The Cowen Insight: OEM Earnings, Railcar Demand

Written by Matt Elkott, Transportation OEM Analyst, Cowen and Company
For 2020, 2021, and 2022, we are projecting railcar deliveries of 32.2K, 35.9K and 36.2K units, respectively.

For 2020, 2021, and 2022, we are projecting railcar deliveries of 32.2K, 35.9K and 36.2K units, respectively.

At Cowen and Company, we are revising our transportation OEM and machinery earnings estimates for fourth-quarter 2020 and 2021, and introducing our 2022 estimates; updating our North American Class 8 production forecast; and fine-tuning our railcar supply demand model. What are we seeing? Gradually improving supply-side dynamics.

OEM Positioning and New 2022 Estimates

We see Wabtec (WAB) as best positioned into the 4Q20 print. The Greenbrier Companies (GBX) is our top pick for 2021 (as noted in my Dec. 14 column), but we are cautious into the fiscal 1Q21 print in early January. In case of a major pandemic-related setback to global economies (not our assumption currently), Cummins (CMI) and PACCAR, Inc. (PCAR) could see relative near-term outperformance. Also, we’re introducing 2022 transportation OEM earnings estimates and raising some price targets.

• For PCAR, we are maintaining our 2021 EPS estimate of $5.50 and introducing our 2022 EPS estimate of $6.10. Our $88 price target remains unchanged as we move to valuing the stock based on 2022 earnings, previously 2021, while lowering the PE multiple to 14.5 times, from 16.0 times. As in the case of CMI, while the upside reflected in our price target is not compelling enough to warrant a more constructive opinion—in case of a major pandemic-related setback to the global economy (not our assumption at this point)—PCAR could see relative outperformance in the near term as a flight-to-quality dynamic could re-emerge.

• For CMI, we are raising our 2021 EPS estimates to $14, from $13.85, and introducing our 2022 EPS estimate of $16.50. This is largely to reflect the company’s strong execution and the ongoing recovery. Our price target rises from $222 to $239 as we move to valuing the stock based on 2022 earnings, previously 2021, while lowering the PE multiple to 14.5 times, from 16.0 times.

• For GATX, we are raising our 2021 EPS estimate to $4.15, from $4.10, and introducing our 2022 EPS estimate of $5.25 to reflect what we see as improving railcar industry dynamics. Our price target rises from $70 to $84 as we move to valuing the stock based on 2022 earnings, previously 2021, while lowering the PE multiple to 16 times, from 17.0 times. While the upside reflected in our price target is not compelling enough to warrant a more constructive opinion—in case of a major pandemic-related setback to the global economy (not our assumption at this point—GATX could see relative outperformance in the near term within the rail equipment sector due to its quality and the protection provided by lease terms.

We remain confident that railcar demand has bottomed, and following some consolidation, The Greenbrier Companies has more than a 40% manufacturing share in North America.

• For GBX, we are maintaining our calendar year 2021 EPS estimate of $2.89 and introducing our calendar year 2022 EPS estimate of $3.18. Our $41 price target remains unchanged as we move to valuing the stock based on 2022 earnings, previously 2021, while lowering the PE multiple to 13 times, from 14.0 times. We remain confident that railcar demand has bottomed, and following some consolidation, GBX has more than a 40% manufacturing share in North America. Its international markets are also improving. All of this and a right-sized cost structure make GBX our top 2021 pick, although we are cautious into the fiscal 1Q21 print in early January.

• For Trinity Industries (TRN), we are raising our 2021 EPS estimate to $0.80, from $0.77, and introducing our 2022 EPS estimate of $1.25 to reflect what we see as improving railcar industry dynamics. Our SOTP price target rises from $25 to $30 as we move to valuing the stock based on 2022 earnings, previously 2021.

• For WAB, we are maintaining our 2021 EPS estimate of $4.20 and introducing our 2022 EPS estimate of $4.90. Our price target rises from $80 to $86 as we move to valuing the stock based on 2022 earnings, previously 2021, while lowering the PE multiple to 17.5 times, from 19.0 times. Barring a major pandemic-related setback to the global economy (not our assumption at this point), we believe WAB enjoys the best setup into the 4Q20 print. The long-cycle nature of much of the company’s business should enable it to post solid results and continue to be the only company in our universe providing specific guidance.

