PACCAR Inc. Keeps Cruising, but the Market's Worried About Something

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PACCAR Inc. (NASDAQ: PCAR) reported strong results for its third quarter on Oct. 24. Revenue increased 19% and net income was up 16%, with both numbers even coming in ahead of Wall Street analyst expectations. And as is typical of Mr. Market, PACCAR shares fell as much as 7.5% during afternoon trading and closed down almost 6% on the day. 

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So what spooked investors following a solid quarter? There were a few comments from management on the earnings call that could have played a role in sending the stock price down. Let's take a closer look at PACCAR's results, as well as what management had to say, and what the long-term implications are. 

Sales and profits have accelerated on improving demand

After a few quarters of weaker sales and earnings resulting from a decline in North American truck orders, PACCAR has delivered revenue growth two quarters in a row and saw profits jump this quarter. The company reported $5.1 billion in revenue, $402.7 million in net income, and earnings per share of $1.14 in the quarter. For the first nine months of 2017, revenue was $14 billion, net income was $1.09 billion, and earnings per share came in at $3.09. 

The biggest reason for PACCAR's improved results is increased truck demand in North America and Europe, the company's two biggest markets. The company said it delivered 23,300 trucks in the U.S. and Canada last quarter, and 12,400 trucks in Europe, 24% and 7% higher versus last year's third quarter. The company is forecasting 210,000 to 220,000 Class 8 truck sales in 2017, up from its forecast of 190,000 to 220,000 in April. PACCAR is seeing a similar trend in Europe, increasing its full-year forecast from 270,000 to 300,000 trucks this spring to a range of 300,000 to 310,000. 

Looking at 2018, the company sees truck demand accelerating. PACCAR is forecasting demand for 220,000 to 250,000 Class 8 trucks in the U.S. and Canada and 300,000 to 310,000 in Europe next year. 

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So what spooked investors?

Management is optimistic wrapping up 2017 and heading into next year. On the earnings call, CEO Ron Armstrong said the company expects the U.S. economy to grow close to 2.5% this year, and between 2% and 3% in 2018, with strong demand for new housing and from the auto industry, as well as expanded industrial production. This growth is behind the company's expectations for increased demand for Class 8 trucks in North America. The expectations for Europe are similar to those for North America in terms of GDP growth and how this should drive increased truck demand. 

However, one analyst on the earnings call raised a question about incremental margin -- the higher profits that additional units above this year's level should generate. Armstrong's response -- that gross margin percentage for 2018 would probably be in the same range as this year, between 14% and 15% -- didn't sit well. Here's what Armstrong said about incremental margin:

Right now, I guess I would say I expect gross margin for next year to be comparable to what we're seeing in 2017, at the market size estimates we've provided. I would say that if you look at the build rates for DAF and Peterbilt and Kenworth -- where they're currently at, if those build rates were able to be sustained for all of next year, the margins would probably be at the upper end of estimates that we've provided for 2018.

In general terms, this is something investors should pay attention to. A business like PACCAR's is designed to benefit from increased volume, which should produce higher incremental margins, since fixed expenses get spread across more revenue. But at the same time, this isn't something investors should be panicking about. On one hand, Armstrong's response is best described as being conservative. The reality is, predicting economic activity and truck demand so far out is an inexact science at best. 

It's also possible investors weren't satisfied with Armstrong's statements about the future of trucking. Several analysts asked about electrification and driver automation in trucking, and Armstrong was steadfast that PACCAR expects it to take a number of years before those technologies are commercially viable and in high demand. With companies including Tesla and privately held start-up Nikola Motors both talking publicly about introducing battery-powered and hydrogen-powered Class 8 trucks within a few years, management's far more conservative language around alternative technologies could have also concerned some investors. 

Yet at the same time, PACCAR has invested a significant amount of money into technology and innovation. The company opened an R&D facility in Silicon Valley this year and will spend more than $260 million on R&D this year. Next year, the company is beginning a truck platooning trial -- essentially using wireless communications and automation to "link" multiple trucks together -- in the U.K. in 2018. The company announced earlier this year that it was partnered with NVIDIA to bring self-driving technology to its trucks, and chances are its platooning test in the U.K. will be powered by NVIDIA's DRIVE PX 2 platform.

Management said on the earnings call that it will increase R&D spending to as much as $300 million next year, and part of that increase will be tied to the company's SuperTruck II program, which it just launched. 

Looking ahead

Whether it was something management said that spooked investors into selling PACCAR after earnings, or just a product of "profit takers" after a 20% run-up in the share price the past couple of months, long-term investors probably shouldn't be too worried. The company continues to dominate the truck market in North America and make solid gains in Europe, and if the economy in both areas remains steady in coming years, the company is likely to continue increasing its market share and becoming more profitable. 

And when it comes to the risk of disruption from new technologies, investors shouldn't dismiss it out of hand. But at the same time, PACCAR is well positioned as a technology leader and is likely to be one of the companies playing a role in disrupting the status quo. What management said this quarter, and how the company performed, didn't really change the likelihood that PACCAR will remain a technology leader and truckmaker for years to come -- no matter how much technology changes who drives the truck, or what powers it. 

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Jason Hall owns shares of NVIDIA and Tesla. The Motley Fool owns shares of and recommends PACCAR, NVIDIA, and Tesla. The Motley Fool has a disclosure policy.