UPS has been one of the few early adopters of natural gas engines for trucking. Source: UPS.
I've been a staunch supporter of Westport Innovations (WPRT 1.57%) for more than three years, riding the stock all the way up from the high teens to past $40, and then back down to today's price of $6 and change. My defense of the company has largely been predicated on two things: First, investing in the company in a small way and letting the business develop, and second, with the understanding that there would be a lot of turmoil as the trucking business opportunity played out.
But the Westport Innovations of today is not the one I invested in. There have been numerous delays in its high-pressure, direct-injection technology for heavy-duty trucking, delays in its finally released ISX12 G engine built in partnership with Cummins, and now serious issues with demand in its core business of supplying components for natural gas engines to vehicle OEMs in Europe and Asia.
The thing is, I'm still relatively positive on the potential for the company's technology. A form of Stockholm syndrome? It feels like it some days, but there is positive data that shows interest in its products, as well as growing demand. The company is scheduled to report third-quarter earnings on Thursday. With that in mind, here are the key areas of the business I'll pay the closest attention to.
Stabilization in the core business
Westport's core business -- and the segment of the business that will become less important as heavy trucking expands -- happens to be the most important for paying the bills right now. The company's applied technologies segment produced $91 million in sales last year, with most of that coming from supplying European and Asian automakers with components for natural gas versions of their vehicles.
However, the company pre-announced in early October that it was experiencing significant softness in this business, primarily due to weak European and Russian economies and slowing growth in Asia. I'm especially interested to learn what management is doing to mitigate these problems. There is only so much a company can do in a bad economic environment, but Westport must take steps to position itself to match the level of demand.
Updates on trucking
This is twofold. The first part involves current demand, as represented by the company's joint venture with Cummins to produce natural gas engines for medium- and heavy-duty vehicles. Most important, how are sales and orders of the ISX12 G engine? This is essentially the only widely available natural gas engine for heavy-duty trucking. While there are limitations, this engine can handle more than 80% of trucking applications.
Furthermore, natural gas remains significantly cheaper than diesel, even as oil prices have fallen since June, so it's key that demand for this engine remain strong.
The second part is also related to the ISX12 G, as sales of that engine will probably be a leading indicator of demand for new engines. Westport has significantly altered its business model over the past year, exiting the heavy-duty engine business and transitioning to an OEM supplier model for its high-pressure, direct-injection, or HPDI, technology that produces diesel-like performance from a natural gas engine.
The key changes are tied to the company's deal with Delphi Automotive to co-manufacture HPDI injectors. Delphi is already one of the largest injector manufacturers in the world, so this move is a solid step forward. However, the plant is not expected to be at full capacity until 2016, creating another source of delays for bringing this product to market in a big way. Currently, the only two known development partners are Volvo and the company's joint venture with Weichai in China: Weichai Westport, or WWI. WWI is to begin selling HPDI engines in 2015, while Volvo recently announced that it would delay its D13 LNG engine with HPDI until a later date.
Westport claims to to be working with a number of other development partners, but these partnerships offer little value for investors until they move to commercialization. If demand for the ISX12 G grows sharply, competing products are likely to enter the market.
Update on capital allocation and business improvements
Over the past year, President and COO Nancy Gougarty has led the company through a series of major changes. So far, these changes have had a serious impact on improving the cost structure. Through the first six months of 2014, Westport spent $10 million less on research and development, and sales, general, and administrative expenses than it did in the same period of 2013. Look for this trend to continue.
Gross margin improved 26% through the first half of the year, a signal of improved product mix and operations.
Cash burn remains a real concern, as the company has reduced its cash position by $40 million this year. Considering the softness in the core business, it's critical that management figure out how to manage its capital while these new markets build momentum.
Looking ahead
While calling the company's position a "race against time" is probably overdone, it's not completely unfair. Westport had about $170 million in cash and equivalents on the books at the end of the second quarter, and its rate of cash burn is about $80 million per year. That number has to fall, whether through reducing costs further, growing sales, or a combination of the two. I fully expect management to tackle this head-on in the earnings call.
The company's level of risk does seem to be higher now than it was just a few months ago. Westport has less cash on hand, continues to spend more than it brings in, and just announced further delays in product development. Investors need to see some evidence that the business itself is sustainable, and it's going to take at least a few more quarters to answer that question.
