FreightCar America: The Ugly Duckling?

I recently received an email asking why FreightCar America (RAIL), which primarily makes coal-carrying train cars, was ranked as the #1 stock in the market on my Top 25 Stocks List. My “Top 25″ is compiled by a quantitative model - so I have no direct influence over individual choices - but the question made me consider whether or not my methodology was correctly being displayed with a stock like RAIL at #1.

The goal of the Top 25 is to find, using only fundamental data, good businesses trading at reasonable valuations that should outperform the market over the next several months to one year. So far the results have been satisfactory. Is FreightCar America really the most attractive business? The argument can be made both ways - the last several years have seen a surge in orders, so many of the earnings-related metrics might be coming in on the high side and make the company seem deceptively cheap. Still, the massive cash flows the company has generated from that good period aren’t lost - RAIL makes money hand-over-fist when times are good, and has an excellent balance sheet so that the company could surely wait out a few slow years.

Now, I believe this person was short - and seeing their short be called the best stock in the market must be a bit unnerving. They asked for an explanation, and it went along these lines: Fundamentally, you have a company with a huge cash position of more than $15/share for a $50 stock. That cash position may even be understated, as the last quarter’s Statement of Cash Flows was weak on the bottom line, most of that was due to a growth in receivables. Convert those receivables, and you are looking at an additional $5+/share cash.

Also, management is now expanding business beyond just coal cars, so that may even help to balance out some of the cyclicality, and the company earns generous returns on capital. Adding another revenue stream, if it could come close to matching those of coal cars, could be a huge driver of profitability; not to mention that diversifying a business will likely result in multiple expansion as the lessening of uncertainty attracts more buyers.

As for the negatives: yes, the near future doesn’t look good, but is coal power going away anytime soon? I doubt it. In fact, I am betting heavily on coal becoming even more important as a fuel source, and RAIL is a way to play on that thesis. Keep in mind, this company has been around for more than a century and I seriously doubt a few lean years will be a new experience.

So yes, things look ugly short-term. But what do I love about an ugly short-term picture? When it is accompanied by Ken Griffin’s Citadel and Steve Cohen’s SAC Capital buying shares, that gets my attention. You have a stock trading at just 2x EBITDA, 35% of the price is in cash, it has underperformed the market by 25% in the last year, institutions have 1 million shares in net sells in the last quarter, over 20% of the float is short, expectations are for profits to be halved in each of the next two years… and two of the top five or ten hedge funds on the planet have a major ownership stake, both of which have been disclosed in the last five months.

So… do we go against the herd and side with Citadel and SAC, or the fund managers who are terrified of being seen owning such an ugly stock? No, RAIL isn’t the world’s greatest company - I think that might be Accenture (ACN) - and its appearance may be due to the nuances of the model’s ranking method, but I think there is an exceptionally compelling case to be made for a purchase of RAIL here.

RAIL 1-yr chart:

Disclosure: none.

Comments

[Myth454]

Pabrai has also taken a position and his hedge fund has also done quite well.