A decent Christmas for retailers and a sprinkling of better-than-expected economic indicators in recent weeks have raised hopes about the economy. It might seem the perfect time to buy some cyclical stocks. But in the case of truck makers, you’ve probably waited too long.
Paccar’s earnings are every bit as economy-sensitive.
The logic of the cycle is easy to grasp. Freight volumes rise when the economy is humming, and tumble when the economy swoons. The folks who haul freight – trucking companies with big fleets and individual owner-operators alike — tend to buy trucks when freight volume is strong, and make do when their loads are light.
Why would any investor bother with an industry that offers such a rough ride? The answer lies in the sector’s lucrative cycle top. Here’s the outsize profit surge Paccar enjoys when the industry stars line up just right.
Return on equity goes from lousy to really attractive as the cycle picks up speed.
And when times are good, Paccar shares the wealth by declaring special dividends. The latest, a 30-center, doesn’t match up with the $2 payouts periodically declared during the boom years, but it was welcome since the company trimmed its modest regular quarterly dividend in 2009.
The last up cycle got underway in 2004, and it was a rich one. As orders for heavy and medium-duty trucks began pouring in, Paccar and rivals such as Navistar International (NAV) and the Freightliner unit of Germany’s Daimler ran production plants full out. Demand held at peak levels for a couple years, an unusually long stretch at the crest; then, just as the natural cycle began to weaken, trucking companies went on a buying spree to get out in front of new diesel-engine rules set to take effect in early 2007.
Soon after that high-profit sales flurry ended, the truck cycle began heading downhill fast.
During the three-year demand trough that has followed, Paccar managed to remain marginally profitable with the help of a historically low cost structure. Now, at last, it appears poised for some serious earnings expansion.
With the average age of a U.S. commercial truck at its highest level in more than thirty years, trucking companies are paying more and more money just to keep their aging rigs on the road. A flood of replacement orders is expected to drive depressed North American heavy-truck production up by 50 percent in 2011, with anticipated demand even stronger in the following year.
And that’s primarily the replacement cycle. If truckers gain enough confidence to start expanding their fleets rather than just replacing their junkers, demand would ramp up even more.
Lots of questions remain, about the timing and the scope of the truck industry’s coming rebound. But the shares of producers like Paccar, and of suppliers like diesel-engine maker Cummins (CMI), are already in overdrive, compared to the broad market.
And that’s the problem. Nobody wants to be late to the party, so they’ve piled into Paccar shares very early instead. Paccar shares are already priced for the cycle’s turn, even though the rise in demand is only in a preliminary, tentative stage.
Fundamentals-oriented YCharts Pro is flashing a red light, saying Paccar shares are overpriced. Indeed, the truck sector is ready to move up, that’s clear. But it looks like Paccar shares have gotten ahead of themselves.