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We believe the Heavy Truck Industry is poised for a continued recovery over the next few quarters. Macroeconomic conditions are improving, albeit at a slow pace, and this ought to boost truck orders, production, and retail sales. Replacement demand remains elevated, as many firms have decided to replace older trucks with newer, more efficient models. Rising prices for used equipment is another reason that truckers prefer to buy new. However, the sector is facing parts supply concerns, and this could temper results for many truck makers.

According to ACT research, a leader in data and market analysis for the commercial vehicle industry, North American heavy-duty (class 8) truck orders in April rose 157% from the year before, to 38,120. The figure was a 32% jump from March’s tally. The class 8 order backlog now stands at a nearly five-year high. Driving these strong gains were a large number of motor carriers who traded in aging, prerecession truck equipment. Freight demand continues to grow, which has boosted trucker profits, and has also improved truckers’ credit worthiness, which has made it easier for them to make purchases.

PACCAR (PCAR), which controls nearly a quarter of the heavy-duty truck market, has been seeing strong demand trends in both Europe and North America, thanks primarily to its DAF brand of trucks. Although rising component costs, including rubber and steel, remain a concern, we believe the company will be able to pass most of these expenses on to customers. The company is also seeing strong demand in South America, a region that has significant growth potential.

Business prospects at Wabash (WNC) are looking bright as well. The manufacturer of truck trailers reported that sales during the first quarter nearly tripled from a year earlier. Management reported low cancellation rates, a sign that the truck market recovery is gaining steam.

Although demand trends appear to be in very good shape, there are some concerns, particularly on the supply side. We think there is a gap between order intake and build rates, owing to a supply base that simply is not there. For example, Navistar (NAV) recently announced that it would not be able to raise its production beyond where it is now, largely due to the parts supply constraints.

Many truck manufacturers get at least some of their parts from tier one or tier two suppliers. Given the rapid turnaround in the trucking industry over the past few months, many of these suppliers simply cannot boost production quickly enough. A lot of suppliers are now offshore, which has complicated the production process. There appears to be a domino effect where, for example, a truck manufacturer that uses a parts supplier needs to wait for that supplier to get its own parts from a tier two or tier three supplier in another country. Many suppliers in these less-developed regions do not have the capability to boost capacity significantly or quickly.

Another concern facing the industry is the tight supply of commodities in the market. Daimler (DDAIF) Trucks North America President and CEO Martin Daum stated that he would like to increase production further and faster, but he can’t, because of commodity supply issues, starting with tires. His division has run from one shortage to another, so production capabilities at the company remain very choppy.

Despite these issues, we still believe that business prospects for the Heavy Truck Industry remain favorable. An improving economy, higher freight demand, tightening freight capacity, and very strong order figures should help boost profits at most truck manufacturers in the coming quarters. We look for demand from North America and emerging markets to continue to expand at a brisk pace. Although the supplies shortages remain a concern, we think that these issues are likely short term in nature, and should become less of a problem as suppliers move to expand and increase capacity to meet elevated demand levels.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.