Keep An Eye On FreightCar America

I recently purchased some shares of Freight Car America Inc (RAIL). RAIL manufactures railroad freight cars, and is the leading North American company in coal-carrying railroad cars with over an 80% market share. In addition to coal cars, FreightCar America also designs and builds flat cars, mill gondola cars, intermodal cars, coil steel cars and motor vehicle carriers, but coal-carrying cars account for nearly all of their business.

RAIL’s primary customer base are the major railroad shippers, rail leasing companies and some large utilities. The company has somewhat of a deep “moat” because of the dominance in their niche and it would be very costly for one of their customers to switch to a different manufacturer.

But the business is highly cyclical. A railroad car can last over 20 years, and their major shipping customers may order them infrequently. This causes highly variable earnings- probably $10 a share during peak times and $1-$2 a share during slow periods. 2006 was a peak earnings year, but we are entering into a slow year in 2008, when EPS is only projected to be about two dollars a share.

Here are some reasons why I like RAIL right now:

1. Strong balance sheet. The company holds $13 a share in cash and has no debt!
2. Tax loss selling: RAIL’s stock price is near the 52-week low, and tax loss selling is kicking in now. Some shorter term investors are concerned about next years lower earnings estimate. It is hard to say precisely when the order rate will pick up again, but based on historical cyclical patterns they should increase sometime within the two years. Average EPS over the full cycle is about $5 per share. Subtract the $13 cash from the market price and you get a full-cycle P/E ratio of about 5 times earnings.
3. Strong Sponsorship: I checked RAIL on the Stockpickr web site, and saw that SAC Capital (Steve Cohen’s firm) and Citadel Investment own large positions. Stockpickr also lists many “Magic Formula” portfolios that hold the stock (The Magic Formula is described in Joel Greenblatt’s recent book). Some other strong sponsors listed as holders of RAIL are: Stark Offshore Mgt. (Note: One of my favorite investment books is “Special Situation Investing: Hedging, Arbitrage and Liquidation” written by Brian J. Stark when he was still a law student before he became a hedge fund manager. The book is out of print now and used copies go for $388. on Amazon); and Fidelity Leveraged Company Stock Fund- Fidelity Low-Priced Stock Fund
4. Management has been very aggressive with share buybacks.

Full Disclosure: I am long RAIL.

Comments

[jksky]

You bring up some interesting points that are very valid for a deep value investor. I just looked at the ownership and I see that SAC has a 660K stock position as of the end of 2Q and I even see that K Fine on Fast Money is investigating.

I can see many points for a deep value investor to own, there are also significant factors that can prolong the bottom of the cycle. Primarily related to supply/demand balance for coal cars. Longer term the coal fired plants that were originally planned to be brought on line have been delayed/cancelled (ie TXU). Railroads are (particularly the western railroads) are now parking excess cars that they have. They had to buy more in the last cycle because of operational bottlenecks in there systems that are now being eliminated. This reduces the demand for new cars. And when demand picks up, they can just pull out of storage.

I was actually thinking of buying some puts before the earnings announcement. Just for a trade.

However they are keeping their costs under control and attrition of old cars should keep a trickle of new orders plus the jv in India should keep them in business until the next cycle arrives.

[Pavlo]

It’s a good idea, i think. If you are interesting in railcar makers in whole industry, you would keep eye on Ukrainian based companies AZGM, DNVM, KVBZ, MZVM, SVGZ (UZ Equity) – Bloomberg tikers.
And one question. Do you have information about world railcars production dynamics, and maybe some forecast? Especially on tank cars production.