(The following story by Ruthie Ackerman appeared at Forbes.com on June 5.)
NEW YORK — The railroad industry has too many railcars for its own good, and railcar manufacturers are suffering as a result.
Railroads ramped up orders for railcars in recent years, as freight traffic rose due to soaring fuel costs and strong demand for grains, chemicals and coal. Traffic is still up, but not as much as expected, with the U.S. economy slowing and the expected ethanol boom beginning to look like a bust. Overproduction of railcars over the last several years has left the market flooded, with demand further depressed by railroads’ increased operational efficiency.
For railcar makers, that has meant lower prices and talk of consolidation.
In February, billionaire investor Carl Icahn acquired a 9.5% stake in railcar manufacturer Greenbrier, stating that he’s interested in engineering a merger with Missouri-based American Railcar Industries, a $447.4 million market cap manufacturer and servicer of railcars that Icahn owns 53.7% of.
Morgan Keegan analyst Art Hatfield has an “outperform” rating on Greenbrier because he said it is likely that Icahn ultimately purchases the company. Hatfield believes a fair value price would be higher than $30 per share, a significant premium to Wednesday’s closing price of $25.08, which gave the company a market value of $410.5 million.
Demand for railcars peaked in 2006 as many railroad companies stocked up on the belief that ethanol demand would drive substantial growth. In the first quarter of 2006 there were over 35,000 railcar orders. In the first quarter of 2008 there were only 10,000. That’s because after the ethanol bubble burst, railroad companies realized they had more railcars built than necessary, Hatfield said in a note to investors.
In addition, the turmoil in the U.S. economy is pushing freight volumes on motor vehicles and building materials down, meaning railroad companies need fewer railcars. Union Pacific currently has 15,000 to 20,000 railcars in storage.
Hatfield says there are more than 40,000 railcars sitting in storage or idle in the rail industry–a full year’s worth of replacement demand.
Meanwhile, the credit crisis has also impacted the railcar manufacturers as financial institutions and leasing companies–the largest purchasers of railcars–have run into liquidity issues, Hatfield said.
Another blow to railcar manufacturers is that railroad companies are becoming more efficient–increasing velocity and decreasing dwell time in order to expand capacity. Railroads are also using double-decker railcars in order to carry more capacity. Although railroads are moving more tons than they did 15 years ago, the railcar fleet has remained virtually the same.
Last month, American Railcar reported that for the quarter ended March 31 that net income slid 25.0% to $10.1 million, or 48 cents per share, with revenue off slightly to $184.0 million.
American Railcar said the hopper railcar market is very competitive, which has forced the industry to lower prices and has compressed hopper railcar margins below 2007 levels.
One way railcar manufacturers have combated the downturn is to lease railcars to companies, which is a more stable profit stream.
Hatfield believes that GATX, a finance and leasing company that concentrates in transportation assets, is well-positioned to weather the economic storm because of its financial flexibility, which will allow for acquisitions, purchases of second hand railcars, or new railcar purchases.
GATX shares gained 2.3%, or $1.11, to $49.81 at the close on Wednesday.
Other railcar manufacturers were up on Wednesday. American Railcar Industries rose 0.3%, or 7 cents, to $21.00, while Trinity Industries edged up 0.1%, or 2 cents, to $39.81. FreightCar America increased 0.9%, or 38 cents, to $42.20.