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Wabtec (WAB) Research Report: Q1 CY2024 Update


Full Report / May 23, 2024

Rail equipment company Westinghouse Air Brake Technologies (NYSE:WAB) reported Q1 CY2024 results beating Wall Street analysts' expectations, with revenue up 13.8% year on year to $2.50 billion. The company's full-year revenue guidance of $10.4 billion at the midpoint also came in 1.9% above analysts' estimates. It made a non-GAAP profit of $1.89 per share, improving from its profit of $1.28 per share in the same quarter last year.

Wabtec (WAB) Q1 CY2024 Highlights:

  • Revenue: $2.50 billion vs analyst estimates of $2.39 billion (4.4% beat)
  • EPS (non-GAAP): $1.89 vs analyst estimates of $1.48 (27.4% beat)
  • The company lifted its revenue guidance for the full year from $10.2 billion to $10.4 billion at the midpoint, a 2% increase
  • Gross Margin (GAAP): 32.9%, up from 30.5% in the same quarter last year
  • Free Cash Flow of $303 million, down 50.2% from the previous quarter
  • Organic Revenue rose 11.9% year on year
  • (15.7% in the same quarter last year)
  • Market Capitalization: $29.91 billion

Also known as Wabtec, Westinghouse Air Brake Technologies (NYSE:WAB) provides equipment, systems, and its related software for the railway industry.

As the name suggests, the company was a pioneer in braking technology for locomotives that utilized air pressure rather than friction. Today, the company's product portfolio is broader and it serves both the freight (moving goods) and transit (moving passengers) end markets. It provides products like freight and passenger train cars of various types and uses, brake systems, communication systems, and software for train control and monitoring.

It generates revenue through the sale of its aforementioned equipment and through the aftermarket maintenance, repair, and parts supply for its products. While the macro may cause swings in demand for heavy equipment and complex systems, existing trains will continue to need maintenance and repairs. This revenue stream smooths out Wabtec's topline. Its software also provides operational efficiency analytics and improvements for train operators, which together with its maintenance services act as a diversified stream of recurring revenue. As the world digitizes and data becomes table stakes across all industries, these offerings will be more important for Wabtec's success.

Wabtec's customers include freight rail operators, passenger rail operators, railcar manufacturers, mining and industrial companies, as well as governments responsible for the operation of its transit systems. While it has historically grown mostly through organic means, the company acquired GE Transportation in 2019 for $11 billion, paying with a combination of cash and stock.

Heavy Machinery

Automation that increases efficiencies and connected equipment that collects analyzable data have been trending, creating new demand for heavy machinery and equipment companies. The gradual transition to clean energy also allows companies to innovate around emissions, potentially spurring replacement cycles that can accelerate revenue growth. On the other hand, heavy machinery companies are at the whim of economic cycles. Interest rates, for example, can greatly impact the commercial and residential construction that drives demand for these companies’ offerings.

Other companies in the freight and passenger rail industry include Trinity Industries (NYSE:TRN), and European competitors Alstom (EPA:ALO) and Knorr-Bremse AG (ETR:KBX).

Sales Growth

Examining a company's long-term performance can provide clues about its business quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Wabtec's sales grew at an incredible 15.3% compounded annual growth rate over the last five years. This is a great starting point for our analysis because it shows Wabtec's offerings resonate with customers, hinting that it could be a high-quality business. Wabtec Total Revenue

Long-term growth is the most important, but within industrials, a half-decade historical view may miss new industry trends or demand cycles. Wabtec's annualized revenue growth of 12.3% over the last two years is below its five-year trend, but we still think the results were good and suggest demand was strong.

We can better understand the company's sales dynamics by analyzing its organic revenue, which strips out currency fluctuations and one-time events like acquisitions because they don't accurately reflect the demand for the company's offerings. Over the last two years, Wabtec's organic revenue averaged 13% year-on-year growth. Because this number aligns with its revenue growth, we can see the company's core operations drove most of its performance. Wabtec Year-On-Year Organic Revenue Growth

This quarter, Wabtec reported robust year-on-year revenue growth of 13.8%, and its $2.50 billion of revenue exceeded Wall Street's estimates by 4.4%. Looking ahead, Wall Street expects sales to grow 4.2% over the next 12 months, a deceleration from this quarter.

Gross Margin & Pricing Power

All else equal, we prefer higher gross margins. They make it easier to generate more operating profits and indicate that a company commands pricing power by offering more differentiated products.

Wabtec's unit economics are better than the typical industrials business, signaling its products are somewhat differentiated through quality or brand. As you can see below, it's averaged a decent 30.6% gross margin over the last five years. That means for every $100 in sales, roughly $30.63 was left to spend on selling, marketing, and general administrative overhead.

Wabtec Gross Margin

Wabtec produced a 32.9% gross profit margin in Q1, marking a 2.4 percentage point increase from 30.5% in the same quarter last year. Zooming out, the company's margin has remained steady over the last 12 months, suggesting that Wabtec's input costs are under control.

Operating Margin

Operating margin is a key measure of profitability. Think of it as net income–the bottom line–excluding the impact of taxes and interest on debt, which are less connected to business fundamentals.

