Westinghouse Air Brake Technologies Corporation (WAB) Earnings Call Transcript & Summary

Good morning. My name is Nick Heymann, and I am the research analyst here at William Blair who covers Westinghouse Air Brake Technologies, otherwise known as Wabtec. I am required to inform you this morning that a complete list of research disclosures and potential conflicts of interest are available on our website at williamblair.com. Joining us today from Wabtec is Rafael Santana, President and CEO; and Patrick Dugan, Chief Financial Officer. So we very much appreciate you're taking the time today to join us, Rafael and Pat. I thought you guys -- I think do you have an opening commentary, Rafael, that you wanted to share?

Sure. Nick, first of all, well, thanks for having us here and really want to start here just extending the wishes of good health and well-being to everyone in the call. The economic disruption here we've seen with COVID, I think it has forced all of us to really flex and adapt, and I'm very proud of our employees and their commitment during these times. Our essential priorities have continued to be the same as we described during our earnings call. That includes protecting the health and safety of our employees, maintaining our operational capabilities around the world so we can deliver for our customers and really continue to manage costs and manage cash so we can protect and strengthen the company. We're very much laser-focused on aligning our costs for the new volume realities. And we're committed to deliver on the synergy targets by really executing on a pipeline of actions that we have. We will continue to take the necessary measures to control what we can, protect and build the long term of this company, continue to invest in technology that differentiates us and capabilities to ultimately deliver on value for customers and shareholders. So that was kind of it, Nick. And with that, I'll turn it back to you so we can start the dialogue.

Okay. I guess if I had to start this morning, what's the most significant differences today with regards to COVID-19 and the impact on your business versus the downturn in 2008 and '09? And how is Wabtec today outperforming more resiliently because of its changes in the portfolio versus 2008 and '09? And what ways might it actually be a bit more vulnerable to the slowdown?

Yes. Nick, I'll start and I'll -- going to ask Pat to weigh in as he was actually here in '08 and '09 being part of Wabtec. But I think the company has changed significantly. I mean, number one, I think we've got a lot more exposure to international markets being more than 50%, I think that's a big piece. I think we've got a lot more in terms of what I'll call the recurring revenues if you look at aftermarket being closer to 60%. If you look at just the strength of the backlog, I think certainly we've got a longer-term backlog than we've had. And I think we just got more, I think, exposure to a diverse set of markets, including what I'll call adjacencies for our businesses. We get about over $1 billion of really revenues that come from other industries like mining, like well, oil and gas, like industrials overall. So I think in many ways, the company is better if you were to look versus '08. I think we've also grown exposure to different markets. Probably when you look at freights, we're probably about the same than it was back then. But since then, we've had both acquisitions of Faiveley and then the GET business. But Pat, you might have some comments on it.

Yes. If I go back to 2008 and '09, I mean, a very different company. Very, very different revenue profile. The diversity is just wasn't there that there is today. The company was very focused on North America freight rail with a complementary transit business. Today, it's much more of an international footprint and with new products, new technologies and a broader customer base.

Okay. I have one question here somewhat related to this from the field that as that international locomotive sales have begun to come through at significantly lower cash margins, is there a path to higher pricing or lower cost on your future international locomotive business?

A couple of comments here, Nick. Number one, I'll be careful to assess that international sales are not profitable. This is -- pricing on specific projects are very specific project by project. It's also dictated by the level of differentiation we might have in certain markets or not. So the sense that we have lower margins internationally is just a wrong one. We might have better or worse projects at the end of the day, and we might have different maturity levels in certain markets where we have installed base, where we have labs, technology change, where we have a platform that provides us that differentiation. So I'll probably just start with that concept. And anything with regards to international markets, if I compare to North America, I think we have seen a better scenario than we've seen in North America. I think we continue to see strong opportunities in markets where we are under-penetrated like Russia and CIS. Southeast Asia markets continue to provide, I think, good opportunities for us. Customers in, like, South America, I mean we just had a customer that just got the concession renewed. So that's an opportunity for business. So we continue to see opportunity in international. They're probably certainly more vibrant than if we were to look at the North America lot.

