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Morningstar | CNHI Margin Expansion Continues but New CEO Fails to Provide Details on Portfolio Strategy. See Updated Analyst Note from 08 Feb 2019

The fourth-quarter earnings call was the second hosted by new CEO Hubertus Muhlhauser. Unfortunately, he didn’t provide crucial details on CNH’s larger product portfolio strategy, which we feel could use a refresh given the lack of apparent synergies across its segments. We were dismayed to learn that much needed clarification will come during its 2019 capital markets day, which will occur at an unknown date before “Christmas.” Like many of its industrial equipment peers, CNH was able to expand operating margins in the quarter but achieved this with flat revenue growth year over year. Its main industrial activities segment experienced a 110 basis point increase in operating margin, which was up to 5.6% from 4.5% in the fourth-quarter 2017. Management provided upbeat guidance for 2019, suggesting EPS would grow 5% to 10% on slightly elevated revenue. We are keeping our fair value estimate of $12.10 while we await more detail on management’s strategy.

Healthy margin performance in the quarter was driven by improved performance across all of CNH’s segments. Management cited its disciplined cost management and pricing strategies. We note that it has been a favorable environment for manufacturers selling agricultural equipment, construction equipment and commercial vehicles as end-users seek higher margin features to improve their performance in a tight labor market. CNH’s construction equipment revenue grew 7% year over year with margins improving to 3.9% from 0.8% in the fourth-quarter 2017. Global infrastructure development and nonresidential construction growth in North America fueled the gains. We were impressed that management was able to increase the commercial vehicle segment’s operating margin to 2.9%, which represented a 100 basis point improvement from same quarter last year, despite revenue declining 4%. This suggests that its focus on selling CNG- and LNG-fueled heavy trucks is paying dividends as European customer seek diesel alternatives.

Despite the lack of details on CNH’s portfolio strategy during the earnings call, we were impressed with management’s long-term view, which focuses on megatrends--digitalization, electrification, and automation. For 2019, management expects to increase R&D to 4% of sales which will be up modestly from 3.8% of sales in 2018. We like the company’s commitment to investing in precision agriculture while partnering with several smaller agriculture technology companies. Going forward, we think CNH’s approach of developing heavy-duty natural gas vehicles, which will be an important bridge to all electric transportation, is astute use of capital. Moreover, it is taking important steps to introduce natural gas to the off-highway market that should give it an edge over rivals as end-users become more sensitive to environmental concerns and fuel costs.