shares outstanding, which will cause earnings per share to grow faster than expected.

It’s also worth noting that RBC isn’t the only bank to raise its price target on Oshkosh today. Citi, Credit Suisse, Deutsche Bank and Morgan Stanley also raised their price targets – and they all believe Oshkosh stock is worth more than it’s currently selling for.

What Oshkosh said

So what was it that Oshkosh said yesterday that made so many analysts so optimistic about the company’s prospects? Let’s take a look.

Most companies are currently reporting their fourth quarter 2018 results, but Oshkosh announced its “first quarter 2019” results. Earnings per share more than doubled from the first quarter of last year, rising to $1.51 on revenue of $1.8 billion – up 14%. The company highlighted “higher sales in access equipment and fire and emergency” as growth drivers, with both segments reporting “double-digit revenue growth.” And that’s understating how great the news was – access equipment revenue increased 32% year over year, while fire and emergency revenue increased 29%.

CEO Wilson Jones called it a “good start” to fiscal 2019, but not the end of the good news. He continued, “We remain confident in our outlook, supported by positive customer sentiment, a strong backlog and a focused Oshkosh team.” A $1.7 billion Joint Light Tactical Vehicles (JLTV) order received in the quarter will help the company achieve that outlook.

Given the booming business, Oshkosh now expects the company to generate earnings of between $6.90 and $7.40 per share this year on sales of between $8.05 billion and $8.25 billion.

What it means for investors

All of these estimates are higher than the expectations Oshkosh had previously given investors, which explains Wall Street’s enthusiasm for the stock today. But are they high enough to make Oshkosh stock a buy?

I’m not sure.

Consider this: With net income of $524 million and a market capitalization of $5.1 billion, Oshkosh is certainly looks cheap, as shares cost less than 10 times trailing earnings. And assuming the company hits the high end of its earnings forecast, the stock would be almost as cheap at forward P/E as it is at trailing P/E. That looks cheap compared to the 15% growth rate analysts are forecasting for Oshkosh.

What concerns me about Oshkosh, however, is that free cash flow, which was already far behind reported net income at the end of fiscal 2018, is declining even further (both objectively and relative to reported earnings) as we enter the new year. In the first quarter of fiscal 2019, Oshkosh has just $222 million in trailing free cash flow versus $524 million in reported earnings—less than $0.42 in real cash earnings per $1 of reported earnings, according to data from S&P Global Market Intelligence.

This leads me to believe that while Oshkosh’s earnings are currently high, they are low quality and may not be sustainable. This is why I disagree with Merrill Lynch or RBC. No matter how good the earnings look, unless free cash flow improves, I can’t call Oshkosh stock a buy.

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Rich Smith does not own any stocks mentioned. The Motley Fool does not own any stocks mentioned. The Motley Fool has a disclosure policy.