- 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.
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.
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.
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.
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.
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.
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.
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.
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.
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