It's been an eventful week for investors in the trucking industry, and not least for shareholders of Navistar (NAV +0.00%). The stock surged following a well-received set of third-quarter earnings. And almost by stealth, all the leading trucking-sector stocks are now up in the double digits on a year-to-date basis as I write this. Of particular note, engine maker Cummins (CMI 2.98%) and truck manufacturer PACCAR (PCAR 2.29%) are now up nearly 25% on the year, and most of the gains were in the last week! What's going on? Were Navistar's results really that good?
Image source: Getty Images.
Navistar third-quarter earnings
The earnings report was good, with Navistar reporting market share gains and growing sales and earnings in double digits during the quarter. In addition, management confirmed its full-year guidance on sales and adjusted earnings before interest, depreciation, and amortization (EBITDA). Moreover, there was even a slight upgrade to its forecast for full-year Class 8 (heavy duty) industrywide truck production and its core market exposure. For reference, Navistars core markets are Class 8 (heavy trucks and severe service trucks), Class 6 & 7 (medium-duty trucks) and school buses.
|
Navistar Full-Year 2019 Industrywide Volume Guidance (1,000s of units) |
At December |
At March |
At June |
Current |
|---|---|---|---|---|
|
Class 8 |
265 to 295 |
265 to 295 |
290 to 310 |
295 to 315 |
|
Core Markets Industry |
395 to 425 |
395 to 425 |
425 to 445 |
435 to 455 |
Data source: Navistar presentations.
It all looks pretty good, but was it that good? Does merely confirming full-year guidance justify a 30% upward move in the stock price in the five days after the results?
Navistar's results weren't that positive
Of course, these are rhetorical questions, as there's no rational reason for Navistar's market cap to rise nearly a third after these results. Although it reported market share gains -- its share of the combined Class 8 category (heavy duty and severe service trucks) was 13.9% in the third quarter versus 12.3% in the same period a year ago -- there were also some negatives in the report.
The downside came from the fact that full-year revenue is expected to be "toward the lower half of our guidance range of $11.25 billion to $11.75 billion for the year," according to CFO Walter Borst on the earnings call. Moreover, full-year gross margin expectations were nudged down slightly from a range of 18.25% to 18.75%, to 17.75% to 18%. Borst put this down to a combination of relatively higher truck sales (parts margin tends to be higher), higher commodity prices, and weakness in the used truck market.
In addition, management gave industrywide production-volume guidance for 2020 indicating that it would be a down year for the industry.
|
Navistar Full Year Industry Volume Guidance (1,000s of units) |
2018 |
2019 Estimate |
2020 Estimate |
|---|---|---|---|
|
Class 8 |
277 |
295 to 315 |
210 to 240 |
|
Core Markets Industry |
409 |
435 to 455 |
335 to 365 |
Data source: Navistar presentations.
Furthermore, a look across the industry -- at, say, truck engine manufacturer Cummins -- suggests the trucking market has peaked or is very close to it already. Investors can expect sales declines next year, and analysts already have an 8% sales decline penciled in for Navistar in 2020, with Cummins revenue expected to decline 3%.
So if the earnings weren't that great and the outlook is for a down year in 2020, why did the stock and the sector soar?
Why Navistar stock raced higher
The answer probably lies in the familiar guessing game that the market plays with highly cyclical stocks like Navistar; a similar dynamic exists when investing in the railroad sector.
Many investors shy away from buying into the trucking sector as it's approaching a peak in truck sales, but history suggests that after the peak has passed, and the bad news is baked into guidance, that it's usually a good time to buy into the sector in anticipation of a turn in the cycle in the future. Confused? I'll explain.
The market has known for a while that 2020 was likely to be a down year, and Navistar CEO Troy Clarke provided plenty of evidence to confirm it: Class 8 truck orders declined 75% in the quarter, and backlogs are declining, while U.S. GDP growth is "expected to be around 2% for the balance of the year," according to Clarke.
In these situations, the market tends to price the upcoming decline in truck sales into the valuations of the stocks. As you can see below, the multiples of enterprise value (market cap plus net debt) to EBITDA for Cummins, Navistar, and PACCAR are comparable to what they traded on toward the end of 2016 -- when the trucking market last turned down.
NAV EV to EBITDA (TTM) data by YCharts. TTM = trailing 12 months.
The question now turns to what's baked into guidance for next year. As the chart below indicates, forward valuations in the sector are low and imply notably lower multiples than when truck sales troughed in early 2017. All of which suggests that if you believe that the trucking market will start to stabilize next year, then it makes sense to hold the stocks.
NAV EV to EBITDA (Forward) data by YCharts.
The bottom line
In the end, it's a classic case of selling the rumor and buying the news. In this case, the rumor is that truck sales will decline, and the news is that now, companies are explicitly coming out and saying it. Of course, there's no guarantee that the trucking market will trough in 2020, but the valuations of stocks like Cummins and Navistar make them look attractive on a risk/reward basis.
