Navistar International Corp (NYSE: NAV) well underperformed the Industrials sector by -10.7% as it relates to ROE, producing a poor -0.6% compared to the sector’s 10.1%. But what is more interesting is whether Navistar will continue to produce dissapointing returns moving forward. The DuPont analysis is a useful tool that may help us determine this. In my analysis below, I’ll use the DuPont model to reveal what’s really driving the company’s poor ROE.
Navistar’s ROE Trends
Return on equity or ROE represents the percentage return a company generates on the money shareholders have invested.
ROE = Net Income To Common / Average Total Common Equity
In general, a higher return on equity suggests management is utilizing the capital invested by shareholders efficiently. However, it is important to note that ROE can be impacted by management’s financing decisions such as the deployment of leverage.
Navistar’s recent ROE trends are illustrated in the chart below.
source: finbox.io data explorer – ROE
Unfortunately for shareholders, Navistar’s return on equity has decreased each year since 2015. ROE decreased from 2.8% to 1.7% in fiscal year 2016, decreased to -0.6% in 2017 and the LTM period is also its latest fiscal year. So what’s causing the steady decline?
What’s Causing Navistar’s Declining Return On Equity
A less used approach although being much more intuitive, the DuPont formula is another way to calculate a company’s ROE. It is defined as:
ROE = Net Profit Margin * Asset Turnover * Equity Multiplier
Created by the DuPont Corporation in the 1920s, the analysis is a useful tool that helps determine what’s responsible for changes in a company’s ROE. It highlights that a firm’s ROE is affected by three things: profit margin, asset turnover, and its equity multiplier or financial leverage.
Analyzing changes in these three items over time allows investors to figure out if operating efficiency, asset use efficiency or the use of leverage is what’s causing changes in ROE. Strong companies should have ROE that is increasing because its net profit margin and/or asset turnover is increasing. On the other hand, a company may not be as strong as investors would otherwise think if ROE is increasing from the use of leverage or debt.
So let’s take a closer look at what’s causing Navistar’s declining returns.
Navistar’s Net Profit Margin Trends
It appears that the net profit margin of Navistar has generally been increasing over the last few years. Margins increased from -1.3% to -1.1% in fiscal year 2016, increased to 0.4% in 2017 and the LTM period is also its latest fiscal year.
As a result, the company’s declining ROE is not due to its net profit margin performance which has generally been increasing. Could the poor ROE performance be a result of declining efficiency?
Navistar’s Asset Turnover Trends
It appears that asset turnover of Navistar has generally been declining over the last few years. Turnover decreased from 1.44x to 1.32x in fiscal year 2016, increased to 1.45x in 2017 and the LTM period is also its latest fiscal year.
source: data explorer – asset turnover
Therefore, the company’s decreasing asset turnover ratio helps explain, at least partially, why ROE is also decreasing.
Finally, the DuPont constituents that make up Navistar’s ROE are shown in the table below. Note that the table also compares Navistar to a peer group that includes Cummins Inc. (NYSE: CMI), Oshkosh Corporation (NYSE: OSK), Terex Corporation (NYSE: TEX) and Caterpillar, Inc.(NYSE: CAT).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that Navistar’s continuous fall in return on equity is the result of an improving net profit margin, a declining asset turnover ratio and declining leverage. Therefore when looking at the core operations of the business, Navistar shareholders do not need to be too concerned due to the company’s general improvement in profitability along with a general decline in operational efficiency and declining leverage.
The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. However, it doesn’t necessarily tell the whole story. For example, how do the company’s ROE trends compare to its peers or sector? How about in absolute returns? I recommend that investors continue to research Navistar to gain a better understanding of its fundamentals before making an investment decision.
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.