We have downgraded our long-term recommendation on Navistar International Corporation (NAV) to “Underperform”. The leading truck producer faces difficulty in obtaining smooth supply of materials due to over dependence on a few suppliers. Besides, strict regulation by the government will create pressure on the company, as it generates most of its revenues from services rendered to the government. The company also contends with rising research and development expenses.

Navistar continues to invest in research, development and tooling equipment to design engine products which will meet the Environmental Protection Agency (EPA) and the California Air Resources Board (CARB) emission standards. But the company is incurring substantial expenses to conform to the government regulation on engine emission, noise and safety.

Although the revenues derived from the U.S. government has been progressively declining over the years from 25% in 2009 to 15% in 2010 and 13% in 2011; the company still generates a significant amount of revenues from this source. Besides, Navistar is likely to face a tremendous financial pressure if the government contracts are terminated, rendering renewal of contracts in future extremely doubtful.

Navistar is supplied with materials and manufactured components by third party suppliers. Some of them are the only suppliers of a particular supply item. Any disruption in supply can hinder the productivity as well as the profitability of the company.

The company, however, is making investments in different joint ventures. This will eventually lead to growth opportunities along with expansion in markets. Further business acquisitions will also have a favorable impact on the company.

Navistar has also recorded an improvement in the debt position. Long-term debt was $4.50 billion as of April 30, 2012, compared with $4.86 billion as of October 31, 2011.

The company reported a loss of $137 million or $1.99 per share (excluding special items) in the second quarter of fiscal 2012, in sharp contrast to a profit of $102 million or $1.30 per share recorded in the corresponding quarter last year. The results missed the Zacks Consensus Estimate.

Revenues went down 2.9% year-over-year to $3.3 billion, also falling behind the Zacks Consensus Estimate. The decline was attributable to a decrease in sales in Engine and Part segments, which was partially offset by higher sales in the Truck segment.

Warrenville, Illinois-based Navistar International Corporation manufactures and sells commercial trucks, mid-range diesel engines, buses, military vehicles and chassis for motor homes and step-vans. It also provides service parts for various trucks and trailer.The company is one of the largest truck producers along with Daimler AG (DDAIF) and PACCAR Inc. (PCAR).

Our long-term recommendation is backed by a Zacks #5 Rank, which translates into a short-term (1 to 3 months) “Strong Sell” rating.

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