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FreightCar America (RAIL) still temptingly cheap

July 03, 2007 | About:
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Joe Citarrella

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I’m still doing some work trying to understand the railcar and coal industries, motivated largely by my feeling that RAIL represents a great opportunity. With 80% North American market share in the coal car manufacturing and with the substantial majority of the company’s business tied up in delivering to this market’s participants, it’s clearly an important item of research.

The industry is in a bit of a bubble, some say, that will burst within the next few months/years. Nonetheless, I think this may be a good time to by RAIL, since the bearishness on the industry going forward in the short-term has left the stock under-appreciated and poised to break out over the next few years, as coal has become a more long-term viable and growing business.

Things I like about the company:

- Great market share

- Working to diversify its revenue stream by offering cars catered to the needs of other buyers (not just coal transporters)

- Great returns on capital and respectable margins

- Growing institutional interest given Buffett’s recent railroad purchase and the cheapness of the stock

- Transparency of a good chunk of the next year to two year’s revenue given the nature of contracts with customers and order backlog records.

Things I don’t like:

- Cyclical business

- Product with long life-cycle, dependent upon spotty orders and infrequent repeat business for replacements

- My own uncertainty of the coal industry

About the author:

Joe Citarrella
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 3.7/5 (6 votes)

Comments

harison
Harison - 7 years ago
I love RAIL, it is my favorite idea right now. I've talked about it so many times, I can hear the yawns from the other posters. If you have concerns, go to RAIL's investor relations page and click the presentation tab and read it. They feel that eastern coal-carrying fleet is old and needs to be replaced. It is also steel, they produce aluminum bodied railcars which is more efficient. As you've said, they are a member of an oligopolistic group, a group that has been beaten down because of their cyclical nature. As Carl Icahn(and a few others) says, you must buy what no one else wants(Incidentally he has a stake in ARII). But when the cycle turns, which inevitably it will, this group has high returns on capital. I am a coal bull, global demand for it is projected to grow at 2.5% per year for the next 20 years. Everyone is going crazy over the price of oil and nat gas, but it is projected to grow at 1.7% over the next 20 years. Additionally, coal is much more geopolitically stable in that the U.S. has 25% of the world's coal. The main concern is carbon emissions, and rightly so. Coal is harmful to the environment, and carbon capture initiatives need to brought to the forefront over the next few years. If we can cheaply and effectively capture carbon, coal will be a great alternative to oil and the tumult it has caused, but I stress the word if. In the meantime, coal demand and use isn't going anywhere, GE CEO Jeff Immelt said as much. Thus I believe at this moment coal is undervalued, RAIL is severely undervalued and I'm a bull on both.
MHD
MHD - 7 years ago
Pabrai bought one time a very little stake in RAIL, normally he buys a lot of times small amounts; did someone see him doing this before? Is he testing the bath-water?

Michel
musto
Musto - 7 years ago
harison wrote:

>I am a coal bull.

So am I.

In the US and in China.

Both of those countries have abundant reserves of coal, and they use coal as

the primary fuel for power generation. The only other viable alternative is

nuclear, and for the moment that's not going anywhere.

Just some tidbits.

China has difficulty keeping up mining enough coal for it's industry, and this year for the first time became a net importer of coal.

Every year China is adding as much power capacity as much as one equaling UK's capacity.

They're building a power generating facility a month.

As for the US, coal is extremely cheap on a BTU basis. At $7 natural gas, on a comparable basis, coal should be about $70 a ton. Today the price is about $45.

See the following article on coal.

http://online.barrons.com/article/SB118197314095537755-search.html?KEYWORDS=schneider&COLLECTION=barrons/6month

JJINVEST
JJINVEST premium member - 7 years ago
Listened to their last quarter's earning conference. The management was annoyingly non-transparent. They refused to give some data they had given in previous earning reports, such as the amount of back-log and the coal v.s. non-caol car break-down. RAIL also just stated that 2Q earnings will fall short. There is something fishy here.

The stock looks cheap. I am just going to wait and see if Pabrai buys more. If it goes up, then oh well. But I am not about to jump in, yet.
ccyork
Ccyork - 7 years ago
musto Wrote:

-------------------------------------------------------

> As for the US, coal is extremely cheap on a BTU

> basis. At $7 natural gas, on a comparable basis,

> coal should be about $70 a ton. Today the price is

> about $45.

just for the sake of debate... 8-)

Aubrey McClendon, CEO at Chesapeake Energy is applying EXACTLY the same argument to Natural Gas vs. Oil, except he throws in the additional factor of climate change.

