Over the past few years, freight railcar manufacturers have witnessed strong demand. An improving economy and North America's recent energy boom have been important catalysts. The peer group of public railcar manufacturers includes American Railcar Industries, Inc. (ARII), FreightCar America, Inc. (RAIL), The Greenbrier Companies, Inc. (GBX), and Trinity Industries, Inc. (TRN). All of these companies stock prices have grown substantially since their lows (exception being FreightCar America). Long-term investors should be interested in knowing two things: who is best positioned to prosper and who is in the best position to weather economic downturns.
Based on recent news related to railcar orders, it should be noted that Berkshire Hathaway Inc. (BKR-B) owns both Burlington Northern Santa Fe (BNSF) and Union Tank Car. Union Tank Car and National Steel Car Limited are both private railcar manufacturers competing with the above public peer group.
One perceived challenge for railcar manufacturers involves the continued progression of oil and petrochemicals from rail to pipelines. The impact on the rail industry from future pipeline developments cannot be accurately quantified at the moment. However, as we approach 2015 and beyond, it is speculated by some that demand could potentially fall from today's railcar manufacturer contracted back log levels.
Barron's is never shy to make calls contrary to momentum as evidenced by their "Ready to Jump the Rails" piece last fall. The claim that pipelines and oil tanker ships (maybe barges in here too) had supplanted oil tank cars at the end of the 20th century is an interesting one. At the turn of the 20th century, tank cars had increased by 31% since 1980. Today's industry railcar backlog number is around 73,000 railcars, of which 76% are tank car orders.
Contrarily, safety issues stemming from recent train crashes and tank car explosions have added a potential demand generator for railcar manufacturing. Federal policies are currently in the process of discussing potential regulatory requirements for the DOT-111 tank cars. As of February 2014, there are 335,000 tank cars (228,000 of these are DOT-111) in the railcar fleet. Roughly 92,000 DOT-111 tank cars are used to move flammable liquids, such as crude and ethanol, with approximately 18,000 of those tank cars built to the latest industry safety standards. The outcome of federal regulatory requirements will potentially impact retrofits and new railcar deliveries substantially in the near-term.
The Trinity Industries management team has also repeatedly expressed that they expect there will be downstream railcar demand for refined energy products and that this demand should be felt in the 2015-2016 timeframe. Additionally, American Railcar Industries has stated that they expect stronger demand for hopper cars related to plastic pellet-related products. Refineries such as Philips 66 (PSX) among others have invested in tank cars for the transportation of their products; opportunities will impact operations owning and leasing tank cars. This is anticipated to drive further tank and hopper car demand.
Both of the above charts provide great illustrations of just how dramatic railroads have benefited from the surge in crude oil developments, and that demand is expected to continue in the near-term. While pipeline developments such as the Keystone XL Pipeline Project will add competing capacity, rail will be able to continue to serve the crude oil demands more quickly and efficiently in the near-term.
Railcar Manufacturer Market Leader - Trinity Industries
It is important to understand the generators of railcar demand as well as the makeup of each railcar manufacturer and their approach to growing their respective businesses. When considering this, Trinity Industries stands out as the clear leader amongst its public peers; which will be expanded upon in a later section below. The company is in a very strong position to maintain its market leading role regardless of pipeline developments or regulatory requirements. What is more important than speculation is to understand how Trinity Industries is effectively positioning itself through its business model to be flexible enough to compete and create long-term value for shareholders.
The three primary factors which should continue to allow Trinity Industries to succeed include rail's strong support of commodity flows and the transportation supply chain leading to sustained railcar demand, Trinity's leading market share and diversified complimentary business model, and the company's proven ability to sustain value to shareholders during economic downturns.
RAIL WILL CONTINUE TO BE A MAJOR CONTRIBUTOR TO COMMODITY FLOWS AND THE TRANSPORTATION SUPPLY CHAIN LEADING TO SUSTAINED RAILCAR DEMAND
All Class I rail companies have projected increased revenue growth for 2014 and 2015. This is predicated on expectations for sustained to moderately improved GDP growth. Coal has weighed on rail operators, but this has been offset through volume mix and core pricing for other commodities and sustained intermodal demand. The automotive industry as an example has provided substantial added value to carloads/units moved and pricing. For an in-depth overview of rail operators in North America, please refer to "Is Union Pacific The Best Public Rail Company To Own For 2014 And Beyond?".
A key item to consider here is the resiliency of rail operations through opportunity. Some of the largest rail operators such as Union Pacific Corporation (UNP) have witnessed increased average revenue per carload for all commodity categories including coal while intermodal average revenue per carload has remained constant. Additionally, agricultural product volumes, especially grain has rebounded strongly leading to potential continued positive demand for the first half of the year. Chemicals and petroleum volumes have remained solid and drilling activity driving frac sand has continued to remain robust. This has led to much more positive projections than negative for 2014 and 2015 moving forward.
