|Shares Out. (in M):||12||P/E||0.0x||0.0x|
|Market Cap (in $M):||308||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||-192||EBIT||0||0|
FreightCar America (RAIL) is the dominant coal car OEM in North America, typically garnering at least 2/3rds market share. Without question, the coal car cycle remains depressed, and investor sentiment with regard to anything coal related is certainly out of favor. Nevertheless, with coal carloadings trending above year ago levels and coal cars in storage trending lower, there are signs of light (however faint they may be), and I believe a patient investor can enter a position at the last sale with an attractive risk/reward profile given the company’s fortress balance sheet. Based on a conservative view of the coal car cycle, I believe RAIL will trade towards $40/share, about 50% above the last sale price, within the next 12-18 months. Additionally, given the incredibly over-capitalized nature of its balance sheet, I don’t think it’s out of the realm of possibility that RAIL could attract a strategic investor focused on improving capital allocation.
12-18 month target of $40/share or about 50% upside valuing RAIL on a mid-cycle basis - (~6.5x 2016 EV/EBITDA, a multiple in-line with the average EV/EBITDA mult the stock has traded at over the last seven years).
Lead coal car indicators are generally demonstrating improvement so far this year. Most notably:
- On a year-on-year basis, weekly US coal carloads increased for six straight weeks (week ending April 19), which is the first time that has happened since at least the start of 2012. YTD, coal carloadings are now running 0.8% above year ago levels.
- Coal cars in storage have come down to 16,500 units at 12/31/13, according to RAIL management. This is down from 21,000 units at 9/30/13, and the lowest level since early 2012.
I believe it’s fair to value RAIL on a mid-cycle basis. My 12-18 month price target of $40/share is predicated upon a view of 2016 as a mid-cycle year:
- RAIL has guided to 7,000 deliveries in 2014, and given a backlog of around 6,800 units this guidance seems quite reasonable. I expect continued improvement in 2015 and 2016 driven by both: a) replacement orders from Eastern US railroad, and b) modest growth in non-coal car deliveries by RAIL.
- Assuming stable pricing, I believe RAIL can earn about ~$40-45mm in EBITDA in 2016.
What’s notable is that RAIL has a huge net cash position on its balance sheet that represents close to 60% of its market cap - at 12/31/13, the company had $192mm of net cash and equivalents. That cash balance is inflated as it includes a large customer advance, though, nevertheless, it still represents a very large portion of the enterprise value. With >$100mm of cash just sitting on their balance sheet and no material and active share buyback plan, I believe the company screens as a candidate for a strategic investor looking to improve capital allocation.
II. COMPANY SUMMARY
Formerly known as Johnstown America, RAIL has been manufacturing railcars since 1901, and today is the preeminent manufacturer of coal cars in North America. RAIL’s railcar manufacturing facilities are located in Danville, Illinois, Roanoke, Virginia, and Shoals in Alabama (this is a facility that is leased from Navistar). All facilities have the capability to manufacture a variety of types of railcars, including aluminum-bodied and steel-bodied railcars. In May 2008, RAIL closed their manufacturing facility located in Johnstown, Pennsylvania. In addition, through their acquisition of the business assets of DTE Rail Services, Inc., they have repair and maintenance and inspection facilities in Clinton, Indiana, Grand Island, Nebraska and Hastings, Nebraska.
The North American coal car fleet, in particular, will see above normal replacement demand over the next several years as the railroads look to retire a fleet of steel coal cars (representing ~30% of the fleet) and replace them with more efficient aluminum models – see table below for a age profile of the current coal car fleet. Additionally, managment has indicated current coal cars continue to decline, which is a positive lead indicator in my opinion. Coal cars in storage of 16,500 units at 12/31/13 – this is down from 21,000 units at 9/30/13, and the lowest level since early 2012. RAIL, without question, is going to be the prime beneficiary of these short and medium term trends – it’s really only a question of when in my opinion.
B. SEGMENT OVERVIEW
The Company reports under two segments:
1) Manufacturing – is comprised of RAIL’s railcar OEM operations. This segment comprises >90% of the company’s revenues. RAIL has two main manufacturing facilities - Roanoke, VA and Danville, IL – each have capacity to produce up to 7,500 railcars per year. Additionally, RAIL has recently started manufacturing at a new facility – Shoals in AL – that will be used to build a wide variety of rail cars.
2) Services – is comprised of RAIL’s general railcar repair and maintenance, inspections, parts sales and railcar fleet management services. This segment was formed by RAIL’s acquisition DTE Rail Services in November 2010. This business is much more stable than the Manufacturing business, and generally enjoys higher margins as well (mid-teens EBIT margins generally).
C. CAPITAL INTENSITY
Railcar manufacturing, like any OEM type of business, is of relatively high upfront capital intensity. Furthermore, coupled with the boom-bust nature of railcar cycles, high upfront capital costs provide a significant barrier to entry for new entrants. RAIL has guided to $10mm of capex in 2014, which includes about $7mm related to the ramp up of their Shoals facility.
D. COST STRUCTURE
Given the high degree build-rates fluctuate throughout the cycle, the cost structure for a railcar manufacturer is not highly fixed cost in nature in the medium term – based on several conversations I estimate the breakdown is 20-25% fixed, and 75-80% variable.
The cost of raw materials and components represents a substantial majority of RAIL’s manufacturing costs. In particular, Aluminum prices (and most of the time steel prices) are fixed at the time a railcar order is accepted, mitigating the effect of future fluctuations in prices.
Roughly, the cost structure typically breaks down as follows (though obviously subject to change based on build-rates and raw materials costs): 60% materials (including aluminum, steel, and componentry), 20% labor, 20% other (consisting mainly of energy and depreciation as I understand it).
E. BARRIERS TO ENTRY
The barriers to entry for RAIL are:
- Technological expertise – RAIL is the leader in developing aluminum bodied coal cars.
- Relationships with its customers – RAIL accounts for ~2/3rds of the coal car market, so anyone who needs a coal car has an existing relationship with RAIL.
- High upfront capital costs.
III. INDUSTRY SUMMARY
A. COMPETITIVE STRUCTURE
The domestic coal car market is dominated by two players – RAIL and Trinity Industries (TRN). In a typical mid-cycle year, RAIL will account for 60%-70% of market share, and TRN will account for the bulk of the balance. There are a couple of other competitors in coal car OEM market, however, they remain small. Industry wide, there are six freight car manufacturers in North America today, down from 24 in 1980.
RAIL’s primary customers are railroads, shippers and financial institutions, which represents about 63%, 24% and 3%, respectively, of their total sales (for the year ended December 31, 2010). It’s safe to say, however, that given the lumpy nature of railcar orders, those customer concentration metrics can vary significantly from year to year.
C. NEW OPPORTUNITIES
There are a couple notable avenues of growth for RAIL:
- Services and Parts – RAIL is committed to expanding this business given its $23mm acquisition of DTE at the end of 2010.
- Railcars ex. coal cars – RAIL is expanding their presence in intermodal cars, flat cars, covered hoppers, and aggregate cars. The company is gaining traction in this area.
The main risks to RAIL include:
- During the Q4 conf call in February, management flagged weather as being challenging early in 2014, so I suspect Q1 results won’t be great.
- Railroad profitability deteriorates thereby causing capital spending plans to be scrapped.
- Unexpected competitive pressures that could potentially impact pricing, and ultimately RAIL’s operating margins.
- Lumpiness in railcar orders – the absolute timing of orders is inherently lumpy and tough to predict.
- Relatively illiquid stock – a large investor dumping stock would put significant short term pressure on the price.