Looking to the Future at Navistar

No one has all the answers, but by looking at events from the past and present we can begin to identify what challenges could face companies in the future. Let's look at Navistar's (NYSE: NAV  ) recent woes to see what tomorrow may hold.

Where has it been?
Things have been tense over at Navistar for more than a few years now. The leadership under former CEO Daniel Ustian made a severe lapse in judgment when they decided to divert from the rest of the American heavy-duty diesel engine industry and implement exhaust gas recirculation (EGR) instead of selective catalytic reduction (SCR) emissions technology on their engines, a decision that has proven costly to the company and shareholders alike. 

Opting for EGR technology lead to Navistar's heavy-duty 13-liter and 15-liter engines failing to meet the EPA's emission standards that went into effect in 2010. To be able to sell its "dirty" engines, Navistar had to use emissions credits it had saved up from previous years. After those ran out, the company faced stiff fines on every engine it sold, totaling about $10 million a quarter. To end the fines, Navistar turned to industry competitor Cummins (NYSE: CMI  ) to apply its SCR technology for the 13-liter engine and replaced the Navistar-designed 15-liter with a 15-liter manufactured by Cummins.

The entire fiasco cost an estimated $700 million and dropped Navistar's market share of heavy-duty trucks from 28% in 2010 all the way down to 11% at the beginning of 2013.

Where is it now?
Today the company looks like a limping dog. It has been hampered by consistent operating losses in its diesel engine and truck segments that have led to net losses in four of the last five quarters. Navistar is no longer on the leading edge of diesel engine technology; it is relying on competitor's innovations to keep the power plants inside its heavy-duty trucks road legal.

CEO Troy Clarke took over the reins of the company in March and is facing an uphill battle to get Navistar back on track. Clarke must be ever vigilant as activist investors Carl Icahn and Mark Rachesky will be constantly looking over his shoulder. Collectively, the two men own more than 30% of the company and have four spots on the board.

Despite the ongoing troubles at Navistar, shares are up over 50% year to date. Not all investors are convinced that there is a turnaround in the works -- a staggering 23.5% of shares are held short according to Yahoo! Finance. There is no market consensus when looking at the prospects for Navistar.

Where is it going?
For Navistar to recover the company will have to cut costs and regain lost market share. The new management team is on track to exceed the interim CEO's goal of $175 million in cost-cutting activities. Despite the cost-cutting efforts, the company still has $3.4 billion in pension obligations and about $895 million in expenses related to warranty obligations to attend to. 

Additionally, Navistar will have to address the upcoming 2014 and 2017 EPA regulations for greenhouse gas and fuel economy standards. Hopefully it will have learned from predecessors' mistakes and understands that risking regulatory approval on a new technology with no backup plan is not a wise business proposition.

As a potential investor, I would really like to see Navistar work to bring its emissions systems back in house by increasing research and development spending. In an industry where efficiency and pollution control are major factors in a consumer's purchasing decision, buying your competitor's emissions technology to keep your trucks on the road is like treading water while everyone else is doing the butterfly.

Icahn and Rachesky have staked a large claim in Navistar and their influence should not be discounted. If management fails to achieve a recovery that the two deem adequate, then I would not be surprised to see either one, or both, attempt to initiate a proxy fight. Though this may not be an immediate concern, long term it is a possibility that shareholders ought to keep abreast of.

In a nutshell, Navistar has been through a very rough time; even though the seas are beginning to calm, there is still a lot of work to be done. If management can successfully navigate these issues then the future is bright for Navistar. That is a big if.

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