Alcoa's (NYSE:AA) December quarter results were the latest sign that freight car production remains depressed. While some investors may focus on freight and related traffic as an economic indicator, I would argue that transit, not freight, offers a better opportunity right now.
As such, I'm eyeing shares of Wabtec Corp. (NYSE:WAB). While not a household name, the rail component and solutions provider is solidly positioned to benefit from the upswing in transit demand, and its earnings multiples are poised to expand in the process, offering nice upside in the share price.
Weak freight car traffic does not inspire confidence
Freight transport companies, like Burlington Northern (NYSE:BNI) and Union Pacific (NYSE:UNP), carry a variety of goods -- from autos to lumber, petroleum, coal, chemicals, and more. As such, their business makes them "early cycle" plays during an improving economy. To gauge the tone of the economy in good times and bad, I keep an eye on those companies and weekly carload data from the American Association of Railroads (AAR). Given concern over the fading impact of the government stimulus in the December quarter, it would be silly not to double-check corroborating indicators when possible.
Recent rail data, in my view, does not paint the picture of a vibrant economic recovery. Per AAR data for 2009, total carloads carried by U.S. railroads fell 16% compared to 2008 and are at the lowest levels since 1988. The most recent weekly data showed that weakness continued into January, with the biggest decline in coal carloads. Because the majority of coal cars tend to be made from aluminum, weak coal-car traffic helps explain why aluminum-related freight car demand remains weak at Alcoa.
Depressed traffic and low freight-car utilization to pressure manufacturers
With weak freight-car traffic, rail companies like Union Pacific and Burlington Northern have an idle railcar fleet that numbers in the tens of thousands. In other words, there is ample excess freight car capacity for when the economic rebound strengthens and rail traffic begins to grow. As such, in the near term, new freight-car capital spending by the rail companies is likely to be depressed until utilization levels for existing freight-car fleets improve. This spells trouble for freight-car manufacturers like Trinity Industries (NYSE:TRN) and The Greenbrier Companies (NYSE:GBX). Both companies have experienced significant declines in their railcar backlog, which is a key indicator of potential near-term production levels. As production levels "rightsize" against current backlog levels, competitive pricing to win what new orders are placed will pressure both revenues and margins at railcar manufacturers.
Transit market offers a brighter opportunity, and Wabtec is a ticket to ride
What Trinity, Greenbrier, and others such as FreightCar America (NASDAQ:RAIL) lack is meaningful exposure to the one area of rail that is vibrant -- the transit market, which is poised to benefit from the government stimulus and other infrastructure spending programs. In particular, the passenger railcar market had one of its best years in 2009, with new car deliveries at their highest levels since 2001. Moreover, the industry backlog for transit cars spans more than two years of production and thus offers solid visibility. Add to this plans by passenger rail companies to place additional transit-car orders in 2010, and prospects for the transit market are even brighter.
Arguably, one of the best -- if not the best -- companies positioned to capitalize on that is Westinghouse Air and Brake Technologies (NYSE:WAB), aka Wabtec, a component and solutions provider that serves both transit and freight. All in all, more than 60% of its revenue in the September quarter was derived from the company's transit segment, while freight accounted for less than 20% of the current backlog. While part of the OEM freight-car business has been under pressure, the transit businesses is up over 22% year-to-date and has helped enable Wabtec to remain nicely profitable compared to The Greenbrier Companies and FreightCar America.
While some may voice a concern that Wabtec shares are approaching their 52-week high, I could see those shares trading higher as the transit market kicks into gear in 2010. And I'm not alone. The investing community at Motley Fool CAPS, including more than 100 All-Stars, has rated Wabtec four out of a potential five stars. Head over to CAPS to get your vote counted, and sound off below on the transit vs. freight debate.
