Westinghouse Air Brake: The Power of Predictability

Author's Avatar
Nov 05, 2014
Article's Main Image

In a high tech age, an age that now depends on dashboard GPS and waits for the driverless car, it’s easy to take railroads for granted. And perhaps even easier to not see the gritty components that keep the steel wheels moving.

Westinghouse Air Brake Technologies (WAB, Financial), which dates its origins back almost a century and a half, makes many of the components you see (or don’t see) inside the wheels of millions of train cars and locomotives. And, in some cases, it makes the locomotives, too. It may also have made many parts of the transit trains that we wait for impatiently.

03May20171308281493834908.jpg

WAB, or Wabtec as its generally known, is one of just 56 stocks to make it through the current Buffett Munger screener at GuruFocus. Getting through this screener says a great deal about its earnings ability and its current value.

03May20171308291493834909.jpg

History

1869: the original company is formed after George Westinghouse successfully demonstrates his air brake system

1872: Westinghouse develops the first automatic air brake system, which could shut down an entire train if it loses air pressure

1968: American Standard buys Westinghouse Air Brake

1972: Morrison Knudsen starts the Rail Systems Group (which was to become MotivePower, a manufacturer and remanufacturer of locomotives)

1990: the management team buys the Westinghouse name and assets from American Standard

1994: MK Rail Corporation (MotivePower) established as a subsidiary of Morrison Knudsen.

1995: Westinghouse goes public, on the New York Stock Exchange, symbol WAB

1996: MK Rail separates from Morrison Knudsen and incorporates as MotivePower Industries Corporation

1999: MotivePower Industries and Westinghouse Air Brake Company merge to form Westinghouse Air Brake Technologies Corporation (Wabtec); Boise Locomotive Company (a subsidiary of MotivePower Industries) changes its name to MotivePower, Inc.;

2013: sales from new products and technologies introduced or acquired during the previous five years represent about 38 percent of total sales for the fiscal year

Both Westinghouse Air Brake and MotivePower had been active acquisitors during their histories before merging, and after 1999 the merged company continued that practice. History based on information at the company website, the MotivePower website, and Wikipedia.org.

A note about the name: The company refers to itself mainly as Wabtec Corporation or Wabtec, but the name listed at the top of the 10-K is Westinghouse Air Brake Technologies Corporation. We will mostly refer to the company as Wabtec and symbol WAB throughout this article.

Takeaways: Two companies with long, storied histories combined to create the modern Wabtec; as we’ve seen, acquisitions have played a major role in the company’s growth.

Wabtec’s Business

As the merger of 1999 suggests, this company is all about railroading, and more specifically about building and equipping locomotives and rolling stock. Braking systems continue to be a big part of the business. In general, its markets are the worldwide freight rail and passenger transit industries.

In its Annual Report/10-K Report for 2013, the company reports that it operates in two major segments: Freight and Transit.

For the Freight business, it "...manufactures and services components for new and existing locomotive and freight cars." That includes:

  • railway electronics
  • positive train control equipment (PTC)
  • signal design and engineering services
  • builds switcher locomotives, and rebuilds freight locomotives
  • provides heat exchangers and cooling systems for rail and other industrial markets.

Customers: large, publicly-traded railroads, leasing companies, and manufacturers of original equipment such as locomotives and freight cars, and utilities.

For the Transit Segment, it mainly manufactures and services components for new and existing passenger transit vehicles, including:

  • subway cars
  • buses
  • builds new commuter locomotives
  • refurbishes subway cars.

Customers include public transit authorities and municipalities, leasing companies, and manufacturers of subway cars and buses around the world.

For the two segments, it is both an OEM (Original Equipment Manufacturer) and an aftermarket supplier.

Wabtec is a Delaware corporation, based in Wilmerding, PA (near Pittsburgh); it has about 50 plants and offices worldwide, along with about 12,000 employees.

Revenues

The following excerpt shows the sources of revenue for fiscal 2013:

03May20171308291493834909.jpg

Of the $2.566 billion in revenue, about $1.2 billion, or a bit under half, came from international sales.

This excerpt from the Q3, 2014 Report shows how third quarter revenue for 2014 compares with third quarter revenues from 2013.

