Westport Fuel Systems Trucking Toward Profitability

Summary

• The EU, China, India, and United States impose new laws and regulations  transitioning their economies and ecology away from diesel.
• Natural gas fuels and battery-electric solutions are primary.
• Millions of trucks, buses, fleet vehicles, light duty vehicles, forklifts, ships, and trains will switch to natural gas and electricity.
• The small natural gas engine technology company Westport Fuel Systems may be one of the top beneficiaries of the transition.

Recent studies have shown that diesel exhaust is responsible for a major portion of the millions of air pollution deaths worldwide every year. Air pollution threatens the political stability of some local and even national governments. Especially in Asia, Europe, and California, billions of people would like to see diesel exhaust fumes and their carcinogenic pollution disappear from their lives.

Hence, the massive and sudden political movements against diesel and governments' new laws and regulations transitioning their economies from diesel and petrol.

Starting in March (this month), the Chinese province of Hainan will no longer allow the sale of diesel and petrol vehicles. There were one million vehicles in Hainan in 2017, and almost all of them were diesel or petrol.

The Indian province of Andhra Pradesh will stop the registration of diesel and petrol vehicles in 2024. The nation of India has announced it is transitioning to a natural gas-based economy, which will increase the number of compressed natural gas filling stations by several times over the ten years or so. Hundreds of new CNG stations are already being built right now. Thousands of electric and natural gas buses are being purchased by Indian governments.

The Spanish Balearic Islands will ban the entry of diesel vehicles in 2025 and ban petrol vehicles a decade after that.

California seeks to transition all of their buses to electric by 2030. Their new environmental legislation mandates that the state be carbon neutral by 2040.

In February, the EU announced that trucks must emit 15% less carbon by 2025 and 30% less by 2030. They may adjust this in a 2022 review.

In September 2018, China announced that it will force the replacement of one million older diesel heavy duty trucks. By December, Weichai had jacked up production of natural gas trucks to 10,000 engines in a single month; this in turn, seemed to cause a big leap upward in the stock price of Westport Fuel Systems (NASDAQ:WPRT), which partners with Weichai in the production of natural gas-fueled trucks. Production of their Weichai-Westport HPDI 2.0 natural gas truck begins in the second half of 2019, just in time to export to fleet owners in the EU, now looking for lower emissions at a price not so expensive as the still-unproven and rarely-sighted electric heavy duty truck.

And of course, as provinces like Beijing and Hainan start cracking down on diesel pollution, Weichai will be squarely prepared to sell the new HPDI 2.0 natural gas engines, which offer the torque of diesel engines with the lower emissions of a natural gas engine. A Westport field representative referred me to the website, which states

Designed to allow engines to meet the latest stringent emission regulations including Euro VI, HPDI 2.0 reduces GHGs by 20-100% compared to the equivalent diesel engine on a well-to-wheel basis.

GHG stands for Greenhouse Gases, and this metric is as important as MPG in the current political-ecological climate. The 20% reduction is with typical natural gas; the 100% reduction happens with use of renewable natural gas (RNG).

Even with all of these developments, Westport Fuel Systems seemed to underwhelm investors with its Q4 earnings report. The loss per share was worse than expected. The revenues were well-within their own guidance, which also seemed to disappoint.

I believe what investors were truly waiting for was guidance for 2019, and that seemed to disappoint too. Unlike Clean Energy Fuels (CLNE), which sells natural gas fuels at filling stations in the United States, WPRT's upper end guidance on revenues did not even predict a 10% increase. CLNE guided volume increases in the "low double-digits." Amidst quickly improving demand for natural gas transport among populations totaling in the billions, how could Westport predict less than 10% increases in revenues?

The analysts on the call also seemed to be somewhat flummoxed, asking questions about what assumptions were baked in, and just how conservative Westport was being.

When Westport actually broke down their sales projections by division, it sounded better. With California ramping up regulations for vehicles at its smog-ridden ports, the WPRT joint venture with truck manufacturing giant Cummins (CMI), which is known as CWI, will grow solidly this year, it sounds from the conference call:

Yes, CWI is looking to grow this year. The near-zero product has been well received and we are seeing both new buses as well as re-powers [...] There is [the] California HVIP program, the Voucher program has got $79 million this year sort of earmarked for near-zero engine replacement. So, we are seeing tick-up in California. And it's broadening as well to other markets that look at near-zero as a very favorable thing. So, definitely growth for CWI this year.

"Near-zero" refers to the "near-zero" smog (Nitrogen Oxides) engines produced by CWI. In addition to the HVIP program, Volkswagen settlement money, various non-California state subsidies, federal renewable natural gas subsidies, and CARB's Carl Moyer program amount to hundreds of millions of more dollars incentivizing the purchase of natural gas trucks and buses.

Major policy catalysts coming up in the United States are new California regulations on NOx pollution and new federal regulations on that same type of toxic pollution.

