Whether it's truck and engine company executives like those at Navistar (NYSE:NAV) and Caterpillar (NYSE:CAT), environmentalists, or energy policy pundits, it seems like there's a broad agreement that the U.S. needs to do more to make use of natural gas as a vehicle fuel. With high-quality partners like Volvo (OTC:VOLVY) and Cummins (NYSE:CMI), Westport Innovations (Nasdaq:WPRT) continues to look like a promising play on that trend. That said, while these shares could indeed have substantial upside from here, the LNG/CNG engine market is still in its infancy and there are no guarantees that customers will go in the direction of Westport's technology.

Investopedia Broker Guide: Enhance your trading with the tools from today's top online brokers

Sluggish Third Quarter Results Don't Matter Too Much
Westport is arguably still at a point in its life cycle where quarter-to-quarter financial results are not the "end-all, be-all" for the stock. Nevertheless, these results do point to some of the ongoing challenges that the company faces.

Revenue declined 6% from last year (and 28% from the prior quarter), with product revenue down 10% from last year. While the reported revenue number missed the average analyst estimate by about 10%, the overall shipment numbers were broadly in-line. Revenue from the company's Cummins JV fell 8%, while light duty revenue was basically flat. Heavy-duty revenue was down 36%, but makes up a tiny part of revenue today. Although not consolidated, the company's venture with Weichai saw revenue nearly double.

Profitability was weaker than expected, but not alarmingly so. Gross margin fell about 300 basis points from last year, and more than 10 points from the prior quarter, largely on higher warranty costs. Margins improved into the 6%s within the company's light- and heavy-duty operations, while the gross margin at the Cummins JV fell more than seven points to 13.4%. Westport posted an operating loss, though the Cummins JV was profitable at the operating line.

SEE: Everything Investors Need To Know About Earnings

Shipments Progressing, with Big Launches on the Way
Westport has the unenviable task of trying to launch new technologies at a time when the commercial truck business is seeing tough times. Whether you look at OEMs like Navistar and Oshkosh (NYSE:OSK) or component players like Eaton (NYSE:ETN), nobody is saying too many good things about truck demand right now.

It's not altogether surprising to me, then, that shipments were down this quarter. In the Cummins JV, engine shipments were down 2% from last year and almost 20% from the second quarter. Heavy-duty shipments were down even more (32% from last year and about 20% sequentially), but at 58 it's definitely a small base.

I would think shipments should start accelerating next year. Volvo's new 13-liter engine should be available in 2013, and the Cummins JV should be launching its new 12-liter engine early in the year as well. What's more, Westport continues to make progress with off-highway customers like Caterpillar, as well as passenger vehicle manufacturers.

SEE: The Impact Of Recession On Businesses

Nothing's Certain, but the Economics Seem Compelling
Clearly there is plenty that can still go wrong with the Westport story. Although the company has a solid long-term relationship with Cummins in lighter-duty applications, there is still the risk that customers will prefer Cummins' own spark ignition (SI) engines or the dual-fuel approach previously favored by Navistar.

Likewise, while the difference between today's LNG prices and diesel offer quick payback for LNG engines (about three years) despite their higher cost, there are many industries building up on the back of cheap natural gas. Over time, that could shrink that fuel cost advantage and constrain or slow LNG/CNG engine adoption.

The Bottom Line
There's always an element of guesswork to any cash flow model or valuation analysis, but that's particularly true in the case of a company like Westport, where the model is explicitly predicated on big changes in the addressable market. Although I don't really argue with Westport bulls who believe Westport technology will be a share leader, I believe there's still many opportunities to debate just how large that market will be and how quickly it will develop.

Right now, I'm expecting the company to see a significant ramp up in revenue to about $1 billion in 2017, with double-digit growth for five years thereafter. At the end of that horizon, I see about $300 million in free cash flow, and that works out to a fair value in the high $20s. While I'm sure Westport bulls will argue that those numbers are appallingly conservative, I have always found it better to be careful with unproven stories, and even with that conservatism I think there's room to buy these shares today.

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

Related Articles
  1. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  4. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  5. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  6. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  7. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  8. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  9. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  10. Stock Analysis

    GoPro's Stock: Can it Fall Much Further? (GPRO)

    As a company that primarily sells discretionary products, GoPro and its potential falls right in line with consumer trends. Is that good or bad?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center