PACCAR Q3 2024 Earnings Call Transcript

Participants

Corporate Executives

• Ken Hastings, Director of Investor Relations
• R. Preston Feight, Chief Executive Officer
• Harrie Schippers, Executive President and Chief Financial Officer
• Brice Poplawski, Vice President and Controller

Analysts

• Stephen Volkmann, Jefferies Financial Group Inc.
• Rob Wertheimer, Melius Research
• Steven Fisher, UBS Group AG
• Tami Zakaria, J.P. Morgan
• Angel Castillo, Morgan Stanley
• Jamie Cook, Truist Securities
• David Raso, Evercore ISI
• Jerry Revich, The Goldman Sachs Group, Inc.
• Tim Thein, Raymond James
• Kyle Menges, Smith Barney Citigroup
• Chad Dillard, AB Bernstein
• Jeffrey A. Kauffman, Vertical Research Partners
• Michael Feniger, Bank of America Merrill Lynch
• Scott Group, Wolfe Research

Presentation

[Operator]

Good morning, and welcome to PACCAR's Third Quarter 2024 Earnings Conference Call. [Operator Instructions] Today's call is being recorded. [Operator Instructions]

I would now like to introduce Mr. Ken Hastings, PACCAR's Director of Investor Relations. Mr. Hastings, please go ahead.

[Ken Hastings, Director of Investor Relations at PACCAR]

Good morning. We would like to welcome those listening by phone and those on the webcast.

My name is Ken Hastings, PACCAR's Director of Investor Relations. And joining me this morning are Preston Feight, Chief Executive Officer; Harrie Schippers, President and Chief Financial Officer; and Brice Poplawski, Vice President and Controller.

As with prior conference calls, we ask that any members of the media on the line participate in a listen-only mode.

Certain information presented today will be forward-looking and involve risks and uncertainties that may affect expected results. For additional information, please see our SEC filings at the Investor Relations page of paccar.com.

I would now like to introduce Preston Feight.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Thanks, Ken. Good morning, everyone. Harrie, Brice, Ken and I will update you on our excellent third quarter financial results and other business highlights.

I'd like to start by thanking PACCAR's wonderful employees to deliver PACCAR's high-quality trucks and transportation solutions to our customers all around the world.

PACCAR earned a strong $972 million on revenues of $8.2 billion for an industry-leading after-tax return on revenue of 11.8%. PACCAR Parts third quarter revenues increased 5% to $1.66 billion and pretax profits were $407 million. PACCAR Financial earned pretax income of $107 million in the third quarter. We estimate this year's U.S. and Canadian Class 8 market to be around 260,000 trucks and next year to be in the range of 250,000 to 280,000 vehicles.

The vocational segment, where Peterbilt and Kenworth are the market leaders is strong and is expected to remain strong with continued infrastructure investments. The less-than-truckload market is performing well, while the truckload segment seems to have stabilized. Peterbilt and Kenworth combined Class 8 share has increased from 29.5% to 31.1%. Kenworth and Peterbilt's dealer inventory is a healthy 2.9 months. Kenworth and Peterbilt increased their medium-duty market share in the first nine months of this year to 17.2% compared to 14.5% last year.

In Europe, this year's truck industry registrations in the above 16-tonne segment are estimated to be around 300,000 vehicles. The 2025 market is expected to be in the range of 270,000 to 300,000 trucks. Last month, at the IAA Truck Show in Germany, DAF introduced its new 2025 lineup of trucks which improved fuel economy by 3% and use advanced driver assistance systems to enhance safety. In addition, the 2025 vehicles feature PACCAR's connected truck solutions, which bring great value to the customer.

The South American above 16-tonne market is projected to be in a range of 110,000 to 120,000 trucks this year and in a similar range next year. PACCAR's premium lineup of trucks are performing well for customers in South America especially in the important Brazilian market.

PACCAR and its dealers are delivering excellent trucks and transportation solutions to our customers, and we are excited about the future.

Thank you. Harrie will now provide an update on PACCAR Parts, PACCAR Financial Services and other business highlights. Harrie?

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

Thanks, Preston.

PACCAR delivered 44,900 trucks during the third quarter. We expect fourth quarter deliveries to be around 42,000 vehicles. More production days in Europe will be offset by fewer production days due to normal holidays in North America and some supplier-related limitations.

PACCAR Parts delivered third quarter gross margins of 30.1%. Parts quarterly sales grew by 5% compared to the same period last year and are expected to grow around 4% in the fourth quarter. PACCAR Parts is focused on expanding its customer base and providing a full range of transportation solutions is delivering sales growth and a smaller aftersales market. PACCAR Parts just opened a new distribution center in Massbach, Germany. This new distribution center increases the number of dealers and customers benefiting from receiving parts on the same or next day in the important German market. Truck parts and other gross margins were 16.6% in the third quarter. We anticipate fourth quarter gross margins to be in the range of 15.5% to 16%.

