Medium- and heavy-duty truck maker PACCAR (NASDAQ: PCAR) has been on a bit of a roll over the past year, with truck sales booming after a nearly decade-long slump. But after a strong run that saw the company's stock outperform the S&P 500 in 2014, concerns about a slowing economy -- and the potential impact on truck sales -- has led to poor returns this year. Year to date, PACCAR's stock is down nearly 20%:
With earnings set for release on Oct. 27, what should we expect? Let's take a closer look.
Short-term concerns
While PACCAR's stock has sold off in 2015, the company's business results have been pretty stellar. Over the past year-plus, heavy-duty truck sales -- a major source of business for PACCAR's Peterbilt and Kenworth brands in the U.S. and DAF in Europe and parts of South America -- have finally rebounded, leading PACCAR to report its second most profitable year ever and its best since the financial crisis. The first half of 2015 has been even better, with revenue and profits in the second quarter at the highest ever for that period.
However, market fears of an economic slowdown, as well as the impact of cheaper fuel costs potentially leading to some fleet operators delaying investments in newer, more fuel-efficient trucks, has affected the stock over the past several months.
Recent earnings releases from competitors Volvo AB (ADR) (NASDAQOTH: VOLVY) and Navistar International Corp (NYSE: NAV) have also raised short-term concerns as well.
Volvo Group -- which makes Volvo and Mack medium- and heavy-duty vehicles -- reported a 3% increase in truck deliveries in its third quarter. Sales were weak in South America, but increased by 13% in Europe and 10% in North America. That's the good news. Volvo reported a 15% decline in orders for new trucks and a more than one-third decrease in order for construction equipment. Looking specifically at U.S. factory orders, Volvo reported a 50% decline in its Mack brand and 30% fewer orders for Volvo trucks in North America in the quarter.
This probably sounds a lot worse than it really is, as Volvo management said much of the reduced factory order activity was a result of dealer focus on reducing inventory, saying that retail activity was still relatively strong. After all, U.S. freight activity has remained relatively high on strong automotive business and a residential construction market that has steadily improved over the past couple of years.
Navistar reported earnings back in early September, and management said that class 8 truck sales only increased about 3% in the third quarter, a disappointment for the company, especially in a strong market. However, Navistar's problems are more likely tied to its efforts to rebuild its image and reattract customers after years of below-average reliability with some of its core products.
Looking at the big picture
PACCAR is well on track to having its best year ever in terms of profits, but the market has been fearful that an economic slowdown will stop the music and end the party early. And while that's quite possible, there's more to consider.
Yes, PACCAR operates in a highly cyclical industry:
US Industrial Production: Heavy Duty Truck data by YCharts.
As you can see, industrial production of heavy trucks tends to peak before economic recession (gray columns), and then rebound sharply after. The cycle repeats as truck fleet operators halt spending in bad economies -- corresponding to reduced demand for the transportation of goods -- before ramping up spending to both meet increased demand and to replace older equipment when things improve. The table above also shows us that the current rebound is still below the two prior cyclical peaks.
That's not to say that sales have to go higher before they eventually do fall, but it's a reminder that the U.S. economy (a major source of PACCAR's business) is larger now than it was before either of the most recent economic downturns, and truck sales are still below 2007 levels. So there is likely still pent-up demand for new and replacement trucks, but that's not a promise that PACCAR's sales and profits are going to keep improving, if the current uncertainty about the economy turns into a reality.
What to focus on
The bigger point? PACCAR operates in a cyclical business, but management has proven very capable at capital allocation, cost containment, and building a strong business in both peaks and declines of the industry cycle. Case in point: Class 8 truck sales have rebounded sharply, but are still well below 2007 levels, yet PACCAR is on pace to have its most profitable year ever:
PCAR Net Income (TTM) data by YCharts.
The key reasons? Management has done an admirable job of getting costs down, which has led to strong growth in margins, cash flows, and operating income, but just as much emphasis has been placed on building reliable, fuel-efficient, and cost-competitive products. These steps won't make PACCAR immune to the next inevitable industry downturn, but they will certainly make it easier for management to navigate it.
PACCAR is likely to report strong revenue and profits on the 27th, but like its competitors, it may have some disappointing news about new orders. But looking at the big picture, the company remains one of the strongest in its industry, with a solid management team navigating the ups and downs.
