Best Outcome on Non-Conformance Penalties, Outlook Still Pretty Grim
Still Expect NAV to Lose Market Share, Generate Losses. Paccar a Potential Winner.
Surprisingly Small Changes: Navistar avoided retroactive fines, outright bans and prohibitively high fines. The new maximum penalty is $3,775, increasing “several hundred dollars per engine each year for later model years.” The EPA release can be found at http://www.epa.gov/otaq/regs/hd-hwy/ncp/420f12049.pdf.
Breathing Room: Navistar can continue to sell its existing 13L engine at this penalty level for quite some time. That may give NAV additional time to integrate the 15L engine from Cummins, which we expect to take longer than the company’s current January 2013 forecast. It may allow Navistar to delay the new 13L engine and develop a more practical solution. The revised NCPs help to ease selling risks in CARB states in the near-term.
Expect Challenges: Competitors may not see this as an adequate penalty and the court may well agree. The advantages of noncompliance probably exceed the increased (straight-line) cost addition of $400-$800 per year.
Navistar a Potential Zero (Reflexive Risk): That Navistar looks like it could end up in distress increases the probability that Navistar WILL end up in distress. Customers need a strong corporation providing warranties, service and replacement parts for years to come. Residual value guarantees and off balance sheet commitments could add to the concerns should the resale market falter. Customers depend heavily on their trucks and do not want supplier risk. Once confidence is lost, it will probably require an outside buyer like VW or Hino to get it back. The CDS chart below shows how confidence in NAV is trending. Looking like a failure risk could make Navistar a failure risk.
Products Matter: Navistar does not have a successful product strategy, in our view. There are already concerns regarding the reliability of the current 13L MaxxForce engine. The 15L from Cummins looks like the most promising answer, but 15L engines represent less than half of the class 8 market and it isn’t obvious that they can get it out by January 2013. At least initially, we expect NAV’s EGR cum SCR 13L engine to be uncompetitive.
Navistar Losses: Heavy discounting has allowed the company to maintain market share amid product uncertainty. Losses could accelerate as the company runs out of emissions credits and NCPs increase. We expect NAV to lose market share as its financial situation looks more acute and the company struggles to deliver compliant products.
Market Share Losses: Even if NAV is purchased by a stronger company, International is likely to shed market share in 2H 2012/2013. Navistar cannot maintain heavy discounting indefinitely.
PCAR and Volatility, Not NAV: Navistar is most likely not going to resolve these problems as an independent company, in our view. The brand and dealer network are valuable assets and Navistar could get bought, though probably not at a price above $40/share. That makes shorting very risky. However, the company may well be purchased in distress or even bankruptcy, if this drags on. That makes long positions a tough bet. We would keep an eye on implied volatility, though, and consider January straddles if they get cheap, with the Cummins 15L, a potential acquisition and market share losses as catalysts. Better, the best way to play problems at Navistar is to be long PCAR, in our view, a company likely to benefit from Navistar’s market share losses.