2023-12-14 12:10:10 ET
Summary
- Paccar, the owner of brands such as Peterbilt and Kenworth, has shown strong revenue growth and consistent dividend payouts.
- The company's focus on execution, efficiency, and its service business has contributed to its success and profitability.
- While the stock is currently trading at an all-time high, long-term investors may still find value in Paccar's business model and execution.
Introduction
Trucks manufacturers belong to an industry which doesn't attract much attention from investors. Not only it is part of industrials, a sector where competition is fierce, margins are low and a lot of capital is required; but also, it is exposed to cyclicality and to interest rates because most customers finance their purchase of new trucks or buses. Since in recent years it has been shown and repeated more and more that to succeed in investing it is best to buy high-quality compounders whose free cash flow generations is reliable and growing, truck manufacturers are automatically ruled out.
And yet, even within this industry there are two, if not three, very interesting companies that can check at least a few of the boxes of a high-quality company. I have talked elsewhere about my bull-case on Volvo Group ( VLVLY , VOLAF ) and I have also pointed out how Daimler Truck (DTRUY) may be closing the gap with the industry leaders. However, in this article, I want to talk about what seems to be the company whose revenue sports the highest quality among its peers: Paccar (PCAR), the owner of brands such as Peterbilt, Kenworth and DAF. After all, Paccar this year has greatly outperformed its peers, and I think this is somewhat deserved.
Christmas surprise for Paccar's shareholders
We need to go over the company because it recently declared an extra cash dividend of $3.20 per share, payable on January 4th, 2024 to stockholders of record at market close on December 15th, 2023. This comes after, last December, the company declared a 50% stock dividend of the common stock. This year's special dividend makes the company actually have a 4.4% dividend yield, which makes it very attractive. If we look back at the company's dividend history, every December its shareholders have received a "gift" for Christmas, as its dividend history shows below.
Now, these gifts don't come out of the blue. They are just the tip of the iceberg of a business that, yes, may be highly competitive, but, is laser focused on generating sustainable cash flows. Without these, no way we would see such a consistent streak of growing dividends coupled with a yearly special dividend.
Paccar's Execution
Let's leave aside for this time the impact of the $1.2 trillion spending approved with the Infrastructure Investment and Jobs Act, which will benefit Paccar as it is the industry leader in vocational trucks (Kenworth and Peterbilt have 40% market share in the vocational segment in the U.S. and Canada).
Let's leave aside the fact that around 74% of freight is moved by truck and will keep on being moved in this way because of trucks' ability to go almost anywhere.
Let's leave aside Paccar's BEV portfolio and how it is well ahead of supposedly-innovative companies such as Nikola ( NKLA ).
Let's instead look at a few metrics used to measure how a company executes. As taken for granted as they may be, most business find it hard to focus on improving them. Paccar manufactures a type of product many other companies produce as well. But it does so with better execution.
First: it is head-to-head with Volvo when considering operating efficiency. Moreover, during favorable economic conditions such as the ones we have just went through during the post-Covid cycle, Paccar (together with Volvo) was able to improve its operating margin at a brisker pace than the other competitors.
Second, when we consider efficiency under the inventory turns perspective, Paccar is way ahead of all its other peers, with a 12 instead of 4-5.
Third, when we consider its operating efficiency in terms of how SG&A weighs on sales, Paccar shows outstanding execution with around 2% of its sales revenue used to finance SG&A.
Fourth, Paccar's profitability is best in class because in the wider machinery manufacturing industry, it has the best return on invested capital, overcoming industry leaders such as Caterpillar (CAT) and Deere (DE). So, not only Paccar is more efficient in its operations, but the money it saves there can be deployed back into the business at a higher rate. This is exactly how a compounder works.
Fifth, Paccar has a superb balance sheet, carrying no manufacturing debt and $7.4 billion in manufacturing cash and securities. This makes the company deserve an A+/A1 credit rating, providing easy access to the credit markets for its financing branch.
Paccar's secret
What makes Paccar so reliable? Where does the company reinvest its money? Well, the answer is simple. Paccar has focused on building a service business with a wide distribution network able to provide spare parts quickly.
In other words, Paccar has built a business on top of its manufacturing one. More in detail, Paccar is the company, within its industry, with a clear focus on profiting not only from the sale of a truck, but from its whole lifecycle. As we can see below, Paccar's Parts business has very high gross margins (32% against 16% for trucks), ever trending upwards with very little cyclicality. We see the company was at almost 32% at the end of 2022 and, during the last earnings call, it reported its total returns on invested capital for the first nine months of the year was 35%.
Let's look a little more in depth at Paccar Parts. In the last 20 years, Paccar has compounded this business at 9% per year, making it a $6 billion business. Considering Paccar's revenues should be around $34 billion this year, we are talking about 18% of the overall business. But this 18% generates pretax profits of almost $1.5 billion (25% pretax margin). Considering the company's overall earnings before taxes is about $5.5 billion, we understand that Paccar Parts sales generate around 27% of the company's pre-tax earnings.
Not only Paccar Parts makes up more than a quarter of Paccar's pre-tax earnings, but also, it generates recurring revenues, which help the company smooth its top-line cycles, while providing always some "fat" for the bottom line.
With the fundamentals we have seen, no wonder Paccar recently reported record Q3 financial results, with net income increased 60% YoY to $1.23 billion from a 23% revenue growth to $8.7 billion.
Considering the company's cash from operations in the last TTM is $4.3 billion and that it spent $169 million in interest expense, paid $932 million in taxes and invested $1207 in capex, we are left with $1.9 billion in free cash flow. In the same time period, the company paid $506 million in dividends, leaving $1.4 billion of its FCF untouched. So, with the special dividend the company will pay an extra $1.7 billion to its shareholders. Where do the $300 million in difference come from? I suspect Paccar already knows Q4 has seen tremendous free cash flow generation which will support this special dividend without making the company take on new debt.
Valuation and conclusion
Paccar's story is nice, promising and convincing. Yet, we have to consider if it is currently a buy. So far, the stock has gone upwards, following the trajectory of its profits. Now, don't get me wrong. If a stock is trading at ATH, this doesn't necessarily mean it should not be bought. Long-term compounders sail usually in one direction: north.
Yet, Paccar has guided for lower sales next year, especially in Europe and, to a lesser extent, in North America. This will have an impact on revenues and on margins.
But we need to stretch our forecast over the 1 year time frame. After all, I go after long-term holdings, whose earnings and cash flows ten years or more from now will be significantly higher than today.
I consider Paccar able to grow its top line at a CAGR of 5% over the next decade, leading to around $55 billion in revenue by 2033. Over this time period, considering a net income margin of 12%, the company will overall generate around the same amount in earnings: $53 billion. The free cash flows we can expect can thus add up to around $25 billion in a decade.
Paccar's current market cap is $51 billion. This mean is trading around 1 in terms of its 2033 fwd earnings multiple and around a 2 if we consider its FCF multiple. Not expensive, but these are multiples for results way out in the future. Overall, considering everything we have said, I would not pay for Paccar's next year's earnings more than 11 times, which is more or less the fwd PE multiple it is trading at. This is why I keep on thinking the company is fairly priced.
So, we are before two choices: those confident in Paccar's business model and execution and with the right mindset and available time-frame to hold on to a stock for 10+ years, should not be afraid of today's price. For sure, those who are already invested in the company should hold on to their shares. But some investors may still want a larger margin of safety and will prefer to buy the company on a potential dip. This is why I still rate is as hold, which should not be seen as a negative rating, but rather as the sign that at this price we have several strategies that could work well.
For further details see:
Paccar Announces (Again) A Christmas Gift