Bullish Case For Westport Innovations

| About: Westport Fuel (WPRT)

Some of the readers of my last article The Long-Term Bullish Case For Natural Gas Related Stocks emailed me at my web page with the question: "How do I know when to buy Westport Innovations, Chart Industries, Cheniere Energy or Clean Energy Fuels?"

A major point is you will never "know" with complete certainty the perfect timing to make an investment. What you want to do is to place the odds of success in your favor. Nothing in life is certain and just so in the same way, nothing on Wall Street is certain. However, individual investors can increase their odds of success by:

  1. Reviewing the macro factors driving an industry (the big picture analysis)
  2. Reviewing the specific company fundamentals
  3. Considering the timing of their investments

For this discussion, I am going to use Westport Innovations (NASDAQ:WPRT) as my example case.

Bullish Ideas: Westport Innovations in focus

Westport Innovations is a company that stands to benefit greatly from the macro economic events unfolding now in the natural gas market.

Step 1: The macro review or big picture analysis

Why use natural gas as a transportation fuel?

The migration to utilize natural gas for transportation fuel is based on sound business economics. Efficiently run companies always find ways of becoming more profitable by squeezing every last drop from their cost structure. Companies routinely chase after very marginal cost savings opportunities. Moving from diesel to natural gas for a logistics fuel has the current potential to save companies 50% per gallon on their fuel costs. This equates to millions and millions of dollars in benefits for shareholders in companies like FedEx, UPS, Walmart, Target, Waste Management, Pepsi and Coca-Cola, just to name a few. Companies will RUSH to implement changes when millions of dollars are on the line, and when those changes provide a competitive cost structure advantage over peers.

The natural gas train has left the station and adoption is occurring - this can be seen by the recent articles from major corporations like GE, Blackstone Energy, Westport and Caterpillar, just to name a few. Some of the major factors working for and against natural gas are discussed below.

The primary factor working against natural gas adoption:

The lack of infrastructure to support exploding demand is the primary hurdle to adoption. This is, however, only an issue of time and has nothing to do with the economics. This issue of "infrastructure build out" is what provides the investor with an economically resistant and decade-long investment opportunity.

Factors working in favor of natural gas include:

Natural gas is abundant and inexpensive. It is available within the United States, and therefore supplies are dependable. Worldwide demand for oil continues to increase resulting in upward pricing pressure. Instability within the Middle East continues to place a supply interruption premium on oil prices. Natural gas is environmentally more appealing when compared to oil, coal and nuclear energy. The pricing differential discussed graphically below substantially favors the adoption of natural gas as a primary transportation fuel.

Click to enlarge

The chart above graphically illustrates the pricing differential between diesel and natural gas through March 2012. This pricing differential is the single most important factor for investing in natural gas related companies. As this relative price gap widens, the Return on Investment (ROI) payback period shortens and the incentive to invest becomes more attractive. Note: In March of 2012 natural gas hit a 10-year low, while oil prices (and therefore diesel prices) continue to rise.

Magnitude of savings

Government statistics conservatively estimate that 2 million moderate- to heavy-duty vehicles (class 5-8) operate in the United States. Industry experts assume 30%-40% of the class 5-8 trucks are considered "high-mileage" vehicles. A high-mileage vehicle is defined as traveling 80,000 to 160,000 miles (or more) annually. These are the trucks that will benefit significantly by utilizing lower-cost fuel.

For illustrative purposes we will calculate the savings on 30% of the class 5-8 vehicles (only high-mileage vehicles) and use 120,000 annual miles as the "average" annual mileage. If we assume 5 miles per gallon (which can vary dramatically based on load weight), total fuel consumption calculates to 24,000 gallons (120,000 miles / 5 mpg) of diesel used annually. Now if the average cost of diesel is $4 per gallon and a 50% cost reduction (or $2 per gallon savings) can be achieved by switching to natural gas, this calculates to $48,000 ($2 savings x 24,000 gallons) per vehicle per year.

The fuel cost reduction on only the number of high mileage vehicles - 600,000 (2 million x 30%) is billions in annual savings. This is absolutely enormous! A potential savings of this magnitude supports massive investments for engine conversions, infrastructure, and retail opportunities. Companies adopting the technology can earn huge returns on investments, which in turn gives substantial pricing power to the companies developing the technology and companies providing infrastructure components (expanding volumes and margins).

I could continue on with the lower-mileage heavy-duty trucks, medium-duty trucks, light-duty trucks and everyday cars, but I think you get the idea that the demand for corporate efficiency and a competitive advantage will be driving industry adoption of natural gas for decades to come.

The reality is even better because as long as the structural price differences remain (natural gas prices less than diesel), the magnitude of savings (billions) will drive the paradigm shift toward adoption of natural gas and support billions of dollars in investments. Additionally, because of the ROI and competitive advantage for early adopters, this change will take place no matter what the overall economic conditions within the United States are at the time, making this a premier area to invest in over the short and long term.

Step 2: The fundamental case for Westport Innovations

The phrase "linchpin" can be figuratively defined to mean; "something that holds various elements of a complicated structure together." The linchpin that makes the conversion to natural gas powered transportation vehicles possible is Westport Innovations. Westport is one of the companies that stand to benefit the most over the next several years from the migration to natural gas as a transportation fuel. It is a pure play on gas powered engines and current global leader in natural gas engine technology. Its intellectual property position gives it a competitive advantage over others.

So what exactly is WPRT's business?