Maybe the client was asking about -- the investor was asking about some of your transit contracts that related to both Fandstan and Faiveley in Europe whereas you're getting through some of those older contracts that perhaps weren't priced as optimally. But by the end of this year, those should be pretty much complete, right?

Well, so number one, when I look at our backlog for the transit business, I'm really happy to say that the team has done, what I'll call, significant change in the tendering process. When I look at the orders we've gotten over last year, we have those orders at a higher margin rate than we had in our backlog in. So we're moving the right direction there and it's a function of really, I'll call, going to projects where we have differentiation, where we can exercise pricing and making sure we're not signing up for, I'll call, terms and conditions that we cannot mitigate risk through that process. So I think there's improvement there, but there's also improvement on execution, Nick. When I think about elements of on-time delivery, cost of quality, I think we're seeing improvement on the business. It's sustainable over time. It's not a perfect line. We're going to have some -- a variation, as you very much comment, associated with, I'm going to call, potentially older contracts, but we're taking steps in the right direction.

Okay. Okay. I guess, today, you have various parts of your business that are more seasonally impacted certain quarters, whether it's your modification, your overhaul, your service work. How has COVID-19 pushed that around here in 2020?

I would say when we look at COVID, I mean, of course, second quarter is going to bear the bulk of, I'll call, the pain associated with COVID-19. I think from an operational perspective, I think the worst is behind us through this pandemic. We've had, at certain points, 20% or so of our sites being impacted in some ways; in some cases, complete shutdown like we had in India for some time. But today, we're largely operational. All of our sites are up back in operations, making, I'll call, the necessary progress to make sure we're getting back to on-time delivery with customers. We've been able, through that time, to maintain largely operational through our facilities and work with customers so we didn't, I'm going to call -- we supported customers based on their needs during this time and we were able to support them through the pandemic. Right now, it's more of a function of making sure we continue to make progress on the operational side to execute on those deliveries. We've had no cancellations for 2020 associated with the pandemic and we're continuing to make progress. But there's certainly a shift, I think, in some of the schedules.

Okay. Right now, what changes have occurred with regards to how your Class I North American freight railroads are prioritizing their spending on Wabtec's products, services, analytics? How have that changed the result of COVID-19 or the current period that we're in might have been accentuated?

Well, I think we're still going through a lot of doubt, Nick, to be very honest. I think we're working very close with customers to look for ways to continue to, I'll call, accelerate efficiency and productivity for down. And I think it's a function not just of some programs that we're currently executing for now like the modernizations, but it's actual -- also bringing in, what I'll call, more enhancements to these. So we've got a number of areas that it's really exciting to see how much more fuel efficiency we can bring; how much more, I'll call, predictability and really ways of running the railroads with more automation, whether if it's a function of how you plan and how you dispatch locomotives, whether if that's a function of simply how you really plan for unscheduled maintenance. And I think we'll continue to accelerate those. I think there's actually an opportunity here to accelerate automation through this process, whether if you talk about single men crew or ways to speed up some of the elements of maintenance through the cycle. So working some of these more and more.

Okay. Okay. We just had a question come in from the field. Could you just speak about the chances of being able to incorporate more legacy Wabtec PTC products across the installed base of GE Locomotives and what might that mean for the company financially? I think they're probably referring to maybe the modernizations where you're taking old Dash 8 or 9 locomotives and then converting them from DC to AC and then also upgrading them to be PTC compliant.

