Westport Innovation: Over-Hyped by Wall St., Now a Sell

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Westport Innovations

As is often the case in high growth companies, valuation metrics seems to diverge significantly from the underlying business and market fundamentals. You don’t need to look beyond American Superconductor (NASDAQ: AMSC), Green Dot (NASDAQ: GDOT), OpenTable (NASDAQ: OPEN), and RealID (NYSE: RLD) as some examples of companies that have been brought back to earth after spending time ascending stratospheric levels. As is often the case, these companies enjoyed significant sponsorship from the sell-side and had highly promotional management teams that did not hesitate at any given instant to tom-tom the merits of their addressable opportunity.

We believe that Westport Innovations (“Westport” or the “Company”), a natural gas engine manufacturer represents one such company and is an extremely compelling short candidate at current levels. The frenzy in Westport Innovations (after all 11 out of the 17 sell-side analysts rate the company a “Buy”) stock has been driven by the Company doing a stellar job promoting itself across various media channels and the sell-side community positioning it as one of the best ways to play the natural gas “nirvana” for transportation engines.

This euphoria in Westport driven by historically low natural gas prices has translated into a share price that has almost tripled over the past three years. At a current market capitalization of $2.1B and an Enterprise Value of $1.9B, Westport enjoys an extremely rich valuation of 4.50x FY2012 Revenue consensus with market participants not discounting the very real and obvious risks to its business model detailed below.

The Company is EBITDA negative with analysts projecting Westport to generate $10.2M in EBITDA for FY2013. The Company completed a secondary offerings earlier this year exploiting the momentum in its share price and raising ~$270M. Since pricing at $43.25 per share, the Company has traded below the issue price. We believe that there is much more room for the stock to decline and provide our views on the same.

The Short Thesis
The Cummins Westport JV was amended in February this year with what we believe to be unfavorable long-term consequences for Westport. Suffice it to say, we believe that the economic profile of the CWI JV has peaked and we expect margins to decline going forward as Cummins captures the incremental margin from the mark-up which previously would have accrued to the JV. Also, there has been a sequential deceleration in the JV business this year which does not bode well for the Company as it happens to be the only profit making unit within the enterprise.

The key growth engine (“pun intended”) that provides the supposed justification for the overall valuation of the Company remains the Heavy Duty segment - upon which the sell-side analysts are counting on Westport to deliver strong results. However, this segment remains constrained by exogenous factors such as the build-out of adequate fueling infrastructure which will take a significant amount of time to materialize. For instance there are about 1,000 natural gas stations in the United States versus more than 160,000 gasoline stations. Till then, customer purchases will be sporadic at best as evidenced by the most recent quarter, where unit sales were down over 50% sequentially. Even if the infrastructure build-out starts gaining momentum and the move to purchase LNG enabled engines by Class 8 trucks becomes a reality, we find it highly unlikely that the existing incumbents will just watch the action unfold without making an aggressive push to develop a stronghold in the market.

Quick Valuation
We analyzed Morgan Stanley’s DCF model, in order to understand the assumptions baked into the current valuation. For the Company to be valued as per their “Bear” case (which we believe is still aggressive and translates into a $21 share price – ~45% downside from current levels), the Company will still need to grow EBITDA at a 70% CAGR over the FY2014-FY2019 period with FY2019 EBITDA of ~$270M. If we assume that CWI JV grows at a 20% CAGR over the 2011-2019 period, translates into ~$140M of EBITDA. Given the dynamics highlighted above that relates to the JV, we believe that this could be a tall order to accomplish given margin deterioration and increasing competition.

Summary
To summarize, Westport Innovation’s current valuation has diverged significantly from its intrinsic valuation based on both current and forward business fundamentals and metrics. With the market ascribing tremendous value to the Heavy Duty segment as if the growth in this segment and associated revenue capture by the Company was a “done deal”, the margin of safety is non-existent at current levels. With an increasing number of the established diesel engine manufacturers putting forward strategies for natural gas engines, the demise of Westport Innovations is not an “if” but “when” situation. In the meantime, the Company continues to burn approximately $100M in cash per year with a continued ramp in its opex indicating the lack of operating leverage in its business model. Note that timing of the short to play out is difficult to predict but we are certain that the underlying fundamentals of the business have begun to rapidly deteriorate as evidenced by their recently announced quarter. Given that ~38% of the float is sold short, we would encourage investors to size positions accordingly.

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Comments

  1. Jonathan Garza September 21, 2012

    I had a conversation with some co-workers over lunch this week regarding Natural Gas in the North and how well it was doing due to the price. Just from talks, it sounds like Natural Gas is a good investment these days.

    Is that accurate?

  2. David Owen September 21, 2012

    1) Westport's growth is not geared toward JV with Cummins - it is clear they are focused on internally seeking partners away from Cummins and are also focused on expanding in Asia. In fact, Cummins stuttered on their past quarterly conference call and are nowhere near developing an engine that compares to CWI's, which I believe has forced them into a panic mode.
    2) You didn't brush at all on the market opportunity, which is what matters most with growth co's. Their market opportunity in North America alone is enormous, never mind factoring in that the rest of the world wants off foreign oil.
    3) Another favorable trait not mentioned - MARQUEE PARTNERSHIPS. This is probably the biggest catalyst to growth for Westport, as they will be able to manage it better being able to service larger partners that have respectable brands, thus enhancing sell-through.

