Westport Innovations (WPRT 3.75%) tried everything it could to woo investors when it reported its third-quarter numbers late last month. It trimmed losses on a falling top line, slashed costs further, and also dropped hints of strong demand for its high-potential 12-liter ISX12 G engine. But nothing appears to convince the market. Westport's stock is dropping lower and lower.
The massive 46% drop in Westport's Q3 sales perhaps caught the market off guard. While lower revenue wasn't surprising since the company had downgraded its full-year guidance just early last month, the extent of the fall and the reasons behind it send out a warning message: Westport's top line is clearly under pressure.
Service revenue takes a hit
Lower service revenue was one of the factors that drove Westport's Q3 sales down. Westport provides product development services to original equipment manufacturers, or OEMs under research and development arrangements with them. In return, it receives payments that are measured against pre-set performance milestones. So if Westport doesn't meet those milestones, its service revenue takes a hit.
A quick glance over the past ten quarters shows how volatile Westport's service revenue can be.
Source: Westport Innovations financials. Graph by author.
Unfortunately, things are unlikely to settle down anytime soon, and could get even uglier in the near future. That's because service revenue under several of Westport's development programs for its high pressure direct injection, or HPDI technology, is set to get delayed because of the company's increased focus on its second-generation HPDI system. While HPDI 2.0 is an advanced technology, commercial launch of the first product is still months away.
In any case, as long as a part of the company's revenue is linked to performance-based objectives, its top line growth is bound to be choppy. That's not too encouraging, given that service (and other) revenue contributes more than 10% to Westport's total revenue -- It made up 15% and 10% of total revenue in 2012 and 2013, respectively.
Primary markets are in a muddle
Weakness in key markets is another big factor driving Westport's revenue down. The company segregates its revenue on the basis of three regions : Americas, Asia, and Other. The following pie charts show Westport's revenue breakup by geography for the past two financial years. You'll be surprised to know which region contributes the bulk to the company's top line.
Source: Westport Innovations financials. Charts by author
"Other", which primarily constitutes Europe, is where all the action is for Westport right now. Much of Westport's revenue currently comes from components that it supplies to OEMs in Europe. And that's where the problem lies.
Aside from challenging economic conditions in the European region, Westport is also facing setbacks from low government incentives for alternative fuel products and decreasing oil prices. Meanwhile, ruble's freefall has dealt a big blow to Westport's business in Russia – another high-potential growth market for NGVs.
Sluggishness in Europe might be a temporary hiccup, but absence of strong incentives such as tax credits, rebates and grants, and the narrowing cost differential between gas-oil and natural gas can be detrimental to NGV prospects in the longer run. For now, Westport's progress could grind to a halt if its primary markets don't recover soon.
Feeling the gasoline price drop pinch
Westport pointed at another factor that pulled its Q3 sales down: Lower demand for its WiNG power system products designed for Ford (F -1.15%) pickups. In CFO Ashoka Achuthan's words ,
In the US, Ford sales are visibly affected by the decline in gasoline prices to the lowest level in four years. Although it is true that there is still a big gap between gasoline and CNG prices, the incentive to aggressively shift to CNG is simply not as strong.
The message is clear: Demand for CNG vehicles isn't going to take off anytime soon. That's not what Westport investors want to hear.
Westport's partnership with Ford, in particular, is considered to be one of its trump cards for the U.S. market. With the WiNG business taking a hit, it remains to be seen whether Westport can hit its goal of turning its Ford WiNG business operating profit positive this year.
Much of Westport's optimism revolved around the launch of Ford's hot seller F-150 pickup with WiNG power late last year. But response to CNG F-150 has been muted at best -- numbers reported this past April pegged sales at around 200 units only since December 2013. With gasoline slipping to multi-year lows, prospects for Ford's flagship truck's natural-gas version appear dim.
Westport WiNG Ford-150 CNG Pickup. Source: Westport Innovations
There's another important, yet overlooked factor worth considering: Ford's 2015 aluminum-body F-150 could, ironically, prove a speed bump in natural-gas F-150's ramp up. That's because 2015 F-150 will provide much better (up to 20%) fuel economy versus its older version; and fuel economy also remains one of the key incentives to switch to NGVs. So when a gasoline-driven pickup can bring in greater fuel efficiency, those who aren't willing to take the natural-gas plunge yet may just get another reason to stay away from the alternative fuel. All this rings trouble for Westport.
It's a tough road ahead
How quickly Westport can hit profitability and positive cash flow depends a good deal on its ability to generate greater sales. While Westport hopes to turn its consolidated business adjusted EBITDA positive by next year, headwinds mentioned above could make things very difficult. The company clearly needs to work harder now to convince investors.