...and he's backed up his belief by investing boatloads of his own money over the years. even recently, since March he has invested about $20 million of his own cash. that's what I'd call conviction

his words below:

http://www.chkenergy.com/LettertoShareholders/p/435/Default.aspx

"As the debate in America intensifies about how to become more energy independent in an increasingly dangerous world and at the same time reduce greenhouse gas emissions in a growing economy, we need to frame the problem truthfully and solve it practically. The vast majority of greenhouse gas emissions are caused by transportation vehicles burning gasoline and diesel and by power plants and factories burning coal. Today, we see policymakers promoting alternative fuels such as wind, solar, biofuels and nuclear. These are all legitimate alternatives (although some much less so than others), yet none can offer energy in great abundance at a reasonable price anytime soon. On the other hand, burning natural gas instead of gasoline, diesel or coal reduces greenhouse gas emissions by approximately 50%. We believe the evidence clearly demonstrates that natural gas is by far the most practical solution to the problem – it is abundant, affordable, reliable, clean burning and domestically produced...For many years, natural gas has been valued at a BTU discount to oil. We believe the opportunity is now at hand for the climate change debate to lead to an increased appreciation of natural gas and a higher valuation for the superior fuel we produce."


musto
Musto - 7 years ago
There's yet another twist into being bullish on coal.

When I checked into some coal companies I realized they all had

the transportation as being one of the major risks in their business.

The railroads are the undisputed choice of transporting coal.

Barges are the only other viable alternative, but are limited because of

the geography.

If the price of coal goes up, my guess is the railroads are going to be

dying to have part of those profits. They essentially have a toll-both system

with a very strong pricing potential.

By the way, that may also be part of the reason why WEB made a huge investment

in the railroads.


DaveinHackensack
DaveinHackensack - 7 years ago
Musto, I am long on RAIL, but the bullish case for coal has to be tempered by an understanding of the political environment. Recall that the recent TXU buyout was predicated on a promise to cancel most of TXU's proposed coal-fired power stations. Also, Democrats (except for coal state governors like Brian Schweitzer) are not fans of coal, due to their obsession with greenhouse gas emissions, and Democrats are currently well-positioned for the '08 elections. There are technologies to convert coal to liquid and sequester the carbon during this process, but so far they haven't proven popular.

It may be that the economic logic of coal -- and the realization that we are the Saudi Arabia of coal -- will win out in the end, but it's important to remember that economic logic alone won't determine our future coal use; the political environment will affect it as well.

musto
Musto - 7 years ago
Your point about the political risks makes sense.

I was looking strictly from an economic stand point of view.

My personal feel about the politics is that, no matter which party denomination they're from, the politicians will have to choose the option that economically makes more sense for most of their constituents.

So if coal costs the least to produce power, then the coal should logically prevail.

munger
Munger - 7 years ago
Nish is going in slowly on this one, probably due to the huge short on the float. I too would expect some volatility in this one.
billytickets
Billytickets - 7 years ago
Billytickets Mr Lare cap himself is "intrigued" by the conversation. I sincerely enjoy your conversation it is educational and enjoyable. You guys all should be in "sales" with your logic based ideas
kfh227
Kfh227 premium member - 7 years ago
Why does RAIL say that most coal cars in the US need replacement? How do they arrive at their numbers? Unless the structure is on the brink of failing, I don't know why a company would spend money buying new cars.

Admittedly, I haven't read up this info on my own, but I was wondering if any of hte RAIL fans know the answer.

Also, in terms of moat, does RAIL have one? To me, it almost sounds like people are speculating.
harison
Harison - 7 years ago
Global Insight says that the average age of a railcar in America is 20 years old, at some point they will need to be replaced. The industry has been under enormous consolidation and is now an oligopoly consisting of six players. Of those six, RAIL controls 25% of the overall market, 80% of the coal market, and is the industry leader in terms of margins. It seems like it is being valued as if another railcar will never be ordered again. Mohnish Pabrai, Steve Cohen, and Ken Griffin have all been accumulating shares, hence it appears to be an attractive situation. That's the bull case in a nutshell. I think at some point I might start a thread as to how played out this moat discussion can be at times. Other things like scale, management, and of course price tag are hugely important. When talking about moats, ask yourself what moat really do any of the financials like USB, WFC, MTB have? Yet Buffett bought those. At some point every business has to compete. Where was Coke's moat when Pepsi knocked the cover off the ball these past 10 years? Isn't WPO's moat crumbling before our eyes if it hasn't already? I think moat analysis gets a little too simplistic and there are many other considerations that need to be given more weight when trying to make investment decisions.
kfh227
Kfh227 premium member - 7 years ago
I'm pessimistic. Future EPS looks like it's going to push the PE near 20. That and no dividend history to speak of (only about 10 payments ever) will keep me on the sidelines. I guess all that Iam saying is that while the rewards might be there, I don't see this as a home run.

