Navistar International Is Making A Comeback

| About: Navistar International (NAV)
This article is now exclusive for PRO subscribers.

Summary

Navistar had made a mistake earlier that led to high warranty costs, but it is now taking the right steps to improve its performance.

Navistar is already seeing growth in its order backlog, and the growth of the class 8 truck market will continue acting as a catalyst.

Navistar's earnings are expected to improve in the long run as compared to a drop in the last five years.

It has been a rocky year for Navistar International (NYSE:NAV). The maker of trucks and engines is down 5% in 2014 as it has been unable to make the most of the growth in the trucking market, and it is still engaged in reducing its losses. However, a mix of cost reduction efforts and a restructuring in its operations should help Navistar make a recovery. But, on taking a closer look, it will become evident that Navistar's short-term pain will pave way for long-term growth.

Warranty pains are easing

Navistar had ventured into an expensive proprietary smog-reduction system, which not only cost the company market share, but also increased its warranty expenses. This was a disastrous approach undertaken by the company for developing an in-house solution to meet the new U.S. clean-air rules. But, management has learned from its past mistakes, and has decided to outsource the development of such systems. Hence, Navistar is negotiating with Weichai Holdings (OTCPK:WEICY), which is one of the largest makers of diesel engines and vehicle transmissions.

Thus, as Navistar outsources the development of this technology, it will be able to focus more on truck sales and improving quality checks. In fact, the company is already making progress in this direction as warranty expenses are falling. By improving its repair practices, the cost of each repair is declining. Moreover, the improved quality of its new SCR engines is resulting in less maintenance requirements. In addition, the deployment of a new remote diagnostics product and OnCommand Connection will also decrease its warranty costs.

Truck market's growth will be a catalyst

Hence, Navistar should see a gradual improvement in its cost structure as warranty pains ease out. Moreover, the company can now pay greater attention to improving its truck sales and take advantage of a growing truck market in the U.S. The class 8 truck market in the U.S. is expected to grow at an impressive rate in the future. According to a report:

"FTR released preliminary data showing October 2014 North American Class 8 truck net orders at 45,795 units. That made October the second highest order month ever recorded, with orders rising 87 percent month-over-month and 76 percent year-over-year, FTR said.

Those orders mostly are for trucks that will be built and delivered in 2015, and that underscores the economic confidence of the companies placing the orders. After two strong quarters of freight demand and higher rates, motor carriers are beginning to add capacity."

Thus, it is evident that truck orders and deliveries are expected to accelerate going forward, and Navistar needs to pull up its socks in order to tap this opportunity. The company is already making some progress on this front, as its order backlog improved 54% in the last quarter. This is impressive, and Navistar's new products seem to have played a key role in this growth.

New and reliable products will help improve performance

The company has recently launched ProStar, a class 8 truck that it claims to be one of the most-efficient ones on the road. The important part is that the truck seems to be scoring high on reliability, as a key Navistar customer found no issues with ProStar in the first three months of use. To sustain the momentum, the company has also launched WorkStar and DuraStar trucks. These are equipped with a selective catalytic reduction (NYSE:SCR) system and work on Navistar's 9/10 liter engine.

Hence, it is not surprising to see that Navistar's backlog is improving on the back of new products. In addition, Navistar's ISX engine and MaxxForce 13 SCR should also gain traction on the back of a growing class 8 truck market.

Another headwind

However, there is another headwind that investors need to be cautious about. Navistar is facing some challenges in Brazil on account of a gloomy economic environment. In the near term, it anticipates an 18% decline in engine volumes in the region. However, the Brazilian truck market is expected to grow at a 1% annual rate in the next decade, so it is possible that the prospects of this market will improve in the future as economic activity picks up.

More importantly, to mitigate the effects of this short-term decline in Brazil, Navistar is focusing on lowering costs. In fact, Navistar is implementing cost reduction efforts across all geographies, which will strengthen its bottom line going forward.

Wrapping up

Navistar's results have been weighed by a wrong decision that it had made in the past. But the company is now taking the right steps and this should lead to better times in the future. Analysts also forecast the same, as they expect that Navistar will deliver a bottom line improvement of 9% a year over the next five years, which is a massive improvement over the 8% annual drop seen in the previous five years. Hence, investors should consider taking a closer look at Navistar as the stock's weak performance this year looks like an opportunity.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.