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

Well, good morning, everyone. I'm Jerry Revich from Goldman Sachs. Really excited to have with us from Wabtec, John Olin, Chief Financial Officer; Kyra Yates, Head of Investor Relations. John, Kyra, thank you so much for joining us.

Thank you for having us.

Good to be here.

So we're going to run the conversation in the fireside chat format, and we'll open up for questions towards the end. To start the conversation, John, your team has achieved your 5-year targets 2 years early. So congratulations. Can you talk about what's played out ahead of expectations to enable that level of performance?

I'd say, Jerry, that a lot of things have played out probably equally across that period of time. And I think to understand a little bit about the results that you've seen in us doing what we expect to do in 5 years and 3 years. is really gaining a better understanding of how our company came together. And in the way it came together with opportunities that's left behind for us the mine. And I think that you'll see in the fruits of that. What I mean by that is Wabtec is one of the oldest companies in America, 155 years old this year. And having said that, you'd think that a lot of the opportunity in an old industry and an old company would be mined and -- but the case is not so. The way we came together is 2 multinational -- 3 multinationals coming together in a very short period of time. So the company in 2016 was about $2 billion. It doubled in an acquisition in late 2016, and then it doubled again in 2019 when we acquired GE's transportation business. And so with that, I like to think of us as a 155-year old 5-year start-up. And so kind of first things first. And that's the way we have attacked the business and not only in the second acquisition, do we acquire 23,000 locomotive installed base around the world. We also acquired our CEO, Rafael Santana, who's got a view of how to integrate these companies. So I think what you're seeing over the last several years is first steps first. As you think about a start-up, I've kind of explained some of the performance that you're seeing. But I think it's coming across the spectrum all across our margin profile. Whether it be from a pricing standpoint. Certainly, the cost standpoint has been the biggest driver of that. And as recent as this year, starting to look at how do we optimize that portfolio and shed ourselves of some businesses that aren't going to take us to the future.

Can we expand on that last comment in terms of what's the range of opportunity of those businesses? What's the margin profile? And what's the timing in terms of when you're going to decide, stay or go on those assets?

Well, on the things that we're looking ahead. So, again, in terms of first things first, we started to address some of the cost with Integration 2.0. And just recently, earlier this year, we announced a portfolio optimization program and the first bite of that Apple was $110 million of businesses that didn't fit in. Our company has come together. It has been a byproduct of many acquisitions and time going by or something that just didn't keep up with the profile that we need and expect out of our assets. And so with that, we took that action and sold those businesses or exited them, and they were very low profit margin and therefore, expanded our margins and some of that you're seeing in the results this year. And we think there's more of those opportunities to come.

And John, on that last point, how much more, another $110 million net order of magnitude or...

Going forward probably in the similar range.

And it's interesting to hear you folks talking about Integration 2.0, like you said, in so many years after the acquisition. And the company has had strong margin performance immediately when the acquisitions rate as well. Can you just expand on that because it's not often that you're finding cost reduction opportunities year 5 after an acquisition?

Fair enough. And that's true, Jerry. But again, think in terms of a 155-year old 5-year startup, right? I've been with Wabtec 3 years now, and I came in and we're seeing things that just didn't add up to me to be a 155-year old company. And those things are largely an incredible amount of opportunity, not only on the cost side, but on bringing the company together and continuing to drive some of the revenue synergies from the acquisition. And again, it's been an exercise and getting organized around what's first what's most important. And how much can the organization handle. And I think that Integration 2.0 is a great example of that. So we promised $250 million of synergy coming out of the acquisition of GE Freight. We got that 1.5 years early. And we kind of looked and said, well, what's next? And the opportunities were just very abundant. And what we took as the first bite of that apple and said, how much can we absorb, not how much opportunity that we had, but how much can we absorb with everything else that we're doing, all the innovation that we're bringing to market and what can we do in terms of integration where was it going to hit with segments and so on and so forth. And with that, Jerry, we ended up with a program of driving $75 million to $90 million. And we're ending that investment phase this month. And we're seeing a lot of that ramp coming in 2024. We'll expect more of it in 2025 until we get to our ongoing savings of the $75 million to $90 million. And all of that's coming in ahead of what we had anticipated when we put the program together. And right now, we're looking at well what's next and what's the next bite of that apple. And I would say, to your point, it's been 5 years. I would say that we have more opportunity today than we did when 3 years ago when we made the decision to do Integration 2.0. And why would that be? Is we've learned how to do it. And a lot of it is looking at our assets around the world and some of them in tougher markets to adjust, but I think we've gained a strong competency and how to become more efficient. And again, a tremendous number of assets to work on. We've got 153 plants around the world, a fair amount of complexity and how do we reduce that complexity, tighten the system and all in the name of driving margin without having to sell another locomotive or transit system.

