All improvement: PACCAR Management Discusses Q4 2013 Results

Executives

Robin E. Easton - Treasurer

Mark C. Pigott - Chairman, Chief Executive Officer and Chairman of Executive Committee

Robert J. Christensen - Chief Financial Officer and Executive Vice President

Analysts

Jamie L. Cook - Crédit Suisse AG, Research Division

Stephen E. Volkmann - Jefferies LLC, Research Division

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Andrew Kaplowitz - Barclays Capital, Research Division

Michael Shlisky - JP Morgan Chase & Co, Research Division

Jerry Revich - Goldman Sachs Group Inc., Research Division

Joel Gifford Tiss - BMO Capital Markets U.S.

Steven Fisher - UBS Investment Bank, Research Division

Robert Wertheimer - Vertical Research Partners, LLC

J. B. Groh - D.A. Davidson & Co., Research Division

Seth Weber - RBC Capital Markets, LLC, Research Division

Adam William Uhlman - Cleveland Research Company

Jeffrey Asher Kauffman - The Buckingham Research Group Incorporated

Timothy Denoyer

Scott H. Group - Wolfe Research, LLC

Brian Sponheimer - G. Research, Inc.

Tim Robinson - Susquehanna Financial Group, LLLP, Research Division

PACCAR (PCAR) Q4 2013 Earnings Call January 31, 2014 12:00 PM ET

Operator

Good morning, and welcome to PACCAR's Fourth Quarter 2013 Earnings Conference Call. [Operator Instructions] Today's call is being recorded, and if anyone has an objection, they should disconnect at this time. I would now like to introduce Mr. Robin Easton, PACCAR's Treasurer. Mr. Easton, please go ahead.

Robin E. Easton

Good morning. We would like to welcome those listening by phone and those on the webcast. My name is Robin Easton, Treasurer of PACCAR. And joining me this morning are Mark Pigott, Chairman and Chief Executive Officer; Ron Armstrong, President; Bob Christensen, Chief Financial Officer and Executive Vice President; and Michael Barkley, Vice President, Controller.

[Operator Instructions] Certain information presented today will be forward-looking and involve risks and uncertainties, including general economic and competitive conditions that may affect expected results.

I would now like to introduce Mark Pigott.

Mark C. Pigott

Good morning. It's a pleasure to share that in 2013, PACCAR achieved record annual revenues and earned our third best annual net income. For the year, PACCAR reported record revenues of $17.1 billion. Net income was $1.170 billion, an increase of 5% versus a year ago. 2013 was PACCAR's 75th consecutive year of earning a net income.

Having been at the helm of this great company for each of the top 10 years for revenue and net income, I can say that each year has its own unique path. What is consistent is the quality and determination of our 22,000 employees, who delivered industry-leading products and services to our customers every day.

PACCAR reported strong revenues and net income for the fourth quarter of 2013. PACCAR's fourth quarter sales and Financial Services revenue were $4.6 billion, and quarterly net income was $334 million and after-tax return on revenues of 7.3%. This was the best quarterly net income since the first quarter of 2007.

Net income increased 32% compared to results generated in the fourth quarter last year. Positive contribution of all the company segments enables PACCAR to attain the highest operating margins in our industry and to deliver excellent shareholder returns while investing during all phases of the business cycle.

PACCAR declared cash dividends of $1.70 per share last year, an 8% increase compared to 2012. PACCAR's total return to shareholders was 34.9% last year, and stockholder equity at year-end was a record $6.6 billion.

PACCAR delivered 36,400 trucks during the fourth quarter, a 3% increase versus the third quarter. The improvement reflects increased European truck deliveries as customers purchased trucks ahead of the January 1, 2014 implementation of the Euro 6 regulations.

PACCAR began production of many new vocational vehicles in the fourth quarter, the Peterbilt Model 567, the Kenworth T880 and DAF CF and LF Euro 6 models. In addition, we began production of the new PACCAR MX-11 diesel engine for Europe. This engine is planned to be available in Kenworth and Peterbilt trucks in 2015. We expect to increase truck deliveries in the first quarter by 5% compared to a year ago.

