Trinity Industries (TRN): Are they still running down the track?

9 minutes

 

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Trinity Industries (TRN) is a leading company that specializes in industrial products and services. They offer railcars, railcar parts, and leasing, management and maintenance products. They also offer additional services such as barges, storage and distribution containers as well as highway products and wind towers.

The company which is based in Dallas, Texas was founded in 1933 and employs 22,030 people and has annual sales of $6,392.7 billion as of 2015. Sales have tripled in the last five years from $1.9 billion to the current $6.4 billion.

In the last five years, TRN stock has seen a 74% increase in the current price of $23.49.

The last decade has seen a steady increase in earnings growth as well as dividend increases as well. TRN has paid dividends for the last 209 quarters and counting. While not in the same class as a Dividend Aristocrat, the fact that they have paid a dividend since 1964 lets me know that their shareholders are important to them.

TRN is not the highest-yielding stock. Its dividend currently is a pretty paltry 1.86% right now. But what it lacks in yield, it makes up for with consistency.

Business Overview

Trinity Industries breaks up their business into five different groups. We will discuss them in turn.

Rail Group

The Rail Group which is responsible for 45% of the revenue generated by TRN is a leading manufacturer of railcars, railcar axles, and railcar coupling devices.

They also produce autorack cars, boxcars, covered hopper cars, and tank cars among others. Currently, they compete against five other major railcar manufacturers in North America.

In 2015 TRN shipped 34,295 railcars which were 41% of all railcars shipped in North America.

In addition to the railcars, the Rail Group also manufactures railcar parts and components used in manufacturing or repairing railcars including couplers, axles, and other equipment. They also have repair services available at multiple facilities in the US.

They have set up the manufacturing to be able to change to demands of the business and be able to provide any type of railcar that is needed.

Railcar Leasing and Management Services Group

This group is a leading provider of leases for tank and freight railcars. Through TrinityRail they coordinate sales and marketing for this group, which provide a single point of contact for railroads and shippers seeking railcars and services.

Railcar Leasing was the second biggest driver of revenue and profit for TRN in 2016 with 20% and 35% respectively.

In addition, the Railcar Leasing Group also administers and manages a newer initiative for them. It is known as RIV Rail Holdings(RIV). TrinityRail was the first in the industry to create a platform of RIVs for institutional investors. Since 2006, TRN has placed $5.1 billion to RIVs.

RIV or Railcar Investment Vehicles are customized portfolios of leased railcars for institutional investors. All which are managed by TrinityRail.

Construction Products Group

Construction Products Group or CPG is a leading full-line manufacturer of highway guardrail and crash cushions in the US. In addition, TRN is a leading producer and distributor of lightweight and natural aggregates for concrete producers.

The Construction Products Group contributes 10% of the revenue and 5% of the profits for Trinity Industrials.

Energy Equipment Group

The Energy Equipment Group is a leading manufacturer of structural wind towers used in the wind energy market. The towers are produced in the US and Mexico and assembled by the customers. Most of the customers are wind turbine producers.

In addition to the wind towers, they also produce utility structures for electrical transmission and distribution, storage and distribution containers, cryogenic tanks and tank heads for pressure and non-pressure vessels.

The utility structures for electrical transmissions are used by primarily municipalities and other local and state governments. They are produced in US and Mexico and assembled by the customer. TRN is a leading manufacturer of these products.

This group contributes 15% of the revenues and 13% of the profits.

Inland Barge Group

This Group is a leading manufacturer of inland barges and fiberglass barge covers here in the US. TRN manufacturers a wide range of dry cargo barges, such as deck barges and open and covered barges that transport items such as grain, coal, and aggregates. The Inland Barge Group also manufacturers tank barges that are used to transport liquids such as chemicals and petroleum products. The fiberglass segment is used for grain barges.

The Inland Barge Group was responsible for 10% of the revenue and 7% of the profit.

All in all, this is quite a diverse lineup of products and services that are provided by Trinity Industrials. The two largest departments, Railcar Group and Railcar Leasing make up 65% of the revenues and 75% of the profits of the company.

