August 08, 2013 - 1:29am EST by
2013 2014
Price: 39.84 EPS $4.10 $4.20
Shares Out. (in M): 77 P/E 9.7x 9.5x
Market Cap (in $M): 3,000 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 705 750
TEV ($): 3,000 TEV/EBIT 4.3x 4.0x

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  • Railroad
  • Equipment Rental


Trinity Industries (TRN) - LONG.  
That is not a typo.  I find myself a little surprised to have come to this view, and I am sure many members of VIC would be too.  However, recent moves to monetize the leasing business have changed the profile of Trinity and a fresh analysis of the business suggests substantial upside, limited downside, and many possible ways to win.
I believe TRN has easily 50%+ upside and it is difficult to create a valuation scenario with more than 10-15% downside.
Trinity background
Trinity is a combination of a diversified manufacturing business and a captive leasing company.  As most people know, a large percentage of the manufacturing and all of the leasing business are focused on railcars.  The railcar manufacturing and leasing are for a wide variety of railcar types, though much of the manufacturing in the last several years has been focused on tank railcars.  Trinity also has significant business in manufacturing barges, wind towers and energy storage containers, construction and highway equipment.  Each of the various businesses is cyclical, but the businesses cycles tend to be fairly independent and uncorrelated.
On the leasing side, Trinity has operated a wholly-owned fleet (TILC) and a majority-owned fleet (TRIP).  The leasing business has historically been controversial since it has been viewed as an artificial driver of demand and profit for the rail manufacturing business.   
What changed recently
Trinity announced a transaction with Napier Park in May.  Napier Park is a $7b multi-strategy asset management firm that spun out from Citigroup.  Napier and a co-investor made investments into two separate leasing entities controlled by Trinity.  This was the first time that Trinity monetized its leasing business, and the valuations implied by these deals for the first time validate meaningful real value in the leasing entities.
In the first transaction, investors recapitalized TRIP.  The new investors purchased some of the Trinity equity, all of the remaining non-Trinity legacy equity, and paid down the $170m notes TRIP had outstanding ($110m of which was lent by Trinity).  The end result was that new investors owned 55% of TRIP, Trinity's stake dropped from 73% to 45%, and TRIP's debt declined by $170m.
In the second transaction, the same investors created a new SPV called RIV 2013 to buy leasing assets from TILC.  The new outside investors own 69% of the economics in RIV 2013 and Trinity owns the remaining 31%.  RIV 2013 has commitments to buy $1,000m of railcar assets from TILC (the wholly-owned Trinity leasing business) over a couple year period, and bought $450m of assets as part of the initial formation of RIV 2013.
Trinity still manages the lease fleets for both TRIP and RIV 2013 on behalf of the investors in the new entities.  It still fully consolidates both TRIP and RIV, even though Trinity owns less than 50% of the economic interest in each.
As a result of the transactions, Trinity immediately generated $175m of cash.  Trinity will generate another $500m+ of cash from the eventual full funding of RIV.  On its recent Q2 earnings call, Trinity indicated that it had completed the second securitization for RIV 2013, which was much sooner than the 18 month timeline outlined in May.
Why are the Napier Park transactions transformational?
The transactions were transformational for a few reasons.  
First, they established for the first time legitimate third-party valuations for the Trinity leasing businesses.  In the past, there have been lots of questions about what value the leasing businesses should have.
The valuation for both TRIP and RIV indicate that the book value of Trinity's leasing fleet understates the actual market value.  In the case of TRIP, investors bought 55% ownership with $200m of equity, which implies a $364m equity value.  $170m was used to pay down TRIP debt, which increased market value equity in TRIP to $534m ($364m + $170m).  Trinity owns 45% of this equity which is worth $240m.  The carrying value in TRIP is $162m on the balance sheet which implies a 50% market premium to carrying value.  An alternate calculation shows that Trinity got ~1x BV + deferred profit for TRIP.  TRIP had $180m of deferred profit as of Q1 (no disclosure was provided for Q2 as reporting detail changed), but as Trinity owns 45% of the remaining equity, it had $80m of deferred profit in TRIP, for a total equity in TRIP of $242m ($162m carrying value + $80m of ownership in deferred profit).  The implied equity stake in TRIP ($240m) is equal to the carrying value + deferred book value ($242).
