Founded in 1905, Washington-based PACCAR (PCAR) is a global technology company, which designs and manufactures light, medium, and heavy-duty commercial trucks. The company operates through three segments: Truck, Parts, and Financial Services.
PACCAR recently reported earnings for the first quarter of 2022. The company saw revenue beat by $610 million, while earnings per share beat by $0.16. In total, revenue was $6.47 billion, while EPS was $1.72. Despite these strong results, we are neutral on the company.
PACCAR has seen minimal volatility so far in 2022, and these results did little to change that. However, management’s comments during the earnings call suggest that the economy is currently strong, and will remain so throughout 2022 and into 2023.
PACCAR and the Economy Are Poised for Growth
Management at PACCAR believes that both the economy and the company are set to grow in 2022, as well as 2023. Lately, there have been talks about how spot rates, which is the price shippers have to pay to move a load at current market prices, have been falling. This has led to concerns that demand may be waning for the transportation industry.
However, when asked about spot rates, CEO Preston Feight countered with the following:
“If you think of spot rates, they’re really the fringe of the business. They’re not the foundation of the business. And so, I think people may want to use them as a leading indicator, but they shouldn’t think of them as systemically covering what freight is doing out there. And so, since there is strong business out there, even if spot rates decline a little bit, they’re still present and the fixed contracts are still really strong. So as long as that continues, it bodes well for the market.”
Essentially, he is saying that just because prices have come down doesn’t mean that activity has declined. Instead, Mr. Feight claimed that all conversations with customers had a common theme — more trucks are needed.
This claim can be confirmed by the fact that PACCAR has a strong backlog of orders that is essentially full for the year in both Europe and North America.
This provides the company with great visibility for the rest of the year, giving management enough confidence to guide for full-year truck deliveries. PACCAR expects to deliver between 260,000 to 290,000 trucks in North America, and 270,000 to 300,000 trucks in Europe.
Growth Catalysts
In addition to the high demand for trucks, growth catalysts that are specific to PACCAR position it to benefit greatly from the current economic setup. To begin with, the company produces trucks with the highest fuel efficiency in the industry.
It claims that its trucks are 7% to 10% more efficient than competitors. Over millions of miles, the cost savings can be substantial for shipping companies. This is one of the factors that has allowed the company to increase its market share in North America from 24% to 28% year-over-year. Management expects this number to grow to 30% to 31% by the end of the year.
In addition, it was noted by Feight that the average truck age is up 10% to 15% because companies are holding onto their fleets for longer periods of time. This can benefit the company in two ways. The first is that customers will begin to replace their aging fleets with newer models.
Secondly, older vehicles require old parts to be replaced. Since PACCAR also sells parts, it can capitalize on this opportunity as well. It’s also worth mentioning that the Parts segment is a higher margin segment than the Truck segment.
Lastly, PACCAR has been developing electric trucks over the past several years. The company expects to deliver hundreds of vehicles in 2022.
Although it may not seem like much, it’s getting ahead of electric titan Tesla (TSLA), which hasn’t yet produced a commercial truck. This will allow PCAR to have a strong competitive chance against Tesla when it does finally enter this market.
PACCAR Creates Value for Shareholders
Great companies often have great management teams that can effectively allocate capital to profitable projects. We can try to get a good picture of management’s effectiveness by simply looking at the numbers. A metric we like to look at is the economic spread, which is defined as follows:
Economic Spread = Return on Invested Capital – Weighted Average Cost of Capital
The idea is very simple, if the return on invested capital is greater than the cost of that same capital, then the company is creating value for its shareholders through well-thought-out projects. Otherwise, the company is destroying value and would be better off simply investing money into risk-free bonds.
For PACCAR, the economic spread is a follows:
Economic Spread = 8.6% – 8%
Economic Spread = 0.6%
It’s important to note that the nature of the business is cyclical. Thus, it would make more sense to use the average return on invested capital over the past five years. In that case, ROIC is 9.8% with some years seeing this metric as high as 12%.
Nevertheless, the company is creating value for its shareholders in both scenarios, implying that management is efficiently allocating capital.
Wall Street’s Take
Turning to Wall Street, PACCAR has a Moderate Buy consensus rating, based on six Buys, seven Holds, and two Sells assigned in the past three months. The average PACCAR price target of $96.47 implies 14.8% upside potential.
Final Thoughts
PACCAR is a great company that is well managed and set to continue growing by capturing more market share. In addition, management’s comments about the economy’s outlook highlight its belief that it will continue to be strong going forward, and that a recession is unlikely.
Nevertheless, we remain neutral on the stock because we don’t believe a 14.8% margin of safety is large enough when investing in a cyclical company such as PACCAR.
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