Cyclical stocks can be challenging in the best of times, and forecasting gets especially interesting when established rules about the cycles appear to be changing. That’s the issue I see with PACCAR (PCAR) – the pandemic and supply shortages that started in 2021 have absolutely altered the normal trajectory of the heavy truck cycle, but so too may be the ongoing growth in e-commerce. On top of all that, while orders are looking healthy, it remains to be seen how fleet operators will respond to what could be double-digit price increases in 2022.
When I last wrote about PACCAR (roughly a year ago), I was not excited about the potential and I said it was a name to reconsider on a meaningful pullback. The shares then declined about 15% through the fall before beginning a rebound that has brought the shares back to where they were at the time of that last article.
I’m more bullish than a year ago, but not bullish enough to want to own the shares here, as the Street is still concerned about peaking orders and the ongoing impact of component shortages and input cost inflation. I think fair value is in the high $ 90’s to low 100%’s ($ 97 to $ 102), but I would like either a wider margin of safety (a share price in the $ 80’s) or a little more visibility on the 2023 book before getting more bullish.
PACCAR – Interesting Trends In A Mixed Quarter
This was a “best of times, worst of times” sort of quarter for PACCAR, with something to feed both bulls and bears.
On the top line, 20% overall revenue growth was impressive, beating by 15% to 23% depending on which source you use for the average Wall Street estimate (a 15% beat by Visible Alpha). Truck revenue shot up 23%, beating by 18%, as pricing strengthened (up 7% yoy) and deliveries surprised (a 17% beat) as the company did a much better job of shipping out units previously delayed by component shortages.
Parts revenue rose 22%, beating by 5%, while Finance revenue declined 10% and missed by 13%. Parts revenue continues to grow as a long-term percentage of sales, as management continues to execute on this important growth driver.
Margins are where things get interesting; unless otherwise specified, I will be talking about margins excluding the finance business. Gross margin declined 120bp yoy and 40bp qoq, missing by 110bp. The weaker gross margin on higher deliveries is attributable largely to PACCAR using more reengineered and brokered components to ship out those delayed units.
Operating income (ex-Finance) rose 8%, but margin declined 100bp to 7.6% and the operating result missed expectations by about 2% (again, Visible Alpha). By segment, Truck profits declined 18% with margin down 190bp to 3.9%, while Parts profits rose 38% with margin up 270bp to 23.4%. Finance segment profits rose 111%, with margin up 2,020bp to 34.5%
Strong Pricing, A Healthy Backlog… A “New Normal” On The Way?
Production for 2022 is not yet fully covered by orders according to management, but it’s close and management sees a healthy backlog at least six months out. Given soaring used truck prices at the end of the year, I do not think PACCAR’s 2022 book of business is in danger from the demand side, though it remains to be seen whether component availability improves.
To that end, management shipped 7K of the 10K “red-tag” units it had in its backlog without any incremental additions. Shipping out the remainder will weigh on margins some, but component availability should continue to improve as the year goes on. Meanwhile, management has been pushing through pricing actions, and I think we’ll likely see pricing rise by double-digits in 2022.
“Then what?” is the important question to consider. Management’s guidance for North American Class 8 truck orders (250K to 290K) was more conservative than ACT’s 298K figure, and I’m very curious to see how the 2023 book shapes up with those price hikes in store. Given the conditions in the used market and the fact that most carriers are trying to expand their fleets in response to strong demand (led, at least in part, by both recovery demand and e-commerce), I do not think fleet operators are going to have much choice in the matter.
One interesting recent comment from management is a projection that the new baseline level for demand could be above 250K units. This demand is largely being fueled by e-commerce, and that trend shows no evidence of slowing meaningfully. It would make sense that a growing trucking industry would lead to a higher baseline demand level, but “it’s different this time” are some of the most dangerous words in investing, particularly with cyclical stocks.
PCAR Stock Outlook
My concerns around PACCAR now are solely about the order book for 2023 and the pace of supply chain improvements. I continue to believe that the company is well-placed for the future (electric and other alternative propulsion sources like hydrogen), and I have no concerns where market share or execution are involved. To the latter point, I expect ongoing execution on efforts to further grow the aftermarket parts business, and this is lucrative add-on business for the company.
I expect revenue to increase around 16% this year and another 15% in 2023. I do expect a decline in 2024, but I think it will be a gentler adjustment than in past cycles, with revenue declining less than 10% in 2024 (the past few cyclical declines were 10% -plus). Relative to the last peak, I expect long-term annualized revenue growth of 3% to 4%, with improving FCF margins driving double-digit annualized FCF growth.
While long-term modeling is all well and good, with cyclical stocks all you can really hope for is to be “generally right” beyond the next two to three years (if that). Given that, I also rely on margin / return-driven EV / EBITDA valuation, as well as P / E, with multiples largely driven by past cyclical norms. Between those all, I end up with a fair value in the high- $ 90s to low- $ 100’s using an 9.5x multiple on my ’22 EBITDA estimate and 12.6x-14x multiples on my 2022 and 2023 EPS estimates.
The Bottom Line
Not unlike a year-ago, PACCAR’s share price is neither too rich nor too low to drive me to a really strong opinion about the shares. I do think the company has some good business opportunities ahead of it, but I also think a lot of that is already known (or assumed). Were the shares to retreat back into the $ 80’s (without a material worsening of end-market conditions), I’d take a serious second look, but for now I do not see a big enough cushion for me to want to take the risks that go with owning cyclical names.