Start out with the next presentation. For those that don't know me, my name is Felix Boeschen , Senior Machinery and Trucking Analyst here at Raymond James. Today very happy to have Wabtec with us. Presenting will be the company CFO, John Olin. You know, before we kinda jump into a true maybe fireside chat format, John, I was just hoping you could give 5, 10 minutes on Wabtec, maybe the company, what you guys do...
Great.
Markets you play in, and I'll kinda take it from there.
All right. Excellent. Hello, everyone. Again, my name is John Olin. I couldn't be more excited to be in sunny Orlando with you. I couldn't be more excited to be the CFO of Wabtec. What a great company it is. I'm gonna give a brief high-level overview. We're about $8.5 billion in revenue, 16% on zip code in terms of margin. We are a conglomeration of three multinationals that came together in the last several years, one that bears our name, Wabtec. Goes back 154 years. George Westinghouse started it. Wabtec stands for Westinghouse Air Brakes Technology. 2016, late 2016, the size of the company was about $2 billion. It doubled when it purchased a company called Faiveley Transport, a French company.
A couple years went by, and the company over doubled again when a $4 billion combined company merged with GE Transportation, which is about $4.5 billion, and that created the company that we have today. As I'm sure we'll talk about some of the opportunity that's come about, by putting, you know, one of the oldest industries, and one of the oldest companies in America together and the opportunities that's created. We are organized in two segments, very simple. Freight, that does everything freight, and transit that does everything transit. Our freight segment we break into four different groups. One is equipment. Call it about $1.5 billion of revenue, and it makes locomotives, it makes mining equipment and some marine engines, and it all uses the same technology.
The technology to pull 200 rail cars full of coal also helps you to get a massive truck the size of a two-story house out of a big hole, right, in terms of the tractive effort that it has. We have a service business, about $2.5 billion . Very high profit, high margin business, and it does the servicing of the locomotives that we have around the world. It also has a modernization business in it we'll talk a lot about, and that's a substitute for a new locomotive.
It's one that we've pulled off the rails after 20 years, put all new vital organs in it, new engine, injectors, motors and so on and so forth, it runs as good as the new, not as long as the new, as good as the new. We've got a digital business, it does onboard train stuff. It's Trip Optimizer. It basically is cruise control for just like your car on tracks. We've got software that talks to different locomotives in a consist. We do dispatch systems. We do port systems. We do rail yard systems. Anything that has to do with digital aspects of the freight business, we do it. The fourth area is components. We sell components into locomotives.
We sell components into rail cars, and we have Part of that is a regular industrial businesses that leverages some of the things that we're very good at in the train business, whether that be turbos, heat exchangers and those types of things. That freight side is two-thirds of our revenue and three-quarters of our profit. The transit side is one-third of our revenue and about 25% of our profit, and it does not make rail cars, but it makes all the highly engineered systems that go into them. Think about braking systems. Think about the door system, HVAC, heating and cooling, passenger information systems. It does all of that. Okay? When we think about the company, we've got five core strategies.
I think they'll tell us a lot about who we are, what we do, and how we're getting there. The first one is to lead the world in decarbonization, right? In 20 years, there will not be carbon or diesel locomotives out on the tracks. One nice thing is that all of our locomotives are electric. The diesel is just there to run through an alternator to create the electricity, so it's not far-fetched for us to move into batteries, and we'll talk a little bit about that. Number one is to decarbonize the world on rail. The second one is to drive technology in everything that we do. 154 years old, we spend more on technology than the average industrial company does. 6%-7% of our revenue is spent on engineering and technology.
Tough for me to get my head around that, right? We've been around forever, there's so many opportunities to invest in technology and a lot of that digital technology. The third area is to grow the install base. With the acquisition or the merger with GE, we picked up 23,000 locomotives around the world, and as a locomotive runs, it needs to be serviced. It's got maintenance. It's got spare parts. It's got digital assets that need to be updated. Some of those are SaaS model. It needs an overhaul. It needs to be modernized, and the whole company feeds off the install base that we have, whether it's locomotives or transit cars on the other side. The fourth area is to build recurring revenue and to grow that. As of 2022, 44% of our revenue was recurring.