A major highlight during the fourth quarter was the start of production at DAF's new truck assembly plant in Brazil. This wonderful accomplishment was due to the efforts of many PACCAR employees worldwide. Truck production of the DAF facility is planned to gradually increase over the next 18 to 24 months. DAF has a long-term market share goal in Brazil of 20%. Brazil truck market above 6 tonnes was 149,000 vehicles last year and is expected to be at comparable levels this year.

Peterbilt and Kenworth achieved excellent market share of 28% in the U.S. and Canadian heavy-duty truck market last year. Industry retail truck sales totaled 212,000 units. U.S. and Canadian Class 8 industry truck retail sales are estimated to be in the range of 210,000 to 240,000 units this year, reflecting ongoing replacement demand and some expansion of the industry fleet. For the full year, DAF achieved record market share of 16.2% in the above 16-tonne European truck market, which totaled 240,000 units last year.

Looking at this year, we're encouraged by the improved GDP growth of the eurozone, which should benefit the truck market. Excluding the effects of the pre-buy, which is estimated at 20,000 to 30,000 units, we anticipate that the European industry truck sales could be slightly higher this year.

Switching to parts. PACCAR Parts business generated record quarterly revenues of $730 million, a 9% increase compared to $671 million in the same quarter of the prior year. PACCAR Parts quarterly pretax income was $105 million, an increase of 12% compared to $94 million earned in the fourth quarter 2012. The excellent results were driven by strong freight tonnage, improved fleet utilization and the many innovative products and services offered by PACCAR Parts. For the full year, PACCAR Parts achieved record revenues of over $2.8 billion.

PACCAR Financial Services revenue were $300 million in the fourth quarter compared to $298 million a year ago. PACCAR Financial's fourth quarter pretax income was a record $90 million compared to $79 million earned a year ago. The excellent results benefited from growth in asset balances and continuing strong portfolio performance. For the full year, PACCAR Financial Services earned record pretax income of $340 million. Many records last year.

PACCAR's capital spending of $350 million to $400 million this year is targeted at enhanced powertrain development and increased operating efficiency of our assembly facilities. R&D expenses are estimated to be in the range of $225 million to $275 million.

On a personal note, I'd like to say thanks for the excellent questions that you have generously asked on our quarterly calls during the last 17 years. It's an honor and a privilege to work at PACCAR, and I appreciate your interest in the company as you tour our wonderful factories and meet our outstanding employees.

Thank you. Pleased to answer your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Jamie Cook from Crédit Suisse.

Jamie L. Cook - Crédit Suisse AG, Research Division

Just a couple of questions. Just, one, you talked about deliveries, I think, being up 5% in the first quarter. Can you talk about what you expect the mix is versus -- U.S. versus Europe? And then, I guess, also any color you're seeing in order trends in Europe as we look to January, given the strong pre-buy that we had. And then my last question, how are you thinking about the ability to improve margins in 2014 over '13, given your retail sales forecast?

Mark C. Pigott

Okay. Let's start with margins. We think margins for the first quarter will be comparable to about a year ago.

Jamie L. Cook - Crédit Suisse AG, Research Division

Is that on gross or operating?

Robert J. Christensen

Gross.

Mark C. Pigott

Gross margins. And in terms of production, first quarter versus fourth quarter probably will be down about 10%, and most of that is in Europe. But as I say year-on-year, production will be up about 5%, so we're pleased with that. And as the year goes on, we look for some steady improvement in the margin side. All of Kenworth, Peterbilt, DAF are all doing a pretty good job, and all the new products that we've been working on for the last 3, 4 years seem to be met with very strong market reception. Customers like it. They're delivering all the attributes we wanted. And I think we will look at things like record market share at DAF as a very positive signal for the company.

Jamie L. Cook - Crédit Suisse AG, Research Division

I guess, just last question, how do you feel about your ability to pass through -- fully pass through the Euro 6 cost? And is that margin accretive? Is the margin dilutive?

Mark C. Pigott

Additionally, I think we've been able to [ph] reasonably well. And, obviously, that's our goal, and it's been our goal every year or 2 as we have new environmental regulations to comply with. So that's certainly something that I think we're becoming quite proficient at incorporating into our designs and working with our dealers to pass through most of that additional cost.

