2014 has been a rough year for CSX (CSX +0.30%). A second train derailment on April 30 in Lynchburg, VA, prompted the evacuation of several hundred residents. Closer investigation reveled numerous tank cars jackknifed, with leaking oil catching fire from cars that fell into the James River, which feeds into the Chesapeake Bay.
The accident comes on the same day that New York State Governor Andrew Cuomo sent a letter to the White House urging an overhaul of outdated safety regulations. This was prompted by the release of Transporting Crude Oil in New York State, which highlighted past incidents and the future concerns.
The report noted that with the absence of adequate pipeline supply feeding Bakken oil to east coast refineries, trains have been utilized. This has led to safety concerns due to the increased volume and the outdated tank cars transporting the fuel.
One of the solutions proposed in the report is upgrading tank car fleets. If companies don't take that on voluntarily, the government might force the issue. Beneficiaries of such an action would be the companies that make the tank cars or key components.
American Railcar Industries (NASDAQ: ARII) designs, manufactures, and sells or leases tank cars. The company also provides railcar services consisting of repair, engineering, and field services, as well as fleet management.
On April 30, American Railcar released its first quarter earnings, and the Street was less than thrilled. Expected EPS of $1.18 fell short and came in at $0.97 EPS. Revenues were down $13 million year over year as more completed cars entered into leases as opposed to being sold. The company's stock was down 15% as a result.
This move to the downside is overdone. Leasing rail cars creates a steady long term income stream that offers insulation against short term economic fluctuations. While this quarter's balance sheet may have suffered as a result of initiating these leases, future balance sheets will see the benefits of accruing leases working to create steady and increasing income. Long-term investors should applaud this strategy.
American Railcar may be inspired by the success that Trinity Industries (TRN 0.79%) experienced with its leasing model. Leases now account for 19% of revenue, but make up 33% of operating profits.
The company's latest quarter saw a 188% increase in EPS to $2.85 year over year. Timothy R. Wallace, Trinity's Chairman, CEO, and President, stated, "I am pleased with the value we are creating from the strategic railcar leasing transactions we have completed over the last year. Our leasing platform provides the Company with a tremendous amount of financial flexibility, creating capital available to invest across our portfolio of businesses and grow through acquisitions." During the first quarter of 2014, the Railcar Leasing and Management Services Group reported revenues of $443.1 million as compared to revenues of $134.4 million in the first quarter of 2013.
With Trinity's stock up 90% over the last year, many investors might be a bit spooked buying in after such a tremendous run. The $80 price tag may look steep, but when you factor in an expected EPS of $7.44 for the 2014 fiscal year then it doesn't seem so expensive on a forward basis.
The payoff
More oil and gas is being transported by rail. As a result, there will be increasing scrutiny by both the public and the government regarding how these fuels are transported. If transportation companies do not voluntarily invest in newer and safer technology, government regulations and mandates will not be far behind.
This should benefit rail car producers that are already seeing increased demand due to the shale boom. They may experience a second wave of demand as retrofitting and replacement become the order of the day. Companies that manufacture and then lease these cars present solid long-term investments due to their reliable income streams that provide insulation against short-term market fluctuations.
