FreightCar America: Steering Hard Towards The Right Direction (Rating Upgrade)

Summary

• FreightCar America reported Q2 2023 earnings with an EPS of $0.02 and total revenues of $88.6 million, beating EPS expectations but falling short of revenue expectations.
• The company's gross margin improved by 56% YoY in Q2 2023, signaling progress towards profitability.
• FreightCar America is transforming into a pure play rail car manufacturer, cutting its leased car segment and focusing on increasing production efficiency.
• The company paid down most of its debt by issuing preferred stock, but at a salty coupon.
• Business plan shifting and financial prudency measures are two strategical policies that I believe will work out for the company, but there's still way to go.

robeo

Today, I'm revisiting the case of FreightCar America (NASDAQ:RAIL), a small-cap company specialized in the construction of rail cars, such as bulk commodity cars and coal cars, as well as in the conversion of existing cars for different purposes. In my last article about the company, which was published 9 months ago, I assigned a "Sell" rating to FreightCar America, due to the anticipated dilution on their course towards profitability. Since, their share price has fallen by 31%, while the S&P 500 has gained 14%. Let's see if something meaningful has changed in the company, in the light of their recently announced Q2 2023 earnings.

Earnings snapshot

Two weeks ago, the company posted their Q2 2023 earnings, reporting an EPS figure of $0.02 and total revenues of $88.6 million. In relation to estimates, the company beat EPS expectations by $0.12 per share, while it fell short in revenue expectations by $6.8 million, despite the 56% YoY increase. During the second quarter of 2023, the company delivered 760 rail cars, a number increased by 58% compared to the number of rail cars delivered in Q2 2022. The company's guidance for the delivery of 3400 to 3700 railcars and total revenues of $400 to $430 million for the full year 2023 remains unchanged. On the contrary, the company revised its full year EBITDA guidance upwards, from $15-$20 million to $18-$22 million.

Data by YCharts

Except for the sequential growth in earnings and revenues, it is worth taking a look at the historical fluctuations of these two metrics. As we can see in the graph listed above, revenues have followed a clearly defined uptrend during the past three years, having reached at higher levels than 2019.

From an earnings per share standpoint, we can see the tremendous work that has been done in this company. Just 4 quarters ago, FreightCar America was posting losses in the ballpark of $0.20 per share. And here we are today, having seen the light of day for the first time in many years.

Freightcar America EPS figures (Seeking Alpha Premium)

Improving margins pave the way to profitability

It was several years ago when the company decided to transfer all of their U.S. based production to their Castanos facility in Mexico. The company has currently three production lines operating in this facility, with a fourth one nearing completion in the next few months. With the Castanos facility firing in all cylinders, the company will have a production capacity of 4k to 5k rail cars per year.

The Castanos facility (Freightcar America website)

But what would the value of such volumes be, if it weren't for the improving margins? For the second quarter of 2023, the company reported a gross margin figure of 14.6%, up by 56% from the previous year. I expect gross margins to continue to improve, as the company focuses exclusively on manufacturing, ditching the tighter leasing business.

Business model revisited

The company is transforming itself into a pure play rail car manufacturer, giving away its leased car segment. This is important for several reasons. Firstly, rail car lessors are transformed from competitors to customers. By cutting their leased cars segment, the company is focused in increasing the efficiency of their production while at the same time making deals with companies which otherwise would be their competitors.

And this may prove to be a very smart move, considering the prospects of rail car leasing in the next years. Indeed, the rail car leasing industry is expected to grow at a CAGR of 9% until 2031, or at a slower rate according to this report. In addition, FreightCar America is shielded against market downturns, with the added flexibility of the multi-line Castanos facility and the transformation of their business model I wrote about in the previous paragraph.

Debt and Warrants

In a continuous effort to remain afloat during the harder previous years, the company issued warrants on 31% of their total common shares outstanding. These are options given to the debt holders, that can be exercised upon the presence of certain conditions. According to the company's latest 10-Q, the total liability of their issued warrants is $41 million.

Moreover, during Q2 2023, the company issued preferred stock, in order to extinguish their growing and expensive debt. Keep in mind that the company was paying $5.8 million per year in interest, which is more than 10% of their total market cap.This development resulted in the company recording a loss on debt extinguishment of $17.9 million for the previous quarter from the termination of the M&T Credit Agreement and Forbearance Agreement.

This is a strategic and very important step towards corporate growth, as the company is becoming essentially debt free. Of course, they will have to deal with the warrants provided down the road, but at this point, this is a deal that I think is of utmost importance.

