A SWOT Analysis of American Railcar and FreightCar America
Rupert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
A key part of the economic recovery is infrastructure growth and a good way to play this trend lies in the railroad stocks.
However, I am less interested in the traditional railroad companies such as Union Pacific (NYSE: UNP) and CSX but the rail car manufacturers, in particular, American Railcar Industries (NASDAQ: ARII) and FreightCar America (NASDAQ: RAIL).
Both companies have their strengths and weaknesses and the best way to set these out is by analyzing the Strengths, Weaknesses, Opportunities and Threats (SWOT) the two companies face. Welcome to their SWOT analysis.
FreightCa has a strong balance sheet with cash accounting for $9.64 per share, slightly over half of the company's current share price. The company has also been in operation for 100 years, so I don’t doubt the company's experience and ability to outlast any recessionary influences in the industry.
American Railcardoesn't have such a strong balance sheet and the company has some debt (40% debt/equity ratio). That said, American Railcar's leasing division now accounts for 40% of the company's revenue and produces a 15% return on equity per year - more than FreightCar's return on equity. Indeed, Railcar is rapidly growing its lucrative leasing fleet, with each rental typically of 5-7 years delivering cash flow for years to come. The company has an overall gross margin of +20% and a strong order backlog of 6500 railcars. Unlike FreightCar, Railcar has exposure to the oil industry as the company manufactures oil tankers.
FreightCar's main weaknesses are the company's exposure to the rapidly declining coal industry and lack of exposure to the oil tanker industry - the company offers no oil tankers for sale on its website. Additionally, FreightCar has high fixed costs and gross margin stands at 6%. Moreover, the company's order backlog is less than 2000.
Railcar's biggest weakness is it cash burn, however, this is actually a reflection of the company's investment in its rental fleet. This investment is not recognised immediately in revenues but this provides a good long term cash flow - as I have mentioned above.
FreightCar's biggest opportunity lies in expansion into the oil tanker market, although this option is not currently on the table. The company is also set to benefit from a slight return to coal as a cheap power source in the US after declining use of the fossil fuel throughout 2012.
Opportunity also lies in FreightCar's solid cash balance and recent expansion of manufacturing facilities, but first the company needs to win orders.
Railcar on the other hand has a wealth of opportunities available to it. In particular, the industry order backlog for rail cars was 71,700 at the end of March 31, and 91% of this was for tanker and hopper cars where Railcar is a specialist. There could also be a requirement to improve safety and order new cars following the Canadian derailment, which would mean a flood of orders for the company.
FreightCar is threatened by a continuation of the deterioration in the coal market, which would further depress order volumes and the company's backlog. The company is also faced with competition from larger more efficient peers such as Railcar and shirking profit margins on its cars.
Railcar's threats include activist investor Carl Icahn, who holds a large stake in the company, rising costs and falling profit margins and the threat of rising oil prices and additional pipeline capacity, which could dent demand for oil transportation by rail.
Looking for diversification
Of course if you are looking for a well-diversified play on the economic railroad recovery, then Union Pacific could be your best bet. The company recently released its best ever quarterly results, boosted by the oil boom and economic growth in general. Furthermore, unlike peers CSX and Norfolk Southern, Union Pacific is not overly weighted to coal transportation, which has seen a rapid decline in recent years thanks to the domestic oil boom. While I have mentioned above that this decline could be bottoming out, I would not go so far as to say coal use will undergo a serious, sustainable recovery until oil & gas is exhausted.
At the end of 2012 only 20% of Union Pacific's revenue came from the transportation of coal. Automotive uses accounted for 9%, agricultural accounted for 17% and industrial products accounted for 18%. Intermodal and chemicals transportation accounted for the last 36%.
So, Union Pacific is a well diversified play on the general US recovery. In addition, the company's stock price has more than doubled since the lows in 2009 and with a current return-on-equity of 21% and a return-on-investment of 15% the company is well placed for growth and the creation of shareholder value well into the future.
Overall, it would appear that American Railcar is well placed to ride the economic recover here in the US thanks to its exposure to the oil and gas industry, growing rental fleet, strong return-on-equity and wide profit margins.
Despite its strong balance sheet, FreightCar is just to exposed to the coal industry and margins are shrinking so it could be a company to avoid for now.
Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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!