Westinghouse Air Brake Technologies: Higher PTC Sales and Fandstan Acquisition Signal Faster Growth

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Wabtec reported second-quarter diluted EPS of $0.91, an 18% increase from the prior year and better than both consensus of $0.87 and our $0.86 estimate. While sales were slightly lower than expected, stronger operating margins (+$0.04), and a lower tax rate (+$0.01) accounted for the $0.05 upside to our forecast. Second-quarter sales of $731 million rose 15% year-over-year, slightly below our $738 million forecast and consensus expectations. Both freight group ($411.5 million versus our $415.5 million forecast) and transit group ($319.6 million versus our $322.8 million forecast) sales trailed projections.

Revenues expanded 16% for the freight segment and 13% at transit. Stronger freight revenue growth is very positive, given freight’s operating margins are nearly twice the transit segment’s. Gross margin of 30.7% rose 50 basis points from the year prior and exceeded our 30.0% forecast. The effective tax rate of 30.7% was 130 basis points lower than the year prior and below our 31.4% forecast. Based on Wabtec’s first-half results and outlook for the rest of the year, the company increased its 2014 guidance for EPS to approximately $3.52 (previously $3.45), with revenues expected to rise about 15% (no change) in 2014. Prior to today’s earnings release, our model had assumed 15% revenue growth (consensus was at 15%) and EPS of $3.45 (consensus was at $3.49).

During the quarter, Wabtec repurchased 194,700 shares for $14 million. The company has $184 million remaining on its recently approved $200 million sharerepurchase authorization. Wabtec had cash of $226 million and debt of $501 million, for net debt of $275 million at the end of the second quarter. Net debt to total capital was approximately 12.5%, up from 7.3% in the year-ago period. Cash flow from operations in the quarter was $111 million, or 15% of sales. We are raising our 2014 EPS estimate to $3.55 (previously $3.45) and our 2015 EPS estimate to $4.05 (previously $3.95), representing a 14% increase for 2015 EPS. We continue to project a 15.0% gain in 2014 sales, to $2.95 billion, with operating margins expanding 70 basis points, to 17.7%.

We maintain our Market Perform rating but are increasing our 12-month price target for Wabtec to $80 (previously $70). This assumes the shares trade at a 35% relative P/E premium (up from 30% previously) to FactSet’s 2014E S&P 500 P/E multiple of 16.7 times and based on our revised 2014E EPS of $3.55. Our higher relative valuation reflects stronger PTC growth in 2014 and 2015 of 20%-25%, versus 10%- 15% previously, reflecting resolution of prior U.S. regulatory roadblocks.

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