|Shares Out. (in M):||21||P/E||17.7x||17.3x|
|Market Cap (in M):||1,719||P/FCF||0.0x||0.0x|
|Net Debt (in M):||170||EBIT||163||172|
Investment Thesis – American Railcar common stock is a short because:
¦ American Railcar is massively over-earning due to temporary demand for tank cars to ship crude oil
¦ Shares are expensive on even aggressive estimates of normalized earnings
American Railcar manufactures, leases and services tank and covered hopper railcars. Tank cars are used to haul liquids such as chemicals, ethanol or crude oil over rail lines. Covered hoppers are generally used to transport bulk commodities such as cement, grains or sand. Approximately 80% of sales and 75% operating profit are from sales of rail cars to third parties such as leasing companies, railroads or industrial shippers. The rest of the business relates to leasing and servicing rail cars.
Tank Cars Account for the Vast Majority of Profits
ARII does not disclose the precise breakdown of sales and profits for tank cars vs. hoppers, however making some reasonable assumptions allows us to get close. The company has said that they have capacity to produce 5000 tank cars and are running at capacity. My research indicates that these cars should sell for about $140k and at this price would have about a 26% margin. As shown in figure 1 below, plugging in these estimates to ARII’s reported numbers implies that tank cars account for about 85% of the manufacturing segment’s profit.
Figure 1: Most of ARII’s Profits are From Tank Cars
|LTM deliveries (external & internal)||7,400|
|Manufacturing Revenue (incld intersegment)||944||LTM segment EBIT||222|
|Revenue per car||$ 127,571||Estimated tank car margin||26%|
|Cost of tank car||$ 142,000||Tank car EBIT||184.6|
|Number of tank cars||5,000||Implied hopper margin||16%|
|Tank car revenue||710|
|Hopper car revenue||234||Tank car % of segment EBIT||83%|
|Implied cost of hopper car||$ 97,509|
Crude-by-Rail Has Exploded
Since 2011, tank cars sales have exploded beyond any historical precedent. This is almost entirely the result of demand for cars to ship crude oil from the Bakken shale. In 2008 there were only 9,500 crude rail car loadings in the U.S. By 2013 this number grew to 407,642. Until recently, shipping crude oil via rail was rather uncommon since pipelines are generally the cheapest, safest and most efficient way to transport oil and shipping by rail costs 2-3x more than via pipeline. However, the unexpectedly rapid growth of Bakken oil coupled with a lack of infrastructure has caused production to outstrip available pipeline capacity.
Figure 2: Crude-by-Rail Shipments and Tank Car Backlog
Tank Car Build Level is Unsustainable
Currently there are approximately 55,000 tank cars used for crude oil transportation in North America. However, the current backlog consists of approximately 30,000 crude cars and the industry is manufacturing about 6,000 crude cars ever quarter which is enough to grow the current fleet by almost 50% every year. However, it is nearly impossible to construct a reasonable scenario where crude-by-rail volumes grow at anything close to this rate. As shown in figure 2 above, U.S. crude-by-rail shipments appear to have plateaued after a period of rapid growth. This is because the rise of Bakken production was a one-time event that will never be duplicated. While Canadian volumes should continue to grow, even aggressive estimates for Canadian growth implies only modest industry-wide expansion. Even assuming some demand growth from new chemical plants and other tank car uses, it is very difficult to see how the industry absorbs anything close to the current production rate for an extended period.
In the near-term, demand will also be augmented by new safety standards for crude tank cars. In July, the Department of Transportation released initial proposals for the new standards; however it will be several months before the requirements are finalized. At that point, tank car owners will either have to modify their cars in order to comply with the new standards or scrap the existing cars and purchase new ones. To the extent owners choose to purchase new cars, this will benefit suppliers such as ARII.
Based on the current proposals, it appears that most cars will be retrofitted rather than scrapped. A new tank car will cost $140k+ will take 18mos to be delivered and will last for over 30yrs. The proposed retrofit costs range from $25-$35k and given that most of the cars in service today are less than 10yrs old (built either for the current crude demand or the previous ethanol boom) it would not make sense to buy an entirely new car. The DOT has said it expects the majority of impacted cars to be retrofitted and that “No existing tank cars will be forced into early retirement.” As such, I believe its reasonable to assume that the new safety standards will result in incremental demand for about 10,000 new tank cars.