Perfect. So well, in terms of PTC compliance, I mean we're installing PTC, of course, across the fleet as we go. On the modernizations, I think those strategies vary customer by customer, but we continue to have like a very significant pool of DC locomotives where you're able to fundamentally replace 2 AC locomotives for 3 DC locomotives. So this is a program that will continue. And it's not just a function of the horsepower of this locomotives. Actually, the running costs associated with this will be lower as we're putting some fuel improvements into these fleets that are being upgraded. And we're bringing also, what I'll call, reliability enhancements as we do some of these. So there's like a combination of improvements that really allow for what'll I call fast payback for our customers through that process. In terms of Wabtec content, of course, as we do those, we increase and we look at ways of increasing the Wabtec content as we have a lot more, I will call, solutions that go in terms of heat exchangers, in terms of brake systems, in terms of electronics that we can put onboard the locomotive. And that's an opportunity in terms of being more vertically integrated than we were before.

And I think if I recall correctly, GE had some products that they previously sourced from outside sources that now, as those contracts wind down, can be actually switched over to incorporate Wabtec components and products. Is that basically starting up this year or next year that you're going to step up your content on Wabtec products on GE Locomotives?

We started some of that on day 1. It's not just a function of North America, but internationally as well. That's probably where we gained a lot of the traction initially as, I guess, we saw customers a lot more open in terms of really being open to the specification changes and things like that. But even in North America, I think people are ultimately interested on alternatives and I think we're continuing to build on those dynamics.

Okay. In the first quarter, I think the carload volumes declined about 5% in North America year-over-year and intermodal was down about 8%. In the second quarter, these surged way up into the mid upper 20s and now they started to inflect. And over the last 3, 4 weeks, they've been steadily declining. One, when do you think we'll get back to flat year-over-year, if you had a best guess? And two, the employment report last week suggested that we may actually, perhaps, maybe it was misunderstood data and misclassification of furloughs and layoffs, but we may actually have a quicker recovery. And if we did that, what would your customers more likely do? Would they find it easier to modernize more locomotives? Or would it be more efficient to actually pull forward some of the previously possibly deferred orders that they earlier stepped back from and rescheduled?

Yes. I think from a COVID-19 perspective, we saw carloads, to your point, really reached a bottom here through the second quarter, Nick. I think in large, I think as the economy starts to open back up and supply chain resumes itself, I think we have significant opportunity here to gain some of this volume fast or faster than we start otherwise. And this has largely to do with just the economy getting back up with automotive. I mean automotive, if you look at the numbers for this last week, it was like below 4% of the total volume that's being transported. And it's generally above 6%, 6.5%. So a significant opportunity there, significant opportunity just for intermodal to start picking back up. And I think the strategies, I think on the beginning, it starts with just unparking of existing fleets, whether if it's orders of freight cars. But then as you start, I'll call, moving back up with volume demand, I think some of those strategies are going to vary customer by customer. Some customers might actually look in to follow up continue to buy new locomotives. Some other customers might look at modernization as an opportunity here to gain efficiency through it. So it's really customer dependence and based on the maturity of the fleets and the age of the fleets of customers. So also not risk on pinning down when exactly we're going to be back to, I guess, what you call normal volumes there. I think there's a lot still to be understood here as we continue to operate in the course of the next couple of months.

Do you think that the resurgence is going to come from domestic freight, more cars, more appliances, more building products or perhaps more commodities? Or is it really going to be coming from perhaps more exports? So when you think about where the resurgence and things seem to inflect more quickly, what will the source of that cargo update, do you think?

I think the initial source of recovery, when I look at bulk of the bond will come from what I'll call a U.S. manufacturing reopening. And for me, that's going to drive a lot of the elements of whether it's automotive, whether it's demand for metals or even if you go into petroleum products or chemicals and as consumers start going back to work, and well, a more normal life, I think you're going to see intermodal coming back up. I think the latter part of what you said will also help, but I think it's more of a second step in terms of the volume recovery.

Okay. We had a question from the field. With regards to the increased sales of integrated digital solutions that are combined with PTC, everything, how do you protect cybersecurity, protections from the locomotives being hacked and the system being properly protected so that there's not outside forces intervening to kind of take over operation of the trains?

