Even post-Brexit orders are strong for PACCAR, while North America is down from 2015. Image source: PACCAR subsidiary DAF.
Heavy-duty truck manufacturer PACCAR Inc. (PCAR +0.73%) reported financial results for its second quarter on July 26 using the same incredibly boring term to describe this quarter as it did the first quarter: "good." What exactly does that even mean?
Apparently, it means something like "better than bad, but not as good as last year." Let's dig into the financial and operating results and see if we can get to the heart of PACCAR's results.
The numbers
| Metric | Q2 2016 | Q2 2015 | Change |
|---|---|---|---|
| Revenue | $4,410 | $5,080 | (13.2%) |
| Net income | $481.3 | $447.2 | 7.6% |
| Adjusted net income* | $371.7 | $447.2 | (16.9%) |
| Earnings per share | $1.37 | $1.26 | 8.7% |
| Adjusted EPS* | $1.06 | $1.26 | (15.9%) |
Revenue, net income, and adjusted net income in millions.
*There were no adjustments reported to Q2 2015 net income or EPS.
Data source: PACCAR.
If you go back to the first quarter, you'll remember that PACCAR reported a $430 million loss after taking a huge $942.6 million one-time charge related to a major European Commission investigation into price fixing by heavy-truck manufacturers. As a result, the company reported both GAAP and adjusted earnings in order for investors to more easily review the company's operating performance without the impact of the charge to cover potential fines.
Fast-forward to the second quarter, and PACCAR has settled with the EC, and for $109 million less than it had set aside in the first quarter. So we have another one-time adjustment this quarter, but with the key difference: This one is a positive adjustment, adding $109 million to profits, while last quarter's charge was a loss on the books.
Again, PACCAR has given us both GAAP and adjusted net income to better evaluate operating performance without the boost of the positive adjustment.
Keys to the quarter
- North American truck deliveries fell 26% in the quarter, to 19,800, an acceleration from the 24% Q1 decline.
- Truck deliveries in Europe were up 17% in the quarter, to 13,100, and are up 25% so far this year.
- Deliveries to "other" -- which is primarily Brazil and other parts of South America -- were up 8% in the quarter.
- However, this market continues to remain weak. Management said 35,000 trucks would be sold across the industry in Brazil this year, down from 100,000 at the peak a few years ago.
- Because of the sheer size of the North American market, and PACCAR's huge 28% market share, total unit deliveries were down 12% in the quarter.
- So far this year, units are down 10%.
- In the truck, parts, and other operating segments, gross margin percent of 15.2% was essentially unchanged from the year-ago quarter, but R&D and SG&A expenses were up $3.5 million, further squeezing operating profits.
- Financial services segment also reported higher expenses, including interest, SG&A, and higher provisions for losses, though it still produced strong segment profits of $83.7 million.
What management said
CEO Ron Armstrong talked about the relative strength of the U.S. economy driving a solid year for heavy-duty truck sales:
The ISM Manufacturing Index has been over 50 indicating expansion for the last four months. Consumer spending and disposable income are outgrowing the overall economy, which is supportive of freight in the truck industry. We estimate U.S. and Canadian Class 8 truck industry retail sales will be in a range of 220,000 units to 240,000 units this year, which is the third best in the last decade.
He also pointed out that PACCAR continues to maintain 28% of market share in sales so far this year, while also making up more than 30% of total orders across the industry. Yes, sales are down, but they're down from the best year in North American truck sales in more than a decade. Europe has been especially strong for PACCAR's DAF unit. Armstrong again:
We've raised our forecast for Europe's greater-than-16-tonne market to a range of 280,000 units to 300,000 units, reflecting strong demand and the steady economic outlook. The eurozone's GDP growth expectations for this year are 1.5%. Freight transport activity on German highways in the first half of this year was up 3.4% over the same period last year. Since the vote in the U.K. to exit the European Union, DAF's truck orders, parts and service sales, and finance business continue at strong levels comparable to the period prior to the vote.
The continued strong order activity following the Brexit vote is worth noting. The U.K. is PACCAR's biggest market in Europe, and it's unclear what (if any) impact the Brexit could have on DAF, which has production facilities in the U.K., Belgium, and the Netherlands.
Looking ahead: Steady focus on great products, responsible capital management
Even with slightly higher operating costs, and the overall decline in revenues after a decade-best 2015 in North America, PACCAR's financial and operating results in the second quarter were, well, good -- just as the company described it. The company also moved past the EC investigation, and though it paid a very steep $800 million-plus fine, PACCAR can now move on, and focus on capturing more market share, and driving down its manufacturing costs.
Looking at the rest of 2016, Armstrong said he expects similar unit sales in North America in the third quarter, and reiterated continued strong demand in Europe following the Brexit vote. While it's unclear what the impact will be in coming years, PACCAR seems to be avoiding any short-term pains -- at least so far.
PACCAR will always be subject to the cyclical ups and downs of its industry, as demand for new trucks follows bigger macroeconomic trends. But from a long-term perspective, PACCAR's history as a market-beating investment has been a result of two things:
- Steady operating excellence at keeping costs in line while manufacturing a superior, reliable product that holds its value.
- Regularly returning excess profits to shareholders, primarily through a reliable dividend that has been regularly increased when market conditions support it.
The market in North America won't be as good in 2016 as it was last year, and early estimates are that truck sales could decline again in 2017. That's not good news if you're looking for a short-term investment. For long-term investors, however, the way PACCAR management has run the business through every part of the cycle has paid off very well. Don't expect that approach to change anytime soon.
