By: Rob Wertheimer
There is a fascinating amount of technology change in the truck manufacturing industry. In general, that probably means higher risk than in the past…risk of technology overspend, underspend, fragmentation of technology and loss of economy of scale, and so forth. We’ve noted in the past that in the ag machinery market, Deere’s incremental spend on R&D (current levels have stepped up a bit) is greater than AGCO’s total R&D spend. A similar gulf is true in the truck space, where Daimler’s incremental spend on electrification is not too far off PACCAR’s total R&D budget. That feels like a rising risk to us. The counterweight, though, is that PACCAR has been extremely good at execution, and continues to build on a growing parts annuity that may be underappreciated.
New disclosure at PACCAR’s investor day shows some incremental positives on its exceptional parts business. The strategy of bringing PACCAR engines to the North American market, nearly a decade ago, starts to pay off in aftermarket revenues across the next five years. Parts for engines are more stable, more proprietary and higher margin than less differentiated parts for the truck. Parts in total have grown at an 8% CAGR for 15 years, and engines look to be pushing that up a bit now. What’s new?
- PACCAR’s mix within its parts/aftermarket business has improved. Parts for engines now make up ~26% of the PACCAR parts mix, up from 17% five years ago, 12% ten years ago, and 7% 15 years ago.
- Engine parts appear to be more stable. In 2009, engine parts fell ~3%. Non-engine parts sales fell more than 20%. In 2015-16, a more typical downturn, engine parts sales rose. Non engine parts fell ~8%.
- Aftermarket for engines really doesn’t kick in until 4+ years after sale, and the highest revenue curve comes 8-12 years after the engine is put into service. That means PACCAR has a rising tailwind from engines that went on sale for the first time in North America a decade ago. Parts sales for engines outgrew the total parts business over the past two years, averaging 20% growth versus the total parts at 13%. Few machinery companies have that same engine driven tailwind.
So one question for investors is what is an annuity with strengthening margins, strengthening margin support, and an 8% revenue CAGR worth? Our simple math would point to $1.50 in after tax parts profits per share, which at a 20 multiple would make the parts business worth more than $30 per share. That might be understating the value of the growth. Ten years ago, the same math would have parts worth more like $10 per share. The same framework would also imply the OE/new truck build part of PACCAR’s business is worth ~$35-40 per share, not too different from 5-10 years ago, although OE revenues are 60% higher peak to peak, (continued)