In December of 2019, I wrote my most recent article covering the truck producer Navistar (NYSE:NAV). Back then, I advised staying away until the economy had bottomed. As it turns out, while leading indicators were slowly bottoming back then, we would get an unprecedented economic shock due to a global COVID-19 related economic shutdown. The company’s just-released second-quarter earnings display the impact of this economic event. While the company won’t go bankrupt, I really dislike the current risk/reward as the stock has recovered quite a lot while economic risks remain elevated.
Here’s What Happened In Q2
Let’s start by taking a look at the company’s adjusted earnings per share result. In its second quarter, the company reported a loss of $0.10. While this erases all gains from the prior-year quarter, it is still $0.20 above expectations. However, and this is where the bad news comes in again, the company has reported its third consecutive quarterly decline as the economic decline started to hit the company in the second half of 2019 – prior to any negative news regarding COVID-19.
Source: Estimize (EPS)
With that said, and to support what I am going to say next, I am also showing you the table below, which displays year-on-year sales growth. As you can see, contraction accelerated since the second half of 2019 after the company did tremendously well in the years prior to 2019, thanks to elevated global growth and higher commodity prices.
Source: Estimize (Revenue)
In the second quarter, sales were down 36% as macroeconomic conditions worsened significantly. For example, class 8 truck orders in the US and Canada averaged 3,000 units per week in February (when COVID-19 started to gain momentum in China). This number dropped to roughly 1,000 units per week per month in April. This has resulted in total chargeouts of 14,200 units for the quarter ending April 30. This is down from 23,700 units in the prior-year quarter. This translates to a decline of roughly 40%. The adjusted EBITDA margin dropped from 7.5% to 4.6%, resulting in an adjusted EBITDA decline from $224 million to $88 million.
Weaker sales have caused the day’s sales inventory on-hand to increase to 127 days. This is 7 days above the normal range. However, note that this range includes severe economic weakness and strong economic growth. While economic expectations improved in 2016, growth was still weak, resulting in multiple outliers. In 2018, the company also saw some outliers below the normal range as global growth peaked.
However, note that there is also good news. The company’s market share improved significantly. Class 6 and 7 medium truck market share increased from 20.3% in the prior-year quarter to 22.9%. Class 8 heavy trucks increased from 6.1% to 11.6%. Unfortunately, almost all markets have lower market shares compared to Q3 of 2019. So, while it is certainly good news that the company saw improvements in Q2/2020, it’s not as good as is looks at first sight.
Economic Growth & Financial Strength
To assess whether Navistar will be able to report better sales in its third quarter, I like to look at the ISM manufacturing index. While I expect a surge to at least 45 due to the reopening of the economy, we must acknowledge that stocks have priced in a lot more than that. Right now, Navistar is trading roughly 10% below the price right at the start of the year. That’s not at all what I consider to be a discount, given the economic circumstances – especially as the stock almost doubled since the March lows.
Right now, the stock has run into severe resistance as the market is waiting for economic data. The first sell-off (crash) has been bought. Now, the big question is ‘will the economy show a V-shaped recovery?’.
I believe the answer is ‘no’ as the economy was weakening in 2019 due to the trade war, falling commodity prices, and declining consumer sentiment. While we did see the start of a bottom in the first quarter, COVID-19 quickly crushed all hopes. I believe we will see a gradual improvement but not the ‘back to normal’ move some might have expected before stocks weakened a couple of weeks ago.
In other words, right now, my advice is to stay away from Navistar. Not because I don’t like the company or management, but simply because of the economy and the fact that the stock is down just 10% year to date.
The company also has an elevated debt load, which will accelerate selling based on the fact that cyclical companies with a lot of leverage tend to be sold off more severely. At the end of Q2, the company’s liabilities were valued at 160% of total assets (negative equity). Net debt was valued at almost 15x EBITDA. This is up from 4.2x in 2019 as a result of lower EBITDA.
However, and this is why I am not too worried right now, liquidity is strong as current assets cover almost 170% of current liabilities. Even adjusted for inventories, this value is 120%. Unfortunately, falling EBITDA/EBIT has resulted in an EBIT/interest expense ratio of 0.77. This is a ratio worth monitoring if the economy is unable to recover in 2020 as it could harm liquidity.
It’s all about risk/reward. And in this case, I don’t like what I see. The company’s stock price has recovered most of its year-to-date declines as investors and traders were betting on a quick economic recovery. While the third quarter will without a doubt be better than the second due to the reopening of the economy, I doubt we will see a strong V-shaped rebound. When adding that Navistar is down only 10% year to date and has an elevated debt load, I believe the smartest thing to do is to stay away. Note that this is not the call to short anything. My strategy is to move these macro stocks to my watchlist to pull the trigger once they trade lower and offer a better risk/reward. One example is Terex (NYSE:TEX). While the risk is to miss any upside, I think it’s a risk worth taking.
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Disclosure: I am/we are long TEX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.