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Summary

  • High quality industry leader selling a somewhat intangible product that benefits from trends in technology, safety, and regulation.
  • Strong ROIC >20%.
  • Seemingly fairly-valued at this point at 31x LTM EBIT(1-t) and 19x FY14E earnings.

Business

WABCO (NYSE:WBC) is a very intriguing business. The company is a global leader in the manufacturing of automotive control systems (ex: pneumatic anti-lock braking systems or "ABS") and sale primarily to commercial vehicle OEMs. What impresses me most about the business is the company's dominance in its categories:

We estimate that our products are included in approximately two out of three commercial vehicles with advanced vehicle control systems.

I see auto part manufacturing in general as an okay business. It's not commoditized as there is some room for differentiation through quality, brand, etc., but it's also not as intangible as something like a consulting service or a can of soda. However, the categories WABCO is in seem much more attractive than auto parts in general. Braking systems and control systems are critical to the safety and performance of the vehicle and increasingly so. It is difficult to place a dollar value on the utility of vehicle safety especially considering potential forgone legal costs and such. These parts benefit from the broad, intuitive tech shift (and more specifically the Internet of Things as applied to the vehicle) and from trends in safety and regulation that are evidenced by the recent multi-company, but GM (NYSE:GM) -centric, vehicle recall and legal debacle. My girlfriend's father works for UPS (NYSE:UPS) and apparently the company is making major investments in electronic integration on its fleet. I suspect many other companies are doing the same.

The company invested 4.4% of sales in R&D in FY2013 which seems adequate compared to other companies I've looked at.

I also like that the company has a long-time CEO/Chairman and seems well-managed in general.

I got a pretty strong initial impression that WABCO is a high quality industry leader. I would feel comfortable investing here at the right price.

ROIC

ROIC is the best quantitative measure of business quality in my opinion so I always like to take the time to get a good calculation. The company's tax rate is temporarily reduced to almost nothing due to tax assets, but I assumed 37% for normalization purposes. I also excluded the company's $362M of goodwill from invested capital. The calculation was:

EBIT(1-t) / (Total Assets - Goodwill - Current Liabilities + ST Debt)

I got 20.6% which is very good - well above the average of 8-10% - and aligns with my qualitative conclusions above.

Valuation

I calculated the following CAGRs for the company:

  • Revenue over past 8.25 years: 5.3%
  • EPS over 8.25 years: 21.4%
  • EBIT over 8.25 years: 4%
  • FCF over 6 years: 19%

Some of the numbers are distorted to the upside by a recent "European Commission Fine Reimbursement" of $280M which was highly accretive to LTM profitability. This line item is non-recurring and non-operating.

Analysts estimate 13% annual EPS growth over the next 5 years.

For a high quality business growing 10%+ with ROIC 20%+, I would see shares as very cheap at about 15x EBIT(1-t) and fairly-valued at 20-22x. The stock currently trades at 31.2x LTM EBIT(1-t) and 19x FY14E earnings. The stock seems insufficiently discounted in my view.

Conclusion

WABCO impressed me as a high quality enterprise and my ROIC calculation of >20% supports this view, but the stock seems fairly-valued at this point and so I will move on for now. I will set a price target at 15x or $83.25.

Source: WABCO: High Quality Enterprise, But Is The Price Right?