Seeking Alpha
Small-cap, long/short equity, special situations
Profile| Send Message|
( followers)  

Over the past seven or eight months shares of Westport Innovations (WPRT) have been seesawing back and forth in a narrow price band as bulls and bears argue back and forth about the future of Westport and its alternative fuel systems. Indeed, in the most recent few weeks the band has compressed to around $26.50 to $31.00. If you are happy with returns in the low double digits, read no further. Grab a stock chart, trade away in that little band - and hope there is no serious fundamental development that sends the stock charging off against your long (or short) position.

If you demand higher returns or have an aversion to fundamental surprises, you might do well with a bit of homework. Westport Innovations sells engines for buses and trucks that can use natural gas and other gaseous fuels such as liquid petroleum gas or hydrogen. The company also sells natural gas compression components and subsystems for engines and rail locomotives. Westport's business is principally driven by the adoption of natural gas by rail, bus and industry, a circumstance which is in turn impacted by the availability of refueling infrastructure.

Gnashing of teeth over future sales and earnings

We could spend quite of bit of time gnashing our teeth over Westport's ability to penetrate its markets and the trajectory of sales and earnings. There has been plenty of commentary on that line of inquiry already. Indeed, I suspect divergent views on Westport's future prospects are what have generated that seesaw effect in the WPRT historic price chart. Just take a look at the consensus estimate. The dozen or so analysts who publish estimates for Westport seem to be of a common mind that Westport will not report a profit any time soon. However, there is quite a bit of disagreement on just how fast Westport can ramp sales and climb up out of the red ink that has characterized its performance since inception.

The consensus earnings estimate for 2013 is a net loss of $1.90 per share on $177.6 million in total sales. (Just so you know, these numbers are all in U.S. dollars even though Westport is a Canadian company.) The current year consensus seems reasonable given the net loss was $1.96 per share on $149.7 million in the last twelve months. However, management's guidance, which was most recently updated in early May 2013, when the company reported March quarter results, is for sales in a range of $180 million to $200 million in the year 2013. A consensus estimate below company guidance suggests a whiff of caution in the air despite management's cheerleading.

What is more instructive is the range in contributions to the consensus estimates. The range for sales estimates for 2013 is from $152.1 million to $186.1 million. That is not so remarkable. However, look closer at the range of loss estimates - a deep loss of $2.22 to a very optimistic loss of $1.06. Since the ten or so contributions average to a $1.90 loss per share we know most are leaning toward a deeper loss and the analyst with the $1.06 net loss prediction is standing out there alone. Still the wide range of estimates suggests there is little agreement on the monetary value of the company's various joint ventures and distribution partnerships.

The group is having an even harder time interpreting Westport's prospects one more year out. The consensus estimates for 2014 are $256.3 million in total sales resulting in a net loss of $1.28 per share. The range of estimate contributions is wide. Sales estimates range from $194.3 million (modest growth) to $335.5 million (Wowza!). It is no surprise that earnings estimates are all over the place as well, from a loss of $2.15 (little improvement in profitability) to a loss of $0.46 per share (positive cash flow is near at hand).

If there is the possibility that Westport could reach positive cash flow in the year 2014, at least on a quarterly basis, are there adequate resources to support operations without an additional capital raise?

Weighing the balance sheet

Westport's cash flows and balances could provide vital information that could answer that question and maybe tip the scale in favor of the bull case or bear case. Make no mistake about it, sales and earnings growth (or the lack thereof) is the principal driver of stock prices. The most pristine balance sheet in the world will not make up for lackluster sales that produce no earnings. Still, analyzing cash flows and balances tell a great deal about a business and its value.

Westport Innovations has been in business for over a decade, but has yet to post a net profit. Much of this time has been spent in perfecting the product line and establishing partnerships to cultivate and penetrate the transportation market with alternative fuel engines and systems. Along with a bit of debt, the company has taken in $752 million from equity investors to keep the company going. The cumulative deficit was $462 million at end of March 2013. Adding cash, marketable and all other financial assets, Westport still has $195 million at its disposal to support operations. Is it enough?