Operator

Your next question comes from the line of Stephen Volkmann from Jefferies.

Stephen E. Volkmann - Jefferies LLC, Research Division

Wondering if I can switch over to Brazil. And I know you mentioned that you sort of see gradually improving production rates down there. I guess, I'm just trying to sort of maybe get a little bit sharper pencil on that. Really, what I'm trying to get at is thinking about the impact on profitability in 2014. I assume it's a drag, as it was in '13, but less of a drag. And I don't know -- as we end the year, is that business breakeven? Or is that too optimistic?

Mark C. Pigott

Well, the good news is we're doubling production in a week or so [ph] from 1 truck to 2 trucks a day. That's always positive.

Stephen E. Volkmann - Jefferies LLC, Research Division

Can you do that every day?

Mark C. Pigott

If you've got the magic wand, we'd be interested. So that's -- it's going well. Obviously, it's a multiple-year program as we gradually ramp up production, but we're encouraged during the early days. And I think as we get towards the end of the year, certainly, we hope to be at least breakeven at the facility. So I think your analysis is accurate.

Stephen E. Volkmann - Jefferies LLC, Research Division

Okay, great. And then, I guess, just back on Europe for a second and then I'll pass it on. The registration data in Europe was huge in December, much bigger than what your revenues might suggest. And, I guess, I'm trying to figure out just how this whole cadence worked. Was there some inventory build that happened and then things got registered out of inventory in the fourth quarter? Or -- it doesn't look like your market share changed in any negative way. I think it was actually up a little bit, so...

Mark C. Pigott

Our market share is a record. In fact, we've got very strong market share in the fourth quarter and in December for DAF, over 17%. And so we're very, very pleased with that.

Stephen E. Volkmann - Jefferies LLC, Research Division

So did you sell a bunch out of inventory in the fourth quarter?

Mark C. Pigott

Well, we -- the pre-buy started in the third quarter, and inventories increased at the end of the third and during the fourth. But as we got to the end of the fourth, a lot of those trucks started to be delivered to customers, registered, and so we finished very strongly.

Stephen E. Volkmann - Jefferies LLC, Research Division

I got it. And then is there some delivery potential in the first quarter that's still sort of Euro 5? Or was it sort of a hard stop on January 1?

Mark C. Pigott

Yes. That's a good question. Really, as we look through this year, we probably have about 20% of our production will be Euro 5, primarily for markets outside of Western Europe. So that will be ongoing for a number of years.

Operator

Your next question comes from the line of Andy Casey from Wells Fargo Securities.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

A couple of questions, mostly, surprisingly around Europe. Earlier in the week, different manufacturers talked about a difficult pricing environment. Are you seeing that?

Mark C. Pigott

No. I think the pricing environment is pretty steady. If anything, it might be a little bit better. I'm not sure who you're talking about. We've increased share. Some of our competitors might have lost a little bit of share, which might have some impact on them. But our products are very well-received. We're having a lot of great truck shows. The dealers are excited about it. And our goal is to continue to have the best products in the industry and gain a little bit of share every year. So we're -- pricing is reasonable.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Okay. It was a Scandinavian, soon-to-be German competitor. And then second, if memory serves, the U.K. had an earlier stop in terms of the Euro 6 transition, like September time frame. We're now a few months past there. Have you seen any improvement in the demand, given that the economy is doing pretty well?

Mark C. Pigott

Yes, the economy, they're talking about over 2% GDP growth, I think, for the U.K. this year, which should be very healthy. Yes, they had a slightly different program in the U.K., and as a result, we still are delivering some Euro 6 and Euro 5 vehicles in the U.K. They seem to be very upbeat in the U.K. right now, which is encouraging. I know even on the car side, they're going to be well over 2 million units for the car industry. So...

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Have you seen a greater uptick in the Euro 6 appetite in the U.K. than other regions?

