Upshot: The internals of today’s report from WAB continue to point to 2016 EPS well below $4.00. While we need the 10-K for a proper analysis given WAB’s skimpy disclosure, the implied orders, aftermarket sales, and PTC trends look pretty negative to us. The big picture of rail equipment capital spending rolling over from a significant long-term up cycle remains intact.
We don’t think that the 2016 guide from WAB makes sense, beyond what we expect is management’s desire to see a higher share price to appease a no doubt disgruntled Faiveley family. The internals in the 4Q 2015 report are poor, with deterioration in non-PTC aftermarket sales, a book-to-bill below 1, and a sizeable drop in Freight segment backlog. With NAFTA freight rail traffic down 5% so far this year, 2016 guidance based on “flat” 2016 rail traffic is likely both back end loaded and not credible. The expectation of flat revenue in the Freight segment is also not particularly reasonable given a book-to-bill at around 0.80, peaking PTC sales, weak international markets, and sizeable expected declines in rail car & locomotive deliveries. While it is possible that further draws on backlogged orders, large share repurchases, and incremental acquisitions might get WAB to guidance, markets are unlikely to care. The freight rail market is entering a long downcycle, in our view, and WAB’s changed behavior serves as confirmation for us. Given the skimpy disclosure WAB provides, we will need the 10-K to really understand the results.
Ping us back if you would like to see our updated EQM model/data sets, or recent Black Book.
Backlogs & Book-to-Bill
Freight Segment: The Freight book-to-bill came in just under 0.80, as backlog dropped meaningfully. That is not a positive indicator for forward revenue growth, and suggests that guidance for flat revenue in 2016 is likely to be too optimistic. That low book-to-bill is for 4Q 2015, before the anticipated 25% decline in freight car deliveries and 5% decline in locomotive deliveries. The next 12 month Freight backlog dropped 31% year-over-year, which also makes the expectation of flat 2016 Freight revenue unrealistic – at least on an organic basis.
Transit Segment: While the Transit book-to-bill was a healthy 1.21, it is much less relevant given the lower profitability of the segment. The Transit backlog is also getting further out, with both sequential and year-on-year declines in next 12 month backlogs. With some very long-term orders potentially skewing the Transit total backlog, we would view the next 12 month reading as more indicative of demand trends. With U.S. and Canada ridership down ~1% in 4Q 2015 despite peaking employment (lower gas prices?), usage trends do not seem robust.
Total Backlog: Total backlog for delivery in the next 12 months was down 19.6%, which also doesn’t point to a great topline for 2016.
Aftermarket & PTC: Aftermarket sales were only specified for the year, but we calculate a 16% decline in fourth quarter aftermarket revenue ex-PTC sales (PTC is lumped in with aftermarket). In a very interesting disclosure on the call, management suggested that 75% of PTC revenue was to North American Freight, while only 15% was to Transit and 10% international. If accurate, that would spell big trouble for ultra-high margin PTC revenues as the 2018 deadline approaches…unless you believe the defensive speculation about PTC aftermarket opportunities. Further, management is guiding to “slight growth” for PTC sales in 2016. We estimate that PTC revenues are currently right around peak levels, and “slight growth” would represent a dramatic deceleration in PTC sales growth.
PTC has been a significant profit driver for WAB, and “slight growth” sounds like “peaking” to us.
Mix Negative: With the Transit segment taking the lead heading into 2016, we would expect negative mix to pressure margins. We see this as another reason to be skeptical of the 2016 EPS guidance.
Secular Change, Growth Holders In Trouble: From our perspective, this is the second earnings call with a negative tone; even when management was ‘excited’, they didn’t sound very excited. Management implied that the market was “on the way down”. Most importantly for growth holders, management said in prepared commentary that “headwinds could represent secular changes in our markets….” If you look at what WAB is doing - shifting capital allocation towards buybacks and larger public deals, for example – it would certainly seem that they are signaling that their market is past peak. If we had to guess, the large number of growth holders stuck in a deeply cyclical railroad equipment value trap will have a very difficult time finding the liquidity to sell. In the end, we’d bet they end up grateful for the elevated short interest.
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Takeaway: Sanders faces a pivotal moment in Nevada. Republicans get hawkish on national defense.
Editor's Note: Below is a brief excerpt from Potomac Research Group Senior Analyst JT Taylor's Morning Bullets sent to institutional clients each morning.
The next two weeks of the Democratic primary are pivotal, determining whether Clinton can contain Sanders' momentum. Her "firewall" will face its first test in Nevada, where the state's diversity mirrors the U.S. as a whole. With the contest now a dead heat, a Sanders victory in Nevada could give him enough momentum to knock a hole in Clinton's double-digit lead in SC, calling into question the integrity of her wall across the other Southern states. Someone had better tell the Clinton campaign that fire does sometimes jump firewalls...
HAWKS CIRCLING SC:
Republican candidates in veteran-heavy SC have been competing for the title of most-hawkish. Marco Rubio has been hitting Ted Cruz as "weak on national security," for his votes on defense reauthorization bills. Meanwhile Cruz pledged to expand the military by 100,000 active-duty troops and "unleash the holy wrath" of America on its enemies. Bush is on tour this week with venerable hawk Senator Lindsey Graham, and even John Kasich has toughened his rhetoric.
Excluding Bernie Sanders, every candidate in this race would be more interventionist than President Obama -- there's a growing consensus on Capitol Hill as well as the campaign trail that current policies and spending on defense are inadequate. To reiterate our colleague LtGen Gardner's point, it's hard to see how the current environment doesn't result in increased defense spending.
Hedgeye highlights three key points from Walmart's quarter courtesy of our Retail analyst Brian McGough.
Takeaway: A quick wrap up on our Macro team's U.S. recession call.
Since January, our Macro team has highlighted the increasing likelihood that the U.S. economy slips into recession sometime in Q2 or Q3 of 2016. Below are charts and analysis from Hedgeye CEO Keith McCullough and Senior Macro analyst Darius Dale based on today's economic data.
While today's jobless claims data was strong, a "strong" jobs market always precedes a recession.
Consumer confidence is beginning to roll over...
"On a ratio basis, however, it's starting to signal what the trend in corporate profits and jobless claims already have ("Recession" in ~6 months)," Dale writes.
Here's the chart.
Recessionary gales are blowing. Dale is also tabulating a massive amount of economic data that is heading south.
Still unconvinced? Watch McCullough in the video below laying out "The Three Signs of A Coming Recession."
No, we're not bullish.
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