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Should Cummins Investors Be Concerned About Volkswagen's Stake in Navistar?

By Daniel Miller – Sep 7, 2016 at 11:44AM

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Initially, the market sold off Cummins when Volkswagen announced its equity stake in Navistar, but it might not be as big of a deal as you think.


Navistar's International TranStar truck. Image source: Navistar.

It's difficult to imagine that amid Volkswagen Group's (VWAGY -1.69%) embarrassing and expensive diesel emissions scandal it would actually be seen as a savior for a struggling Navistar International Corporation (NAV). But that's the world we live in, and Volkswagen's new large equity stake in Navistar might be the best thing to happen to the latter in years.

Let's check out the details, what it means for the two companies, and also why investors of Cummins (CMI -1.91%) shouldn't hit the panic button just yet.

Navistar had lost its way

Barely four years ago, analysts and investors had nearly written off Navistar and assumed it was heading toward an inevitable bankruptcy. Much of that was due to the barrels of cash the company invested into a diesel engine that didn't gain the approval of the Environmental Protection Agency (EPA). In addition to wasting billions on the project, it also resulted in the company losing market share in its heavy trucks business.

Despite the doom and gloom surrounding Navistar in recent years, Volkswagen's $256 million investment in the company could be just what the doctor ordered. The German automaker agreed to purchase a 16.6% stake in Navistar with the promise to hold onto those shares for at least three years. The agreement enables Volkswagen to place two people on Navistar's board of directors, and the companies agreed to share technology. 

What does this mean for Navistar?

This development does quite a few things for Navistar. First, as the companies share technology and purchasing, Navistar's scale will be vastly improved with Volkswagen's Truck & Bus presence. Going hand in hand with Navistar's increased scale, the company also expects it will generate half a billion dollars of synergies over the next five years and $200 million in annual cost savings by 2021.

This agreement also gives Navistar new liquidity, and arguably just as importantly, it gives investors a vote of confidence that perhaps the worst is over for Navistar. Further, Navistar investors believe this could end up being a full-out acquisition down the road, which would mean a much more financially stable company as a whole -- at least from Navistar's perspective.

For Volkswagen, its investment in Navistar could be key to unlocking a market it's long been attempting to crack. While Volkswagen is mostly known for its new-vehicle brands -- Audi, for one example -- its truck business has long been trying to get a foothold in the North American market without much success. With Navistar's large dealership network here in the U.S. market, Volkswagen might finally be able to grow its truck and commercial vehicle presence.

"We are now taking the next step on our way to becoming a Global Champion in the commercial vehicles industry. The strategic alliance with Navistar is an important milestone and will be very beneficial for both sides," Andreas Renschler, CEO of Volkswagen Truck & Bus, said in a press release.

How concerned should Cummins investors be?

This development is largely seen as a positive for both Volkswagen and Navistar, but for Cummins investors, it only cranks up the anxiety levels. Vertical integration has always been a prominent bear argument for Cummins, as more consumers who have historically purchased Cummins engines are beginning to develop those technologies on their own, in-house.

Consider that through the first eight months of 2016, roughly 70% of Navistar Class 8 trucks used a Cummins engine, according to Barrons.com, and if Volkswagen assumes that role for Navistar going forward, it'll have an obvious negative impact for Cummins' business. However, there isn't any reason for Cummins investors to panic just yet.

To help put it in perspective, Navistar probably represents between 5% and 10% of Cummins top-line revenue, and the move to begin using Volkswagen engines will likely take a few years to gradually implement -- so, it's not as if Cummins' business will fall off a cliff in the immediate future.

Daniel Miller has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Cummins. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Navistar International Stock Quote
Navistar International
NAV
Volkswagen AG (ADR) Stock Quote
Volkswagen AG (ADR)
VWAGY
$18.61 (-1.69%) $0.32
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Cummins
CMI
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