PACCAR Financial Services results in the third quarter benefited from excellent portfolio quality. Pretax income was $107 million. The used truck market has normalized in North America, while remaining soft in Europe. PACCAR Financial is a market leader in supporting customers with innovative technologies that provide seamless credit application and loan servicing processes.

PACCAR's net income of $3.3 billion in the first nine months of this year generated a strong $3.2 billion operating cash flow. PACCAR's return on invested capital was an excellent 25% in the first nine months of this year.

This year's capital expenditures are projected to be between $760 million and $800 million and research and development expenses will be $450 million to $470 million. Next year, we estimate the company will invest $700 million to $800 million in capital projects and $480 million to $530 million in research and development projects.

PACCAR continues to expand manufacturing capacity at our factories in Europe, United States, Mexico, Brazil and Australia. These investments are supporting PACCAR's growth as well as our customers' success. PACCAR's investments in its premium truck lineup, efficient manufacturing capacity, best-in-class parts and financial services businesses and the continued development of advanced technologies position the company for industry-leading performance in all phases of the business cycle.

Thank you. We'd be pleased to answer your questions.

Questions and Answers

[Operator]

Thank you. [Operator Instructions] Our first question comes from the line of Stephen Volkmann with Jefferies. Steven, please go ahead.

[Stephen Volkmann, Analyst at Jefferies Financial Group]

Thank you so much. Good morning and good afternoon. I'm curious if we can talk a little bit about what you're seeing on the pricing side? I know we need to normally wait for the Q to get a sense of that. But if you can give us a quick preview of what we're seeing in pricing and kind of how you're expecting that to flow through in the fourth quarter as well?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Sure. If you think about price cost, it's kind of price was flat in Q3, and costs were up 3%. So when I think about that's on the truck side. If you think about how we look forward at that, we think that the location market is going to remain strong. We think the less-than-truckload market is doing really well in addition. And then the truckload sector still seems to be feeling its pressure, but it does seem to have stabilized. And so we're kind of starting to see signs of maybe that tension will release over the coming months and next year, which could be good for us in terms of price versus cost as we look into next year.

[Stephen Volkmann, Analyst at Jefferies Financial Group]

Okay. Good. Maybe that starts to answer my follow-up, which is that, I'm curious, overall, you're sort of flattish globally with your market forecast for next year, maybe you'll gain a little bit of market share like you usually do. But that fourth quarter run rate of 15.5% to 16% gross margin, is that a good sort of base to think about for 2025? Or is there something that could move that one way or the other? Thanks.

[R. Preston Feight, Chief Executive Officer at PACCAR]

I think if you go and look at what's been going on this year, right, the year started exceptionally strong in all sectors. And I think maybe the truckload carriers have had a tougher road to hope for a little while here. Maybe what you'd expect to see in 2025 is a mere image of that, where the year starts a little bit like it's finishing and then accelerates, I think from there. Timing exactly? I don't know that, but it does feel like that's where we're starting to see the stabilization for the truckload sector, just significant. And so we would expect to see some growth over the coming year.

[Stephen Volkmann, Analyst at Jefferies Financial Group]

Super, thank you. I'll pass it on.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Alright.

[Operator]

Our next question comes from the line of Rob Wertheimer with Melius Research. Please go ahead.

[Rob Wertheimer, Analyst at Melius Research]

Hi. Thanks, and...

[R. Preston Feight, Chief Executive Officer at PACCAR]

Hey, Rob.

[Rob Wertheimer, Analyst at Melius Research]

Good morning, guys. So I guess just a follow-up on that question. If you look at gross margin, still at very healthy levels, really historically, but down sequentially. Price was kind of flat, you said, year-over-year and costs creep up a little bit. Is there anything that really should otherwise be called out in the sequential move in gross margin? Thank you.

[R. Preston Feight, Chief Executive Officer at PACCAR]

I don't think there's anything different that I would call out for that. I think the thing that's really good for us is the product introductions we've done over the past few years have -- I mean it's just stunning how great the trucks are right now. The fuel economy is outstanding, the reliability is outstanding, the customer desire for the trucks is very high as well. So I think that what we'll see is people's desire to have those trucks as the market opens up.