Westport HPDI 2.0 versus Iveco Stralis

As for the HPDI 2.0 sales in the EU, which, from what we know for sure right now are through Volvo's HPDI 2.0 heavy duty truck engines, the new CEO David Johnson said that he could not disclose the actual sales of the HPDI 2.0 engines because of agreements with OEMs. But he did say that there were publicly disclosed reports of fleets " placing orders for 20 units or 50 units at a time. And so this is really material." Twenty or fifty units does not sound like much, but such engine sales may be just getting started, as the new EU regulations were just recently decided.

If you do go by news reports, it would seem that nat gas-powered Iveco Stralis NP trucks seem to sell better than the Volvo natural gas trucks. But this may change with the implementation of the new regulations. In fact, Iveco may have miscalculated just how determined the EU is to reduce emissions. The Iveco Stralis trucks apparently lower emissions by up to 10%, which does not come close to meeting the 15% reduction in GHG emissions required for fleets by 2025. Meanwhile, the Westport HPDI 2.0 already meets the 2030 requirement of 20% reductions in GHG emissions.

The new regulations are disruptive. EU trucking firms complain of the lack of infrastructure for natural gas trucking; indeed it is skeletal. And they complain that there is no infrastructure for electric trucks. And most importantly, electric trucks are still in the testing phase and are exorbitantly expensive.

In the Q3 call, Westport reported that EU fleets really have a narrow set of solutions to their emissions problem, and Westport lies squarely in that narrow range. Westport also reported in Q3 that the Weichai deal will allow the HPDI 2.0 engines to be produced at a lower cost as economies of scale develop. Costs will play a crucial role, although operating a nat-gas truck is substantially cheaper than operating a diesel truck.

It had been estimated that the payback on a nat-gas truck was about 18 months. If oil continues its upward trend, and if costs for Westport go down, that payback may be lowered further. The orders of twenty and fifty may ratchet up into orders for the hundreds or thousands as the obvious economic and ecological solution is the HPDI 2.0 engine.

China

Chinese pollution intensified this winter, and the Party seeks to regain its anti-pollution footing by reducing coal consumption, increasing imports of Liquefied Natural Gas, and reducing the use of diesel-fueled trucks. If indeed the national government forces a million old diesel trucks off the road (as it says it will), Chinese fleets may look for lower-polluting trucks that save them millions of dollars each year through cheaper fuel (LNG). Cost-cutting is an important cultural trait of Chinese businesses.

What is unclear is exactly how much Westport makes per HPDI 2.0 engine, and how much they make for the non-HPDI 2.0 engines that the Weichai-Westport joint venture sells. It seems that Westport did not profit a great deal from the 10,000 nat gas engine that Weichai produced in December 2018. These were non-HPDI 2.0.

My hunch is that the new deal, production for which will likely start in late Q3 (from the conference call), pays much more per truck because of the new technology licenses and royalties involved. The HPDI 2.0 technology really is a "game-changer" as some have called it. It combines diesel power with steep reductions in GHG, apparently twice as much as the competition.

Conservative Guidance

Finally, one explanation for the sub-10% increase in revenues as guided for 2019 may have to do with how certain cash additions are accounted for. For instance, the CWI revenues do not count as WPRT revenues. Cash collected from the 50% ownership of CWI is classified as Income from Unconsolidated Joint Ventures. In 2018, this amounted to nearly 23 million, and was derived from nearly 320 million in joint venture revenues. It is the most profitable area of WPRT's business.

Also, Weichai pays WPRT for helping them develop the HPDI 2.0 engine to be manufactured in China. These payments also do not count as revenue.

Even if Weichai starts production in Q3 (which is planned for), when does production ramp up to higher levels and when do the payments start rolling in to WPRT? It may be late in 2019 or early 2020; perhaps those revenues have not been included in the forecast.

Meanwhile, Westport works with Tata in India to develop engines for strict new emissions standards in India. Tata is preparing for manufacture of these new engines and there may be little financial reward for WPRT until buses and trucks start rolling from the shop floor.

Non-HD Truck Markets

Just in India, the number of natural gas engines for buses, trucks, and passenger vehicles may soon number in the millions per year. Volkswagen, Maruti Suzuki and others are rushing to meet demand for nat gas passenger vehicles in India and Europe. Westport is looking for contracts to help develop these new models, and companies like Volkswagen seem to be rushing to get into the market as soon as possible.

So, the theme is, demand for natural gas vehicle engines (including ship engines) is growing quickly. Westport Fuel Systems looks prepared to exploit this through their HPDI 2.0 heavy duty truck engines and the CWI near-zero NOx engines. Sales of sanitation truck engines seem to remain strong and likely will grow stronger with the growth of renewable natural gas production from those corresponding landfills. Regarding buses, postal vehicles, delivery trucks, and passenger cars, it is less clear if and by how much Westport will grow their worldwide share.

SEC

As for the SEC investigation, no one outside of the company knows anything about it. But both the CEO and the CFO have resigned, so, for me, I believe it is a matter in the rear view mirror of the HPDI 2.0 truck climbing a hill with 20% less GHG and nearly zero smog. For more on the costs of the investigation, which is winding down, it seems, see below.

