Navistar International Corporation's (NYSE:NAV) fiscal second-quarter 2018 results, released earlier this month, revealed that the commercial truck manufacturer is utilizing its capacity to take advantage of favorable economic conditions. Revenue rose nearly 16%, to $2.4 billion, during the last three months, and Navistar posted net profit of $55 million against a loss of $80 million in the prior-year quarter.
During the company's earnings conference call, management discussed both recent success factors and the outlook for the remainder of the year. Below, we'll discuss three of the most important points that will follow quotes taken directly from the earnings transcript:
Industry conditions are favorable
Multiple indicators in the second quarter, starting with projected annual US GDP growth above 2% indicate a strong market for trucks during the remainder of 2018. -- CEO Tony Clarke
A moderately expanding economy has provided the baseline for demand in the truck manufacturing industry. As CEO Tony Clarke points out above, U.S. gross domestic product, or GDP, is projected to remain above 2% for the remainder of the year. The economy is, in fact, coming off four consecutive quarters of 2%-plus growth:
Clarke cited other favorable statistics in the broader economy, including housing starts, which rose 10.5% in April. He also observed that recent spot (market) freight rates are up more than 27% year over year.
The freight industry, which utilizes the vehicles Navistar and its competitors manufacture, is currently experiencing extremely tight capacity. I've recently written about freight logistics companies and the factors driving up freight rates -- the bottom line is that demand is outstripping supply in the truckload and less-than-truckload (LTL) markets, a condition generally positive for truck manufacturers.
Indeed, Navistar reported that one of its heaviest weight classes, "Class 8" trucks, sold quite well during the quarter due to both demand factors and a refreshed lineup in the company's "LT" series. Total truck segment revenue rose at the brisk clip of 22%, to $1.7 billion, in the second quarter.
Our Volkswagen joint venture is delivering promised results
The alliance with Volkswagen, as planned, is enabling access to advance technology and global scale. The alliance of procurement joint venture remains on track to achieve targeted savings ahead of schedule. Next generation product programs are also on track and updates will be provided as these launches draw closer. -- CEO Tony Clarke
In February of last year, Navistar and Volkswagen AG subsidiary Volkswagen Truck and Bus initiated a wide-ranging joint venture, encompassing joint materials procurement, technology sharing, and supply-chain collaboration. As part of the transaction, Volkswagen Truck and Bus paid $256 million for a 16.6% equity investment in Navistar.
Initially, Navistar predicted that it would reap $500 million in cumulative synergies during the first five years following completion of the transaction and an additional $200 million in annual synergies after year five. As Clarke outlines above, these projected cost savings are running ahead of schedule, although management so far has declined to quantify the pace or revise Navistar's initial projections.
Executives discussed some of the tangible products coming out of the partnership, including the introduction of the "chargE" electric-school-bus concept vehicle, which recently completed a tour of west coast school districts. According to Navistar, the chargE is the only electric school bus currently in development.
It features an electric drivetrain, can cover up to 120 miles on a single charge, and boasts zero emissions. The bus is emblematic of the potential of the Navistar/Volkswagen partnership, as it's likely that some of the electric drive technology being developed for the school-bus market can be transferred to larger class vehicles in the future.
Profitability is attractive, with caveats
Gross margin for the quarter grew to 18% of revenue, up 270 basis points from Q2 of 2017. The improvement reflects higher volumes and $48 million lower used truck reserve editions in the quarter ... Profits from volume growth, together with used truck performance and savings from the procurement JV with Volkswagen Truck and Bus more than offset higher commodity and structural costs. -- CFO Walter Borst
Overall, Navistar executives are pleased with the company's current gross margin, which, as CFO Walter Bost explains above, is benefiting from both higher sales and the bottom-line impact of the procurement initiative within the Volkswagen joint venture.
However, gross margin contracted in the company's parts segment during the last three months. Parts revenue pales to truck revenue -- in the second quarter, the parts segment top line of $601 million was a little less than one-third of total truck sales. But it's, by far, the more profitable division, contributing the lion's share of Navistar profits in any given quarter. During the second quarter, parts segment profit of $132 million dwarfed truck manufacturing profit of $42 million.
Due to weaker gross margin, second-quarter parts segment profit declined roughly 14% from the prior year. Management attributed the dip to lower U.S. sales volumes, a higher degree of private label sales versus proprietary branded products, and rising freight costs. Shareholders should keep an eye on this segment in the third and fourth quarters.
Management raised full-year EBITDA guidance by $25 million in Navistar's latest report to a range of $725 million to $775 million, but this is predicated on stable performance in parts during the back half of the year and continued fast expansion in truck volumes. Parts margin will remain an area of risk in an otherwise positive picture for Navistar in fiscal 2018.