Not worth the price

PACCAR (PCAR) is a manufacturer of medium to heavy-duty trucks that are sold internationally. We think PCAR is a great company, but we are neutral on the stock due to its valuation.

Measure effectiveness

PACCAR needs to keep a lot of inventory to run the business. Therefore, the speed at which a company can move its inventory and convert it into cash is very important in predicting success. To measure its effectiveness, we will use the cash conversion cycle, which indicates the number of days it takes to convert inventory into cash. It is calculated as follows:

CCC = Current Inventory Days + Current Sale Days – Current Payment Days

PACCAR’s cash conversion cycle is -23, which means the company converts inventory to cash before it has to pay suppliers. Basically, PACCAR doesn’t have to invest money to fund inventory purchases because it can move its inventory and collect payments while still on credit. Thus, PACCAR’s suppliers essentially finance its operations.

However, it is important to note that this negative CCC number is not the historical norm for the company. In 2020, the figure was 20 days as it was impacted by COVID-19. The reason CCC has dropped so much in 2021 is that the number of days past due has increased significantly from 28 days in 2020 to 71 days in 2021. This means that suppliers have given PCAR more time to repay them.

However, before the pandemic, that figure was constantly hovering between 11 and 15 days, which is quite impressive considering the company sells heavy machinery. Therefore, it is reasonable to assume that the cash conversion cycle will eventually return to the historical range.

Dividend

PACCAR currently has a dividend yield of 3.02%, which is above the industry average of 1.34%. When looking at its 2021 free cash flow figure of $554 million, its dividend payout of $708 million appears to be in trouble.

However, it is important to remember that PCAR is a cyclical business. Therefore, it would be more appropriate to look at its average free cash flow over the past five years to determine if the payment is safe. In doing so, we find that PCAR has an average free cash flow of over $900 million per year, which means that the current payout is indeed secure.

Looking at its historical dividend payouts, we can see that its yield range has tended to decline over the past few years.

At 3.02%, the company’s dividend is near the bottom of its range, implying the stock price is trading at a premium to returns investors have seen in the past.

Evaluation

To value PACCAR, we will use a one-step DCF model because its free cash flow is volatile and difficult to predict. For the terminal growth rate, we will use the 30-year US Treasury yield as a proxy for expected long-term GDP growth.

Our calculation is as follows:

Fair value = five-year average FCF per share / (discount rate – terminal growth)
$70.05 = $2.69 / (0.0607 – 0.0223)

Accordingly, we estimate the fair value of PACCAR to be approximately $70.05 under current market conditions.

The Taking of Wall Street

On Wall Street, PACCAR has a Moderate Buy consensus rating, based on four buys, four holds and one sell assigned over the past three months. The PACCAR average price target of $100.33 implies an upside potential of 6.7%.

Final Thoughts

PACCAR runs a very efficient business because it is able to quickly convert inventory into cash, despite the capital expenditure heavy nature of its business. Plus, it has a relatively decent yield for income-seeking investors.

Nonetheless, we believe the stock is overvalued both from a historic dividend yield standpoint and from a one-step DCF standpoint. As a result, we remain neutral on the stock.

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Eleanor C. William