Can you give us 1 or 2 examples of the recent program just to help us get a few as [indiscernible]?

Sure. We -- probably out of the amount of savings, I would imagine that probably 50% of it is in our transit group. And about 25% of the revenue, about 50% of the savings. We had a facility in Germany. And it wasn't doing what we needed it to do, it was a relatively new facility. The margin structure there wasn't there for us to be competitive. And with that, we exited that facility, moved some of that product to India. We had other facilities in India and other of them in the various areas in Europe. And with that, we've driven a tremendous amount of profit improvement, larger than our brakes line in Europe.

Very interesting. So initially, it sounds like a lot of the consolidation savings were in the duty transportation part of the business now. We're feeling back on and looking at legacy Wabtec [indiscernible]?

Absolutely. Yes.

Very interesting. And John, you also mentioned that we feel like there's more opportunities today than 3 years ago, which is really interesting. So we count on $75 million to $90 million of annual cost improvement?

You can be assured that we're looking at it real hard.

Fascinating. And as you look at the optimal level of doing business across the 153 plants, how many of them are in the Wabtec going forward, first quarter?

I think that, again, that goes with the fact that there's more opportunity today than 3 years ago. And maybe that's not the right way to say it. We can see that opportunity and see how we execute against that opportunity much better today than we did 3 years ago. But we don't need that many facilities. We got excess capacity. And in some of that, we don't need to be doing the products that we're doing because they're not delivering the mail, so to speak, in terms of the margins that we require. And again, it's just the next phase and how do we continue to mature as a company we are today, not 1 of the 3 companies that we were 5 years ago.

Very interesting. And in terms of the freight segment, world-class product, 26% margins, attractive margins, other companies with your type of market position, can have margins that are in the mid- to high 30s. Is that feasible to get your freight business to over time? Is that the blue sky scenario?

We can't put a number on it. What we can say is that we got 30,000 people that wake up every morning, how to make a better product and deliver a return for investment to our customers. And I think that actually, Jerry, that might be a place to spend a little bit of time is our business model, when you sell an asset that can last 20 to 30 years, is you've got to figure out a way to get them to trade up earlier because 20 to 30 years is a hell of a long time to wait, right? Now we make a lot of money as that asset runs on all the service businesses that -- the services that we provide to it in digital and so on and so forth. But the entire organization is geared and the engineering community is geared on how do we drive a return on investment for our customers. So most of the things that we sell have a strong return on investment. And what that means is let's take a locomotive, for example. If the market is not expanding as we've not seen much expansion in the North American market, we still need to sell locomotives, right? And -- so to make that locomotive much better than we made it 5 years ago and certainly 20 years ago, provides a strong return on investment for our customers. So it's not a straight replacement, a gratuitous act by a locomotive is a very strong return for them to do that. And we do that by becoming more efficient. And when you're in the rail business, the areas of driving most efficiency is around fuel. And so our engines and our engine construct allows us to be able to drive more fuel efficiencies than our competition. And with that, today's engines are 5% more fuel efficient than the ones that they're replacing. That helps provide that return on investment to our customer as well as a fair profit to us.

And on that note, the locomotive upgrade program, we should expand on. So you folks have done an outstanding job of adding value on locomotive rebuilds. So the mod solution you have for the older FDL locomotive, you've upgraded over 2,000 plus so far. How big is the installed base of FDL locomotives? And do you have a view on what proportion of that range is likely to be upgraded over time?

