September 3, 2015

Heavy Truck Warranties:

Six companies have 12 brand names that account for almost all the heavy trucks carrying freight on the highways and motorways of North America and Europe. And while it's not possible to figure out how much warranty costs on a per-truck basis, all six parent companies do disclose their total worldwide warranty expenses.

As your editor spent the last two weeks driving the family around the Interstate highways of the eastern states of the U.S., two questions came to mind: first, why is that giant tractor-trailer tailgating me, flashing its headlights and honking its horn, and second, what brand is that truck in the rear-view mirror?

It turns out that only six companies control the vast majority of heavy truck sales in North America and Europe: the Volvo Group, Navistar International Corp., Paccar Inc., Daimler AG, Volkswagen AG, and CNH Industrial N.V. Four are active in North America, and five are active in Europe. And between them, they have about a dozen truck brands that account for upwards of 95% of the rigs now on the road.

When it comes to looking at their warranty expenses, however, a major problem arises. Only the first three companies are what we'd call a "pure play" in trucks. The other three are dominated by sales of other products, such as passenger cars for Daimler and VW, and farm equipment for CNH. And since we get only one set of warranty numbers for each company, there's no reliable way to separate the data into truck and non-truck portions.

Still, let's take a look at the six companies, starting with the three "pure plays." It turns out that two of them also have below average warranty expense rates, which we think is not just a coincidence. Although there are exceptions to the rule, heavy truck manufacturers tend to spend less on warranty work than do the passenger car makers. And the on-highway heavy vehicles seem to have lower warranty expenses than the off-highway heavy equipment, though again, exceptions exist.

Volvo Trucks

The Volvo Group is one of the few truck makers with leading market shares in both Europe and North America. In fact, it's one of the few companies that can say that a majority of their revenues come from the Class 8 heavy trucks used to transport freight on North American highways (analogous to the Large Goods Vehicles that carry freight on the motorways in Europe). Last year, 67% of Volvo's revenue came from trucks; 6% from buses; and 19% from construction equipment.

The company has Volvo Trucks North America and Mack Trucks in the U.S., and Renault Trucks in Europe. Volvo also now holds a minority interest in China's Dongfeng Commercial Vehicles, is in a joint venture with India's Eicher Motors, and in Japan it now owns UD Trucks, formerly Nissan Diesel. Meanwhile, Volvo's passenger car operations were sold to the Ford Motor Co. in 1999, which sold it in 2010 to a Chinese company that also acquired the manufacturer of the iconic black London taxicabs.

In its annual report, Volvo states that about 38% of its total revenue comes from European sources, while about 27% comes from North America. The company estimates that it has about a quarter of the heavy truck market share in Europe and about a fifth of the market share in North America. Total industry volumes in both markets have remained a little above or below 250,000 units sold per year for the last couple of years.

Volvo's warranty expense rates have remained relatively stable since 2003. As can be seen in Figure 1 below, both its claims rate (in red) and its accrual rate (in green) have remained very close to their 2.4% historical average, especially in the last five years. Its claims rate was highest in 2009 and lowest in 2007 -- both times about a percentage point away from the average.


Figure 1
Volvo Group
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2014)

Figure 1


Volvo reports its warranty expenses only once a year, so we've extrapolated the expense rates that we calculate over all four quarters of the year. Our next two companies, however, are based in the U.S. and are therefore required to report their warranty expenses in both their annual reports and their quarterly financial statements. So while for Volvo we have only 12 pairs of measurements for 12 years, for the American companies we have four times as many measurements.

Navistar International Corp.

For Navistar, in fact, we now have 51 pairs of measurements, because the company last week filed a financial statement for its third fiscal quarter ended July 31, 2015. Paccar follows the calendar, so we're only up to its second quarter 2015 report, giving us 50 pairs of data from 2003 to mid-2015.

Navistar has the International Trucks brand, which used to be part of the International Harvester Co. until the parent company changed its name in 1986 after selling its agricultural equipment division to Tenneco. That unit merged with Case, which became the C in CNH Global after joining with the New Holland Machine Co.

Navistar reports that in fiscal year 2014 about 66% of its sales came from "North American Truck" while 23% came from "North American Parts." Having delivered 186,700 Class 8 heavy trucks that year, Navistar estimated its market share at 14% of the U.S. and Canada total. But it also held 35% of the school bus market, as well as 21% of the market for smaller trucks, according to its annual report.

Navistar has suffered tremendous problems in recent years with the warranty costs associated with its new diesel engines, which we wrote about extensively in the June 21, 2012 and November 13, 2014 newsletters, among others. The U.S. Environmental Protection Agency wouldn't certify the engines to be compliant with recent anti-pollution emission standards, so Navistar had to pay penalties for every unit they sold.

In warranty terms, however, the big difference between heavy trucks and passenger cars is the way they warrant the components. With passenger cars, the OEM warrants the unit "bumper to bumper," even if the engine is made by another supplier. But with trucks, the engine manufacturer typically warrants its engine directly, as does the transmission manufacturer and other major component manufacturers. Therefore, strictly speaking, the problem was with Navistar's MaxxForce engines, not International's trucks or buses.

