ANALYSIS - VW revs up its global CV ambitions with Navistar deal
Navistar's range of heavy duty trucks is potentially a good strategic tie-in to VW Group's global presence in the sector with its Scania, MAN and Volkswagen branded trucks
Volkswagen's intent to acquire a 16.6% (post dilution) stake in Lisle, Illinois-based Navistar, coupled with a strategic technology and supply cooperation and the establishment of a purchasing joint venture represents a significant step forward for the German company's global ambitions, ambitions that have so far been tempered by a lack of presence in the North American heavy truck sector.
With Scania, MAN and Volkswagen Caminhões e Ônibus, the heavy truck contenders encompassed within Volkswagen Truck and Bus GmbH, heavily focused on European and South American markets, VW has been unable to leverage the recent strength of the North American Class 8 sector, a disadvantage not shared by key European rivals Volvo (including Mack) and Daimler (Freightliner and Western Star), and North American heavyweights Paccar (Kenworth and Peterbilt) and Navistar (International).
While current conditions in the North American heavy trucking sector are undoubtedly "post-peak" and an uncertain downcycle beckons both in terms of magnitude and longevity, this will give VW and Navistar breathing space to fully evaluate and exploit potential opportunities for cooperation in important areas such as component sourcing, purchasing, product development and marketing.
The new relationship with Navistar also represents a feather in the cap of Volkswagen Truck & Bus chief Andreas Renschler, who, with just over 18 months under his belt in the job, can now claim at least the first step towards the company assuming a more global role in the heavy truck industry. Renschler's appointment as member of the VW Board of Management with responsibility for Commercial Vehicles was announced in late-February 2014 but he did not take up his current position until 1 February 2015. Having focused on collaboration and synergies between Scania and MAN to date, the emphasis being on reduced costs and more effective marketing, a focus that is far from being at an advanced stage, Renschler can now also add a more global dimension to these tasks.
Speaking at a media event at the end of May 2016, Renschler had confirmed that the target for synergy-related savings across the Volkswagen Truck & Bus operations had been raised to EUR1bn – a EUR150m increase from a cost saving target that was originally outlined in 2008. As of May 2016, EUR200m of savings were claimed, mainly from purchasing activities, but Renschler noted at the time that the group was "making progress at high speed" towards additional cooperation projects.
Interestingly, Renschler (who has hands-on experience at Daimler Trucks of running operations in the US and therefore a more globally-positioned truck OEM), also outlined possible strategic options for the VW truck interests going forward. These included the possibility of an initial public offering for investors, thereby somewhat distancing the trucks business from parent company activities, and growth possibilities/opportunities driven by acquisitions. He was quoted at the time as specifically noting that VW was keeping all its options open for building the truck business in the US, a comment that alerted industry analysts (again) to the possibility of developments involving Navistar and Paccar. Acquisition of the 16.6% stake in Navistar, via a primary share issuance (16.2 million shares), at a price that by historical standards appears cheap (US$15.76 per share, versus over US$50 per share five years ago), plus two seats on the Navistar board (replacing two existing but now retiring members), now represents clarification and crystallisation of this ambition to build the business in the US. Total investment of around US$256m (EUR229m) appears a modest price for VW to pay to set it on the path of being, as Renschler has noted, a "Global Champion in the commercial vehicles industry." Volkswagen Truck & Bus has agreed to hold the newly acquired shares for a minimum of three years.
For Navistar, which has fought hard in recent years through the North American heavy truck market upcycle to rebuild and restore its reputation, sales, market share and profitability following the abandoning of EGR technology in 2012, closer cooperation with Scania and MAN might reassure doubters that full recovery can be completed. A small number of key strategic investors – including Carl Icahn and Mark Rachesky, who both have two representatives on Navistar's ten-person board – have played a key role in Navistar's strategic direction, and VW's similar influence going forward will add an additional dimension to this guidance.
With the (vital) help of Cummins, Navistar has made considerable progress in restoring faith in its powertrain strategy and reputation for reliability and efficiency, although this has not necessarily translated fully into the rebuilding of market share and improved financial performance. With the company's entire product portfolio due to have been replaced by the end of 2018 and operating costs having been significantly lowered in recent years, optimism that a fuller recovery can be secured, even against a background of unhelpful demand conditions in North America, has grown. However, some analysts have continued to express unease that Navistar can, independently, fully restore its market position in the face of severe competition from the likes of Freightliner, the Class 8 market leader by a significant margin, as well as Paccar (which benefits from its ownership of DAF in Europe) and Volvo/Mack.
