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

Hi. I'm Saree Boroditsky, industrials analyst here at Jefferies. We're really excited to have Pat Dugan, CFO of Wabtec, here with us today. So we're going to really start with the fireside chat. So we're going to get into some questions on the near-term trends and then follow that up with some more longer-term questions. So thanks for joining us today.

Thanks, Saree. Thanks for having us, and looking forward to talking to the group.

So starting with some near-term trends. Freight service held in well in the quarter with an only an 8% decline despite the almost 20% decline in freight volumes, just given the benefit of mod deliveries. How do you think about services demand for the remainder of the year as maybe [ you see ] some lower mod deliveries but freight volumes improves?

Yes. So we've been working very hard and making sure that we grow our freight service revenue. Year-over-year, our revenue is higher. And we really think that that's the strength of our business right now. When you look at the quarter, we look at a number and you got to kind of break down our freight service revenue into its elements. That product line is -- it consists of -- about 50% of it is covered by maintenance contracts, contracts where we service and take care of our installed base for our customers. That tends to be a lot more stable. Each contract is a little bit different, constructed a little bit differently. But you're -- you have situations where you have like a menu of activity that happens. You have other contracts where you might have a day rate for an active running locomotive versus a parked locomotive. But ultimately, there's an expectation of maintenance through the cycle. And we were able to oftentimes kind of help our customers in a slower-volume period get caught up on maintenance that maybe wasn't as prioritized in the past and just get caught up. That occurred in the second quarter. The next element of the service revenue are modernizations of locomotives. That's a lot more -- it's a lot more stable. That's a production schedule. It's in our backlog. It's work on units that were contracted in previous years, previous quarters. And we were able to execute in Q2 to that schedule. And then the last element is 30% are parts. And as you would expect, that was a little more impacted by freight volumes. So when you -- more disruption in the early month of Q2 and less in the third month. You saw those exit rates really improve in that product line or that element of sales. We expect it going into the rest of the year as the economy recovers. We're monitoring metrics like car loadings and parked locomotives. And so we expect with those improving numbers that our freight service revenue will also improve sequentially through the rest of the year.

That's helpful color. The North American rails have really been talking about increased focus on reliability and fuel efficiency from locomotives related to PSR initiatives. I know you had a strong mod performance in the second quarter, but can you update us on how these conversations are going with Class Is post the COVID-19? And then on fuel efficiency, could you just provide us some color on your new offerings and any feedback that you're receiving from customers?

Yes. So the mods, the modernizations of locomotives just remains a real, real opportunity for our customers and for Wabtec to -- as part of their element of their fleet strategy within PSR. Oftentimes, we can -- customers can kind of look at that as an opportunity to take a look at their fleet, the age of their locomotives to make an investment that is not as high as a brand-new locomotive but get a lot of the same performance improvements that you would get with an OE. So you get efficiencies, you get technology, you get performance with -- and an extended asset life with that mod. So we continue to see that as a real opportunity. We are right now working through that backlog in 2020 of orders that were placed last year, and we continue to work with our customers on figuring out exactly what their CapEx needs are going to be, what their mod expectations are going to be for next year. With a better economy and a recovering economy, we see those orders to remain strong and a core part of our service revenue. When you look at PSR, the initial elements will really just take cost out. But now we feel that when you look at the PSR goals, that we're going to start looking at efficiency gains and productivity gains. And so our customers are looking at things like our Trip Optimizer software; our smart HPT, which helps with kind of starting and stopping the locomotive; [ LXA ] and LOCOTROL, which allows us to -- allows the customer to run longer and more efficient trains and get productivity savings out of that; and of course, [ 0 to 0 ] and PTC. All those tools are really elements of the PSR story as customers try and get to even further cost improvement [ in ORs ].

Great. And then I guess, turning on international front. International locomotive prospects have been a target opportunity set for Wabtec and help offset some of the weakness in North America. Can you talk through some of the demand trends you're seeing by region? And how much of the growth is coming from market demand versus your ability to gain share in this area?

