Widening losses, problems with products, lower guidance: Is it time to bring out the yellow flags for Navistar International (NYSE: NAV)? Perhaps. The truck maker's first quarter wasn't good, and there are big challenges that it needs to deal with. Let's take a look.
Messy quarter
Navistar will want to forget that first quarter soon. Although revenue rose 11%, the company incurred losses of $153 million primarily due to unexpectedly higher expenses. To start with, some engines Navistar had built in 2010 developed issues -- primarily engine calibration problems, but also emission compliance shortfalls. This led to heavy warranty claims and repair costs. And as if that weren't enough, the company also had issues with a brake supplier last month, hurting production and shipments. To top it off, an unfavorable ruling in a litigation resulted in higher retirement costs for the company.
Digging deeper, I think two things in particular are worrisome: warranties and compliance.
Fixing and retaining
Faulty products can hurt a company's image. Compare Navistar's case with peer Cummins (NYSE: CMI). Cummins also had to keep the U.S. Environmental Protection Agency (EPA) emission standards in mind while launching engines in 2010. But, unlike Navistar, its engines hadn't spurred warranty claims. In fact, Cummins' warranty costs were at a 15-year low in 2011. Navistar needs to work hard to make sure confidence in its engines does not dwindle.
Navistar's engines aren't the only things causing the company trouble. They are also recalling school buses manufactured from 2010 onward to fix possible leaks, which could lead to faulty brakes, as well as some seat-cushion problems.
Navistar is redesigning its engines to reduce warranty claims in the future, but such steps will increase costs and weigh on its margins. As a result, it's a two-way challenge for Navistar -- fixing up issues in the most cost-effective way while retaining customer confidence.
Compliance issues
Navistar has come under EPA's notice for not complying with emission standards. The matter is still open, and the picture will become clearer only when the final verdict is out. Adding fuel to the fire, the company is wrestling with a problem dealing with pollution credits earned between 2007 and 2009. The credits will expire this year and as a consequence, Navistar will be forced to bear the brunt of heavy fines, unless it gets its engines duly certified by the EPA. Certification, again, can be a very time-consuming process. As of now, Navistar has sent only its 13-liter engine for certification, while others, such as the 15-liter one, are yet to be sent.
Fines could dent the company's margins as well as its image. And if the certification doesn't come through, it could mean substantial losses for Navistar.
The Foolish bottom line
Concerns remain and we need to see how Navistar deals with them. The miserable quarter compelled the company to cut its full-year earnings per share guidance to $4.25 to $5.25 from the $5 to $5.75 established previously.
Navistar might not be looking like a very tempting bet, but I'm not striking the company completely off my Watchlist yet, because there are reasons to view Navistar as an intriguing play in the longer run. I'll take this up soon in my next article on the company. To make sure you don't miss it, just add Navistar to our free and personalized stock Watchlist now.
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