The decline in crude oil prices and the simultaneous increase in natural gas costs have reduced the incentives for purchasers of vehicles containing Westport Innovations’ (WPRT.O) natural gas-burning engines to spend the money for the pricey trucks.

The plunge in the price of crude oil, while it has alleviated some of the pressure on consumers who had been paying hefty prices for gasoline, hasn’t removed the political pressure to shift to cleaner-burning fuels. But Westport Innovations Inc., (WPRT.O) a Canadian company that specializes in constructing engines to run on cleaner-burning fuels like natural gas, has been hit with a double whammy by the commodities markets. As crude prices have fallen to $98 a barrel from $123 within the last three months (based on the Brent crude benchmark), natural gas prices have rebounded, from about $2 per thousand cubic feet to nearly $3. That kind of divergence is bad news for a company in Westport’s business, selling specialized engines to truck manufacturers like Volvo. As gas prices rise, buyers are less willing to pay the premium demanded by Volvo and others for vehicles with specialized engines, and that then filters back to Westport.

Those unpleasant economic realities mean that every analyst covering the stock has cut his or her estimates for the company’s earnings. Moreover, while the mean I/B/E/S consensus estimate now calls for the company to lose nearly 30 cents a share in the second quarter, the StarMine SmartEstimate indicates that this may be closer to 33.5 cents. That gives the company a negative Predicted Surprise of -13.6%, signaling that there is a high probability it may report a loss that is larger than most analysts are anticipating. Indeed, one five-star analyst recently published a report suggesting that Westport’s loss may be closer to 36 cents a share.

The problem Westport is facing isn’t confined to commodity prices, however. The company’s capital spending in the first quarter of 2012 hit $9 million – the highest recorded in any quarter during the last five years – and in the last three quarters, capital spending has exceed the cash flow that Westport has generated from its operations. (Indeed, for two of those quarters, Westport reported that its cash flow from operations was an outflow rather than an inflow.) Combined with the trend in commodities prices, this is putting pressure on Westport’s earnings; it seems likely that this is one of the reasons the company has reported earnings that fell short of expectations for the last six quarters. It appears likely that the second quarter of 2012 will turn out to be number seven. These trends are taking a toll on Westport’s earnings quality, as well; the company’s score on the StarMine Earnings Quality (EQ) model is the lowest possible, a 1, warning investors that its earnings are not coming from sustainable sources.

The outlook for Westport’s business is uncertain, being somewhat dependent on government regulations mandating the use of cleaner-burning fuels in fleets of trucks, as well as any subsidies offered to those fleet owners to compensate them for the higher prices of engines such as those Westport makes. Without some economic support, whether in the form of subsidies or other government program, or clear energy price trends favoring conversion to natural gas, Westport will be struggling to make headway.

Going forward, Westport is placing a lot of hope that the Chinese market will play a key role in helping to boost both revenues and profits in the coming months and years. Chinese authorities clearly are intent on reducing the level of air pollution that leaves its major cities blanketed in smog for weeks at a time, and Westport has a joint venture in place with Weichai Power Co.,Ltd, (WEICF.PK) a firm of heavy-duty engine manufacturers, to supply natural gas engines for trucks.-“I don’t think there’s going to be any constraint on growth in China,” Demers told an earnings conference call in early May. “In China, we’re seeing really spectacular investment in LNG infrastructure already, and some substantial government support for doing that. You can see our sales were up 50% year over year. I think that’s going to be a pretty regular occurrence going forward.”

While Demers may be optimistic, his comments highlighted the extent to which Westport’s future growth prospects depend on both economic growth in China and continued government support. Given that the International Monetary Fund just cut its forecast for Chinese growth, those may not be in place to the extent that Westport hopes. In the interim, Westport is on track to disappoint investors by announcing a larger-than-expected loss for the second quarter of 2012 when it unveils its results for the quarter on August 6.

 
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