That fits in really well to the previous answer, right, is we're always trying to make them better. So what you're talking about is you go back -- what is it Kyra 2005, I believe, is we switch engines from what we call the FDL engine to the EVO engine. And in 2017, we developed a product called the modernization, which took advantage of a regulation that said as long as it's not 50% new, you can use Tier 3 engine versus the new Tier 4 engines that came out about the same time. And with that, we came out with a product called FDL Advantage, which was a series of innovations that drive about 5% of fuel efficiency. And with that, it helped that modernization program come together, in which our customers make a strong double-digit return on their investment, and we make a good profit on that. And with that, there was about 8,000 of those FDL advantage -- I'm sorry, FDL engines out there, and that was largely our Dash 8 and Dash 9s. Now they're not all modable, but the majority are -- and to your point, we've done in a couple of thousand range of them. So there's still thousands left. And now that was 2005 next year in a month, it's going to be 2025. So those are the 20-year mark. And typically, when we look at modernization, we do overhauls and overhauls happen around every 8 years. And typically, in the third overhaul -- overhaul is very expensive. It's a rebuild of the engine is when it [feels] to be the sweet spot for doing a mod, right? So and that's in the 15- to 20-year range. So anyhow, we're driving a new technology. It's out in test and where we had the FDL advantage, we now have the EVO advantage, and we believe we can save up to 7% fuel on those. And again, that gives us an opportunity to start to trade up those locomotives to modernize them or to swap them out for new because of the fuel savings. And it's not only the engine and the fuel that we're doing that on, it's all aspects of their business and how do we help out the labor. We do a lot of digital products for our customers. We got onboard electronics. We've got a collision avoidance system called PTC that we're the industry's provider for that and then network optimization and how do they run their assets better, and Movement Planner and dispatch systems and the like.

And it hasn't been 15 years yet since you've offered the mods. But what proportion of your customers do you think will opt to get them rebuilt again?

Part of that, Jerry, is how many do they have? And every railroad is in a different situation in terms of the power they need and the power that they have in the park, right? And what's usable in the park. So some of our customers are very short on power. And if they don't have things that they can mod or the time to give them to us to mod them, it takes a while to do that. then they're more interested in buying new, right? Some customers prefer new over mods. But to answer your question, over the last 5 years, I would rough guess to say about 80% have been mods. So it is an opportunity to, again, take an asset that they already own, punch it up the life and get the air emissions to what current standards are. And with that, there's less fuel, there's more fuel efficiency, less fuel use. Our Tier 4 engines, which are the new ones that we sell today, are focused on eliminating pollution, NOx [indiscernible] in particular manner. But in any event, each customer is a little bit different in what they're looking for, but the majority has been mods.

And you folks, I think, start shipping maybe 2014 ramped up over the next couple of years on the mod side. Do you think is it a foregone conclusion that every first mile is going to come back to be a second mod where we had [2030, 2031]?

Again, that hasn't been seen yet because they're not that old. But we'll have to take a look at that. But we've got a lot more others in the park to work on or in their fleets to work on before we're thinking about the second turn of the mod, and that's still probably 7, 8 years away.

Yes. And you spoke about the evolution series. So really interesting, the 7% fuel economy improvement. The FDL mod program was really successful, and that was with 5% higher fuel economy. In terms of the field population that we're looking at that was produced for you folks between 2005 and 2017 -- or 2015, excuse me, how big is that compared to the 8,000 we spoke for?

A little bit north of the 8,000.

And in terms of once that solution is available, so we're out with a good chunk of that installed base is going to be more than 15 years old. Do you folks have the capability to massively ramp up mod deliveries once it becomes commercially available. It sounds like it could be -- could be a coiled spring if based on the timing?

Yes. Well, we certainly have plenty of productivity on local production side, in particular, in North America.

And am I correct in thinking about it that initially, you're going to have essentially 5 years worth of demand?

No. I don't know if that's necessarily the way to think about it. The way our customers think about it is if I get a good return on investment, I'm interested. Right? And so having the EVO advantage and that opportunity to put in 7% savings is the opportunity to put that formula together, I think that what they're going to look at is, are there returns there? And does that fit into their current needs. And with that, we'll see what volume comes out of it. But it is a very large pool of assets out there, that are not nearly as sufficient as the ones today.

And have you shared the pricing paradigm with customers yet?

No. No. We're still in the form of railroads testing it for us. They test everything.