ARII is Expensive on Normalized Earnings
Once the new safety standards are fully implemented, the crude tank car fleet will only need to grow as fast as shipment volumes. Industry experts I spoke with said that over the next several years, crude-by-rail volumes would likely growth by about 10-15% per year. This implies industry-wide demand of about 8,000 new crude cars annually. As shown in figure 3 below, if ARII’s tank-car volumes decline in-line with the total market and margins return to normal levels, the company would earn normalized EPS of about $3-$4/share.
Figure 3: Estimated Normalized Earnings
|Current annual crude car delivers||24,000||Normalized segment margin (historical avg)||12%|
|Non-crude cars||10,000||Manufacturing EBIT||73|
|Total annual tank car production||34,000||Leasing EBIT(2)||45|
|Assumed normalized crude car delivers||8,000||Corporate||-20|
|Non-crude cars||10,000||Total EBIT||111|
|Normalized industry volume||18,000||- Interest(3)||9|
|- Taxes (32%)||33|
|Tank car revenue if decrease is in-line with industry||376||EPS||$3.24|
|Hopper car revenue||234||P/E||24.8x|
|Total manufacturing revenue(1)||610|
|(1) Assumes no internal sales to owned lease fleet||(2) Assumes $250mm in 2014 capex to bring total lease fleet to 6,250 cars|
|(3) Assumes 3% interest and all remaining 2014 capex is paid from cash on-hand||Annual lease rates of $15k and 50% EBIT margin|
If anything, I think my estimate of normalized earnings is aggressive for the following reasons:
1) First, I’ve assumed ARII sells all production externally. Over the last few years however, the company has used significant production capacity to build its internal lease fleet. Internal sales do not contribute to current year earnings. As such to the extent that ARII continues to build its lease fleet, earnings could be lower.
2) Second, I’ve assumed lease rates do not fall. In reality, lower demand would likely lead to lower lease rates.
3) Finally, this business is highly cyclical with boom periods (like today) inevitably followed by busts. My estimates of normalized demand assume no excess supply is created in the current boom period
The obvious risks here are that tank car demand is simply higher than expected either due to more stringent safety standards being adopted or simply higher than expected crude volume growth. While this is clearly possible, it seems unlikely that this impact would be large enough to really cause the short to lose over the long term. What could meaningfully hurt a short is a spike in tank car demand from an entirely new source, possibly something that is not currently shipped by rail at all. I have no idea what this could be, but almost no one foresaw the past two demand spikes (first from ethanol and now from crude) and a new demand source could lead to a permanent capital impairment.
|Subject||Bberg artilce on tank car demand (abt 3 mos late, but still...)|
|Entry||01/23/2015 08:33 AM|
Rail Tank-Car Orders Threatened by U.S. Crude’s Collapse
Add tank-car makers to the list of U.S. industries bracing for the effects from the plunge in crude prices.
While 2014’s record orders, including an all-time high 42,900 in the third quarter, will drive deliveries this year, according to Susquehanna International Group, manufacturers from Carl Icahn’s American Railcar Industries Inc. (ARII) to Warren Buffett’s Union Tank Car Co. are facing a decline. New bookings in 2015 may plunge 70 percent, Macquarie Capital USA Inc. said, putting earnings at risk when scheduled deliveries drop in 2016.
Oil prices down 49 percent since June have crimped investment in U.S. fields including the Bakken range, where horizontal drilling and hydraulic fracturing is more expensive than conventional oil drilling. That has hurt industries from steel to heavy equipment. It also has slowed the boom in oil-by-rail shipping, which along with new federal safety rules, had fueled the record orders.
“The confidence of the industry has been shaken quite seriously,” Cleo Zagrean, a New York-based analyst for Macquarie Capital said by phone Jan. 15.
Tank-car maker stocks have suffered amid the oil price decline, with shares of Trinity Industries Inc. dropping 40 percent in the fourth quarter, according to data compiled by Bloomberg. American Railcar shares fell 30 percent and Greenbrier Cos. dropped 27 percent.
“It’s having an impact already,” said Art Hatfield, a managing director of equity research at Raymond James & Associates Inc. in Memphis, Tennessee. “I think the forward-looking minds are realizing that we may have hit a cyclical peak within the industry.”