Also:

http://photo.gangus.com/d/26788-2/ackbar.jpg

ccyork
Ccyork - 7 years ago
harison Wrote:

-------------------------------------------------------

>I think at some

> point I might start a thread as to how played out

> this moat discussion can be at times.

Well said harison. Yes an economic moat is important, especially if you plan to hold a stock forever. But in many cases, price is a much more important factor. I hate to keep bringing up KOMG, but there's a company that had absolutely zero economic moat, but the price was so cheap that it just screamed value. When weighing an investment you must consider your time frame and exit strategy. You don't have to hold your stocks forever. I think that tends to make us more "emotional" with our investments.

I know this is heresy, but I suspect that those looking for the best returns would be better off not imitating investors like '07 Warren Buffet. Instead emulate Rodriguez, Whitman, Pabrai, Greenblatt, 60's Buffett and some others.

Remember Warren Buffett sold 'em all in the early 1970's. I doubt he would do that today.

I will now run for cover!

--ccyork

harison
Harison - 7 years ago
I agree ccyork. Buffett has stated time and time again that if he had to start over he would do exactly what he used to do, try to find the cheapest stuff available. He has a very different situation from us and must invest accordingly.

Take a look at the 10 year business performance of these consumer staples with large moats. KO, HSY, HNZ, BUD, and CLX. None have been particularly stellar, some have been erratic, and none have big growth potential. The moat theory is not perfect, I think if you blindly buy consumer staple stocks you won't get the returns you were hoping for. I think passing up opportunities because you do not think a company has a moat can dampen your returns as well.
billytickets
Billytickets - 7 years ago
PRICE is KEY.purchasing companies with agreat moat but ahigh PE is foolish,like proven by my last article about does PE ratio matter. However WEB bought many of his "small caps" at PE's of 1-8. The key is value.Alow PE and high ROE like Pabrais's biggest holding PESCO shows value his 2nd highest holding FFH has a mucher higher Pe(28) but it has as much cash as the stock price. Value is in BOTh companies. Large caps multinational consumer staples are GReat if they are purchased properly. Bud is featured in my book Consume cosume and Consume More and despite its lack of "growth" has yielded me a 17% annual return( including dividends) in the last 18 months with a great"hedge' against inflation the dollar and "bad times". Buying them blindly as stated is asinine of course

Both Buffett and Pabrai like buying stocks at or near their 52 week lows. Buying high PE companies with no hidden assets or moats simply because u think they will"grow" may work out but the chance of permanent loss is much greater
armeetofo
Armeetofo - 7 years ago
"moat" i do not like it much due to easy to be misunderstanding,

"monopoly" is illegal,

Dominate might be lack of argument

buying the great company at the wrong price always turn out to be poor return, it is for sure, such as KO, HP,GE's p/e were more than 60 in the end of last decade.
buffetteer17
Buffetteer17 premium member - 7 years ago
I got interested in RAIL by Pabrai's purchase and the discussion here. I just took a look at the 10Ks and 10Qs and cobbled together a quick-and-dirty DCF model. Assume $100m free cash flow, growth rate of 6%, discount rate of 9.5%.

The fair value comes out as $160! The price is around $50. Dollars on sale for 31 cents??? ROE of 63%??? Am I missing something? This appears to be a no-brainer. Time for some due diligence...
billytickets
Billytickets - 7 years ago
Buffetteer17 this is the"classic" value investor play. Stock just announces falling earnings Stock has 15 dollars of cash with a high ROE and decent earnings. the"trick" is that according to the company the earnings are not growing at all."temporaray bad news" is how Buffett made great profits with AM EX in 1960, Wash Post in 1970s coca caloa in 1980s and Wells fargo in 1990 and USG in 2000.The"uncertaintity" in the stock added to our "raging bull" will helps "catapult" stocks who are actually growing their earnings has penailized rail for the short term.If pabrai owns some then you know its "worth a shot" at an appropriate price. Although I only invest in large caps stocks It is clear that RAIL will prove to be proifitable for the"patient" investor
buffetteer17
Buffetteer17 premium member - 7 years ago
Geez, If I plug in ZERO growth into my DCF model for the next 10 YEARS, I STILL get an intrinsic value of $115. I just did a "toe in the water" buy of 400 shares. I generally don't buy a full position all at once, to avoid accidently buying at a short term high point. I'll buy another 1000 shares over the next few weeks, assuming the due diligence works out okay.
dwiprut
Dwiprut - 7 years ago
buffetteer17 Wrote:

