This Rail Should Keep Chugging Higher

 | Dec 06, 2012 | 9:30 AM EST  | Comments
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The "fiscal cliff" issue continues to dominate the news, taking the oxygen away from most other stories that investors would ordinarily be watching. One item that folks may have missed is this: On Tuesday, the U.S. Energy Information Administration said U.S. crude-oil production reached its highest level for nearly 15 years in September.  Production was up 16% year over year, and now stands at 6.5 million barrels per day. Domestic energy production expansion continues to be one of the most positive stories over the last half-decade in this country.

When oil-and-gas production increases from so many sources throughout the nation, one of the challenges is being able to build all of the infrastructure necessary to bring the additional production to market. Although thousands of miles of new pipeline have been built over the past few years, there are still areas where pipeline cannot bring production to market. Energy production in those areas commands a lower price due to the extra costs necessary for alternative transport -- that is, truck or rail.

Pipeline transport is the ideal and low-cost way to bring new production to market. However, there are reasons why pipelines are sometimes slow to be built, or are not built at all. Some of these reasons include prohibitive regulation or environmental concerns (EX, Keystone). Another is difficulty in acquiring financing, and/or not being able to sign producers' large-term, fixed-fee contracts to the extent necessary to finance and build a new pipeline trunk. Oneok Partners (OKS) just canceled a huge pipeline project to the Bakken shale formation -- one with capacity for 200,000 barrels per day -- due to the latter reason.

As a result, more and more oil production is being brought to market by rail. Plains All American (PAA), a midstream provider, just paid $500 million to buy five oil rail facilities, with a combined capacity to transport 85,000 bpd.

One of the primary beneficiaries of this trend is American Railcar Industries (ARII), which manufacturers hopper, tank and other types of railcars in North America. As of the end of the second quarter, the backlog for tank cars represented more than 70% of the total industry backlog for all rail cars. American Railcar gets 20% (and increasing) of its revenue from tank cars, and the stock has had a nice run. However, this demand is in the early innings. The stock has a cheap valuation, and demand for its other core products -- for example, covered hoppers -- is strong.

Here are five additional reasons American Railcar is good pick-up at $31 a share:

● Over the past two months, consensus earnings estimates have moved up nicely for both fiscal 2012 and 2013, and American Railcar shares sell for less than 9.5x forward earnings, a deep discount to their five-year average of 37.6x.

● The company recently resumed paying a dividend, with a quarterly payout declared at $.25 a share. That comes to a yield of more than 3%.

● Insiders have been net buyers of the stock over the last year and a half, and the five-year projection for its price-to-earnings ratio to growth (PEG) comes in at 0.76 -- in the desirable under-1 territory.

● The outlook for covered hoppers, which generates just over 30% of the company's total revenue, is solid. Fertilizer, grain and fracking-sand deliveries should remain strong for the foreseeable future, and demand will benefit if the housing recovery continues, with the growing need to transport cement.

● Billionaire investor Carl Icahn owns a huge stake in American Railcar. There has been some speculation recently that he might try to unlock value by trying to merge this company with Greenbrier (GBX), in which he has a 10% stake. In fact, this is a potential combination he pursued in 2008.

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