Maybe Wall Street just isn’t a fan of trains. “There was skepticism about GE and its ability to execute deals in general,” says Cowen analyst Matt Elkott. One concern, he says, was whether an investigation of GE Power’s accounting “could spill over to GE Transportation.” But “that concern has subsided in the last month, since Wabtec has gotten a lot of regulatory approvals” needed for the deal, and the Department of Justice has ended its review of the merger. Still, Wabtec (ticker: WAB) trades more than 35% below its 52-week high of $115.40, hit last September, partly on worries about the deal, expected to close this month and now valued around $9 billion. The bearishness seems overdone. GE Transportation had about $3.9 billion of sales in 2017. The combined entity, expected to retain the Wabtec name, “should be a less cyclical company that benefits from expanded recurring after-market revenue growth,” argued Nicholas Heymann, an analyst at William Blair, in a recent note. Why would Wilmerding, Pa.–based Wabtec, which garnered two-thirds of its $3.9 billion in 2017 sales from the steadier transit, or passenger, side of the business, want to bet big on the highly cyclical freight sector? For one thing, some analysts argue, the most recent locomotive-delivery cycle, which peaked in 2015, bottomed last year. For another, “the deal was complementary,” says Wabtec CEO Ray Betler. “There’s almost no overlap.” In addition, Heymann says, GE’s rail freight business is evolving. “You have less cyclicality because of the changing mix to more analytics” and products aimed at boosting safety and productivity. In 2017, equipment accounted for 45% of GE Transportation’s sales. Digital services kicked in just 7%, but are expected to grow. Most of the rest was generated by service and maintenance. Some 21,000 GE locomotives are in active use, about 70% of them under long-term service agreements. All of which should enable Wabtec, whose many products include brake systems and doors, to provide more components to those locomotives. The stock could come under more pressure in the short term, due to additional shares coming onto the market. Under the merger’s terms, existing Wabtec shareholders will own just over half of the new entity, with General Electric holding a little under 25% and GE shareholders, 24.3%. GE, which will receive about $2.9 billion at the closing, has up to three years to sell its stake. But “a lot of that is reflected in the underperformance” of the stock, argues Elkott of Cowen who rates Wabtec Outperform, with a 12-month price target of $88, more than 20% above its recent price of about $73. The company is scheduled to report fourth-quarter earnings when the merger closes. Wabtec, officially known as Westinghouse Air Brake Technologies, is the top provider of North American positive train control systems, which use GPS and wayside track signals to prevent derailments and collisions. The technology, widely adopted by large U.S. freight carriers, is gaining acceptance by passenger railroads, as well. On a pro forma basis, Heymann forecasts that the new company’s earnings before interest and taxes margin will increase to 19.4% in 2022 from 16.2% this year, without factoring in the expected synergies from the merger. He expects GAAP earnings to hit $7.26 in 2020, versus $5.70 this year, with strong cash flow growth. Wabtec shares, which yield 0.7%, fetch 18.8 times their 2018 earnings estimate, versus a five-year average of 21.6, according to FactSet. Another encouraging sign: “North American Class I rail traffic continues to be in solid growth mode,” says Elkott. It’s up 4.5% so far this year, compared with the level a year earlier. And that’s atop a 3.5% increase for all of 2018. To help fund the deal, Wabtec expects to add nearly $3 billion to its debt, which would then total $4.6 billion—about 3.3 times the new entity’s adjusted earnings before interest, taxes, interest, depreciation, and amortization. Bulls view that as manageable. Investors should view the current stock price as an opportunity. Write to Lawrence C. Strauss at lawrence.strauss@barrons.com
GE ’s merger with GE , first announced in May , is near to closing, and has the potential to create a major rail-equipment entity. Concerns regarding Wabtec ’s move into the highly cyclical freight sector have largely been assuaged, with analysts pointing to the changing nature of the locomotive delivery cycle, and the fact that the most recent cycle hit its peak in 2015 and its bottom May . Wabtec will be able to provide components to GE , which should boost after-market revenues. about $3.9 billion is expected to be added to Wabtec ’s debt to fund the merger.