Westport is a global leader in alternative fuel, low-emissions technologies that allow combustion engines to have cleaner emissions through the reduction of greenhouse gases and lower amount of particulate matter. Their technologies allow engines to run on clean-burning fuels - such as compressed natural gas (CNG), liquefied natural gas and biofuels (landfill gas).

The company targets three engine markets - light-, medium- and heavy-duty. Westport addresses each market separately through the use of joint ventures or in house development. The light-duty market or Westport LD - is focused on light-duty automotive systems, components and engines. This area also includes industrial applications for smaller vehicles such as forklifts.

The medium duty and heavy duty segments are currently dominated by the Cummings/Westport 50-50 joint venture. The joint venture currently includes a wide range of natural gas engine sizes from 5.9 to 8.9 liters. Additional investments / development costs have been incurred and a 12-liter engine is now in field trials.

Traditional fundamental comments

WPRT as a result of the Macroeconomic factors discussed above is a company growing at an exponential rate. The growth curve results in a company that has a strong business case and not a strong income statement as measured by traditional standards. When a company is first building a business the expenses (both fixed and variable) to establish the supporting mechanisms for future growth are necessary. This results in losses in the early years where the sales trajectory and related margins don't cover the necessary business startup expenses. Traditional fundamentals just don't apply. The losses do, however, give the pundits something to write about and offer up their opinions. All this should just be considered investing noise. I can't even count the number of articles written about start-up tech companies running losses during their exponential growth phase.

Start-up companies need to be reviewed by the balance sheet and not the income statement. Investors need to ask themselves: Does the company have enough cash on hand to achieve its goals? Will the company have to issue more shares and raise additional funds thereby diluting current shareholders? WPRT has recently issued equity (first quarter of 2012) in return for cash. Management has acknowledged at this time it doesn't foresee another equity offering in the near future. Stated another way, it may be saying: "We have enough cash to achieve our business goals."

Fundamentally, for a start-up company, you should pay attention to the sales trajectory. With WPRT, you should also keep watching the price of natural gas to diesel chart (noted above in the Big Picture Analysis). If either of these items change substantially - beware, there would be substantial down side as the business case would no longer support investment.

Step 3: Timing of investments

So how do we place the odds in our favor when making a longer term investment? And when should we push the buy button?

The next critical item relates to the timing of your investment. Bad timing can decimate a good investment. Just look at how many people bought technology stocks in the bubble - Microsoft (MSFT), Cisco (CSCO) and Intel (INTC) just to name a few. All are dominant within their industry, and great businesses with excellent business cases supporting the investments, but the timing was awful and as a result many people took huge losses or are still sitting on unrealized losses eight years later. Timing is so important and many investors don't have a clue about it.

So, in the example below, I have detailed some of the points of technical analysis that I have used during my investing career, using WPRT as my example.

Please note - this is not a recommendation to buy WPRT or any other financial instrument. This example is for illustration and education purposes only.

Step 3.1: Market Health

Review the technical health of the major indices. I like to use the S&P with an eye on Nasdaq 100 - which unfortunately must be discounted due to the weighting Apple (AAPL) carries within the index. By most measures, the S&P is extended and needs to consolidate through time (many more weeks of basing near the highs) or constructively pull back to either the rising 50- or 200-day moving average. Now is not the time to initiate new investments, no matter what the business case.

Step 3.2: Individual Stock Health (weekly, then daily charts)

The weekly and daily charts of WPRT are broken and no longer bullish. Distribution (higher volume down weeks / days) has been occurring over the last 8 weeks on a regular basis (the daily charts shows this better than the weekly). Now is not the time to be initiating new investments based on technical analysis.

Step 3.3: So if now is not the time to buy, where would a great buy point be on the charts?

I like to look at both weekly and daily charts. I am looking for "buy points" for long-term investments- assuming the business case is still valid and the market is not crashing. The examples are below.

Buy point (1) is at the 200-period moving average. This is an established area of support on the charts - primarily as a result of institutional buys occurring in these areas, which creates demand and therefore price support. This area also roughly coincides with support formed over a 9-month period as noted on the daily chart in step one above.

Now as you can see the weekly buy area (2) is a significant distance from the current price and in all likelihood will never be challenged / tested unless;

(1) The overall market falls into a bear market, or

(2) Problems/ doubts about the "business investment case" develop.

You should, however, keep the weekly buy area in mind for the "once in a decade" investment opportunities brought about when Wall Street goes bananas (1,000 points down in 15 minutes), the market is crashing (no bulls to be found), and blood is running on Wall Street. This is the point at which you should review your investment thesis and put money to work.

Additionally, this area (on the weekly chart) can be looked at as support that should not be broken on a technical basis. If this area is broken, you should immediately review the investment thesis and make changes accordingly.

Lastly, don't think of these technical areas as hard boards - areas accountable - " to the penny," but think of them as mattresses - a range of support where nothing is "to the penny. "

Closing comments

The general market conditions are not right for going long WPRT at this moment. So sit tight and pick your buy point carefully. Keep watch of the macroeconomic events in the natural gas market and sales trends at WPRT. Be patient when investing. Remember investing is for long term capital appreciation - not the $2 your stock went up yesterday.

It has been my experience that through utilizing the 3 Steps detailed above and a somewhat diversified portfolio of assets the "common" investor can outperform the markets.

Finally, you don't need to put all your money at work on one trade. Pick a range to buy your full position or a timeline (over weeks) - do not be in a hurry. I enjoy averaging into positions that I have unrealized gains currently - averaging up and never average down.

Disclosure: I am long WPRT.

Additional disclosure: I may buy more on a general market pullback at or near the 200-day moving average.