[Rob Wertheimer, Analyst at Melius Research]

All right. Perfect. And then I've asked you this before. I'm not sure you'll give me a different answer now, but your differentiation is pretty good and vocational. I mean it's a product that has a lot more -- it has variability to it, let's say, and you guys are real leaders there. Is that at all a margin tailwind for you into next year?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes. It's a very good point, Rob, and yes, it is. I would say that's a positive statement to make. I think one of the things that we look at right now is our inventory is in very good shape, as we mentioned. And over half of our inventory is vocational trucks that are at body builders right now. So we feel well positioned overall with inventory. And then we know that our vocational inventory is strong. We feel like that is good for our business.

[Rob Wertheimer, Analyst at Melius Research]

And then vocational can be up next year? And I'll stop there. I apologize. Thank you.

[R. Preston Feight, Chief Executive Officer at PACCAR]

I think vocational will continue to run strong next year.

[Rob Wertheimer, Analyst at Melius Research]

Thank you.

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet.

[Operator]

Our next question comes from the line of Steven Fisher with UBS. Steven, please go ahead.

[Steven Fisher, Analyst at UBS Group]

Thanks, good morning. You mentioned that your inventory is what you'd characterize as healthy at 2.9 months. I guess can you talk about where that 2.9 months is relative to your ideal targets for this point in the cycle? Do you think there's sort of inventory reductions that you have to make? And just curious kind of what you're seeing from competitors in that perspective? And are they needing to take inventory out? And is that putting some price pressure into the market?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Well, I'll let them talk about their inventory positions. But for our inventory position, we feel very good at 2.9 months. That's a very healthy level for us, especially as I mentioned, to Rob, the fact that our vocational inventory takes up a chunk of that. So we feel quite comfortable with our inventory levels and our build rates being well positioned.

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

And it's even come down a little bit during the quarter. At the end of June, we were at 3.3 months and currently we're at 2.9 months.

[Steven Fisher, Analyst at UBS Group]

Okay. And then just you mentioned about some potential reacceleration in the second half of the year. How are you thinking about the concept of a prebuy at this point? Is that kind of at all in the thinking? Or is it more just sort of the freight market recovering? And if it's a prebuy in your thinking, what do you think it will take to kick start that? Is it just timing and getting closer to the '26-'27 time frame? Or does it actually also require some degree of improvement in the freight market?

[R. Preston Feight, Chief Executive Officer at PACCAR]

I think we're going to see some improvement in the freight market. Some of the carriers have started to leave the market, which is something that's been anticipated, I would say. I also think that as you think about it, there will be -- people's trucks have gotten older, and there will be people interested in making sure they're buying enough trucks for the next several years. So that's going to take an effect, I think, as we go through 2025 and add to 2025's growth.

[Steven Fisher, Analyst at UBS Group]

Okay. Thank you very much.

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet.

[Operator]

Next question comes from the line of Tami Zakaria with J.P. Morgan. Tami, please go ahead.

[Tami Zakaria, Analyst at J.P. Morgan]

Hi, thank you so much. So my first question is on Europe. So your outlook for next year, I think it's down 5% at the midpoint for retail sales. And this year, your deliveries are down more than the retail sales expectation. So as we think about next year, do you plan on delivering to demand? Or do you expect to underproduce even next year? So how should we think about production in Europe next year?

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

But Tami, European volumes have been down a little bit more than the market this year. That was really strong in Central and Eastern Europe where the market has been more affected by the war in Ukraine and the economy is a lot slower there than in some other parts of Europe. We expect things to continue at that pace more or less as we enter next year and then we'll see how it progresses during the year.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes, exactly what Harrie said, I think the other thing is the team in Europe has done a great job on price discipline with the great new trucks. And so I think those two things combined is we feel pretty well positioned in Europe too that we will build to demand next year.

[Tami Zakaria, Analyst at J.P. Morgan]

Got it. That is very helpful. And my second question, going back to pricing, I think you said flattish this quarter. Just trying to get a sense of -- did you open order books for next year? If so, what -- any reads on what pricing you're seeing for next year?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Sure, Tami. I mean, obviously, it's not so binary as opening and closing the order books, but we did have a significant engagement with a bunch of customers at the recent ATA show, so if you wanted to call that the normal cadence of fleets thinking about their purchases. We had great conversations with them, a lot of enthusiasm for the trucks and kind of an expectation of purchases next year. I think they're obviously because of the condition they're all in, it puts some price/cost tension into the world right now, but I also feel like that's going to relieve -- find some relief as we go into 2025.

[Tami Zakaria, Analyst at J.P. Morgan]

Got it. Thank you.

[Operator]

The next question comes from Angel Castillo with Morgan Stanley. Angel, please go ahead.

