THE HEDGEYE EDGE
Capital equipment suppliers to a cyclical industry are usually more cyclical than their customers.
We believe Wabtec was a beneficiary of both resources-related capital spending (international freight railroads) and the congestion of the U.S. rail system in 2014. With rail speeds increasing and mining capex falling through the floor, those supports should gradually be removed from this richly-valued stock.
The end markets do not look promising for Wabtec. Freight car orders are coming off their all-time highs as backlog does the same per Railway Supply Institute data. Class 1 Railroads are curbing capex spending in the face of slowing freight volumes. U.S. railroads are now putting equipment into storage.
Wabtec’s end markets are largely driven by its Freight business (75% of Operating Income), with the remainder going to its Transit business (passenger travel by rail).
In addition, the company is acquisitive. We believe that this "acquisitiveness" has been a key factor in its being miscategorized as a ‘growth’ industrial. In our view, railroad parts was a growth industry back in the days of the robber barrons.
Wabtec’s recent acquisition of Faiveley Transport indicates to us that both companies' management teams see trouble ahead. Faiveley’s major customers are consolidating, while WAB may be looking for ways to maintain growth in a weaker Freight rail demand environment.
INTERMEDIATE TERM (TREND) (the next 3 months or more)
The lead time on major U.S. freight orders is quite short for Wabtec – well short of a full quarter. The decline in expectations should come with the U.S. Freight rail capital budget guidance, which should come with 4Q2015 railroad earnings reports.
LONG-TERM (TAIL) (the next 3 years or less)
By the time utilization has declined (amid peak equipment deliveries and stagnant traffic) it will be too late to exit/short Wabtec -- assuming we are correct. Investors should increasingly note a disconnect between weaker order rates versus expectations for continued robust earnings growth in 2016. That would be a big problem for a 'growth' name with a high valuation.
We see the set-up as analogous to Joy Global (JOY) and Caterpillar (CAT) back in 2012.