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

This is Justin Long from Stephens. I want to thank everyone for joining us today for our next fireside chat with Wabtec. Joining us from the company today is Rafael Santana, CEO. Rafael, thanks for being here. Thanks for making the time. I wish we could do it in Nashville, but it will make 2021 even sweeter, hopefully, when that happens, knock on wood. Just as a reminder to everyone that is joining us today, this will be a Q&A session. You can e-mail me questions at justin.long@stephens.com, and I'll weave in as many as I can in the next 45 minutes. So Rafael, maybe to just kind of get things kicked off, you could give us a lay of the land. I'm curious how things are trending quarter-to-date relative to expectations. Any areas of either outperformance or underperformance that you'd highlight?

Okay. Well, first of all, good morning, everyone. Justin, thanks for having us here. And Justin, perhaps, just before starting, it was more than 20 months ago that we announced the merger of GE Transportation to Wabtec. I think some of the things that we mentioned back then were the opportunity to really build on a strong portfolio. We talked about the resilience of the portfolio. We talked about the opportunity to drive synergies for shareholders. We talked about strong cash flows. We talked about the opportunity to really create a leader in terms of technology into this space and, ultimately, our ability to drive, I think, productivity for customers and improve the way the world moved tanks. I think, in a lot of ways, we have been severely tested over the last months. Probably when we first announced it, we had the largest single strike this company has ever faced into it. Then we had China tariffs. We had PSR. We have freight recession and at last, we've had COVID. I think through that time line, we've really stayed focused with our teams. I think despite of those headwinds, I think the teams have really stayed -- really focused on the things that we control. And just as we closed here the third quarter, I think our ability to generate cash, we've generated -- we've paid down more than $490 million of debt. We've returned over $190 million to the shareholder. We'll continue to stay ahead on the synergies front despite of headwinds on volume there. We will be ahead of $150 million for this year, and we will get to the $250 million before end of next year. I think our teams are really working well together. We're happy with the progress here, and this is work that we'll continue to work on. In terms of some of the trends here, Justin, to add on, I think we're, of course, watching a lot of the elements here of how this next wave is playing out. I think as we look into the Freight business, no, call it, changes to everything that we have thought up to this point. On the Transit front, we're certainly watching what impact some of those lockdowns could have, especially in Europe. And I'd say at this point on where we stand with -- I'll call, headwinds and tailwinds, no changes for the year. So we feel pretty confident about what we had discussed during earnings 2 weeks ago. So as we look into, I'll call the market ahead, especially into next year, I'd say, Services continues to be a recovery story. We saw that starting first in the international markets, and we saw fleets being unparked for both freight cars and for locomotives, and we see those volumes coming back. We saw it later on in North America, but we see that continue to recover. So the trough for our Services business happens this year as we look at it, and keep in mind, the shorter term of the orders in that specific front. On the original Equipment, I'd say that's a longer cycle. We've -- we're really happy to see how the pipeline has evolved over 6 months ago. It started again internationally. We're seeing some of those orders starting to -- some of this pipeline start to convert into orders. So that's call a good. We saw it first in Latin America. We've got to see that expanding to other markets, and I think it's going to take a little bit longer in the North American market. That's maybe just trying to give a little bit of a sense of what we see ahead, Justin.

That's very helpful. And maybe to dovetail on the North American aftermarket business first. It sounds like based on the call, there is a lag in that business picking up, but you started to see it, I think, in September. Is that correct? And have you seen momentum build in September -- October and November as well? Have you seen sequential improvement in that area of the business continue?

The answer is, yes, Justin. I think you've got to keep in mind the lag coming down as the lag coming up. Carloads were down like close to 20% in the second quarter. Our services business is going to come down by 20%. It was more like 9% down. So I just want you to keep that element in mind. So yes, we are seeing that taking place. And to look into -- very specific into our Services business, I think as both freight cars get unparked and locomotives, we're seeing that pick up, I think operators looking very much into the reliability of their fleets. And we do expect, say, mods to be up going to next year versus this year.

And on that point, I think on the call, you talked about your business from an OE perspective being down in 2021. I wanted to clarify, did that reference both locomotives and railcars being down? And when you think about those markets getting worse and mods getting better, what's the net impact of all that?

Justin, two things. So I'll be careful here on not really getting into any elements of guidance going to next year, but a couple of things to add -- to keep in mind. I think for the freight cars side, this year, we'll finish the year with -- for North American specific, above 30,000 freight cars being built. That's expected to be, I'll call, more than 20%, 25% down going to next year, so below 25,000 of freight cars. So that does have an impact. And for North America, if you think about locomotives, I think we've been pretty explicit about not having any deliveries of new locomotives into North America going into next year. And that's down. I mean, this year, we'll have delivered more than 100 locomotives in North America.

Is there a way to think about the international markets for locomotive deliveries similar to what you said for North America? I know with India, you've got at least 100 a year, but it's kind of hard to piece together some of the other markets. So any perspective you can give us on where you'll be in 2020 on international locomotive deliveries? And what that could look like next year, given some of the, it sounds like, recent wins and orders that you've received?

