Shares of American Railcar Industries (NASDAQ:ARII), a small-cap manufacturer and lessor of hopper railcars, which carry dry bulk goods, and tank railcars, which are primarily responsible for carrying liquids and gases, tumbled 13% in September based on data from S&P Capital IQ.
The cement block weighing on American Railcar during the month was a price target cut from investment banking firm UBS from $55 to $41. UBS kept its "neutral" rating on the stock, for what it's worth.
The impetus for the substantial price target cut, according to covering analyst Eric Crawford, has to do with the expectation of fewer deliveries in the second-half of fiscal 2015 and reduced visibility in the order backlog. Crawford notes that he and his firm have reduced second-half delivery estimates to 3,500 railcars, of which 2,500 will generate revenue as a direct sale and the remaining 1,000 will be leased. If there is a silver lining here, Crawford notes that weak steel prices continue to keep American Railcars' expenses down.
The other issue for American Railcar is a carryover from its second-quarter report in late July. What we're seeing from American Railcar's customers is that more are opting to lease railcars rather than purchase them. This could be a direct result of weaker oil prices, which have caused tank car sales to decrease, while hopper car sales have increased. Hopper cars sell at lower prices than tank cars, which require more material and labor costs, meaning American Railcar is seeing its margins squeezed a bit.
The big question is this: despite the company's derailing in September, should investors consider this recent dip in American Railcar a buying opportunity?
I believe the tentative answer is "yes," but investors should also understand that this isn't an instance where a resurgence in margins is going to happen overnight.
As it stands now, American Railcar is slated to realize lease revenue over time (which actually isn't so bad if you think about it), but in the meantime it could lead to a surprising drop-off in revenue, as leasing activity rather than direct sales picks up. We also have little visibility as to when oil prices might stabilize and lend to an increase in tank car sales.
However, over the long run a strong case can be made that oil prices are likely to trend higher as demand for oil grows worldwide. With shale assets galore in the U.S., American Railcar should find its long-term growth outlook still intact. If investors can deal with what I suspect is a temporary margin contraction, then they could be landing a company with a high single-digit forward P/E that's currently yielding a whopping 4.6%.