PACCAR Inc.

Moat: 3.5/5

Understandability: 2/5

Balance Sheet Health: 5/5

PACCAR is a global technology company designing, manufacturing and selling light, medium and heavy-duty commercial trucks. The company’s parts and service, and financial services divisions are integral to its operations.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

PACCAR operates in a cyclical industry, and its sales are very much dependent on macroeconomic conditions. Its performance is affected by demand for trucks, input costs, interest rates and regulatory changes. The company has a well-established market presence and strong brands that include Kenworth, Peterbilt and DAF. PACCAR’s business can be broadly segmented into three areas:

  • Trucks: This segment involves the design, manufacturing, and sales of premium heavy, medium and light-duty commercial trucks. They are sold under the Kenworth, Peterbilt, and DAF brand names. PACCAR has a significant presence in North America, Europe, Australia, and South America.
  • Parts: The company manufactures and distributes replacement parts for the trucks it sells. Parts are sold to dealers and truck owners under the PACCAR Genuine and TRP brands.
  • Financial Services: This segment provides a wide range of services, including financing and leasing. In addition, PACCAR Financial offers various other services, such as full-service leasing, insurance, and fleet management.

The heavy-duty truck industry is characterized by high capital intensity and a long product life cycle. Given high capital expenditures and cyclicality in demand, profitability and the creation of a strong moat is very difficult. The high-end luxury segment is an exception.

Moat Analysis: 3.5/5

PACCAR has a narrow but strengthening moat, built around several key advantages:

  1. Brand Strength and Customer Loyalty: PACCAR’s brands, Kenworth and Peterbilt, are highly regarded, especially in North America, by owner-operators and fleets and are synonymous with quality and durability. This reputation for high-quality and durable trucks creates strong customer loyalty and allows PACCAR to capture market share, even when their prices are higher. The DAF brand is a major player in Europe and is highly regarded there.
  2. Extensive Distribution Network: The company’s extensive dealer network is key to retaining existing customers, while having good access to repair and parts. This large and well-established network allows PACCAR to quickly source and deliver parts and provides reliable after-sales service, thereby minimizing downtime for truck operators.
  3. Innovation and Technology: PACCAR has a history of innovation and investment in advanced technologies. They are focused on integrating electric and other new technologies to reduce emissions and increase fuel efficiency. Further, the company is investing heavily in autonomous and electric vehicles, which are both very costly and highly specialized, posing as a barrier for new entrants. However, competitors can catch up with these technologies in the future, thereby narrowing their moat.
  4. Vertical Integration: PACCAR’s degree of vertical integration is higher than most of its peers with internal engine manufacturing capabilities, in-house component design and more. The company is using its engine development to gain competitive advantage by increasing fuel efficiency, an important factor for its customers. They also manufacture a large proportion of its parts internally, which gives it more power in negotiations with its suppliers.

While PACCAR possesses many of these attributes, their ability to generate excess returns on invested capital is not as good as other high moat businesses because the truck industry is more cyclical.

Risks to the Moat and Business Resilience

Despite the moat, PACCAR faces several notable risks:

  1. Cyclicality of Demand: The truck industry is highly cyclical, and PACCAR’s financial performance is tied to macroeconomic conditions, which are inherently unpredictable. Economic downturns can significantly reduce demand for new trucks and impact company’s revenue, profits and profitability.
  2. Intense Competition: The heavy-duty truck industry has several competitors that are trying to win customers by offering better products and/or lowering costs. This increased competition may require PACCAR to lower its prices, increase incentives, and compromise on margins. There is also more competition on technology that can lead to greater innovation spending.
  3. High Input Costs and Supply Chain Issues: PACCAR, like all other manufacturing companies, is susceptible to fluctuations in commodity prices and supply chain disruptions, which can lead to increases in raw material and transportation costs, thus reducing profitability.
  4. Regulatory Risk: Government regulations on emission standards and fuel efficiency can influence PACCAR’s product development costs and production. These changes can have implications for existing products and force companies to upgrade their technology.
  5. Technological Disruption: Shifts in preferences towards electric and hydrogen powered trucks and autonomous vehicles may prove costly for PACCAR, and if the management does not pick the correct technologies to invest in, may mean huge amounts of wasted capital.
  6. Geopolitical Factors: Geopolitical uncertainty can have a negative impact on prices of commodities that PACCAR depends on. Political instability in other regions can hurt sales in those areas.

While it is difficult to shield against cyclicality, PACCAR has some advantages that allow it to withstand temporary adversities. It has a fortress-like balance sheet, a wide geographical reach, and strong brand recognition, which will likely help PACCAR when downturns in demand happen.

Detailed Business Explanation

PACCAR has a diverse business model that spans multiple segments and industries.

  • Truck Sales The company sells its trucks mainly through its extensive dealer network that is located all over the world. The company’s product portfolio consists of light, medium and heavy-duty trucks, which cater to a wide range of industries and needs. PACCAR’s brands have a good reputation in each of its geographies.
  • Parts The parts segment includes production of replacements parts for all of PACCAR trucks. These parts are distributed through PACCAR’s dealer network. The company has two main brands, PACCAR Genuine and TRP for higher and lower end parts respectively. A significant amount of revenue from the after-market provides a great source of consistent income and higher margins for the business.
  • Financial Services PACCAR Financial services helps provide financing solutions to its customers. The main parts of PACCAR Financial are truck financing, truck leasing, and insurance. It also has different revenue streams related to finance, such as interest income, fees and commissions. This service is extremely important to the PACCAR’s trucks as it allows many new businesses to afford and buy their vehicles.

In terms of geographical breakdown, North America contributes the highest share of total revenues, followed by Europe and South America. PACCAR has a well-balanced geographical reach that protects it from being exposed to a single market.

