A Quality Exec Comp Plan Lowers The Risk Of Investing In Paccar

Recap from May Picks

The Exec Comp Aligned with ROIC Model Portfolio (+10.0%) outperformed the S&P 500 (+6.1%) from May 12, 2023 through June 13, 2023. The best performing stock in the portfolio was up 20%. Overall, 13 out of the 15 Exec Comp Aligned with ROIC Stocks outperformed the S&P from May 12, 2023 through June 13, 2023.

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 Stock Feature for June: Paccar Inc.

PCAR

Paccar Inc. (PCAR) is the featured stock in June’s Exec Comp Aligned with ROIC Model Portfolio. I originally made Paccar a Long Idea in June 2020 and the stock remains undervalued.

Paccar Inc. has grown revenue and net operating profit after tax (NOPAT) by 10% and 21% compounded annually, respectively, since 2016. The company’s NOPAT margin improved from 7% in 2016 to 12% in the trailing twelve months (TTM), while invested capital turns rose from 2.0 to 2.6 over the same time. Rising NOPAT margins and invested capital turns drive the company’s return on invested capital (ROIC) from 14% in 2016 to 32% in the TTM.

Figure 1: Paccar’s Revenue & NOPAT: 2012 – TTM

Executive Compensation Properly Aligns Incentives

Paccar’s executive compensation plan aligns the interests of executives and shareholders by tying a portion of its long-term cash awards to return on capital according to the company’s proxy statement.

The company’s inclusion of return on capital, a variation on ROIC, as a performance goal has helped create shareholder value by driving higher ROIC and economic earnings. When I calculate ROIC using my firm’s superior fundamental data, I find that Paccar’s ROIC has increased from 16% in 2012 to 32% in the TTM. Economic earnings rose from $805 million to $2.9 billion over the same time.

Figure 2: Paccar’s ROIC: 2012 – TTM

PCAR Has Further Upside

At the current price of $79/share, PCAR has a price-to-economic book value (PEBV) ratio of 0.7. This ratio implies the market expects Paccar’s NOPAT to permanently fall by 30%. This expectation seems overly pessimistic for a company that has grown NOPAT 13% compounded annually over the past decade.

Even if Paccar’s NOPAT margin falls to 8% (5-year average, compared to 12% in the TTM) and the company’s revenue grows 6% compounded annually over the next decade (equal to compound annual growth rate over past decade), the stock would be worth $97/share today – a 25% upside. See the math behind this reverse DCF scenario. In this scenario, Paccar’s NOPAT grows 4% compounded annually through 2032.

For reference, Paccar has grown NOPAT by 12% compounded annually over the past decade. 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 made based on Robo-Analyst findings in Paccar’s 10-K and 10-Qs:

Income Statement: I made $212 million in adjustments with a net effect of removing $130 million in non-operating income (<1% of revenue).

Balance Sheet: I made $6.7 billion in adjustments to calculate invested capital with a net decrease of $4.5 billion. One of the largest adjustments was $953 million (6% of reported net assets) in other comprehensive income.

Valuation: I made $5.4 billion in adjustments, with a net effect of increasing shareholder value by $4.5 billion. The most notable adjustment to shareholder value was $4.4 billion in excess cash. This adjustment represents 11% of Paccar’s market value.

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