Fitch Affirms Navistar & Navistar Financial; Outlook Remains Stable
CHICAGO--June 14, 2005--Fitch Ratings affirms Navistar International Corp. (Navistar) as follows:Navistar
-- Senior unsecured debt 'BB';
-- Subordinated debt 'B+'.
Navistar Financial Corp. (NFC)
-- Senior unsecured debt 'BB'.
Fitch has also withdrawn NFC's subordinated debt rating as Navistar has assumed the subordinated debt of NFC. Due to the close operating relationship governed by a formal operating agreement and importance to the parent, NFC's ratings are directly linked with the parent. The Rating Outlook remains Stable. Approximately $3.3 billion of debt is covered by Fitch's actions.
The rating affirmation reflects Navistar's improved profitability from industry volumes, market penetration and cost reduction efforts. Fitch expects medium and heavy truck markets to remain strong through 2006. Similar to the pre-buy situation that developed in 2002 and the resulting lower volume in 2003, Fitch expects industry demand to be negatively impacted by more stringent air emissions regulations in 2007.
Navistar has introduced several new products that have lead to market expansion for the company. Fitch calculates that Navistar's calendar 2005 year-to-date total market share of the medium and heavy truck market has risen to approximately 23% versus 21% for all of 2004. Fitch expects Navistar to at least maintain or modestly grow market share due to the penetration of low-cab-forward delivery, paratransit, military and severe service segments. In addition, upcoming new product launches from the XT product family and Class 8 truck should support Navistar's market share.
Fitch expects cost reduction efforts to enable greater manufacturing flexibility over the demand cycle of the medium and heavy truck market. Cost reduction efforts have included plant consolidation, improved geographic manufacturing footprint and reduced headcount. Maintaining a lower fixed-cost base over the demand cycle should support improved levels of profitability through industry volume volatility. In addition, while steel costs are still having a negative year-over-year impact, Fitch believes that margin pressure from steel prices should eventually abate, demonstrated by currently lower spot market prices.
Rating concerns center on Navistar's ongoing relationship to a somewhat weakened Ford, future cash requirements related to engine research and development, an underfunded pension position and healthcare, as well as the magnitude of the potential volume decline in 2007. While diesel penetration of Ford truck products has increased year-over-year and Ford truck volumes are expected to remain healthy, Ford is Navistar's largest single customer but has been weakened due to the market share losses and the proposed Visteon bail-out. Fitch expects Navistar to invest heavily in new engine technology to meet 2007 and beyond air emissions regulations. However, due to the price competitive nature of the market, Fitch does not expect any margin opportunities resulting from the change in the mandated standard.
Pension obligations will require meaningful cash contributions beginning in 2006, potentially exacerbated by new pension legislation currently under discussion in Congress. In 2005, Navistar is not required to make cash contributions to its two largest plans, but expects to make a mandatory contribution of approximately $20 million to other pension plans. With positive returns of $230 million from plan asset performance and a substantial cash contribution of $231 million in 2004, beneficiary payments of $323 million were more than offset from plan assets.
With NFC on an equity basis, Navistar debt has increased from $1.3 billion at the end of fiscal 2004 to $1.7 billion at the end of the fiscal 2005 second quarter. Despite the increase in leverage, Total Debt to Last-12-Months (LTM) EBITDA remains almost unchanged at 2.7 times (x) versus 2.6x at fiscal year end. LTM EBITDA to Interest Incurred is about 8.7x, at the higher end of the historic range established by Navistar over the past industry cycle. Navistar's cash balance was $751 million at the end of the second fiscal quarter, a slight increase from the fiscal year end but up significantly from $464 million a year ago. Over the last 12 months, Fitch calculates that Navistar has generated $206 million in free cash flow. Fitch estimates Navistar should remain free cash flow positive through at least 2006. As a result, Fitch would expect Navistar to bolster its balance sheet, potentially enabling the company to be in an improved financial position to weather the next decline in industry demand -- assuming a 2006 pre-buy and a negative impact on industry volume due to 2007 emissions regulations.
NFC's operating performance is consistent and serves as a partial offset to Navistar's cyclical business. NFC's net income increased to $61 million in the fiscal year ending Oct. 31, 2004 from $56 million in fiscal 2003. The rise in net income was driven principally by growth in originations, decline in borrowing costs, and decreased credit costs. Retail note originations grew approximately 25% to $1.39 billion for the fiscal year ending Oct. 31, 2004 from $1.11 billion in 2003. Future earnings are expected to continue to improve relative to fiscal 2004 as credit costs should remain stable and asset securitization activity returns to more normal levels with increased growth in originations.
Asset quality continued to improve in fiscal 2004 and for the three months ended Jan. 31, 2005 as delinquencies in conjunction with firming of used truck pricing reduced credit costs from prior year levels. Capitalization both on an absolute and risk-adjusted basis is adequate based on the credit risk of receivables financed and the current rating category. Managed leverage, defined as managed debt (Marketable securities are deducted from managed debt as they are used as collateral for the warehouse facility.) divided by tangible equity, has improved to 10.31x at Jan. 3, 20051, 2005, its lowest level over the past five years. Beyond the immediate term, Fitch expects managed leverage to increase to 10.5x-11.0x:1 over the next few years as receivable growth outpaces internal capital formation.
Fitch's rating definitions are available on the agency's public web site, www.fitchratings.com. Published ratings, criteria and methodologies and relevant policies and procedures are also available from this site, at all times. This document will remain on the public site for seven days.