Converting sales to cash

Accountants and analysts have a fancy calculation to tell investors how long it takes a company to convert sales to cash and another that measures how many days current resources will support operations if cost and spending rates continue without change. Let's look first at the cash conversion cycle, or as it turns out in Westport's case the financing interval.

Before seeing even one dollar of cash manufacturers like Westport first have to invest in inventory and then collect from customers. Two measures - "inventory days" and "days-sales outstanding" - tell us in days how long that takes. Over the last year that was a whopping 274 days for Westport. (See the calculations below.) However, manufacturers can get a break from suppliers with terms that let them slide on payments for materials and such. Accounts payable days tell us how long the break might be. Westport supplier credit tides it over for about 165 days.

That leaves 109 days that Westport must come up with cash to cover its working capital requirements. This is why I called it a financing interval. In dollar terms it is about $29 million.

Yet Westport has more to support than just the flow of inventory purchases and receivable collections. Now we can use what financial analysts call the "cash interval." Since gross profits are not sufficient to cover operating costs, the company is still using cash resources to cover salaries and other costs. If we include long-term financial assets, I estimate Westport has enough cash and working capital resources to support operations for one year and one month, carrying the company into the second quarter 2014.

Of course, this line of reasoning assumes there is no change in Westport's sales level, profit margin or spending on salaries, sales or marketing. Even though analysts have little agreement over the exact numbers, they are all pretty much firm on some increase in sales and some improvement in profit margins. That is more than likely to result in improvement in cash flows, i.e. the required financing interval will shrink and our cash interval will lengthen. Chalk up two points in favor of the bull case for WPRT, at least in terms of the direction of Westport's financial health.

Still it appears close. Will sales and profits ramp fast enough to staunch the flow of red ink before the cash runs out?

Let's take a look at Westport's cash situation from a different angle. What sales level is needed to break even if operating expenses remain at the current level? Since Westport has a very modest level of non-cash expenses, positive cash flow from operations will likely begin just before the company reaches breakeven on an operating basis. Well, if the gross margin remains near 35%, as it was in the last year, it would require about $470 million in sales to support operating spending near $165 million - the amount of operating expenses over the last twelve months. Barring a string of new customer relationships yet in this year, achievement of that sales level is probably at least two or three years out. Maybe we have to take that point away for what appears to be a very close call on cash resources covering the ramp to positive cash flow.

Investors and traders unite

If this analysis of Westport's cash situation is enough to tip your view in favor of a long position in Westport Innovations, it will still be necessary to decide whether the current price level is fair. We have already looked at the consensus estimate and found that even the professionals find little agreement on future earnings. Recent trading in the stock has been frustrating to watch as the stock has continued to trade in that narrow band despite quite favorable news such as the announcement a precedent-setting order from the Canadian National Railway of four liquid natural gas "tenders" to carry fuel for its train locomotives.

The cash flow conundrum cues up a chance for traders and investors to share some notes. A long position accumulated near the bottom of the range might help limit downside risk and leave open the potential for price appreciation even if no catalysts of sufficient strength come along to propel WPRT shares significantly higher.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

Calculations:

Inventory Days = Inventory ÷ (Cost of Goods Sold ÷ 365)

$48.2 ÷ ($97.3 ÷ 365) = 181 days

Days Sales Outstanding = Accounts Receivable ÷ (Sales ÷ 365)

$38.3 ÷ ($149.7 ÷ 365) = 93 days

Accounts Payable Days =

Accounts Payable ÷ [(Inventory Change + Cost of Goods) ÷ 365]

$46.4 ÷ [($5.3 + $97.3) ÷ 365] = 165 days

Cash Conversion Cycle (Financing Interval) =

181 + 93 - 165 = 109 days

Financing Interval in Dollar Terms =

Financing Interval x (Cost of Goods ÷ 365)

109 days x ($97.3 ÷ 365) = $29 million

Cash Interval = Working Capital and Financial Asset

[(Cost of Goods + Cash Operating Expenses) ÷ 365]

($165.7 + $8.2 + $38.3 + $48.2 + $20.5)

[($97.4 + $163.7) ÷ 365] = 393 days

All balance sheet figures are as of March 31, 2013. Sales and cost of goods sold are for the twelve month period ending March 31, 2013.

Source: Conundrum Over Cash At Westport Innovations