Is Navistar Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Navistar (NAV) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Navistar's story, and we'll be grading the quality of that story in several ways:

• Growth: Are profits, margins, and free cash flow all increasing?
• Valuation: Is share price growing in line with earnings per share?
• Opportunities: Is return on equity increasing while debt to equity declines?
• Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Navistar's key statistics:

NAV Total Return Price data by YCharts

Source: YCharts. * Period begins at end of Q2 2010.

NAV Return on Equity data by YCharts

Source: YCharts. * Period begins at end of Q2 2010.

How we got here and where we're going
We first looked at Navistar last year, and it has lost two passing grade in its second assessment, falling to only two one of seven passing grades this time. Over the past year, Navistar's revenues have dwindled, and the bottom line has fallen through the floor.

This might be a bad sign for the economy as well as for Navistar -- trucking is such an important part of the economy that reduced sales from one of the largest truck manufacturers bodes poorly for the health of that sector. Are Navistar's wounds self-inflicted and capable of healing, or this it merely the canary in the coal mine for the rest of the country? Let's dig a little deeper to find out.

Over the past few quarters, Navistar has been struggling with regulatory rejection of its engines, which were found to be noncompliant with EPA standards.

Fool contributor Daniel Ferry points out that Cummins (CMI 0.79%), which once was a primary competitor of Navistar, now supplies engines and component technology for Navistar's medium-duty trucks and buses, since the EPA doubled the fines for trucks which didn't comply to emission standards.

While other integrated manufacturers have managed to offload some component work successfully, Navistar seems to be weakened by a reliance on Cummins's technology. However, the company might soon be able to reduce that reliance, as it won EPA approval for its 13-liter heavy-duty truck engine over the summer.

The company has seen very modest success as a defense contractor, having obtained several contracts from the U.S. Department of Defense earlier this year. The Pentagon awarded Navistar a $10.2 million contract to supply 75 refrigerator food supply trucks, and a $8.9 million contract to service armored mine-resistant vehicles.

However, Navistar earlier lost out on a huge $22 billion military contract, which involves the replacement of around 55,000 military Humvees for the U.S. Army and Marines, to Oshkosh (OSK 0.74%) and two other defense contractors. As a result, Navistar suspended its production at its Mississippi plant amid federal budget cuts and a slowing demand for defense vehicles, which might hurt its profitability in the near future.

My Foolish colleague Dan Caplinger notes that Navistar has been restructuring the business to focus on its core operations and to improve its cash balances. Earlier this year, Navistar sold off its 49% stake in two joint ventures, Mahindra Navistar Automotives and Mahindra Navistar Engines, for $33 million in cash. The company also sold off its Navistar RV business, including the Holiday Rambler and R-Vision brands, to Allied Specialty Vehicles this past spring.  This isn't enough to pad the coffers, and the debt-laden company filed to raise $200 million in new debt earlier this month.

However, Navistar should be poised to benefit from numerous opportunities in the commercial nat-gas vehicle segment, as it expects one-third of all trucks it sells to run on natural gas in the next couple of years. As a result, the company is strengthening its relationship with nat-gas engine makers such as Cummins and Westport Innovations (WPRT 0.34%), as Navistar has no competing technology for the heavy-duty Westport-Cummins nat-gas engines.

Navistar's rival PACCAR (PCAR 0.66%), which currently holds more than 40% of the U.S. heavy-duty nat-gas truck market, also uses Cummins-Westport engines in its Peterbilt and Kenworth trucks, which makes economies of scale in chassis construction all the more important -- and potentially elusive -- for Navistar.

Putting the pieces together
Today, Navistar has few of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.