FreightCar America Is Sooo Twentieth Century

Here at StockReply we are quick to bring you news of stocks to hesitate over. So when we read that Amaranth was liquidating its position in FreightCar America, Inc. [RAIL], and saw this piece from the increasingly shrill Fool, we thought we'd ride the rail, jump the tracks etc, etc.

RAIL makes specialized aluminum railroad cars, mainly used to transport coal, and has done since 1901. How picturesque, pre-internet and manly can you get? There is little competition, partly because all of its competitors have died or merged and partly because the cars are too heavy to import cheaply.

The major issue in valuation, and what makes this an interesting case is the cyclicity of demand. We might even use this as a proxy case before tackling something similar but more meaty, like the house builders. The 10-Ksets out clearly the drivers but the easiest number to latch onto is the new rail-car backlog. At the end of 2005 it was over 20,000 and right now it is over 12,000. The worst year in the most recent cycle was 2002 when it was 1,000.

This ratio of worst to [presumably] best is mirrored in the turnover, which was $225m in 2002 and will likely be close to $1.5 billion this year. Management looks pretty good but inevitably there is an even bigger swing in profitability. This year EBIT looks like it will turn out at c.$200m but in 2002 it was next to zero.

RAIL is churning out cash at the moment and had $185m net at the last quarter end. There are no other net operating assets. The interesting question is how to value the operating cashflows. What would you pay for a cashflow that fluctuates between zero and [a fully taxed] $135 million per annum? Unlikely to be above ten times peak, or $1.35 billion, or below zero.

One approach would be to take the average cashflow over the cycle and capitalize it. This might be worth $675m. In fact, RAIL didn't make very much in 2003 and 2004 so this would probably turn out an overestimate.

Still, sticking to the $675m and using the current cash as a base gives a minimum value per share of $13.40 and maximum of $62.32, which is not so far above the current price. We would be interested in comments and some alternative methodologies for valuing this one.

RAIL 1-yr chart

Comments

[Justin Sink:]

I think that it is important to look forward to the next cycle instead of backward. The reason is that 2002-2006 was not typical. First 2002 was the lowest bottom ever for the rail car industry. Using this year is like using black Monday to study typical stock market variations. Second there were a lot of extraordinary costs in 2004 and 2005. These include a large settlement with the unions, and the IPO for the stock. These costs should be added back to earnings to find the real operating earnings power. Third the nature of the company has changed with the addition of low cost non-union plants that as of last quarter churned out 80% of the cars for RAIL, some of these addtional margins will be retained. Fourth the coal industry has huge amounts of potential growth ahead of it with much of the coal coming from the West and being hauled much further. RAIL is the undisputed low cost leader in making cars for this coal with 84% market share. This along with an aging coal car fleet that must be replaced and a booming capacity constrained railroad industry with lots of free cash points to a much less severe trough in the next couple of cycles. Fifth, RAIL is moving into other car types, intermodal and covered hoppers, and up to 4 more international joint ventures which must be added to the valuation as a future growth opportunity. Sixth, it looks like RAIL’s pension will be fully funded after this year with will add to future earnings going forward. Last and most important is that RAIL is hanging on to a huge wad of cash, 30% of their market value, that should be removed from their market cap as a non-operating asset giving RAIL a current equity market value of about $40 per share.

P.S. With 112.5% institutional ownership going short RAIL seems more than a bit crazy.

2006 Dec 19 11:46 AM