He’s Been Working on the Railroad

04/17/2007 12:00 am EST

Focus:

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Elliott H. Gue, editor of The Energy Strategist, recommends three manufacturers of railcars as a way to play the railroad boom sparked by the surge in coal and ethanol shipments.

Coal is far and away the [railroad] industry’s most-important cargo: More than half of the US power supply comes from coal, and rails carry virtually all the coal consumed in power plants.

Traditionally, most US coal production came from Appalachia. But coal production from the region has been falling due to high mining costs and thinning seams. Production from the West has picked up; states such as Wyoming and Colorado are becoming the dominant coal suppliers. That’s a far more profitable route for the rails.

[Meanwhile,] US ethanol consumption is up more than 75% since the beginning of 2004 and is projected to grow by at least another 50% between now and 2012. Railroads haul the vast majority of corn from farms to ethanol-production facilities. It’s currently the fastest growing shipment for railroads.

Prime beneficiaries of these trends are companies that provide freight cars to haul all that coal, grain, and ethanol. American Railcar Industries (NASDAQ: ARII) derives most of its revenue from building and selling tank railcars and hopper cars. Tanker cars are used to haul liquid commodities, [while] hopper cars transport grain, cement, and industrial materials.

Tanker cars represent American Railcar’s strongest and fastest growing business right now. Driven primarily by sales of ethanol tankers, deliveries soared [by] more than 32% [in] the final quarter of 2006 [from the same quarter in 2005].

[Also] new government safety requirements are forcing shippers to upgrade and replace their older carriers with safer models. American Railcar Industries is a buy under $33. (It closed Monday at around $32.50.)

FreightCar America (NASDAQ: RAIL) is the leading manufacturer of coal cars in the US. In fact, the company manufactured more than 80% of the coal railcars delivered in North America since 2003; coal cars represent more than 90% of FreightCar’s annual production.

The coal car business has been booming amid strong demand for coal and the need to replace an aging fleet of older railcars. Newer aluminum railcars can carry the same loads but weigh a third less than traditional steel cars—translating to major fuel savings for the rails.

Not surprisingly, FreightCar’s total car sales grew from less than 8,000 cars in 2004 to close to 19,000 last year. FreightCar has a backlog of unfilled orders covering roughly six months of sales. FreightCar America rates a buy under 55. (It closed Monday above $50.)

Larger rival Trinity Industries (NYSE: TRN) manufactures both tanker cars and hopper cars. With a fleet of more than 85,000 railcars, Trinity also is one of the largest railcar-leasing firms in the US. Trinity also builds hopper and tanker barges designed to transport liquids and grains via US inland waterways. With revenues up 19% in 2006 and the backlog of unfilled orders at an all-time record of 36,000 cars, Trinity’s business remains on solid footing. Buy Trinity Industries under 46. (It closed Monday above $44.)

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