Wabtec Makes Its Third-Largest Deal, And Rail Continues To Recover

Summary

• Wabtec's deal for Nordco looks like a relatively low-risk way to expand maintenance of way offerings, with added revenue synergy potential from taking Nordco's offerings worldwide.
• The proposed infrastructure bill includes potentially significant funding support for transport and freight rail, including modernization of rolling stock, track, and signaling.
• Mid-single-digit long-term FCF growth can support a fair value around $100 in 2023 and a mid-to-high single-digit return thereafter; a decent but perhaps not compelling return opportunity.

Writing about Wabtec (NYSE:WAB) a month ago, I did see some near-term risks to the business from the freight business, but more so from sell-side expectations that I thought were a little too high. I also saw an opportunity to buy into a large player in freight and passenger train equipment and services at a time when pessimism was still running high.

A month isn’t much of a window for evaluating performance, but the shares have modestly outperformed the S&P 500 since then (while almost matching the Dow Jones Transports). More interesting to me are the revisions in sell-side expectations, the announcement of the Nordco deal, and some opportunities tied to federal infrastructure stimulus. Between them, I believe Wabtec has upgraded the business and expectations are a little more reasonable for the near term.

I still believe that Wabtec could be a $100-plus stock in 2023 and in normal markets, that’s not a bad prospective return. I’m expecting long-term adjusted revenue in the low single-digits, reflecting challenges and changes in the freight market, as well as mid-single-digit FCF growth and margin improvements over the next three to five years.

Nordco Expands The Service Offering

Maintenance of way hasn’t historically been a large part of Wabtec’s business, but management decided to diversify in that direction, acquiring Nordco from Greenbriar for $400M. The deal values Nordco at about 10x forward EBITDA and represents the third-largest deal in Wabtec’s history.

Nordco generates about 50% of its revenue from roadway work equipment, including spike drivers/pullers, tied exchangers, ballast regulators, cribbers, and another 10% from rail inspection equipment. The remaining 40% comes from railcar movers, shuttle wagons, and lift trucks, and there’s a small ESG kicker here, as Nordco is, I believe, the only provider of battery electric equipment in this segment.

Given the customer overlap, I see relatively low integration risk from Nordco. Almost all of Nordco’s revenue comes from customers in North America and leveraging Nordco’s products through Wabtec’s international distribution is a key revenue synergy opportunity over the long term. While management does expect some cost synergies from the deal, I don’t think you typically want to get too aggressive in assuming major cost synergies (and I don’t believe Wabtec is being aggressive) when buying from private equity, as they’re typically pretty brutal about stripping costs out.

My only quibble with this deal may sound a little ironic given the international revenue synergy opportunity. I would like to see Wabtec make a few more deals aimed at expanding and improving their international reach. Still, I see nothing wrong with this deal and I believe it’s modestly accretive.

Infrastructure Spending Could Drive Some Opportunities

The infrastructure and jobs bill recently proposed by the White House includes a number of provisions that could, at least in theory, drive revenue opportunities for Wabtec.

The White House pitch includes $85B for public transit, including an unspecified allocation to transit rail, while mentioning issues like an estimated backlog of $105B for repairs to capital like 5,000 transit rail cars and rail/signaling infrastructure. On top of that, the bill asks for $80B for freight rail modernization, including upgrades to the Amtrak system.

What, if anything, actually makes it into law remains to be seen, but I do think there is at least some momentum for an infrastructure spending bill, and I do believe that upgrades to transit rail are likely to make it through to a final bill. Moreover, given the “America first” elements of the bill, Wabtec could have some advantages over Knorr Bremse (OTCPK:KNBHF) (OTCPK:KNRRY) when it comes to securing work under the bill.

While I’m not counting on this (literally, I’m not changing my model for it at this point), it would represent revenue upside and enhanced volume that could help fix some of the transit margin issues that have dogged the business for a while.

Other Puts And Takes In The Industry

I don’t expect the announced deal between Canadian Pacific (CP) and Kansas City Southern (KSU) to present much risk to Wabtec. I suppose there’s a slight risk of reduced locomotive modernization demand, but both companies already run pretty lean networks. Moreover, with modal conversion opportunities driving some of the synergy of the deal, increased volumes could drive some small incremental opportunities for Wabtec.

Speaking of freight more broadly, the market continues to recover. Overall rail traffic improved 16% year-over-year for the week ended March 27, with freight volume up about 6%. Freight car deliveries are still likely to be weak in 2021, and below replacement demand, but improving traffic should still drive more modernization and maintenance revenue.

With modernization, locomotive modernization is still a significant driver to watch over the next five years. While precision scheduled railroading (or PSR) has dramatically reduced the number of locomotives in service, those locomotives are still doing hard work and will need modernization and refurbishment to keep running. While this process does generate less revenue for Wabtec than new sales (around 50% or so), it tends to be higher-margin revenue.

The Outlook

Adding in Nordco doesn’t change my long-term numbers all that much, and my 2021-2023 revenue numbers are now about 1% to 2% higher with slight accretion to EBITDA margins. Federally-funded stimulus for track and rolling stock improvements in transit and freight could make a more meaningful difference, but we’ll see what happens to the bill as it moves through Congress.

I value Wabtec on the basis of low single-digit long-term revenue growth and FCF margins improving from the low to mid-teens over the next decade as the company realizes more synergies from the GE deal, improves the transit business, and gains more scale in international markets. On a pre-pandemic adjusted basis, that works out to mid-single-digit FCF growth.

The Bottom Line

I don’t see Wabtec as a screaming bargain, but I do see upside to around $100 over the next three years and long-term total annualized return potential in the vicinity of 7%. As usually happens when I write about Wabtec, I’m sure I’ll see comments about how much Wabtec sucks as a company, and that’s fine – I like buying into retail investor pessimism.

Still, at this point, I wouldn’t call Wabtec a completely compelling name and there are other ideas with more upside that interest me more. On a pullback, or just a longer period of “meh” performance I may reconsider.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.