Fair enough. In terms of -- you had mentioned roughly 80% of deliveries have been mods and when you think of mod plus new. You folks have spoken about...

In North America. Outside then they're all new.

Yes, you spoke about, John, over the past couple of years, mod plus new deliveries have grown at double digit for the company. Can you talk to us about your backlog? How long is that double-digit growth sustainable based on [what you see]?

So we've got a fair amount of locos and backlog. Internationally, they've always been sold on long-term contracts, largely sold on long-term contracts, I think it's a little bit relatively newer in North America. So we do have a fair amount in backlog over the next 2 or 3 years to continue to drive our revenues higher. And in typically, every quarter, every other quarter, we have a pretty big order most recently, we had a $600 million order for new and then some international orders. One in Kazakhstan on a $2 billion MOU, about $400 million of that and one that we're very thrilled about is a mining project in Guinea between Rio Tinto and the Chinese government or the Chinese where we've garnered a huge order out of that.

And in terms of the conversation we had about a month ago with you folks and Rafael, you and Rafael characterize the environment for international demand is the strongest the company has seen in 5 years. So you've outlined some of the awards and MOUs that have come out -- it sounds like there is a pipeline beyond that, given those comments?

Yes. When you look at our business, our largest market for locomotives is North America, our largest single market. International is a similar size, but across many geographies. I think when we think about North America, there's not been a lot of underlying growth, right? Carload growth has been pretty flat for the last 10 or 15 years. And with that, our business has grown strong. And again, that is the need to replace the locomotive. And with some of the purchasing patterns of the class 1s over the last decade, they've been probably buying under the replacement rate. So that leaves a lot of opportunity for us to continue to grow in a market that might not be growing underlying. Now when we look at international, it is completely different, Jerry. Those markets are growing at a very good clip. And our market shares are growing, right? And in the U.S., we've got the replacement and our market shares have been strong as well. So internationally, it represents a tremendous opportunity for the company to grow. And it's not only selling in at a higher rate and the installed base of our international business is growing at almost a 5% CAGR. And that means everything that's running is growing at 5%. And as these markets get more scale, they draw on exponentially more products from us. One, our service networks get much more defined on the -- the monitoring equipment and the railroads and the rail systems go deeper on the digital products, onboard technologies, PTC networks signaling networks and so on and so forth, start to come into play with that scale. And that's what we're seeing in Australia and Brazil and certainly in Kazakhstan. So it's a much deeper penetration of all of our things with that growth of the installed base internationally.

And that's a good segue to talk about your service network because when you folks come into a new market, you provide the service levels that Wabtec is known for. So initially, your margin profile is lower in new countries. You mentioned Australia, Brazil, Kazakhstan and also India. Is it fair to think of those countries as having full benefit of absorption now that product has been out in the field for a couple of years?

Yes. I think when you think of us and the freight side, and again, we've got a trains side, we haven't talked about. But on the freight side, you think of vast lands and mining you're going to think of Wabtec. And not only for locomotives, but also mining equipment that we sell. Same technologies that pull all that wait from a dead stop also help mining truck, the size of a 2-story house, get out of a hole. But in any event, those markets are more mature for us. The growth aspects are much more pronounced than there in North America. But we do have those network set up and getting a lot of full benefits still growing but a major benefit. To move into another market, sometimes, yes, it requires an investment in that market to get to a point where you're putting the service elements in, and they're starting to get interested in the digital because they have the scale. But the markets I mentioned are much more -- well underway, still great opportunity in market share with regards to PTC and onboard products and digital products. But we've got the scale in those markets to make it work.

And in those markets, Jeff, how much of a tailwind is it that you folks are the industry leader in Tier 4 because at least on the on-highway side, a lot of those markets will be moving to Tier 4 equivalent for on-highway. Some of them don't have on the books yet Tier 4 for off-highway, but is it an advantage for you folks because the customers in those areas [indiscernible]?

You're talking about the mining equipment?

Locomotives?

So locomotives, we don't sell Tier 4 internationally. They're not regulated. That's only U.S. that has the [indiscernible].