In the case of RIV, investors valued the assets at 1.9x carrying value.  Carrying value was $22m at Q2.  Investors paid $94.6m for 69% ownership in the first RIV transaction, valuing this equity at $137m total.  This valued Trinity's stake in RIV 2013 at $43m or 1.9x the carrying value.  The 1.9x book represents recovery of deferred profit of approximately 10% of assets (close to historical range) plus a mark to market increase in rail assets of 7% (RIV bought $455m of assets that had book asset value of $425m).  The 7% asset premium implies 25% premium to equity book value since the assets were financed with 73% debt/capital (3.7x leverage).
The transactions were also transformational since they clearly showed Trinity's intent to monetize its leasing business.  Prior to this, Trinity built the leasing business almost exclusively on balance sheet (except for the one-off TRIP structure).  This required significant capital.  The transactions marked the first time Trinity began to monetize these assets in bulk.  Also, on the announcement and in subsequent statements, Trinity has said repeatedly that it intends to replicate the RIV structure to further monetize its leasing business.  
The monetizations are clearly value creating  
First, they are at material premium to carrying value or stated book (1.9x as shown above), by generating cash for the deferred profit in the leasing fleet and monetizing asset appreciation.  
The transactions also transition Trinity into a capital light business model with fantastic returns.  Assuming 70-75% debt/equity financing and TILC maintaining a 31% equity stake, Trinity needs only $8-10m of equity for every $100m of railcar assets purchased through one of its leasing entities.  Assuming 10% margin in railcar manufacturing, Trinity generates $10m of pretax profit on this $100m lease order. So a $10m investment by Trinity generates an immediate $10m profit (i.e., immediate return of capital) and a 31% stake in a lease entity with immediate value of $8-10m.  Not bad.
The monetizations are also converting earnings to cash at >30x EPS (vs the stock trading <10x).  At the end of Q2, TILC had $1,124m of book value of equity and deferred profit on wholly owned fleets.  Partially owned fleets had book value of equity and deferred profit of $490m for consolidated lease equity and deferred profit of approximately $1,600m.  Guidance for the full year has lease EBIT of $270m which included $12m of EBIT on gain on railcar sales, for full year normalized core EBIT of about $260m in leasing.  Rail interest expense is about $185m annually, which gets to $75m of pre-tax profit and $50m of net income on the wholly owned plus partially owned fleets before subtracting the minority interest.  So if Trinity can sell lease assets at effective book value (stated book adding back deferred profit), it is getting 32x EPS ($1,600m/$50m).  As demonstrated above, Trinity is in fact realizing a premium to the book value plus deferred profit.  Selling assets at >30x EPS when the company trades at <10x generates value.
This is unlevered?  What about all that debt on the balance sheet...
Before valuing Trinity, the capital structure needs to be analyzed.  A simple screen or cursory look at financials is very misleading as it appears Trinity carries almost $2,500m of net debt.  The manufacturing business and holdco have $446m of cash and $450m of debt, or effectively no net debt as of the end of Q2.  The lease entities have $229m of cash, $44m of recourse debt, and $2,470m of non-recourse debt.  So Trinity in reality is a combination of an un-levered manufacturing business and a non-recourse financed leasing company.  
Paying only 1x EBITDA for railcar manufacturing?
The leasing business is worth ~$18-22/share.  An exact estimate is hard to quantify, but as of end of Q2, the lease business had $1,124m of wholly owned book value plus deferred profit, which is $14.60/share.  The value of the Trinity's first RIV investment is $45m and the TRIP stake is worth $240m as calculated above.  So the partially owned stakes are worth $3.70/share.  Combined these get to $18.30/share.  However, as shown above, book value plus deferred understates the value of the assets, so applying a 20-25% premium to only the wholly owned fleet adds another $3-3.50/share.  So a range of $18-22/share seems reasonable for the leasing assets.
This means that the manufacturing business is valued at approximately $1,500m (77m shares * $20/share (current $40/share stock price less $20/share for lease)).  For 2013, Trinity has guided EBIT of $400-$470m, so the manufacturing business is being valued at ~3.5x EBIT.  On an EBITDA basis, this translates to $470-545m of EBITDA, or about 3x EBITDA.  This appears fairly attractive, especially when considering rail manufacturing has 2 years of backlog.
