It's been a rough year for Navistar International (NYSE: NAV). The truck and engine manufacturer has been steadily losing market share, under EPA scrutiny over the production of engines that don't meet 2010 emissions standards. Now, facing a daunting turnaround effort, Navistar must race to come out with its own compliant engine technology and re-establish its reputation before its competitors capture its customers.
Recently, the EPA nearly doubled the fines it was charging Navistar for non-compliant engines. Under the weight of these fines, Navistar will abandon its own 15-liter engine technology and adopt that of rival engine maker Cummins (NYSE: CMI). The bright side is that the EPA didn't apply the new fine retroactively to previous engines. That could have bankrupted the company, and the prospect alone pushed Navistar's share price near five-year lows. Now, with at least the short-term survival of the company more secure, is Navistar a good value investment -- or a value trap?
Passing gas
Navistar had been paying a $1,919 fine per non-compliant engine sold, but the EPA ruling increased that figure to $3,775. In the wake of this announcement, Navistar announced that it will incur $40 million to $60 million in restructuring charges, and the company's president, chairman, and CEO, Daniel Ustian, resigned, effective immediately. Ustian had been a leading proponent of using a technology called exhaust-gas recirculation, or EGR, to lower the emissions of nitrogen oxide gas, a chemical known to cause lung damage and acid rain. Ustian pushed for EGR despite internal hesitation, so his ouster will be critical to moving the company forward.
Other manufacturers in the industry, such as engine-maker Cummins and vertically integrated truck-maker PACCAR (Nasdaq: PCAR), correctly foresaw that EGR alone wouldn't meet EPA standards and so employed the costlier and more maintenance-heavy selective catalytic reduction, or SCR, method. Natural gas engines such as those designed by Westport Innovations (Nasdaq: WPRT) burn more cleanly and don't require SCR to meet standards.
With the failure of the $700 million, decade-long EGR diesel engine project, not only must Navistar scramble to conform to industry standards, but it also has to contend with the two-year head start its SCR rivals have on it.
Navistar has lost customers by pursuing a dead-end technology. Between 2010 and 2011, for example, Navistar lost a quarter of its share in the traditional truck market, slipping from 28% to 21% while its competitors gain ground. PACCAR has gained not only market share but also pricing power over Navistar because of its superior technology. Cummins has found Navistar to be a great customer, as the company has been forced to rely more and more on Cummins' 15-liter diesel engines instead of its own.
Get that engine turned over
Recently, Navistar's board has been admirably proactive in trying to leave the EGR mistakes behind and making the tough decisions required to put the company back on the road to profitability. The request for Ustian, champion of the failed strategy, to step down is one such obvious move.
The company also swallowed the bitter pill of purchasing technology and engine parts from Cummins, long a rival, to make its own MaxxForce engines compliant. While embarrassing, and a great victory for Cummins, this was the right move for Navistar. By transitioning immediately to proven technology instead of trying to develop its own, Navistar can keep its important supply partnerships intact.
Caterpillar (NYSE: CAT), for example, purchases Navistar engines for its line of vocational trucks. Caterpillar announced earlier this month that, equipped with Cummins technology to ensure their compliance, Caterpillar would continue to use Navistar engines in their products. If Navistar had attempted to design an engine from the drawing board, relationships like this would have been threatened.
Navistar also secured a five-year, $1 billion loan from a consortium of lenders. With these moves in place, Navistar has secured its short-term future. If Navistar can make its way back to profitability, even with a severely impaired market share, investors getting in at today's prices should be richly rewarded. Expectations for Navistar, currently valued at 2.2 times cash flow, are low. If the company can stanch its loss of market share and pricing power, multiple expansion alone should drive the stock price up 50% or more. If the company can successfully execute a turnaround, and start to actually regain share or pricing power, today's investors will do even better.
One road sign to look for
One of Navistar's customers with a much less risky future is Caterpillar. The company remains a market-share leader in an industry in which size matters, and its quality products, extensive service network, and unparalleled brand strength combine to give it solid competitive advantages. Read all about Caterpillar's strengths and weaknesses, and whether the stock is currently a buy or a sell in our brand-new report. Access it now.
