Background: In October, with Trinity Industries (TRN) shares trading around $45, I reviewed the company and proposed a 50% upside move in one year as a reasonable expectation. Less than five months later, the stock has done exactly that, closing around $68 following blowout quarterly results and a bullish company forecast this past week. I reviewed TRN bullishly two more times, most recently on December 17. In that review, I pointed out that the company had beaten consensus earnings expectation four quarters in a row.
With Trinity posting yet another beat and raise quarter, I'd like to focus on the power of Trinity's strategy.
Introduction: Trinity's focus is on railcar production and leasing. It also recently entered into an alliance with Element Financial to assist with Element's interest in investing in leased railcars. It has diverse operations. For example, it manufactures barges, wind towers, and equipment for the conventional energy industry. It has an important leasing operations, dominated by railcars. Recently it made two acquisitions in the cryogenic field, which is needed for liquefied natural gas transport.
It is no secret that the growth of unconventional oil and gas production has led to a need for many more railcars to get the product to refineries and/or market. So, Trinity's presence in this product category does not mean that its financial results would be surprisingly good quarter after quarter, powering strong stock market returns. Yet it continues to beat expectations, even though at least some of its secondary business lines, such as barge manufacturing, are sluggish. I believe that a good part of the explanation relates to the corporate strategy that the current CEO implemented several years ago. This was discussed in a CNNMoney article in 2000 about the rise of the current CEO, Tim Wallace, within Trinity, eventually succeeding his father in that role.
Why Trinity is so good: That article discusses Tim Wallace as a young manager focusing on involving employees much more than is typical, and he has extended that practice to making the company operationally flexible. In his spring 2013 shareholder letter, Mr. Wallace closes with this:
Our integrated business model enables us to quickly assimilate resources - facilities, equipment, competencies, and talent - to align production capacity to meet customer needs and enhance our earnings and returns. Our business approach differentiates
Trinity from single-industry manufacturing companies and plays an important role in our goal of becoming a premier company.
I remain convinced that successful companies will be those
that maintain low cost structures and are able to make quick, efficient adjustments at a moment's notice. Trinity is agile in many respects, and we continually strive to improve in this area...
...We will strive to take advantage of acquisitions and organic growth opportunities that enhance our operating flexibility,
further diversify our portfolio of businesses, reduce the cyclicality of our earnings, and generate stable cash flows.
The flexibility Wallace praises requires increased investment in employees and in infrastructure. When business opportunities shift, the company can beat the competition to the new sources of profit. A broader acquisition strategy may be pursued as well, because the company is already more diversified (or able to be) than its operations per se require.
These advantages have been in evidence recently. In the Seeking Alpha conference call transcript, multiple references to the company's operational flexibility are made by different executives, both in the prepared remarks and in the Q&A. For example, Mr. Wallace responds in part to a question about capital deployment and diversification from railcars from someone named Bascome Majors by saying:
We're fortunate to have a highly flexible and collaborative manufacturing platform that we build upon.
This is of a piece with this theme that he emphasized in his introductory prepared remarks. One such comment came early in those remarks:
Our Rail Group generated strong financial results in the fourth quarter, reporting a record level of quarterly revenue and operating profit. I remain impressed with the group's ability to continue to improve its performance while converting manufacturing space, making line changeovers and increasing production levels.
He gave lots of fodder to the bulls on the stock, by also clearly saying:
We have a great deal of positive momentum occurring within our company.
The strategy is working.
Upside potential: I do not want to repeat the details in the company's press release, my prior Seeking Alpha articles on TRN, or even the nice review by SA contributor Dan Strack who got an article on TRN out the day of earnings, titled Trinity Industries Hits a Homerun on Earnings.
What I do want to do is continue the top-down, thematic approach. Thus I note the acceleration in acquisition and partnering activities the company recently accomplished. These show a company in expansion mode, focusing on total return to shareholders. The company also noted that a former CEO of Pemex, the Mexican oil monopoly, is on Trinity's board, and Trinity has delineated significant growth potential in Mexico. I expect international expansion will play a growing role in TRN's growth in the out years.
