After rival railcar manufacturer, Greenbrier Companies (NYSE: GBX ) reported a strong set of earnings recently, investors in American Railcar Industries (NASDAQ: ARII ) must be wondering if it and Trinity Industries (NYSE: TRN ) have any upside going into their forthcoming earnings?
Greenbrier beats, American Railcar Industries next?
There are three factors that Fools need to focus on with the earnings of Greenbrier, American Railcar Industries, and Trinity Industries:
- Railcar order books
- Demand created by regulatory changes
- The mix of railcars for sale (more upfront revenue) versus railcars for lease (longer term earnings and cash flow, but less upfront revenue)
The indications are that railcar demand is strong in 2014. Going back to American Railcar's last set of results (delivered at the start of May), management pointed out that the industry reported 24,050 railcar orders with 13,954 deliveries in the first quarter. In other words, the book-to-bill ratio stood at 1.72 for the quarter. Fast forward to Greenbrier's third-quarter results (released in early July for the quarter ending in May) and end market demand looks even stronger. Greenbrier reported 15,600 new railcar orders bringing its backlog to 26,400 and creating a book to bill of 3.6 in the quarter. In addition, Greenbrier reported 2,700 new orders since the end of the May quarter.
Regulatory changes impacting Trinity Industries, Greenbrier, and American Railcar?
Greenbrier shares increased 16% in the days following its results, as investors warmed to the strong order growth. Moreover, there was a sense of relief around the earnings, because industry speculators had begun to fear the impact of future changes in regulatory standards for tank cars. Railcars consist of hoppers (mainly used to transport loose bulk commodities) and tank cars (liquid and gaseous commodities). The latter has seen strong growth in recent years as part of the North American shale revolution.
But the Pipeline and Hazardous Materials Safety Administration, or PHMSA, is due to regulate on railcar designs for future tank cars. Quoting from Trinity Industries first quarter conference call at the end of April:
We are monitoring closely the potential regulatory actions of PHMSA, the U.S. Department of Transportation and Transport Canada with respect to changes in railcar designs for tank cars carrying flammable commodities. PHMSA recently proposed an accelerated timeline that we expect to lead to a final rule shortly after September 30, 2014.
Indeed, Trinity's management had also outlined that tank orders "have slowed" in recent quarters, even while overall railcar industry orders were "very strong." It's difficult for the industry to know exactly how customers will react in waiting for the new regulations. Ultimately, they may prove to spur long-term demand in the industry because customers may need to order new tank cars, or at least make retrofit orders to existing tank cars.
The good news is that Greenbrier's backlog has around 40% in tank cars, and the company's management also outlined, "In tank cars, we expect substantial demand for tank cars as the regulations are finally sorted out."
If Greenbrier's results are a good guide, than American Railcar and Trinity investors can expect a decent set of tank car orders in the upcoming results.
American Railcar, lease or sale?
Aside from the regulatory issue, American Railcar investors also face some variability in their company's earnings due to the mix of railcars that are sold or leased. Moreover, well-known investor Carl Icahn has an involvement. According to the company's annual report, a company that leases and sells its railcars, American Railcar Leasing, or ARL, is an affiliate of Carl Icahn. Furthermore, AEP Leasing (the biggest customer representing 31.7% of consolidated revenue) is also an affiliate of Carl Icahn. Given that Icahn was, until very recently, the chairman of American Railcar, it's fair to say he has had some influence of the mix of railcars sold or leased. Furthermore, the risk in this relationship is outlined in the company's 10-K:
We could compete directly with ARL or its affiliate, AEP, in our lease business if ARL or AEP provides a potential customer with better terms than what we would offer. ARL and AEP also lease railcars and therefore market our railcars and their own railcars to the same customer base.
Moreover, there is no obligation on ARL or AEP to continue to purchase all their railcars from American Railcar.
While the mix of railcars sold or leased shouldn't matter too much to investors in the long term (shifting to the latter tends to imply trading off more upfront revenue for long-term earnings and cash flows), it matters in the short term. Indeed, American Railcar's stock fell sharply (down 20% in the week after the results) after the first quarter results, because it missed earnings and revenue forecasts due to a shift to cars built for leasing.
As for the guidance for the second quarter, CEO Jeffrey Hollister indicated that direct sales might bounce back: "I mean in the first quarter I think you are going to see a little stronger mix on the lease side. The second quarter it might bounce back more on a direct sales side."
Where next for American Railcar?
All told, the industry backdrop remains positive. Greenbrier's results give notice that end demand isn't falling off a cliff thanks to regulatory uncertainty and American Railcar and Trinity Industries can expect decent tank car orders as well. Probably, the biggest short-term issue that American Railcar investors face is the mix of lease versus direct sale railcars in the quarter, or more specifically, how the market reacts to it. Thinking longer term, the risk of Icahn's relationship with American Railcar changing in future is a possibility, but for now the company looks set for a decent set of results. In any case, investors can always look at Trinity or Greenbrier for stocks with exposure to the industry, but will less variability around their earnings.
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