Similarly, North America's energy boom is not going to end anytime soon. The Keystone XL Pipeline Project is consistently touted as being a contributor to negatively impacting rail operators for the transport of crude oil. The figure below displays the proposed Keystone XL project as well as the existing pipelines including the existing Keystone Pipeline, Cushing extension, and recently opened Gulf Coast project.
Judging from Union Pacific's fourth quarter call, there is definitely going to be an expected impact from the Gulf Coast pipeline. Crude oil volume mix was the weakest link for the company's chemicals segment, down 22% during the quarter and management clearly stated that they expected pipeline capacity to be one of the pressures moving forward.
So there are definitely legitimate concerns for how pipeline infrastructure will impact rail operators. However, there are still a couple of challenges for pipelines: safety is a legitimate concern and even after large-scale projects are built, there may still be too much crude oil demand and rail will continue to be relied upon. To highlight these points the following articles provide examples of the launch of an oversight network - Texas Pipeline Watch by Texas property owners for the newly operating Gulf Coast extension and the Association of American Railroads and ITG estimate that Canadian crude oil demand will require rail to continue to play a crucial role transporting the commodity.
Specifically looking at railcars, the best way to get a clear snapshot of demand is to consider historical trends. To understand economic cycles, it is important to pay close attention to recession and post-recession dynamics. Westinghouse Air Brake Technologies Corporation's (WAB) provides an overview of both annual locomotive and freight railcar deliveries within each annual 10-K filing as evidenced by the chart below.
Westinghouse is not included in this assessment as they supply components which are included in the manufacturing process, but they do not deliver completed railcars. Westinghouse should, however, benefit from the continued demand for railcars. Additionally, freight railcar delivery information is provided by RailServe.com, which uses the Association of American Railroads, or AAR as its data source.
It is clear that impacts to railcar manufacturing have led to significant declines which have lagged the economic bottoms of each of the more recent recessions. In both 2002 and 2010 total freight railcars delivered were near 17,000. Additionally, it would appear that today's post-recession high is much lower than the 75,000 railcars delivered in 2006.
One of the key trends to highlight from this chart is that prior to the recession in 2009 and since 1992, the average number of railcars delivered per year has been 50,000. This number has declined to around 49,000 post-recession during the overall 22-year period. However, the post-recession and post-bottom of 2010 average is now at 53,000 railcars delivered per year (3-year trend).
From the above chart it is clear to see that tank cars have been the leading driver for railcar demand over the past 30 years. Tank cars of late have reflected about 21% of the freight railcar fleet. This is also consistent when comparing individual rail operators. Tanks cars increased 9 consecutive years from 1992 to 2000. This solidifies an important point that it appears that tank car demand has been in an upward trend for over 20 years now, despite continued pipeline progression.
The other day American Railcar Industries and Trinity Industries reported blockbuster earnings. Sequentially the proportion of tank cars has decreased from 80% to 76% of the total railcar backlog as of the 2013 fourth quarter. Total backlogs have remained stable so it would appear that railcar mix is adjusting - covered hopper railcars are a big part of this, but other railcars may be improving as well. Roughly 53,000 railcars were delivered in 2013 and for 2014 it is estimated that over 60,000 railcars will be delivered.
TRINITY INDUSTRIES IS THE CLEAR MARKET LEADER AND ITS DIVERSIFIED BUSINESS MODEL WILL SUSTAIN THIS OVER TIME
Trinity Industries is the current market leader for railcar manufacturing and has increased its market share significantly during the past year. From the chart below Trinity Industries has never had a market share lower than 26% since 2003. Post-recession Trinity has significantly outperformed the peer group with railcar manufacturing growth. The Greenbrier Company has been the second best performer, while American Railcar Industries has been flat, and FreightCar America has had a challenging year during 2013. This chart is a great illustration of Trinity's ability to maintain its market leading position, but there are more fine details between the companies to help understand their businesses.
Before getting into a comparative assessment of how these companies compete against each other, the table below provides a snapshot of how this group has performed from an investment perspective. Stock price comparisons are between 12-year, 6-year, and 3-year periods ending as of December 31, 2013 and year-to-date, or YTD as of February 21, 2014. These returns do not include dividends, which will be discussed in the section below.
From this table The Greenbrier Companies has exploded in 2014 (just 52 days), however, over longer term trends Trinity Industries has outperformed Greenbrier. While not having as long of a history, American Railcar has provided significant performance beating out all peers for the 3-year and 6-year periods, and FreightCar America has struggled with inconsistency.