Yes. I think there are -- Justin, number one, I think we've had a lot more, I'll call it, longer-term orders on that front as well. And I think back to what I had mentioned to you, I think we see some of that pipeline converting. So I think the momentum is good there. So as we look into, I'll call it, especially going into '22 and beyond, I think we see the opportunities to continue to drive growth in the international markets. So of course, there is an element here of I'll just call it nature of the length of the cycle between when you get an order and when you deliver. But that's maybe the way to answer it.

That's helpful. So it sounds like based on what you already have in the pipeline with multiyear orders, you feel confident in saying 2022 will see growth. To what magnitude, we'll just see how things progress between now and then.

For the international market, certainly. I think for North America, I mean after 0, I'd like to think that it can only go up. So I guess the question is really to what extent you'll see that playing out. So I think we've continued to take the necessary actions across the business to make sure that we adjust our cost base to these realities. So I think that's something that we've had in our game plan very much along the way.

And with mods, I personally feel like that's an underappreciated opportunity as we look out over the next 5 years or so. But one thing that's kind of tough is to put numbers around that. Is there any sense you can give us on like the number of mods that you're doing this year as we just have a base for growth going forward? Because it doesn't sound like you expect growth in 2021.

Here's the way to think about it, Justin. I think you should think -- especially in terms of -- let me try to answer you with the focus I think you have which is North America, right? I think for the North American market, you should think about 15,000 locomotives that run at, what I call, prime horsepower for the railroads out there. And if you think about those 15 locomotives, they will go through the overhaul cycle. And by the time you reach the third overhaul cycle, right, you really got an asset now that you're exiting in 20 years. I think the question is, do you just do a simple overhaul in that asset, you'd return it back to be in the same application? Well, it's hard to do, especially if you need reliability on that asset. And if you look at the opportunity you have to modernize it with a lot of the technologies we have, driving fuel efficiency, driving, I'll call it, just better productivity with a lot of the digital electronic tools we have, we see that as a significant opportunity. So if you play that out, we see the opportunity to modernize the fleet in the U.S. by more than 500 units per year in average. If that's going to play out into new locomotives or mods, that's maybe the way we think about it. We see the opportunity to grow mods going to next year. Do we expect that to be a significant growth? No. But I think there's pent-up demand here in terms of just the dynamics you've seen in carloads, and we think that, that's going to be a story that's even more robust and a lot more robust as you go into '22 and beyond. And I don't want you to forget about new locomotives because that's a story that will play out with some customers because that happens to be one of the most efficient ways for them to also drive productivity. So it's ultimately associated with fleet strategies you've got customer by customer.

Okay. That's very helpful. I wanted to circle back to the synergy commentary that you made initially. So you said, this year, you will exceed the $150 million target that you've laid out. And I believe you said, next year, you'll be at that $250 million run rate by the end of the year. I just wanted to clarify that because that was originally a 2022 target. So has that been pulled forward by roughly a year? Is that a fair way to think about it?

That is the right way to think about it.

Okay.

So yes, we've pulled in for about a year.

Okay. And then one question I get from investors around that transaction is, there have been a lot of adjustments, a lot of restructuring charges each quarter. As you look ahead to 2021, do you think those restructuring charges should essentially go away? Should we be looking at kind of cleaner numbers in terms of adjusted EPS versus GAAP EPS outside of the amortization that would be noncash?

So the short answer is, yes. Justin, I think you're going to see that come down. I think a couple of things to keep in mind here, okay? Number one is, look at this year, right now, and we've had just -- let me start with cash here specifically. We've had more than $170 million, what I'll call, onetimers, and the vast majority of those came from tanks sale from last year, right? If you were to exclude those, I mean I think you would have seen cash conversion being actually north of 100% for the year. So I want you to keep that in mind. I think there are some other elements to keep in mind as we go through it. Restructuring is one of them, Justin, but I think we have the opportunity here to -- well, pay -- down payments is another significant element that you should always keep in mind, if you think about our cash conversion moving forward. I think another element is that we'll continue to be restructuring. We'll be very thoughtful on how we think about restructuring in the business, but we do have the opportunity with some short-term paybacks on some areas, and we'll continue to work on that. So we can improve the profitability of the business over time. So expect less restructuring and -- of those one-time charges going to next year. So very much aligned with how we think about it.

And on the cash conversion point, as we look into 2021, we think about the potential for working capital changes, et cetera. Do you still feel comfortable with the 90%-plus conversion guidance that you've laid out?

Yes, Justin. And I think a piece of that is we continue to have significant opportunity here to improve the working capital in the businesses. There are some businesses that are really running at low churn, inventory churns, and we're really signing specific actions to drive those up across the business. So it's one area that we continue to have an opportunity. I think, again, you've got to keep in mind some of the elements of down payments that can play into those, but I think driving cash conversion above 90%, something that we'll continue to pursue over the cycle.

