Westinghouse Air Brake Technologies Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Westinghouse Air Brake Technologies Corporation (WAB), commonly known as Wabtec, is a global provider of value-added, technology-based products and services for the rail and transit industries, manufacturing components and equipment, developing systems, and providing aftermarket services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Wabtec operates in the rail and transit industry, which includes freight and passenger rail. Their business is broken down into two main segments:

Freight Segment: This segment serves railroad freight car owners with products including braking equipment, positive train control, air compressors, and related components and service. It represents a large part of their business, and these components are essential for the functioning of the railways.
Transit Segment: This segment caters to the passenger transit sector. This includes designing, manufacturing, and providing services for transit customers for subway, light rail, and commuter trains. These products include train doors, brake systems, and safety systems. They benefit from governmental funding of public transportation.

In 2022, their combined sales from these segments totalled approximately $8.2 Billion. Their 2022 earnings were heavily affected by a cyber security incident that cost them $127 million in losses. In 2021 the company earned revenues of $7.9 billion, which is an increase of 4% from 2020 revenues of $7.6 billion, primarily due to the economic recovery after the worst of Covid, and acquisitions completed in 2021.

The company also benefits from a long history and presence in the industry with a portfolio of 150 different product categories. They also tend to focus on the North American market, which forms the majority of their sales and revenue. They are also very involved in research and development in order to provide better products and to stay ahead of competitors with innovative technology, which represents around 3.5% of sales.

Moat Analysis:

Wabtec possesses a narrow moat, with a score of 3 out of 5, primarily derived from:

Switching Costs: Due to the high costs of switching to new suppliers, Wabtec enjoys a degree of customer lock-in, particularly in the freight segment. Its products are deeply embedded within customers’ operations, and replacement of components is a costly process, which reduces the likelihood of customers opting for a competitor’s products.
Barriers to Entry: The high costs of entry, and need for specialized components makes it difficult for new companies to enter the market, leading to a high level of consolidation in the railway industry.
Reputation: Wabtec has built a strong reputation and has developed strong relations with long-time clients, which adds some durability to its competitive advantage.

However, these competitive advantages are not exceptionally strong or durable enough to create a wide moat due to:

Competition from large players: Despite some differentiation, Wabtec still operates within a market that includes large and credible competitors that can be very competitive in terms of pricing and quality.
Government Regulations: While regulatory approvals may provide some degree of moat, they also often act as a cap on the total value that can be obtained.

Moat Rating: 3/5 Narrow Moat

Risks to the Moat and Business Resilience

Technological Disruption: Rapid changes in technology could obsolete existing solutions and thus weaken their moat, such as a major shift in electrification of rail.
Cyclical Downturns: The rail industry is subject to economic cycles, which directly affect demand for Wabtec’s products and services. The company would experience a big dip in profitability during recessionary times.
Supply chain Issues: Recent supply chain issues are a big concern for the company. They faced pressure to meet demand in the recent times, having to spend more on premium freight, and they are expecting to continue facing issues in supply chains throughout 2023. These issues could lead to lower production, thus lower sales and revenue.
Commodity Price Volatility: A big jump in steel and other raw material prices could increase costs and lower margins if they are not passed on to the customers.
Acquisition Risk: WAB is prone to acquisitions, but the recent history of acquisitions is filled with missteps and write-downs. A bad acquisition could be detrimental for future growth and performance.
Cyber Security: The company has been targeted by cyber attacks, which have had material effects on company revenues. Failure to protect itself would harm the business in future as well.

Despite these risks, Wabtec demonstrates considerable resilience due to its large installed base of equipment, its long-standing relationships with customers, and the essential nature of its products. However, they should take steps to strengthen their position in relation to long term structural issues.

In-Depth Business Explanation:

Revenue Distribution: Wabtec’s revenue is derived primarily from the sale of equipment and aftermarket services in its two main segments: Freight and Transit. Most of the company’s revenues are generated in North America and Europe. Specifically, the Freight segment contributed 64% of their overall revenues in 2022 while Transit was 36%. A key growth area is its digital products offerings, such as those improving safety and efficiency.
Margins: The gross profit margin for Wabtec is around 28%, but it varies quite significantly between different segments, with Transit being more profitable than Freight. Their Operating profit margin is much lower, around 10.1% because the company has to deal with considerable operating expenses and selling, general, and administrative expenses. The main reason for this relatively low profitability is their dependency on raw materials, and a reliance on large amounts of capital to keep up production.
Competitive Landscape: The industry is highly competitive. In the Freight segment, key competitors include Siemens, and Progress Rail; whereas, in the Transit sector key competitors include Siemens, Alstom, and Bombardier.
What Makes Wabtec Different: Wabtec focuses on innovation in the rail and transportation industry. They invest heavily in technologies for predictive maintenance, automation, and remote monitoring. This distinguishes them from some of their competitors that are focused on more traditional solutions. They also try to maintain a wide portfolio and invest in software and digital solutions which has given them a competitive advantage.

Financials:

Profitability: Despite the large topline, Wabtec’s net income margin is under pressure, at 1.6% in 2022. The company was negatively affected by a cyber security issue in 2022, which contributed to large non-recurring expenses. The company’s ROIC which dropped to around 11%, but is expected to rebound to ~15% in the next couple of years.
Growth: While organic growth has been moderate, acquisitions continue to be an important component of their strategy. They expect a growth of 4-5% in revenues in the next few years, and a big growth in free cash flows to follow. Their growth is also supplemented by a push for digital offerings.
Cash Flow: The company generates consistent cash flow from operations of ~ $1 billion per year, allowing them to re-invest into the business and reward shareholders through buybacks and dividends.

Recent Issues: Wabtec has recently faced headwinds due to:

Supply chain issues: have been putting pressure on their revenues and earnings.
Cyber security attacks: have reduced earnings and revenue, putting pressure on bottomline profitability.
General economic slowdown: recessionary fears may hinder growth for the company and industry.

Management Perspective

Management is attempting to push for more organic growth through R&D investments and new product sales, along with margin expansion through increasing revenue and cutting costs. It was noted that management has a good record of acquisitions, but they still face challenges when it comes to acquisitions. They also recognize that there is high potential in emerging markets that they want to explore in future. All of these should lead to improved performance and better profitability in the coming future.

Understandability Rating: 2/5

Wabtec’s business model is complex due to its involvement in numerous components of the rail and transit industries. Their supply chain is difficult to understand for the casual investors as well. It requires a significant amount of industry knowledge to really grasp what their business really entails.
The company’s wide array of product offerings, while beneficial, can also make it hard to gain a full understanding of all their products and what segment they truly contribute to.
While the core concept of a company serving railways is easy to understand, understanding all the products and services of Wabtec can be too complex for a normal investor.

Balance Sheet Health: 4/5

Liquidity: Wabtec has very good liquidity with current assets outmatching their current liabilities by a comfortable margin. They are able to meet their short-term obligations well.
Debt: While the company has a significant amount of debt (~$5 Billion), this figure is manageable and the company generates enough revenue and operating profit to easily pay off its obligations and maintain its current rating of Ba1. They had an interest coverage ratio of 11.1 in the most recent quarter. A high degree of debt may, however, become a risk for investors in the future, especially if performance deteriorates.
Solvency: The company’s asset base is large enough to comfortably absorb its liabilities. Their shareholder equity is also adequate at $6 Billion. They are capable of meeting their long-term and short-term obligations without significant issues.

Overall, Wabtec’s balance sheet appears to be reasonably strong, but they should take care to manage debt, which is their only real weak point. Their large debt also puts the company at a higher risk in the event of rising interest rates.