60% is aftermarket, 44% is coming to us. No matter what, when they buy, it's coming to us. We were up 3 percentage points in 2022, and I'm certainly very focused and proud of that. Finally is to drive improvement in everything we do and to be a culture of continuous improvement, certainly lean within our factories and so on and so forth. Those are the five main strategies that we're marching to. Quick results. 2022, if you take out currency, which was a big headwind, sales were up 10.8%, revenue up 10.8%, margin up to 16.2%, up 30 basis points, and EPS up 14.5%, 14.4% to be exact. When we look to the future, we would expect mid-single digit revenue growth.
We would expect margins to grow 250 to 300 basis points over a 5-year period of time. That includes 2022, and, we would expect EPS in the double-digit and, cash at over 90%. All right, Felix, I think that was it.
Yeah, that was great.
All right. Let's talk.
Short and sweet.
We gonna sit, stand?
I'll stand. You can sit. Up to you.
Okay.
John, this might be an unfair question, but I'm new to Wabtec, relatively new. We launched last year. In a way, you are new to Wabtec as well.
Mm-hmm.
You know, when I first started looking at the name, I just thought, "Wow, there's a lot going on." You got rail equipment cycle, you got two big deals, you got international. Maybe help us understand, you know, maybe what surprised you since joining the organization? Secondly, what are you most excited about?
Great. Surprised and excited. Surprised. I've been with the company 1.5 years . I came out, the company before this, they had a lot of heritage as well, and a lot of longevity. The biggest surprise was by far the opportunity that's in front of us, and it goes back to 154 years old. There are very few industries that were back then that are still here today, and we're one of the oldest companies in America. With that, my expectation wasn't, you know, to stumble over opportunity in every respect.
I think Felix and the rest, it goes back to, probably several months in, it really dawned on me, and it explained a lot about Wabtec to me and the things that I was seeing, is that we are a 154-year-old company that's a 3-year startup, right? With that has come tremendous opportunity in taking three multinationals and beginning to integrate them, in an industry that has also benefited by the ESG push, right? We're inherently much more clean than other modes of transportation, safer and cheaper. All of those elements, 154 years later, are coming into our stride in terms of putting these companies together.
In terms of most excited about, I guess, is the latter, is really the power of ESG and the inherent benefits that we have as an industry and then the particular advantages that we have as a player within that industry. We are by far the leader in technology. Our locomotives are inherently more efficient, about 5% at the engine level, another 1% when you add that to our tractive motors, and that's 6% advantage. If you look at the digital assets, that adds 12 percentage points, 12%-18%. We're 18% advantage. Anybody that buys our product, it's not gratuitous to the environment that they're cleaning it up by taking an old one that pollutes more off the rails.
It is a tremendous ROI that they have because we've driven a lot of technology into that and pushed down fuel costs and other operating costs for them.
Maybe that's a good place to start. You know, you've talked about 16,000 locomotives, you know, average replacement cycle, I think 25 years, very long -term. You know, where are we today if you kinda add up your modernizations, new builds relative to that? You know, how do you think you get to replacement demand? Is it an efficiency story? Is it tied to cargo growth? Maybe help investors understand how you think about that opportunity.
Okay. Let's start with the latter part of it, Felix, is when we look forward, we are not counting on a lot of inherent and underlying growth. You say, "Is that the same guy that just said, 'Look at the opportunity that we have to take share from, you know, trucks,' and so on and so forth?" In the last 10 years, the rail industry has not really increased their share of that space. They focused on cost reduction and have done an extraordinarily good job at it. As we look forward, I think that, if the rail industry chooses to compete for share, they'll be very successful given the inherited advantages of rail over truck. We haven't really built that into our going forward piece.
I guess as you guys as investors, I would first make 2 cases to you as to why it is a good investment. The first one is, Felix was alluding to, is that the industry has been significantly underinvested in. Maybe I shouldn't use significantly. It's been underinvested in. When you look at there are 16,000 locomotives in North America, and just speaking of North America right now, which is our biggest market. About 16,000 locomotives do the heavy work of moving goods around the country, around North America. There's probably double that, but they're in rail yards, and they're not pulling 200 rail cars, right? Our equipment lasts 20-30 years, so call it an average of 25 years.
That's a replacement value without any growth of 640 units. We got a chart that shows, what, 10-15. I'm sorry, 5-15 years ago, the average was about 600 units a year. In the last 5 years, that has dropped significantly to 300, a little bit less than 300. That's due to, you know, a term you'll hear, PSR and COVID and all the other headwinds, and the industry largely focusing on profitability and really sweating the assets a little bit more. I haven't been with Wabtec too long, but I think there's only two things that make up a railroad, and one is the track, and the other is a locomotive. That investment's gotta come back, and that's without any growth assumption.