However, there's a catch, If we look at the deal, we can see that dividends will continue to stack up to the preferred shares at a rate of 17.5% per year. Given that we're talking about cumulative preferred shares, we realize that they will suck most of the profits in the following years. What is more important, however, is the provision that states that if the company doesn't redeem these shares until 2027, the coupon rate will increase by 0.5% for each financial quarter thereon. In addition, the preferred stock owner has the right to demand the redeeming of the shares at any time after 2029.

Final remarks

When I wrote my previous article about FreightCar America, I reckoned that the company was in dire straits, and I was confirmed. To be honest, I didn't expect the company to take such decisive steps towards what I think is the right direction. The company reported some quite strong results for the quarter, and it seems that the steering away from the leased cars segment is a right and resilient choice. However, recovery will not be linear. The company recorded $8.5 million of revenues from the sale of the largest part (424 railcars) of their leased car fleet. This is a one-off item and accounts for 10% of the total revenues reported for Q2 2023. On the other hand, loss on debt extinguishment is also a one-off item. The debt deal and the issuance of the preferred stock bought the company time, kicking the can of liquidity down the road. If it will work out, remains to be seen.

From a comparative analysis perspective, there's only one reason to stick to the company, rather than one of its peers: Speculation. Of course, in the following table we can see companies with market caps of several billions. Speculators would expect a small cap company like FreightCar America to grow its revenues at a much faster pace that its larger peers. And we can see that the three year revenue CAGR is much higher than that of RAIL's peers. The company also expects revenues to grow faster than its competitors in the next twelve months.

Freightcar America and competitors revenues (Seeking Alpha Premium)

So, all in all, I am slightly optimistic, but not so much to initiate a long position at this time. In my opinion, we investors should wait a couple of quarters in order to see if this turnaround is sustainable. Not to add the risk of dilution, which is normally the case with small caps. We can see below that they have been seriously diluting their shareholders in the past few years.

Data by YCharts

So until then, I believe that remaining on the sidelines is the right thing to do, for investors that currently don't have a share position. For FreightCar America stockholders, I believe that Holding on their position is the best option.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

This article was written for information purposes only. You should not, in any case, take the contents of this article to be an urge to buy, hold or sell securities. Always perform your own research before investing in the stock market.

Comments

[preterist]

Is the PFD publicaly traded? If so, what's the symbol?

[GM77]

The warrant holder is one of their largest shareholders. I was told 2 weeks ago by RAIL’s IR team. So, large shareholder has warrants, the other has the preferred stock. It’s in their best interest to not do major dilution and because they are keeping financing close to the chest, I think they see production growing another $100M revenues by end of 2023 and I also agree they have a 5th production line they ‘could’ look into making. I’d say give it through 2024 because YOY numbers will beat and new COO will keep operating margins in the double digits. I own 30k shares at $2.73. Plan to buy another 40-50k shares if we stay in the $2’s. I see this as growth story and or acquisition target. This is double digit stock and even with warrants it’s nearly a micro cap. Up up and away we will go!

[Joelg5]

@GM77 Thank you for sharing! Any idea the exercise price and how many warrants this large shareholder controls? I have a pretty good long position myself averaging somewhere in the 2s, and earned some good money selling freight-car loads of covered calls when stock was closer to 5. I like your plan. Your eventual problem with adding a train-car load of new shares will be avoiding the NIIT on all those cap gains when stock awakens from its slumber! At one time in previous decade when RAIL stock was flying high and in double digits, pension funds owned the stock and it might have even been paying dividends (before my time). I caught stock on way down, liked it in 4-7 range, and then loaded up when it dropped into 1s. Sold a few shares ~5.

[rjm22]

@Joelg5
When I bought this stock on 8-15-19 they had a book value of $8-9 I think.
Then they pissed away all their equity and gave away huge amounts of warrants.

I lucked the heck out to be able to sell at $6.09 avg for a 52% gain. (March 2021)

Now, book value is Negative $2.73 per share per yahoo with massive amounts of penny warrants.

And often yahoo does not take into account the preferred stock with a liquidation value of $87+ million.

So that could add another $4.86 to their book value per common share making it a negative $7.59 per share.

If they were to start earning 50 cents a share it would take 15+ years to get rid of their negative book value.

Seems like a slam dunk to me.

I am torn as to if I should go all in on the stock or send care packages to their officers.
$1.19 for the CEO
$548K for the Chief Commerical Officer
$463k for the CFO
(per yahoo)
And they now have a chief operating officer with a $450k base salary.

