Westinghouse Air Brake Technologies Corporation (NYSE:WAB) Q4 2023 Earnings Call Transcript

Westinghouse Air Brake Technologies Corporation (NYSE:WAB) Q4 2023 Earnings Call Transcript February 14, 2024

Westinghouse Air Brake Technologies Corporation misses on earnings expectations. Reported EPS is $1.54 EPS, expectations were $1.57. Westinghouse Air Brake Technologies Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and welcome to the Wabtec Fourth Quarter and Year End 2023 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] Please note, today’s event is being recorded. I would now like to turn the conference over to Kristine Kubacki, Vice President of Investor Relations. Please go ahead.

Kristine Kubacki: Thank you, operator. Good morning, everyone, and welcome to Wabtec’s fourth quarter 2023 earnings call. With us today are President and CEO, Rafael Santana; CFO, John Olin; and Senior Vice President of Finance, John Mastalerz. Today’s slide presentation, along with our earnings release and financial disclosures, were posted to our website earlier today and can be accessed on the Investor Relations tab on wabteccorp.com. Some statements we are making are forward-looking and based on our best view of the world and our business today. For more detailed risks, uncertainties and assumptions relating to our forward-looking statements, please see the disclosures in our earnings release and presentation. We will also discuss non-GAAP financial metrics and encourage you to read our disclosures and reconciliation tables carefully as you consider these metrics. I will now turn the call over to Rafael.

Rafael Santana: Thanks, Kristine, and good morning, everyone. I’ll start with an update on our business, my perspectives on the quarter, our progress against our long-term value creation framework, and then John will cover the financials. We delivered a strong year with another solid quarter as evidenced by robust sales growth, margin expansion, and increased earnings and cash flow. We achieved this despite continued uncertainty in the broader economy and in the North America rail industry. Sales were $2.5 billion, which was up 9.5% versus prior year. Revenue growth was driven by strong performance from both the Freight and Transit segments. And adjusted EPS was up 18.5% from the year-ago quarter, driven by margin expansion across both segments.

Total cash flow from operations for the quarter was $686 million, and total year cash flow was $1.2 billion. The 12-month backlog was $7.5 billion, up 10%, signifying continued momentum and visibility across the business into 2024, and total multi-year backlog was $22 billion. Overall, the Wabtec team delivered a strong year. Looking forward, I am encouraged by both the underlying momentum across the business, and the team’s unrelenting focus on delivering for our customers. I believe Wabtec is well-positioned to drive profitable growth ahead. Our financial position remains strong. We continue to execute against our capital allocation framework to maximize shareholder value by investing for future growth and returning cash to shareholders. And as a result of our performance in 2023 and our confidence in the future of the company, our Board of Directors approved an 18% increase in the quarterly dividend and a $1 billion share buyback authorization that replaces our existing program.

Shifting our focus to Slide 5, let’s talk about 2024 and market expectations in more details. While key metrics across our Freight business remain mixed, we continue to be encouraged by the strength of the business, international markets, and our robust pipeline of opportunities across geographies. North American carloads were up 2.8% in the quarter, while the active locomotive fleet was down slightly when compared to where the industry exited last year. Yet, we continue to see significant opportunities across the globe and demand for new locomotives, modernizations, and digital technologies, as our customers invest in solutions that continues to drive reliability, productivity, safety, and fuel efficiency. Looking at the North America railcar build, demand for new railcar showed growth in 2023 at approximately 45,000 cars.

The industry outlook for 2024 is for about 38,000 cars to be delivered. Internationally, activity is strong across core markets such as Latin America, Australia, Africa, and Kazakhstan. Significant investments to expand and upgrade infrastructure are continuing to support our robust international orders pipeline. In mining, commodity prices and an aging fleet are supporting activity to refresh and upgrade the truck fleet. Finally, moving to the Transit sector, the megatrends of urbanization and decarbonization remain in place, driving the need for clean, safe, and efficient transportation solutions around the globe. Next, let’s turn to Slide 6 to discuss a few recent business highlights. In North America, we won a multi-year order for over 200 modernizations from CSX, demonstrating customer demand for a best-in-class solution to improve productivity, while driving down fuel usage and emissions.

