I) Overview and History
American Railway Industries (ARII) was founded in 1988 in Missouri and later incorporated in 2006 in Delaware after the acquisition of ACF and began trading publicly in January 2006. ARI is a leader, offering integrated rail cars, railcar components, railcar maintenance services and fleet management services. American Railway is a manufacturer of both general and specialty hopper rail cars. The hopper’s are made to carry different resources varying from grain, cement, potash, sand, plastic pellets, food grade starches and flours, clay, ore and high value specialty products.
They are also a manufacturer of tanker rail cars designed to handle a variety of commodities like petroleum products, ethanol, asphalt, vegetable oil, corn syrup and other food products. American Railway also has the ability to produce other railcar types including intermodal, gondola and iron ore rail cars with bottom and rotary discharge.
- From the IPO in January 2006 shareholder equity has quadrupled from 106.76M to 399.00M while earnings per share have risen from 0.14 in 2005 to 2.99 Fiscal 2012.
- Long term debt being paid down from 272M in December 2012 to 191M in 13Q2
- Operating earnings, revenues, and margins returning to normalized levels from recession slump
- Retained earnings has increased almost 10 fold in an 8-year period
- 5-year average gross profit margin of over 12.5% but the most recent fiscal year boasting 20.1%
- A very impressive ROIC of 20.2% average over the last 8 years.
Today Carl Icahn is chairman of the board of directors and controls 55.7% of the company. He is actively engaged in the company presumably using it as a vehicle to produce future surplus cash-flow that is reinvested in other activist operations. As recently as December he was making efforts to take over a competitor in the space, Greenbrier Companies Inc. The 1994 acquisition of railcar component manufacturing and railcar maintenance assets from American Car and Foundry Company (ACF Industries) was the beginning but surely not the end. The company has roots dating back to before the 20th century and is part of the foundation that helped create America.
III) Business & Competitors
Manufacturing operations consist of hopper rail cars, tank rail cars, rail car leasing, component manufacturing, and consulting/contract agreements.
Rail car services are made up of repair services (mobile and full service), engineering and field services, and fleet management services.
The company has 2,643 full-time employees in various locations across the U.S and Canada. ARI is now incorporated in North Dakota as of 2009. ARI has a joint venture partnership with three other companies, Ohio Castings Company (33% ownership), Axis (41.9%), and Amtek Railcar Industries (50% ownership).
Competitors include Greenbrier Companies Inc, FreightCar America, Inc., Westinghouse Air Brake Technologies Corp, and Trinity Industries Inc. American Railway industries is in the top quartile (top 15%) versus the industry in profitability like EPS growth %, ROIC, ROE, ROA, operating margin, net margin, EBITDA growth and revenue growth.
IV) Operations and Competitive Advantages
The primary customers include leasing companies, industrial companies and those that use rail cars for freight transport, or shippers, and Class I railroads. (Carl Icahn also only buys from ARI for ACF) “U.S. Class I Railroads are line haul freight railroads with 2011 operating revenue of $433.2 million or more. Two Canadian railroads, CN and Canadian Pacific, have enough revenue that they would be U.S. Class I railroads if they were U.S. companies.” (Associate of American Railroads, 2013)
The leasing operations, integrated rail car repair, general maintenance and after service fleet management provide an opportunity to up-sell/cross-sell as well as penetrate the general market with more efficiency, widening the companies economic moat.
Over half the North American rail car fleet is tank cars and covered hoppers with over 1.5M North American rail car fleet as of July 2012. (Investor Presentation, 2012)
- 20% Tank Cars
- 32% Covered Hoppers
- 11% Open Top Hoppers
- 16% Gondolas
- 8% Flat Cars
- 4% Intermodal
- 9% Box Cars
ARI is able to make large capital expenditure outlays, increasing future revenue from the leasing operation and manufacturing locations are also strategically placed close to major railroads and customers. The company is NON-unionized and uses it as a major beneficial factor for controlling employee expenses and operating margins. The supply chain is vertically integrated meaning profits are maximized, hold-ups are avoided and common ownership aligns interest of all parties involved.
1) Axis, LLC – Responsibilities include forging, heat treating, machining, and finishing axles for international use. Located next to a major manufacturing facility of ARII in Paragould, AR.
2) Ohio Castings, LLC – Founded in 2003, is a manufacturer of side frames, bolsters and other rail car components. Figure 1: an example of a side frame & bolster
3) Amtek Railcar Industries is pursuing the India joint venture and international expansion. Amtek is a manufacturer of flywheel ring gears, automotive part machining, forging, casting iron and casting aluminum. Located globally in various countries, Italy, Mexico, Brazil, India, Germany and The U.K, Amtek is in position to lead the ARI global expansion.
All joint ventures individually are not profitable currently with Ohio Castings as an exception, swinging to a profit in 2012. (Details below in Figure 5)
American Railway Industries has future plans of strategically exploring and expanding into Russia and Saudi Arabia while maturing the production operations in India as the developmental stage is completed. The cyclically of the business is also a very important factor as it is an art to normalizing earnings. There is an explosive trend working with ARI as the majority of the railcar fleet is aged 15-20 years old and needs replaced as pent-up demand is released and utilization/capacity rates increase to expansion levels (It looks like this may already be occurring when you look at the Capex, cash flow from investments and ISM/PMI trends).
Figure 2: Comparable Companies
|Valuation Metric||FreightCar America||Westinghouse Air Brake Technologies Corp||Trinity Industries Inc|
|ROIC (3-Year Avg. Weighting)||15.46%||57.6%||9.6%|
|American Railway Industries||Greenbrier Companies Inc|
V) Balance Sheet and Profitability
Debt to equity is relatively moderate sitting at 0.5 after long-term debt was paid down in the first half of 2013. Backlog is very healthy at the end of December 2012, approximately 7,061 rail cars with estimated sales value of 889.8M.
