Westport Innovations (WPRT), a manufacturer of natural gas engines, has been confusing its investors in the last ten days or so since the day it slashed its revenue guidance for this year, citing slower-than-expected adoption rate for natural gas as the main reason. The stock fell by more than 11% on this news.
In a week's time, the stock declined again as both Goldman Sachs (GS) and Piper Jaffray put the stock on a sell rating, citing weak demand for its products and slower development of natural gas infrastructure as the main reasons. On 8th November, the company reported its earnings which missed both the revenue as well as the earnings estimates leading to a further decline.
However, the confusion came in the scene when the stock started to climb after CEO David Demers claimed that the order activity for the quarter was high and the revenue is expected to grow by 30% for 2013, which was consistent with the long-term forecasts for the company's performance. Also, the management claimed that the demand for its products was not sluggish. The heavy-duty segment, the segment highly criticized by the investors (reasons stated below), of the company is seeing repeat orders.
If that was not enough to surprise the investors, Deutsche Bank (DB), yesterday initiated a buy rating for the stock, citing that the negative news of slower-than-expected natural gas adoption rate has already been priced in the stock (the stock fell after the company slashed its revenue guidance). It also sees an inflection point for natural gas vehicles (NGV) from 2013 as the engine technology advances. According to Deutsche Bank, the stock will be pushed up by multiple potential catalysts in the future.
WPRT reported a loss per share of 46 cents, 12 cents below the Street's consensus of 58 cents and -70% on a Y-o-Y basis. The revenue of $76 million was -6% Y-o-Y and below the estimates of $83 million. The company reported solid results for its light-duty truck business. The revenues for the segment remained flat. However, keeping foreign exchange neutral, the segment's revenue rose by 10%. The strong results in North American operations were offset by the weak European operations. Margins for the LD segments also rose.
The main concern for the investors has been the Heavy -Duty (HD) segment. The HD NGV adoption rate has been slower than what the market expected. Last quarter, the company's revenue for this segment declined by 32%. The operating loss also increased by 16% clearly showing why it has worried the investors.
In the HD category, the comparison between Spark Ignition (SI) and High Pressure Direct Injection (HPDI) is made time and again. Where HPDI is superior in technology because of its better fuel economy, better braking power and lesser exhaust heat, SI is cheaper in cost and has lesser EPA requirements to be fulfilled.
Why I disagree with Goldman Sachs and Agree with Deutsche Bank
· GS believes that the company's HD segment is expected to face many potential headwinds in the future which will delay its time taken to generate the first dollar of profit. GS and JP Morgan (JPM) both believe that it is SI technology and not HPDI technology which will ultimately win substantial share of the Class 8 long-haul natural gas truck market.
This can be a major headwind for WPRT given that over the years, it has developed its reputation and expertise in developing HPDI technology and not SI.
To me, the notion of SI gaining share over HPDI seems a plausible idea. However, one should not forget that WPRT also has exposure in SI technology through the joint venture with Cummins (CMI), the Columbus-based truck engine manufacturer. In that lieu, CWI's (the Joint Venture between WPRT and CMI) 12-L engine (equipped with SI technology) is expected to receive significant interest from the market.
Also, WPRT is relying on HPDI technology to penetrate the market for heavy machinery. Its partnership with Caterpillar (CAT) is a good example of it. HPDI will be used in high horsepower applications for rail and mining markets.
WPRT is gradually penetrating in the massive Chinese market through its JV with Weichai, one of the leading natural gas engine suppliers in China. WPRT's 12-liter engine is expected to deliver strong market share as the market for natural gas engines develops in China.
Another possibility can be that given the high standards that WPRT's HPDI technology has reached, any other company (possibly a competitor) can think of acquiring that technology from WPRT to increase its market share.
· According to GS, JV with CMI is scheduled to terminate in 2021 with a buyout option at 1.3x EBIT in 2019.
This can again be a major headwind for the company given that CWI accounts for most of the revenues of WPRT. A buyout would mean that WPRT would no longer own the terminal value of the business. WPRT's economic share of JV would be around 30%, much lower than its current share of 50-75% of JV's profits.
I believe that chances of a buyout are high. However, WPRT has developed a solid repute in the field of natural gas engine manufacturing. This will help it to establish meaningful partnership with another significant global truck manufacturer. The partnership will provide distribution channel for WPRT engine products, just like the way CMI has provided it with an extensive distribution channel. Market considers Daimler (OTCPK:DDAIF) as the foremost contender for this partnership.
Lastly, we can always consider the possibility of CMI extending CWI JV beyond the current term. This possibility cannot be neglected given that more than half a decade is still to go and circumstances can change in the favor of WPRT. For example, WPRT establishes its name in SI technology as well and so on.
GS expects WPRT to turn profitable in 2015. This notion can be refuted in the light of the NG adoption rate. Given that NG adoption rate paces up, the demand for gas driven trucks will go up and WPRT will turn profitable much earlier than 2015. The NG adoption factor heavily relies on NG fueling infrastructure. No one wants to end up in the middle of the road with an empty tank. In this context, Clean Energy Fuel Corp. (CLNE) has been playing a vital role by setting up the American Natural Gas Highway. The company plans to establish a network of 150 stations by the end of 2013 with 70 stations built by the end of this year. Earlier, bears claimed that CLNE was slow on developing 70 units for this year. However, this idea was clearly proved wrong when CLNE announced in its 3Q earning release that it had already deployed 48 LNG stations and was well on target to make another 22 for this year.
The summit to be hosted by American Trucking Association from 28th to 30th of this month, will be an important event as different trucking companies, shippers and truck-stop companies will sit together to decide how the trucking industry can switch to natural gas.
The stock is down 22% YTD. Currently, almost 28% of the total float has been shorted. This shows the bearish sentiment of the market towards the stock. I discussed in my previous article and I reiterate it here that this stock is ready to be short-squeezed given that the shale gas boom has brought down the natural gas prices to ridiculously low levels. Most of the sell-side, just like the market, is being overly anxious about the future of the stock. I believe that the recent decline in WPRT's price, brought by the cut in revenue guidance, provides investors a good entry point in the stock. I recommend a long position in this stock.