Looking at our mining business, we are seeing continued momentum and visibility. The team signed orders totaling over $300 million in the quarter, which is up double digits versus last year. In Transit, we won a major order worth over $150 million to supply high-performance brake systems in India. These brake systems will provide improved operating performance, efficiency, and safety for a new line of 1,200 electric locomotives. Also, during the quarter, we announced our entrance into the railcar telematics market. Our innovative telematics platform will improve shipment visibility, it will increase on-time performance, and expand asset utilization to make shipping freight by rail more competitive. Finally, during December, we acquired the remaining 50% of our JV in Kazakhstan.

This strategic acquisition enhances our manufacturing capability, both globally and in the region poised for continued long-term growth. All of this demonstrates the continued momentum across the business, the team’s relentless focus on delivering for our customer, and strong pipeline of opportunities we’re executing on. Wabtec is well-positioned to capture profitable growth with innovative and scalable technologies that address our customers’ most pressing needs. Moving to Slide 7. Before turning it over to John, I want to briefly discuss our ability to deliver strong results through the economic cycle. Over the last four years, Wabtec has demonstrated a solid track record of managing through challenging markets and significant disruptions.

We believe our favorable end markets, combined with our leading technologies and solutions, will enable us to remain resilient and more predictable. Our 12-month backlog of $7.5 billion provide significant visibility and support for growth. The 12-month backlog has consistently grown over the past four years, despite a challenging North America rail market and a volatile macroeconomy. And finally, we have consistently demonstrated our ability to execute our strategies, generate strong cash flow, deliver growth, and create value through disciplined capital allocation. Our track record of strong operating margin expansion across the business is evidence of our ability to deliver productivity, manage costs, and price for inflation. Our execution, combined with the strength of our business, leading products, and technologies, which result in Wabtec being resilient through economic cycles, delivering predictable earnings and superior shareholder returns.

With that, I’ll turn the call over to John to review the quarter, segment results, and our overall financial performance. John?

John Olin: Thanks, Rafael, and hello, everyone. Turning to Slide 8, I will review our fourth quarter results in more detail. We finished the year with another solid quarter of operational and financial performance. Sales for the fourth quarter were $2.53 billion, which reflects a 9.5% increase versus the prior year. Sales were driven by strong growth across both the Freight and Transit segments. For the quarter, GAAP operating income was $308 million, driven by higher sales, improved gross margin, and focused cost management. Adjusted operating margin in Q4 was 17.0%, up 1.7 percentage points versus the prior year. This increase was driven by a higher gross margin of 1.2 percentage points, and 0.5 percentage points of lower SG&A and engineering expenses as a percent of sales.

GAAP earnings per diluted share were $1.20, which was up 39.5% versus the fourth quarter a year ago. During the quarter, we had pre-tax charges of $47 million, of which $19 million was for restructuring, which was primarily related to our Integration 2.0 initiative to further integrate Wabtec’s operations and to drive $75 million to $90 million of run rate savings by 2025. In addition, we are exiting some small non-strategic product lines and related assets, which generated a Q4 charge of $28 million. Finally, in the quarter, our acquisition of the remaining 50% interest in our LKZ assembly joint venture generated a gain of $35 million on our existing ownership interest. I will talk more about our progress on Integration 2.0 and portfolio optimization in more detail in a few minutes.

In the quarter, adjusted earnings per diluted share were $1.54, up 18.5% versus prior year. Overall, Wabtec delivered another solid quarter, demonstrating the underlying strength of the business. Turning to Slide 9, let’s review our product lines in more detail. Fourth quarter consolidated sales were up 9.5%. Equipment sales were down 19.3% from last year as higher mining sales were more than offset by lower locomotive deliveries during the quarter. Recall that second half locomotive deliveries, as planned, were significantly skewed to the third quarter. Total equipment sales for the year were up a very strong 15.8%. Component sales were up 17.4% versus last year, largely driven by the higher demand for railcar products, along with increased sales from industrial products.