03May20171308291493834909.jpg

Competitive Advantage

In looking at a Buffett Munger candidate, we want to know if the company has some competitive advantage, a moat, which gives it a long-term opportunity to consistently generate above average revenue and earnings. Wabtec management lists four ‘strengths’ in its 10-K:

  • Leading market positions in core products
  • Breadth of product offering with a stable mix of original equipment market (OEM) and aftermarket business
  • Leading design and engineering capabilities
  • Experienced management team and the Wabtec Performance System (more on the latter in the Growth section)

Competition

Wabtec believes it has, "...a 50% market share in North America for our primary braking-related equipment and a leading market position in North America for most of our other product lines." Internationally, its market share is smaller.

It faces strong competition, in part because there are a relatively small number of customers, and they are all price-conscious. Transit operations depend on customers which are often funded by governments.

OEM competitors in North America include New York Air Brake Company (private), and Amsted Rail Company, Inc. On the repair side in North America, the competition comes from in-house operations, Electro-Motive Diesel (private), GE Transportation Systems (GE, Financial), and New York Air Brake/Knorr. Outside of North America, competition is more fragmented.

Takeaways: Wabtec is an established company in an historic industry, and closing in on $3-billion in annual sales. It has a solid market share, but depends on a relatively small number of customers in the Freight segment and many government-funded entities in the Transit segment. With a mix of OEM and aftermarket products and services, it is well diversified within in its niches.

Growth

Some 25 years ago, the company created what it calls The Wabtec Performance System and made it a part of its core corporate culture. According to the 2013 Annual Report, the System comprises the following four pillars:

  • Global and market expansion
  • Aftermarket expansion
  • New products and technologies
  • Strategic acquisitions

How has that worked out so far? Here’s a GuruFocus chart showing the growth of revenue (blue line) and Earnings per Share (red line) along with the share price (green line):

03May20171308301493834910.png

In its third quarter 2014 press release, the company said it expected revenue for fiscal 2014 to be up about 18%, and that earnings per diluted share to come in at $3.58-$3.62 (compared to earnings per diluted share of $3.01 for fiscal 2013).

The 14 analysts followed by Yahoo! Finance have an average earnings target of $4.15 for fiscal 2015 (low estimate $4.02 and high estimate $4.30).

Takeaways: With ongoing initiatives in each of the four pillars of its Wabtec Performance System, as well as international expansion, WAB should be able to continue growing its top and bottom lines.

Management

Executive Chairman: Albert J. Neupaver served as President and CEO from 2006 through 2014; earlier this year he moved to his current position. Prior to joining Wabtec, he served as president of the Electromechanical Group of AMETEK, Inc.

President & Chief Executive Officer: Raymond T. Betler

Senior Vice President and Chief Financial Officer: Patrick D. Dugan

Board of Directors: ten directors including Executive Chairman Neupaver, CEO Betler, and Lead Director Bill Kassling. Kassling is the former Chairman and led the management buyout in 1990. Five of the ten directors are current or former Wabtec executives, and the other five all have CEO or Chairman in their titles (in some cases, Former). Areas of expertise and experience among independent directors include transportation (including rail), investment banking, and engineered components.

Takeaways: A well-established management team and board of directors.

Ownership

Gurus: Eight gurus followed by GuruFocus have holdings in WAB; the largest holding is that of Columbia Wanger (Trades, Portfolio), with 1,200,000 shares (about 1.25% of shares outstanding). Other gurus holding stock include Jim Simons (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio), First Pacific Advisors (Trades, Portfolio), Ron Baron (Trades, Portfolio), John Keeley (Trades, Portfolio), Mariko Gordon (Trades, Portfolio), and Chuck Royce (Trades, Portfolio).

Institutions: nasdaq.com puts the number of institutional shareholders at 402, and collectively they own 87,464,333 shares, which represents just under 91% of shares outstanding.

Shorts: GuruFocus puts the short interests at 0.95% of the float, and shows their history in this chart:

03May20171308301493834910.png

Insiders: As of May 14, 2014 Yahoo! Finance showed Director Emilio Fernandez holding the highest number of shares among insiders, with 838,078; Executive Chairman and Director Albert Neupaver clocks in second with 494,528 shares. GuruFocus assesses insider ownership at 3%.

Takeaways: WAB provides the ownership profile we expect for a company with this kind of history and past performance. High institutional ownership, along with modest holdings by gurus, shorts, and insiders.

WAB by the Numbers

03May20171308311493834911.jpg

Takeaways: A small dividend and no share repurchases in 2013, however, it has a strong Return on Equity (trailing twelve months).