So that's number one is to make the case to you as an investor that there has been underinvestment and by virtue of holding volumes flat, that that's got to come back in a pretty meaningful way. The second piece, natural question is, well, when? They just showed that they can wait you out 5 years, right? When is it gonna happen? I think that's the most exciting part of the entire story, is I believe it's gonna happen in, you know, which is in the timeframe of most of the investors in our stock. They've all got ESG targets, and I'm not just talking North America, the whole world, every railroad's got ESG targets, and all the mining companies that we sell into have ESG targets.
I will tell you, unless biofuels comes back at a very low price and there's significant quantity of it in the next 7 years, there's only one company on the face of this planet that can help the railroads get to those targets, and that's Wabtec. They're gonna do it through a multitude of things, but the first one is, again, going back and replacing old locomotives. They don't haul as much, they pollute more, and they use a lot more fuel. We can either modernize them or we can sell a new. With that, it'll clean up a lot of that and help them get to their targets, which are mainly in the 30% range for 2030.
The second way is biofuels are, locomotives will take them, any biofuels, but nobody's using more than 5% at this time. We can go up to 20%-25% mixture. We're working on battery-electric, so we're in the commercialization phase of putting a boatload of batteries into a locomotive and having it do the same thing as those diesel engines did in creating the electricity that we need, you know, to pull 200 railcars of coal. The first ones will be shipped about 1 year from now, we're very excited about that. The combination of those two things, one is there's a need, and secondly is that need is bound by time. I don't think that the railroads are gonna look to not make those targets.
Again, that kind of puts us in a pretty good time frame.
Yeah. So that's a, that's maybe a good point for me here, but so on the modernizations, can you first of all maybe explain to everybody what is a modernization? How does that work? How do the unit economics stack up versus a new locomotive? Secondly, you know, they have 2030 targets out there. Can you remind us how long does it take to get a modernized locomotive? What are the lead times today? How long do they have to plan for that?
Okay. From a railroaders perspective, they need power, right? They can buy a new locomotive. Let's just talk in big generalities. That would cost $3 million-$3.5 million. A lot of the difference is on the digital assets that might be on that locomotive and other things, a railroad might require or ask for. You can modernize, and it is simply that. They drop off an old locomotive, call it 20 years old, and we will strip it down, and all the vital organs we will replace, so they're brand new, and it will come out doing a lot of what a Tier 4 would do, or a new locomotive would do. For that, it costs about $2 million-$2.5 million. Doesn't last as long.
A new locomotive lasts 20- 30 years and the modernized probably 10- 15 years. They've got that choice to make. When we look at it from their perspective, there's a good return on their investment for that, probably a little bit better on the new side because it lasts longer. Very attractive and over their cost of capital, a fair amount over their cost of capital. The other question you had.
Lead times.
Pardon me?
Lead times on a new mod.
Yes. A lead time for either a locomotive or a modernization has typically been in the 9-12 months, you know, for us to get the parts ordered and all the subsystems and that type of thing. Certainly with the supply disruptions, that has increased a fair amount, probably 50%-75% longer than that. Call it, you know, up to 18 months now. We're starting to see that get a little bit better, but, so we've got that lead time in there.
Got it. You know, one of the things that I think is fascinating about Wabtec is just the earnings power of the model at presumably fairly low capacity utilization levels. Can you maybe talk about that since the GE deal, what have you done to the footprint? You know, when we do see either mods accelerate or new builds accelerate, how do you think about those incremental margins coming into your business?
When we look at Wabtec and how kind of, the structure, our cost structure kinda works out, 15%-20% of our cost of goods sold is fixed, right? Very easy to leverage that. Two ways that we can do that. One is to put more throughput through, and the other is to reduce that capacity, and we're looking to do both. In terms of some of the orders that we've taken in, had a very good year in terms of building the backlog in 2022. That will start to drive higher incremental margins. We'll talk about that in a second.
The other is we've got a program called Integration 2.0, and after kind of the first barrage of putting these things together, got a lot of opportunity to take out additional footprint. As those costs go away, obviously, margins will go up. 10%- 15%, let's call it fixed manufacturing costs. Then we get a little bit of leverage out of, or a fair amount of leverage out of the SG&A side. While SG&A will inflate, in terms of what you need in terms of growth, it's probably about 80% fixed, 75%-80% fixed.