Well, I think the market demand versus gaining share, it's a little -- it's coming from both, really. I mean you look at -- especially in the international markets, the locomotives and the freight rail infrastructure there is -- are -- oftentimes are aging. There hasn't been investment. We work with customers to help with the projects to even help with financing and with their own financing with banks to kind of demonstrate the value of that new investment. And so that aging infrastructure creates opportunities for us for all of our products. But we also feel really good about our new products or the technology, and that allows us to win work that maybe in the past we wouldn't have. And so we're hoping and expecting we'll continue to see market share gains going forward. When you look around the globe, I mean, we see strengths in kind of traditional markets. We see opportunities in Brazil, in South Africa, in Australia. Or obviously, India for us is very strong both for Transit and Freight. We're working with opportunities in Eastern Europe and Russia and even in the Middle East. So all those markets, for us, we see a steady pipeline of opportunities. We have localized teams, we're actively engaged. We both go create opportunities and partner with our customer and -- customers. And I -- and so we see that as really a big part of our Freight segment strategy going forward.

I believe on your recent earnings call you mentioned some tenders being pushed out. Have you started to see those come back? And was this just temporary disruption? Or do you think that some projects will be canceled?

I think it's temporary. I -- it's interesting times right now. Some of the CapEx decisions for both Freight and Transit are being delayed and deferred as everybody kind of assesses the extent and the length of the disruption from COVID-19. Especially Freight is a little more near term because you've got CapEx decisions leading into next year with Class Is and others. But the international locomotive is kind -- is more like our Transit business, tend to be government funded, there's a long sales cycle and lead time to those opportunities. The underlying reasons for making the investment by our customers are based on economic considerations that can be kind of bigger and more macro. And so while the decisions are being pushed off, we don't see those as being canceled. They're going to come back with a better visibility into what's happening in each of those regions. Hey, Saree, you might be muted. There we go.

Sorry about that. I don't know how it might have happened.

No, it's all right.

So Wabtec saw higher mining sales in the quarter, where you also highlighted lower sales in oil and gas and power gen. Could you just [ provide a little bit more ] color on what you saw in those industrial markets as you exited the quarter and kind of the outlook there?

Yes. So oil and gas and power gen, for us, are really kind of embedded or legacy Wabtec products very much impacted by the price of oil as we're dealing with services customers, people that are in the oil patch and oil field services. And so with activity down, oil and gas business was impacted. I think when you see -- start to see drilling activity and other oil and gas services recover with more stable and certain oil prices, our business will go correspondingly. We definitely saw it improve within the quarter. So the exit rate was better than obviously April. Power gen, very similar, same thing. As economies recover, power gen will recover. Our mining business is a little bit more long term. It's -- we're providing propulsion for some key customers, and they are using our componentry and components for both kind of domestic and international applications. And so right now, we have visibility in our backlog and strength, and we continue to partner with them. So things [ seem ] pretty stable in that area.

Both Wabtec and GE have this industrial focus, but do you continue to see these businesses as core to Wabtec? Or would you be open to selling really these nonrail assets in the future?

I think right now we're very committed to those businesses. We continually go through kind of a strategic review of all of our products and every year. And so you -- we'll look at the opportunities and look at these type of things and see what make sense from a strategic standpoint. These businesses, though, are very, very much adjacent technologies -- adjacent markets to our core technologies. Mining and that propulsion is really embedded within the Equipment business. And the oil and gas is a part of our heat exchange business that really was embedded within our radiator and other heat exchange applications for rail. So it -- right now, they're very strategic, pretty core. But you never say never.

So digital was a bright spot in the quarter and it's been one of the key areas of focus as we think about the benefits of the Wabtec-GE Transportation merger. Can you talk about the potential to combine technologies such as PTC and Trip Optimizer to provide more autonomous rail solutions?

