The global leader in natural gas engines.

NASDAQ:    WPRT  -  24.17

Monopolistic Review:

What makes this a good business?

We believe this is a very good business that has robust revenue growth resulting from the steady migration towards natural gas powered engines as an OEM option for several major auto manufacturers, and the rapidly expanding acceptance of Westport Innovations (WPRT) natural gas powered engines and it’s innovative and patented technology.  At the same time the cost/performance for these new solutions is improving, the commodity pricing for natural gas is falling, giving a substantial return for alternative clean energy natural gas engines.  Westport’s global leadership advantage in sales, industry partnerships, and innovation are a significant deterrent for new competitors.  Having already spent over $300 million towards the research, development, and commercialization of their proprietary technology, Westport holds an enviable patent portfolio of intellectual properties, making it a very desirable partner when much larger or more established companies look to migrate into this rapidly expanding field. Their current position, prominent partners, scalability, and patent advantages give them an odds on advantage to be the stand alone leader if not a domineering monopoly position in this field.

The Industry

The natural gas engine has a much lower fuel cost advantage over more traditional fossil fuels.  This equates to about a $2 to $2.50 savings per gallon, depending on the open market prices.  It now appears the US has become the “Saudi Arabia of Natural Gas” with so much of it available as a result of the advanced horizontal drilling and fracking technologies currently being utilized.  In fact, “Dry Gas” only wells are now frequently being mothballed, as more focus goes towards “Wet Gas”.  The continued build up of natural gas inventories during last winter’s (peak) season is a secondary indicator that there are years of gas surplus available at low prices.  Today, a unit of West Texas crude cost more than 33 times as much as a unit of natural gas.  That’s up from a more historical 6 times as much as natural gas prices.

The biggest obstacle the natural gas engine industry faces may be refueling.  For companies like Waste Management, UPS, ATT and Ryder, whose fleet vehicles return to a central hub each night, refueling is not an issue.  This is an outstanding solution for these companies, who have already purchased this technology.  However, this remains an issue for long hauls and/or deliveries to many random or distant locations.   While gas companies are working to increase their natural gas distribution network by targeting the major truck routes and thoroughfares, this is both a timely and costly build out.  We expect the natural gas engine industry will continue to gain market share as natural gas stations build out progresses, making this an excellent and desirable business segment.  While Westport is faced with the challenge of organic growth, we see the largest single factor for the long term success of this company being the whole industry’s achievement of critical mass, where long haul trucking companies don’t need to be concerned about the lack of refueling stations.

Our previous studies have recognized that companies achieving monopoly positions have more of a “gutter approach” versus the individual roof shingle, which only see the rain that falls on it.  While the gutters often remain unseen, they typically receive the same amount of rain (or in business terms, profit) as all of the singles combined.  Westport is endeavoring to be the stand alone leader and the de facto standard for the entire new natural gas engine industry.  There are outstanding barriers to competition, and Westport has been able to achieve excellent margins and economics of scale as a result of their strategic partnerships.

Some of Westport partners are:

• Cummins, Inc
• Volvo
• Navistar
• Canadian National Railways
• Ford F-250 and F-350 Super Duty pickup trucks
• General Motors
• Caterpillar, Inc
• Peterbilt Motors Company, a division of PACCAR Inc
• Clark Material Handling
• Daimler Trucks / Freightliner
• Minda Emer Technologies Limited, which supplies Suzuki Maruti, the market leader of passenger cars in India.

Although Navistar is only one of many companies working with Westport, Eric Tech, president of Navistar’s engine business, stated that Navistar is expanding “to a full range of products using natural gas in the next 18 months.”  This year Navistar is introducing delivery trucks burning natural gas.  Next year, it is adding long-haul trucks with its biggest engines.  Mr. Tech also stated that in a couple of years, every one in three Navistar trucks sold will burn natural gas.  ”This is not a subsidy-driven market,” Mr. Tech says, “It’s developing on its own because the economics are compelling.”  With many of Westports larger clients looking to aggressively expand, it helps paint a nice growth scenario.

Risks - The Stock Price, and Cummins entrance into large engine 15 liter market.

Cummins (CMI) has the right to market 15 liter engines outside of North America, in markets where they do not directly compete with the joint venture Cummins Westport Inc (CWI).  Even though Westport’s stock reacted very negitively to this announcment, and that over time CMI could become a potential competitor, it does not change or effect their (CWI) joint venture relationship in the immediate or forseeable future.

Probably the hardest question to answer concerning Westport is what the fair valuation of this company should be.  When compared to Cummings or Caterpillar, two leading companies in closely related industries, Westport has superior revenue margins and top line growth, and trades at about 3 times the same metrics of these more established but slower growth partners.  With the stock recently hitting the skids and dropping over 35%, the valuation currently given it is significantly less than it was just two month earlier when the market evidently chose to look more at partnerships and surging first quarter revenue growth. Westport’s gross margins have consistently stayed well above the 30% mark during the past few quarters, and revenue growth is projected to remain over 50%.

It’s extraordinarily difficult at best to predict just how soon or how far in front of this swelling tidal wave of earnings the market will undoubtedly anticipate its arrival and demand a far richer multiple for such explosive growth.  In short, if and when the market decides to again look beyond the bottom line and focus more upon Westport’s continued new product innovations and top line revenue growth, the valuation for Westport will increase, perhaps significantly and without much warning.

In Summary

The potential market for Natural gas is enormous.  The 3.2 million big rigs on U.S. roads today burn some 25 billion gallons of diesel annually.  Almost 7 million single-unit trucks, such as UPS or FedEx Corp trucks, consume another 10 billion gallons of diesel.  Converting even a modest number of these trucks, which often get 5 to 8 miles a gallon, to natural gas could result in the saving of significant amounts of money.  Tail pipe emissions also would drop, since natural gas burns cleaner than diesel or gasoline.  This would mean big business for the possibly monopolistic leader in this industry.

Westport has already seen significant growth, is a true market leader, and has established certain scale and technical advantages that has moved it from a start up company to the forefront of a possible monopoly position in the industry in only 17 years.  It now appears to be in a great position to start substantially monetizing their pole position within the industry, with very few players (if anybody) left scrambling for second place.  This, combined with a potentially explosive growth industry, makes the sum total of Westport’s market, its products, and its intellectual properties all extremely attractive as a longer term investment opportunity.

Disclosure:  Durig Capital and certain of its clients may currently hold positions in
Westport innovations Inc.

Disclosure:

Durig Capital clients may currently own these bonds.
Contact our fixed Income analyst for questions at 971-327-8847.

Durig.com | Investment-Income.net

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