Trinity Industries - Acquisition Of Meyer Reduces The Reliance On The Railcar Business

|
 |  About: Trinity Industries Inc. (TRN)
by: The Value Investor

Summary

Trinity Industries expands into the utility steel structure business.

This is a move which will reduce the reliance upon the cyclical railcar business.

After the huge momentum witnessed over the past year, I am a bit cautious to jump on the bandwagon.

Trinity Industries (NYSE:TRN) announced the acquisition of Meyer Steel Structures in a move to expand its presence in the utility steel structure business, which reduces the reliance upon its booming railcar business.

Shares have seen a lot of momentum over the past year driven by the increase in demand for railcars amidst the U.S. shale gas and oil revolution. Finding it difficult to estimate how much of this uptick is driven by structural versus cyclical changed operating conditions, I remain reserved and avoid shares after the huge momentum.

Highlights Of The Deal

Trinity Industries announced that it has entered into an agreement to acquire Meyer Steel Structures for $600 million. Meyer is the utility steel structure business owned by the ABB Group at the moment.

Meyer is a provider of tubular steel structures for electricity transmission and distribution. The company produces engineering poles, H-frames, light duty poles and substation structures, among others.

Meyer currently employs 1,100 workers in manufacturing facilities located in Alabama, South Carolina, Texas and Wisconsin. The facilities are expected to report record revenues of $325 million for the year of 2014.

The deal is expected to close as soon as the third quarter of this year.

Strategic And Financial Rationale

CEO Timothy Wallace is excited about the deal with Meyer seen becoming part of Trinity's Energy Equipment Group. He stressed that Trinity entered the market for utility steel structures a few years ago and that the deal will add to growth and complement the commitment to the utility steel structure business.

Wallace furthermore believes that the deal will add to Trinity being a premier but well-diversified industrial company. He furthermore added that opportunities to acquire such great businesses don't come by very often while he has admired the leadership and reputation of Meyer for years.

Based on the reported $600 million price tag, Trinity is paying roughly 1.8 times anticipated sales for this year. The deal is expected to be accretive to earnings already this year. Unfortunately, the company cannot specify the degree by just how much earnings will see a boost from the deal.

Recent Investor Presentation

Back in May, Trinity held a big investor presentation, updating its investors on current progress and future ambitions.

The diversified industrial company is operating in five major business segments being the rail group, railcar leasing and management, inland barge group, construction product group and the energy equipment group. The acquisition of Meyer will add significantly to the energy equipment group.

While these industrial activities can result in quite some cyclicality, Trinity aims to focus on market leading positions, seasoned performers, diversification, focus on enrichment of value as well as flexible and cost-effective manufacturing facilities.

While this diversification seems nice, Trinity in reality derives roughly half of its revenues from the railcar business, which is seeing a huge upswing on the back of the U.S. oil and gas revolution. The company has delivered 25,995 railcars over the past year, making up nearly half of total industry shipments. Strong orders added to the railcar backlog, which rose to $5.2 billion, worth over 1.5 years of production.

Valuing Trinity Industries

Back in April, Trinity released its first quarter results. The company ended the quarter with $788 million in cash and equivalents, having access to roughly $1.5 billion in total liquidity. As such financing of the deal should provide no difficulties.

Total debt stands at $2.94 billion with much of its debt being tied to the railcar leasing business against which it holds real assets, which are in great demand currently. As such, Trinity will operate with a net debt position of about $2.8 billion following closure of the deal.

The company posted very strong first quarter results with revenues increasing by 56.6% to $1.46 billion. Net earnings nearly tripled to $226.4 million, aided by strong operating sales leverage and $88.4 million in one-time gains.

For the full year of 2014, Trinity anticipates sales of $6.2 billion and earnings of $7.00 to $7.50 per share. This guidance was given before the company splits its shares in a 2-for-1 ratio, implying that the new earnings guidance will come in at between $3.50 and $3.75 per share.

At $43 per share, Trinity's equity is valued around $6.7 billion. This values the company's equity at little over 1 times annual sales and 11-12 times anticipated earnings.

Trinity's quarterly dividend of $0.10 per share provides investors with a 0.9% dividend yield.

A Look In The Rear View Mirror

While Trinity's current growth is spectacular and intentions to be less cyclical are applauded, Trinity is still quite cyclical. Between 2008 and 2010, Trinity saw its revenues being cut in half to just $1.9 billion in the wake of the recession. Ever since, revenues have seen a big uptrend again, more than tripling in the meantime, anticipated to come in at an annual rate of $6.5 billion going forwards.

What is interesting is that shares of Trinity have seen huge momentum. Shares traded at highs of $20 before the crisis and have seen astonishing returns of roughly 125% over the past twelve months. The main reason is of course that the company is the nation's largest producer and lessor of railcars in the U.S., which are in great demand given the oil revolution.

Takeaway For Investors

Investors have had a great run in recent times, yet I am a bit cautious after the very strong momentum with shares having returned nearly 60% already in 2014 alone.

Despite the huge run in the share price, there is arguably appeal at 11-12 times earnings based on the headline numbers. Yet keep a close eye on the fact that Trinity's earnings are very cyclical with both revenues as well as margins expanding during the good times, to compress during the recession. This positive correlation between both metrics can of course have serious implications for investors and the valuation, a key reason why one should consider the average margins and revenues throughout the economic cycle.

Yet the oil revolution brings some real arguments into play, whether current growth is more of a structural growth story now compared to previous upturns. Strong production growth and limited building of pipelines in recent years have pushed up demand for railcars, yet it will be difficult to figure out the true long-term impact of this on the business. Of course these developments are a net positive, yet one can expect more pressure to allow the building of pipelines as well as competition kicking in for the production of railcars.

After the huge momentum, I will avoid being the greater fool at current levels, yet I do recognize the potential that structural changes are occurring. As such, it is probably a wise move by management to diversify the business further away from the railcar business. On a decent dip, I might reconsider my investment stance.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.