[Angel Castillo, Analyst at Morgan Stanley]

Hi, good morning. And thanks for taking my question. Just wanted to go back to the margin conversation, in particular, just understanding the price cost dynamics. So you came in ahead of your expectations on total units for the third quarter and price seems to be maybe relatively stable, all things considered. But the 16.6% margin implies decrementals on a pretax basis of over 50%, which is kind of above the levels that I think of as kind of normal. So was there anything that surprised to the upside or that's leading to kind of higher decrementals than you would have typically expected? And then similar kind of line of question for 4Q in terms of help us kind of bridge the gap, like if it's not price degradation, what's kind of causing the margin contraction?

[R. Preston Feight, Chief Executive Officer at PACCAR]

I don't know, Harrie, you want to take a swing?

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

Yes. I think mostly any difference with what we saw a quarter ago would be at the cost side where we had some cost elements. There were some supplier issues at that point in time, some other operating costs or maybe the cost side was the difference, if you want to point to something.

[Ken Hastings, Director of Investor Relations at PACCAR]

Also lower volumes, yes.

[R. Preston Feight, Chief Executive Officer at PACCAR]

But I think when we're looking at that, we're looking at the totality of this thing, and it feels like these are pretty healthy levels for us, given this point in the cycle and where we see ourselves sitting. So it feels pretty good.

[Angel Castillo, Analyst at Morgan Stanley]

Got it. And then maybe a similar dynamic or just a conversation around the parts profitability. Just what do you see there in terms of that business as you think about as we go into 2025, just in terms of the profitability, it seems like it's stepped up nicely in the -- or kind of remain relatively stable, I guess, for 2Q to 3Q. But that was an area that we're seeing a little bit of softness as we were talking about it last quarter. So just what's kind of the ongoing trends there?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes. I think the macro thing to think about in the Parts market right now is that there's a smaller overall aftersales market this year and our team has just done a tremendous job of holding excellent margins in that smaller market and seeing growth in fact, right, as we talked about 5% growth this quarter. So I couldn't be more happy with the work they're doing, the systems they're bringing in, the new PDCs they're opening and how closely they're working with all the customers to grow that business. So a great story there for the Parts team.

[Angel Castillo, Analyst at Morgan Stanley]

Understood. Thank you.

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet.

[Operator]

The next question comes from Jamie Cook with Truist Securities. Jamie, please go ahead.

[Jamie Cook, Analyst at Truist Securities]

Hi, good morning. Sorry, just to follow up on the Parts aftermarket. Can you comment specifically what price cost was like you did for truck, that would be helpful. And then I guess my other question would be, as you think about truck, you said price flat cost up 3%. Was there any major variances sort of by region and there's been this thesis that everyone would act more rational this cycle as some of your peers are now spun off public companies. Just any comment on how you're seeing behavior sort of this cycle versus previous cycles? Thank you.

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

So starting with Parts. Jamie, for Parts, price was up 3% and costs was up 4% in the quarter. And your other question was about?

[R. Preston Feight, Chief Executive Officer at PACCAR]

I think if you think about the disciplines of the -- all the other OEMs being public, listen, it's a competitive world, but PACCAR's has this advantage of having premium products that people really do desire and so the team has close relationships with the customers and feel like it puts us in a good position as we noted in the beginning of our commentary. We have best-in-class performance because of the performance of our products for our customers, and we expect that will continue.

[Jamie Cook, Analyst at Truist Securities]

I guess just a follow-up question, Preston, understanding your outlook for 2025, and it sounds like things should get better in the back half of the year. As we progress through the cycle, and we get a prebuy ahead of 2027. Is there any reason to believe PACCAR cannot deliver above-average incremental margins like you did prior to this most recent sort of mini-downturn, given just the new product introductions, et cetera?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes. No, Jamie, it's a great question, a great way to frame it. I like the way you frame it and I think we can deliver excellent performance in the coming years. So I agree with you.

[Jamie Cook, Analyst at Truist Securities]

Thank you.

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet.

[Operator]

The next question comes from David Raso with Evercore ISI. David, please go ahead.

[David Raso, Analyst at Evercore ISI]

Hi, thanks -- yes, thanks for the time. I have one short-term one, maybe a little bit longer term. On the build -- sorry, deliveries for the fourth quarter, the 42,000. The geographic composition of that, I mean obviously, historically, Europe will step up. Are we saying even with the extra days in Europe, we won't get a step up in Europe, so that's sort of flattish and maybe other is flattish and sequentially, U.S./Canada is the down 11% to get us to the 42%. I'm just trying to be thoughtful about the geographic mix when I think about the margins.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes. I think, David, you're not off on that. I think that it's relatively flattish 3Q to 4Q for Europe and again, we've gotten our inventory in a very good position there. And then I would expect that we're -- maybe it's up slightly even and then we're going to see in the -- what we're going to see for the U.S. is a normal holiday cadence. And obviously, there was a couple of hurricanes that came through, which did affect some suppliers. And so we're working through that right now with them. The supply base is doing a great job of sorting that out, and it's just something we got to kind of sort out as a team.