When considering how each one of these companies compares from a business perspective there are some initial clarifications to note to get a sense of how these companies compete. First, the primary way these companies make money is through railcar manufacturing. This is the core focus of how each company generates the majority of its revenue. The table below provides the most recent two fiscal years of railcar manufacturing revenue expressed in millions, and railcars delivered. Greenbrier is the only company which operates with the company's year-end occurring in August. All other companies operate on a calendar-year basis.
The key point to highlight here which is obvious is that both FreightCar America and Greenbrier's manufacturing revenue decreased, American Railcar's was flat for the most part, while Trinity's increased nearly 50%. All companies saw a decrease in railcars delivered with the exception being Trinity whose railcar's delivered increased by 26%. American Railcar is the only company not to provide guidance for 2014. FreightCar America is expecting an increase in railcar deliveries of 83%, Greenbrier is expecting a 29% increase, and Trinity is expecting a 9% increase at the midpoint. It should also be noted that Greenbrier's revenue includes railcars manufactured in Europe and that marine vessel manufacturing is included too. All other companies reflect North American railcars.
All of the peer group companies provide railcar manufacturing for a variety of railcars including auto carrier cars, box cars, gondola cars, hopper cars, intermodal cars, specialty cars, and tank cars. It should be noted that both Greenbrier and Trinity provide robust comprehensive manufacturing capacity, while American Railcar focuses on general service and specialty hopper cars and tank cars, and FreightCar America focuses on stainless steel and hybrid stainless/aluminum coal cars, bethgon series aluminum-bodied coal gondola cars, autoflood series open-top hopper five-pocket coal cars, and other coal cars.
The remaining revenue areas with which to compare these peers is between railcar leasing, components manufacturing and repairs, and other services. Some of the peers include components and repair and other services all together. Components manufacturing and repair includes couplers, axles, cleaning, exterior/interior coating, repair/rebuilding, wheel services, and other maintenance. Other services include engineering, field, management. The table below provides a similar 2-year fiscal comparison and is expressed in millions.
From this table we can clearly see that both Trinity and Greenbrier have taken separate approaches towards adding valuable services to their manufacturer businesses. Through this each company has generated near and over $500 million in revenue. American Railcar is beginning to invest more in railcar leasing as well. The railcar leasing business is a much higher operating margin generating business. Trinity generated around a 45% operating margin or just under $300 million for 2013. This compares to a roughly 17% operating margin for railcar manufacturing including components for both Trinity and American Railcar. Greenbrier has struggled from a margin perspective much more which is driven by lower railcar manufacturing and its wheels, repairs, and parts businesses.
Moving forward from a revenue perspective Trinity Industries separates itself from the peer group. The company operates three other business segments including the construction products group, inland barge group, and energy equipment group. All three of these segments generated another combined $1.8 billion in revenue for 2013. The table below provides a comparison of these business segment revenues for both 2013 and 2012 in millions to be consistent with the previous tables.
The two primary manufacturing aspects of these businesses are inland barges and structural wind towers. These two areas are not high-growth drivers, but more steady revenue streams. Inland barge operating margins are similar to rail manufacturing margins. One of the most exciting areas for Trinity is within their energy equipment group. This segment grew near 20% year-over-year, or YOY. The company has made three recent acquisitions gaining more exposure to chemical and petroleum tank storage. The management team expects to grow this segment as a complimentary product offering with its energy-related railcar and inland barge products. The company will also look to develop these product offerings in Mexico as energy reform opportunities continue.
The following tables below are provided as added comparative information amongst the peer group. All trends are as of each company's 2013 calendar year unless noted as trailing twelve-month, or TTM period, and all numbers are expressed in millions.
This table provides adequate revenue growth information, however, on the diluted EPS side, both FreightCar America and Greenbrier had negative net income during 2013. Trinity's 12-year diluted EPS information is not included as the company did not generate positive income during 2001. In order to consider each company's operations, the table below will assess operating and free cash flows.
From the above table, it is clear that these companies are able to generate substantial operating cash flow. As a percentage of revenue, American Railcar generated 22%, FreightCar America generated 11%, Greenbrier generated 6%, and Trinity generated 15% OCF. When comparing free cash flow, Greenbrier stands out as the clear leader of late. This is due in part to the fact that Greenbrier is the only company which does not currently pay a dividend to its shareholders.
The next two tables below provide comparative valuation metrics including TTM for the following; enterprise value, or EV, EV to sales, price to book, or P/B, debt, and debt/equity. Also included are current price to earnings, or P/E, 2014 forecast P/E, and TTM price to cash, price to FCF, and return on equity, or ROE.