Sales also benefited from the acquisition of L&M earlier in the year by $32 million. Digital intelligence sales were down 6.7% from last year, which was driven by lower revenues in our North American market, partially offset by higher demand for international PTC, next-gen on-board locomotive products, and digital mining. Our services sales grew 23.9%. Sales growth was driven by significantly higher modernization deliveries. In contrast to new locomotive sales, our planned second half mods deliveries were significantly skewed to the fourth quarter. Additionally, parts sales continued to show strength as our customers continue to recognize the superior performance, reliability, efficiency, and availability across their Wabtec locomotive fleets.

Across our Transit segment, OE and aftermarket sales increased versus last year. Segment sales were up 14.3% to $728 million, behind execution of our growing backlog. The momentum in this segment is strong across our core markets as secular drivers such as urbanization and decarbonization accelerate the need for global investments in sustainable infrastructure. Moving to Slide 10. GAAP gross margin was 30.3%, which was up 2.0 percentage points from Q4 last year. Adjusted gross profit margin was up 1.2 percentage points, driven by higher sales, favorable price/mix, and foreign currency exchange, as well as improved productivity. Our team continues to execute well to mitigate the impact of continued cost pressures by driving operational productivity and lean initiatives.

Now, turning to Slide 11. For the fourth quarter, GAAP operating margin was 12.2%, which was up 1.5 percentage points versus last year, while adjusted operating margin improved 1.7 percentage points to 17.0%. GAAP and adjusted SG&A expenses were down as a percentage of revenue as we leveraged higher sales with a strong focus on managing costs. Engineering expense was $61 million, about flat with Q4 last year. We continue to invest engineering resources and current business opportunities, but more importantly, we are investing in our future as an industry leader in decarbonization and digital technologies that improve our customers’ productivity, capacity utilization, and safety. Now let’s take a look at segment results on Slide 12, starting with the Freight segment.

As I already discussed, Freight segment sales were up 7.7% during the quarter. GAAP segment operating income was $246 million for an operating margin of 13.7%, up 1.2 percentage points versus last year. GAAP operating income includes $28 million of portfolio optimization costs. Adjusted operating income for the Freight segment was $347 million, up 22.2% versus the prior year. Adjusted operating margin in the Freight segment was up 2.3 percentage points from the prior year at 19.3%. The increase was driven by significantly higher gross margin, which benefited from higher sales, favorable price/mix, and improved productivity and absorption. At the same time, SG&A and engineering expenses were lower as a percentage of revenue. Finally, segment 12-month backlog was $5.45 billion, up 11.2% from the same period a year ago.

The multi-year backlog was $17.83 billion, down 4.3% from the prior year. Both our 12-month and multi-year backlogs demonstrate good visibility into 2024 and beyond. Turning to Slide 13, Transit segment sales were up 14.3% to $728 million. When adjusting for foreign currency, Transit sales were up 9.9%. GAAP operating income was $86 million, up 36.5%. Restructuring costs related to Integration 2.0 activities were $17 million in Q4. Adjusted segment operating income was $108 million, which was up 13.7%. Adjusted operating margin of 14.9% was up 0.1 percentage points from last year, driven by the benefits of volume growth and Integration 2.0 savings. Finally, Transit segment 12-month backlog for the quarter was $2.01 billion, up 8.0% versus a year ago.

The multi-year backlog was also up 9.7% to $4.17 billion. Moving to Slide 14, over the next two slides, I would like to touch on both our progress against our Integration 2.0 initiative, as well as provide details on our portfolio optimization. The efforts of both these programs in 2024 will unlock greater profitability and margin expansion across the portfolio. With regards to Integration 2.0, recall that during our Investor Day in 2022, we announced a restructuring program comprised of estimated one-time expenses between $135 million and $165 million, that would yield an incremental $75 million to $90 million of run rate savings by 2025. These savings are to be achieved through a combination of actions which simplify, streamline, and consolidate parts of our operations.

With program-to-date restructuring expenses of $118 million, we achieved $22 million of run rate savings as we exited 2023. We expect savings to ramp more meaningfully in 2024, and we remain on track to meet our 2025 goals. Now turning to Slide 15. As you are aware, we are very focused on driving improved shareholder value through the addition of strategic bolt-on acquisitions with accretive earnings, margins, and return on invested capital. In the second quarter of 2023, we acquired L&M, a business that is very complementary to our heat transfer portfolio and enhances our mining installed base. In the short time that we’ve owned this business, we are pleased with its performance, and more importantly, we are excited about its future potential for driving long-term profitable growth for Wabtec.