The company’s operations are also impacted by other factors:

  • Raw materials Raw material prices are a big input cost for PACCAR, and any increase in raw material prices can affect the profitability of the business. This can come in the form of fluctuations in the price of steel, iron, aluminum, and plastics, and other raw materials.
  • Energy costs The transportation of goods, from parts to trucks, involves considerable energy costs, the price of which can rise quite significantly depending on various factors including the price of oil.
  • Labor costs PACCAR’s workers are mainly unionized in North America, so contract negotiations and rising wages can effect profitability.

Overall, PACCAR operates in a highly competitive market with strong headwinds from macro factors and input costs. The company has shown resilience with its operational efficiency, and it is a great idea to monitor PACCAR’s profitability and how its moat stacks up against its competitors.

Financials In-Depth

A deep dive into PACCAR’s financials reveals the following:

  • Revenues: PACCAR has had fairly consistent revenues with strong growth in the last few years. They have risen from $17 billion in 2019 to almost $30 billion in 2022, followed by minor contraction in 2023. This expansion was mainly driven by a substantial increase in demand for its trucks, an effect that was felt all over the industry.
  • Profit Margins: Gross margins have shown steady improvement from 2019 to 2023, rising from around 12% to over 18%. This can mostly be attributed to an increase in higher prices and increased productivity at its plants.

Operating profits have followed the general trend in gross profits, but is a lot more volatile given different market conditions. In 2019 the company had operating margins of 10.7%, which has steadily increased to over 14% in 2022 before falling to 10.9% in 2023. This increase and decrease can also be attributed to a very large increase in the demand for trucks and the reversal in that trend. It is a very important factor to monitor closely going ahead.

  • Return on Invested Capital (ROIC): PACCAR’s ROIC has had a volatile few years, ranging from 16% in 2018 to less than 5% in 2020 during Covid. With the boom in demand for trucks, PACCAR’s ROIC shot up to over 20%, before coming down to 16% in 2023.
  • Earnings Per Share (EPS): Diluted earnings per share has followed the overall performance of the company. The EPS increased from 6.01 dollars in 2018 to a high of 8.21 dollars in 2022. The EPS for 2023 is lower than 2022, but still significantly higher than previous years.
  • Free Cash Flow (FCF): PACCAR has historically produced very strong free cash flow for many years. This cash flow allows it to invest in growth, and also buy back shares and pay dividends, making the company a shareholder-friendly business.

Understandability: 2/5

PACCAR is a fairly difficult business to understand. While its business model is simple, it is difficult to form a view on its prospects and moat. The following factors contribute to that:

  1. Cyclicality of the Industry: The heavy-duty truck industry is subject to significant cyclicality, which means that their earnings are highly dependent on macroeconomic conditions. This makes future performance prediction quite difficult.
  2. Technological Disruption: Emerging technological trends, like electronic vehicles and autonomous vehicles, introduce some ambiguity on whether the existing business will remain relevant. In addition, there are also uncertainties around adoption and timing of newer technologies.
  3. Intricate Supply Chain: PACCAR depends on a complex supply chain with multiple suppliers that are located all over the globe. This makes it difficult to model the economic effect of supply chain changes.
  4. Accounting Changes: There are frequent changes to regulations and accounting that make it harder to understand PACCAR’s true profitability and its results. Changes to taxes, and pension liabilities affect the numbers, requiring extra work to understand.

Balance Sheet Health: 5/5

PACCAR’s balance sheet is incredibly strong:

  1. Strong Cash Position: The company has substantial cash and marketable securities on its balance sheet. This allows it to make strategic acquisitions, to fund buybacks, dividends and R&D, while also protecting it during downturns.
  2. Low Debt: PACCAR’s debt levels are very low relative to its assets, and the company has a low Debt to Equity ratio compared to its peers.
  3. High-Quality Assets: The company has mostly high-quality assets, with a good proportion of tangible assets, such as property, equipment and inventory that can be used to create revenue or to pay off debt.

All of this leads to a company that is highly financially secure and will not be susceptible to bankruptcy.

Recent Controversies and Problems

PACCAR, along with the rest of the industry, is still facing some challenges:

  • Supply Chain Issues: While supply chains have started to stabilize, PACCAR is still facing disruptions that lead to slower production and higher prices, which also affects profitability.
  • Inflation: High inflation is leading to increased raw material and labor costs. PACCAR has started raising prices, but customers may become reluctant to pay higher prices.
  • Interest Rates Rising interest rates affect the cost of borrowing that is used to buy trucks, and the increasing interest rates have also affected the business segment. The company has increased rates on financing and is expecting to raise them even more.
  • Transition to New Technologies: PACCAR is investing in electric and autonomous vehicles, but adoption of these technologies is still very much uncertain, as are their economics, which may lead to some write-offs.

In terms of management commentary, the company’s management is optimistic about future business and believes it is well prepared to mitigate these risks. Management also noted that order intake and production is still healthy and they continue to build at rates above industry averages. They believe that if there is a slowdown they will be able to use their strong financial position and their established network to outperform their competition. The management expects a strong market in the near term.

The CFO’s commentary was as follows, during the latest earnings call:

“PACCAR is continuing to implement its plans for next generation zero-emission technologies, and is focused on reducing its operating costs in the future, while growing revenue. PACCA’’s first quarter net revenue, excluding Financial Services, was $6.6 billion, an increase of 29% over the first quarter of 2022. PACCAR delivered solid financial results as it benefits from supply chain improvements and strong market demand. PACCAR continues to create new technologies that will help its customers increase operating efficiency and further lower its carbon footprint.”

In conclusion, PACCAR is a great business with a strengthening moat, and a great balance sheet, which allows for consistent profitability and growth. Management is taking the business in a good direction, although there are some risks that can diminish the company’s strengths.