Navistar: Equity Or Credit?

Citi downgraded its Buy rating on Navistar International Corp NAV's 2021 Senior Notes to Neutral and its Overweight issuer weighting to Marketweight, given debate around long-term fundamentals.

The brokerage also expressed concerns on the cycle and the company expectations for a much weaker second half, large pension obligation, and lack of appetite for CCC credits.

"At the same time, we remain comfortable with our Buy on the term loan given seniority in capital structure and ability to deliver on cost savings," analyst Manish Somaiya wrote in a note.

However, Somaiya likes the company's ability to execute on cost saving targets and noted the company is likely to benefit from higher market share in the strong medium duty segment compared to a deteriorating heavy duty segment.

Navistar expects cost reduction of greater than about $200 million after completing $56 million of cost savings in the second quarter and $113 million year-to-date.

Shares of Navistar rose 25 percent Monday and 60 percent in 2016, but the analyst noted about 60 percent of the equity is owned by three holders: Icahn, MHR, and Franklin.

"Therefore, we think the best way to express cost reduction execution and company specific initiatives is through Buy rated term loan (L+550/1% floor) given its seniority in the capital structure (net leverage of 1.7x) in light of downside pressure if the Class 8 environment deteriorates more than expectations," Somaiya highlighted.

For the full year, the analyst still expects EBITDA of about $550 million on revenue of $8.3 billion (vs. $8.7 billion previously) owing to combination of expectations for lower volumes combined with execution on cost saving initiatives.

Somaiya projects net senior leverage to increase slightly at year-end to 3.2x resulting in net total leverage of 4.3x.

On the call, the company indicated F2017 to see continued challenges in the heavy duty segment while medium duty and bus segments should remain stable.

"We expect softer fundamentals in 2017 with our current estimates including $488mm of EBITDA on $7.65bn of revenue resulting in net senior leverage of 3.9x and net total leverage of 5.0x," Somaiya added.

At time of writing, shares of Navistar rose 7.36 percent to $15.61.