If you take those and you look at our margin at 16%, and that next dollar of revenue that runs through, given that same existing base of assets that we have, that derives about 25%-30% incremental margin.
Okay. Then you mentioned Integration 2.0. Can we talk about the timeline of that, sort of where you are in terms of, you know, what maybe you could see in 2023 versus what's to come in 2024, 2025?
Yep. We announced Integration 2.0 about 1 year ago, 1 year ago about right now. What that is, it's an investment that we're making to tighten up that system and continuing to integrate. The investment is about $135 million-$165 million. At the end of that, we would expect that the savings to be $75 million-$90 million ongoing from that point after the 3 years. That would be the run rate that we come out in 2025, would be $75 million-$90 million. Where we sit today after the 1st year, we've invested, what, about $70 million, $60 million-$70 million. We have $5 million of savings on our way to $75 million-$90 million, and we've got 2 more years to get to that run rate.
We would expect to see those savings ramp quite a bit. Most all the savings that we need or most of the projects that we need to get those savings have been approved. They're in various stages of announcement and delivery.
Okay. you know, you did give 2023 guidance not too long ago. Can you maybe talk about the current environment? What I'm specifically curious about is if I look at, you know, the announcements on the modernizations, it seems like that's going to be up quite nicely for you all into next year. Maybe help us understand what's embedded on the core service business. you know, just one of the pushbacks we get is this idea of maybe more locomotive parkings.
Right.
Could you maybe talk about that, what's embedded, how you think about that into 2023?
Maybe if you don't Felix, i'll expand it a little bit. When we look at our plan for 2023, some of the key assumptions that we've got in it, one is on GDP. We expect GDP to slow down a fair amount in 2023 versus 2022, but we are not planning on, we haven't forecasted a recession within those numbers, but a significant slowdown, more in the back half of the U.S. and front half in Europe of that. The second is the supply chain. Big assumption, right? We've got a fair amount of product still backed up, and we would expect the supply chain to ease over the next four quarters. We've seen a little bit of easing on a lot of the supply chain, majority of it in the last three quarters.
Computer chips, which we use a lot in our digital business, is the fourth quarter of last year was the first time we saw any easing there. We would expect that to continue, and that'll be a tailwind for 2023. When we look at car loads, there's not a direct correlation, but over time, we certainly like higher car loads than lower car load growth. We're expecting car loads by the railroads to be flat to down a little bit. With that, we expect the railroads to considerably improve their speeds as well as their dwell times. If you take flat car load growth and improve the efficiency, we would expect there to be some excess capacity in terms of their locomotive needs, right?
At least in the short -term, we would expect their focus on growth, the, you know, provide a big benefit going forward. Haven't forecasted, but we would expect that. In 2023, we are planning for the park of the slot locomotives that are kind of off the rails because they're not needed to grow. That would be a headwind in terms of our service revenues.
Okay. The other thing that's, you know, that's obviously been a factor for, frankly, all of my machinery companies is the idea of cost inflation certainly ramping up in 2021 and 2022. Could you maybe talk about just price cost at Wabtec? It's unique in the sense that your backlog is much longer than many of my other companies. Could you maybe just talk about how you think about pricing, you know, what % is on long-term contracts, and how we should think about that?
Yeah. I think to that Felix, one of the things that makes we're a little bit unique is about 60% of our revenue is tied up in a long-term contract. That could be a long-term contract to deliver equipment, to provide service, for the equipment that we do sell. We got a backlog of about $23 billion. Again, about $8.5 billion of revenue and a backlog of $23 billion. When we look at... What was the?
Price, cost, and long-term contracts.
I'm sorry. When we look at that 60% of long-term contracts, the majority of those have price escalators. Because they're long-term contracts, right, majority, a vast majority have price escalators in them. Basically, that takes several elements of our cost structure, puts it into indices, and we track that. If the contract's 2 years, 3 years, 10 years, we've got a way that it goes up and down for us both to be happy with that. Typically, they run around metals. On a locomotive, we would take how much copper, aluminum, steel, nickel, and all those has made up the percentages. We would agree on targets or indices, and we would run it that way. Labor's always in there as well, so there's a constant labor piece of it.
Labor typically goes up over time. Then you got an all other CPI type of catch-all. About 60% of our revenue is in long-term contracts, so a lot of that's protected. We saw those work. They worked well through history, and they certainly worked well in the supply chain disruptions that we saw in 2021 and 2022. With that, by the second quarter of 2022, we were at price cost equilibrium. We've held that for the last three quarters. You know, costs are still rising. The reason they're still rising when we're starting to see metals go down and some other costs go down is because they were all put into inventory and they have to cycle through inventory.
