Which Names to Buy Amid an Improving Truck Market
Zain is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The trucking industry has been in the news recently, especially after the market viewed some optimism in the last earnings season. Performance of this industry is important, as it is a leading indicator of the health of the economy. Recently, some numbers relevant to the trucking industry were released, which can help us understand the industry’s performance.
ACT Research released NAFTA original equipment manufacturer (OEM) build and retail sales data for the month of May, with industry builds coming in at 23,300, up from 22,700 in April but still down from 27,400 in May 2012. May represents the fifth-consecutive month of sequential growth in Class 8 builds (+2.5% month-over-month on a sequential basis). The May data is supportive of the view of a relatively healthy, replacement-driven NAFTA Class 8 market.
Moreover, it suggests that the gradual improvements in monthly build rates thus far in 2013 reflect a NAFTA Class 8 market that seems to be on somewhat firmer footing following a period of choppy/declining builds. Class 8 backlog was flat at 85,800 (vs. 85,700 in April), reflecting order and build rates that have generally trended inline with one another over the past several months and supporting the point of view that orders will need to remain at least in the low 20,000/month range to maintain current backlog levels.
Which companies will benefit?
Positive numbers tell us that the industry is gradually improving but it doesn’t tell us which companies are performing well. Let’s have a look:
Navistar’s (NYSE: NAV) Class 8 retail sales share for May was 12.5% (down from 13.9% in April). Although it is important for Navistar to demonstrate some progress on driving market share improvements over time, it is not unusual for Navistar to have a decline in market share in the first month of its fiscal quarter (Navistar’s retail sales share has declined in May in seven out of the previous 10 years, with an average decline of 140 bps over that time period matching the decline in this month’s data).
Hence, Navistar’s share could remain subdued/choppy in the near term, but the market is cautiously optimistic that as FY 2013 progresses, and especially in FY 2014, Navistar could continue to gradually ramp-up production and retail share with its Cummins' (NYSE: CMI) ISX15L-equipped ProStar as well as with its proprietary 13L-equipped ProStar.
Cummins – The savior
And who can forget Navistar’s disastrous engine strategy employed by former CEO Dan Ustian? It was in April that Navistar was finally able to solve its engine problems. The truck maker announced that the Environmental Protection Agency (EPA) had finally blessed the company’s 13-liter engine, which paved the way for customer delivery to begin by April’s end.
This wasn’t some trivial matter for Navistar, which in the last year and a half ran dead smack into regulatory and legal issues that threatened the life of the company. For those not familiar with the story, Navistar made a big bet on an engine design that failed to win EPA approval and as it started running low on emission “credits,” there was a thought Navistar might have to shut down its engine line.
The company, however, received a lifeline from the EPA (which was later thrown out in court) and it used the extra time to redesign its engines and source other engines from Cummins. That kept the lights on and the Illinois-based company is now poised to get its own engines out into the market, hopefully recover some lost market share and keep a few activists (Carl Icahn and Mark Rachesky) at bay.
Cummins itself is inexpensive given that it trades at a forward multiple of 11x only vs. the industry average of 14x. Cummins’ stock price is expected to be driven by (1.) higher US truck market share; (2.) higher Brazil truck engine and after-treatment production; (3.) improved power generation operating efficiency following 4Q 2012 production cuts; and (4.) fewer inventory de-stocking headwinds than in 4Q.
Beyond the quarter, the management is expected to raise its full-year sales guidance driven by (1.) higher Navistar after-treatment sales, as current guidance assumes $19 million of sales; (2.) higher US truck market share, which is running 2% to 4% above guidance, and; (3.) higher Brazil truck production forecasts. In the longer term, the earnings estimates are expected to be beaten by over $1 billion of new product sales at well above-average incremental margins.
Only recently, Navistar announced that it has selected Cummins' Selective Catalytic Reduction (SCR) after-treatment technology for use on its medium-duty engines, available beginning in the first quarter of 2014. Navistar reported production of 46,830 Class 5 through Class 7 trucks in 2012. This is expected to bring in $350 million worth of incremental revenue for Cummins in 2014.
Who took advantage of Navistar’s engine problems?
The market knows that the creator of Kenworth and Peterbilt trucks, Paccar (NASDAQ: PCAR), snatched the market share from Navistar after the latter ran into engine problems. As far as May’s performance is concerned, Paccar’s Class 8 retail sales share for May was 31.2%, an increase from its April share of 29.1%. Paccar’s Class 8 builds share was fairly stable (28.5% vs. 28.8% in April) and with Paccar having built over 13,000 NAFTA Class 8 trucks in the first two months of 2Q (vs. 16,700 in all of 1Q), which seems supportive of Paccar’s guidance of global production/deliveries +5% to 10% sequentially in 2Q. This despite what could be some still more muted European trends in the near term.
Paccar is considered to be the best-in-class OEM. The stock trades at industry average multiple of 14x. However, currently, it is not on the buy list given that the Street prefers the suppliers over the OEMs. Hence, the Street is more in favor of companies like Cummins and Allison Transmission rather than Navistar and Paccar. Moreover, Paccar has a high European exposure, which doesn’t bode well for the company given declining truck registrations in Europe.
Definitely, the North American trucking market looks bright. Europe has been, and will remain, a potential headwind for the truck players in the near future until the debt crisis is solved. Therefore, for the time being, I will prefer Cummins over Paccar and Navistar (suppliers over OEMs), given that it is more immune to losses in Europe and in a better position to benefit from an improving North American market.
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Zain Abbas has no position in any stocks mentioned. The Motley Fool recommends Cummins and Paccar. The Motley Fool owns shares of Cummins and 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!