Paccar Stock: Strong Visibility Through H2 2024 With Improving Unit Economics (PCAR)

Summary

Readers may find my previous coverage via this link. My previous rating was a buy, as I believed PACCAR Inc. (NASDAQ:PCAR) would continue to do well given the strong visibility into its FY23 performance. Even with conservative earnings growth assumptions, the upside was very attractive. I am reiterating my buy rating for PCAR as I believe the market is still undervaluing the business (my revised price target is $160.86). The PCAR demand outlook remains strong with strong visibility through 2H24 and should see momentum continue through FY24 as the US economy recovers. Moreover, unit economics continue to trend positively, suggesting that in future cycles, profitability will be much better.

Financials / Valuation

As a result, PCAR’s 4Q23 EPS of $2.70 was higher than the $2.23 consensus estimate. The sales of trucks, parts, and other items increased by 11% year-over-year, reaching $8.6 billion, contributing 11.7% of the total revenue growth, which came to $9.08 billion. The improvement in Truck, Parts & Other gross margin of 350bps YoY to 19.4% was the primary driver of the 370bps improvement in blended gross margin, which increased it from 20% to 23.7%. Global truck deliveries fell 1% but increased 2% sequentially to 51.1K units, in terms of volumes. This volume performance was slightly higher than the upper limit of the 48 to 51k range that management had guided for. Management reiterated its expectations for the trucking industry in 2024, predicting retail sales in the US and Canada of 260–300k units, registrations in Europe of >16t trucks to be between 260 and 300k units, and sales in South America of 105–115k units.

My simplified DCF model continues to suggest that the market is undervaluing PCAR’s business. As I discussed below, the unit economies of this cycle are a lot better than the previous cycle’s peak, which paints a very positive outlook for future cycles’ unit profitability (in terms of absolute figures). With the US economy potentially turning for the better in 2024 and beyond, PCAR could see faster earnings growth than its historical performance. Nonetheless, to ensure that I am not overly bullish, I continue to model a 6% EPS growth (1% above historical 5% CAGR between FY12 and FY22), followed by a 3% terminal growth rate (2% inflation + 1% volume growth). Adjusting EPS to the LTM figure of $8.76, my revised target price is $160.86.

Comments

Before going into the deeper details, I just want to give an update on the stock’s performance since my July writeup last year. My previous price target was $127.80, and the stock has performed very well against my price target, rising from ~$85 to the current level of $101. I believe the market is still not fully pricing the potential upside. With the demand outlook still strong with an improving profit trend, I continue to reiterate my buy recommendation.

I will start with the demand outlook. Management has once again emphasized the strength of the regional truck markets in South America, Australia, and Mexico, while North America has maintained very high levels of stability. Looking at demand by sector also reveals a positive trend: medium duty, vocational, and LTL (less-than-truckload) continue to do well, while the truckload market may have moved past its trough. Additionally, it seems like industry players have gotten more rational as they are now purchasing trucks to keep their fleets at a reasonable age (instead of delaying purchase). Additionally, regarding visibility, the management has mentioned that the order books for 1Q24 are nearly full, the order books for 2Q24 are filling up nicely, and the growth in 2H24 backlogs is excellent. More than just restating a prior guide, this seems to indicate a strong belief in the full-year outlook range. What this further implies is that, in order for FY24 to be weak, PCAR will need to see a significant decline in demand in 2H24. While this is not impossible, I think the odds are in my favor (bullish) as the US economy appears to be on the right track of recovery—inflation coming down, rates potentially getting cut, job growth cooled towards a steady pace, and many other indicators. With a possible macro recovery, it should drive an increase in demand for trucks, which should support PCAR’s 2H24 growth outlook.

And so they’re looking to keep their fleet at a reasonable age and buying trucks and continuing that pattern. And then they’re managing that against the fact that contract rates and spot rates are lower than they were and trying to maintain that balance of fleet age with capital spending. Source: 4Q23 earnings

On top of a strong demand outlook, the unit economics are also trending positively, which I expect to sustain in the near term as PCAR releases new products. The fact that profit unit economics is almost 2x higher than the previous cycle high ($10k in FY19) bodes really well for future cycles’ profit outlook, which also proved that my previous EPS growth assumption of 6% might be too low.

So I expect parts to continue to hum. And, on the truck side, again, great new trucks providing good margin performance. And, obviously, doing a fantastic job for our customers. That’s what we see out there. Source: 4Q23 earnings

Moving on to parts sales, the demand forecast appears to be excellent as well, with management expecting a 3-5% increase in 1Q24 and a 4-8% increase for FY24. I believe this guide reflects that PCAR still benefiting from its dealer network, PDC expansion, and usage MDI to improve parts availability.

It reflects really reflects all the fantastic things our parts team is doing, focusing on technology that makes it easier to buy from us, the e-commerce technology, the MDI where we manage the dealer’s inventory and make sure the parts are available when needed, our continuous investments in parts distribution centers, the strong performance of the PACCAR Engine that provide us more proprietary parts. Source: 4Q23 earnings

Risk & conclusion

The European economy is expected to remain soft in 2024, and management expects its deliveries in the region to be down ~15–20%. If the economy fares worse than expected, a much weaker European performance might drag down the entire group’s performance. Management expectations for US performance might be overestimated, as ACT research suggests a potential weak 2024.

Overall, I still think PCAR stock is cheap at this level. I reiterate my buy recommendation. 4Q23 performance was great, with truck, parts, and other sales contributing to positive trends. The demand outlook also remains favorable, especially in South America, Australia, and Mexico, with medium duty and vocational sectors doing well too. Notably, there is high visibility into order books for 1Q24 and 2Q24, which I expect strong demand to flow into 2H24 books as well. Unit economics are also trending in the right direction with current unit profitability 2x the previous cycle’s peak.