i’ve been working on the railroad

When I seek new investments for my $100 million fund, I often research companies that benefit from secular changes, large shifts in society and business.  Three epic secular shifts happening right now are: the rapid adoption of cloud computing platforms, the tidal wave of growth in Texas (almost a million people a year are moving to that state), and America’s booming energy renaissance.  The last change is particularly breathtaking. We’re pulling up almost nine million barrels of oil a day now in this country. That’s almost double the amount we extracted ten years ago.  Natural gas production is way up as well, causing some analysts to predict America will be a net exporter of fossil fuels sometime in the next decade.

This growth in domestic oil and gas production is obviously good for energy companies. But how those fossil fuels get from the ground to the gas pump will strongly benefit one, very old-school mode of transportation: railroads. That’s why one of my favorite stocks these days is Trinity Industries’ (TRN). Its products were last considered “high tech” in the 19th century. But they’re going to make the company a ton of money here in the 21st.

We might be extracting more fossil fuels than ever in America, but our capacity to refine them is flat, and likely to remain so. There are only 150 refineries in the U.S. Given the costs and the political unpopularity of Big Oil, good luck getting a new one built. Not only that, most existing refineries are along coastal areas, nowhere near big new reserves in places like North Dakota and West Texas. That means crude oil has to travel long distances over land. There are only two commercially viable ways it can do that: pipelines and railcars. If you haven’t noticed, getting a pipeline built nowadays (cough, Keystone, cough) is harder than getting approval for a new refinery. Which leaves one and only one option: choo-choo!

Guess who builds more oil tank railroad cars than any other company? Trinity Industries. Not surprisingly, it reported a strong first quarter last week, with revenues jumping 57 percent to $1.5 billion.  Earnings per share were $2.85, vs. a Wall Street consensus of $2.53 and company guidance of $2.45-$2.65.  More importantly, Trinity raised its 2014 earnings per share guidance to a $7-$7.50 range from previous guidance of $6.30-$7.  Trinity’s railcar division received orders for 9625 railcars, resulting in a record backlog of 42,630 units. (Trinity’s other major divisions, manufacturing inland barges and energy equipment/construction products, also performed well.)   A majority of these rail orders are for higher priced, higher margin tank cars.  Trinity also increased it quarterly dividend and announced a 2 for 1 stock split.

But, you might ask, what about all those terrible news stories in recent months of explosions in trains carrying crude oil? Won’t those tragedies hurt Trinity’s business? The short answer is: no. The long answer is: those unfortunate events will help TRN grow even faster. Every time a train blows up, it increases the political pressure to replace older DOT-111 tank cars, which are seen as being vulnerable to puncturing and leakage. You know who will fill the majority of those new orders for more robust (and more expensive) railcars? Trinity Industries.

The railroad industry is still perceived by many analysts and money managers as deeply cyclical. That explains Trinity’s low PE ratio of 10-11x 2014 estimated earnings.  A few months ago a railroad analyst at Raymond James predicted that the industry’s upswing would be short lived, leaving a glut of tank cars “at some point.”  Since then, TRN is up 20 points.  And if railroads stand to be the beneficiary of a multi-year secular change, as I suspect they will, both Trinity’s stock and its PE ratio should go a lot higher. In other words: “All aboard!”

3 thoughts on “i’ve been working on the railroad

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