Where to Stash Your Cash in the Railcar Leasing Market

Last week American Railcar Industries (NASDAQ: ARII  ) released an impressive set of results. The company has been riding the U.S. oil-by-rail boom, and a combination of higher leasing revenues and rising demand for the company's tanker cars drove year-on-year revenue and earnings up 18% and 17% respectively.

But even after these impressive results, American Railcar still trades at a discount to its industry peers. Indeed, American Railcar trades at a trailing-12-month P/E of 10.7 while close peers Trinity Industries (NYSE: TRN  ) and GATX Corporation (NYSE: GMT  )  trade at a TTM P/E of 12.8 and 16.9 respectively.

The question we have to ask is, does American Railcar deserve this low valuation?

Lacking something
Well for a start, American Railcar lacks the diversification of peer Trinity. In particular, according to American Railcar's own website, the company only offers railcar-related services, such as manufacturing, fleet management, repair, and parts. Trinity on the other hand is involved within a range of industries including railcar leasing, production, inland barge manufacture, construction services and equipment production for the energy industry.

This diversification outside of the rail industry does give Trinity an advantage. Actually, of Trinity's total $1,110 million in revenue reported for the fiscal third quarter, 78% came from the rail division. So, for the most part the company is still railroad-focused.

What's more, Trinity's operating margin for its Railcar Leasing and Management Services division was close to 49% for the fiscal second quarter. Indeed, although this division only accounted for 14% of revenue, it contributed 36% to operating profit. American Railcar lags Trinity again in this respect as American Railcar has a relatively small rental fleet in comparison toTrinity.

For example, during American Railcar's fiscal third quarter, the company only reported $8.3 million in revenues from its rental fleet, a tiny 4% of overall revenue. However, this translated into 12% of total earnings.

So when it comes to the lucrative railcar rental business, American Railcar's fleet and income lags that of peer Trinity. In addition, American Railcar also lags the diversification of Trinity.

How does American Railcar compare to GATX?
Well, GATX was founded in 1898 and has paid a consistent dividend since 1919, so for this history alone, the company deserves a premium over its peers. Moreover, GATX leases 117,000 railcars within the U.S., 22,000 within Europe, and 46 within India, giving the company international diversification.

GATX is a pure leasing company and has no production operations like Trinity and American Railcar. However, GATX does own the American Steamship Company and has a portfolio of selective domestic marine and container-related assets. So the company has some diversification.

Still, one thing that caught my eye about GATX. The company has extremely high profit margins when compared to the rental divisions of Trinity and American Railcar.

GATX

Rail N.A.

Rail Int'l

Value of lease assets

$4,495

$1,203

Q3 Operating profit

$156

$78

Return on assets

14%

26%

Source: GATX investor relations. Return on assets based on Q3 operating profit annualized. $US millions.

Now, if we compare this to the return-on-assets for both Trinity and American Railcar:

 

Trinity

American Railcar

Value of lease assets

$3,490

$321

Operating profit

$74

$4.3

Return on assets

8%

5.3%

Source: GATX investor relations

We can see that GATX achieves a much higher return on assets than both of its peers. This is extremely impressive and explains GATX's higher valuation over its peers.

What's more, based on these numbers and American Railcar's lack of diversification, American Railcar's low valuation is also justified. It would appear that GATX and Trinity are both stronger companies on multiple metrics and when considering diversification.

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