Tuesday, May 31, 2011

Freight cars: A red-hot market

Written by  Luther S. Miller, Senior Consulting Editor

What the sudden surge in orders means for carbuilders and their customers. A giant bulge in freight car orders in this year’s first quarter sent waves of optimism through an industry that is the bedrock of the railway supply business. There were also undercurrents of concern.

Hope that the freight car industry was pulling out of its recession slump was tempered by fears that the sudden feast of orders might produce a famine of castings and components.

A spiral in prices also accompanied the news in May that in this year’s first three months, new car orders climbed to 36,903 (equal to more than six quarters of production at the current rate) and the backlog of cars on order and undelivered jumped to 51,913 on May 1. In all of last year, only 29,992 cars were ordered and only 16,535 were built. Orders dropped to a recession low of 8,336 in 2009.

All of this caused old-timers to wonder if the spring 2011 surge would produce some of the problems that overtook the industry in 1978-79. That was when buyers, spurred by newly created per-diem incentives, flooded the marketplace with orders for 127,000 cars in a single year. At that time, there were nearly 20 North American carbuilders (vs. today’s six) and they scrambled to find scarce parts to keep assembly lines moving. In this search, they were competing not only with each other but also with the repair shops of railroads and other car owners.

Builders were quick to look offshore for help and all too quick to find it. Countries as far away as Japan, Brazil, and Rumania offered parts at premium prices. Bulgaria shipped whole car kits, ready for assembly, to the U.S. Quality was not always a survivor, and quantity soon became a problem. It took years to digest an overabundance of cars, and builders suffered.

There’s no sign that today’s carbuilders either want or need to go that route on any long-term basis—any farther, that is, than they have already gone.

One major carbuilder told Railway Age late in May:

“We are already experiencing component shortages that could have a dampening impact this year. Many of the problems are coming from our offshore suppliers of bearings and truck castings.

“Unlike the shortage of 25 years ago, we already depend on offshore sources. However, we are importing from U.S. manufacturers who have an established presence in Asia. This is a ramping-up issue, and it is anticipated that it will resolve itself by fall. China and Russia are still building cars at a high rate. Some idled domestic capacity could come on line in the fourth quarter.

“We expect a delivery rate in 2011 in the 35,000+/- range, which could be higher if the materials issue gets resolved. There will be a spillover into 2012 for products expected in 2011. We will hit the 60,000+ rate in 2013 and will stay at that level through 2016.”

(These expectations are in line with the revised projections announced earlier in May 2011 by Economic Planning Associates, which under the guidance of Peter J. Toja has been providing the industry’s most reliable forecasts for nearly three decades. See chart on this page.)

Railway Age Financial Editor Anthony Kruglinski’s annual survey of freight car leasing companies also uncovered concerns about rising prices and stretched-out deliveries.

“We expect carloadings to continue to rise, resulting in higher demand for leased railcars,” said Rich Meyers, president of CK Industries, Inc. “However, we do have a concern with the rapid price increases of new cars. For example, 3,200-cube covered hoppers were priced in the low $60,000 range last fall. Today they are being quoted in excess of $70,000, subject to escalation for increases in steel and component prices affecting builders. Another problem is that deliveries for certain types of cars ordered today will not occur until early 2012. That’s a lot of time for escalation to occur.”

Eugene Henneberry, CEO of Flagship Rail Services LLC, was “pleasantly surprised to see lease rates improve at the rate that they have,” but he said, “Constraints on new car deliveries due to the ability to ramp up pricing, and the availability of component parts and materials will remain a concern for the next six to nine months.”

With railroad freight traffic steadily rising, led by double-digit intermodal growth, an increased demand for rolling stock was inevitable. It’s questionable how far that need can be met by existing equipment now in storage. As of May 1, the railroad industry still had 276,228 cars idled—that is, they had not moved a load in 60 days—down from a recession high of 502,863 in July 2009. But industry observers say that many of the still-idled cars are in a condition that puts them closer to the scrap heap than active duty.

There’s also the fact that in these demanding times of specialization, just any car won’t do. Railway Supply Institute President Tom Simpson recently observed: “One issue that hangs over tank car production is the type of car needed for movement of Packing Groups 1 and 2 (primarily for ethanol but other commodities as well) and crude oil. There’s a petition for rulemaking at the Department of Transportation for a federal rule on tank car design for these commodities, but it could take several months or more to develop a final rule. Thus there is some uncertainty with shippers and builders over what type of car to build for this service.”

Sizing up the current freight car market in numbers is relatively easy. Putting a dollar value on it is something else, because price varies according to car type. However, taking the average value of a freight car as $100,000 (close to the actual figure in 2009), the May 1 backlog represents $5.2 billion in business. Is it any wonder that railroad carbuilder shares are trading at up to twice their value a year ago?