WABCO's Quality Already Reflected In The Stock

By Stephen D. Simpson, CFA | October 03, 2012 AAA

Investors have gotten pretty skittish about vehicle part/component suppliers, even if quality companies overweighted towards commercial and/or emerging markets are getting an incremental premium. With good cash flow and solid (albeit erratic) returns on capital, WABCO (NYSE:WBC) stands out as a quality commercial vehicle original equipment manufacturers (OEM) supplier and unfortunately the stock reflects that.

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Stop And Go
Not unlike Cummins (NYSE:CMI), WABCO is a quality supplier to a range of commercial vehicle manufacturers with solid recent growth in major emerging markets such as Brazil, China and India. Whereas Cummins focuses on engines (as well as other components like filtration and emissions control), WABCO is built around a host of electrical and electromechanical components such as brakes, automated transmissions and air processing/compression. Unlike Cummins, WABCO doesn't have to worry quite as much about OEMs like Navistar (NYSE:NAV) or Tata (NYSE:TTM) developing systems internally, and the competition is pretty concentrated. Neither Knorr-Bremse nor Haldex are household names for most investors, but they hold about 45% and 10% market share respectively (with WABCO holding about 40%).

Largely All About The OUS
WABCO is also a little unusual in that it generates relatively little revenue from the United States. North America is often only about 10% of the company's sales base, with Europe contributing more than 60% and growing emerging markets like India and China contributing more than 20%. This is a mixed blessing. North America has been stronger lately, but new emissions standards should boost truck production in Europe relatively soon. At the same time, the company is seeing strong end market growth (on a longer-term basis) in major emerging markets and increasing content per vehicle.

It's hard to argue the company's decision to actively target emerging market growth. Like other commercial vehicle suppliers such as Honeywell (NYSE:HON), Cummins and Eaton (NYSE:ETN), WABCO has established physical presences in major emerging markets and sought to work actively with local vehicle OEMs. Though there is a longer-term threat of local competition, Cummins has shown that long-term investments and partnerships can pay significant dividends in terms of market share and sentiment.

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Waiting On 2013
WABCO's revenue comps have not been all that good lately, and it's not a big surprise. It seems as though there's a daily stream of news talking about how bad things are in Europe and/or how things are slowing in Brazil, India or China. It seems almost certain, then, that WABCO is going to end 2012 with lower revenue and earnings from last year. But 2013 is another story. Developing economies should start showing improvements and the company can also look to take advantage of new wins and increased per-vehicle content. At the same time, while Europe is not likely to see a big overall economic rebound, there could be significant interest in buying trucks ahead of the new regulations that go into effect in 2014.

The Bottom Line
I like WABCO quite a lot as a company; the company's quality technology has established very significant market share which has, in turn, translated into good margins and respectable cash flows. Moreover, the company has a clean balance sheet and I believe WABCO can make selective acquisitions to further diversify its component or vehicle addressable markets. What I don't like about WABCO is the price. An assumption of 8% compound annual free cash flow (FCF) growth generates a price target about 10% higher than today's price, and the company's trailing EV/EBITDA ratio of approximately 8 times seems about in line with its likely medium-term growth potential. Consequently, while I think WABCO is a very good hold today, Cummins and Dana (NYSE:DAN) seem like better bargains right now.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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