I don't know if the nearly 60% move in Navistar (NYSE:NAV) over the past six months is due to Wall Street's confidence in Navistar's turnaround efforts or investors simply looking around for a stock that seemed a little undervalued. In any case, it seems harder to argue that investors aren't already factoring in a pretty solid recovery for this struggling truck builder. An industry recovery in 2014 could certainly help, but investors shouldn't underestimate the challenges in rebuilding customer confidence and regaining the market position of years past.
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Share Declines And Warranty Costs Continue To Hit Results
Navistar didn't post a great fiscal second quarter result, though once again I have to think that the company and stock will be shielded in part by low expectations on the Street.
Overall revenue declined 23%, with a similar 23% decline in manufacturing revenue. Revenue from the truck segment declined 34% on ongoing share loss, while engine revenue also declined 17%. Parts revenue was the lone bright spot, with a 7% increase in revenue. All told, Navistar's manufacturing revenue missed the average Street target by about 14%, which is arguably worse than it looks as analysts have monthly order data that they can use to adjust estimates on an ongoing basis.
Navistar's profitability is still a mess. The manufacturing gross margin fell by half, and the company logged a nine-digit operating loss in the manufacturing operations, though the adjusted EBITDA number of negative $14 million was more encouraging. Of particular note, the company is still seeing high warranty costs tied mostly to EGR valves. With management suggesting they're about two-thirds of the way through that mess, a few more quarters of elevated warranty losses seem likely.
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Can Navistar Regain Lost Share?
Due in large part to the company's decision to go its own way with engine development (and resulting issues with performance and reliability), Navistar has lost significant share in the Class 8 truck market. Navistar exited this quarter with about 15% share, making it the #5 truck builder in North America. PACCAR (Nasdaq:PCAR) has also been losing some share, while Volvo (Nasdaq:VOLVY) has picked up some market share and Daimler's Freightliner has picked up at least six points of share since last year.
So, that's what has happened, but where could the market go in the future? Management was confident that it could exit the year with 18% market share, but I'm not sure what that prediction is worth. First, there's not too much downside to making that prediction given Navistar's significant overall issues. Second, even 18% share isn't a profitable level of business, so while share re-gain would be nice, Navistar needs to do better than that.
Luckily for investors, that could happen. The company is ramping up production of ProStar trucks with the Cummins (NYSE:CMI) ISX15L engine, and management also confirmed that it will use Cummins SCR aftertreatment on medium-duty engines. While Navistar's market share in medium duty has fallen to about one-quarter (from over 40% in 2011), partnering with Cummins could help restore that business to some of its former glory.
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The Bottom Line
I do believe that the commercial truck business is due to recover in 2014, and I likewise believe that Navistar will get itself turned around. It doesn't follow, though, that I think Navistar is still the best play on that theme. I would rather own a quality parts and components supplier like Cummins or a speculative parts and components supplier like Commercial Vehicle Group (Nasdaq:CVGI) to play that theme.
I'll freely admit that there is plenty of guesswork and uncertainty when it comes to tagging a fair value onto Navistar. I'm modeling 4% annual revenue growth (averaged) out to 2022 and free cash flow (FCF) margins in the mid-single digits. Navistar never has delivered the sort of year-in, year-out consistency I'm modeling, and the actual reported numbers will probably show bigger swings between the low and high single digits through the truck cycles. In any case, with the debt Navistar has on the balance sheet, the fair value would appear to be in the $20's today.
Free cash flow can be tricky in these situations, though. Turning to P/E and EV/EBITDA methodologies, a better picture emerges. Modeling the company's earnings per share and EBITDA in 2015, assigning a mid-cycle multiple, and then discounting back (at a somewhat elevated discount rate, given the risks of a turnaround story in a cyclical industry) suggests a fair value range from the low $30s to perhaps the low $40s. The 30%-plus potential suggest by a low $40s fair value is admittedly pretty appealing, but it's still hard for me to put Navistar at the top of my shopping list for industrials right now.
At the time of writing, Stephen D. Simpson owned shares of Commercial Vehicle Group.