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

Good morning, everyone. Once again, I'm Jerry Revich, and delighted to have with us from Wabtec, John Olin, CFO. And we also have Kristine Kubacki, Head of Investor Relations. John, Kristine, thank you so much for joining us.

Thrilled to be here.

So we're going to run the conversation in a fireside chat format. And John, I wanted to start the conversation just to follow-up on your Analyst Day not long ago, but a couple of interesting developments, a big write-down and your biggest competitor really stands out. Can you talk about any changes at the margin to the opportunities and strategic priorities from what you folks outlined in the vision that you rolled out just last year?

Yes. About a year ago, we presented our next 5-year view. And with that, we really encapsulated the strategies that will take the company into the future. And as Jerry mentioned, 2022 was an interesting maybe watershed year in a lot of ways, a tremendous number of headwinds that we work through. And the question being is, has anything fundamentally changed from then, the answer is absolutely not. Right? The 5 core strategies that are taking us into the future is a bit as important as they were a year ago. Maybe further validated by some of the things that we saw in 2022. Some of the things that we're seeing here in 2023, whether it'd be regulation and those types of things. But those 5 things are: one, is the lead the world in decarbonization of rail. So this is coming. And we are at the lead of it today, and we expect to be there at the end of the day and making sure that we have the products to take the world to a zero-carbon world in terms of greenhouse gases and the bridges to get there. These are very long-term assets. It's not going to happen overnight. The second is to lead in digital technologies. We are there today. We run and manage most of the trains that move on the face of the planet in terms of the speeds at which they do, making sure that we optimize fuel use. We've got software that goes between locomotives and [indiscernible] as well as at one point the train is coming up over a hill, one is pushing, one is pulling and with RPMs that should run to save that fuel and with that technology, we deliver about 18% fuel savings versus a locomotive that don't have those digital assets. The third area is to leverage the installed base. Four years ago, we bought GE Transportation. And with that, we bought 23,000 installed base of locomotives and the company feeds off of with the exception of our transit group. Those assets are making sure that all of our parts and those types of things are on those locomotives. The fourth area is the focus on recurring revenue. We had a great year in 2022 with regards to that. It grew from 42% to 44% of our revenue is recurring. And then finally, a focus on continuous improvement. I think that what 2022 did is showed the resilience of the company. And I think we were into our plan about 55 days when the invasion of Ukraine took place, and we lost 5% of our revenue overnight. We held our guidance and figured out how to deliver on the commitments that we had and that was really just the start of the year. Currency went, fuel cost skyrocketed, metals went for the second lift at that period of time. So a very challenging year that made us stronger in the end. But the core direction is the same and the core strategies.

And John, can we expand and pull on a couple of threads there. So -- in terms of the competitive landscape, so Caterpillars out of Tier 4 final engines, can you talk about what you're seeing from there internationally? Would Kristine and I were catching up there. I was surprised to hear that you're still bumping up against them in international tenders. Can you just expand on what that looks like?

Yes. So again, a lot of the question is probably directly for Progress Rail, A Caterpillar. From what we understand, they took a write-down about 4 months ago, I think, in the December time frame. And they talked about exiting their investment in Tier 4 locomotives. So there's Tier 4 is required in the United States, if it's new. It needs to be Tier 4. And they had been struggling with that product. And we had about 90% of the assets running in North America with our Tier 4s and they chose to exit that business. That does not mean that Progress Rail is not a great competitor and a very formidable competitor. But in Tier 4, they appear they won't be competing going forward. So anything that's new in the United States from here on out, they would not be an option for a customer. And given the competitive dynamics that would be we're the only other competitor that supplies Tier 4. When you talk about around the world, Jerry, we sell -- we do not sell Tier 4s around the world. There's not a requirement for them to buy that technology. And again, Tier 4 is really focused on NOx and SOx that reduces 70% of the emissions on NOx and SOx versus a Tier 3 locomotive. So in any event, to answer your question, Progress Rail is continuing to sell the same products they sold internationally as they did before their announcement with regards to Tier 4.

And John, is there a time frame for major markets to shift towards Tier 4 off-highway? Outside of the U.S.?

