American Railcar Industries, Inc. (NASDAQ:ARII) is not your average value stock. With an asset value per share of $17.8, American Railcar looks expensive compared to its assets. Indeed, the company is more expensive on a price-to-book basis than its peer FreightCar America, Inc. (NASDAQ:RAIL), which trades at a price-to-book ratio of 1 and has $9.6 per share in cash, at approximately 50% of its market cap. That said, FreightCar’s low valuation is more to do with the company’s exposure to the declining coal industry.
American Railcar Industries’ stocks attractive
However, American Railcar Industries, Inc. (NASDAQ:ARII) offers a different kind of value and after a 23% decline since March, the company looks very attractive.
With the domestic oil industry in the U.S. booming, many producers need to transport their crude away from production sites. Even with huge projects underway to expand the country’s pipeline network, for the most part, many hydrocarbon producers have no choice but to transport their products by rail.
The size of oil-by-rail transportation market is huge. For example, 91% of the estimated 71,700 railcars on order in the U.S. are for tankers and hopper cars, and American Railcar is a specialist in both.
As of June 30, American Railcar Industries, Inc. (NASDAQ:ARII) had a backlog of 6,940 railcars, worth a total of $889 million or six quarters of revenue if production continues at the same rate seen in Q2. However, this figure includes 2,620 railcars that the company is manufacturing for itself to form part of its leasing fleet. It is important to note that these cars are booked in the company’s revenues as if they were sold to a third party but the earnings on these transactions are not reported. Instead, the company reports leasing revenue over the duration of the lease. Moreover, the cost of these cars is deducted from company cash, part of the reason for $150 million in CAPEX spending during the last two quarters.
However, this is where the company is generating long term value.
American Railcar leasing tactic to generate long term value
Leasing railcars produces a sustainable, long term cash flow as leases are usually signed for 5-7 years. Leasing also provides a good return on investment. For example, during the second quarter the company generated an annualized 8% return on total shareholder equity with the leased railcars alone, this equated to a 10% return on the value of the leased railcars.
Leasing only accounted for 5% of revenues during the first half of the year. However, the company is planning to expand its rental fleet, and this expansion should increase the fleet by 89%, which at current rates, indicates income of $53 million a year for the new expanded fleet – an increase of 7.5% for full-year 2012 revenue.
A 7.5% rise in revenue may not seem like may not seem like much, but as the construction of the leasing fleet is funded from cash, the majority of leasing income goes straight to the bottom line.
American Railcar noted increase in rental revenue
During the first half of 2013, the company noted a 250% increase in rental revenues thanks to heavy investment in the fleet. The company’s overall revenue only grew by 2% but the higher margins from the rental fleet resulted in a 42%, year-on-year rise in earnings from operations.
Unfortunately, this income is not being realized as cash. The company is spending heavily to ramp up its production of leased cars but this is creating sustainable long-term value and a highly cash generative business model. Furthermore, with leases running for up to 7 years, the company removes a lot of risk related to peaks and troughs in the manufacturing cycle.
Furthermore, discounting CAPEX spending on its leasing fleet, the company would have produced a free cash flow of $50 million for the first half of 2013 and 2012, indicating a full year free cash flow of $100 million, a 13% return on assets and a staggering 28% return on equity.
While American Railcar Industries, Inc. (NASDAQ:ARII) may not offer immediate value, the company is well placed to generate a huge amount of cash and value in the future.