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

Yes. On a per-day basis, Europe is flattish going into the fourth quarter. But the more production days, I think it provides a couple of thousand more trucks in Europe compared to the third quarter -- in the fourth quarter.

[David Raso, Analyst at Evercore ISI]

Well, that's the whole thing. If it's a couple of thousand more to keep the whole company down to 42%. I'm just trying to figure out, is North America -- sorry, U.S. Canada down 20% sequentially. I'm just trying to get a sense of the magnitude because that could explain the margin pressure a little.

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

Not 20%, but that's what is it, seven or eight fewer working days in the fourth quarter in North America.

[David Raso, Analyst at Evercore ISI]

Okay. That's helpful. And then on the issue of the supply of the pre-buy -- I'm sorry, go ahead, Preston.

[R. Preston Feight, Chief Executive Officer at PACCAR]

No, go ahead.

[David Raso, Analyst at Evercore ISI]

Well, I was just moving on to the second question I had about the prebuy. A major engine supplier, we hear could be pulling their engine for '27 earlier, which could actually inspire maybe some buying of their engine in '25. So I just wanted to see if you'd enlighten us on that at all, if that is maybe what's playing out, which could help '25.

And then second, on the inventory for the vocational. You mentioned the body builders who continue to be a bottleneck. So the inventory sitting out there in vocational does lead argue, have a customer, they're just the bottleneck of the body builder to finish off the job. Is there something going on with the body builders that can sort of break that through a little bit? And if not, is the level of occasional trucks sitting there waiting for a body builder an impediment to you being able to grow your vocational business more in '25?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes. I think that what you've seen is there was this impulse throughout 2024 in the vocational market. And I think that's maybe stabilized at a high level. So I think people are doing a job, a good job of catching up and what the body builder capacity has been and is. So they're getting that sorted out is what it feels like, David. Obviously, there's some components on vocational trucks that are unique and some of those are in tight supply right now, which sends some throttle on it. All of that together means that I think 2025 will continue strong in the vocational sector. There's still infrastructure spending. The country is doing well. And so I would expect vocational to remain a strong point for us. And as you well know, right, we have over 40% market share in that sector. So that will be good for PACCAR in '25.

And coming back around to your first question, we have a great relationship with Cummins. We build our own engines. We are well positioned for today's emission standards as well as the upcoming emission standards and feel like we'll be able to offer our customers the right products for the upcoming markets and don't have any concerns about how that's going to play out.

[David Raso, Analyst at Evercore ISI]

Okay, I'll leave it there. Thank you so much.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Great.

[Operator]

Our next question comes from Jerry Revich with Goldman Sachs. Please go ahead, Jerry.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Yes, hi. Good morning. Good afternoon, everyone. I'm wondering...

[R. Preston Feight, Chief Executive Officer at PACCAR]

Hey, Jerry.

[Jerry Revich, Analyst at The Goldman Sachs Group]

-- if you could just talk about -- hi. I'm wondering if you could just talk about on the cost side, your teams have been sprinting really hard to get trucks out the door when supply was tight and I'm wondering based on the cost of materials that are now flowing through the factories. When do you think we could see per truck costs actually coming down? And if the current steel price cost curve holds in particular, do you think we could be looking at per truck cost potentially tailwind at some point in early '25 on a year-over-year basis?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes. Jerry, I'd say it's a possibility. I think there's a little bit of labor that factors into here too that you look at on a year-over-year basis, which is something that's been incurred by the industry as a whole, including our supply base, much written about. So I think we'll just have to watch how those two things interplay with each other in the coming six months.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Yes. And then in terms of the mix of what you folks have in backlog. Can you talk about that? You mentioned earlier in the conversation, the margin step down has been driven large by mix of product. How does the mix of what you folks have left the backlog look compared to what we shipped this quarter?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes. We still see the same ratios of really strong truck versus tractor production. Truck production is still running around 50%. So that's above a historical number, but very good numbers for us.