Right. I mean it's for us -- and we talked about this a lot in our Investor Day back in March. This is where our expectation is growth -- for growth will be higher than the rest of the company. What does our Digital Electronics group do? And this kind of goes with the earlier question. They really have a portfolio of products that help our customers with fuel efficiency, with safety, all which -- besides safety being the right thing to do, it is -- it helps with costs. It also gives us network optimization opportunities, productivity and asset performance improvements. So that's our portfolio of products. But then when you kind of use that as your building block, as your core, you can see that those Trip Optimizers, the distributed power, the PTC capabilities really gives you that foundation of technology that leads to kind of incremental steps in terms of automation so that maybe you have attended automation where the locomotive runs with someone attending but not completely out of the cab and you get into single-person crews. And then maybe you go to different levels of capability of that crew and then to full automation. That is going to be an incremental kind of curve as those products become vital, as they become more tested and proven, and we feel like we have the -- have that basic technology, and we're ready to go. We're working with our customers and their own comfort level for that kind of technology adoption, but ultimately we think it's key to helping our customers achieve a lot of the efficiency gains that they're looking for and full automation is part of that -- part of those efficiencies.

I know it's probably hard to come up with an exact number, but do you have a time line as many years that you think we'll be seeing autonomous rail?

Yes. I -- the years, it's kind of hard to predict. And frankly, I think that this comes with our customers' own desire and time line for that kind of automation. A lot has to happen, and there has to be certainty about the safety and capabilities of the technology and we really would need to partner with our customers, but we're ready to be part of that journey.

Another benefit of the GE Transportation transaction was the ability of Wabtec to gain content on locomotives. I believe there are some contracts like [ braces and slacks ]. Have you been able to realize content gains? And how does this vary between your North American customers and international?

Yes. So the content gains are a real opportunity. We didn't necessarily talk a lot about this at the combination of the 2 companies. But when you kind of look at every locomotive as on an OE basis and then in a lesser extent but also meaningful for the modernizations is that you could put Wabtec components onto locomotives at a greater market share, a greater penetration than what maybe would have happened in the past when we were competing, when we were not a combined company. So total content estimates maybe about $200,000 of opportunity for Wabtec beyond the locomotive, things like brake systems and compressors and electronics and other products. And we are probably in the -- about half that at best. And so we're -- but we -- there's definitely going to be a certain amount of reengineering that would come or some of the designs that would come with. There would have to be customer acceptance. A little bit slower in the North American market but a little faster an opportunity for international markets. So we're definitely making gains. It will be over time. And then we're very excited about that. And what also comes with getting more content on those locomotives is the installed base and the services that come with it. So it really is a nice opportunity for Wabtec.

Sticking with the transaction. You've been right ahead of schedule on the cost synergies with GE with an incremental $120 million expected for 2020. During the recent call, you talked about accelerating efforts on structural costs. Can you provide some color on some of the actions you're taking there?

Right. So just as background. We -- our $250 million of synergies were a core foundation of the combination. They mostly consisted of cost synergies. We did not really project or include much related to revenue synergies, just like we talked about. Part of it is just timing of realization and comfort. You know you can go out and execute on cost. So as part of the $250 million goal, we put -- we stood up a very aggressive team. We defined opportunities that exceeded the $250 million. We definitely worked very hard to validate and verify and when they would happen and that they were realizable on when they would happen. And I think that that's really going to pay off in opportunities going forward that we'll be able to get -- over time, we'll be able to get more than the $250 million. How we get there, it's going to consist of exiting -- we talked about exiting TSAs and reducing our SG&A costs by getting into shared service environments for our combined companies. Obviously, sourcing, buying better and leveraging each other's supply chain to reduce our material costs. We've been reducing our footprint. We've reduced something approaching 10% of our manufacturing work space. And we think that there's more to go there. So all those things have really contributed to very sustainable reductions in kind of fixed costs that will improve our margins on a go-forward basis.