Trucks vs. Engines?

However, as external observers, all we get are one set of worldwide warranty expense figures per company. So it's impossible to separate the expenses of the different product lines or the different geographies. We don't know whether Mack or Volvo has lower expense rates, and we don't know what percentage of Navistar's warranty expenses came from trucks, buses, or engines.

The surge in Navistar's warranty expenses is painfully apparent in 2013, though it continues to subside. The company's latest warranty expense figures suggest an accrual rate around 2.3%, which is actually below its long-term average. However, its claims rate, at 4.1% in the latest two reports, is still quite elevated compared to the pre-2012 figures.


Figure 2
Navistar International Corp.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2015)

Figure 2


Not all the good news fits into the chart in Figure 2, however. In the past, we've written about how Navistar has frequently been forced to add extra money to its reserves to cover insufficient accruals in previous years. But in the first three quarters of this fiscal year, it has actually been removing money from its warranty reserve, because its previous cost estimates are turning out to be too pessimistic. So far, the company has taken out only a net $39 million this year, but that's much better than the $65 million extra it had to add in a year ago.

Paccar, or PACCAR, as the company prefers, used to be called the Pacific Car and Foundry Company, back when it made railway equipment and logging trucks a hundred years ago. Paccar acquired the Kenworth brand in 1945, and the Peterbilt brand in 1954.

In Europe, it acquired DAF Trucks and Leyland Trucks in 1996 and 1998, respectively. In Australia and South America, heavy trucks are sold under both the Kenworth and DAF nameplates.

In its annual report, Paccar notes that commercial truck manufacturing comprises the largest segment of its business, accounting for 77% of its 2014 sales revenues. The U.S. and Canada accounted for 61% of sales, while Europe accounted for 25%. Paccar estimates that it has about 28% of the heavy truck market share in the U.S. and Canada, and about 14% in Europe.

Rising Expense Rates

In the chart below, besides the recessionary chaos of 2009 and 2010, the most noticeable feature is the recent rise in warranty expense rates. Earlier this year, Paccar featured multiple times in the top ten expense rate increase charts in the March 12 newsletter.

And by the looks of the expense rates reported for the first and second quarters of 2015, the elevated expense rates continue. Long term, the company's average warranty expense rate is 2.2%. But in the five most recent quarters, its claims rate has averaged 2.6%, while its accrual rate has remained close to 3.7%.


Figure 3
Paccar Inc.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2015)

Figure 3


From the perspective of their passenger car manufacturing operations, both Daimler and Volkswagen were included in the July 9 report on European auto warranties. This week, we'll look at the same data in a different way, focusing on their respective heavy truck manufacturing operations.

In terms of heavy trucks, Daimler has the Freightliner and Western Star brands in the U.S. It uses the Mercedes-Benz brand name for its trucks in Europe, and owns a majority of the Mitsubishi Fuso Truck and Bus Corp. in Japan. In China, it has a joint venture with Foton Motor in the company called Beijing Foton Daimler Automotive Co. Ltd. (BFDA). Daimler Trucks has also been manufacturing trucks in India under the BharatBenz brand name.

Worldwide, about 55% of Daimler's revenue comes from passenger cars, while about 23% comes from heavy trucks (excluding vans and buses). The company reports that about 34% of its total revenue comes from Western Europe, while about 29% comes from North America.

Daimler Truck Sales in Asia

For trucks only, about 12% of unit sales are made in Western Europe, while about 33% of unit sales are made in North America. Surprisingly, the company states that its biggest market for heavy trucks is Asia, which now accounts for 34% of its unit sales of trucks. However, it's still the market leader in the U.S. and Canada, with a 37% market share in North America. The company estimates its heavy truck market share to be 24% in Europe, which places it third behind Volvo and VW.

In the chart below, passenger cars probably account for most of the warranty expenses of the parent company. Also, Chrysler is a part of the data from 2003 to 2006, a period when the expenses were reported on a quarterly basis. But when Daimler sold the majority of Chrysler to a private equity firm in 2007, it cut back its reports to once a year, which is why the 2007-to-2014 data looks more like a staircase.


Figure 4
Daimler AG
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2014)

Figure 4


The good news is that the chart above proves that Daimler has been steadily reducing its warranty expense rates for more than a decade. The bad news is that we don't really know if the good news came from the car, truck, van, or bus divisions. And we don't know if the sale of Chrysler had a positive, negative, or no effect on expense rates.

Numerically, the company sold 1.7 million cars and light trucks against half a million heavy trucks, with the revenue share coming in at 55%/23%. So we'd suggest the cost reductions came mainly from cars. But as external observers, we can't be sure.

Sleeper Trucks

Among the six highway truck brands that dominate the North American market, there are some important differences between the trucks. For instance, Kenworth and Volvo Trucks tend to be used more for multi-day long-haul transportation, where the driver sleeps in the vehicle. Freightliner and Peterbilt models tend to be used for shorter trips, or for longer trips where the driver either goes home at night or sleeps in a hotel. Mack and International trucks come in both sleeper and day models.

