Bret Jensen, editor of Small Cap Gems, focuses on underfollowed and out-of-favor sectors. Here, he explains why a number of catalysts have created opportunity for companies that make rail cars; he also highlights three stocks poised to benefit from these developments.

Steven Halpern: Our guest today is Bret Jensen, Editor of Small Cap Gems. How are you doing today, Bret?

Bret Jensen: I'm doing good, Steve.

Steven Halpern: Before we look at some specific investment opportunities, could you give our listeners a little background about Small Cap Gems and describe your overall investing approach?

Bret Jensen: Certainly. Small Cap Gems is a monthly newsletter that provides my top 20 picks within the small-cap sector, diversified across various industries. We look for undervalued and underfollowed plays with positive catalysts that are not currently appreciated by the market and have substantial upside.

Steven Halpern: Now, one area that's a little under-the-radar that you focused on in a recent report is the very niche market for rail cars, a market that has been out-of-favor due in part to weak energy markets over the past year. Could you explain how energy impacts the market for rail cars and perhaps take an overall view of what the rail care industry is all about?

Bret Jensen: Certainly. Rail cars have been impacted by the energy market in such that five or six years ago, maybe 20,000 barrels a day were transferred by rail of domestic crude oil production.

That number today is over a million barrels a day and has been in a substantial demand driver for the rail car industry over the past half dozen years.

With the plunge in crude, investors have become overly concerned that that demand will completely dry up and that earnings and profits will be affected across the rail car industry. Those concerns are overblown for a couple of reasons.

Number one: new safety regulations that just got published by the US government—probably be followed by the Canadian government—due to several oil train explosions have been a cause for much more safe tank cars with much thicker skin and pneumonic brakes on each of the individual oil cars.

So, that's going to mean approximately 100,000 current oil tank cars that either need to be replaced or retro-fitted in the next three years and then anywhere from 50,000 to 75,000 existing cars that are safer than the older ones will have to do the same by 2020.

Whatever demand that's lost due to lower oil prices and demand for carrying that current production will be more than made up for by the retrofitting and replacement of those cars due to new legislation, so there are some really good opportunities to buy these plays very cheap because people are missing the actual impacts of the dynamics of the market.

In addition, a lot of these plays get 70% outside oil tank cars, so indices, kind of, price more like 50% or 60% of their total production is oil tank cars and that is not the case.

Steven Halpern: And if the energy markets improve, that will also just add to their long-term potential.

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Bret Jensen: It should improve the sentiment. And you can start to see this since oil bottomed late in the first quarter, and has gone up about 40%, the fundamentals and the sediment around these plays have improved substantially over the last six weeks.

Steven Halpern: So, let's look at a couple of investment opportunities in this sector and you cite Greenbrier (GBX) as your favorite play on this trend. Could you tell us about this company?

Bret Jensen: Yes. Greenbrier is a small rail car manufacturer. It has several things I absolutely love about the company, and first of all, earnings should go from about just over $3 last year to almost $6 this year.

They are absolutely killing it with as far as new demand. They have over $4 billion in backlog, which is over a year and a half of work at current production levels.

In addition, they are extremely cheap at under 11 times this earnings, great balance sheet, and just operating on all cylinders. Earning investments have gone up over the last month, even as concerns about the oil market has overtaken the market.

Steven Halpern: You also highlighted a company called Trinity (TRN). What's the attraction there?

Bret Jensen: Well, Trinity is actually even cheaper than Greenbrier on a forward earnings basis. The overhang on Trinity is they have just got subpoenaed for a federal investigation regarding their guardrails, which is a minor part of their business that allegedly has been connected to eight deaths.

Recent safety tests showed the guardrails were safe, but obviously, in this era of regulatory environment, no one really wants to be involved in any company that is getting investigated by any kind of federal agency.

It is a long-term opportunity. I think they'll overcome this. They will make some sort of settlement. This stock is cheap, but it does have that overhang.

Steven Halpern: Now, finally, you point to American Railcar Industries (ARII) as an opportunity with in the space. Could you expand on that?

Bret Jensen: Certainly. American Railcar is my third choice in the space. It is cheap. Not as cheap as Greenbrier or as Trinity but it has the added attraction that it pays a very nice dividend at almost 3%. Very solid. It's 10 times forward earnings. It's not going quite as fast as Greenbrier.

The other dynamic in the space that should be mentioned is; Carl Icahn at one time was interested in combining American Railcar with Greenbrier to make one manufacturer and get the economy of that scale. That is something that may come to the floor at some point in the future.

Steven Halpern: Again, our guest is Bret Jensen, Editor of Small Cap Gems. Thank you so much for taking the time today.

Bret Jensen: Thanks, Steve. I'm glad that you chose to have me on today. Thank you.

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