Navistar Misstep Raises Yields

Truckmaker faces liquidity problems after design flaw as Icahn expands influence.

Navistar International Corp. bond yields are rising while those of other U.S. junk-rated truckmakers fall as investors penalize it for an engine design flaw and Carl Icahn expands his influence in the industry.

Yields on its notes are up 2 percentage points this year as those on the 20 most-indebted high-yield automotive companies fall, according to Bank of America Merrill Lynch index data. Icahn, who owns 14.8 percent of Navistar’s shares, is offering $3 billion for Oshkosh Corp. after a failed bid last year prompted speculation of a merger between the two companies.

Navistar, which spent $600 million to design engines that failed to meet emissions rules, is paying Cummins Inc. for replacement technology to reverse a forecast $325.4 million annual loss in the year ended Oct. 31. Liquidity has declined for four straight quarters, and the Lisle, Illinois-based firm sold $200 million of equity last month to bolster cash.

“Liquidity could get very tight over the next few quarters,” Kirk Ludtke, an analyst at Stamford, Connecticut-based securities research and brokerage firm CRT Capital Group LLC, said in a telephone interview. “Management just tapped the equity market at a four-year low, which says a lot.”

Navistar’s quick ratio, a measure of liquidity, has fallen in each of the last four quarters since declining below 1 at the end of 2011, meaning it can’t pay its current liabilities from cash and near-cash holdings.

The company had about $3 billion in long-term debt on July 31, it said in a Sept. 6 regulatory filing.

Navistar also took out a $1 billion term loan on Aug. 17, using part of the proceeds to repay outstanding loans from an October 2011 credit facility. That borrowing increased the net debt by $740 million, according to Vicki Bryan, an analyst at research firm Gimme Credit LLC. The loan yields 7 percent or 5.5 percentage points more than the London interbank offered rate, whichever is higher. Libor, the rate at which banks say they can borrow from each other, was fixed at 0.31 percent yesterday.

Navistar consumed as much as $532 million in cash in its fourth quarter, which ended Sept. 30, after reporting $706 million of cash and equivalents on July 31, Bryan estimated. Navistar needs $500 million to $1 billion to remain solvent through next year, she wrote in an Oct. 24 report.


Liquidity Strain

The company’s liquidity strain is exacerbated by mandatory pension payments and cash costs associated with the overhaul of product lines and restructuring-related outlays, Bryan wrote in an Oct. 25 report. Its unfunded pensions and other postemployment benefits exceed the company’s market value, she wrote.

Navistar’s $900 million of 8.25 percent bonds due in November 2021 fell to 94 cents on the dollar to yield 9.25 percent on Nov. 2 from 106 cents and a 7.38 percent rate at the end of 2011, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The company’s debt is rated B2 by Moody’s Investors Service and an equivalent B at Standard & Poor’s. The categories denote borrowers that are likely to be unable or unwilling to pay debts if business conditions deteriorate.

Yields on each of the 20 other most indebted junk-rated members of the Bank of America Merrill Lynch High-Yield Automotive and Auto parts index have fallen by at least 0.2 percentage points since the beginning of the year.

“2012 has been a challenging year,” Steve Schrier, a spokesman for Navistar said in a telephone interview. “Our outlook for 2013 includes a significant improvement in our performance.”

“We raised more than $200 million in additional capital” through the equity offering, said Navistar’s Schrier, “which allows us to put to rest the uncertainty of whether Navistar will have enough available liquidity to manage through the current industry downturn and bridge us through our new product launches throughout the year.”

The company sold 10.6 million shares in a secondary offering Oct. 24, raising money to pay suppliers and to pay Cummins for 15-liter engines and to use its technology in future 11- and 13-liter Navistar models.

Navistar’s shares ended at $20.13 yesterday, up from $18.51 on Oct. 26, the lowest closing price since November 2008. That made its market capitalization $1.61 billion, Bloomberg data show.

Sourcing the after-treatment system from another company probably costs several thousand dollars per engine, said CRT’s Ludtke. “They’ve given the market the impression that they’re indifferent between paying the non-conforming penalty and buying equipment from Cummins.”


Icahn, Rachesky

Icahn and Mark Rachesky’s MHR Fund Management LLC each purchased 1.6 million additional shares in the company after the new offering, giving each about a 14.8 percent stake. A so-called poison pill provision, adopted by the company in June to prevent “coercive takeover tactics,” would be triggered if a shareholder acquired 15 percent or more. The provision would allow existing owners to buy more stock at half the market price.

The two investors each were given a seat on the Navistar board and jointly given a third position on the 10-director panel last month, according to an Oct. 8 statement. Rachesky was previously Icahn’s chief investment officer before striking out on his own.

Icahn is also the largest shareholder in Oshkosh with a 9.5 percent stake. The Oshkosh board rejected his $3 billion offer to buy the company last month. Icahn said that he doesn’t want to combine the two and that Oshkosh would be worth more in pieces.

“I don’t expect any sort of merger in the near term,” Brian Sponheimer, an analyst at Rye, New York-based Gabelli & Co., an asset manager with bonds in both companies and stock in Navistar, according to Bloomberg data, said in a telephone interview. “The mandate for Navistar management is very clear, and any discussion outside of fixing the core business is noise and a distraction that the company doesn’t need.”

The company said in a regulatory filing last week it was closing its truck factory in Garland, Texas, in “efforts to reduce costs and optimize its manufacturing footprint.” The closing will result in annual savings of $25 million to $35 million in operating, according to the filing.

Troy Clarke, Navistar’s president and chief operating officer, said on a Sept. 6 conference call to discuss third- quarter earnings with analysts and investors that the company will hit the “pause button” on its competing technology that recirculates exhaust into the engine using high temperatures to reduce pollution.

“There is obviously a significant amount of execution risk that remains” as the truckmaker tries to bring the new engines to market, Sponheimer said. If Navistar is successful “there’s an opportunity to see a much different company by the 2014 fiscal year.”



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