Navistar earnings under attack from defense cuts

The US government’s ongoing battle to curtail spending of all kinds, particularly when it comes to the outsize military budget, is starting to take a toll on the profitability of companies like Navistar International Corporation (NAV), which the StarMine research team expects will report earnings that fall short of analysts’ estimates when it reports fiscal first-quarter results, expected on March 9, 2012.

Navistar, a manufacturer of military trucks, buses and diesel engines and other parts for trucks and trailers, earned about $2 billion of its total revenues of $14 billion in the fiscal year that ended October 31, 2011 from sales to the military, according to its 10-K filing with the SEC. Not surprisingly, the prospect of weaker government spending on the military puts the company squarely in line to take a blow to both revenues and profits, and indeed, the company now has a negative Predicted Surprise of -26.4%.

StarMine has flagged an estimate by David Leiker of Robert W. Baird & Co. that Navistar will earn 34 cents a share in its current quarter, ending January 31, 2012. as a “Bold Estimate.” This signifies that StarMine rates Leiker as a five-star analyst thanks to the accuracy and timeliness of his forecasts, and that his estimate for Navistar’s profits – significantly below the current I/B/E/S consensus of 51 cents a share – should be heeded. Keep in mind that StarMine assigns only 10% of all analysts a five-star rating, so when one of them sticks his or her neck out by publishing a forecast that diverges from the mean, it may be worth being particularly attentive to that estimate. Indeed, both of the two Bold Estimates for Navistar predict the company will report earnings that fall well below the current consensus. Even though that I/B/E/S consensus (represented by the gold line in the chart below) has fallen 38% in the last month to 51 cents a share today, that is still significantly above the SmartEstimate (represented by the blue line in the chart below), which now sits at 37 cents a share. That is another reason to be wary of the company’s earnings prospects, as that significant a gap between them tends to foreshadow either further reductions in the consensus or a “miss” by the company when it reports earnings.

The introduction of new emissions standards for vehicles is a mixed blessing for Navistar. On the plus side, it may drive fleet owners to place a flurry of new orders; orders Navistar believes it has enough of a competitive advantage to capture at the expense of its competitors. On the downside, however, some engines that Navistar produces have been meeting EPA and CARB certification requirements only because of the use of emissions credits. Given that management has said it expects to use up those carbon credits during 2012, the company may not be able to rely on them much longer. Once they run out of emissions credits, Navistar may have to pay an emissions surcharge on each vehicle it sells, lowering its margins further. Navistar is in ongoing negotiations with both the EPA and CARB (California Air Resource Board) regarding potential regulatory solutions, it said in its 10-K filing.

Navistar Defense LLC, one of Navistar’s principal units and the division responsible for military contracts, also confronts some possible headwinds. Archie Massicotte, the division’s president, acknowledged in the company’s last earnings conference call that “as the military tightens their boot straps up a little bit, margins are going to get squeezed.” (You can access the rest of the transcript on Thomson Reuters StreetEvents.) The bright spot for the parent company is that the NAV International division has recorded strong sales of both its diesel engines and commercial trucks. It will be interesting to see if that unit’s resilience will be enough to offset the long-term pressure on margins coming from the military as it attempts to cut its spending. But the answer to that question will emerge only after many more quarters of financial results. For now, with an earnings report due out in only a few weeks’ time, it seems that the most likely near-term scenario is that Navistar’s earnings will fall short of analysts’ estimates.

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