Also, as Rafael stated, late in the fourth quarter, we acquired the remaining 50% stake of our unconsolidated LKZ assembly joint venture in Kazakhstan for $81 million net of cash received. As a result of the transaction, we recorded a $35 million non-cash gain in the quarter, which is excluded from adjusted earnings. Going forward, this business will be 100% owned by Wabtec and consolidated in our financial results. We would expect virtually no impact to sales and limited benefit to earnings in 2024. We’re also announcing today the exit of some non-strategic product lines in 2024. Pruning of these product lines will improve focus in profitability, while reducing manufacturing complexity. Sales from these product lines totaled about $110 million of sales in 2023, and represented a lower-than-average margin profile.

The expected net exit charges of roughly $85 million are largely non-cash, of which we recognized $28 million of non-cash charges in our Q4 GAAP results. Both our progress against our Integration 2.0 initiative and the announced portfolio moves will help position Wabtec to drive multi-year margin expansion. Now, let’s turn to our financial position on Slide 16. Fourth quarter cash generation was strong at $686 million, resulting in total cash from operations of $1.2 billion versus $1.04 billion in the prior year, an increase of 15.7%. Cash flow benefited from higher earnings and improved working capital. Our balance sheet and financial position continue to be strong. We ended the quarter with liquidity of $2.12 billion. And our net debt leverage ratio was 1.9 times at the end of the fourth quarter, which was favorable versus the prior year’s 2.2 times debt leverage.

During 2023, we invested $308 million on the strategic acquisitions of L&M and the LKZ joint venture, and returned $532 million to shareholders through share repurchases and dividends. Finally, we improved ROIC during the year by 1.2 percentage points. We continue to allocate capital in a disciplined and balanced way to maximize returns for our shareholders. Moving to Slide 17, quickly recapping the year. Overall, the team delivered a strong year for all our stakeholders. Despite macro challenges, we drove strong revenue growth, expanded our operating margins, and generated robust cash flows. The resiliency of the business and strong execution provides us with a solid foundation for profitable growth as we enter 2024. With that, I’d like to turn the call back over to Rafael to provide our 2024 financial guidance.

Rafael Santana: Thanks, John. Now, let’s turn to Slide 18 to discuss our 2024 outlook and guidance. We believe that the underlying customer demand for our products and solutions continues across our business. This is the strongest order pipeline we’ve had since 2019. Our 12-month and multi-year backlogs, as well as our orders pipeline, continue to be strong, providing solid visibility for profitable growth ahead. The team is committed to driving top-line growth and margin expansion in 2024, despite an uncertain macroenvironment. With these factors in mind, we expect 2024 sales of $10.2 billion at the midpoint, over 5% growth versus last year, and adjusted EPS midpoint of $6.70 per share, up about 13% from last year. We also expect cash flow conversion to be greater than 90%.

Looking ahead, I’m confident that Wabtec is well positioned to drive profitable growth in 2024, which is aligned to our long-term financial framework. Now, let’s wrap up on Slide 19. As you’ve heard today, our team delivered a solid quarter to finish out a very strong year, thanks in large part to our resilient installed base, world-class team, innovative technologies, and our continued focus on our customers. These results were in line with our long-term value creation framework. I’d like to take a moment to thank all the employees of Wabtec, whose dedication and focus on execution make these strong results possible. With solid underlying demand across the portfolio, increased visibility through our backlog, and intense focus on continuous improvement, Wabtec is well positioned to drive profitable long-term growth and maximize shareholder returns.

With that, I want to thank you for your time this morning. I’ll turn the call over to Kristine to begin the Q&A portion of our discussion. Kristine?

Kristine Kubacki: Thank you, Rafael. We will now move on to questions. But before we do and out of consideration for others on the call, I ask that you limit yourself to one question and one follow-up question. If you have additional questions, please rejoin the queue. Operator, we’re ready for our first question.

