Shares of WABCO Holdings Inc. (NYSE:WBC) are up an impressive 21.97% YTD and now trade 64.7% above their 52-week low of $48.89 per share. A casual glance at the company’s return on equity gives the impression that this move is justified, but what is really going on? Is management boosting returns by taking on more leverage or has the company been growing by becoming more efficient and profitable?
Dissecting Return on Equity
While aggregate calculations, like return on equity, are the starting point for most equity research and performance reviews, even more important is an evaluation of the inner workings of these top-line results. To help accomplish this, I have broken down WABCO Holdings Inc. (NYSE:WBC)’s ROE into its three most basic components – Profitability, Asset Turnover and Leverage. These figures are frequently used to compare competing firms but I like to use them to look for potential problems, opportunities and trends that can be expected to continue into the future. With that said, below is a look at how the components of WABCO’s ROE have changed over the past five quarters and five years.
Overall, yearly returns have been rocky, but the company is a hard one to criticize seeing as last year’s ROE of 44.67% was well above the industry average of 18.4% and this year looks to be more of the same. Profit margins this year have been under pressure, but they are still well above the pace set by the competition and shareholders should be happy to see that leverage has been coming down as a result of equity growth and liability restraint.
Its important to note, that these returns are an aggregation of the business and sales that WABCO Holdings Inc. (NYSE:WBC) has been doing world-wide. Operations are still highly dependent on the European economy (~60%), but this reliance has been slowly declining as the company has diversified its operations and now has customers all over the globe.
The short-term outlook has been somewhat mixed for investors. On one hand, WABCO Holdings Inc. (NYSE:WBC)’s earnings reports have consistently shown declining production in almost every market while at the same time, freight activity has been rebounding and customers like Daimler AG have been reporting increased sales.
Music to WABCO Holdings Inc. (NYSE:WBC) investors’ ears considering that the company supports all of Daimler’s brands and has strengthened its relationship with the company to the point that it has started to collect annual supplier performance awards from them. Daimler is one of the largest purchaser of WABCO’s MAXX single-pistion air disc brakes, the lightest and highest performing single-piston air disc brake for trucks and buses, and one that Daimler uses to improve fuel economy and increase its transport payload (as described on P.9 here).
Long term, I see growing populations, more stringent safety and environmental regulations and higher gas prices all increasing the demand for products that WABCO and other manufacturers like Cummins Inc. (NYSE:CMI) produce. Why? More people equals more freight, more regulation translates to more components being put into the vehicles and higher gas prices lead me to believe that more money will come from the replacement of aging trucks that are being pushed to last longer.