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...
To say the news out of the American trucking sector is "mixed" would be an understatement.
Over the last 12 months, shares of PACCAR (NASDAQ:PCAR) are down 5%, Cummins (NYSE:CMI) stock is off by 14%, and WABCO (NYSE:WBC) is down more than 18%. Yesterday, the news promised to get worse before it gets better -- January orders for Class 8 trucks declined 68% year over year, and orders for smaller Class 5-7 trucks were down 24%, according to TheFly.com (citing a JPMorgan report).
Here's what you need to know.
Who does what?
WABCO, the smallest of these three companies, makes pneumatic anti-lock brakes, electronic stability control systems, and other crucial parts for commercial trucks. Larger Cummins specializes in manufacturing diesel engines. PACCAR builds entire trucks under its Kenworth, Peterbilt, and DAF brand names.
All three companies' fortunes are therefore tied to the health of the North American truck market -- and judging from recent statistics, that market is not healthy at all. Class 8 truck orders fell 43% year over year in December, and 15% in November, according to JPMorgan -- so not only are orders declining, but the rate at which they decline is accelerating.
Around the cloud, a silver lining
And yet, bad as all this news seems, investment banker R.W. Baird comes away from this data with a surprising conclusion: It's often darkest before the dawn, and rapidly collapsing orders for new trucks tells Baird that there's a "bottom" forming in the trucking cycle -- a bottom off of which PACCAR, Cummins, and WABCO stocks might very well bounce.
This morning, Baird announced it's upgrading shares of all three of these trucking stocks to outperform. Baird set an $80 price target on PACCAR (up from $62 previously), priced WABCO shares at $150, and pegged Cummins as worth $195.
And to an extent, that makes sense. After all, while declining orders sound scary, the lack of orders of today is likely to create pent-up demand that must be fulfilled...sometime. It makes sense then, that in a cyclical industry like truck manufacturing, a bottom will at some point be reached, and order flow will tick back up. (And even if that day turns out to be some time away, fellow analyst Piper Jaffray noted that for PACCAR at least, the company's large quantity of backlogged orders should support the company's revenue for the near term.)
At the very least, it can't hurt to begin valuing the prospects so that once orders do pick up again, investors will know which of these stocks they might like to add to their portfolios. So let's do that.
Valuing the prospects
Let's begin with Cummins -- probably the highest-profile name of the three stocks Baird is recommending. Valued at $23.9 billion in market cap, and with less than $1 billion in net debt, Cummins' balance sheet looks rock-solid. Cummins sells for a modest 11.2 times its $2.1 billion in net income, is pegged for 10% long-term earnings growth by most analysts who follow it (according to S&P Global Market Intelligence), and pays a generous 3.1% dividend yield -- about 1 percentage point more than the average dividend yield on the S&P 500, according to Morningstar.
That's a valuation that's hard to beat -- and I have to say, with regret, that I don't think PACCAR can beat it. Although Piper Jaffray likes the stock, most analysts agree PACCAR will be growing slower than Cummins over the next five years, with earnings rising just 8% per annum. PACCAR mostly makes up for this with a beefier dividend yield -- 5% -- but its balance sheet is weaker: $22.7 billion in market cap, but with $6.9 billion in net debt. Although PACCAR stock is the cheapest of the three Baird reviewed at 10.4 times earnings, I think I still prefer Cummins over it.
And WABCO looks even weaker as an investment prospect. Although it doesn't carry as much debt as either Cummins or PACCAR (just $168 million), that debt looms larger relative to the company's smaller market cap of just $6.1 billion. WABCO is also both the priciest stock of the three (P/E ratio: 13.7), and the slowest grower. S&P Global estimates show WABCO unlikely to grow earnings even 6% annually over the next five years -- and WABCO pays no dividend at all.
Long story short, while all three stocks are worth a look if you are looking forward to the day when trucking stocks rebound, WABCO appears to be the worst prospect -- and Cummins, the best.