Mark C. Pigott

Yes, I think there -- U.K. is always pretty forward-thinking in terms of embracing the new products. So I think our share, once again, went up in the U.K. as a marketplace, and the dealers are -- have embraced all our new products. But everybody -- in all the regions that we operate, this is every couple of year program. So I think the industry, the customers, the dealers have been through it in the last 10 years 3x. So they know the drill.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Okay. And then switching over to U.S. and Canada. We've had, so far, kind of a muted cycle relative to the last 2, and we've had some recent volatility in the orders, 2 good months, 1 weaker relative month in between. How are you characterizing the cycle? I mean, is it...

Mark C. Pigott

I think we are on a steadily improving path. And a couple of reasons for that. First of all, in the first quarter, I'm talking about U.S. and Canada, the industry had a little over 70,000 orders, which is the best quarter since the first quarter of 2006. So that's quite a few years ago. Second, as you've seen, but just the macroeconomic data, the U.S. GDP growth in the fourth quarter was a little over 3%, which is good for all industries. And finally, as we talk with our customers, we just had our large dealer meetings, more and more fleets are saying they feel good about it. Construction is going to be -- home construction starts over 1 million, 16 million car production estimated this year. They're starting to say, "Let's start to replace our vehicles. We feel good about our own industry. We see our end customers are improving their business." So I think steadily improving path, positive. So we feel good about it.

Operator

Your next question comes from the line of Andrew Kaplowitz from Barclays.

Andrew Kaplowitz - Barclays Capital, Research Division

Mark, can you talk about your Rest of World sales, your other sales? Those sales have continued to weaken a little bit sequentially. Do you think you are at the bottom in those markets now and you should actually start to grow again in '14? And maybe you could sort of parse out the regions for us and what you're seeing in the different regions.

Mark C. Pigott

Okay. We look at Rest of the World or -- we look at all these home markets. That's how we look at them. Russia continues to be a very strong growth story for us. And 3,900 units, primarily DAF and some Kenworth trucks in there, adding new dealers, very excited about that market. Taiwan, we're now the second largest market share in the sort of 16-tonne market, and that continues to grow. Mexico is down a little bit because of some, let's call it, economic changes that they're implementing, but we think that's starting to stabilize. Colombia, which is a very strong market for us for most of the last decade, has declined because they finished some major infrastructure projects. I think that's now probably at a stable platform, and hopefully, that will improve. Australia, actually, is improving again. It's been pretty good through all the last decade. So for us, we see that's a very important part of our business, and probably, we're -- we might be at the low point and look for some positive improvement there.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

That's helpful, Mark. And then maybe if I could shift to PACCAR Parts. For the year, you had about 6% growth, but your fleet continues to get larger. You've talked about adding distribution centers. You've added them. We're going to see some growth here in the overall aftermarket. So can we see some acceleration in that business in '14? And should we see some margin improvement still? I mean, it's been good margins, but it hasn't been improving. But could we see that continue?

Mark C. Pigott

Yes. Well, I'm very proud of the team at Parts, record total revenues, $2.8 billion, and as you've indicated, they continue to grow. We're looking for some growth again this year of, hopefully, at least 5%. We did add a number of the Parts distribution centers. Our largest one in Eindhoven opened up about a year ago. And we continue to examine. Do we need additional one? We have a new PDC in Brazil connected with the factories. That's starting to -- its operations. So they're all -- these Parts guys are always coming up with very innovative ideas that we still -- we have a record truck market out there in terms of number of vehicles, and they're doing a very good job of growing the business into other businesses, whether it's competitive brands or bus business, trailer business. So that's a big driver for us, at least 5% growth this year.

Operator

Your next question comes from the line of Ann Duignan from JPMorgan.

Michael Shlisky - JP Morgan Chase & Co, Research Division

It's Mike Shlisky filling in for Ann. Kind of a 2-part question here on Brazil. Can you maybe share with us what market share or retail sales you expect to get by the end of the year in 2014? And then, I guess, part 2 of that would be, would production -- would the share of factory shipments be above retail for 2014, given the ramp here?

Robert J. Christensen

Yes. Our share -- it's early days, but 1% to 2%, I think, is a very reasonable target. And as soon as we get the orders in, we build them, we ship them, we sell them. So it's pretty quick process for us in Brazil.

Operator

Your next question comes from the line of Jerry Revich from Goldman Sachs.