Westport Innovations (WPRT 1.06%) has become a "love it or hate it" company over the past several years. The promise of cheap domestic natural gas reducing our dependence on imported and more polluting gas and diesel for transportation is incredibly appealing. As the producer of some of the most innovative technology for natural gas engines, Westport's promise has drawn a lot of attention. But inconsistent results, a somewhat confusing business model that has undergone significant changes over the past year, and what seems to be very slow adoption of natural gas vehicles, has whipsawed the stock back and forth and cost investors a lot of money.
As things stand today, there are many questions about natural gas vehicles in general, and Westport Innovations in particular. Let's look at the company's past, current situation, and future prospects. Is it time to move on, or is there some light at the end of the tunnel?
What Westport does versus what Westport did
Detractors point to Westport's 2013 decision to discontinue its 15-liter natural gas engine for heavy-duty trucking as proof that its business model and the market aren't viable. The company's product development is spread across a number of markets, including passenger cars and trucks, mass transit vehicles, heavy-duty trucks, and locomotive engines -- but the biggest immediate opportunity is in heavy trucking, which consumes more than 30 billion gallons of diesel annually in North America, spread out over less than 3 million vehicles. That's an average of 10,000 gallons of diesel per vehicle per year. That's $38,000 per year spent just for diesel, on average. I'm sure you can see why natural gas -- at upward of 30% cheaper than diesel -- is attractive to truck fleet operators.
The Weichai Westport WP12 will be available with HPDI 2.0 in 2015. Source: Westport.
Westport's 15-liter engine -- which the company built on a Cummins (CMI -1.32%) diesel engine platform, and now referred to as HPDI 1.0 -- was the first to use HPDI technology, which produces diesel-like performance and efficiency. But late last year, as part of a wider initiative to focus on profitable expansion, Westport announced it was discontinuing HPDI 1.0 because it wasn't able to build it profitably at the low levels of demand the company was seeing.
Needless to say, when there's not enough demand to build a product profitably, investors aren't going to be pleased. When it's based on a technology -- HPDI -- claimed to be transformative for the industry, it's even worse.
Volvo's D13 will also be available with HPDI 2.0 in 2015. Source: Author.
But to stop there ignores a few things. First, the 15-liter engine size fits a small niche in the truck market. It's too large and uses too much fuel for the majority of users, so it's unsurprising that there wasn't significant demand. Second, discontinuing the engine was part of a larger decision to refocus the company away from being an engine builder, and instead work with engine and truck makers as an OEM supplier.
Enter Nancy Gougarty and Westport's new focus
Nancy Gougarty, Westport president and COO since 2013, built a strong career at TRW Automotive (NYSE: TRW), where she ran the Asia-Pacific group, which is a $2.3 billion business on its own. Gougarty's vast experience with TRW, a global and profitable OEM supplier (generating $1 billion in profit on $17.7 billion in sales last year) brought a wealth of needed expertise to Westport. But there's more to it:
WPRT Cash and Short Term Investments (Quarterly) data by YCharts.
As you can see, Westport's model of product development without yet having any solidly profitable products repeatedly led to the company running low on cash and having to dilute investors' holdings with share offerings. Since late last year, management has solidly focused on developing products that would more quickly lead to profits. Not only was this move better for the company, but it was incredibly shareholder-friendly.
What about the future?
The measuring stick management is using for 2014 and 2015 is adjusted EBITDA, which is earnings before interest, taxes, amortization, and depreciation. Sure, Berkshire Hathaway Vice Chairman Charlie Munger once said, "I think that, every time you saw the word EBITDA, you should substitute the word 'bullshit' earnings," but that great one-liner ignores the fact that EBITDA can actually be a valuable measuring tool.
Adjusted EBITDA essentially shows if Westport can bring in enough cash from its core business to show the business to be viable. The company's goal for 2014 was to reach adjusted EBITDA-positive for its three operating business units by the end of the year; Westport exceeded that target by six months, reaching it during the second quarter.
However, engine sales at its joint ventures -- both the JV with Cummins and the Chinese JV with Weichai -- showed very little revenue growth, and engine unit sales declined. Considering that it's been less than a year since Westport and Cummins launched the much-anticipated ISX12 G 12-liter engine for trucking, this looked like bad news. But before you race to hit the "sell" button on your Westport shares, remember that context is key.
Sales for trucking applications are up almost 80%. Source: Author.
Cummins Westport's sales for trucking applications are up 79% since the launch of the ISX12 G. That's a great sign, and points out that the quarterly softness was driven by engine sales for buses and waste removal trucks, which have been historically lumpy. Why does this matter? Cummins Westport has a commanding market share in bus and waste removal already, and this market is a mere fraction of the opportunity in heavy trucking. We want to see growth in heavy trucking, and we are seeing it.
Furthermore, industry analysts have been predicting for some time that sales of natural gas engines for trucking applications in 2014 would be back-loaded, as trucking fleets continue to test the ISX12 G before placing large orders. The evidence that this is happening is supported by the market penetration rates Westport has targeted, of between 3% and 5%. So far, sales for trucking applications have been within this range, and Westport's reiteration of its full-year revenue guidance indicates that the second half of the year will indeed be strong.
Souce: Westport Innovations
Furthermore, CFO Ashoka Achutan, when asked about higher receivables and inventories on the most recent earnings call, described it as a matter of timing, largely tied to sales of Westport's iCE PACK LNG fuel system for heavy trucks. Considering that essentially every sale of an iCE PACK system is attached to the sale of an ISX12 G, this is a positive sign for the second half of 2014.
Furthermore (and more important to some number crunchers), Westport has reduced operating expenses by more than $10 million, and increased gross margin from 25% to 36% through the first half of the year. Combined with the anticipated sales growth in the second half of the year, the company should be positioned to reach adjusted EBITDA positive for the consolidated business in 2015.
Final thoughts: Not the time to walk away
Things are happening at the pace most industry insiders have expected, meaning a roughly 3% natural gas adoption rate for heavy trucking this year. Furthermore, Westport's new leadership has shown that a fiscally disciplined approach can make real impacts on the company's bottom line. As Westport's reiteration of sales guidance for the year, and its inventory levels show, adoption of natural gas for trucking is set to ramp up. Westport's position as a technology leader and OEM partner, combined with a new, more focused approach, point toward a confluence of strong growth in the next few years.
Hang in there if you're a shareholder. I know I am.
