Westport Innovations Inc. (NASDAQ: WPRT) stock is up about 37% since hitting (what we hope turns out to be) bottom in mid-January. However, long-term investors are still looking at a big loser in their portfolios, and can't help but hope things continue to improve. But, of course, "hope" isn't a very dependable investing thesis, especially for Westport, which is burning cash like crazy and struggling to turn the corner from development-stage technology company to profitable manufacturer and OEM equipment supplier.
Investors need to pay close attention to a handful of key issues when Westport issues its latest earnings report next week. Let's talk about them now.
1. Joint ventures must contribute meaningful profits
Westport's future is heavily tied to the adoption of natural-gas engines by commercial users, largely heavy trucking, and over time off-road, rail, and potentially even maritime applications. Since the company's core operations remain money losers as it builds them up in scale, the best chance for profits today rests with its joint ventures with diesel engine expert Cummins in North America and Chinese engine leader Weichai in Asia.
Last year started off rough with both Cummins Westport, or CWI, and Weichai Westport, or WWI, experiencing major margin compression early on. Cummins Westport reported a surprise loss in the first quarter, taking almost $19 million in warranty adjustments and claims due to issues with its nine-liter engine. This knocked gross margin down almost 60% and meant no profits from the JV were paid to Westport in the quarter, versus $800,000 the year before. Similarly WWI's margins were compressed in the quarter, but mainly due to competitive pressures. The Chinese JV did pay Westport $500,000, but that was half as much as in the same 2013 quarter.
However, both ventures look to have turned things around by the end of the year, with a combined $14.1 million in profit paid to Westport a slight improvement on the $13.7 million in 2013. The biggest two contributors were a positive warranty adjustment at CWI in the fourth quarter, which indicated it has moved beyond the warranty problems with the nine-liter engine, along with a strong rebound in gross margin at WWI by the end of the year. While WWI's gross margin of 8.5% is still quite low compared to the Cummins venture's, it did improve 50 basis points from 2013.
2. Operations improvements need to positively impact bottom line
Over the past year, Westport has significantly refocused its business operations. Under the direction of President and Chief Operating Officer Nancy Gougarty, the company has shifted its focus from product development to being a key product supplier to OEMs. There have been some major pains along the way, including the necessary decisions to exit unprofitable businesses and to reduce spending on product development while focusing on products with near-term market viability.
This has been exacerbated by the continual economic challenges in Europe, which is a major customer for Westport's core on-road business, which supplies numerous components used in passenger and commercial natural-gas vehicles. Add in the massive drop in oil prices -- making the price advantage of NG versus gas and diesel less compelling -- and the company has been forced to take major steps to reduce its cost structure and improve operational efficiency.
This latest quarter should be one of the first that shows how these major changes will impact the bottom line, and it should help investors set a baseline for cash burn from the company's operating units going forward.
3. Westport must sell its way out of this
This remains the bottom line for Westport. The company's products have proven to be reliable and compelling in industries such as transit and waste hauling, where natural-gas engines make up the majority of unit sales of both vehicle segments. However, that same trend has yet to fully materialize in the trucking business. This is a big deal because trucking is orders of magnitude larger than these other segments, and the much larger engines (and LNG fuel systems) the company sells carry a lot more economic value for the company.
While Westport can only control so much, and the macroeconomic challenges are completely out of its control, the company's steps to grow while also being highly cost conscious bear close watching. With this in mind, moves like December's acquisition of Holland-based Prins Autogassystemen could be a smart way to grow.
While the $15 million in cash and debt cost further squeeze the company's need to get to positive cash flow, adding a profitable business that will be accretive to 2015 results is probably a step in the right direction. "Bolt-on" buys of profitable companies are likely to be smarter than pouring cash into the bottomless R&D pit of recent years.
What to expect?
Frankly, I'm not completely sure. I think CWI has turned the page and should contribute meaningful profits, though I have limited faith that WWI's margins won't be squeezed again. Only a long period of sustained margin levels there would be evidence that last quarter's improvement is sustainable. In any case, the growth rate and market opportunity in Asia do make up for what is likely to be a lower level of profitability in its other businesses.
As to its core business units, look for some moderate improvement at the bottom line, but I think it's too early to expect a major step forward. A reduction in losses, though, is necessary, maybe even imperative. What will those improvements look like?
We will know when Westport reports in the week of May 4. Tune back in for more once the release is out.