On a positive note, Navistar reported that US$113m of structural cost reductions were achieved in H1 FY2016 (six months ended 30 April 2016), and the company asserted that it is on track target to "well exceed" its target for cost reductions of US$200m for the full year. However, the H1 results also highlighted some negatives – a significant drop in chargeouts (trucks that have been invoiced to customers) and revenue (but a rise in adjusted EBITDA). Navistar management remains optimistic that the goal of generating manufacturing free cash flow in 2016 remains achievable, although guidance was lowered when reporting Q2 FY2016 results. Navistar's CEO, Troy Clarke conceded that: "While we were net income positive in the second quarter [US$4m], it will now be difficult for us to be profitable for the entire year given the tougher than anticipated market conditions, primarily due to the lower outlook for Class 8 industry volumes [loss of US$29m in H1 FY2016]." On a slightly more positive note, he added: "We are confident we will generate and implement additional performance improvements to partially offset current industry conditions." Whatever the scale of these improvements, Navistar's debt position, at around US$5bn, remains a tremendous burden and Q3 performance details, to be published on 8 September, are unlikely to show a much brighter picture.
Emphasising the perceived operational and financial benefits of the alliance with VW, Clarke noted: "Starting in the near term, this alliance will benefit our purchasing operations through global scope and scale. Over the longer term, it is intended to expand the technology options we are able to offer our customers by leveraging the best of both companies and enabling Navistar to deliver enhanced uptime. Volkswagen Truck & Bus's equity investment will strengthen our liquidity position and expand our financial flexibility, while aligning us with a valuable strategic partner." Navistar expects to realize cumulative synergies of US$500m from the new alliance with VW Truck & Bus over the first five years of operation. By year five, it expects the alliance will generate annual synergies of at least US$200m for the company and this annual run rate is expected to grow materially after that as the companies continue to introduce technologies from the collaboration.
Adding a little more colour to the strategic technology and supply cooperation aspects of the announcement, Matthias Gründler, Chief Financial Officer of Volkswagen Truck & Bus, commented: "Our collaboration, especially with regard to the powertrain, will considerably increase our synergy potential. Navistar will be able to profit from excellent powertrain technologies and we, in turn, will benefit from significantly higher volumes. Initiating this strategic alliance now will enable us to implement the requirements of Navistar into our joint component platforms from the get-go."
Inevitably, some key questions regarding the full impact of the agreement remain unanswered at the present time, not least of which is how Navistar's current relationship with Cummins will evolve and the possible impact on Navistar's existing powertrain manufacturing footprint. This footprint, which encompasses facilities in North and South America and China (joint venture with Anhui Jianghuai Automobile Co (JAC)), has already undergone significant rationalisation in recent years.
Details of the technology collaboration framework also remain somewhat (understandably) vague, although initial work will undoubtedly focus on powertrain systems, with the VW business expected to supply and license relevant technology to Navistar and the US company to localise product where appropriate. Looking further ahead, planned collaboration around future technologies is likely to encompass ADAS, connected vehicle solutions, platooning and autonomous technologies, electric vehicles, cab and chassis components and fuel efficiency technologies. Such collaboration is likely to include joint research, development, testing and production.
In 2015, the brands of Volkswagen Truck & Bus sold a total of 179,000 vehicles (162,000 trucks), generating revenue of over EUR20bn. The product range includes medium- and heavy-duty trucks and buses that are manufactured at 25 sites in 17 countries. As of 31 December 2015, the company employed 76,000 people within all commercial vehicle brands worldwide. In the same year, Navistar manufactured Class 4 through 8 International brand commercial trucks, military trucks, MaxxForce brand diesel engines, and IC Bus brand school and commercial buses. Worldwide truck chargeouts from continuing operations in Navistar's FY2015 (year ended 31 October 2015) totalled 84,500, generating revenue of US$10.14bn, versus 90,000 in the previous year, a fall of 6.1%, with Class 8 heavy truck sales declining 3.8%, or 1,000 units, from 26,000 to 25,000. In contrast, a marked rise in the medium-duty segment continued, unit chargeouts gaining 17.5% to 18,800 from 16,000. Class 6 and 7 shares in the US and Canada, were 23%, up from the previous year, but a significant downtick in the Class 8 heavy trucks share – to 11% - was also apparent. The combined Class 8 market share in FY2015 fell to 12% from 14% in FY2014. All shares were significantly below levels enjoyed five years ago.
While perhaps a somewhat tentative first step for VW Truck & Bus towards becoming the desired Global Champion in the commercial vehicles sector – a full acquisition of Navistar would have been a bolder, if far more expensive move – it undoubtedly places the German company in a stronger position from which to confront rivals such as Daimler Trucks and Volvo. It also surely better positions the company to pursue a more independent ownership route (from parent VW, via an IPO) in the longer-term future.