Westport Innovations (WPRT) and Fuel Systems Solutions (FSYS) design and manufacture natural gas engines for light, medium and heavy-duty trucks. Therefore, they are pure-plays on natural gas. By pure-play I mean that a higher natural gas (NG) adoption rate will lead to higher revenues for both the companies. Similarly, a slow rate of switching from gasoline/diesel to natural gas as a source of fuel will hurt both the stocks.
However, despite the fact that both the companies are selling the same type of product, I recommend WPRT as a buy and FSYS as a sell. What separates them is the difference in the end markets which they serve. The following charts show the area-wise revenues made by both the companies.
WPRT earns most of its revenues from North America. However, FSYS operations are widely spread all over the world. Though this means more diversified operations (i.e. not all eggs are in one basket), it also means that the company's operations are more exposed to different economies around the world.
The US auto market is picking up strength. The following graph shows the strong results for US SAAR:
The SAAR for September came in at 14.88 million, which was much higher than the Bloomberg estimates of 14.5 million. However, the results for October were spoiled by Sandy Hurricane in the last week of the month. According to Edmunds, historically, auto sales in the last week of October account for 30% of the overall sales in October.
Many people think that the Auto SAAR is not a relevant figure for WPRT and FSYS, given that both these companies manufacture engines for trucks and not passenger cars. However, the US Auto SAAR is not totally irrelevant to these NG-related stocks. The SAAR figure also includes the sale of light trucks in the US. As noted, both WPRT and FSYS, produce engines for the light, medium and heavy-duty trucks.
While the sales figure for the light-duty trucks is covered by the US Auto SAAR, the sales figure for the medium and heavy-duty trucks are released by ACT Research on a monthly basis. In October (latest release), the truck orders for Class 5-7 and 8 trucks came in strong. Class 8 truck orders (heavy-duty trucks) came in at 23,200 units, the highest since January this year. Moreover, 18,500 medium-duty trucks (Class 5-7) were ordered in October. This is the highest figure in the last 56 months.
The growth rate in the adoption of NG is another figure that will directly influence the performance of these stocks. The NG adoption rate has been slower than what the market anticipated. The lack of fueling infrastructure has been the main reason for a slow adoption rate. However, many companies, including Clean Energy Fuel Co (CLNE), are working hard to set up a natural gas fueling infrastructure in America that will surely pace up the NG adoption rate. I have given the details on the development infrastructure in my article on CLNE.
WPRT, having more exposure in North America as compared to FSYS, is expected to benefit more from an increased usage of the NG vehicles in the US.
The circumstances are not getting any better in Europe. The recent figure for October auto sales showed a Y-o-Y decline of 4.6%.
Even though the statistics show the decline in the passenger car registrations and do not specifically show the performance of the light-duty and heavy-duty vehicles, yet these figures help us in understanding the current health of the European economy. The improvement in sales of auto vehicles (trucks) comes on the heels of recovery in the consumer spending and consumer confidence.
Along with a weak European auto market, the natural gas prices in Europe are also a lot more than in the US. Europe gets most of its natural gas supplies from Russia. Following chart shows the difference between the gas prices in, both, North America and Europe:
We can see that the natural gas is much expensive in Europe as compared to the US. Normally, the natural gas price is linked to the oil price. However, in the US, the shale gas boom has made the natural gas a lot cheaper.
Therefore, FSYS, with more than 30% of revenues coming from Europe, is worse-off.
The NG prices are also on a rise in many parts of South America especially Brazil.
FSYS clearly stated in its earnings release that it expects a soft OEM demand in Latin America. Also, the revenue contributions from certain Latin American automotive markets are expected to be delayed from 2012 to the next year.
We have discussed in detail the different areas from where FSYS expects its revenues in the future. However, we have not shed light on the product line that FSYS offers. The company makes its revenues from 2 segments; the automotive operations and the industrial operations.
As already mentioned, the company expects a slower than the previously expected growth rate in the automotive segment. The growth in the demand for aftermarket products in Europe is expected to be slower than the previously expected rate. Also, the revenue contributions are expected to be delayed in Thailand and Latin America.
As far as the industrial operations are concerned, they are expected to show continued slowdown in the auxiliary power unit (APU), the stationery equipment and the mobile industrial equipment markets.
On the other hand, Deutsche Bank believes that WPRT's stock is expected to move on multiple potential catalysts in the near future. I have covered this stock in detail in two of my previous articles. Briefly summarizing it, the main growth is expected to come from the company's light-duty segment. Also, the company is expected to launch 11.9-liter and 13-liter engines in collaboration with Cummins (CMI) in the first three months of the next year. These engines are really desired by the heavy-duty trucking market. The company is also growing in China in collaboration with Weichai, one of the leading natural gas engine distributors in China.
Valuations and Conclusion
Recently, FSYS was initiated by Piper Jaffray as a buy stock. The analyst at Piper believes that FSYS is the cheapest way to invest in the improving US NG market. However, I believe that WPRT is a better way to benefit from an improvement in the NG adoption rate in the US. Why I say this is because WPRT is more exposed to the US market as compared to FSYS. Also, in case of FSYS, a weakness in the European market will offset most of the gains made in the US market.
No doubt, FSYS has been making profits and has no debt to pay-off, but this has already been priced in the stock (given the high forward multiple of 22x). WPRT, on the other hand, is down 21% on a YTD basis. I believe that WPRT is ready to go up once the NG adoption rate improves in the US.