New freight-car orders fell to 37,431 in the fourth quarter, down 13 percent from record highs, according to data from the Railway Supply Institute, reported Thursday. Leasing company GATX Corp. (GMT)’s deal with Trinity added 8,950 new car orders in the fourth quarter. Those cars will be delivered over a four-year period beginning March 2016.
Backlogs swelled to a record 142,837 orders the Washington-based RSI said. These may bolster the industry through 2015.
Throughout last year, buyers piled on requests for cars amid an oil boom in North Dakota and Texas. Freight-car bookings and backlogs swelled to record highs even as West Texas Intermediate crude oil prices fell 14 percent between July and the end of September, according to data compiled by Bloomberg.
Orders for cars that carry cement and frac sand, a resource instrumental in the U.S. shale boom, declined in the fourth quarter from a record, according to Bascome Majors, an Atlanta-based transportation and rail-equipment analyst for Susquehanna International. Falling oil prices might temper future demand for frac-sand cars, he said.
Oil prices tumbled 18 percent in November and 19 percent the next month, ending the year with the steepest monthly loss in six years, data compiled by Bloomberg show.
“The oil price drop is a significant hit” to the tank-car industry, Macquarie’s Zagrean said. As customers re-evaluate the cost of new cars, even extensions on orders can weaken manufacturers’ earnings, she said.
Freight-car producer Greenbrier (GBX) has dodged order cancellations as oil prices fell. Only one customer approached the company about canceling an order but has yet to call the deal off, William Furman, chief executive officer, said in a conference call Jan. 7.
Trinity had not seen any “appreciable impact” on its business from the low oil prices in the third quarter, Stephen Menzies, group president of the company’s rail and railcar leasing group, said in an earnings call October 29. The company stands by those comments, spokesman Jack Todd said in a Jan. 21 e-mail.
Union Tank Car spokesman Bruce Winslow declined to comment on the company’s orders. GATX’s director of investor relations Jennifer Van Aken didn’t return phone calls seeking comment.
In addition to concerns that low oil prices will threaten demand, the industry faces new regulations spurred by accidents including the July 2013 derailment and explosion in Lac-Megantic, Quebec, that killed 47 people.
The U.S. Pipeline and Hazardous Materials Administration plans to issue rules to phase out older rail cars that carry crude in the coming month, Susan Lagana, a PHMSA spokeswoman, wrote in an e-mailed statement Jan. 15. The type of tank car most implicated in spills, known as the DOT-111, would be phased out or rebuilt to meet the new standards within two years for the most volatile crude oil, according to the proposal.
New rules may create “quite a lot of replacement demand,” Greenbrier CEO Furman said in the earnings call. Currently, the Lake Oswego, Oregon-based company’s tank-car orders comprise just slightly more than a quarter of its backlog, according to company spokesman Jack Isselmann.
Owners are expected to scrap more than a fifth of an estimated 117,000 tankers that would require modifications. The work, which may include adding full height steel shields at the ends and adding a metal jacket around the body, is estimated to cost between $27,000 and $46,700 per car, an RSI study said.
BNSF Railway Co., which like Union Tank Car is owned by Buffett’s Berkshire Hathaway Inc., delayed an order of 5,000 new and safer oil-tank cars until the new safety standards are set. The railroad said last year that it would buy the new cars because of safety concerns even though railroads typically don’t own the cars that their locomotives haul on the track.
Many of the orders for safer tank cars might already be included in the backlog as buyers line up in anticipation, Hatfield of Raymond James said.
“This industry has really earned a lot of money in the last few years due to this tank-car boom and when that goes away, it’s going to have an impact on peoples’ businesses,” he said.
|Subject||Re: Re: Re: Re: short still works at $55?|
|Entry||02/18/2015 02:04 PM|
Thanks for the reply - we agree with the leasing risk - looks really like "back door" leverage on an asset whose book value most definitely has declined over the last 6 months based on current lease rates.
The following article notes the decline in tank car lease rates (as well as the cause - low WTI price differential is crushing the arb on the east coast). Thanks again for your thoughts.
|Subject||Re: Re: Re: Re: Re: short still works at $55?|
|Entry||03/23/2015 07:23 PM|
I'd also call out the KSU pre-announcement
|Subject||Any updated thoughts?|
|Entry||12/01/2015 03:45 PM|
Stock back to 2015 highs...
Know company aggresively buying back stock (on limited free float) and that may explain some of the run since Q315 print.
Anything else change in the story over the last few months?