Here at Marketdepth, we are not in the business of selling equities to the public. In fact, our focus is often on the somewhat less glamorous activity of preserving capital. However, being of a generally curious disposition, from time to time we do a bit of digging on one of the local companies of our acquaintance. Small cap management in town is generally rather approachable and we enjoy hearing them out. When the time to buy advantageously comes along we know how to hit a bid. But every company knows a lot of other times.
It is in this spirit that I review Vancouver-based engine technology business, Westport Innovations Inc. (TSX:WPT). Recession notwithstanding, the company still grew sales by 9% and its gross margin dollar line expanded by 28% in calendar year 2009. While not cheap on a ratio basis, I consider
Figure 1: Better to Light a Single Candle…
The principal current installations of these engines are municipal service vehicles like buses and garbage trucks. However, there is clearly potential to expand the penetration of
From an investment standpoint, it is useful to consider two important, and separate, underlying drivers of demand for
The second key driver of demand for
Figure 2: Oil to Gas Ratio
On a pure energy equivalent basis, the ratio between the value of a barrel of oil and a thousand cubic feet of gas (mcf) should be 6 to 1. However, with current market prices of about $80/barrel of oil and $4/mcf for gas the actual price ratio is 20 to 1. In other words, the market is paying more than three times the price it “should” pay for petroleum products relative to the price of gas or liquefied natural gas (LNG). Why the discrepancy? Clearly gas is in a glut situation, driven by large new discoveries and improved extraction techniques. On the other hand oil markets are facing dwindling conventional production combined with a growing base of transportation equipment designed to run on petroleum-based fuels.
The other factor weighing against gas at the moment is that the market lacks the necessary infrastructure (pipelines, distribution networks, marketing organizations etc.) which are required to realize the pure chemical arbitrage. However, I believe it reasonable to expect that the long-run oil-to-gas price relationship will converge towards the energy equivalence ratio of 6 to 1. And, given that prospective trend, underlying demand fundamentals appear generally supportive of
With a recent enterprise value of about $450 million, Westport Innovations is somewhat bigger than your typical acorn. And trading at 4X consolidated sales, it is difficult to construct a classic value case here. Simply put, this company needs to grow rapidly in order to justify its valuation.
I tend to agree with management that the prospects for