Growth Prospects

Frankly, the growth prospects for Trinity Industrials in the short term are bleak. The company is very much a cyclical company and they are dependent on the whims of the economic cycle. With the current economic environment, they have seen a slowdown in orders for railcars from the industrial sector. In the second quarter of 2016, they received orders for 2910 railcars.

These orders reflect the economic environment and the replacement of the aging North American car fleet. Currently, TRN has a backlog of 40,205 railcars that are valued at $4.3 billion. With the orders they have received for the second quarter, the entire production of 2016 of 27,000 railcars has been sold and are currently working on getting orders for 2017.

There is weak industrial end-user markets, large American railcars, and excess railcar industry manufacturing continue to negatively impact new railcar orders and put pressure on lease fleet utilization and rates.

There are small pockets of industry that are seeing some light at the end of the tunnel. One of those industries being the frac sand producers. The sand producers are optimistic following the uptick in oil prices in the last quarter. They are indicating as the uptick in oil continues that there will be a strengthening demand for sand usage. This is being closely monitored by TRN and they have the ability to adapt their production to deliver smaller cube covered hoppers when the demand increases.

During the second quarter 2016, Rail Group delivered 6500 railcars, a 15% decline from the first quarter. This directly impacted the operating and financial performance for the quarter.

Another area that has been pressured by the downturn in industrial demand has been the lease fleet. The utilization of the lease fleet was down to 96.4% for the second quarter. The overhang of existing railcars in the marketplace and weak industrial demand is reducing renewals and causing declines in lease rents.

One area of promise is the RIV platform, which is currently guiding between $300 million to $400 million for the year, with a sales range between $130 million to $230 million for the second half of 2016. In the second quarter of 2016, the Leasing Group was able to complete sales of $149 million which resulted in a $43 million profit.

The RIV platform currently helps the Trinity Rail Group drive 25% profit to the bottom line of Trinity Industries. As the economy continues to muddle along, institutional investors are going to continue looking for hard assets to invest in. RIV offers them a hard asset that will continue to grow in value, has 30-40 years of life, and provide access to the continuing shift from shippers and railroads to third party lessors like TrinityRail.  The RIV platform provides Trinity Industries with a fantastic way to help utilize their current manufacturing abilities while not having to change who they are fundamentally. It also gives them another source of income and help insulates them from the vagaries of economic conditions.

Risks

Trinity Industries faces three main risks as they continue down the path.

  • Cyclical business: Trinity Industries is a manufacturing business that is dependent on the ups and downs of the economic conditions. As the economy improves there will be more demand for delivery of goods and services. As railcars are critical components of North America’s transportation infrastructure. Trinity Industries stands to ride that wave as things improve, calling for more orders of railcars to fill the customer’s needs. And conversely, as things wane the demand will lesson.
  • Steel Industry: The principal material used in TRN’s production is steel. During 2015, the supply of steel was enough to support the manufacturing needs. The market for steel is extremely volatile and ended 2015 lower than 2014. TRN utilizes many different strategies to help mitigate the volatility in steel and currently have enough in the supply industry to meet its demand.

The price of steel dropped early in 2016 and had a late rally around April. It is expected to fall again this fall as the glut of steel on the market drives orders down which will drive down demand and the price. Also to factor in is the upcoming election and the uncertainty that will bring. China, who is the largest producer of steel in the world has agreed to cut production but has failed to do so as of October 2016. This has had a drag on the market because they are also one of the biggest exporters of steel because of the government subsidies that drive down the price. US steel companies have been struggling to keep up.

Falling prices are good for Trinity Industries as it provides more profit margin on their production of rail cars. Steel is the number one commodity that they buy and the weakness in the industry has driven the price of steel down such that it has had a benefit for TRN.

Price of steel right now 10-25-2016  $300 per ton   

  • Litigation: Currently TRN is middle of a contentious lawsuit regarding ET-Plus, a guardrail system that they created and installed. Trying to predict the outcome of the trial is impossible but there is a $663 million settlement pending the result of the trial. The settlement is currently under appeal but it is anyone’s guess how that will go.

