FreightCar America - another value to avoid

FreightCar America (RAIL, $53.40)

Here at StockReply we are quick to bring you news of stocks to hesitate over. So when we read that Amaranth was liquidating its position in RAIL and this piece from the increasingly shrill Fool we thought we'd ride the rail, jump the tracks etc etc.

RAIL makes specialised aluminum railroad cars, mainly used to transport coal, and has done since 1901. How picturesque, pre-internet and manly can you get? There is little competition, partly because all of its competitors have died or merged and partly because the cars are too heavy to import cheaply.

The major issue in valuation, and what makes this an interesting case, is the cyclicality of demand. We might even use this as a proxy case before tackling something similar but more meaty, like the housebuilders. The 10-K sets out clearly the drivers but the easiest number to latch onto is the new railcar backlog. At the end of 2005 it was over 20,000 and right now it is over 12,000. The worst year in the most recent cycle was 2002 when it was 1,000.

This ratio of worst to (presumably) best is mirrored in the turnover, which was $225m in 2002 and will likely be close to $1.5 billion this year. Management looks pretty good but inevitably there is an even bigger swing in profitablity. This year EBIT looks like it will turn out at c.$200m but in 2002 it was next to zero.

RAIL is churning out cash at the moment and had $185m net at the last quarter end. There are no other net operating assets. The interesting question is how to value the operating cashflows. What would you pay for a cashflow that fluctuates between zero and (a fully taxed) $135 million per annum? Unlikely to be above ten times peak, or $1.35 billion, or below zero.

One approach would be to take the average cashflow over the cycle and capitalise it. This might be worth $675m. In fact, RAIL didn't make very much in 2003 and 2004 so this would probably turn out an overestimate.

Still, sticking to the $675m and using the current cash as a base gives a minimum value per share of $13.40 and maximum of $62.32, which is not so far above the current price. We would be interested in comments and some alternative methodologies for valuing this one.