Navistar Looking For A Higher Gear

By Stephen D. Simpson, CFA | June 09, 2011 AAA

These are good days for truck makers as the market is enjoying a sharp recovery out of the depths of the recession. However, they are not equally good days for all players. While PACCAR (Nasdaq:PCAR), Volvo (Nasdaq:VOLVY.PK) and Daimler (Nasdaq:DDAIY.PK) are all enjoying good growth and share gains in the North American truck market, Navistar (NYSE:NAV) is the unfortunate source of that market share growth. While Navistar is showing some progress on the top line, investors have good reasons to be concerned about the company's market position and its decision to stick with its own engine designs.

TUTORIAL: Risk and Diversification

Mixed Fiscal Q2 Performance
Navistar's performance in the second quarter was pretty mixed. True, the company did post revenue growth of 22% (on 17% shipment growth), but the company again seems to be leaking share to its rivals. Operating performance was more encouraging to a point - gross margin slid a bit (down 70 basis points), but operating income more than doubled from the year-ago level. Even so, this was weaker than most analysts had projected.

Can Going Its Own Way Pay Off?
Navistar had used engines from Cummins (NYSE:CMI) in its Class 8 trucks for decades before Cummins (along with almost all of the rest of truck engine makers) switched to SCR technology (selective catalytic reduction). Navistar decided to go its own way with EGR (exhaust gas recirculation) technology.

So far, that decision (and the resulting MaxxForce engine) has not worked to plan. Reports of unreliability and maintenance issues have cropped up and it seems as though Navistar is seeing not only higher warranty and replacement costs, but irritated customers. Navistar seems committed to this technology, but continued problems will force a tough decision - stick with the technology and work out the kinks (and risk missing sales during a cyclical upswing), or switch back to Cummins engines and lose the potential leverage from having a successful in-house product (to say nothing of the pride that would have to be swallowed along with a fair bit of crow). (For more, see The Upside Of Trucking.)

Military Boost Unlikely
Making matters a little bit worse, it doesn't look like Navistar is going to get any significant boost from its military business. War weariness and budget problems in the United States are likely to limit future vehicle purchases from the military, and Navistar has seen severe competition from the likes of Oshkosh (NYSE:OSK), Textron (NYSE:TXT), BAE Systems (Nasdaq:BAESY.PK) and General Dynamics (NYSE:GD). This is still a significant business for Navistar, but one where the momentum seems to be a concern.

A Back-Half Story
Navistar management still sounds relatively confident, going as far as suggesting full-year results will be on the high end of prior guidance. That looks like a challenging hurdle - not impossible, mind you, but a target that will require a strong second half to attain.

The issues with the MaxxForce really seem to be the central issue to the story. If early reports of reliability problems turn out to be exaggerated (or lend themselves to easy fixes), there is no reason that Navistar should not regain its momentum and market share. If this engine is meaningfully flawed, though, and the company stubbornly sticks by it, there is a real risk that Navistar misses out on this rebound and has to wait a few more years to really deliver strong cash flow growth. (For related reading, see JB Hunt: The Trucking Company That Isn't.)

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