Operator: [Operator Instructions] Today’s first question comes from Justin Long with Stephens. Please go ahead.

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Q&A Session

Justin Long: Thanks, and good morning.

Rafael Santana: Good morning, Justin.

Justin Long: So, maybe to start with a question on Freight margins, if you look at the fourth quarter, we saw a decline relative to the third quarter, despite mix looking like it got better. Equipment sales were down a lot sequentially, services revenue was up a lot sequentially. So, can you talk about what drove that pressure kind of quarter-to-quarter in Freight margins, and what you’re anticipating for the progression of Freight margins as we look at the 2024 guide?

John Olin: Yes. Justin, this is John. I probably wouldn’t characterize it as pressure between the third and the fourth quarter. A lot of that is just seasonality of our overall margin structure. We’ve talked about the back-half margins versus year ago being the strongest in the back half and even stronger in the fourth quarter, and that’s exactly what we saw with the fourth quarter, company margins being up 1.7%, but when we dig down a little bit deeper into that and we look at the Freight segment, they were up 2.3 percentage points. So, again, we feel real good about those margins that we did deliver in the fourth quarter in the Freight segment. When we look forward, we’ve talked about on the overall guidance, you’ve seen the guidance, and we would expect both our Freight and Transit segments to grow revenue as well as margin in 2024.

Justin Long: Okay. Great. That’s helpful. And I guess as a follow-up, I know we can see some lumpiness in the business on a quarterly basis because of mix and the timing of deliveries, similar to what we saw here in the fourth quarter. So, as we think about the 2024 guidance, is there anything you can share on the expected quarterly cadence of revenue and earnings?

John Olin: Yeah, let’s keep that — talking about it in half to half, again, Justin, any given quarter can be moved pretty much by a handful or two of locomotives. So, the most important part is that we expect ’24 revenue and operating margins to be up versus 2023, and generally in line with our long-term growth framework. But more specifically, in ’24, we expect to see higher revenue growth in the first half versus the second half, and we also expect to see modestly higher margin growth in the first half than the second half. So, when we look at the drivers of the cadence, one continues to be on the volume side, hinges on the timing of our loco and mods deliveries and comping against higher 2023 margins in the second half.

Justin Long: Okay. Great. I’ll leave it at that. Thanks for the time.

Rafael Santana: Thanks.

John Olin: Thanks, Justin.

Operator: Thank you. And our next question today comes from Matt Elkott with TD Cowen. Please go ahead. Pardon me, Mr. Elkott, your line is open. Are you perhaps muted?

Matt Elkott: Sorry about that. Good morning, everyone. Can you guys give us some more insight on the 5% revenue growth at the midpoint, price versus volume? Are there any acquisitions baked in? I also ask because your backlog is 10% higher, and your revenue growth is 5%. Last year you did 16% revenue growth. Is it just a function of comps being more difficult for revenue this year?

Rafael Santana: Matt, a couple of things. First, the fundamentals for the business are strong. We have the coverage. We have the orders to execute here. The portfolio is well-positioned to provide customers with fairly a significant payback. Fleets are old. And we’re still coming out of a trough in terms of customers’ investments, India fleets. There’s also significant drivers globally. International, as you’ve heard, is very strong, which drives demand not just on the locomotive front, but if you think about mining, transit, digital and the overall freight. Emissions, as you know, emission regulation is a tailwind for us. We have continued to expand our visibility with really improved backlog coverage, which goes beyond ’24, and that really positions us well to deliver ahead of our long-term guidance.

With that being said, our guidance takes into consideration a number of factors. If you think about ’24, you still have North America carloads continues to be on the low end. We expect parkings to continue to go up, and freight car build is actually down. With that, our approach has consistently ensured really a strong say/do ratio with results ahead of our commitments, and we continue to be committed to overdeliver.

Matt Elkott: That’s helpful, Rafael. As my follow-up question, some of the kind of headwinds you mentioned, is that the reason why the Freight organic — the organic Freight revenue contribution to growth in the fourth quarter was lower than 3Q, and basically, the lowest in the last couple of years, if I’m doing my numbers correctly? And do you expect that to continue to trend downward in ’24?

