There are plenty of examples of small companies growing through tough times in their sectors, often by grabbing share with new and innovative approaches to old problems. Nevertheless, it is still generally the case that when the big boys catch a sniffle, the smaller companies suffer even more.

With major construction and agriculture equipment original equipment manufacturers (OEMs) such as Caterpillar (NYSE:CAT) and Deere (NYSE:DE) looking a little weaker (and their managements sounding more cautious), it's not so surprising that the shares of Titan International (NYSE:TWI), a maker of wheels and tires for off-road commercial vehicles, have weakened. Titan remains an ambitious and aggressive company, however, and these shares look quite interesting as a more aggressive play on long-term growth in sectors such as mining, construction and agriculture.

Investopedia Broker Guide: Enhance your trading with the tools from today's top online brokers

Drought, Doubt and Debt
As 2012 has moved along, investors have gotten significantly less optimistic about the outlook in 2013 for construction, mining and agriculture equipment. In only one quarter, 2013 analysts' numbers for Caterpillar (one of the world's largest manufacturers of mining and construction equipment) have fallen nearly 10%, and while the revisions for farm and construction equipment makers Deere and CNH Global N.V. (NYSE:CNH) haven't been as severe, there are substantial worries about the impact of Europe's debt crisis, the North American drought and ongoing economic turbulence in major emerging markets such as China and Brazil.

It's not hard to understand the concern. Off-road commercial vehicle OEMs have seen major revenue rebounds since 2009, but now dealer inventories in China are clogged, U.S. economic activity has slowed and bears are rushing to point out that these have always been businesses in cyclical industries. While it may be true that machinery operators will continue to need consumables like tires, Titan is nevertheless vulnerable if these end markets are due for a serious correction.

SEE: How The Severe Drought Will Affect Americans

Ambitious Growth Plans
Titan's management is certainly not positioning the business on the assumption of a prolonged malaise in these end markets. The company has launched a bid for sister company Titan Europe, which, if successful, will expand the company's exposure not only to Europe, but also to markets like mining and product categories like undercarriages.

But if management's prior comments to analysts and investors are still valid, a lot more could be on the way. Management has talked about some bold plans/targets for 2014 revenue, and those are likely to include additional acquisitions - whether that means buying more businesses from Goodyear (NYSE:GT), distributors and small manufacturers in mining or agriculture, or perhaps even wheel/tire businesses of rivals like Trelleborg (if they'd be interested in selling, of course).

Titan's goals don't lie solely on deals, however. The company has already begun building its mining wheel/tire business on its own, and there should be opportunities to win more business from the likes of Caterpillar, Komatsu (OTC:KMTUY) and other global OEMs.

SEE: Mergers and Acquisitions: Understanding Takeovers

How Good Can It Get?
Titan's ambitious growth potential has to be considered in the context of the risks and realities of its business and industry. Titan has already posted some good operating margins for an OEM components supplier; improved manufacturing efficiencies and overhead utilization could drive them higher, but how much higher can they go?

Likewise, can Titan convert revenue to free cash flow at a rate above the mid single digits? The company hasn't done so thus far, and aggressive revenue growth will require capital spending to support it, but this is arguably the biggest variable when it comes to projecting Titan's future value.

Companies such as Cummins (NYSE:CMI), Allison Transmission (NYSE:ALSN) and Commercial Vehicle Group (Nasdaq:CVGI) offer only very limited comparability to Titan, but they do support the broader point - that pushing operating margins beyond 20% and free cash flow margin into the high single digits is not easy as a commercial vehicle component supplier, but can be possible in some cases.

SEE: Free Cash Flow: Free, But Not Always Easy

The Bottom Line
I admit that the range of possible outcomes on revenue, margins and free cash flow are large with Titan, but I do believe these shares are undervalued today. If the company can produce revenue of around $2.5 billion and a free cash flow margin of 6.5% in 2017, these shares can support a fair value in the high $20s.

Don't underestimate the importance of that free cash flow conversion, however. Drop the 2017 estimated free cash flow margin to 5% and revenue has to be $3.3 billion to achieve the same free cash flow production. What's more, while further M&A may build the revenue base faster, additional debt and/or share dilution reduces the implied fair value.

All of that said, I still like Titan. This is not a safe stock, and investors shouldn't underestimate the risks of small-cap cyclicals, but I like management's growth ambitions and the opportunity Titan offers to play multiple markets (construction, mining, agriculture) all at once.

Stephen Simpson has owned shares of Commercial Vehicle Group for over 5 years.

Related Articles
  1. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  2. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  3. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  4. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  5. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  6. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  7. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  8. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  9. Investing News

    A 2016 Outlook: What January 2009 Can Teach Us

    January 2009 and January 2016 were similar from an investment standpoint, but from a forward-looking perspective, they were very different.
  10. Mutual Funds & ETFs

    3 Vanguard Equity Fund Underperformers

    Discover three funds from Vanguard Group that consistently underperform their indexes. Learn how consistent most Vanguard low-fee funds are at matching their indexes.
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center