There's another whole report to be written on heavy truck engine warranties, and then on heavy truck transmission warranties, and heavy truck cab and chassis warranties. For instance, Paccar is a major customer for engines made by Cummins Inc., which also has long-term heavy-duty engine supply agreements in place with Navistar, Volvo Trucks North America and Daimler Trucks North America. Unlike passenger cars and light trucks, with heavy trucks it's a mix-and-match world, where the end user obtains warranties from multiple component suppliers.

Detroit Diesel Corp., another wholly-owned subsidiary of Daimler, supplies engines to not only Western Star and Freightliner, but also to its competitors. And then there's Caterpillar Inc., which makes large diesel engines for its own construction and mining vehicles as well as for the heavy equipment of others. Allison Transmission Inc., which like Detroit Diesel was once part of the General Motors family, is now an independent manufacturer of Class 8 truck transmissions used in models made by Daimler, Navistar, and others. And then there are numerous other suppliers that also focus on the truck market.

Before we complete our highway truck tour, there are two more companies that own three heavy truck brands that are more frequently found in Europe. Volkswagen owns a majority of MAN SE, and MAN and Volkswagen together own a majority of Scania AB. And finally, CNH Industrial is now the owner of the Iveco truck brand that was formerly a part of Fiat Industrial S.p.A.

Volkswagen's Truck Divisions

MAN reported sales of 120,000 units in 2014, down from 140,000 units sold in 2013. Scania reported sales of 80,000 units in both 2013 and 2014. That's only a small percentage of the 10.2 million vehicles of all sizes that the Volkswagen Group sold last year. But of course, heavy trucks cost more than the average passenger car.

In terms of revenue, Scania accounts for about 6% of VW's automotive revenue, while MAN accounts for about 8%. Commercial vehicles of all sizes, including medium trucks, accounts for about 19% of VW's automotive revenue. Therefore, in Figure 5, we're not really looking at heavy truck data. It's more than 80% passenger cars and light trucks, with some medium trucks included as well.

Still, the warranty expense data has remained at a consistently high level for more than a decade. VW averages a claims rate of 4.1%, and an accrual rate of 5.4%. The gap between the two rates has led to a massive buildup of warranty reserves, which grew to a balance in excess of 20.5 billion euro by the end of 2014. In contrast, Daimler was just under 5 billion euro at the same date, while Fiat and BMW were each under 4.9 billion euro. In other words, VW carries more warranty reserves on its books than Daimler, Fiat, and BMW combined.


Figure 5
Volkswagen AG
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2014)

Figure 5


Finally, we previously included the 2003-to-2014 warranty expense data of CNH in the July 23 report on international heavy equipment warranties, but for the convenience of readers we shall repeat it here. Since the company releases its warranty expense data only once a year, nothing has been added to the record since that report appeared. But this time, we're looking at the on-highway truck portion of the company, rather than its off-highway agricultural equipment.

Iveco is an abbreviation for Industrial Vehicles Corporation, which is what the company was called when it was created out of a merger between several Italian, French and German truck brands in 1975. Over the next few decades, Iveco was part of Fiat Powertrain Technologies, and then Fiat Industrial. But then in September 2013, Fiat Industrial merged with CNH Global, and the name of the parent company was changed to CNH Industrial.

Iveco in Europe Only?

In 2014, about half the company's product revenue worldwide came from agricultural equipment, and about 35% came from commercial vehicles of all shapes and sizes. Overall, about 45% of CNH Industrial's revenue comes from European sources, while about 28% is from North America. However, most of that is farm equipment, not trucks. Looking strictly at commercial on-highway vehicles, about three-quarters of Iveco's revenue comes from Europe, while almost none of it comes from North America.

Over the past decade, CNH has kept its warranty expense rates very close to their historical average of 2.5%. From 2003 to 2010 the data was reported quarterly, and from 2011 to 2014 it was reported annually. But what's remarkable about it, considering all the mergers and reorganizations, is how unaffected the averages have been.


Figure 6
CNH Industrial N.V.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2014)

Figure 6


These six companies account for the vast majority of heavy trucks sold in North America and Europe. In North America, the market leaders are Daimler and Paccar, with Volvo in third place and Navistar in fourth. In Europe, the market leaders are Volkswagen and Volvo, closely followed by Daimler, then Paccar and finally CNH.

However, when it comes to warranty expenses, heavy trucks are probably a small part of the total for half of these parent companies. While heavy trucks sales generate the majority of revenue at Volvo, Navistar, and Paccar, they're responsible for well under half the revenue at Daimler, VW, and CNH. Therefore, we suspect they also account for less than half the warranty expense at these companies.

Overall, the average warranty expense rate for all these OEMs is around 2.6%. Out of all six parent companies, Paccar has reported the lowest average warranty expense rates over the long term, though its most recent reports have been higher than usual. CNH and Volvo are consistently below the industry average, while Navistar and Daimler are a bit above average. VW has the highest warranty expense rates in the industry, though we suspect most of that comes from its passenger car operations.





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