FreightCar America has taken significant steps in recent months to improve is cost structure and right-size its manufacturing footprint.

• For FreightCar America (RAIL), we are revising our 2021 loss/share estimate to $0.97, from $0.68, and introducing our 2022 loss/share estimate of $0.22. Our EV/EBITDA price target remains unchanged at $2.65, as we move to valuing the stock based on 2022 results, previously
2021, while maintaining a multiple of 4.0 times as industry conditions improve and given the significant steps the company has taken in recent months to improve its cost structure and right-size its manufacturing footprint.

Updated North American Class 8 Truck Production Forecast

We are now modeling for 2020 Class 8 build of 216K units, above the ACT estimate of 211K units and possibly above the consensus view. However, our 2021 estimate of 265K units is well below the 296K units projected by ACT. This is as we believe that, after the initial COVID-19 shutdowns, the gradual re-opening brought about new dynamics that are effectively pulling forward the Class 8 cycle somewhat.

What dynamics have improved truck carriers’ financials, positioning them well for equipment replacement? They are:

  • Oil price declines.
  • Lower interest rates.
  • Less drastic truck insurance premium increases than we had initially expected.
  • A surge in truckload demand driven by inventory replenishment.

These dynamics should continue for the balance of the year and into the early part of 2021, driving increases in truck orders and production. However, we would expect a quick moderation into mid-2021.

Our North American Railcar Industry Order and Production Forecast

Fine Tuning Our Railcar Supply Demand Model

For 2020, 2021 and 2022, we are projecting deliveries of 32.2K units, 35.9K units and 36.2K units, respectively. Our order assumption is 20.4K units this year, increasing to 36.0K units in 2021 and 40.6K units in 2022.

Our projected 77% increase in industry orders in 2021 is based on the following four factors:

  1. Decelerating rail traffic declines in second-half 20 and our anticipated 6%-7% growth next year. We are projecting a traffic decrease of approximately 8% in 2020, following a 4% actual decline last year.
  2. Improving utilization (526K railcars in storage in July to 428K units in December).
  3. In the railroad industry, the resiliency of the industry-wide, far-reaching capacity rationalization by the Class Is as part of Precision Scheduled Railroading (PSR) has not yet been tested in a growing traffic environment and could lead to service hiccups in 2021— something that would be a driver of equipment demand.
  4. Replacement demand for aging grain cars, box fleet homogenization, and other potential bright spots, such as intermodal equipment and certain types of tank cars.

Gradually Improving Supply-Side Dynamics

The railcar manufacturing industry now looks like a near-duopoly, with TRN and GBX covering approximately 70% of the market.

We believe these four fluid dynamics bode well for the two builders in 2021:

  1. The number of railcars in storage has declined meaningfully for three consecutive months, from about 526K units in July to about 507K units in August, about 477K units in September, 452K in October, 439K units in November, and 428K units in December.
  2. A resuscitation of a long-futile push for railcar scrappage tax subsidies is under way. That said, based on multiple channel checks we have conducted with industry stakeholders, we would not assign a chance of success higher than 50%.
  3. We see RAIL’s recently announced footprint consolidation as a net reduction of approximately 5K units per year to the industry’s maximum manufacturing for the foreseeable future.
  4. With the industry having recently consolidated from six to five builders, and with the consolidator, GBX, having right-sized its own combined manufacturing footprint dramatically this year, we believe the industry is better positioned to exercise price discipline in this cycle than in prior ones. Importantly, some of the capacity rationalization by TRN and GBX is likely to be permanent—something that could effectively reduce the maximum possible industry output, which has historically been 60K-90K units, in our estimation. Our range is a function of the degree of mix uniformity in a given upcycle. At the height of the biggest expansion ever, railcar manufacturers produced 82K units in 2015, thanks to the CBR boom, when lead times for tank cars reached 18 months. Current lead times are likely in the two-to-five-month range. Industry replacement demand had generally been thought to be in a range of 40K-50K units, but due to PSR and several strong railcar build years, it may now be 30K-40K units.
Matt Elkott, Cowen and Company OEM Transportation Analyst
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