Okay. Great. And then on the conference call, earnings call, I asked about buybacks, and I think you used the word intensify. I was wondering if you could provide a little bit more color on that. Any thoughts about the timing of when you would expect to complete your share authorization or buyback program. And could the pace of those buybacks accelerate post-election and some of the vaccine news and macro developments we've seen?

So Justin, I think, number one, I think we've been going through our strategic plan period, and a lot of my comments were associated with some of the things that we're seeing ahead of us. So I think we see the opportunity here to drive shareholder -- higher shareholder returns and stock buyback being a key element of that, considering where the stock price is. And with that in mind, I'd say, we've been buying in the last couple of weeks. So just to leave you with that thought. In terms of the specific elements of when we finish it or not, I'm not going to comment on those, but we're going to be disciplined on how we go about it. And we're going to stay flexible in terms of any other alternatives we might face into it. Right now, I can't say I have exceptional opportunities on the M&A front. So we're focused on stock buyback at this point.

Great. And maybe we could shift to Digital Electronics just because I know that's a key area of growth going forward. And I know some of the recent decisions have been pushed out to the right, just given the macro uncertainties. Have you seen that change at all quarter-to-date just based on some of the macro developments that we've seen? And any way to help us frame up the magnitude of the pipeline in Digital? Because I know the decisions are pushed out, but it feels like that pipeline is still strong. So we'd love to get more color around that.

Yes. So Justin, you're absolutely right in terms of all decisions being pushed to the right. Does the story change? It doesn't. I think the way we look at it -- let me just give you an example here, which we announced in the third quarter, which was the Zero-to-Zero order we got from Class I. That's another building block towards automation. The way I want you to think about that is, think of the, I'll call it, fundamental building block on this journey, which speaks to a Trip Optimizer, which we have more than 11,000 units currently in the installed base. If I think about the entitlement that we have with Trip Optimizer alone, I'll refer to another building block on that journey, which is called distributed power LOCOTROL. We've got over 18,000 LOCOTROLs installed in customers across the world. If you think about Trip Optimizer, where it is, and where it can go, that's how we think about entitlement on the various areas of our digital portfolio. So we continue to have opportunity to expand on Trip Optimizer. A piece of it is also the customer is maturing so they can actually take full advantage of some of these solutions. But we've got things like SmartHPT, which can provide us short-term growth here because it's a product that has been proven to our customers, and it's one that I think we're very excited about driving significant growth going into next year. Zero-to-Zero, it's another one that builds on top of that. And I want you to think about these products on the magnitude that I just described. So ultimately, we see entitlement to Trip Optimizer installed base level, but that base should grow over time.

And you're still thinking about Digital Electronics being a 10%-plus CAGR over the next 5 years, as you outlined at the Investor Day? There is nothing that has changed your opinion on that given what's happened in 2020?

We expect out to grow, Justin, I'll call it, 3x faster than you'll see the growth necessarily in, I'll call, rail in average. So yes, at the double-digit level, considering rail growth at the low single digits.

And then one more question on this topic. I know your CTO, Dominique, recently went to CN. Curious if that actually presents an opportunity, having someone that you know extremely well at CN, and CN has really been pushing on technology, I would argue more so than any other Class I at this point. So wanted to get your comments on that. And then also at UP with Eric stepping into Jim Vena's role. He has a 15-year background in engineering. We actually spoke with him this morning in another fireside chat. When you look at those relationships at 2 of the sizable Class Is, what kind of opportunity does that present?

So the answer is yes and yes, Justin. I think Dominique was a great person for us here. I think we've had another great individual to come in and take that on, being Eric Gebhardt. I think the comments are very positive with the impact Eric has had in the very short term here in the business. And what I'll tell you, with just those 2 customers, I'll call our engagement levels are significantly up. And there is significant opportunities for us to work on with these customers, having Dominique there, like you described, it's certainly an element of somebody that understands well some of the things that we've been working on and that I think can help us accelerate. So we do see an opportunity here to continue to create value with our Digital Electronics portfolio, and it's a story that will continue to play out.

And the rails, in general, have been talking about how do we leverage PTC. I think that's been a theme that we've heard a lot more in the last couple of years or so. And I wanted to ask about that in the context of your business. And you touched on that a little bit a moment ago when you were talking about Trip Optimizer and how you could leverage that technology. But when you think about Wabtec and the specific products that you can provide to leverage PTC and make more progress on automating the rail network, what are the key products that you would highlight for investors?

Okay. So I think there is an element of integrating PTC with some of these different products. So we're doing that Justin, as we speak, right, with the different Class Is. There is an element of continuing to expand the suite of products we have like Movement Planner that allows you to automate planning through your railroads. We're taking PTC internationally. So I mean, you'll hear more from us on that, but that's another element of how you continue to help customers ultimately automate systems out there. So I think that opportunity is both integrating PTC and the various solutions we have with what the customer asks, expanding that footprint in North America, but then ultimately, internationally, I think there is a significant opportunity for us to grow there.

And when you think about your products related to PTC and automation, what's the interoperability of those products with the Cat locomotive? That's one question that I just received online. Just wondering if that's a potential opportunity from just a market share perspective.