Fitch Cuts Navistar Ratings

Zacks Equity Research
July 16, 2012

Fitch Ratings has lowered the long-term issuer default rating of Navistar International Corporation (NAV) and its subsidiary Navistar Financial Corporation (:NFC) to "B+" from "BB-." Fitch has also downgraded the rating on Navistar’s senior subordinated convertible debt to "B-" from "B" while the rating agency remained consistent with the previous rating on senior unsecured debt at "BB-."

The change in ratings depicts the free cash flow and liquidity condition of the company which Fitch considers would be affected in the near future, owing to the soaring costs associated with the implementation of new engine strategy.  In addition, the company’s low margins, large pension obligation and the execution risks related to the engine transition are the other factors that are concerning for the rating agency.

Navistar’s net cash flow from operations was $49 million in second-quarter 2012 (ended April 30) compared with $226 million a year ago. The company recorded cash and cash equivalents of $400 million as of April 30, 2012, a decrease from $539 million as of October 31, 2011.

This is for the second time within a span of 30 days that Fitch has downgraded its rating for Navistar and NFC. Last time, the rating service lowered the long-term issuer default rating and senior unsecured notes rating of the company to "BB-" from "BB" and downgraded senior subordinated notes rating to "B" from "B+."

The rating adjustments were due to a boost in warranty costs on engines, lower margins, slow growth of Navistar’s market share of medium and heavy duty trucks in the U.S. and Canada and risks associated with emission standard of its engines.

Fitch said that its ratings may further decline if the warranty cost does not improve. Growth in free cash flow is needed in order to stabilize the liquidity condition of the company. Decline in margins due to the integration and expansion of the company overseas will also have its unfavorable impact on the ratings.

Navistar will be incorporating SCR technology in its engines to satisfy the 2010 U.S. emission regulations. The inclusion of the SCR technology is driven by the delay in certification of the company’s EGR engine by the Environmental Protection Agency (:EPA). Fitch has adopted a negative outlook apprehending disruption in truck delivery in the transition period.

Warrenville, Illinois-based Navistar manufactures and sells commercial trucks, mid-range diesel engines, buses, military vehicles and chassis for motor homes and step-vans. It also provides service parts for various trucks and trailers. The company is one of the largest truck producers along with Daimler AG (DDAIF) and PACCAR Inc. (PCAR).

Currently, Navistar retains a Zacks #5 Rank, which translates into a short-term (1 to 3 months) Strong Sell rating. We have a long-term (more than 6 months) Underperform recommendation on the stock.
 

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