Just following up. You mentioned the footprint reduction of 10%. So is there additional footprint reductions, actions you plan on taking in light of coronavirus? Or do you think that volumes will recover to prior levels to support the current manufacturing footprint?

Well, I think it's an element of the fact that -- element of the -- kind of the larger opportunity that we've alluded to or discussed. I think the impact of COVID-19 is that we were able to move faster, right? You don't -- with volumes changing and where we had a very logical time line and calendar for doing certain things. Now with lower volumes, you can move faster, less disruption and you can move faster. So we're constantly looking at things. And I'll kind of look at what we've done already. We've -- taking North America locomotive plants 2 down to -- 3 down to 2, excuse me. We recently had some of the headlines about some U.K. refurbishment operations that went from 2 to 1. We've -- we're constantly assessing our -- where we make things and how -- and what our manufacturing footprint looks like. And we're just assessing where things should be and making sure that we're picking low-cost countries, best performing, best execution, closest to our engineering and things like that. So lots of work yet to do and -- but a real opportunity.

Wabtec's historical freight margins peaked at slightly over 23%. Do you think there's an opportunity to get back to these levels or perhaps eclipse them? And how much of the long-term margin improvement is dependent on volume versus cost cutting or favorable mix of mods and digital?

Yes. So our high point in terms of the freight margins. We're definitely impacted by PTC in a very strong electronics business. This is a historical number. And what we -- what I feel really good about is that we're at about an adjusted freight margin around 19% right now in the second quarter. So you think about the volume disruption we've gone through, the decremental margin on that margin. We were able to keep -- take enough cost out of our company so that the decremental margin was manageable, offset by the synergies that we achieved, permanent and sustainable synergy programs. And I feel like that, that 19% was a good performance, good execution. So when you look at the fact that we're going to go and continue to execute on synergies and you couple that with kind of a normal volume level, a -- not a COVID-disrupted volume, that margin percentages should improve in the Freight segment. And I think that this -- some of that also applies in our Transit segment, too.

[ We said that the ] thing about Transit, we typically think about business is more steady, but COVID-19 has a significant impact on ridership levels and potentially government finances. Can you talk about how you've seen aftermarket trends as some of the economies have reopened? And do you need ridership to get back to prior levels to see aftermarket fully recover?

Yes. So we saw some pretty concerning headlines in terms of ridership. I remember seeing ridership down 80%, but for us it's not quite as linear. It's not -- you don't quite tie it off. Capacity is really what drives our aftermarket. So while ridership numbers could be down maybe greater than 80%, the actual transit authorities reduced the number of trains running, the number of buses running, more like down 20%, very similar levels with what we saw in Freight. So as the economies -- honestly, as the -- we're monitoring this very closely, we're looking at ridership, we're looking at capacity changes in our end customers. And as these regions, these transit authorities are reopening, getting back to work, we're seeing our aftermarket business go right hand-in-hand with it, as you would expect. I mean these transit authorities and the investments that they've made over decades, obviously, powers the economies of these urban areas. So we're very -- we think that that's just going to be a continuing improvement. And we should see it. We've also seen pockets of strength where some of these transit authorities have caught up on some of the work that they maybe hadn't prioritized this -- in the past, things that needed to be done but were put in the back burner until they had a break in volumes, and that did occur. We also saw some of the transit authorities build safety stock. So all in all, it was a mixed story of aftermarket. On the OE side, generally, those contracts are very long term. What we're working on now and delivering and generating revenue from now had been awarded and remitted to us in a couple of years ago. We think that with more certainty in the economy; with infrastructure spending funded by government budgets, by national and federal budgets; and the need for stimulus, that I -- that our OE business will be fine.

With that, I think that we're actually running up against the clock. So I really appreciate you taking the time to speak with us today and for attending the Jefferies conference.

Yes. Thank you for having me, and look forward to meeting with all of you at some point.

[ Thanks ].

Bye.