[Jerry Revich, Analyst at The Goldman Sachs Group]

And you folks have improved your truck profitability significantly cycle over cycle. In the past, we've seen margins peak to trough, truck gross margins range from 400 to 1,000 basis point peak to trough. How do you think the higher margin profile that you folks have now will translate into truck cyclicality going forward? What's the impact on fixed versus variable cost versus history? Any comments that you care to make on that question.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Sure, Jerry. I think it's a great observation on your part. I think that what we see is the company is performing at a structurally stronger level. I think that's because of the great investments and the efforts of the team to provide excellent products for our customers. I mean they really are helping our customers make money and they are desired by the drivers. So that's a nice position to be in. I think PACCAR's lean culture and operating disciplines are healthy and good for the company and good for our operating performance, good for our customers in terms of us being a lean operating company and good for our shareholders. So, you're right in making the observation and we think that that observation will hold true.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Okay. Super. And lastly, some of your competitors are talking about some pretty small incremental cost increases on EPA 2027 versus what most of us expect. I'm wondering if you could just weigh in on your expectations, especially since you're already up and running in California. Can you talk about what you folks are seeing and expecting?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes, sure. First of all, nice that you even observed the fact that we have a certified engine in California as we're the first manufacturer to do that. So we're well positioned for any of the regulatory conditions that we encounter. Our thoughts is it could be in the 10,000 to 15,000 range right now, subject to change, depends on what the regulatory agencies do, but that feels like the right framing point for the cost as we look at 2027.

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

And Jerry, bear in mind, it's not only about material cost, it's also the extended warranties that we kick in with EPA '27. That will have an effect -- an impact on the cost level as well.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Absolutely. Thank you, everyone.

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet. Great questions.

[Operator]

Our next question comes from Tim Thein with Raymond James. Tim, please go ahead.

[Tim Thein, Analyst at Raymond James]

Great. Thank you. First one, Preston for you. Maybe I'm just curious in terms of the conversations that you and the team are having with your truckload customers and you think about kind of the order progression as we go in the coming months. It seems, and I don't know if you would agree with this. And obviously, you've lived through lots of these truck cycles over time. But just with respect to kind of this election uncertainty and the range of political and kind of regulatory outcomes that may come about, I'm just curious, do you think there's more -- I mean there's always this notion of there's kind of a wait and see around the election, but it does seem like from our standpoint anyway, maybe this year is a little bit greater. So I'm curious, if you share that thought? And if so, would you think it's fair that maybe there's a potential for more of a delayed order cadence as we look into '25.

[R. Preston Feight, Chief Executive Officer at PACCAR]

No, I think that we have some really smart customers, and our observations in those conversations as they think very clearly about their economic conditions that they're operating in. And I think they know that there needs to be a steadiness to their buying cycle of trucks because it's good for their operating models. And so they've been probably reluctant on the truckload side to be able to make the capital truck purchases they wanted for the last little while just based upon rates. And I think they're kind of hopeful that, that's going to change. And I think far more important than anything like election is when those rates change, then they will probably increase the cadence of their buys. And I think that that's what they're thinking about.

[Tim Thein, Analyst at Raymond James]

Got it. Okay. And then just with respect to the deliveries in North America, it seems from some of the third-party data that maybe in the third quarter, you had a little bit heavier on medium duty relative to heavy duty. Is there a -- is there any normalization that may occur in fourth quarter? Or is that -- is it not enough to call out in terms of from a mix perspective as you think 3Q to 4Q?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Harrie, I know you were talking -- you and I were talking about that one too.

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

Yes. So medium-duty volumes were a little bit higher in the third quarter with some catch up related to some extent. So in the fourth quarter, we expect a more normal medium versus heavy mix than like we used to see.

[Tim Thein, Analyst at Raymond James]

Got it. Okay. And I assume, Harrie, that there's not the implications from a profit perspective aren't what they would have been several years ago, just given the improvement in medium-duty side, is that fair?

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

No, no. The margins on our medium-duty products are well in line with the heavies these days.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Nice observation, Tim.

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

Yes. As a percentage, they're smaller trucks, but the percentage is very similar.

[Tim Thein, Analyst at Raymond James]

Yes. All right. Thank you.

[Operator]

Our next question comes from Kyle Menges with Citi. Kyle, please go ahead.

[Kyle Menges, Analyst at Smith Barney Citigroup]

Thank you. I was just curious on the R&D guide for next year, just how we interpret the step-up in R&D guidance for next year, especially given the market, we could be in kind of a flat to slightly up market -- global market for you guys next year?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Well, if you think about where we're at this year and if you took a midpoint at $460 million and then you said if you took the midpoint on something like $500 million or a little over $500 million. It's not that big of a change. And the way we think about R&D is when we have important good projects to work on, be they powertrain or new truck systems or connectivity or electronics or all the things that will make our trucks more profitable for the customers, then we make those investments. And this is the right level of R&D investment for that.

[Kyle Menges, Analyst at Smith Barney Citigroup]

Got it. And then I know you've talked about a strong vocational market into next year more related to Class 8. But just any thoughts on how we should be thinking about the medium-duty market next year in North America?

[R. Preston Feight, Chief Executive Officer at PACCAR]

I think we should see a healthy medium-duty market again next year in North America as well. I think it's been good this year. And there is, as you just kind of indicated there's some portion of that which hits into the vocational market. But overall, it should be a good market -- remain a good market is probably the right way to say it, Kyle.