    I do like your article, I just think you took the MS model and looked at it from a value perspective a little too harshly. Remember, WPRT has no earnings...it hasn't even broken even yet. Watch for its acceleration of revenue to $1 billion.

  3. Cleo Jones September 22, 2012

    David, I agree with your comments. After listening to the last conference call, I believe this stock will generate a profit much quicker than what analysts have predicted. It's obvious the writer of this article is short Westport.

  4. Jeffrey Campbell September 28, 2012

    The writer wrote:

    Even if the infrastructure build-out starts gaining momentum and the move to purchase LNG enabled engines by Class 8 trucks becomes a reality, we find it highly unlikely that the existing incumbents will just watch the action unfold without making an aggressive push to develop a stronghold in the market.

    This is a rather vague statement that did not get fleshed out in the provided report (I realize SumZero has edited the version we are reading and may have left important explanations out).

    As David mentioned above, the addressable market is one important aspect in attempting to value WPRT. Another aspect is their massive patent portfolio which took over $250mm in spending to amass. Relevant to the patents, the final part is that no one engine manufacturer can count on enough sales individually to justify duplicating such a cap-ex spend to avert going through WPRT to offer the market an LNG burning engine of their manufacture. In short, it is much more cost-effective to work with WPRT than avoid them.

    As long as this is true, WPRT offers a rare example of the technology company that is highly levered to the build-up of its industry as a whole. It really has no viable competitor in the LNG truck space at this time.

    A careful study of the economics of selling diesel versus LNG shows that the margins for the latter are much better, and can afford to discount prices (should oil prices drop precipitously) and still make good profits. On the other hand, natural gas feedstock is a much lower percentage of the total cost of LNG fuel and therefore there is plenty of room to absorb high nat gas prices so long as oil remains in an $80+ per barrel range. Oil has held above $75/b since October, 2009 to date. Putting this together, one needs to believe in extremely low oil prices to believe that LNG cannot have a durable price advantage over diesel as a competitive fuel.

    Aside from that, the only good reason I can see for a structural short of WPRT is if a competitive technology emerges which does not violate their patents, has competitive scale an opex, and finds adoption in the market (which is quite possible since no one likes a single source of supply).

    Baring that, we are simply arguing about valuation. Unlike some of the other companies mentioned in the beginning, LNG for transportation is not pie-in-the sky. It is here and now and will grow because it has a sufficiently fast payback period over the life of a new HD truck engine.

    I believe the writer has a good overall grasp of the LNG truck landscape but need to read something persuasive regarding competition for WPRT presence in the engines of Volvo, Ford, Navistar, Cummins, and so forth to believe in a such a long time frame short in this case.

  5. ralph braseth March 01, 2013

    Short Westport? No wonder this article is anonymous. I'm not a sophisticated investor. I'm more of a Peter Lynch disciple (with a 1/3 of his brain power). First let's talk about the market. Cross country hauler, JB Hunt has 12,000 tractor trailers. Can you imagine having 50% of your fuel costs cut? UPS has 88,000 trucks, FedEx has 42,000, there are 92,000 registered buses in the state of Texas alone and there are 62 million automobiles in the United States. WPRT has a moat filled with sharks with laser beams. Cummins is smart to saddle up, but WPRT will benefit more. That Navistar deal that went through a few weeks back. Each one of those trucks is engineered to take only one size of a Cummins' engine, the exact one WPRT uses as their showcase piece. Structural problems? That's B.S. The big boys in the shale game capped 65% of their wells in the past two years because of the glut of gas. Those hot sites can be up and loading in less than 90 days. The structure of filling stations? With the exception of pressure, there is no a lick of difference between a regular gas station and a LPG station. There are four major contractors in the game right now. There is zero barrier entry into constructing these places.

    And that dear anonymous writer is only the United States. Rather than crunch all those meaningless numbers, look at their business plan. China is locked down tight as a tick. Never mind Europe.

    It might be a year, two years or five years, but WPRT is a slam dunk winner. They represent the biggest economic game changer since the industrial revolution. Tell you what, rather than short WPRT, I'll take your wager and offer 6/5 odds.

    You are so wrapped up in your number smarts that you're blinded and cannot envision a grand picture. Of course there will be bumps, but WPRT owns the single most important invention on the market today.

    Hey, I was just kidding about the 6/5 odds wager. I'm a school teacher and don't come from money. I invest my own retirement and I have only started to build my position in WPRT. I have to be really careful because let's be honest, you, me or the smartest people out there can't successfully forecast the market. Nevertheless, within two years, 15% of my retirement will rely on WPRT. I'll be rich or I'll be in sub-standard housing.

    Good luck with your shorts and wish me well with my longs.

    ralph braseth
    chicago

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