So the question is -- so if I'm a customer in Kazakhstan and I'm bidding you against, let's say, electromotive diesel I would think I would be more likely to pick Wabtec because I'm only -- I'm thinking about not only the current locomotive -- but the locomotive in 10 years that I'm going to be buying. Is that a factor?

I think that is absolutely a factor. I don't know if that's necessarily at Tier 4. I mean I think the first consideration is the reliability and durability of our locomotives is better than what the alternatives are. And the fuel efficiency is significantly better. So with all of those aspects, I think, is their first decision point. and then the service network comes into play, right? When you're talking about these vast lands, if a locomotive goes down, it screws everything up for a while. And so the reliability that we need to have and that service network to keep everything running and all the forward-looking things, all the monitors that we have an engine sends off signals, millions of signals a year for our command centers in Europe and in the United States so that we know when to get it off the rail and get it fixed to make sure that, that thing is continuing to run. I think all of those are a little bit more. But when we talk about, as we move into the future, and maybe Jerry is better to talk about our strategy to move to a more carbon-free environment. And I think it's based on a 2 -- It's based on a two-pronged approach. The first one is to take the existing assets of 23,000 locomotives that we have out there and move them from where they are today to near zero. Right, enable the existing technology, the existing equipment, the existing infrastructures that our customers have invested and get them to near zero. The second prong is how do we develop and lead in the decarbonization of rail through 0 emissions. And that is the battery technology. Technology we've just commercialized the first heavy-haul locomotive in the world. Great application in Australia, never needs to be charged, never needs to be fueled in any way. It's all self-generating, right? And it drives that return on investment for a customer, even though they're paying quite a bit more for that locomotive. And then the other is on fuel cells. But let's go over here on this side when we talk about how do we get a customer to near 0. Again, part of our competitive advantage and a 4-stroke engine is it allows it to take [high liquid] hydrogen. It's capable of doing biofuels and renewable fuels. We've got trains running that are running on natural gas or LNG around the world. So depending on which source you have and the quality of that source, our engines are capable of doing that. And there's no change over and so on and so forth. And again, that allows them to continue to use the assets they've already invested in. And maybe even more so, it doesn't require a big change to the wayside. Hydrogen, liquid hydrogen is a little bit different, that would require some investment on their part. And there's also this concept that the railroad is very much like on that of reversibility. So if I don't have biofuels or I'm traveling through in the future when there is liquid hydrogen available on traveling through Denver, and they don't have liquid hydrogen. I just fill it up with diesel and I continue on and complete my mission. But it is reversible and no changeovers. Once you start to talk about fuel cells, no hydrogen, no go, right? It's just there. So trying to help the industry figure out how do we move in the most efficient way and get the most out of the assets that they've already bought from us.

And let's talk about transit next. So you folks have improved margins steadily in that line of business and from the beginning of our conversation as well as what we've spoken in the past, it sounds like there's really optimism in the organization about taking margins structurally higher. Can you talk about, John, what exactly is going on in terms of what you folks are operating. So we heard about restructuring. Can you talk about how you're approaching bids and other changes that you're making in the business? And talk about the margin opportunity?

Yes. Again, the footprint in our transit business is pretty widespread, more international, but a lot of plants and a lot of opportunity to continue to integrate those businesses. And I think that's evidenced by the fact that Integration 2.0, about half the savings is that a little bit more or they're overshared in the savings opportunity. And I think looking forward, we'd have that as well. So from a cost standpoint, I think there's still opportunity from integration standpoint. There's also opportunity on just some of the blocking and tackling from an operation standpoint on lean. And an example of that, which includes the entire company, not only transit, but more pronounced in transit. Is that today, about 60% of our revenue is generated, let's say, 40% of our revenue is generated by plants that are not following lean in any concerted way, shape or form. Now 3 years ago, that was 60%. Again, it goes back to this concept of how can a 155-year old company not have all the revenue manufactured by plants that are driving lean in those facilities. That goes back to it's a 5-year startup, right? We have a lot of opportunity. Some of that margin that you've seen growth in backward looking is because of that. We still have that same opportunity forward looking because 40% still isn't there. And again, a fair amount of that in our transit business. So those are the cost elements. We also, from a margin standpoint, have the opportunity to grow because of the volume growth and just leverage the fixed asset structure we have. The second area is, in particular, in transit is to be more selective on the contracts that we do take. It's a project business. We're bidding on them, and we're trying to move away from bidding on things for the sake of bidding and making sure that we've got an advantage to that and the technology that we bring and working a little bit prior to that process to make sure that our technologies, which we believe are better than most out there are spec-ed into there. So we're driving higher-margin bids. And we're seeing that in our backlog as we look at the profitability of our backlog, which is a forward look from here versus a year ago, we've got more margin built into those by some of the contracts that we're taking. And again, pricing for the value that we're delivering in the technologies that we offer.