Yes. Nick, there's significant investment that we do in that regard. And we have, number one, a very, I'll call, significant engineering workforce that's able to work through these things. But we will also work with I'll call third-party suppliers to come and challenge a lot of these dynamics to make sure that we ultimately have got the best systems to be able to guarantee a safe and secure system. Safety comes first in what we do, and I think it's something that we'll -- we always continue to look for enhancements and ways to make sure we're protecting it.

Okay. And I guess when we think about the modernization part of your business, the service side, you had mentioned that there was many as 10,000 locomotives through 2025 that might be modernized. And I was curious as to how you see modernizations that are largely focused here in North America with the Tier 1s. As you move beyond '21, how is that mix going to shift? Is it going to be predominantly overseas? Or is it going to be domestic still railroads? How do you see that evolving?

We still have the larger part of our fleets operating in the U.S. It's about 15,000 of the 23,000 locomotives that we got or sold. So it continues to be the largest pool of opportunities, but we've seen our organization speed back -- a bit up also internationally. We signed out of last year our first contract. We're moving to, I'll call, a second base of that contracts and I think the opportunities are there as well. And when you talk about modernizations, I think there's also something to be understood in terms of the magnitude of what that modernization can be. It can be like a full rebuilt and modernization of the locomotive, which can go as high as $2 million. But in some cases, it can be on the hundreds of thousands of dollars with really enhancements to the reliability, to the fuel efficiency of the locomotive and those are, I think, different solutions that we have for customers that demand different types of, I guess, solutions for their business.

Okay. And when you think about the -- I got a question here from the floor -- the field. When you think about your long-term growth formula in terms of organic revenue growth versus margin improvement versus earnings, how do you see that evolving as you go forward? You're in a period now where a big component of your growth is coming from your synergies, the $250 million that you're targeting in the first 3 years. And this is a big important year for you, your second year, but you did better than you originally planned last year. And so as you see this moving forward and then beyond 2022 when you're largely finished with your synergies, how will that mix of your growth because I know you're looking for a significant margin improvement from transit as well as from your freight?

Right. Nick, I'll just start with -- we had the Investor Day on the first quarter. And we remain largely -- I'll complement it to the numbers that we spoke there, I think there's a function of time here in terms of -- especially COVID-19 on how that pushes a little bit to the right. But the opportunity is there. We're going to continue to execute on margin improvement. I think as I look into the short term here, of course, the synergies will help with a lot of that. But on top of synergies, we're taking some very strong cost actions we've started last year and we'll continue to do them this year. We're going to continue to reduce SG&A. We're going to continue to take cost reductions when it comes to CapEx and just looking for ways to be more efficient overall. We don't control the cycles, but I think as I look at us going through this merger, I think we're a stronger and better company, a more resilient company than we would have been in the past. I think our ability to react to some of those volume changes have been faster, and we have continued the opportunity here to see volumes go back up. I think we are -- I think it's positive, the outlook when I think about rail overall. Rail is part of the solution for the world we live in, in terms of wanting to move things in a better way. It's going to come with rail, both for freight and both for transit. And I think we're particularly well positioned with the products that we have, the technology differentiation we have to help customers win share of business as things progress. So it's an exciting space to be at.

Okay. As you think about the company's opportunity to see the fleet of parked locomotives here in North America, get back on the tracks or get modernized. I think it went to the upper 20s at one point here. That's kind of almost good in a way because it gives you more opportunity to help modernize a lot of those locomotives. But because you're putting in place a lot more efficient algorithms to help with connectivity and handoff of the freight in addition to just operating at lower dwell times and higher velocity, how -- what is the optimal, if you will, reserve? Normally, it's around 10% of the locomotives for whole or in part that would be parked? Are algorithms going to change that and 5% will work in the future?

