FreightCar America (NASDAQ:RAIL) is what Joel Greenblatt would call a “Magic Formula Stock” (from his popular The Little Book that Beats the Market), which is currently in the top 30 ranks in terms of high EBIT/EV (return on capital), coupled with high EBIT/Price (earnings yield). With a PE around 6, a nil chance of bankruptcy, and solid growth over the past few years, there is no doubt the company’s numbers look attractive and a possible buying opportunity exists.
Before saying anything else on this company (and to avoid saying what’s already been said just as well if not better), I’ve found it instructive to check out Hans Wagner’s recent post, upon which I hope to build.
Leaving aside all the numbers (important though they are), this seems like an interesting opportunity for several reasons. With an estimated 87% market share for its main product and significant barriers to entry for competitors (including high customer switching costs, economies of scale, and ongoing industry consolidation), the company is not likely to go out of business anytime soon. Furthermore, the company used the proceeds from its IPO a while back to pay off substantially all of its debt, giving it a capital structure far more enticing and significantly less risky than its major competitors (of which, I add, there are only about 3 or 4). Not to mention the fact that FreightCar America’s margins are slightly more intriguing.
So what’s the problem? For me it’s simply a “too hard to understand” proposition. Not so much because I don’t understand the business per se, but because I don’t fully understand the industry and where it’s headed (at least not yet). The number of railcars delivered in any given period of year fluctuates wildly, and the company’s results will logically suffer the same fate. Due to the erratic nature of industry and, by extension, company earnings, I don’t think I can place a reasonable valuation on the business. The company’s fortunes are also highly dependent on the coal industry’s fortunes, and I am far from an expert on the coal industry.
Nonetheless, a cursory glance at the company reveals that it may be relatively undervalued when stacked up against its peers. Given its solid competitive position, strong capital structure, and ability to have weathered recent cyclical downturns, it makes little sense that the company should trade at a PE less than half that of its more poorly positioned peers (including Trinity Industries Inc. (NYSE:TRN), American Railcar Industries (NASDAQ:ARII), and Greenbrier Companies (NYSE:GBX)).
My conjecture is that the biggest variables affecting this discrepancy are 1) the differences among most recently reported backlogs (RAIL’s competitors have all seen backlog increase in their latest 10-Qs, while RAIL has seen a significant decrease in its backlog), and 2) concern over a cyclical downturn in the coal market, to which RAIL’s profits (but not necessarily its competitors’ profits) are inextricably linked.
The key questions for any investment or nifty long-short trade (i.e. buying RAIL and shorting an appropriate basket of its competitors) are logically 1) whether this represents an overreaction by the market and 2) what does the coal market look like going forward. Given that the company is qualitatively strong vis-a-vis its competitors, an investor who can answer these questions correctly may stand to profit handsomely.
RAIL vs. GBX vs. ARII vs. TRN 1-yr. chart