No. No. There is not any other markets that require compliance with Tier 4 and we don't see a lot of momentum in that area, more focus on the ESG -- I'm sorry, the greenhouse gas emissions, which Tier 3 is close to what Tier 4 delivers.

And in terms of -- in the U.S. on the awards for next-generation battery electric and other technologies, the rails have been splitting it 50-50 with you folks and Caterpillar. Is that still continuing post the exit from Tier 4?

Yes. So we look for a little bit more information around that. We started developing a battery electric technology years ago. Actually, GE did before we acquired them. And we are at the point now where we're taking orders and us and Progress Rail are the 2 largest -- we are the only players in the battery electric field. We're still in the process of commercialization. The first ones that we will deliver will be about this time next year. And so we've had orders to your point about the same number of orders for each. And right now, we're just looking for the next phase, which is delivery and [ mentoring ] how well they operate. We believe that we're much further ahead in terms of the core technology of battery electric. We have certainly taken 2 different approaches to the technology and time will tell us we roll these things out.

Really interesting. Can you say more about the difference in approach?

I'm a finance guy, not an engineer. So just Wabtec has got a much more integrated approach just like our other locomotive technologies, everything is integrated and more of a modular approach by Progress Rail, is my understanding. We believe that having everything integrated in particular, the digital assets, we believe we have a significant advantage over because of all the other digital aspects that we have. Completely integrating those will deliver a better product to our customers.

Interesting. And I want to dig into a better, let more in a moment, but just continuing down the competitive landscape lens. Can you talk about in international bids? Who are you folks coming up against in addition to Caterpillar has the competitive landscape evolved at all in terms of who you're seeing internationally?

Yes. So looking overall, internationally, there's very few competitors for freight locomotives, right? Progress Rail is who we would run into in most markets. Other than that, every once in a while, we would run into CRRC, which is a Chinese manufacturer. But again, those are our smaller obscure markets around the world. And then from time to time, TMH, which is a Russian provider of locomotives. But both of those are rare. What we're looking at is largely between us and Progress Rail.

Got it. And in terms of the pipeline of opportunities, you've had a couple of conquest countries, if you will, in terms of where you've set up manufacturing base? What's the opportunity for follow-on orders? And what's the broader pipeline?

When we take a spin around the world, certainly North America, we've got about an 80% share of what is running on the rails of heavy haul locomotives in North America. And when we talk about Tier 4 or new sales of locomotives, that's a much higher percentage of that, it was 90% until Progress Rail's announcement. When you think about vast lands and mining, that's the time to think about diesel electric locomotives -- I'm sorry, yes, diesel electric locomotives. So Brazil, in Kazakhstan, we have a vast lion's share of share. Australia, probably more balanced. And then there's markets such as India, Egypt, South Africa that are key markets for both of us.

Super. And can we talk about the battery electric solution, really interesting path potentially out of California in terms of new regulations that would presumably drive a new build cycle. Can you talk about your views on -- how likely is it that the standards will be passed and what the opportunities...

First, you want me to be a lawyer, I'm talking about the technology. Now you want me to -- I'm sorry, to be an engineer and talk about the technology. Now a lawyer to talk about where we're at. What Jerry is talking about is most recently, well, there's kind of the one tool or the ying and the yang of regulation is the EPA came out and talked about autos, they allowed states to regulate some of the admissions or have tighter constraints than the EPA did and allow that for states. And I don't know, Kristine, where you did -- I think you said on Page 500 or well into that. There was a few paragraphs with regards to the rail industry where he talked about the same thing. So that kind of opened things up that, wow, if states could regulate. And at the same time, [ CARB ] had been talking about potentially regulating some of the aspects of the rail business. And so they kind of worked hand-in-hand, and this all really unfolded in the last few weeks. And I think it was last week, [ CARB ] came out with their recommendation and that will, I'm sure, be challenged by the rail industry. But the gist of what they had said is that by 2030, anything that is older than 23 years old, would not be allowed to operate on the rail system. And by 2030 passenger -- largely passenger would need to be zero emissions. And by 2035, that the freight side would need to be at zero emissions. So to your point, Jerry, that's where the battery electric would come in. And that's the furthest technology at this point. We're certainly working on hydrogen as well but the battery electric is, again, going to be commercialized in an operation a year from now. And those applications would replace -- be capable of replacing a diesel electric locomotive. So those things certainly bode well for an equipment manufacturer, but this is -- there will be, I'm sure, a lot of discussion about it. I think the other interesting thing was that of 16,000 or so thousand trains that we have, the 12,000 of them pass through California in some way, shape or form in a year. So it's a big deal for the industry. And so we'll have to see how it all plays.

