According to the stocks portal beststocks.com, analysts are raising the rating on PACCAR Inc stock (NGS: PCAR), a major global manufacturer of trucks and aftermarket truck parts, to BUY from HOLD. We view PCAR as a well-run company that produces a highly regarded line of trucks. PACCAR has created a specialized niche of high-quality vehicles that command premium prices, but offer enhanced comfort, quality and reliability. We expect PACCAR to generate significantly stronger top- and bottom-line growth in the coming quarters and are raising our EPS estimates for both this year and next.
In particular, the Trucks segment (71% of revenue) saw lower margins and lower production volume due to coronavirus shutdowns. By business segment, Truck revenue fell 30% to $3.504 billion, while pretax profit fell 56% to $210 million. New Truck deliveries totaled 36,000 units, down 27% from 3Q19.
In the Parts business, sales rose 2% and pretax profit rose 1%.
Revenue in PACCAR Financial Services (PFS) rose 9% to $398 million, though pretax profit fell 17% to $56 million. Vehicle resale values were comparable with the second quarter. The current $15.3 billion asset portfolio includes 203,000 trucks.
Although the pandemic had a material impact on 3Q performance, its impact is now diminishing. Nearly all of the company’s manufacturing facilities are back in operation and production volume is increasing.
Earnings & Growth Analysis
PACCAR does not provide detailed financial guidance but does offer an industry outlook. In its 3Q20 earnings report, management noted that U.S.and Canadian Class 8 truck orders through September were up 18% from the prior year.
With that as a backdrop, PCAR raised its 2020 forecast for U.S. and Canadian Class 8 truck sales to 190,000-210,000 vehicles from a prior 160,000-190,000. Retail sales were 309,000 units in 2019, 285,000 in 2018, and 218,000 in 2017. Management also expects Class 8 truck sales of 210,000-250,000 vehicles in 2021.
Our estimate assumes progress in controlling the pandemic. The 2021 consensus estimate is $5.02.
Cummins and Eaton believe that the next-generation transmissions produced by their JV will result in significant fuel efficiency improvements for OEM customers and partners, including PACCAR.
The company expects to begin delivery of these models in 2021.
Financial strength & dividend
Both ratings are considered investment grade. We view this as a competitive advantage as it provides the company with ready access to the credit markets.
The company also has access to a $3.58 billion credit line with $3.27 billion available. The company has no unfunded pension obligations.
We continue to monitor inventories at PCAR. At the end of 3Q20, inventories were down 3% from the end of December 2019 and accounted for less than 10% of non-Financial Service assets.
PACCAR pays a standard quarterly dividend and a special annual dividend. The standard quarterly dividend was last raised by 14% in 4Q18 and is now $0.32, or $1.28 annually.
The company typically announces its special dividend in December, which it pays the following January. In December 2019, it announced a special dividend of $2.30, up from $2.00 in 2018, $1.20 in 2017, and $0.60 in 2016. We expect total dividends (standard plus special) of $3.58 in 2020 and $2.54 in 2021.
PCAR has a stock buyback program. As of June 30, it had $390 million remaining on its $500 million authorization. The company has temporarily suspended buybacks due to the pandemic.
Management & Risks
PACCAR has a new CEO. Preston Feight took over the position on July 1, 2019, replacing Ronald Armstrong, who became the company’s CEO in 2014 and has now retired. Mr. Feight previously served as EVP of PACCAR. Harrie Schippers is the CFO. Mark C. Pigott, who served for many years as CEO, is the executive chairman.
The company operates in a highly competitive and economically sensitive industry, and its earnings could be hurt by rising raw material costs as well as by costs related to new environmental and safety regulations.
The company’s results are linked to global economic trends, particularly in growth markets such as China and Brazil. Recently, the overall outlook for GDP has been scaled back. Global GDP growth is now expected to contract in 2020.
PACCAR manufactures and distributes light-, medium- and heavy-duty commercial trucks; distributes aftermarket parts; and provides vehicle financing to customers and dealers. The company has 27,000 employees.
We view PACCAR as a ‘best-in-class’ industry player that will continue to benefit from its size, geographic diversification, and its product portfolio. Our target price of $108 implies a projected 2021 multiple of 21.8, and a potential total return, including the dividend, of 21% from current levels.
KeyCorp. (NYSE: KEY). Lending growth was helped in 2Q and 3Q by Paycheck Protection Program lending and drawdowns on corporate credit facilities; however, it is likely to be more muted going forward due to still weak economic growth and tighter underwriting standards. Net interest margins are also expected to contract through 1Q21 following the Federal Reserve’s rate cuts.
The company has benefited from positive regulatory developments. Mid-sized banks received favorable regulatory news in May 2018 with changes to the Dodd-Frank Act. One of these changes raised the minimum level of assets for bank holding companies subject to stress tests to $250 billion. We believe that these reduced regulatory requirements have been beneficial for banks in the $50-$250 billion range, which include KeyCorp.
The beta on KEY is 1.47.
Revenues rose 4% to $1.68 billion.
Net charge-offs were $128 million in 3Q20, down from $196 million a year earlier. Over the past four quarters, net charge-offs of $407 million have been well below loss provisions of $1.11 billion, as the company took a substantial provision in 1Q20 in light of CECL accounting changes and in advance of losses expected as a result of the pandemic.
Noninterest income was up 5%, aided by strong growth in mortgage income, as well as in cards and payments income.
Earnings & Growth Analysis
Average loans were up 14% in 3Q20, boosted in part by Paycheck Protection Program lending. Companies also drew down lending facilities to store cash in anticipation of weaker economic conditions. Based on our expectations for continued high unemployment, weaker consumer spending, and lower business confidence, we expect growth in earning assets to be in the low single digits into next year.
Credit quality remains a wild card for 2020 and 2021 given the potential for sizable credit losses from high unemployment. The company has guided toward net charge-offs of 0.55%-0.65% of average loans in 4Q, which would be up from the 0.49% recorded in 3Q.
Expenses remain a bright spot due to efficiency measures, but have been impacted by weak revenue growth. The 3Q20 cash efficiency ratio was 60.6%.
Financial Strength & Dividend
KEY’s capital plan calls for a dividend of $0.185 per common share.
In 2019, the company paid $0.71 in dividends. Our dividend estimates are $0.74 for 2020 and $0.88 for 2021. The company has a long-term target payout ratio range of 40%-50%.
Management & Risks
KeyCorp is led by Chairman and CEO Chris Gorman, who assumed those roles in May 2020 following the retirement of Beth E. Mooney. Mr. Gorman was previously president and COO. Don Kimble is vice chairman and CFO.
The company has a diversified business model. The Key Community Bank segment includes branch-based deposit and investment products; personal finance services; and loans, including residential mortgages, home equity, credit card, and various types of installment loans. The Key Corporate Bank segment includes syndicated finance, debt and equity capital markets, commercial payments, equipment finance, commercial mortgage banking, derivatives, foreign exchange, financial advisory, and public finance.
Among mid-cap regional banks, KeyCorp competes primarily with Fifth Third Bank and Regions Financial.
With about 1,000 branches in 15 states and assets of approximately $170 billion. The company also operates a national consumer bank and a national corporate bank.
At current prices near $13 and down about 37% from its 52-week high, KEY trades at a slight discount to tangible book value.
We believe this discount is unwarranted given the company’s favorable ROE and efficiency metrics and strong credit quality. Our target price of $15 implies a multiple of 11-times our EPS estimate for 2021, when we expect an earnings recovery to be underway.
On October 21 at midday, BUY-rated KEY traded at $12.43, down $0.65.