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Sifting Through The Wreckage
SECTOR REVIEW
A Closer Look at the Truck Cycle
The recent meltdown in the global economy has left the trucking industry in
shambles. In the face of the worst industry downturn in history and the
upcoming 2010 emissions standards, we highlight the key drivers of the truck
cycle throughout this report.
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We believe we are currently entering the bottoming phase of the truck
cycle as truck builds are likely to trough in 2009. By the end of 2009, truck
builds will have fallen 68% from the peak in 2006. This compares to the historical
average decline of ~50% and speaks to both the deterioration of the economy
and the excessive capacity that resulted from the 2006 pre-buy.
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We see a more “normalized” cycle emerging from the ashes. The “great”
cycle of the 2000s will likely be characterized as a period of excess—excess
leverage, excess growth and in the case of the truck market, excess capacity
(per the 2006 pre-buy). Looking ahead, without another U.S. emissions standard
in sight post-2010, we see a truck industry that is likely to experience less
volatility and thus, more normalized earnings streams—albeit at lower levels.
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Emerging markets and vertical integration create L/T industry growth
opportunities. In 2007, China and India represented 46% of the Global Heavy
Duty Truck Demand. This compares to a mere 13% in 1998. As such, we see
further diversification across the global commercial vehicle market as a huge
source of growth and inevitable for the established truck OEs to remain relevant.
Additionally, vertical integration for PCAR and NAV should yield productivity
improvements and enhanced aftermarket opportunities relative to previous
cycles.
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Our top pick remains CMI. We continue to favor Outperform rated CMI relative
to the group reflecting exposure to U.S. truck and secular growth opportunities
within the components business. Furthermore, Cummins is best positioned to
benefit from the growing importance of the emerging markets—particularly China
and India. We continue to believe the market fully appreciates the well
anticipated truck recovery for Neutral rated names, PCAR and RUSHA. In order
to justify a more constructive stance on PCAR, one would have to assume
margins can exceed the 2006 peak. While PCAR remains one of the best run
companies within our industrial universe, we view this as unlikely given the more
muted truck recovery in the U.S. coupled with European headwinds.
Investment Summary
We believe we are currently entering the bottoming phase of the truck cycle as we
expect build will trough in 2009. The current ACT forecast of 121K units in 2009 implies
a peak-to-trough decline of 68% from the 376K unit peak in 2006. This compares to the
historical average decline of ~50% and speaks to both the deterioration of the economy
and the excessive capacity that resulted from the 2006 pre-buy. In the near-term, we
continue to expect fundamentals will remain soft throughout the balance of the year and
into 2010.
Historically, the truck cycle has been highly dependent upon the health of the
economy. While emissions standards have been known to increase volatility throughout
the cycle, economic activity is the overriding determinant of industry volume and
profitability. In the trucking world, economic activity is best defined as truck tonnage. Over
time, we find that there has been a significant correlation between truck tonnage and truck
build. In fact, since 1980, there has only been one year (2006) in which truck builds
increased in the face of a decline in truck tonnage. As such, we believe a stabilization in
truck tonnage will be required before a meaningful rebound in truck build can take place.
According to the CS Transportation and Economic teams, truck tonnage is should bottom
in late 2009.
We see a more “normalized” cycle emerging from the ashes. The “great” cycle of the
2000s will likely be characterized as a period of excess—excess leverage, excess growth
and in the case of the truck market, excess capacity (per the 2006 pre-buy). Looking
ahead, without another U.S. emissions standard in sight post-2010, we see a truck
industry that is likely to experience less volatility and as such, more normalized earnings
streams—albeit at lower levels.
Increased overseas diversification and vertical integration efforts should create
long-term industry growth opportunities. In 2007, China and India represented 46% of
the Global Heavy Duty Truck Demand. This compares to a mere 13% in 1998. As such,
we see further diversification across the global commercial vehicle market as a huge
source of growth and inevitable for the established truck OEs to remain relevant.
Additionally, vertical integration for PCAR and NAV should yield productivity improvements
and enhanced aftermarket opportunities relative to previous cycles.
A 2009 pre-buy is highly unlikely given the excess capacity in the market. With
dealer inventory levels still 13% above the long-term average and down 49% from the
peak (vs. down 60% on average in previous downturns), we believe there will be minimal
pre-buy in ’09. Average tractor mileage remains light (relative to the previous downturn)
and some TLs have decided to park portions of their fleets, which, in our view, dampens
the argument that record fleet age alone can spark a rebound in orders. As such, truckers
will likely delay their capital spending until 2010 even in the face of a $8-12K increase in
the price of a new truck.
We forecast the North America heavy-duty truck market will be down 40% in 2009
and up 25% in 2010. For Europe, we assume the heavy commercial vehicle market is
down 50% in 2009 and down another 5% in 2010.
“Core” Truck Names Look Fairly Valued
In the near-term, the outlook remains challenging. However, as shown in Exhibit 1, the
market appears to be looking past the current downturn as the truck index has significantly
outperformed both the Dow Jones Transportation Index and the S&P 500. Under the
assumption that the DJ Transports normally lead the market out of the trough, the “core”
truck stocks (PACCAR and RUSHA) appear fairly valued. Given the historical relationship
between truck tonnage, builds/orders and stock performance, a stabilization in freight is
likely necessary before we see a meaningful move higher from current levels, in our view.
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