Clicking through to this chart shows a stock that went nowhere from 1972 until the bottom of the liquidation event of 2008-9, then more or less straight up. Is the prior aimless cyclicality over and done with?
If so, then we can look at Yahoo! Finance's summary of recent and current earnings expectation to make some quick estimates of where the stock can trade a few to several years from now. Here is where analysts are reported to be, including their lower numbers of just days earlier:
EPS Trends Current Qtr.
Current Estimate 2.46 1.44 6.72 6.01 7 Days Ago 1.96 1.38 6.01 5.31 30 Days Ago 1.96 1.38 6.01 5.14 60 Days Ago 1.86 1.33 5.87 5.08 90 Days Ago 1.16 1.31 5.16 4.65
The expected decline in earnings in 2015 is due to large one-time gains from sales to Element Financial this year, probably with 2015 results projected cautiously due to very strong railcar sales leading into next year.
In any case, companies with repeated earnings beats with bullish CEOs are prime candidates to continue to beat projected annual earnings estimates from analysts. So I am going to put on a rough-edged seer's hat and say that all these CEO references to flexible manufacturing means something substantial when results are so strong.
(However, insiders have been selling):
Net Share Purchase Activity
Insider Purchases - Last 6 Months Shares Trans Purchases N/A 0 Sales 274,346 10 Net Shares Purchased
(274,346) 10 Total Insider Shares Held 1.21M N/A % Net Shares Purchased
So I am going to assume EPS of $6.50 in 2015 and sustainable (non-peak) earnings of $10 by the end of the decade. This would imply low to mid-teens percentage annual total returns. If so, I would anticipate that these returns would be front-loaded, given the stellar current and projected near-term future results.
Looking forward to full-year 2015 results, I think it's not unreasonable for bullish shareholders to dream of $7/share operating earnings and a 15X P/E on them. This would suggest about a $100 price target by the end of next year, or perhaps by mid-year, suggesting an intermediate-term 50% total return as a plausible possibility. After 35 years investing in and closely following stocks, I think that one way or the other, this is a very reasonable, perhaps even likely outcome.
How might this occur? One way is for the company to demonstrate continued strong cash flows in the core railcar manufacturing and leasing businesses, plus unexpected growth elsewhere. Energy products and Mexico are two large areas of growth potential. A large accretive takeover could occur, and of course Trinity itself would appear to be an attractive takeover target to a large company.
After a moonshot move for a company previously viewed, correctly, as a deep cyclical company, the key question for current TRN shareholders is whether this leopard has changed its cyclical spots in a meaningful way.
My take is that it has to a sufficient degree that the outlook for investors has changed. This is turn would yield a higher average P/E.
Opposing views: Trinity remains heavily dependent on railcars, and this industry will determine the fate of TRN shares for some years to come. There are good reasons for shareholders to follow insiders and lighten up on the shares into the recent strength. Among these reasons are the history of TRN shares to peak several quarters before earnings peak and to bottom quarters or even years before earnings trough. Every past time when TRN peaked before a downturn in its business, bulls thought the future looked rosy in the short to intermediate term. Why should this time be different?
In addition, many people believe that economic activity in the U.S. has been artificially pumped up by central governmental fiscal and especially monetary policies, and these unsustainable props are winding down, so prepare for macro contraction or deceleration of growth at best. If that occurs, TRN is unlikely to be spared, at least for a while until it shows it can grow rapidly in a time of threatened recession.
Many other objections to the bull case on TRN exist, of course.
Summary: TRN is very well placed to continue to outperform the general market. It has a leadership position in its core field(s), and its growth driver is a favorite of Wall Street's: the unconventional hydrocarbon extraction business and the related reindustrialization of America.
With strong current results and numerous growth drivers within its existing industries and into new ones, and with international expansion on the short-term horizon, TRN shares may pick up institutional and large-cap brokerage favorable attention. It might even become a bit of an icon, given its employee-centric and forward-looking flexible production focus.
Many investors who enjoy investing in individual stocks will find much to think about if they research the shares of Trinity Industries.
Disclaimer: Not investment advice. I am not an investment adviser.