Truck and Component
Manufacturers
Potential Winners and Losers in the Changing Diesel
Engine Landscape
Machinery
Ann DuignanAC
(1-212) 622-0381
ann.duignan@jpmorgan.com
Chip Miller, CFA
(1-212) 622-2976
cmiller@jpmorgan.com
J.P. Morgan Securities Inc.
See page 28 for analyst certification and important disclosures.
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With the 2010 change in emissions standards fast approaching, and given the
various strategies being pursued by OEMs to meet the standards, we thought it
might be useful to take a step back and look at the opportunities and risks facing
the truck industry and its engine suppliers over the next few years. In this note,
we lay out a range of possible scenarios around potential “winners” and “losers”
in the Class 8 market. We also attempt to size the impact of each scenario on
truck OEMs and engines suppliers. In these scenarios, we assume a “normalized”
year in which the Class 8 market reverts to trend demand of 250,000 units. We
will host a conference call today at 1pm ET entitled, “Identifying Potential
Winners and Losers in the Changing Diesel Engine Landscape.” Dial-in: 888-
469-0882 (US); +1-212-287-1635 (outside US); Passcode: Diesel
• Scenario #1 Base Case. In this scenario, we assume that truck OEM market
shares remain relatively constant and that both NAV and PCAR successfully
launch their own engine offerings. NAV and PCAR’s gains would likely come
at CMI's expense; however, CMI may modestly offset this with modest gains at
Freightliner. We estimate normalized EPS under this scenario would be, CMI at
$4.43, NAV at $8.20, and PCAR at $3.65.
• Scenario #2: NAV’s EGR-Only Engine Prevails. In this scenario, we assume
that NAV’s EGR-only engine becomes the preferred Class 8 engine, resulting in
substantial truck share gains (to 40% from 24% today), and increased internal
engine penetration (to 90% from 33% today). We estimate CMI’s Class 8
engine share would drop to ~26% and PCAR’s truck share would drop to ~20%.
EPS impact would be NAV at $13.33 (up 63% from $8.20 normalized), PCAR
at $3.16 (down 14% from $3.65 normalized), and CMI at $4.14 (down only 7%
from $4.43 normalized).
• Scenario #3: NAV’s EGR-Only Engine Disappoints. In this scenario, we
assume that NAV’s EGR-only engine proves to be a disappointment, potentially
because engine turns out to be significantly less fuel efficient relative to SCR.
This scenario assumes (1) NAV’s Class 8 share drops to 10%, with competitors
gaining share uniformly; and (2) NAV’s internal engine penetration rate falls to
10%. Under this scenario, we estimate that CMI's engine share would be ~41%,
and that PCAR's truck share would rise to ~30%. We estimate EPS would be
NAV at $4.90 (down 40% from $8.20 normalized), PCAR at $3.96 (up 8% from
$3.65 normalized), and CMI at $4.55 (up 3% from $4.43 normalized).
• The analysis highlights the risks for NAV and the slight impact on CMI.
The results of the analysis simply highlight the significant opportunity, or risk,
that lies ahead for the industry, particularly NAV. However, it also highlights
that whatever outcome transpires, CMI will most likely be least impacted due to
the diversity of its business exposure.

Key Points
The Class 8 on-highway diesel engine landscape should change dramatically in
2010. With the EPA’s next mandated change in emissions standards fast
approaching on January 1, 2010, and given the various strategies being pursued by
OEMs to meet the standards, we thought it might be useful to take a step back and
look at the opportunities and risks facing the North American Class 8 truck industry
and its engine suppliers as we go through the next few years. In this note, we
provide background on the Class 8 diesel engine market and lay out a range of
possible scenarios based upon a “normalized” production year of 250,000 units.
Under each scenario, we attempt to analyze the impact on each North American truck
OEM, as well as CMI, which will be the market’s only independent engine supplier,
and identify potential longer-term “winners” and “losers” in the market.
While no outcome is certain, we take the opportunity in this note to review the
following:
• First, what is a diesel engine? It is increasingly important to understand the
basics of diesel engine technology in order to understand the technical challenges
being faced by the industry
• The EPA’s specific requirements in 2010 and what the options are to meet these
requirements, including the two main technology paths being pursued, EGR-only
and SCR
• The strategy being pursued by each OEM and supplier and the unique challenges
being faced by several of the players
• The current engine supply market dynamics and market shares
• Scenarios exploring and quantifying the potential impact on the industry of a
variety of potential outcomes
NAV’s success with its EGR-only engine will be the most important factor in
determining longer-term "winners" and "losers," in our view. NAV is the only
OEM pursuing an EGR-only solution to meet the EPA’s stricter 2010 diesel engine
emissions requirements. The other players in the industry are using SCR systems to
meet these requirements, largely because they have already developed proven SCR
systems in Europe. According to our work, NAV’s decision to “go it alone” presents
the company with both significant opportunities and risks. If successful, NAV stands
to gain significant truck market share, increase its internal engine penetration rate,
garner significant operating leverage benefits, and command increased pricing power
in the marketplace. However, if NAV is unsuccessful in its quest, the opposite could
occur. In the table below, we provide a summary of our scenario analyses. In our
“base case” scenario, which we view as the most likely outcome, we assume CMI’s
market share normalizes as NAV and PCAR have decent success launching their
own engines. According to our work, NAV faces the most significant opportunities
and risks, potentially generating as much as $8.99/share or as little as $0.56/share
from its Class 8 business in a “normalized” production year, depending on the
success of its EGR-only product.