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In connection with the Credit Agreement, the Company issued to an affiliate of the Lender (the “Warrantholder”) a warrant (the “2020 Warrant”), pursuant to that certain warrant acquisition agreement, dated as of October 13, 2020, by and between the Company and the Lender, to purchase a number of shares of Common Stock equal to 23% of the outstanding Common Stock on a fully-diluted basis at the time the 2020 Warrant is exercised (after giving effect to such issuance). The 2020 Warrant was issued on November 24, 2020 and is exercisable for a term of ten (10) years from the date of the issuance of the 2020 Warrant. As of June 30, 2023 and December 31, 2022, the 2020 Warrant was exercisable for an aggregate of 8,711,224 and 6,799,139 shares, respectively, of Common Stock with a per share exercise price of $0.01.

---
Pursuant to the Fourth Amendment and a warrant acquisition agreement, dated as of December 30, 2021, the Company issued to the Lender a warrant (the “2021 Warrant”) to purchase a number of shares of Common Stock equal to 5% of the outstanding Common Stock on a fully-diluted basis at the time the 2021 Warrant is exercised. The 2021 Warrant has an exercise price of $0.01 and a term of ten years. As of June 30, 2023 and December 31, 2022, the 2021 Warrant was exercisable for an aggregate of 1,893,744 and 1,473,726 shares of Common Stock, respectively with a per share exercise price of $0.01.

[Joelg5]

@rjm22 Congrats. You indeed made a timely exit. At Friday's $2.75 closing, I feel lucky to be holding a 13% gain, though if I added in gains from option sales it would be over a 50% gain. Neither my best nor worst stock. There is dilution ahead, but that is not fatal. Given the debt is now suddenly down to zero, the book value number will be looking much better. Which of course is a bit of a mirage or accounting slight of hand, with the debt now preferred stock paying 17.5% interest. That 17.5% rate is what AMRS is paying for debtor in possession (DIP) financing for 3 months. RAIL doing 17.5% for too many years is indeed a cause of concern.

RAIL received $85 million for the new non-convertible preferred stock ($1,000 per share), which reduced long-term debt to zero and "will be used to support further expansion of the Castaños footprint and new growth initiatives," says the Company press release (03-27-23)."As a result of the refinancing, the Company expects approximately $10 million of improvement in annual operating cash flows due to savings on its asset-based lending (ABL) facility and deferred cash dividends." The money invested in the Castaños facility should make the book value higher.

Vickers shows insiders, including CEO Jim Meyers, as buyers of the stock in May at $2.78-3.00 per share. And Pacific Investment Management Co. has been consistently adding shares. And in the 03-27-23 press release on the preferred stock, the Company claims significant financial benefits from the deferred interest scheme:

"Mike Riordan, Chief Financial Officer of FreightCar America, commented, “Given the significant progress and momentum of our business, we’ve taken an important first step in the reshaping of our capital structure through today’s transaction. This transaction significantly improves our balance sheet, lowers our interest costs and generates additional operating cash flow, allowing us to continue to invest in the business. Demand for our railcars is strong and this transaction supports the next increment of our planned growth.”"

[Joelg5]

Good article. Agree with author's wait-and-see sentiment, and am holding my RAIL shares. RAIL has indeed come a long way on the path towards good financial health. With rail-car derailments and destruction almost epidemic in the USA, the need for rail-car replacements should remain strong. The move to Mexico, with its skilled rail-car labor force (workers who were laid off by rail-car competitors), is finally paying off. I believe RAIL still has one more production line ready to come online. Hence, they have room to boost production 25%.

Disagree with author about exercising of warrants and the resulting dilution being a negative for stockholders. Warrants exercising could be very bullish, and propel the stock price upwards - presuming that the money from warrants exercising is sufficient to retire the preferred stock and eliminate the cumulative 17.5% payments. In that event, RAIL would be profitable and in excellent financial shape.

[rjm22]

@Joelg5 I thought the warrants had a 1 cent exercise price?

[Joelg5]

@rjm22 That would be a very unusual and very strange warrant. I know they gave away a huge percentage of the company as free stock in exchange for a loan that had to be paid back.

@True Orion What's the story on the warrants: When issued? How many outstanding? How much dilution? Exercise price? Where do we find this info?

[Joelg5]

@rjm22 In 2020 there was a loan contingent on a stockholder vote to give 20% of the company (via a warrant for new stock, 1 cent par value). Stockholders approved. RAIL got the loan. Lender got the stock for free (1 cent would have been an over-payment).

I assume the author, True Orlon, is referring to something else. But maybe not?

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[Higas34]

Arff arff give a dog a bone