And John, what's been the organization's performance of delivering to contract in backlog? What has the variance been?

In terms of what's in backlog and what gets executed?

Yes. So in other words, so the sales team gets evaluated based on the anticipated margin and then when things hit the factory, we can have positive or negative variances?

So at times when we talk about productivity in the quarter, when we talk about how good execution was -- there's a lot of products that we deliver around the world, a lot of complexity and a lot of different business models. But as we execute those -- we've got the orders in the backlog, and it's just a matter of getting at them. So we know when the schedules are due. And sometimes, we do a better job than others. But over the last couple of years, our execution has been fantastic. Which means that we're getting to the backlog when they're doing on time and delivering those products. We're a little bit -- maybe somewhat unique in the fact that we do have a large backlog. So 60% of our revenue is backed up for a long-term contract or contracts that are over a year. That leaves 25% to -- about 25% to 30% of our business. Being flow businesses. So with that, we have good visibility into the future. And in any particular year, when we start a year, we have about 70% of our revenue set for that year. So then again, Jerry goes back to how do we execute against that? And can we execute against all of it. And we've been doing very good and a very high percentage of that. The rest of the 30% comes in flow businesses, which are largely parts and some of our railcar business that is on a much more shorter cycle. But overall, the backlog is $23 billion, which represents 2.5 years of overall sales. But we keep a strong eye on our 12, 18 and 24-month backlog to make sure that we're building that growth in, so right now, most of the company is working on how to fill the bucket of growth in 2026. And our focus is on executing what we've got in orders 2025.

And in terms of the profile of the transit business in margin and backlog, how much higher are they compared to what you [indiscernible].

That I can't provide, I can tell you they're higher.

Yes. Okay. And in terms of the types of contracts that you're bidding on, can you just spend a minute? Is it certain geographies that you're getting more business from where -- just how do you get that higher quality backlog?

So, let's spend a second on what we're talking about in transit. So we do not make locomotives or the power units in our transit business, what we make are component systems. And they are such as brake systems, door systems, HVAC, passenger information. We make the pantographs the world's leader in pantographs on the electrical aspect of how to bring electricity from a catenary down into the train. So all of those elements come into when a car builder, which is an assembler of these systems, and that is Siemens and ALSTOM's [indiscernible] and Stadler, our main customers from an OE standpoint. And we sell into them those components. And then the other 60% of our business is on the aftermarket, which we largely sell into the operators to drive that forward.

In the business that we're winning, that's higher margin?

I'm sorry, yes. So what we -- our focus is on the businesses that are higher margin, and that have a quicker turn from the OE product, which tends to be at a lower margin for the aftermarket. So some of them are immediate, right? When you think in terms of brakes or pantographs. Right? They have a consumable piece, those brake pads and we make the friction aspects. And we just bought a company that makes the carbon strips for the pantographs. So we take all of that into consideration and then the technologies that we bring to bear. And other things that we're looking and bidding on that doesn't have that quick upturn into the higher-margin service or our lower it don't make sense for the capital that we're [indiscernible]. Your participation in this conference has been terminated by the host. Goodbye. [Audio Gap] returns to our shareholders in the form of share repurchases. And we're not looking to build cash on our balance sheet. If we don't have good M&A, we'll return it to repurchases, evidenced by the first 3 quarters of this year, we didn't have any M&A and we returned $1 billion of our cash and share repurchases.

Super. That's all the time we have John, Kyra. Thank you so much for joining us.

Thank you, Jerry, and thank you, everyone, for your interest in some of your investment in Wabtec. [indiscernible] other information please give Kyra a ring. She's the best in the business, and we'll get you all the information you need to make a decision.

Thanks [indiscernible].