2 Reasons PACCAR Inc. Stock Is Poised to Pop

PACCAR shares have dropped 7% since earnings, but those betting against the stock could go horribly wrong.

May 20, 2014 at 7:05PM

Why should a company's shares fall after it tramples Street estimates on quarterly earnings, projects a good next quarter, and even increases its dividend? That question must be haunting every PACCAR (NASDAQ:PCAR) investor. The stock has given up 7% gains, as of this writing, over the past three weeks ever since the truck maker reported its first-quarter numbers.

The weakness in PACCAR shares is surprising. The company is among the top three truck makers in the world, is now ramping up its engines business in a bid to reduce dependence on Cummins (NYSE:CMI) engines, and remains the leader in the natural-gas powered truck market thanks to its long-standing relationship with Westport Innovations (NASDAQ:WPRT).

So why is the market worried? PACCAR's first-quarter report should, in fact, give you ample reasons to get the stock on your radar. Here's why.

Truck business is speeding up
The average age of heavy-duty Class 8 trucks is hovering at historical highs, encouraging customers to replace their aging fleet especially as construction activity in the U.S. gathers steam. PACCAR's first-quarter revenue climbed 12% year over year as improving freight tonnage and strong replacement demand pushed its truck deliveries up by 4% to 31,800 units.

PACCAR's strong hold in the North American Class 8 truck market is evident from the following chart, which shows the market share of top truck makers for 2013. Second only to Daimler Freightliner, the owner of Peterbilt and Kenworth brands enjoys strong leads over key players like Volvo, Navistar International, and Mack.


Source: Bloomberg. Data supplied by Ward's Automotive.

The good news is that PACCAR is headed for an even stronger second quarter, pegging its Q2 truck deliveries to improve between 8% and 10% sequentially. Chances are that it will also increase prices as demand picks up, which should further boost its revenue and gross profits.

Vertical integration -- the key to greater success
You have a fair idea about PACCAR's growth potential in the truck business, but how much do you know about its engines? While the company still sources majority of its engines from Cummins, it has started to give its key supplier some sleepless nights of late.

When asked why Cummins expects its share in the North American heavy-duty engine market to drop a percentage point this year at a recent call conference, this is what the company said: "[A]s PACCAR has increased their production of the 13 liter the MX product. We'll see some of our share which was planned to go down at PACCAR." So in an interesting revelation, Cummins told the world how PACCAR's MX-13 engine is taking away some of its customers. You certainly can't take that lightly, knowing how big a brand Cummins is in the engine market.

While the MX-13 engine has been around since 2010, its updated 2013 version has hit the right buttons. As an example, the Kenworth T680, powered by the MX-13, was judged the American Truck Dealers 2013 Heavy-Duty Commercial Truck of the Year.


PACCAR Kenworth T680. Source: PACCAR.

Now picture this: The MX-13 today powers 35% to 40% of Kenworth and Peterbilt trucks. In other words, PACCAR is increasingly becoming self-reliant, which is excellent news for the company and its investors. And given that it still outsources 60% of its engine requirements, the growth potential for its in-house engines is huge.

PACCAR may have just about 8% of the North American heavy-duty engine market under its belt currently, but it's interesting to watch how swiftly the company is closing in on competitors. One look at the following graph, which shows the 2013 market share for engine makers in the North America Class 8 truck market, will explain what I mean.

Engine Market Share

Source: Bloomberg. Data supplied by Ward's Automotive.

It's a close race to the top. But there must be something to the product that has made the industry leader squirm in its chair, and I wouldn't be surprised to see PACCAR jump to the No. 3 spot in coming years.

At the same time, PACCAR is striking a fine balance between producing the engines it can, and outsourcing those it doesn't have expertise in from the best in the industry. PACCAR has always been among the first truck makers to introduce Cummins-Westport Innovations natural-gas engines into its trucks. That has helped the company retain the top spot -- PACCAR dominates the U.S. market for natural-gas, heavy-duty trucks with nearly 40% share.

While natural gas transportation is still a niche market, Navigant Research projects annual sales of natural-gas run trucks and buses to more than double by 2022. No truck company is as well poised to ride that massive growth as PACCAR.

Stay glued to this stock
Sound financials should make it easier for PACCAR to exploit the growth opportunities in the years ahead. The company isn't heavily indebted, enjoys strong operating margins, and is generating good cash flows. That also leaves room for greater shareholder returns -- PACCAR has consistently paid a dividend since 1941, and has just raised its quarterly dividend by 10%. There's absolutely no reason you shouldn't be bullish about PACCAR. 

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Neha Chamaria has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Amazon.com, Cummins, PACCAR, and Westport Innovations. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Jun 12, 2015 at 5:01PM

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