Financial Strength

The GuruFocus automated evaluation system gives Wabtec 6/10 for Financial Strength, and 10/10 for Profitability & Growth:

03May20171308311493834911.jpg

The less-than-stellar rating for financial strength reflects the rising long term debt, from $323 million in fiscal 2012 to $450 million in fiscal 2013, and to $521 million at the end of the third quarter in fiscal 2014. Despite this, the company’s Cash to Debt ratio is still ranked better than 78% of the 1,082 companies in the Railroads industry.

Turning to cash flow, we see it’s also grown, and the following chart shows its ups and downs over the past five years:

03May20171308321493834912.png

Takeaways: While WAB receives a mediocre score for financial strength, it is above average for its industry, and its free cash flow remains strong.

Valuation

For our first look at WAB’s valuation, we take a look at its listing in the Buffett Munger screener:

03May20171308321493834912.jpg

When assessing stocks in the Buffett Munger screener, we want to know the PEPG ratio, which is the P/E ratio divided by the average growth rate of EBITDA over the past 5 years. Looking at the screener (after closing, November 4, 2013) we see the P/E clocks in at 24.90, while the five-year earnings growth comes in at 24.60. Dividing P/E by the earnings growth rate gives us a score of 1.01, which is considered fair valution (anything less than 1.0 is considered undervalued, anything over 2.0 as overvalued, and anything in between at fair value).

Let’s note that only 56 of the many thousands of stocks followed by GuruFocus make it through the Buffett Munger screener, and that in itself is an important consideration.

And, we take note that WAB earns a 5-Star rating for predictability, which means it has been highly consistent in growing its revenues and earnings (and/or EBITDA). Higher predictability almost always indicates better than average price appreciation and lower than average chances of suffering a loss.

Takeaways: A fair-valued stock with much higher than average predictability, making it an excellent long-term prospect.

Opportunities & Risks

Wabtec has successfully used a four-pronged growth strategy - The Wabtec Performance System - for almost 25 years now. The prongs are:

Global and market expansion: emerging markets are particularly important; as their economies grow (some at multiples of North American and European growth rates), their transportation systems grow in lockstep.

Aftermarket expansion: Things that move, like rail cars and locomotives, constantly wear down and require replacement parts.

New products and technologies: Safer, better, cheaper is a mantra of buyers in almost every industry, and companies that can score on one of more of those criteria have big opportunities to expand.

Strategic acquisitions: A company with strong financials has the luxury of buying its way into, or further into, each of the three other prongs: global and market expansion, aftermarket expansion, and new products and technologies.

One specific opportunity warrants attention; the United States government has mandated the use of Positive Train Control (PTC) systems (moving trains into the computer age - "...integrated command, control, communications, and information systems for controlling train movements with safety, security, precision, and efficiency" in the words of the Federal Railroad Administration). This is a promising market for WAB.

Risks to Wabtec’s success and survival include:

The economy, both at home and abroad. When the economy slows down, the wheels slow down, meaning less wear and tear on rolling stock, and less demand for Wabtec products and services.

International expansion may pose any number of problems, including currency risks, lack of control when partnering with other organizations, and the risk of nationalization.

It faces exposure due to warranties on the products it makes and sells; in its 10-K for 2013, the company also notes, "...in recent years, we have introduced a number of new products for which we do not have a history of warranty experience."

It also notes that labor disputes may have a "material adverse effect" on its operations and financial results. About 27% of its workforce is unionized.

Outlook

As they say in the mutual fund ads, past performance is not a guarantee of future results. But, a company’s history provides us with at least some objective perspectives on its future.

In the case of Wabtec, that history looks solid. As Executive Chairman Neupaver reports in the 2013 Annual Report, the year-end share price had increased for 13 straight years, and earnings per diluted share had a compounded annual growth rate of 19% since 2006.

Barring a sudden plunge, the 2014 year-end price should be up again, and barring an earnings surprise, this metric will be higher as well.

As we’ve seen, estimates for 2015 earnings look healthy as well, which should put a positive push behind the share price.

Looking beyond 2015, there appear to be no reasons why the company should not continue along the same prosperous path.

Conclusions

Westinghouse Air Brake Technologies is a solid company, with a long, storied past. It is now much more than just a train brake company, but it has maintained its focus on railroads and rolling stock.

There’s not much here for income investors: WAB pays a forward quarterly dividend of 6 cents, which translates into a yield of less than a third of one percent.

However, for capital appreciation, this looks like a reliable producer for investors who want to tap into the power of predictability.