[Kyle Menges, Analyst at Smith Barney Citigroup]

All right, thank you.

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet.

[Operator]

The next question comes from Chad Dillard with Bernstein. Chad, please go ahead.

[Chad Dillard, Analyst at AB Bernstein]

Hi, good morning, guys.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Hey, Chad.

[Chad Dillard, Analyst at AB Bernstein]

So I just had a question for you on -- hey, how are you? So just a question for you on what you're embedding for your '25 North America truck guide. Just trying to think through the split between vocational versus tractor. I think you mentioned truck was about 50% in '24. Is that the same or a little bit higher? Any prebuy embedded? And then I think you mentioned that the progression of price cost will go into reverse in '25. So is it fair to say that the fourth quarter is probably the trough for TP&O gross margins?

[R. Preston Feight, Chief Executive Officer at PACCAR]

I think what we'll expect to see is that the vocational market remains strong, but there's probably a pickup in the truckload sector. So the ratio of tractor to truck might move around a little bit towards heavier tractor as we go through the year next year. See how that starts and when that takes effect, as you mentioned. But I think that what we're seeing now, as we said, as we started this year in a really strong position, we're finishing at a point where the truckload carriers are still feeling tension. And then as we get into next year into 2025, they're going to want to continue to buy trucks, keep their fleets at the right ages, and so we'll see some increase in the truckload purchases throughout the year. Timing for that, we'll see.

[Chad Dillard, Analyst at AB Bernstein]

Got it. Okay. And then a second question for you on the FinCo business. Just how should we think about that going into the end of the year and in '25? And more specifically, just looking at like the interest and other borrowing expenses, it seems like there's a pretty big step up and just trying to think through how that evolves.

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

The finance company continues to show strong performance. We have a very healthy portfolio of mainly A and B customers. Past dues remain low, seeing a little credit losses, but that's normal at this point in the cycle. So as we get into next year, we'll continue to see strong performance of the finance company. Interest rates, we are time hedged there. So we issue medium-term notes in line with the leases that -- and the financing contracts that we offer. So we don't have a lot of exposure there.

[Brice Poplawski, Vice President and Controller at PACCAR]

And in the portfolio, this is Brice. I'd just like to add that our portfolio is growing very nicely because we have a market right now where the banks are getting out at times, and we're seeing a little bit less competition. Our market share is up actually nicely here in the quarter, and we expect strong continued performance in our business here.

[Chad Dillard, Analyst at AB Bernstein]

Great. Thank you.

[Operator]

The next question comes from Jeff Kauffman with Vertical Research Partners. Please go ahead, Jeff.

[Jeffrey A. Kauffman, Analyst at Vertical Research Partners]

Thank you very much. Hey, everybody.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Hey, Jeff.

[Jeffrey A. Kauffman, Analyst at Vertical Research Partners]

I want to talk a little bit about -- thank you. Thank you and congratulations. I want to talk a little bit about the South American growth is going to be exceeding that in the near term for North America and Europe. Does this at all change the specs on the trucks in terms of what you're seeing and how that might affect ASP?

[R. Preston Feight, Chief Executive Officer at PACCAR]

If you think about the truck specific to Brazil, which is the largest market in South America, we're participating in, is that it really is the DAF truck that we're using there. And that truck is kind of effectively the same truck as we get in Europe. And we have had to put together certain specs for them, where they're operating in different operating conditions, more 6x4s, more sugarcane kind of applications, lumber hauling applications. So it's a bit of heavier duty, so maybe the selling price is a slight bit higher there? But in general, I tend to think about them like a European truck.

[Jeffrey A. Kauffman, Analyst at Vertical Research Partners]

Okay. And then as we transition in 2025 at some point to a market where maybe truckload LTL is growing a little faster than vocational and international, how might that be affecting ASP as we work our way through '25?

[R. Preston Feight, Chief Executive Officer at PACCAR]

And I wouldn't put too much energy into trying to figure out the nuance to that, if it was me. I think that you could obviously think that a high content vocational truck is more expensive than a maybe a standard 6x4 tractor, but I wouldn't probably try to parse that together.

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

That's probably a higher variety and a bigger range in prices for our vocational trucks than you would see for on-highway.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes. And then if you keep the vocational segment and you start thinking about the medium-duty participation in that, I think you'd have a hard thing to kind of suss out there.

[Jeffrey A. Kauffman, Analyst at Vertical Research Partners]

Well, fair enough. I was just looking for some context and that's fine. So that's my one question.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes. Good question. Thanks, Jeff. Good to talk to you.

