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Activist investors’ board wins clears path for Navistar’s plans

Carl Icahn

Carl Icahn

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Updated: November 15, 2012 6:28AM

The road remains rocky for Lisle-based engine and truck maker Navistar International Corp. even though it avoided an ugly proxy fight for control of the company with its biggest shareholders, including billionaire activist investor Carl Icahn, by announcing board changes last week.

“Triage” continues, contends Gimme Credit analyst Vicki Bryan, who welcomed word this week that Navistar had capitulated to investors in naming to its board Vincent Intrieri, senior managing director for Icahn Capital LP, and Mark Rachesky, president of investment firm MHR Fund Management LLC. Navistar also said it will later add a third director to be agreed upon by the investment firms. The two entities each own a nearly 15 percent stake in Navistar.

“It’s a positive for the company because the company above all things needs to restore its credibility with all constituents, with all stakeholders,” Bryan said. “This is a step in the right direction. That said, Navistar’s problems are severe and they’re not going to be fixed overnight.”

Analyst Stephen Volkmann of Jefferies & Co. said the activist investors now have a significant, but not controlling, position on Navistar’s board.

“We believe it was highly likely that activists would have prevailed in a proxy fight, so the fact that these shareholders would now forgo the opportunity to control the company suggests they have concluded the current management plan may be an easier path to value,” he wrote in a client note.

The company, which has watched its shares plunge about 40 percent this year, in August announced the abrupt retirement of its top executive, Daniel Ustian, and named Lewis Campbell its chairman and interim CEO. That move came after the company said it would buy 15-liter engines for its largest commercial trucks from competitor Cummins and was abandoning a lengthy and costly strategy, pursued under Ustian’s leadership, of trying to develop its own EGR emissions technology, a strategy that included paying fines to the U.S. Environmental Protection Agency for having noncompliant engines. Navistar had invested $700 million in the failed effort and lost market share because of it. The company now has decided to use the same exhaust treatment process as its competitors, called SCR, and is retrofitting its 13-liter and 11-liter engines.

Navistar lost $241 million the first nine months of this fiscal year, down from a profit of $1.47 billion in the same period a year ago. Its truck and engine orders were down 20 percent to 40 percent year to date as of its most recent fiscal quarter ended July 31, Bryan noted.

Campbell has said he thinks the company can be turned around in 12 to 18 months.

“First he has to get past the next six,” said Bryan, who noted that the company’s manufacturing segment cash was $627 million as of July 31, down 38 percent, and said as much as $1 billion could be consumed for the full-year. She contends a bankruptcy filing is a possibility if Campbell can’t right the ship, although other analysts don’t see bankruptcy as a risk in the near-term.

Bryan said the company’s profit margins remain “under terrific pressures from escalating costs. Marketability of its new trucks remains questionable since they will have little if any differential from already proven models in a heavily oversupplied market.”

She added that Navistar already has missed the industry truck replacement cycle. Meanwhile, market demand has deteriorated because of global economic conditions, and that has resulted in tumbling commercial truck orders and excessive overproduction, she said.

Campbell told the Wall Street Journal recently that Navistar has identified business units or projects he would shut down or sell to raise margins, which would cut a combined $260 million in annual revenue, but generate $52 million in savings. The company declined to name the units, but it has said it was stopping development of its own 15-liter engine.

“Navistar’s assets could prove tough to sell since they mostly comprise inventory that fails to meet emissions standards around the globe, plus associated plants that will require substantial investment to retool,” Bryan said.

“Our general view is unfunded pension and health-care liabilities are an impediment to anybody buying the company,” said David Leiker, an analyst with Robert W. Baird & Co Inc.

Analysts have speculated that Navistar could try to sell its recreational vehicle business and some or all of its military business.

Navistar has said it plans to scale back overseas growth initiatives as it focuses on improving its North American truck and engine businesses.

Last month, Navistar announced the company was cutting 200 salaried jobs, part of its cost-cutting plan and said it was reviewing its non-core businesses. The company, which employed 6,300 workers in the U.S. as of August, with more than half in Illinois, said it already had eliminated 500 positions through a voluntary separation program. The company said it anticipated that effort would generate $70 million to $80 million in savings, contributing to its goal to reduce costs by $150 million to $175 million, year-over-year starting in fiscal 2013.

“Navistar is chugging along the right road to recovery,” Morningstar Inc. analyst Basili Alukos said in a research note Wednesday. “New CEO Lewis Campbell is taking the necessary steps to fix the company . . . with the engine issues mostly behind the company, we think Lewis’ focus on cost cuts and return on invested capital metrics will bolster profitability and shareholders will benefit as a result.”

Still he thinks Navistar’s engine troubles have caused irreparable damage to its market share. He projects truck revenue will increase at a slower average annual growth rate than the industry.

But without the cost overruns and engine warranty issues Navistar has grappled with, “we believe Navistar will experience gross margin expansion,” Alukos wrote. “We project 18 percent gross margins over the long run, moderately above historical averages.”

Navistar spokeswoman Karen Denning said the company’s leaders have Navistar on the right track.

“In Lewis’ first month with the company he and company president, Troy Clarke, have the organization squarely focused on delivering our clean engine technology, improving quality, and completing the return on invested capital review of businesses and programs to identify those that will be either stopped or candidates for divesting,” she said.

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