In the fourth quarter, we saw significant cost increases, as many companies did. Again, we had our pricing of that was actually a little bit in excess of what we saw in terms of rising costs.
Got it. Interesting. I think we have 5 minutes left. I wanted to make sure I ask on the transit business as well. What I'm trying to understand about transit is there's a lot going on, FX, international exposure. I think you exited some UK aftermarket business. Can you maybe talk to us about what you think the long-term growth algo looks like in transit, and sort of, you know, what you're expecting for 2023?
For those not completely familiar, we look at our transit business and revenue was down 9%. Currency adjusted, it was actually up about 0.5% . Again, I talked about the company, we were up 6.9%. Currency adjusted, we were up 10.8%. The question is what's really the underlying growth in our transit business? I would say that it's been very consistent over time, not only for us but for the industry in that 3%-4% range. When you take 9% down, add back currency, we're up 0.5% . As Felix mentioned, we did some things. We exited low-margin contracts as we focus on our profitability of that segment.
Occurrence, we had a cyber incident that affected revenues a little bit in 2022, and then the supply disruptions of our business. Two areas of supply disruption really hurts the hardest. One was in the transit side of it, and the other was on computer chips in our digital business. When you strip away those, you would find that in 2022, the underlying growth was in that 3%-4% range. You know, going forward, we don't see a big change to that. Governments are investing in the transit system. There's two mega trends that are pulling that forward. One being urbanization, right? Them trying to keep their cities decongested in terms of traffic.
The other is the ESG, and trying to keep that down. We see a constant drumbeat of investment in those assets. When we look at backlog, our backlogs have risen quite a bit in 2022, as have the car builders that are drawing parts from us and systems from us.
You know, if I think back to 4Q earnings, actually what stood out most to me was your transit margins.
Mm-hmm.
I know you were coming out of the cyberattack, can you maybe help us understand those margins, I think mid-teens, you know, how sustainable is that? How do you think about transit margins sort of over the long term?
Going back to when we did the GE merger, the transit margins were 8%-9%. Today they're 12%. We finished the year at 12%. With that revenue down 9%, our margins were down only 10 basis points. We were very pleased with that. It was a fight all year long in terms of holding onto the margin. We have provided guidance that over our investment horizon, we would expect that to get to around 15%. We got various plans in place. One is the underlying growth. We would expect that to continue. That'll drive some level of absorption and productivity. The other is of that Integration 2.0 money.
More of it is over-shared to the transit, where there's a lot more opportunity to consolidate some of the facilities there. Between those two big drivers and the technology that we bring out on a regular basis, we would again expect to see that at around 15% over the next 4- 5 years.
Got it. I think we have 60 seconds left, I have to ask you about capital allocation. M&A's been a big part of the Wabtec model and history. You've recently stepped up some buybacks. I guess, holistically, I'm curious how you think about use of capital.
Okay.
Just broadly, yeah.
Five straightforward priorities. Number one is protect the balance sheet. We're looking to keep our net debt leverage ratio at 2x- 2.5 x. We finished the year at 2.2x in 2022. The second one is to continue to provide an increasing dividend. didn't have a clear dividend strategy coming out of the merger. That is to grow dividends in line with net income on a consistent basis. Number three is to invest in the best investment that we have, and that's ourselves in terms of that technology at 6%-7% of our revenue as well as capital. Now, we're a little bit under what the industrial average would be on capital at about 2% of revenue.
Over-shared on technology, a little bit under-shared on overall capital. With that, in 2022, we had over $1 billion of free or operating cash. You take out the dividends and the CapEx, you're around $700 million-$750 million. With that, we would prioritize M&A above share repurchases. We're only gonna do highly accretive M&A. In 2022, we did three acquisitions that totaled $89 million. With that, we're not looking to build cash on our balance sheet in any way. The rest of it comes back in the form of share repurchases. We repurchased about $434 million, if I remember the number right.
John-
We expect that to continue into the future. If we've got good M&A, we will prioritize that first. Otherwise, it comes back in the form of share repurchases.
John, I appreciate it. We're out of time already. I'm gonna say thank you, everybody. We do have a breakout session downstairs.
Appreciate everyone's interest in Wabtec.