Fitch Upgrades Navistar to 'BB'; Outlook Stable

Navistar (select to view enlarged photo)

CHICAGO--March 15, 2011: Fitch Ratings has upgraded the Issuer Default Ratings (IDRs) for Navistar International Corporation (NAV) and Navistar Financial Corporation (NFC) to 'BB' from 'BB-'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.

The rating upgrade reflects NAV's operating performance through the downturn, solid credit metrics for the rating, Fitch's expectation that the company will generate positive annual free cash flow, and an improving financial profile at NFC as it transfers retail business to GE Capital (GECC). Other rating strengths include strong growth in NAV's North American truck market that could continue through at least 2012, leading market shares in the U.S. and Canada for medium and heavy duty trucks, attractive military and parts businesses, a broad distribution network, and an adequate liquidity position. Litigation surrounding past financial restatements and accounting controls has largely been resolved.

NAV's leverage is down from peak levels and should decline further as earnings benefit from higher sales volumes and an improved cost structure. At Jan. 31, 2011 debt/EBITDA, excluding NFC, was 3.0 times (x). Fitch estimates debt/EBITDA could decline below 2.5x by the end of fiscal 2011. Financial results are likely to experience some pressure in the near term from realignment costs and one-time costs related to the UAW agreement. Despite these pressures, margins can be expected to increase as NAV realizes operating efficiencies related to higher sales volumes and a more flexible manufacturing system.

Results in the first quarter of 2011 included the negative impact of product development expenses for NAV's new big-bore emission technology, including the new 15-liter engine, which were largely completed during the quarter. Orders in recent months have been strong which should support better results during the remainder of 2011 and into 2012. Industry production should grow significantly as truck owners replace aging fleets and eventually add capacity if the economy continues to improve. NAV estimates production in its North American Class 6-8 and bus markets in fiscal 2011 could increase 25%-35%, which Fitch views as realistic and would represent a return to long term average levels.

Rating concerns include the highly cyclical nature of NAV's truck markets, low margins and free cash flow, large pension obligations, and uncertainty about the long-term success of the company's exhaust gas recirculation (EGR) engine technology. NAV's 2010 EPA-compliant EGR-only engines have met or exceeded performance specifications. All other truck makers in the U.S. and Canada use selective catalytic reduction (SCR) after-treatment technology to help meet emissions requirements. There is no industry-wide consensus about which technology strategy is superior or may become dominant. The potential impact of NAV's EGR-only strategy on its competitive position represents a risk until the success of each technology becomes clear.

Due to its EGR-only strategy, fiscal 2011 will be the first full year all vehicles sold by NAV in the U.S. and Canada will use NAV engines exclusively, including NAV's first 15-liter engine launched in the first quarter of fiscal 2011. NAV anticipates the engine could eventually represent 10% of its class 8 truck sales, compared to almost two-thirds of customers in 2009 who bought 15-liter engines. NAV's success at converting customers to 13-liter engines remains a risk and will be a factor in its long-term competitive position. NAV's decision to produce its engines internally partly mitigates the loss of Ford engine business in early 2010. NAV also sells engines to other OEMs although they are a small part of NAV's total sales.

Another concern is the concentration of NAV's revenue in the U.S. and Canada. It is taking steps to address this concern including investing in joint ventures in other regions such as Brazil, India and China. NAV has a well-established engine business in South America and is increasing its presence in adjacent product lines such as military vehicles and recreational vehicles. Approximately 80% of NAV's revenue was located in the U.S. and Canada in 2010.

NAV's exposure to the cyclical truck market is also offset by its parts and military vehicle business. Military vehicles are largely variations of NAV's commercial trucks. NAV expects its military business to generate $1.5-$2 billion of annual sales over the long term. This level of sales includes parts and military variations of NAV's commercial trucks and is not dependent on sales of MRAP vehicles which can be volatile and have an uncertain outlook given the forecasted decline in DOD expenditures in Iraq and Afghanistan. NAV estimates that 40% of military sales could be generated outside the U.S. by 2013.

