PCAR - Paccar: Q2 Fundamentals Remain Sound And Strong

2023-07-28 11:43:00 ET

Summary

• PCAR's recent financial results for 2Q23 show promising growth, with total sales up 24% from the previous year and a significant increase in gross margin.
• I see attractive upside to the stock over the long-term as expectations are low.
• The catalyst for further stock price growth should be more clarity on the FY24 order book.

Summary

PACCAR Inc. ( PCAR ) specializes in the production of trucks of varying sizes and weight classes as well as the distribution of replacement parts for these vehicles. Readers may find my previous coverage via this link.

My previous rating was a buy , as I believed there was enough visibility to underwrite FY23 performance and that the expectations going into FY24 were low. I am reiterating my buy rating for PCAR as I continue to see long-term upside to the stock. I believe expectations are still low at this point, as my DCF model assumes only 6% EPS CAGR growth to achieve an attractive upside. The catalyst for the stock price moving upwards should be when management provides more clarity on the FY24 order book.

Financials/Valuation

PCAR's total sales for recently reported 2Q23 were $8.44 billion, up 24% from 2Q22. The gross margin increased by 440 bps between 2Q22 and 2Q23, from 14.4% to 18.8%. Operating margins of 15.9% were a major contributor to the higher-than-expected EPS of $2.33 vs. consensus estimate of $2.18. Revenue growth is notable in my view because it is supported by an increase in truck deliveries of 11% worldwide vs. 2Q22. I think the improved margins are a good indicator of the generally favorable pricing and cost climate, which is supported by the lessening of constraints in the supply chain. I think margin in the Trucks business is likely to take a hit as prices return to normal, but gains in productivity should be seen from better flow-through once problems with the supply chain are resolved.

Based on my view of the business, PCAR should be able to comfortably grow earnings at a 5% CAGR for the coming years, just like it did from 2012 to 2022. In my opinion, it is better to value PCAR on a long-term basis ((DCF)), rather than a relative basis, as this is a cyclical business. As such, attempting to forecast near- to medium-term earnings would lead to false precision in my opinion. Looking at PCAR's historical margins, PCAR has come a long way, expanding net margins from ~6% to ~14% today, and I expect margins to gradually improve due to PCAR's scale and its structural margin gains. Based on my DCF model, PCAR is worth $127.80.

Comments

PCAR stock price has been very strong since the end of May, and I believe investors shared my optimism regarding the stock. As a result, I am not taken aback by the post-earnings share price activity, wherein I think some investors decided to secure their gains while anticipating more clarity on the demand for 2024. PCAR is scheduled to open order books for the first half of 2024 in August or September of this year.

Importantly, PCAR's management remains confident in their optimism for a strong FY24, as they've been hearing nothing but positive feedback from customers on PCAR's new models and having fruitful discussions with major fleet operators whose order books have always been open. With the company's growth momentum continuing and potential margin gains, I believe PCAR will be able to meet consensus estimates in 2H23.

Specifically on potential margin gains, I expect PCAR will achieve the 18%-19% gross margin range that management has forecasted for Truck, Parts & Other as growth from fuel-efficient and mass-dimension compliant trucks drives structural margin gains for PCAR. Furthermore, the pricing/cost environment seems still favorable, with price increases of 15% for Trucks and 13% for Parts in 2Q23, while cost increases were only 9% for Trucks and slightly higher for Parts. When asked about their price/cost outlook for the next 12 months, management provided the following statement:

"…Like as we've shared before, the new trucks are providing at least a 7% improvement in fuel economy which is bringing thousands and thousands of dollars of benefit to our customers, they're the trucks that his drivers want. And so I think our customers make a good decision around trying to buy the best product for their operations which are PACCAR's products and that gives us a good pricing position as a premium brand in the market…" 2Q23 earnings call

When taken as a whole, the decrease in SG&A expense as a percentage of sales from 2.1% in 2Q22 to 1.7% in 3Q22 also demonstrates to me that management has exercised strict cost discipline.

Looking ahead to FY24, I anticipate that the demand environment will continue to be healthy, if not improve. Management has noted that the truckload industry has likely reached its lowest point in terms of utilization rate pressures, while vocational demand is exceptionally strong thanks to the demand from the US's infrastructure sector.

Risk & Conclusion

I believe PCAR remains an attractive investment opportunity with strong fundamentals and a positive growth outlook. The company's recent financial performance has been robust, with notable increases in total sales and gross margin. Despite potential challenges in the Trucks business as prices normalize, gains in productivity are expected as supply chain issues are resolved. Looking forward, management's confidence in a strong FY24, supported by positive customer feedback and fruitful discussions with major fleet operators, adds to the optimism.

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