- Current Ratio: 3.23
- Quick Ratio: 2.01
- Cash and Cash Equivalents: 94M from 218M at the end of 2012, large increase in property, plant, equipment in the most recent quarter.
- Book Value Per Share: $18.67
- 2.70% dividend yield at a 20% payout ratio
- 2012 Effective Tax Rate 39.7%
Figure 3: Operating Margin by segment.
As cash flow investing activities are completed and additional revenue streams pursued as the business expands, I would expect both the dividend to be raised as well as share buybacks based on current price levels. Carl Icahn is a financial wizard and should be watched closely especially when ROIC is surpassing 20% while comparable earnings yield is 10.2% on a TTM basis.
VI) Management & Compensation
Figure 4: Definitive Proxy Statement of Compensation (April 2013)
|Carl C. Icahn||77||Chairman of the Board||1994|
|James J. Unger||65||Vice Chairman of the Board||1995|
|James C. Pontious *||74||Director||2006|
|J. Mike Laisure *||61||Director||2006|
|Harold First **||76||Director||2007|
|Brett Icahn ***||33||Director||2007|
|SungHwan Cho ***||39||Director||2011|
President and Chief Executive Officer, James Cowan received a salary of $373,333, a bonus of $336,000, another $491,656 awarded as stock, and $27,585 from other compensation for a cumulative total of $1.228M in fiscal year 2012.
Carl Icahn Chairman of the board and his son Brett Icahn sits on as a director, both are very smart capital allocators working for future retained earnings/dividend distribution of ARI.
Dale Davies is the senior vice president, CFO and treasurer earning a salary of $275,000, stock awarded valued at $258,852, and a bonus of $206,250 for a 2012 total of $749,000
Alan Lullman is the senior vice president of sales receiving $270,200 compensation, a $162,120 bonus and $126,984 awarded in stock.
Other directors earning compensation, $52,000 (Harold First) + $47,000 (James Pontious) + $47,000 Mike Laisure) + $65,000 (James Unger) for a total of $201,000
Another 855,476 securities have been set aside for future compensation. I am all in favour of attracting top caliber management through pay incentives especially when top capital allocators are working alongside them. Keep top managment total compensation under 0.5% of sales and I cant complain.
“If you pay peanuts, you get monkey’s”
VII) Value and Price
At $37 PPS the market cap is 789.95M with 21.35M shares outstanding and a 9.45M share float. Using quick conservative estimates for Discounted cash flow @ 10% discount rate, 5% cash-flow growth and initial cash flow of 63.82M. You end up with an estimated Intrinsic value of $62.75 compared to current price of $37 or 58.9% undervalued. With the growing business prospects, stellar ROIC of over 20% and declining debt levels, ARI should trade at a more appropriate multiple of 12-14x and more like 1.5-1.75x sales. Westinghouse Air Brake Technologies Corp has an even more impressive ROIC and earnings history and deserves the multiple the market has given it, possibly even warranting an expansion in P/E (towards 25x) as cyclical names remain in focus, as the risk free rate has caused downward pressure on alternative asset classes. Joint Ventures are priced to be free (While JV’s begin to operate at a profit) as well as the railcar leasing and railcar services businesses, while the manufacturing business would still be trading at a discount. Railcar leasing is the highest operating margin part of the business (55%) and has grown TWENTY FOLD SINCE 2010.
Figure 5: Joint Venture Operational P&L
|Total Loss from JV||$(7,789)||$(7,900)||$ (451)|
Figure 6: table of segmented revenues.
- M&A continued with competitors as the corporate raider Carl Icahn is at the helm.
- Increased growth of the Railcar leasing business that is hidden within the 10-Q’s and 10-K’s.
- Improvements to operational costs as utilization rates increase.
- Expanding backlog and large contracts won due to the aging fleet of American rail cars.
- Cyclical upswing in the manufacturing business revenues as pent-up demand is released.
IX) Specific Risks
The highly cyclical nature of the railcar industry may result in lower revenues during economic downturns. The top 10 customers are attributable to about 80% of overall revenues and a loss of anyone of them could result in material impact to the income statement. As the international expansion continues, ARI is subject to government policy risk as well as international economic risk. After rail cars are leased the company may not be able to re-market them on favourable terms, impacting ROIC. Environmental and safety regulation is always a wildcard for any business or industry and should be ignored until implemented. Key employees and management are crucial to the performance of the business and without them negative impact may be assumed.
X) Why is it cheap
I would not say it is exceptionally cheap (30 or 40 cents on the dollar) but below the companies fair value. The demand for future rail cars is not being accounted for correctly by the market as America shifts to energy independence and continues to be the agriculture juggernaut of the world. Growing freight volumes is evident, while commodity prices are being crushed on global growth concerns, when they begin to stabilize and present supply is soaked up, you can expect capital expenditures to once again flood the market. I don’t believe the market is correctly valuing the company and has given a multiple to reflect the core manufacturing business prospects, not the joint ventures, rail car services and leasing business. Keep an eye on the lease expansion through cash flow from investing activities as well as capital expenditures, it should be an enormous component of the future business given the present spending and operating margins on that part of the business. These assumptions are not including share buy backs or any M&A and as Carl Icahn already owns over 55% of the company, I think it will be a route of interest, he and/or his son ultimately pursue.
Disclosure: This is not a recommendation to buy or sell anything. I have no position in any of the stocks mentioned but may initiate a position in the next 72 hours.
Any and all comments or questions welcome.