Railcar Makers Are Off Track

Shares of railcar manufacturers Trinity Industries (TRN), The Greenbrier Cos. (GBX), and FreightCar America (RAIL) declined over the last three months, as economic data showed the domestic economy was slowing in the second quarter. In particular, Trinity shares fell 34% since a February peak as concerns over a slowing domestic economy led to questions about demand for new rail cars. Several quarters of strong new orders growth and rising industry backlogs helped set the stage for Trinity's 6% decline in railcar backlog at the end of the first quarter. More recently, Greenbrier reported its new railcar-manufacturing backlog at the end of May was 11,500 units, down from 12,500 units at the end of February. The latest data from the Association of American Railroads, which reports weekly rail traffic data, showed that for the first 27 weeks of 2012, combined North American rail volume is down 1.5% compared with the same point last year, but trailers and containers are up 4.4% on the same basis. That's not good, but we are in the midst of second-quarter earnings, and already this week we heard from CSX (CSX) and GATX Corp. (GMT), one of the biggest lessors of railcars. Sifting through CSX's comments, volume-related revenue was affected by a significant decline in utility coal, even though it saw volume gains in export coal, intermodal and merchandise. More specifically, domestic utility coal tons declined 37% in the quarter, as low natural gas prices have led to the displacement of coal at some utilities. Two areas of note were automotive, which was a key driver for CSX's industrial demand as North American light vehicle production increased 25% in the quarter. This strength is expected to continue, as is the rebound in building materials and lumber, which confirms an improving housing and construction market. The net takeaway from CSX management was its expectations for the economy to continue to grow, but at a moderate pace. Despite that outlook, the company reiterated its plan to spend $2.25 billion on capital spending this year as it and other rail operators need to keep up with improving demand from automotive manufacturers. GATX continued to add rail cars to its fleet during the second quarter as it continues to scrap and sell rail cars from its fleet. On the downside, its fleet utilization metrics dipped quarter over quarter, but the average lease renewal term for cars in GATX's leasing price index during the second quarter was 59 months, up from 55 months in the first quarter and 41 months in the second quarter of 2011. Taken together, the picture is far cloudier and less certain than it was several quarters ago when industry rail car backlog levels bottomed and orders rebounded. Even though Trinity's shares are trading at 8.8x consensus expectations of $2.74 per share, the overhanging question is what the company's rail production level will look like in the second half of 2012. Trinity's rail backlog at the end of March was 27,245 units compared with 5,010 units it delivered in the first quarter. That certainly gives the company ample visibility, and margins will no doubt benefit from more favorable pricing in its backlog, as well as longer production runs. But the lingering question is whether new rail car order growth will resume near term. I suspect the combination of the near-term softness in the economy mixed with the cloud of uncertainty -- Europe, tax reform, the fiscal cliff, presidential election, and more -- will restrain spending, including for new rail cars. I'm inclined to sit on the sidelines with TRN, GBX, RAIL and American Railcar Industries (ARII) until signs point to improving rail volumes emerge.

Railcar Makers Are Off Track

A combination of the softness in the economy and a cloud of uncertainty will restrain spending for new rail cars.

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