Arguably the only thing more remarkable than the share growth Navistar (NAV) saw in the first decade of this century has been how quickly it all went wrong when the company decided to break with the pack and pursue its own engine emissions technology. The company has seen since the error of its ways, and though the profitability of the "new" In-Cylinder Plus Technology and the agreement to use Cummins (CMI) engines are uncertain, the company can at least start thinking about getting back to the business of being a respectable truck builder.
As Expected, Q3 Was A Mess
Although Wall Street seems to like what it heard in Navistar's third quarter, I suspect it's more of a relief rally tied to the absence of another significant step backwards.
Revenue actually exceeded the company's relatively recent guidance by more than 10%, but that total was still about 6% below last year's level. Truck revenue dropped more than 5%, while engine revenue plunged 19%. Parts sales did increase 5% for the year. Turning back to trucks, Navistar sent out about 5% fewer trucks this quarter than the prior and about 6% fewer than in the prior year.
Profits continue to be a mess, as the company absorbs a host of charges, fines, and warranty costs. Gross margin dropped about four points from last year, while adjusted manufacturing profits plunged to $21 million on a reported basis. Stripping out all of the charges and so on, the core manufacturing operating margin was pretty much in line, and I don't think this quarter is going to change many minds about this company.
Has The Industry Seen The Worst?
Although August North American Class 8 orders were still pretty weak (down about one-quarter from the year-ago), they did improve on a sequential basis. Orders are not increasing rapidly, though, and suppliers like Eaton (ETN), Cummins and Allison Transmission (ALSN) have stayed pretty cautious with respect to their expectations for a recovery this year.
Likewise, there's no rapid turnaround apparent elsewhere in the world. Dealer inventories in China remain a worry, and none of the major European builders (Volvo, MAN, Scania, Fiat, Daimler) are exceedingly optimistic, with guidance for this year calling for a drop of 5% to 10% on average.
Quite A Lot Of Work Left To Do
At the risk of exaggeration, Navistar has a lot more to worry about than simply the order trends in the various truck markets it serves.
Now-former CEO Ustian pushed ahead with his ill-conceived plan to pursue the EGR technology despite widespread doubt (supposedly internal as well as external). The end result? A lot of disappointed and angry customers, a lot of lost market share, millions of dollars in fines, and millions more wasted in R&D and warranty costs. And at the end of the day, the company still hasn't broken free of its need to offer Cummins engines to stay competitive with the likes of Daimler and PACCAR (PCAR).
Navistar now finds itself needing to retrench around a different engine strategy, rebuild its reputation, and find a new permanent CEO. The good news, such as it is, is that Navistar did not lose a crippling amount of share, and even before the engine debacle the company still often had to price its trucks at a discount to PACCAR. What's more, there's still a chance that ventures like the company's agreement with Clean Energy (CLNE) for CNG trucks can pay off in the years to come.
The Bottom Line
I'd much rather own a supplier/components company like Cummins, Eaton, or Commercial Vehicle Group (CVGI) than a truck builder like Navistar, and that's without even considering the hurdles the company has yet to jump getting this new engine technology ironed out and cleaning up the legacy of the EGR adventure.
On the plus side, new CEO Campbell's tenure at Textron suggests a no-nonsense approach to getting the company back on track with what it does well, even if he does not intend to fill the role permanently. Likewise, the lack of saber-rattling from large shareholder Carl Icahn may give the company and its new management a little time to get its bearings and craft a new strategy for the company.
Also working in Navistar's favor is the low level of expectations for the company at present. Simply put, the company is priced as though it won't grow anymore. While the next couple of years are likely to be pretty bad from a free cash flow perspective, I don't necessarily see that being the case in 2016 or 2017. Consequently, while this is not my idea of a good long-term holding, I can see how some investors may be interested in Navistar as a turnaround now that it has moved to put its mistakes (and the CEO who championed them) in its past.
Disclosure: I am long CVGI.