America's second-largest truck maker, PACCAR (NASDAQ:PCAR), made its investors happy last year with more than 27% stock price gains. In 2014, the momentum has slowed, but the stock is still up more than 2.2% as of this writing, which shows that investors feel upbeat about the stock and the company's future prospects. This is not surprising given the company's strong operating performance in the first half -- revenues were up 9% to $8.95 billion and net profits were up 12% to $593.1 million. These results are backed by some very favorable developments like improving prospects in the domestic truck segment, encouraging performance in the Parts segment, and the flurry of new products that PACCAR is bringing to the market. Let's dig deeper.
Robust demand for big trucks in North America
The heavy- and medium-duty truck market is booming in North America. This is great news for PACCAR, which holds a 28% market share in the heavy-duty Class 8 segment in the U.S. and Canada. Industrywide sales for Class 8 trucks surged 33.1% in August to 19,627 units, from 15,288 units last year. This led to big sales gains for most truck makers. PACCAR's sales increased a healthy 28.6% in the month. In the first eight months of 2014, deliveries for Class 8 trucks in the U.S. have climbed 18.7% to 138,210, from 116,468 in the year-ago period.
Demand is fueled by replacement of old trucks and also some fleet expansion as domestic manufacturing activity gathers steam. The Institute for Supply Management's August purchasing managers' index, or PMI, increased 3.3% to 59, the best-ever level since the 59.1 recorded in March 2011, signaling a recovering U.S. economy. The PMI is calculated by taking into account different indicators for orders, production, employment, deliveries, and inventories.
PACCAR executive vice president Dan Sobic said, "Our customers are benefiting from record levels of freight tonnage, good freight rates, and the excellent operating efficiency of the new Kenworth and Peterbilt trucks for the on-highway and vocational segments." Sobic expects industrywide sales of Class 8 trucks to range between 230,000 and 250,000 units in 2014, compared to 185,000 units in 2013.
Expansion in the profitable parts business
PACCAR has 16 parts-distribution centers to provide after-sales support to over 2,000 DAF, Kenworth, and Peterbilt dealer locations. Parts revenue rose 9% to $1.5 billion in the first six months of the year over the same period last year. During this period, the size of the parts business increased to 17% of total revenues compared to 16% in 2013 and 15% prior to that. This is having a positive impact on the company's overall profitability as the parts business carries more margins than the core trucks business. In the first six months of the year, the parts business had a pre-tax profit margin of 16%, which is more than double the 7% margin fetched by the trucks business.
With higher truck production, new dealer marketing programs, improving fleet utilization, and the aging North American truck fleet, PACCAR senses a good opportunity in further expanding this business. The company plans to add more distribution capacity in the U.S., where most of the action is taking place. Construction of a 176,000-square-foot distribution center in Renton, Washington, is in the cards, which will replace an existing center with approximately half the capacity. The project is scheduled to be completed around mid-2015. According to PACCAR Parts' assistant general manager Tony McQuary in the Q2 press release, the expansion would "more than double the distribution capacity for our dealers and customers in northwestern United States and western Canada."
The past three years have seen PACCAR invest over $2.1 billion in new product and facility launches that are now showing results. The company has launched several new trucks in the past quarter that could boost sales in the latter half of 2014. It's rolled out the new Euro 6 CF and XF four-axle trucks and tractors for heavy-duty functions to reinforce its offerings in the container, construction, and refuse segments. These new products come at a time when buyers in Europe are "gradually adjusting to the increased prices of Euro 6 trucks," according to management.
PACCAR has also introduced new medium-duty Kenworth and Peterbilt brand cab-over-engine distribution trucks, which come with several refreshed exterior and interior features and improvements. The company has given special attention to increasing the turning radius and shortening the overall length of the Kenworth K270 and K370 and the Peterbilt Model 220 so that they are more efficient in city delivery services.
The company has set aside around $250 million to $300 million as capex, and plans to spend $200 million to $225 million on R&D in 2014 for upgrading operations at assembly facilities and powertrain development research, implying better-quality products and services are on the way. These should help PACCAR further leverage the momentum in the truck market in North America and elsewhere.
The improving manufacturing activity in the U.S. is boosting industrywide freight volumes and spurring truck demand. PACCAR is riding this trend well and turning in strong operating performances. Not only is it selling more trucks, it's also expanding its high-margin parts business to ensure a steady supply of parts and components to support dealers. The new launches provide an added incentive for buyers to upgrade their old vehicles and think about fleet additions. With these reassuring trends, PACCAR's performance could get even better with time and create more value for investors.
ICRA Online and Eshna Basu have no position in any stocks mentioned. The Motley Fool recommends and owns shares of Paccar. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.