Nick, a couple of things. I think the strategies of each of the railroads in terms of, I guess, the numbers you described as the reserve fleet still vary just based -- I mean, one thing is the reliability of the locomotive per se. The other one is the reliability of the entire system as you go through floodings, as you go through winter, as you go through various elements that can disrupt their operations. I think from a locomotive perspective, I think we're continuing to improve the elements of, I'll call, predictability around our fleets. I think as we bring more electronics, more software, I think that certainly allows customers to be more efficient as they operate these fleets and I think we have a significant path forward. I think a good example that I'd like to use is think about 1980, we took basically 1 gallon of fuel to move 1 ton of freight. And we were able to do that for 235 miles. 40 years later, so basically in 2018, we were able to double that. We went above 470 miles. We have, in my mind, the opportunity to double that again in the next 10 years with some of the enhancements that we'll continue to improve. So I think there's a lot to be said in terms of the efficiency that you can gain from your fleets, and with that, the share the railroads can get in terms of overall freight that is transported around the world.

Okay. Is autonomous operation of freight rail a key component of those incremental gains over the next decade? We have contracts coming up, I think, in '22. Originally, Wabtec was shooting for capable autonomous freight operation by '23. And then when you merged with GE Transportation, it was '22 that they thought they could provide this capability. Can you talk a little bit about that? Because it doesn't seem like, quite honestly, we're still going to have somebody in the train probably till '27 or later.

Yes. So Nick, once again, I think you go customer by customer. I think there are some customers you'll talk in the U.S. that will be already ready to move in what I'll call single men crew with the current operations they have. There are some other customers that would like to have some specific products in order to get to that point, and we have those products that allow for, I'll call, better and seamless communication of your moving with your trains. And I think the sense of crewless, I think it's probably less a function of technology than it is a function of, I'll call it, regulatory and legislation around it depending on where you operate. So for North America, I think it's more of a question of regulatory to go crewless than a technology one.

Okay. Quickly jumping over to Europe transit. Do you think COVID-19 is going to suppress, on a long-term basis, ridership because of fears of social distancing and everything like that on public rail? Or is that something that will be overcome and should fade over time?

Nick, transit is part of the solution. It's not part of the problem, especially if you think about the long term. I mean as you look at ways of moving things in a better way in a more sustainable world, it's not going to come with millions of cars back into the road so everybody can go and move from point A to point B in their individual vehicle. So I do expect significant growth in the investments of transit overall. So you can do that in, I'll call, a more efficient way. There's also elements of improving those transit systems. So you can respect any elements of social distancing, but a more clean system overall. And I think that's where you're going to see a lot of the investments. But transit is part of the solution of a more sustainable way of moving things. It's not part of the problem. And we do expect to see ridership going back up. It's certainly been handling back goods, but we look positively to the story around transit.

Okay. Pat, I want to get -- make sure I get a question for you. Obviously, this year, you've had about $100 million of onetime expenses that were previously accrued. But on an adjusted basis, do you have a shot at $900 million or so still in your EBITDA target with some benefit from working capital as a source of incremental cash this year? And would debt be the primary -- debt reduction, be the primary focus for use of that cash?

Right. Yes. You're referring to our original cash flow guidance and the fact that the current year was going to be impacted by payments related to items that have been provided or expensed in prior year. Those -- those did impact the first quarter, and there's still a little bit more to go in the rest of the year. But we do see with the disrupted business, revenues have come down because of COVID-19 that working capital becomes a bit of a source of cash. And so we feel very good about our cash conversion being at original guidance about 90% and it being greater because of this change in volume. We -- that cash flow really is earmarked to make sure that we delever. Our focus is to continue to reduce our total debt to make sure that we maintain and even improve our liquidity as we go throughout the year to make sure that cash is managed in a good way that it continues to be a strength for Wabtec and we reduce our total debt for the company.

Okay. I think we're out of time. I appreciate very, very much, Rafael and Pat, your joining us this morning. Good luck as the year progresses. I'm glad you're over the hump, it sounds like, and things are on the mend a bit. And I hope 2020 turns out better than you expected. Thanks very, very much.

Yes. Thank you.

Thanks for hosting us. Thank you.

Okay.