-------------------------------------------------------

> Geez, If I plug in ZERO growth into my DCF model

> for the next 10 YEARS, I STILL get an intrinsic

> value of $115. I just did a "toe in the water" buy

> of 400 shares. I generally don't buy a full

> position all at once, to avoid accidently buying

> at a short term high point. I'll buy another 1000

> shares over the next few weeks, assuming the due

> diligence works out okay.


Perhaps I'm still too new at value investing, and relatively under-capitalized, but it seems like you have quite a large "toe" with 400 shares.

billytickets
Billytickets - 7 years ago
Buffetteer17 the "problem" with projecting earning for this stock is 05 had aloss of 25 million 06 had 45.38 million an dof course 06 had 128.733 million. Management said estimates would be lower for 2nd quarter next week. how do u project what earnings will be 3 or 4 years down the road?

I "agree" that the stock is worth a buy based on Pabrai's investment and other fundamentals but just curious about how u are going to"forecast" earnings
ccyork
Ccyork - 7 years ago


i agree with billyt. i'm not sure DCF is the best way to approach this one.

-- ccyork

billytickets
Billytickets - 7 years ago
well put ccyork. I am NOT saying the investment is not agood one . As many know hereI make very few large bets on stocks like JNJ BUD MO and BRK_B when there stocks were at or near 52 year lows . These stocks have large cash flows high ROE"S and projecting out their future"coupons" as WEB would call it can be done accurately with DCF or the"billytickets formula" which is contained in my book Consume Consume More (which can be ordered at a "discount" price for gurufocus members at ticketbill@aol.com thanks to all who have ordered)

There is "obviously" value here if Pabrai has bought in but using"any " growth rate here would be tough IMO.
harison
Harison - 7 years ago
My thinking is there is little to no downside here. The company is going to miss analyst expectations by give or take 25%. After an initial morning selloff, the stock is higher now than it was the day before the anouncement. As has been mentioned many times before, the company is very conservatively financed with no real liabilities and a cash value that amounts to about 1/3 of its market cap. So for every dollar you invest in RAIL, you are really only invested about 67 cents in the actual enterprise. I think these facts would suggest there is very little downside left in this name. I also like the fact that it is a hated name and industry where some big names are beginning to accumulate shares(Pabrai, Griffin, Cohen in RAIL and Icahn in ARII). I swear this is my last post about RAIL, sorry I made so many guys.
billytickets
Billytickets - 7 years ago
Harison keep posting as much as u see fit. When we all make 45% on this stock we will thank you.lol .Seriously this is a forum.Keep repeating and reiterating your ideas and reasons. Someone might have not "heard your story before' or heard it and is not listening.

Heres a true story.Someone who I "manage money" for called me last month and said to me Billy if we were smart we would have put everything we had in MO when it was in the 20's. Well as the peopel who read my book and others know.I did that exact thing.He was the one who"diversified" with an expert who kept saying my formula and lack of diversification would bankrupt meand my double digit returns would soon diminish( instaed iam retired and he still works.lol) .That same expert also said my book was a"joke" and only an idiot would read it or follow it( i think he doesn't like me lol).

Harison and EVERYONE out there.POST as MUCH as the mood hits you. I for one am "more educated' EVERYTIME you speak. All you"rookies" especially POST as much as u can. One of my best investment theories came from a 8 year old boy.No joke.peace
buffetteer17
Buffetteer17 premium member - 7 years ago
I like to cast things in the form of a DCF because I'm used to it and it produces a numerical value. But you're probably right that it isn't very applicable for RAIL. We know that over the past few years, they had an average free cash flow of $80-$100M/year, but very lumpy. Can they keep that up? It seems likely to me. They're financially sound with plenty of cash. Their stock is out of favor, and they're buying back shares. There is a market for their products, likely to expand. Seems like low risk/high reward to me.

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