At first glance of each company's EV, Trinity seems to be valued significantly higher than its peers. The company is in the higher position for EV/sales, but is in the lower position when considering P/B. While Trinity's debt levels are higher than peers, it should be noted that the majority of Trinity's debt is non-recourse meaning that it is explicitly tied to the collateral used (in this case railcars) and there is no liability for Trinity otherwise. Additionally 49% of Trinity's total non-recourse debt is associated with partially-owned subsidiaries.
Trinity fairs very well against its peers when considering P/E ratios. However, it should be clarified that Trinity will generate roughly $1.05/share from sales of leased railcars to Element Financial Corporation through its strategic railcar lease alliance this first quarter. While Greenbrier appears to generate significant cash flow, the company has been paying down debt so it still has the worst P/Cash metric. On the other hand, both American Railcar and Trinity have been investing significant capital into their railcar leasing businesses and paying out dividends to shareholders, American Railcars has increased its dividend more substantially of late. Both American Railcars and Trinity have much better ROE than the peer group. However, Greenbrier recently had goodwill impairment in its fourth quarter driving much of the company's poorer financial performance. The company has had very erratic ROE historically.
In reviewing the development of the railcar manufacturing industry there are a couple key observations that stand out. First is the fact that Trinity has continued to grow its market share despite significant competition from the peer group and other private companies. Second is how the company has built one of the largest railcar leasing operations to provide a comprehensive product and service offering for customers. The long-term outlook for railcar demand looks to be very positive and Trinity is in a stronger position to continue to lead the industry.
For revenue growth, railcar manufacturing increased near 50% YOY for Trinity. The company's energy equipment group grew near 20% YOY. Including intersegment eliminations, these businesses combined for over $2.6 billion in revenue. That leaves another $1.8 billion in steady revenue streams to compliment this robust growth.
Competitively, both American Railcars and Greenbrier have performed strongly coming out of the recession. Additionally, there has been speculation in the past of these two companies possibly merging. Trinity has more than sufficient capital resources to consider a large acquisition and the company considers deals constantly. If these three companies continue separately, there is room for all to prosper in the near-term and beyond.
Considering the initial focus of who is in the best position to prosper and weather any economic downturns, Trinity is the clear leader based on the company's diversity, its financial discipline, and innovative strategies leading to increased market share on the railcar side of the business. Greenbrier has sought further growth in Europe and American Railcars has adopted a similar railcar leasing strategy. These are two examples confirming Trinity's strong stance in the North American railcar market.
TRINITY INDUSTRIES HAS PROVEN THAT IT CAN SUSTAIN SHAREHOLDERR VALUE DURING ECONOMIC DOWNTURNS
The most emphatic example of this is that Trinity is the only railcar manufacturer to pay a dividend through the 2008/2009 recession. The company has increased its dividend every year since 2005 at an average rate of 16.5% per year, with the only exception being 2010 when it was held constant. American Railcars reduced its dividend by 25% in 2009, and did not pay a dividend during 2010 or 2011. The company reinstated the dividend in 2012, and has increased it significantly since. Greenbrier reduced its dividend by 63% in 2009, and has not paid a dividend since then to date. FreightCar America reduced its dividend by 75% in 2010 and did not pay a dividend in 2011. The dividend was reinstated in 2012.
Both Trinity (-19%) and Greenbrier (-14%) displayed much less of a decline for top-line impacts during the three years 2008-2010 than American Railcars (-22%), and FreightCar America (-39%). During the same time period Greenbrier had the worst performing negative earnings in total, over -$2/share, with FreightCar America being next at -$0.24/share. Trinity had over $2/share in earnings for the same time period and American Railcars had just under $1/share.
For the 2007/2008/2009 years leading to and through the recession Trinity's stock price declined 54%, while American Railcar's declined 84%, Greenbrier's declined 62%, and FreightCar America's declined 74%. Trinity also performed substantially better as a more mature company when comparing similar trends to the 2001/2002 recession.
From a railcar manufacturing perspective, Trinity has continued to show over time that the company is able to grow its market share out of recessions. Greenbrier has also displayed a stronger growth in market share from the 2008/2009 recession. American Railcars has significantly grown its earnings/share, but the company has not been able to keep up with the growth of Trinity and Greenbrier on the top-line side. FreightCar America has too much exposure to coal flows and needs to prove that it can successfully transition to a more diverse business model before it can be recommended as an investment on the level of the other three companies.
Trinity has developed a unique approach to the railcar leasing model, while still being able to provide long-term railcar contracts to the largest North American leasing railcar company, GATX Corporation (GMT). As America Railcars is following the railcar leasing model set by Trinity, this is a testament to Trinity's success. From a business perspective Trinity provides the most diverse operations with a blend of steady added revenue and robust growth potential. Combined with the company's market leading comprehensive railcar services, there is a lot to like for the future.