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Navistar Is Terrible Today, But That May Not Be Relevant (NAV, CMI, PCAR, OSK)

Stephen D. Simpson, CFA

There was absolutely no reason to think that the fiscal fourth quarter was going to be a good one for truck builder Navistar (NYSE:NAV), and it certainly was not a good one. The real question for investors, though, is whether this company can hit its new product launch targets, streamline its manufacturing process and rebuild the share that management missteps destroyed over the past couple of years. This continues to look like a binary stock to me - if management can direct a real turnaround, the shares will thrive from here, but survival (and success) are far from assured.

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Fiscal Fourth Quarter Closes out an Annus Horribilis
Few companies are likely to be as eager to put 2012 behind it as Navistar. Not only did Navistar mark still more share loss, but also an expensive and embarrassing backtrack on its proprietary engine development program.

Revenue plunged 24% this quarter, though it was relatively consistent with the fiscal third quarter even though the commercial truck market hasn't gotten any better. Manufacturing revenue fell 16%, truck revenue dived 195% and engine revenue fell 769%. Parts revenue was the only one that still produced a profit, falling only 16%, but that does very little good.

Navistar's margins are in pretty rough shape at the present. Gross margin fell from almost 20% last year to below 3% this quarter. Operating income reversed a year-ago profit of about $338 million into a loss of $380 million, as both the truck and engine business saw profitability collapse. Although the 13% decline in segment profits for the parts business is not significant in terms of its overall contribution, I find it discouraging that the one Navistar business that delivered revenue growth still saw negative operating leverage.

Investors should also note that the company took some sizable non-operating charges this quarter. A very large percentage of that was $2.2 billion in tax revaluation, but the company also continues to report warranty costs that are higher than management's prior guidance.

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Will Cummins Save the Day?
Industry orders have been getting a little better recently, mostly as commercial fleets waited until the last moment to place orders for 2012. That's really not the major driving factor for Navistar right now, though.

The bigger issue for Navistar is hitting launch targets for new 15L and 13L engines from Cummins (NYSE:CMI). Going back to Cummins engines (at least for a little while) is a big part of the company's plan to repair itself in the wake of its engine debacle, and it will be important for the company to hit these targets. With optimism building that commercial truck orders will improve in 2013, it will be important for the company not to miss out, or rivals like PACCAR (Nasdaq:PCAR) and Volvo (OTC:VOLVY) will grab more share.

Share Losses Are Ugly, but There's Still a Business Here
I've been more than happy to pound on this company for its mistakes, but the reality is that there is still a business here. Moreover, management has apparently become rational about its list of near-term "must do's," and is focused on turning Navistar back into a profitable truck manufacturer that sells reliable products to commercial buyers.

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No doubt, plenty of damage has been done as the company has lost almost one-third of its market share over the last two years. On the other hand, the company still has almost half of the market for school buses and about one-third of the market for severe service and medium-duty trucks. Those are still profitable businesses and rivals like Oshkosh (NYSE:OSK) do have some challenges of their own right now. Rebuilding the Class 8 business is going to take some work, but Navistar has built share in this market in the past.

The Bottom Line
Modeling Navistar's future cash flow is definitely an exercise in guesswork. While it's not unthinkable that the company could have $15 billion or more in revenue in fiscal 2014 and hundreds of millions in free cash flow, it's also not unthinkable that launch failures, further share losses and/or an inability to return to profits could leave the company teetering on the brink. So while it's not too difficult to produce scenarios that point to $30 or more in fair value, those estimates carry a large margin of error.

Although I do believe Navistar has put the worst of its mistakes behind it, I'd prefer to play a rebound in commercial vehicles through names like Cummins, Dana (NYSE:DAN) or Allison Transmission (Nasdaq:ALSN).

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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