But railcar manufacturing is very cyclical and is generating near peak profitability (at least for the next couple years).  Looking only at the non-rail manufacturing businesses removes some of the heavy cyclicality.  The non-rail manufacturing businesses generate $150-170m of EBITDA in 2013 based on guidance.  This number should increase next year as barge and energy businesses grow, and even historically, these businesses generated close to $200m of EBITDA consistently over the last 5 years.  Apply 7x EBITDA, 10x EBITDA-capex, and 13-14x EPS to these businesses gets approximately $15/share of value.  
Thus there is approximately $5/share of implied value left in railcar manufacturing ($40/share less $20/share for lease less $15/share for non-rail manufacturing).  This suggests ~$385m of value for the rail manufacturing business.  For 2013, Trinity has guided to $300-360m of EBIT in rail manufacturing after eliminations for profits to lease fleet, which equates to EBITDA of $320-$380m.  This business has 2 years of remaining backlog assuming no more railcar orders and the company has suggested profitability should continue to increase in this business into 2014.  On a normalized basis, the railcar business generates approximately $150m of EBITDA.  While it is hard to pinpoint an exact fair multiple for the rail manufacturing business, 1x current EBITDA, 0.5x cumulative EBITDA in backlog, and 2.5x normalized EBITDA seem extremely low.  Fair value for this asset appears to be closer to 7x normalized EBITDA, 10x normalized EBITDA-capex, which equates to $13-15/share, and the business should generate an additional $200m more than normal EBITDA in each of the next 2 years, which is another $3-4/share of cash generated after tax.
Adding these pieces up, Trinity safely has $50+/share of value.  But this assumes no use of capital from the monetization of the leasing business.  Trinity purchased $50m of stock in Q2, the first time it bought back stock in a meaningful way.  The company has also indicated an interest in acquiring more adjacent businesses with proceeds from monetization.  Management views the company as an energy renaissance play, and is seeking to grow in bulk energy storage and other metal bending type businesses that would fit well with existing manufacturing capabilities.  RIV 2013 is expected to generate approximately $500m of additional capital for Trinity beyond amounts recognized in Q2.  If Trinity monetizes the remainder of its fleet while maintaining 31% ownership, it can generate at least another $800m.  That is $1,300m of proceeds for buybacks or acquisitions.  This equates to 40% of the current market cap in buyback potential (while still keeping unlevered balance sheet at the manufacturing entity).  Depending on timing and price paid for shares, this would be materially accretive to values highlighted above.  Alternatively, investing some of the proceeds at 10-15% return (seems very conservative) could generate earnings of $1.70-$2.50/share incrementally, while only losing $0.35/share from minority interest (69% minority interest deduction on the $0.50/share of earnings from leasing entities calculated above).  This is a net EPS gain of $1.35-$2.15/share.  At 10x EPS, acquisitions alone could be worth 30-50% of upside for the stock.  Trinity is likely to do some combination of buyback and acquisition, but both are clearly meaningfully additive to value.
Lots of other ways to win
Extension of crude railcar cycle.  The analysis above all supposes crude by rail has peaked and has no upside left.  However, if the cycle is longer than expected, normalized railcar manufacturing EBITDA is higher and embedded value is more. 
Regulation.  There is pending regulation on DOT 111 railcars which are legacy single hull tank cars (kind that caused fire in Quebec crude derailment).  There is a possibility some of these legacy cars will be phased out or require major retrofit, which may extend tank car cycle or create incremental rail refurbishment revenue for Trinity.
Non-crude tank railcar cycle.  Trinity and competitors believe refined product tank car cycle will pick up once crude by rail demand peaks.  This may or may not happen, but again is only upside.
Return of non-tank railcars.  Outside of tank cars, rail manufacturing and leasing business remains near trough levels from 2009.  Any recovery in these markets provides upside.
Barge.  Tank barge cycle appears to be picking up as crude barge demand is now growing.  
Why does this opportunity exist now?
Many investors have a negative bias toward Trinity given history with TRIP and leasing business.  Short interest is 8 days and 15% of float.
Investors are negative about crude by rail cycle, thinking it has peaked or is near peak.
Very little attention has been paid to Napier Park transaction.  Analyst notes were sparse, stock did not react.
Investors have not dug through the financials in detail.  Trinity trades in line with pure manufacturing peers, even though it has considerable leasing assets which should trade at significant premium.
Trinity makes bad acquisition
Operational execution issues
I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.


More monetization of leasing assets
Acquisitions to diversify business and use proceeds from lease sales
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