US Railcar Makers Branch Out

US railcar makers are exploring alternative routes for growth to tackle slowing demand from railroad operators, even as freight volumes fall in a weakening economy.

Manufacturers like Trinity Industries and Greenbrier Cos are focusing more on their non-core businesses, such as building wind turbine towers and inland barges, and also expanding their leasing and aftermarket services. Both companies, along with American Railcar Industries and FreightCar America, are seeing profits from their core business – making railcars – squeezed by pricing pressures.

Industry orders for railcars in the second quarter of 2008 were down about 66% from a 2006 peak of about 36,000, due to the twin effect of railroads becoming more efficient and a drop in freight volumes, according to industry figures.

Trinity, the largest US railcar manufacturer with about a 43% market share, is focusing on its high-margin energy equipment and leasing segments to offset the slowdown in demand for railcars.

The company's energy equipment segment includes the wind tower business, which has grown at a scorching pace of about 150% annually over the last four years, and accounted for about 16% of overall revenue in the latest quarter.

Trinity will shift production at two facilities from making railcars to making wind towers, Chief executive Timothy Wallace said in the company's second-quarter earnings conference call.

The company is also the largest supplier of inland barges and makes construction products, which together account for about a third of its revenue.

"So that gets them through any kind of a storm we're having here in the railcar environment," says analyst Paul Bodnar of Longbow Research. Bodnar rates the stock "neutral".

Trinity posted better-than-expected second-quarter results but expects railcar margins to drop to 6–8% in the third quarter, and to 3–5% in the fourth, from about 12% in the latest quarter, hit by high steel costs and a difficult pricing environment.

"We are not sure how long the decreased demand levels will continue," Trinity CEO Wallace said, adding that the second-quarter results reflected the strength of product diversification. "The company has obviously taken a hit on the profitability in the declining railcar environment. They have other segments that are helping offset that," says Rikard Ekstrand of First Pacific Advisors.

First Pacific is the second largest institutional shareholder of Trinity's shares and owns 6.31% of its share capital. Shares of Trinity have lost about 20%of their value in the last year, while the broader Dow Jones US Industrials index fell 11% in the same period.

Aftermarket, leasing hold promise

Greenbrier, a maker of intermodal cars that use multiple modes of transport, is also seeing contracting margins at its railcar segment. Recent industry trends suggest that orders for intermodal cars have declined sharply.

"We believe that Greenbrier's service and leasing businesses (about 70% of profit) could offset the weakness in its signature intermodal space," says analyst Wendy Caplan of Wachovia.

Greenbrier's latest-quarter results saw railcar manufacturing gross margin plunge to 0.5% from 8.5%, and 98% of overall gross margin came from the refurbishment and parts business. From an earnings standpoint, Greenbrier's latest results were better than expected, but with no help from new car manufacturing, says Robins Group analyst Frank Magdlen.

"The pricing environment stinks," Greenbrier CEO William Furman had said in the company's conference call for the previous quarter. The company is diversifying and expanding into the less cyclical and more stable refurbishment and parts business, as well as the leasing and services businesses. Shares of the company have lost close to 40% of their value in the last 52 weeks.

Long road to recovery?

Railroad companies, such as Union Pacific, Norfolk Southern and Burlington Northern Santa Fe, have improved operational efficiencies to become a viable alternative to road transport as trains use only around a third of the fuel consumed by trucks to move the same freight.

But analysts feel it may take a long time for the recovery in railroad companies to trickle down to railcar makers. First Pacific's Ekstrand says even if the railroads are profitable they will not buy railcars if there is no demand. "It is a positive that railroads are profitable, but in the short term the slowing economy will take its toll and maybe in 2010 railcar makers will start seeing an uptick," he explains.

Although having healthy customers is a good thing for railcar makers, it might be a very flattish 2009 before the absolute number of car builds begins to grow again, says Giles Van Praagh of Atlantic Investment Management, which owns 2.3% of Trinity's shares.

While Trinity and Greenbrier are aggressively branching out, others like American Railcar and FreightCar America have been badly hit by the glut in the market. Bodnar says American Railcar is struggling due to declining backlog, half of which is from the ethanol industry that has slowed on soaring corn prices.

FreightCar America is "pretty much at the bottom or close to it," plagued by high input costs, though its exposure to coal is a saving grace, Bodnar adds. Shares of American Railcar have lost close to 30% of their value in the last 52 weeks, while those of FreightCar America have fallen more than 35%.