And John, the upside I'm asking a finance guy engineering and lawyer questions is, I can understand the response. Well, that, too, but fair enough. We speak the same language. That's very clear. The other area of potential opportunity for you folks is, unfortunately, after the series of accidents, maybe there's upside for adoption of your technology, and that's what I was hoping to expand on, on the conference call. And I'm glad we get a chance to understand what that might mean for Wabtec. Because you folks have a series of autonomous and semi-autonomous solutions that, correct me if I'm wrong, but could have prevented the accidents that we have seen. And so I'm wondering if we saw your technologies adopted across the board, how big is that pie for Wabtec?

So you get a lot there. So number one, I don't know if what we have would have ever prevented what happened. There was a tragic derailment in Ohio, right? They've got investigators are looking at it, and we'll find out what the final report is. The preliminary stuff that no one did anything wrong versus the regulation or protocols. I think that what you're referring to is, there are various safety products that can help in these situations or to minimize or to help in that situation. So again, we can't say that anything would have changed what happened there, and that's what the investigators will look at. Now having said that, it has put a spotlight on the safety and in particular, on derailments, right? And in that conversation, various things have come up as they do when these things happen and they run anywhere from early detection. And there was a lot of detection on what they call hot boxes that monitor the temperature of the bearings and again, everything was from my understanding and the preliminary report done according to protocol and the accident still happened. Having said that, the other part of the conversation that comes up is on the braking systems. Right now, the core braking system is pneumatic, which means one car triggers, and it goes down the line and they trigger electronic brakes, which we happen to offer does it more quickly, does it all simultaneously. But that have prevented it? The answer is probably not. Would it have minimized that? We don't know. But those things are all now up in conversation. And I think the point being is that all the equipment that we make has got safety features on it. And we've got a suite of products and a lot that monitor. And actually, we had an acquisition, but a midtime -- almost a year ago, a company called Beena Vision. So we've got -- we don't make those hot boxes, and we make a much more sophisticated monitoring system and they don't need to be every 10 or 15 miles. They tell a railroad a lot more about what they see and they do that through acoustics, they do it through vibration and they do it through photos. And so all of those things are in conversation. I can't tell you, we've seen more activity in parts of our company around safety and more inquiries and interest. So we're there to serve and we wake up every morning to try to figure out a better way to do things to make sure that we're driving productivity and certainly safety. So we do have a fair number of products that could be of interest.

And in terms of the early detection of electronics, the electronic breaking system, is that a default on everything that comes out as a mod or Tier 4? Or is that a higher ASP versus the base model?

On electronic brakes. Okay. Now we're getting into it. The first tier question is always the easy one. It's the second, third and the fourth one. There are reasons that electronic breaks are not on a lot of rail cars. One is significant cost. But the biggest piece of it is that for that to work, there can't be any break in the chain. So if you've got a train with 200 cars on it, they all have to have electronic brakes. And because railcars are interchangeable for a railroad or the industry to move to electronic brakes, you'd have to change out almost every railcar made. So that they all had it because if one car in that line doesn't have it, it defaults to a pneumatic break. So it is a very big deal for the industry in total to take the 1.5 million railcars and require that. And they have to be put on each railcar, and every locomotive would need a package to be able to operate them as well. And so it's not as simple as starting to migrate that way. In conversation, but that's at this point, there's no requirements, nothing being required of electronic brakes. But -- that's some of the complication of it.

And in terms of some of the other safety systems that you spoke about, John, in terms of early detection, is that something that is the default on every month that goes out?