S&P Places Navistar (NAV) Ratings on CreditWatch Positive Amid Volkswagen Deal

September 7, 2016 12:24 PM EDT

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S&P Global Ratings placed its ratings, including the 'CCC+' corporate credit ratings, on Navistar International Corp. (NYSE: NAV) and its subsidiary Navistar Financial Corp. on CreditWatch with positive implications.

The CreditWatch action follows Navistar's announcement that it has formed a strategic alliance with Volkswagen Truck & Bus, which includes a proposed equity investment in Navistar by Volkswagen Truck & Bus, as well as technology and proposed framework agreements for strategic technology and supply collaboration, and a procurement joint venture. As part of the alliance, Volkswagen Truck & Bus plans to acquire 16.2 million newly issued shares in Navistar, and Navistar expects to receive $256 million from the equity investment, which the company intends to use for general corporate purposes. In our view, pro forma for the proposed equity investment, Navistar would have over $1 billion manufacturing cash as of fiscal year-end October 2016, which should provide some additional liquidity cushion for Navistar, as overall truck demand declines in 2016 versus 2015.

Additionally, we see the potential for Navistar to achieve additional cost savings over time, as the two companies expect to form a procurement joint venture to pursue joint global sourcing opportunities. Navistar expects the alliance to be accretive beginning in the first year, and for cumulative synergies to be $500 million over five years, with annual synergies of $200 million for Navistar in the fifth year. These cost savings would be in addition to the initiatives already underway at Navistar to drive savings through material cost reductions, manufacturing efficiencies, and structural cost improvements, which, along with a shift in product mix, has driven improved operating performance over the past several quarters.

Separately, the two companies intend to enter into definitive agreements to collaborate on technology for powertrain systems, as well as other advanced technologies, which, over the longer term, could improve our view of Navistar's business. Initially, the scope of the technology collaboration would include powertrain systems, where the two companies would jointly develop powertrain-related solutions and Volkswagen Truck & Bus would supply and license the relevant technology to Navistar. Over time, this could help improve Navistar's market share, as the company continues to rebuild its truck franchise following regulatory issues and engine quality problems with its proprietary engine and emissions treatment technology several years ago.

Upon close of the transaction, which the company expects to occur in late 2016 or 2017, we would likely raise our corporate credit rating by one notch to 'B-'. Although we would no longer view the company's capital structure as unsustainable in the long term, we expect the company's debt leverage will remain very elevated at a time when the company could continue to face declining end market demand in the overall U.S. heavy duty commercial vehicle market.

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