Wabtec has managed its expenses well over the last five years. It demonstrated solid profitability for an industrials business, producing an average operating margin of 11.5%.

Analyzing the trend in its profitability, Wabtec's annual operating margin rose by 4.5 percentage points over the last five years, showing its efficiency has improved.

Wabtec Operating Margin (GAAP)

This quarter, Wabtec generated an operating profit margin of 16.5%, up 3.9 percentage points year on year. This increase was encouraging, and since the company's operating margin rose more than its gross margin, we can infer it was recently more efficient with its general expenses like sales, marketing, and administrative overhead.

EPS

Analyzing long-term revenue trends tells us about a company's historical growth, but the long-term change in its earnings per share (EPS) points to the profitability of that growth–for example, a company could inflate its sales through excessive spending on advertising and promotions.

Wabtec's EPS grew at a solid 10.7% compounded annual growth rate over the last five years. Despite its operating margin expansion during that time, this performance was lower than its 15.3% annualized revenue growth. Wabtec EPS (Adjusted)

We can take an even deeper look into Wabtec's earnings quality. A five-year view shows Wabtec has diluted its shareholders, growing its share count by 46.2%. This dilution overshadowed its increased operating efficiency and has led to lower per share earnings. Taxes and interest expenses can also affect EPS but don't tell us as much about a company's fundamentals.

Like with revenue, we also analyze EPS over a shorter period to see if we are missing a change in the business. For Wabtec, its two-year annual EPS growth of 20.5% was higher than its five-year trend. We love it when earnings growth accelerates, especially when it accelerates off an already high base.

In Q1, Wabtec reported EPS at $1.89, up from $1.28 in the same quarter last year. This print beat analysts' estimates by 27.4%. Over the next 12 months, Wall Street expects Wabtec to grow its earnings. Analysts are projecting its EPS of $6.55 in the last year to climb by 6.9% to $7.00.

Cash Is King

If you've followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills.

Wabtec has shown robust cash profitability, giving it an edge over its competitors and the option to reinvest or return capital to investors. The company's free cash flow margin averaged 10.9% over the last five years, quite impressive for an industrials business.

Taking a step back, we can see that Wabtec's margin expanded by 5.4 percentage points during that time. This is encouraging because it gives it multiple ways to win.

Wabtec Free Cash Flow Margin

Wabtec's free cash flow clocked in at $303 million in Q1, equivalent to a 12.1% margin. This quarter's result was nice as its cash flow turned positive after being negative in the same quarter last year, but we wouldn't put too much weight on it because businesses' working capital needs can be seasonal, causing quarter-to-quarter swings.

Return on Invested Capital (ROIC)

EPS and free cash flow tell us whether a company was profitable while growing its revenue. But was that growth capital-efficient? A company’s ROIC explains this by showing how much operating profit a company makes compared to how much money it has raised (debt and equity).

Although Wabtec has shown solid business quality lately, it historically did a mediocre job investing in profitable business initiatives. Its five-year average ROIC was 5.8%, somewhat low compared to the best industrials companies that consistently pump out 20%+.

Wabtec Return On Invested Capital

The trend in its ROIC, however, is often what surprises the market and drives the stock price. Over the last few years, Wabtec's ROIC averaged 2.7 percentage point increases. The company's rising ROIC is a good sign and could suggest its competitive advantage or profitable business opportunities are expanding.

Balance Sheet Risk

As long-term investors, the risk we care most about is the permanent loss of capital. This can happen when a company goes bankrupt or raises money from a disadvantaged position and is separate from short-term stock price volatility, which we are much less bothered by.

Wabtec reported $639 million of cash and $4 billion of debt on its balance sheet in the most recent quarter. As investors in high-quality companies, we primarily focus on two things: 1) that a company's debt level isn't too high and 2) that its interest payments are not excessively burdening the business.

With $1.97 billion of EBITDA over the last 12 months, we view Wabtec's 1.7x net-debt-to-EBITDA ratio as safe. We also see its $204 million of annual interest expenses as appropriate. The company's profits give it plenty of breathing room, allowing it to continue investing in new initiatives.

Key Takeaways from Wabtec's Q1 Results

We were impressed by how significantly Wabtec blew past analysts' organic revenue expectations this quarter. We were also excited its EPS outperformed Wall Street's estimates. Zooming out, we think this was a fantastic quarter that should have shareholders cheering. The stock is flat after reporting and currently trades at $169.98 per share.

Is Now The Time?

Wabtec may have had a good quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

There are several reasons why we think Wabtec is a great business. For starters, its revenue growth has been exceptional over the last five years. And while its relatively low ROIC suggests it has historically struggled to find profitable business opportunities, its rising cash profitability gives it more optionality. On top of that, its operating margin expansion shows the business has become more efficient.

Wabtec's price-to-earnings ratio based on the next 12 months is 24.2x. Looking at the industrials landscape today, Wabtec's qualities as one of the best businesses really stand out. There's no doubt it's a bit of a market darling given its higher multiple, but we don't mind paying a premium for a high-quality business. We would argue it's often wise to hold them over the long term even if expectations are high.

Wall Street analysts covering the company had a one-year price target of $155.70 right before these results (compared to the current share price of $169.98).

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