Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Down 5% since the year began, and 11% since its highs of mid-February, PACCAR (PCAR -0.59%) stock is having a rough time of things in 2017. But don't lose heart: One analyst thinks PACCAR shares are due for a turnaround -- and could leave February's highs in the dust.
Here are three things you should know about that.
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1. UBS shifts into "buy" gear
Over in Switzerland, analysts at megabank UBS have just upgraded PACCAR stock to buy and assigned a $75 price target. As explained in an update on StreetInsider.com today (may require subscription), there's a shift happening in the truck market, the first signs of which should become evident later this year.
Already, says UBS, PACCAR's "Class 8 truck orders" are up 36% year to date, and sales on the "used truck market" are also stabilizing. Freight activity is improving among trucking companies, and UBS says it expects to begin seeing PACCAR converting orders into production (sales and profits) over the course of this year.
2. Industry trends
Data from freight industry tracker DAT supports this view. According to DAT, the average flatbed load-to-truck ratio (the amount of freight being transported, relative to the number of trucks available to transport it) in May more than doubled in comparison to May 2016, while flatbed rates rose 9.4%.
What that means is more freight is being shipped, and at better prices -- a boon to trucking companies like Old Dominion Freight Line (ODFL -7.24%) -- and a boon to truck makers like PACCAR, which sell the trucks that truckers need to carry their freight. (Not coincidentally, Old Dominion Freight Line itself won an upgrade from Merrill Lynch this morning, from underperform to neutral.)
Further supporting this view, DAT data show that spot market loads were up 100% year over year in May, while capacity to carry those loads rose only 2.7% -- another tailwind for truck production.
3. What it means for PACCAR
In UBS' view, this trend of rising demand for freight hauling and diminished supply of trucks to do it should produce 10% revenue growth for PACCAR this year. And with better utilization of its factories, production efficiency should improve, adding 110 basis points to the profit margins that PACCAR earns on its growing revenue.
Nor is UBS the only one optimistic about PACCAR's prospects. According to data from S&P Global Market Intelligence, the consensus on Wall Street is that PACCAR's earnings could more than double in comparison to 2016 earnings, rising to $3.72 per share this year, and continuing to grow as far out as 2020.
The most important thing: Valuing PACCAR
Even assuming the analysts are right, though, does this mean you should buy PACCAR stock? Not necessarily.
Let's assume for the moment that the estimates are right. At $3.72 per share this year, and a $62 stock price, PACCAR stock would be selling for about 16.6 times current-year earnings. That doesn't sound unreasonable, given that most analysts agree PACCAR will be able to grow earnings at about 14% annually over the next five years, and given that the stock pays a 2.6% dividend yield.
Those numbers actually hit the total return ratio of 1.0 exactly on the nose -- a 16.6 P/E ratio divided by a "total return" of 16.6% from both earnings growth and dividends.
What worries me, though, is the quality of PACCAR's earnings. You see, while PACCAR's "profits" may look good this year, this company doesn't have a very good record of converting GAAP profits into actual free cash flow. Last year, for example, PACCAR reported "earning" $522 million -- but its free cash flow for the year was only $335 million. In fact, it's been nearly seven years since PACCAR last reported free cash flow in excess of GAAP net income, which tells me that the company's quality of earnings leaves something to be desired.
Long story short? Despite UBS' endorsement, I won't be buying PACCAR stock today. While the low P/E and a decent growth rate are enticing, in the absence of strong free cash flow to back up the GAAP numbers, I just don't have faith that these earnings are all they're cracked up to be.
