Westport Innovations, (NASDAQ:WPRT) has been one of the most disappointing stocks of the past several years. The company's technology -- touted for its ability to make natural gas a viable fuel for transportation -- has yet to lead to the profits many predicted a few years ago, when many picked the stock as a great investment. Here's what's happened instead:
While many investors (including this writer) have suffered major losses, the story isn't over just yet. Does that mean Westport Innovations is a great turnaround investment, or are the company's efforts simply delaying an inevitable death? Let's take a closer look at three things investors need to know before making that call.
1. What Westport really does
Much about Westport's business has changed over the past 18 months, both out of necessity to reduce fixed costs, and to better position the company and its strengths. This process started in late 2013, when the company announced that it was discontinuing its 15-liter HPDI (high-pressure, direct-injection) engine because of a couple of factors. For starters, the company's joint venture with Cummins had launched the ISX12 G spark-ignited natural gas engine earlier that year, which meets the needs of a large percentage of trucking applications, at a lower cost and with more flexible configurations than the 15-liter engine. Second, Westport was losing money on the engine, because of the low sales volume.
Furthermore, being in the engine business -- even the 15-liter wasn't a Westport engine, but a Cummins diesel engine that Westport installed the necessary NG components on -- put Westport in competition with companies it needed to count as major customers, like truck and engine makers such as Volvo AB and PACCAR. The same holds true with engine makers like Cummins, and Weichai Power, China's leading medium- and heavy-duty diesel engine manufacturer, both of which Westport has long-standing joint ventures with, which it relies on for income. By exiting the engine building business, Westport removed a potential roadblock to its OEM relationships.
These larger manufacturers have scale benefits that Westport can't match. By developing HPDI 2.0 (which the company will manufacture in a partnership with Delphi Automotive PLC) to integrate with OEM assembly lines, costs will be lower, says the company, leading to a cheaper product.
Westport's strength is its technology, and the repositioning focuses on that. Over time, that should pay off. But it has meant a major hit to sales in the short term:
2. Why Westport isn't making money
It wasn't until current President and COO Nancy Gougarty came on board in 2013 that the aforementioned shift gained momentum. Many of the changes that have happened were necessary and have led to big writedowns and one-time expenses, exacerbating the losses while the transition happens. Unfortunately these major changes occurred at the same time Westport's joint ventures with Cummins and Weichai faced significant profit-pinches.
CWI took a major warranty charge early in 2014 that significantly cut its profits, while WWI's margins had been getting squeezed for more than a year in the face of stiff competition. Through the first nine months of 2014, the JVs had only paid Westport $2.9 million compared to $10.2 million the year before. Remember, the CWI venture was expected to be paying more income, with the ISX12 G now fully in the marketplace.
However, it appeared that both ventures turned a major corner in the fourth quarter, with Westport getting $11.3 million in profits from them on strong margin growth at WWI and CWI reported a favorable warranty adjustment, boosting profits.
However, the company's WiNG program to modify Ford trucks and vans continues to lose money, and its core business of supplying OEM parts to automakers in Europe, Russia, and China has struggled because of poor economic conditions.
But here's the real kicker for Westport: $76.4 million spent on research and development last year, on $130 million in sales. That development follows the $91 million spent in 2013. While product development is key to the company's future, something's gotta give.
3. Why the company probably will need to go to the well again
Over the past year, Westport management has done an admirable job cutting costs. Just this past quarter, the company announced that it had reduced its active development programs to just over 20, focusing on the ones that are closest to commercialization. This move involved some painful decisions, including reducing staff, but it should lead to a company better able to assess opportunities and dedicate resources to get a quicker return.
It's tough to say whether the steps to reshape the company and reduce costs will be enough. There remains a lot of uncertainty around oil prices and what the long-term impact of a sustained cheap oil environment would mean for Westport. If Westport's effort to cut costs corresponds to some growth in natural-gas heavy-truck sales and a rebound in Europe's economy, it could mean the company's $95 million cash position is sufficient for the next year or so.
If things don't bounce back in Europe, and American heavy trucking continues its slow pace of adoption, Westport will have to raise cash. That would mean either another share offering, or some sort of debt that would increase interest expense. The company has gone to both of these wells in the past few years, and it's probably inevitable that it has to do so again:
I own Westport shares and options, and I'm holding on to them, but I don't expect I'll be adding to my position anytime soon. However, that doesn't mean it's not worth a look for your portfolio. As things stand, much of the bad is priced in, but don't think the stock can't fall further -- I promise you it can. If you understand the risks -- namely, that Westport must significantly reduce cash burn through cost cuts and profit recovery, and this is still an upstream swim -- the company will need cash. Whatever it does to get that cash will affect the share price.
If you're willing to take on that risk and have the stomach for the roller coaster the stock will ride during earnings season, there's still potential for a recovery. Frankly, the right people are running the show today. Only time will tell whether they have enough time to turn things around.