CLNE signs up 500 WPRT trucks

Roger Gilroy wrote a story on Clean Energy Fuels for Transport Topics, dated March 14, two days after the CLNE earnings conference call. He interviewed the head of sustainability Ashley White at CLNE, and he snuck in at the end of the article that

White said operators of 500 Class 8s had taken advantage of Clean Energy's Zero Now financing that makes the cost of purchasing a new natural gas heavy-duty truck equipped with the Cummins Westport ISX12N near-zero engine equal or lower in price than the same truck equipped with a diesel engine, according to the company.

The Zero Now program offers Class 8 CWI near-zero NOx nat gas trucks at the price of a diesel truck (or cheaper) in exchange for a fueling supply deal with CLNE. It is not clear when these 500 trucks were signed up, and if the orders have even been registered by WPRT. If CWI were to increase sales of engines per quarter by 500, it would be a major boost to the bottom line, expanding gross margin per unit as well.

Signing up 500 trucks does not sound like much, but when your American Joint Venture manufacturing segment sells less than 7400 units (and not all were Class 8 HD truck engines) in 2018, a boost of 500 of your most expensive engine in a single quarter would be significant.

Furthermore, none of this boost has been foreshadowed by the revenue guidance because revenues do not include CWI cash payments. Those cash payments do, however, drop to the bottom line.

If CLNE signs up 500 trucks per quarter, and those truck orders represent half of the increase in HD truck engine orders, and if we extrapolate that to four quarters, that amounts to an increase of 4000 Class 8 truck engines for 2019.

CWI wrote checks for $22.7 million to WPRT in 2018, for their share of the profits.

Considering the increased gross margin per engine due to increased scale, and that the HD truck engine is their most powerful, complex part for sale, it is very conceivable that CWI pays WPRT an additional $20 million in 2019, over and above the $22.7 million paid in 2018.

Profits in 2019?

It is this $20 million boost in payments from CWI that is at the center of my thesis that WPRT could be profitable in 2019. According to guidance, Westport Fuel Systems' "consolidated revenues" may increase by up to $25 million; this is less than 10% and may represent, say, $5 million in increased gross margin.

Non-revenue cash payments from Weichai (see above) may help the bottom line. As the year-long SEC investigation comes to an end, this may relieve the company of legal expenses they paid in 2018. In fact, the company may recover some cash via insurance payments (they confirmed insurance coverage on the cc). Foreign exchange losses may reverse in 2019 and become foreign exchange gains.

The 2018 net loss for WPRT was just over $40 million. It included foreign exchange losses of $9 million and SEC investigation legal costs of $10 million. Remove that $19 million from the loss, and you get a $21 million loss. Let's say an additional an increase of revenues of $20 million from consolidated activities adds just a bit over $1 million to the bottom line.

Then add the aforementioned $20 million from the unconsolidated CWI profits, and WPRT is at break-even.

I did not include the cash payments from Weichai because I do not know how they will be accounted for. At the very least, they will add to WPRT's cash position. If it adds to the bottom line, WPRT makes a profit for the year.

I have also not counted any new development contracts, which WPRT is presently negotiating; these are high-margin engineering projects. I have not counted any new OEMs agreeing to license WPRT technology or buy their parts. And a number of situations may surprise to the upside. It would not be shocking for Weichai to start selling the HPDI 2.0 engines early in H2 rather than late in H2.

Weichai seemed to surprise investors by pumping out 10,000 nat gas engines in the month of December. What if they sell 5,000 HPDI nat gas engines in H2? Revenue estimates may surprise to the upside.

Confirmed WPRT customer, Volkswagen, seeks to sell up to 10% of their cars with CNG engines. Maruti Suzuki plans on selling 200,000 nat gas vehicles per year in India by 2022. The Indian shift to a CNG-based transport system may pay major, surprise dividends in 2019.

Three other big surprise elephants in the room are: 1) If Iveco rolls out their truck engines with HPDI 2.0 technology; WPRT called Iveco a "launch partner" in the Q3 call, 2) If EU truck sales accelerate faster than expected, and 3) If Tata truck, bus, and vehicle sales reap benefits in 2019.

Any number of catalysts may put WPRT in the black. Black as in green cash, not black as in toxic ash.

Stock Price

Well, what does that mean for the stock price? HC Wainwright has a $6 price target. Even amid the Great Recession, aka the Global Financial Crisis, governments ratcheted up their environmental regulations and clean energy programs. I expect new truck regulations to be implemented in the near future in the United States, Latin America (which will be a major market), Africa, Eastern Europe, Southeast Asia, Pakistan, and South Korea.

Plus the renewable natural gas revolution has just begun (see my previous article on CLNE), and all of that carbon-neutral fuel must be used somehow; the most environmentally responsible way will be through fueling formerly diesel trucks. We are talking about possibly several billions of diesel-gallon equivalents of RNG produced just in the United States.

Finally, the Green New Deal is coming. It's coming, y'all. The $6 price target is not unreasonable at all.

Disclosure: I am/we are long WPRT, CLNE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.