The ratings or Outlook could be revised upward if margins and free cash flow improve consistently, NAV's EGR strategy is successful, the company's cost controls and product development are effective, and diversification into other product and geographic markets helps to dampen cyclical results over the long term. The ratings and Outlook could be negatively affected if EGR technology causes NAV's market share to fall materially, free cash flow and liquidity are insufficient to fund NAV's product development and investments in joint ventures, or in the event of a significant, unexpected downturn in truck demand in the near term.

Fitch estimates that NAV's free cash flow will continue to be positive on an annual basis. It could improve modestly from $161 million reported in 2010 as sales volumes rise and margins improve. NAV estimates it reduced its cost structure by $100 million in 2010 as it moved to a flexible manufacturing system. These savings exclude the impact of increased operating flexibility related to the new labor agreement with the UAW in October 2010. Capital expenditures, which have been relatively low in recent years, may increase toward the upper end of NAV's normal range of $250 million to $350 million. The higher spending level partly reflects the planned relocation of NAV's headquarters and certain engine operations which will be funded from proceeds of revenue bonds issued in October 2010.

NAV can also be expected to use cash for additional investments in its joint ventures. NAV expects to increase pension contributions in 2011 to $178 million compared to $115 million in 2010. Contributions could be at least $193 million annually from 2012 through 2014. These amounts are less than previously indicated due to the longer amortization permitted under the Pension Relief Act of 2010. At the end of fiscal 2010, NAV's pension plans were underfunded by roughly $1.5 billion (62% funded), largely unchanged from the prior year. Future contributions will depend on asset returns and the discount rate which was near historically low levels at the end of fiscal 2010.

At Jan. 31, 2011, Navistar's liquidity excluding NFC included $762 million of cash and marketable securities and availability under a $200 million revolver. These amounts were offset by approximately $134 million of debt due within one year. Scheduled debt repayments are less than $150 million annually until 2014 when $570 million of convertible notes mature.

Fitch expects NFC's retail portfolio to continue to reduce in size over the next couple of years due to the GE funding agreement on retail notes. NFC will continue to provide wholesale floorplan financing to its dealers and will be an important part of the overall Navistar business model by continuing to enhance Navistar's ability to sell trucks. At NFC, profitability improved in 2010 due in part to declines in provisions for credit losses. Delinquencies improved significantly during the year. NFC's earning assets fell as a decline in retail notes more than offset an increase in wholesale notes as dealers replenished inventories from historical lows.

The decline in the amount of retail notes outstanding reflects the impact of NFC's agreement with GECC in 2010. Under the agreement, GECC will fund the retail portion of NFC's business. The agreement reduces NFC's funding and capital needs while allowing NAV to offer financing to its retail customers, including a greater share of fleet customers than NFC could provide on its own. The agreement is in place for three years and includes automatic annual extensions. It can be terminated early by either party with a one-year advance notice.

NFC's improving financial profile reduces previous concerns about potential support required from NAV. Furthermore, NAV should benefit from NFC's ability to support NAV's dealers as industry demand recovers.

Fitch's ratings cover approximately $2 billion of debt at NAV, including project bonds, and $2.6 billion of outstanding debt at Navistar Financial Corp. (NFC) as of Jan. 31, 2011.

Fitch has upgraded the ratings as follows:

Navistar International Corporation

--IDR to 'BB' from 'BB-';

--Senior unsecured notes to 'BB' from 'BB-';

--The County of Cook, Illinois recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 to 'BB' from 'BB-';

--Illinois Finance Authority (IFA) recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 to 'BB' from 'BB-';

--Senior subordinated notes to 'B+' from 'B'.

Navistar Financial Corporation

--IDR to 'BB' from 'BB-';

--Senior unsecured bank credit facilities to 'BB' from 'BB-'.

Due to NFC's close operating relationship and importance to the parent, its ratings are directly linked to those of the ultimate parent. The relationship is governed by the Master Intercompany Agreement, and there is a requirement referenced in the NFC credit agreement requiring Navistar, Inc. and NAV to own 100% of NFC's equity at all times.

Additional information is available at www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology', Aug. 16, 2010;

--'Finance and Leasing Companies Criteria', Dec. 13, 2010;

--'Rating Linkages in Nonbank Financial Subsidiary Relationships', Nov. 29, 2010;

--'2011 Outlook: U.S. Diversified Industrials and Capital Goods', Jan. 13, 2011.