John Olin: I’m sorry, Matt. I’m not sure I completely understand the question. Can you repeat the driver of…

Matt Elkott: Yeah, John. Like the $92 million organic Freight revenue contribution in the fourth quarter, if I look back over the last two years, it’s the lowest number we’ve seen from organic Freight revenue. Is that a function of the headwinds in the North American rail market? And do you expect it to continue to trend downwards?

Rafael Santana: So, let me just be clear here. Our backlog is strong. We feel good about it. The pipeline of opportunities show it, as I said, the strongest pipeline we’ve looked at in the last five years. And despite of some of the dynamics here, we just described to you in North America with carloads, and so forth, we’re continuing to see really customers investing for cost, investing for reliability, and we continue to see both an element of growth both for us in North America and international. You’re going to have variation here, as John described, quarter-to-quarter, but we’re continuing to look at profitable growth as we go in ’24, and most importantly, I think we’ve got a stronger element of international here that really provides us visibility now into ’25, ’26, and ’27.

Matt Elkott: Got it. Thanks, Rafael. Thanks, John.

Rafael Santana: Thank you.

Operator: Thank you. And our next question comes from Jerry Revich with Goldman Sachs. Please go ahead.

Jerry Revich: Yes. Hi. Good morning, everyone.

Rafael Santana: Hi, Jerry.

Jerry Revich: Rafael — hi. Rafael, I’m wondering can you just provide an update on how your customers are thinking about the discussions with California on sub-Tier 4 locomotives in the fleet? And how do you folks see the regulatory process and timeline unfolding? And is that driving customer preference for new versus mods that wouldn’t fit the new CARB-proposed standards? Can you just talk about how the ebbs and flows are going and the timeline that you expect could drive from a clarity standpoint for the industry?

Rafael Santana: Yes. So, Jerry, last November, CARB petitioned the EPA for a waiver and supports for regulation for in-use locomotives. EPA has not responded to California’s waiver request, and the ruling became effective beginning of this year. In one hand, I’d say the outcome of the rule remains fluid, but we are technically very well-positioned to support our customers here for all outcomes. We have the best-in-class products, lowest fuel consumption, lowest emission, best reliability, best availability, and regardless of further regulation what I’ll tell you the good news is, our entire installed base will be able to burn bio and renewable fuels. But what’s more exciting to me is, our newer fleets, they will ultimately go beyond bio and renewable fuel.

We firmly believe we can bridge customers here to their ultimate near-zero emission goals. We are aggressively testing alternative fuels, hydrogen being part of that mix in our newer internal combustion engines, and with really an eye towards enabling customer sustainability journey, and in parallel, we’re integrating batteries, and ultimately hybrid systems into our fleet. So, we have not incorporated regulatory change into our guidance. So, that would be a tailwind for us.

Jerry Revich: Super. And then, can I just ask, you’ve been very clear on the cash flow from operations conversion rate at over 90%. The CapEx that we’re seeing at 2% of sales, is that the run rate that we should be thinking about, John? Are there any ebbs and flows as we think about what total net income to free cash flow conversion should be like over the next couple of years depending on your CapEx plan?

John Olin: So, when we look off over the rest of our investment horizon that we came out with a couple of years ago, we would expect 2% range of CapEx over that entire period of time.

Jerry Revich: That’s clear. All right. Thank you.

Operator: Thank you. And our next question today comes from Rob Wertheimer with Melius Research. Please go ahead.

Rob Wertheimer: Thank you. And I guess a little bit similar to Jerry’s question, but I think you had a healthy order for mods from CSX that just came through. I’m wondering if you can give us any sense of where your total number of mods was in ’23, just your perspective on what that order kind of means in context. And then, more general, even if we leave aside California, there’s also the climate goals that the rails have, and there’s a fairly old fleet that they’re running, and maybe record old fleet that they’re running. So, in your conversations with your customers in North America, how much are they actually thinking about new locomotives right now with or without California? How is that balance looking? [Does anybody] (ph) think they can get to their climate goals with just mods? Maybe just any color around that level of mods, and then how to think about new? Thank you.