[Operator]

Our next question comes from Michael Feniger with Bank of America. Please go ahead, Michael.

[Michael Feniger, Analyst at Bank of America Merrill Lynch]

Great. Yes. Thank you, gentlemen, for taking my questions. It's just you guys have really been investing in the business in your trucks, in your facilities. I'm just curious how much more capacity can you bring on to serve the U.S. market? Is it 10% to 15%? Is it 20% more than what you guys could do previously? And is this higher capacity? Is this available in 2025 in the second half when we see that ramp? Or is this more of a 2026 that you guys can raise capacity in some of these facilities?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Hey Mike, thanks for the comments. They're nice to hear. The thing we're doing with our capital expenditures, as we noted, is we are making investments in the factories, and that's not a new thing, right? We've been doing that over the past few years in anticipation of where the markets will be in our growth. So some of those capacity investments are in and complete, others are underway. So we have all the capacity we need for the markets in the coming years. We will not be capacity constrained, and we do anticipate growth.

[Michael Feniger, Analyst at Bank of America Merrill Lynch]

Okay. Helpful. And then just, I guess, the last question. You guys talked a little bit about a normalization of the used market in North America, a little weaker in Europe. I was hoping you kind of flesh that out. And I'm curious if the spread between the new price for a truck, let's say, in 2025 versus what you're seeing for a used truck right now, is that spread kind of normal? Is it wider than usual? Just curious if you guys are seeing anything there in the market. Thank you.

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

As the used truck market normalizes, also that spread becomes more normal.

[R. Preston Feight, Chief Executive Officer at PACCAR]

And if I was to think about it, I would think that what we've seen is, as we said, is used truck prices have found their space right now. And I think the trucks in the used market will look pretty good to us in 2025. And like we said, we also expect the new trucks to improve in 2025 in terms of market outlook. So it feels like they're staying together, right? There's not a big separation between new and used.

[Harrie Schippers, Executive President and Chief Financial Officer at PACCAR]

And just looking at our inventory position in North America, that used truck inventory is at very, very healthy levels for us. So that gives us confidence that we'll be able to operate at good levels there.

[Michael Feniger, Analyst at Bank of America Merrill Lynch]

Yes. That is helpful. Thanks, gentlemen. And just the last one to squeeze in. Just on Parts. I'm curious if there's anything you guys would call out that's weighed on the margin for parts that might normalize or go away next year? Like if next year, parts are up 5%, do you think the profit for Parts can grow more than 5%? Just kind of curious on the puts and takes of what you guys have been seeing the last -- this year and how we think about that for '25. Thank you.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes. It's a good question, fun to think about it. I think as we noted in our comments, right, there is a smaller overall aftersales market in 2024. So purely the number of parts overall has gone down that are being sold, but the parts team has grown the business even in that environment. So I think as the overall after-sales market picks up with increased freight activity, that will be good for the business and should be a tailwind for us. Emily?

[Operator]

Our next question comes from Scott Group with Wolfe Research. Scott, please go ahead.

[Scott Group, Analyst at Wolfe Research]

Hey, thanks, guys. I just want to follow-up on the -- some of the gross margin commentary. So you got a comment that first half would be pressured and then improve in the second half next year. I'm wondering, was that a year-over-year or a sequential comment? Meaning, do we see further sequential gross margin pressure in the first half from where we are now? Or was that just purely a year-over-year comment?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes, Scott, you might have heard more than we said even there. I think what we actually said was we feel like we will see improvement through the course of 2025. I can't be so specific as to know how that's going to play off. But it does feel like it will be a mirror image of this year. So the strength we saw in the first half in '24 will be -- and then the normalization in the third, fourth quarter here, likely will be inverted as we get into 2025. But the specifics of that, they're hard to detail out.

[Scott Group, Analyst at Wolfe Research]

Yes. I mean, ultimately, I'm trying to figure out if you are -- if you think that this Q4 is the bottom for gross margin?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes. I think I understand that. And I think your intuitions aren't far off.

[Scott Group, Analyst at Wolfe Research]

Okay. Okay. And then just lastly, any thoughts on how you're sort of thinking about approaching the market next year? Is it in terms of market share growth or a little bit more focused on price? How are you balancing that for next year?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Well, we like to see market share growth and we like to see ourselves perform well as a company for our shareholders, we'll be pursuing both of those next year.

[Scott Group, Analyst at Wolfe Research]

Okay. Okay. Thank you guys.

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet.

[Operator]

Thank you. There are no other questions in the queue at this time. Are there any additional remarks from the company?

[Ken Hastings, Director of Investor Relations at PACCAR]

I'd like to thank everyone for joining the call, and thank you, Emily.

[Operator]

[Operator Closing Remarks]