A Quality Executive Company’s Plan Lowers The Risk Of Investing In PACCAR Inc.

Three new stocks made November’s Exec Comp Aligned with ROIC Model Portfolio, available to members as of November 16, 2022.

Recap From October’s Picks

The Exec Comp Aligned with ROIC Model Portfolio (+10.0%) underperformed the S&P 500 (+10.5%) from October 14, 2022 through November 14, 2022. The best-performing stock in the portfolio was up 23%. Overall, eight out of the 15 Exec Comp Aligned with ROIC stocks outperformed the S&P 500 from October 14, 2022 through November 14, 2022.

This Model Portfolio only includes stocks that earn an attractive or very attractive rating and align executive compensation with improving ROIC. I think this combination provides a uniquely well-screened list of long ideas because return on invested capital (ROIC) is the primary driver of shareholder value creation.

New Feature Stock for November: PACCAR Inc.

PACCAR Inc. (PCAR ) is the featured stock in November’s Exec Comp Aligned with ROIC Model Portfolio. I made PCAR a Long Idea in July 2020 as one of my ”See Through the Dip” stocks. Since then, the stock is up 30% compared to a 22% gain for the S&P 500.

Though PACCAR’s profits fell during the pandemic, net operating profit after tax (NOPAT) soared to all-time highs over the trailing-twelve-months (TTM). PACCAR has grown revenue and NOPAT by 5% and 9% compounded annually, respectively, since 2011. The company’s NOPAT margin rose from 6% in 2011 to 9% over the TTM, while return on invested capital (ROIC) rose from 17% to 21% over the same time.

Figure 1: PACCAR’s Revenue & NOPAT: 2011 – TTM

Executive Compensation Properly Aligns Incentives

PACCAR’s executive compensation plan aligns the interests of executives and shareholders by tying the payout of equity- and cash-based awards to a three-year target return on capital, which is similar to my calculation of return on invested capital (ROIC).

The company’s inclusion of return on capital as a performance goal has helped create shareholder value through rising ROIC and economic earnings. PACCAR’s ROIC improved from 14% in 2016 to 21% over the TTM and the company’s economic earnings rose from $735 million to $1.8 billion over the same period.

Figure 2: PACCAR’s ROIC: 2016 – TTM

PCAR Is Undervalued

At its current price of $104/share, PCAR has a price-to-economic book value (PEBV) ratio of 0.9. This ratio means the market expects PACCAR’s NOPAT to permanently fall by 10%. This expectation seems overly pessimistic for a company that has grown NOPAT by 9% compounded annually since 2011.

If PACCAR’s NOPAT margin falls to 8% (compared to TTM margin of 9%), and the company grows revenue by just 5% compounded annually over the next 10 years, the stock would be worth $130/share today – a 25% upside. In this scenario, PACCAR’s NOPAT would grow just 6% compounded annually over the next decade (compared to 9% since 2011). See the math behind this reverse DCF scenario. Should the company grow NOPAT more in line with historical growth rates, the stock has even more upside.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in PACCAR’s 10-Qs and 10-Ks:

Income Statement: I made $122 million in adjustments with a net effect of removing $56 million in non-operating income (<1% of revenue).

Balance Sheet: I made $5.6 billion in adjustments to calculate invested capital with a net decrease of $3.1 billion. One of the largest adjustments was $921 million (7% of reported net assets) in other comprehensive income.

Valuation: I made $4.3 billion in adjustments with a net effect of increasing shareholder value by $3.2 billion. The most notable adjustment to shareholder value was $3.4 billion in excess cash. This adjustment represents 9% of PACCAR’s market cap.

Disclosure: David Trainer, Kyle Guske II, Matt Shuler, and Italo Mendonça receive no compensation to write about any specific stock, style, or theme.