The unit in question that sold the guardrails is the Construction Products Group, which has been a small but stable source of operating profits for Trinity Industries. Right now, Trinity holds about $614 in cash on their balance sheet. The reality is that this lawsuit is unlikely to bring Trinity down or affect the operating units of TRN that much. It could affect the valuation of the stock in the short term but the strength of the company will continue to lead it forward.

Valuation

The current P/E ratio for TRN is 5.73 for TTM, while the S&P 500 ended September with a 24.15 P/E and a 2.76 for P/B. While Trinity is sitting at a 0.89 for P/B. For a comparison, the industry average is a 15.56 P/E and the P/B is 1.17.

Currently, the stock is trading at a price-earnings ratio below its historical average of 11.31. So, it’s about half its historical valuation at current prices. This bodes well for the continued growth of the company, despite the short-term headwinds it is currently experiencing in the slowdown of railcar orders and the litigation that is still out there.

The EPS for TRN has seen steady growth the last ten years, despite the short drop during the economic downturn of 2007. EPS has grown from $2.88 in 2006 to finish 2015 at $5.08. That is an increase of 43% including a negative EPS in 2009. The company has shown the ability to weather many different types of fluctuation in the economy and cyclical nature of its business. With the many different types of revenue it has created they have become more than just a railcar company. Even with the downturn in the RailCar Group, which they guided too. They have been able to remain profitable, albeit not as profitable as just a year ago.

Credit ratings:

  • Current ratio    3.51
  • Debt/equity      0.89
  • Cash($ Millions)    $664
  • Last Year Free Cash Flow   $-90 Million
  • Last Year Net Income       $826 Million
  • Last Year Dividends Paid    $63.84, Million

The Current Ratio is at the highest level seen for the last ten years. And it is higher than 91% of all companies in the train industry. The backlog that TRN is currently sitting on is driving this number up. Right now TRN is sitting on $4.3 billion in railcar assets, with $535 million of that being produced in the last 6 months. The ratio is a little higher than we would like to see and is a minor concern with it being the highest seen for the last ten years. Overall this is not a concern as they are expecting to deliver 27,000 railcars in 2016 which will reduce the current inventory, which is one factor driving up the current ratio.

I am quite comfortable with the debt ratio as it stands. With the company’s current backlog of railcars and their ability to turn those into cash.  Either utilizing a sale or with the lease program, those railcars will provide enough cash to help liquidate those debts.

For the last ten years, TRN has been able to generate free cash flow, even during the Great Recession. Management has done a great job working through the tough challenges they have faced and have built a business that is able to withstand economic headwinds by having flexibility in their manufacturing and diversifying their product base.

TRN has been a consistent dividend payer since their inception. This is an indication of their commitment to their shareholders. Currently, the yield is 1.9%, which is less than stellar but they are consistent and it is a bonus in addition to the growth they have shown. In the first two quarters, they have repurchased shares amounting to $35 million.

Final Thoughts

Trinity Industries is undervalued at the current time given that they’re currently at a P/E of 6 and their historical median is 11.31. This is a discount of 53%. Undoubtedly the company is going thru a headwind with the downturn in the RailGroup and the Leasing portion of their business. However, management has done a great job of developing other streams of income to help lessen this blow.

There is great opportunity with the RIV platform, especially as a means to lessen the downturn in their manufacturing orders. The company has managed to show a profit even during this headwind, which is encouraging. There have also been several developments with the large purchase by ValueWalk, and the possible good outcome of the pending litigation.

Even though there has been a decrease in earnings and profit proportionally, there is still value here and room to grow. With a solid management team in place and a nice sum of $814 million in cash and cash equivalents that they ended the second quarter with. They are in a good position to go many different ways to increase the value of the company. Either through an acquisition or share repurchases.

I currently long TRN and will continue to look for opportunities to buy more on the dips.

Disclosure: I/we am long TRN

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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