By Mark Bern, CPA CFA
Navistar International (NAV) makes commercial trucks, buses, step-vans, diesel engines and chasis for motor homes. The company derives about 20% of its revenue from outside the U.S. (Canada, Mexico, and Brazil). The company's stock dropped last summer along with the market but has not fully recovered. One reason may be that 3rd-quarter revenue fell short of expectations primarily due to lower sales to the military with expectations for more of the same. Another, more recent issue, is an EPA investigation into transition engines that were partially built in 2009 but not completed until 2010, an industry practice that is widespread and common. The EPA claims that the model year may not be compliant with EPA regulations. Now isn't that just a great use of taxpayer money? There are concerns that the EPA may consider similar investigations at other engine manufacturers, Cummins (CMI), Paccar (PCAR) and AB Volvo (OTCPK:VOLVY). Whatever the outcome, it is more than likely to be settled for far less than the maximum penalty of $285 million and NAV's balance sheet could withstand the blow without affecting operations. It's just one of those clouds that hangs over a company for a while and gives savvy investors an opportunity at a bargain.
NAV stock is currently priced at $43.86 (all quotes are as of the close on Thursday, February 16, 2012) and sport a P/E on trailing 12-months earnings of 8.3 based upon 2011 earnings of $5.28 per share. I expect sales to perk up in 2012 with an increase of about 12% and earnings from operations to increase by nearly 25%. How is this possible, you may ask? The trucking industry is very profitable and in the process of replacing older model trucks with more fuel-efficient new ones. The industry put off buying new equipment during the recession, just like the rest of us, and has not yet gotten back to where it should be in terms of fleet age.
According to Americas Commericial Transportation Research (ACT Research) press release of February 13, 2012,
ACT Research remains bullish on Class 8 in the medium to longer term,
According to the February issue of the ACT North American Commercial Vehicle OUTLOOK, published by ACT Research Co.
"We look for economic activity in 2012 to expand at a moderate pace not too different from the 1.7% experienced in 2011," said Sam Kahan, ACT's chief economist. "Regarding commercial vehicles, there has been little change in the outlook, because underlying demand drivers remain strong," he added. "Demand for heavy trucks and trailers is running stronger than demand for medium-duty vehicles because of strong freight markets and healthy trucker profitability."
NAV's sales increased in 2011 by about 16%. With the infrastructure building in Brazil and Mexico, and fleet upgrades in the U.S. and Canada, I would expect that NAV will be able to ride the wave with another strong year. That 1.7% increase quoted above is for trucking freight traffic in the U.S., which just means that demand will continue to be strong for 2012.
A company that grows earnings at more than 20% annually deserves a P/E north of 8.3. The company has a return on total capital ratio of 12%, well above the industry average of 8.5%. The net profit margin is lower than I would like but I expect some improvement in that area over the next few years due to company efficiency efforts and higher capacity utilization rates.
One last note on ratios: don't pay attention to the P/E ratio on Yahoo (YHOO) of 1.94 as it is based on a figure with a one-time non-operating adjustment that inflated 2011 earnings per share to $22.64 per share instead of the earnings per share of $5.28 (without adjustments) that is from operations.
I tend to invest in more conservative, dividend paying stocks like Caterpillar (CAT), Deere (DE) or Cummins, all of which I follow and either have or will write about in the coming week. However, if I were a tad younger and more aggressive I would consider NAV for the appreciation potential over the next five years. I expect this stock to eventually hit a high of $80 during that time frame. That is nearly a double in five years for those who keep track of such things. Happy investing!
If readers are interested in CAT, I have recently published an article that can be found "here."