While the U.S. government ponders whether to finally approve the Keystone pipeline, oil companies and refiners have figured out a way to move their products without the benefit of the less expensive and safer pipeline alternative - by rail.
The result is a huge windfall for the railroads that are moving crude to the Louisiana refineries from the North Dakota Bakken oil fields. The opportunity has mostly been created by an explosion in production from that area, which is not well served by pipelines. This has created a price gap of nearly $20 a barrel (figures in U.S. dollars) between light Louisiana Sweet crude and West Texas Intermediate (WTI) crude, a historically high level. That gap is not likely to diminish for at least another year or two.
Of course, the problem isn't just an American one. Locked-in Alberta heavy oil is faring even worse with discounts to WTI in the $30 a barrel range and higher.
This price gap has North Dakota producers bypassing the storage facilities at Cushing, Oklahoma and heading directly for refineries on the East and Louisiana coasts where oil can then be shipped offshore for a nice profit or sold to Americans for higher margins. This means that even with the price differential by using rail transport (about $2 more a barrel), shipping via the railroads makes economic sense.
This, of course, is benefiting the railways' bottom line. The railroads have been losing a lot of their coal shipping business with the transition of major power suppliers from dirty coal to clean, cheap natural gas. So this boom in oil shipments couldn't come at a better time.
Over the last five years, the rail oil shipments have soared by 7,000% to 88.9 million barrels. One of the big winners is Burlington Northern Santa Fe (BNSF), a former IWB recommendation which was shrewdly bought out by Warren Buffett a few years ago. Canadian railroads are benefitting also, particularly Canadian Pacific whose U.S. operations are based in Minneapolis. CP has reported five consecutive quarters of double-digit growth in its crude by rail business and now transports 70,000 tank cars annually, up from about 500 in 2010.
Among the other companies benefiting are the East Coast refiners that were paying top dollar for expensive crude shipped from Saudi Arabia and other offshore oil producers. These refiners include Phillips 66 (PSX), Suncor (SU), and Valero Energy (NYSE:VLO). The refineries can now bring in inexpensive North Dakota oil at far lower prices and their stocks have been soaring since their profit margins are now significantly better. Fortunately for North Dakota, the state has an extensive railway system dating back in the 1800s which was originally built to move grain and other natural resources. So the Bakken may be short on pipelines but it is long on rail.
Today I want to focus on another group of companies that are benefiting from this explosion in crude oil shipments: the manufacturers of rail tank cars. If you want to ship a lot of crude by rail, you're going to need a lot of railcars. That brings us to the door of American Railcar Industries Inc. (NDQ: ARII) which is owned in part by famed investor Carl Icahn. Mr. Icahn is not always right but he's right more than he is wrong and investing alongside him usually works out.
American Railcar Industries has been making tank cars for over 150 years and is the only U.S. company that still manufactures them domestically.
The company's next earnings release will be Feb. 21 but their third quarter 2012 report was very strong. Revenue came in at $68.2 million and adjusted EBITDA was $36.7 million, which was a new quarterly record. They had net earnings of $14 million, or $0.66 per share, which was also a new quarterly record. The company has a nice backlog of over 7,000 rail cars and is expecting demand to be very strong for the rest of this year.
American Rail does not just build cars. They also lease the equipment to their customers and enjoy a nice post-sale repair business. Of course, the company makes other types of rail cars for shipping grain and other materials but their tanker business is really on fire.
The stock pays a decent dividend of 2.44% and is currently trading at a pricey but not crazy 19.6 p/e ratio (12 months trailing).
Naturally there are others in the business including Canadian company Bombardier. But it mainly makes locomotives and so is not a direct competitor. In the U.S. there are manufacturers like Greenbrier (NYSE:GBX), which Mr. Icahn recently took a run at, Trinity Industries Inc. (NYSE:TRN), and Freight Car of America Inc. (NASDAQ:RAIL).
There is enough competition that it is likely we will see some consolidation within the sector as evidenced by Mr. Icahn's interest in Greenbrier. More merger and acquisition activity is likely which could raise values for the whole group.
ARII is the closest thing to a pure play with 20% of its revenues coming from tank cars. Some of the other companies mentioned will also give you exposure to barge shipping and other modes of transportation so they're worth considering.
Finally, insiders have been net buyers of the stock over the past year and consensus earnings estimates have continued to rise.
Action now: American Railcar Industries is a buy with a target of $48. The shares closed on Friday at $40.95.