Daimler Truck (OTCPK:DTRUY) has just reported earnings and I was eagerly awaiting this report since this is the player within the industry with the clearest turn-around narrative around it. As a result, we need to monitor closely if this company, after its spin-off from Mercedes (OTCPK:MBGAF) will be able to close the gap with the two industry leaders: Swedish Volvo Group and North-American Paccar.
Summary of previous coverage
Trucks are all over the place and no modern economy can run without them. Freight needs to be moved from place to place and trucks offer the greatest flexibility, especially for shipments of less than 1,000 miles.
The industry is vital for the economy and it is highly competitive, with many well-established players. However, it is also an industry where we have seen recent moves with three major spin-offs (Iveco, Traton, and Daimler Truck) and rumors of potential M&As (especially regarding Iveco).
Truck manufacturing is a tough business, with rather low margins and high cyclicality. However, two players stand out from the crowd: Volvo Group (OTCPK:VLVLY) and Paccar (PCAR). They both consistently achieve double-digit margins and have proven to have two resilient business models, with the former focusing on premium vehicles and the latter betting big on its spare parts service.
What we have seen so far regarding Daimler Truck is a turnaround worthy of being noticed. In fact, the company owns strong brands such as Freightliner, Western Star, FUSO and Mercedes-Benz (for trucks, not cars), holding around 40% market share in North America for Class 8 trucks.
And yet, its margins were rather low when the company was spun-off almost two years ago. In the meantime, Daimler Truck has taken advantage of the post-pandemic economic rebound and has been able post its first double digit margin in Q2 2023.
This was a bit warranted, as long as Daimler Truck would not have executed poorly. Pent-up demand coupled with lower commodity prices creates the perfect mix to heal bleeding margins.
However, not everything was great. Daimler Truck, as well as its peers, is seeing new demand declining and, although order books were still at a comfortable level at the end of Q2, they need to be closely monitored in order to see what will happen to the company’s profitability.
Let’s start from the highlights shown by the press release.
Sales increased to €13.9 billion vs. €13.5 billion in Q3 2022. This is just a 3% increase. This increase is only due to pricing, because the company reported a 5% decline in sales volumes, from 134,972 last year to 128,861 in this third quarter. However, YtD, sales are up YoY (385,921 vehicles this year vs. 365,219 vehicles in the first nine months of 2022).
Adj. EBIT increased to €1.34 billion vs. €1.27 billion last year. This is a 5.5% increase.
Adj. return on sales increased by 40 bps YoY and now stands at 9.8%.
Net profit decreased to €957 million from €990 million in Q2 2022. This is a -3.9% change.
This leads to EPS €1.13 vs. €1.17 in the same quarter of the prior year.
On the other hand, free cash flow increased dramatically to €1.09 billion from €592 million in Q3 2022, which is an increase of 83.7% YoY. This helped the company fund €231 million of buybacks.
If we go a bit more in depth into Daimler Truck reported profitability, we need to look at the EBIT of the Industrial Business and look at it by segment. As we have already noticed, EBIT grew YoY. However, it shows signs of deceleration as we overlap very tough comparables in this second half of the year. In fact, it was in the last two quarters of 2022 that many companies started seeing the positive effect of higher prices and supply chain bottlenecks easing.
But, since we, as investors, need to be forward looking, the most important data we need to keep in mind, aside from assessing the quality of recent execution was, is what lies ahead of the company in terms of incoming order.
Here, Daimler Truck confirms what we have heard from Volvo, too. Orders are declining. In particular, North America is down 26% YoY. Moreover, Asia is plummeting. Only buses are doing well, but this is because the segment is still in recovery mode after the pandemic (travel agencies started ordering buses when it was clear the pandemic was over).
This is not good news for Daimler Trucks because, although I don’t think it puts the company at serious risk, there will be further pressure on profits and margins. This is exactly what separates Daimler Truck from the industry leaders. A company with a short history as a stand-alone will have to prove it if can weather moderating order intake which will inevitably slow down revenues.
In particular, what makes Daimler more exposed to changing market conditions is its spare parts centers, which are still seeing ongoing development and network expansion. While Paccar reports its service performance quarterly, showing how it makes up around 20% of total revenues, Daimler still doesn’t do that, indirectly revealing a business line yet to expand to a meaningful size. During economic downturns, services and spare parts are key because they provide recurring revenue and contribute to increasing the total lifetime value of each sold vehicle.
Nonetheless, Daimler Truck felt confident enough with its current operations to instate a dividend of 40% to 60% of net profits and initiate a share buyback program worth up to €2 billion over a period of up to 24 months from August 2023 to August 2025. As of November 3, 2023, the company had already spent €474 million acquiring 14.8 million shares at an average price of €31.98.
As far as I can see, this report marks the peak of the cycle and points towards the next trough. This doesn’t mean the company won’t be able to operate anymore, nor that it will go bankrupt. With almost €10 billion in cash and cash equivalents and €1.9 billion in marketable debt securities, it carries €11.9 billion in liquidity before financing liabilities of €28.4 billion (most of which come from the financial branch of the company), giving a net debt of €16.52 billion. Considering the company’s EBITDA should be around €6 billion this year, the balance sheet is safe enough from downturns. In addition, interest expense amounts to less than €200 million per year, which is clearly well covered by the company’s earnings.
What matters most is what to make of this report in order to give a new valuation of the company.
Next year, we should see a slowdown in sales: we could probably see 500k vehicles sold, compared to the 530k-550k expected for this year. Considering pricing won’t be there anymore to help revenue growth, we might have before us a year where revenues will either remain flat or decline slightly, staying in the €50-€54 range.
Margins will be crucial: will the company be able to execute better and keep on improving its margins from targeting 10%? This will have to be seen.
Currently, the company trades at a 6.8 fwd PE and a fwd EV/EBITDA of 6.2. These are not high multiples, but industrials with rather low margins usually trade below the double digit multiple. True, Paccar trades at a fwd PE of 11, but this factors in its spare parts business which is both highly resilient and with high margins. Overall, I consider the multiple Daimler is trading at fair. But considering upcoming weaker performance, I don’t see the stock as the right place to be anymore, nor do I see it trading with a high margin of safety to make me buy it. This is why I consider it a hold, but I suggest to those who can’t withstand volatility to consider exiting their position and moving onto other sectors.
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