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Berkshire Hathaway’s (NYSE: BRK-B) Chairman Warren Buffett made a big bet on the rail business in 2010 with his acquisition of Burlington Northern, a major part of America’s railroad infrastructure.  The company also competes in the rail services business through its ownership of Union Tank Car, the Chicago-based manufacturer of railcars and related components.  Those investments have continued to pay dividends in 2012, as rising auto shipments led to a 3% gain in volumes for Burlington Northern.  In the first nine months of FY 2012, Berkshire’s railroad segment reported increases in revenues and operating income of 7.9% and 18.3%, respectively, versus the prior year period.  The unit’s diverse customer base has allowed it to outperform its major railroad competitors, who have generally reported flat volume gains for the year.

Similarly, Carl Icahn has been a long-term investor in the rail business through his majority stake in American Railcar Industries (NASDAQ: ARII), a major designer and manufacturer of railcars.  The company’s manufacturing business has been generating significant sales growth since reaching a bottom in 2010, as railroads upgrade their fleets in order to gain efficiencies and meet the federal government’s increasingly stringent regulations.  In the first nine months of FY2012, American Railcar reported increases in revenues and operating income of 56.3% and 338.3%, respectively, compared to the prior year period.  The steep increase in operating margins was primarily the result of a more efficient use of its production facilities, as well a strong pricing environment for railcars.

While American Railcar maintained a conservative balance sheet during the financial crisis, it switched to a growth orientation in 2011 with the creation of a leasing business.  As of Sept. 30, the segment had 2,190 railcars that produced over $4 million in operating profit for the company during the period.  Despite heavy competition from other manufacturers and financial institutions, leasing is a high-margin business and is a natural progression of American Railcar’s manufacturing capabilities.

The company is also on the hunt for acquisitions, with a December offer to purchase competitor Greenbrier (NYSE: GBX) for $22 per share or roughly $600 million.  The offer is a reincarnation of a 2008 proposal by Icahn to merge two of the leading railcar manufacturers.  While Greenbrier’s management rejected the latest proposal, as it has done with prior proposals, it was open to additional dialogue about a future combination of the two companies.

What’s the Value?

Founded in 1974, Greenbrier is a leading manufacturer of railcars and ocean-going vessels through manufacturing facilities located in the U.S., Mexico, and Poland.  It also has one of the largest services networks in North America, with 12 wheel shops and 27 repair locations.  Despite a revenue base that is three times larger than American Railcar’s, Greenbrier is valued at a lower market capitalization due to its higher debt levels and lower profit margins.  The combination of high leverage and operating losses during the financial crisis led to a liquidity crisis for the company, culminating in a capital infusion from investment firm WL Ross in June 2009.

Greenbrier has been performing much better lately, in line with the rebound in orders from the North American rail industry.  In its latest fiscal year, the company reported revenues and operating income of $1.8 billion and $118.8 million, increases of 45.4% and 75.8%, respectively, versus the prior year.  Greenbrier’s growth was paced by a 59.6% rise in unit deliveries, as well as favorable pricing due to high levels of customer demand.  The high profit levels have also resulted in substantial cash flows, with $116.0 million generated during the period, which has allowed the company to continue adding to its industry-leading fleet management business.  Greenbrier is also expecting future growth with the recent announcement of 4,200 new railcar orders since the beginning of September.

Looking Ahead

Investors aren’t expecting too much from Greenbrier at the moment, valuing the company a 7 P/E multiple based on recent prices.  While Greenbrier rejected American Railcar’s latest offer, a future combination is a likely bet, as the combined operation would be better able to compete against Berkshire Hathway and industry leader Trinity Industries.  In the meantime, investors should consider adding American Railcar to their portfolios, due to its higher profit margins, better financial profile, and the potential for a reverse offer by Greenbrier.  With heavyweight advisors Goldman Sachs and Skadden, Arps in their corner, you never know.

rghanley owns shares of Berkshire Hathaway and American Railcar Industries. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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