The Cowen Take on Trinity, Wabtec

Written by Matt Elkott, Transportation OEM Analyst, Cowen and Company
Matt Elkott, Cowen and Company OEM Transportation Analyst

Matt Elkott, Cowen and Company OEM Transportation Analyst

Equipment analyst Matt Elkott offers perspectives on two of the rail industry’s biggest OEMs.

With quarterly earning releases scheduled for Feb. 18, we are cautious into the print for Trinity Industries (TRN), but the long-term story is intactWe expect solid results and guidance from Wabtec Corp. (WAB). Here’s why.

TRN has a difficult setup into the print, in our opinion at Cowen and Company. While improving rail equipment fundamentals bode well for the company, the lagging nature of leasing poses risk to the fourth quarter results and outlook commentary. We think the Thomson Reuters consensus 4Q20 EPS estimate of a $0.05 loss is problematic, and we estimate the real consensus to be a gain of $0.11, above our $0.05 estimate.

We also think WAB enjoys a favorable setup into the 4Q20 print. The long-cycle nature of much of the company’s business should enable it to post solid results, and improving freight and transit fundamentals bode well for guidance. New power technologies and ESG have come to the forefront. We’re raising our 2021 and 2022 EPS estimates; and our PT goes to $90, from $86.

What is going on in the market now that impacts TRN and WAB business? In North America, railcar industry fleet utilization has posted yet another sequential improvement, with units in storage declining to 397K in February, from 409K in January. Since July, idled railcars have dropped by approximately 129K units as a result of favorable rail traffic trends. Class I volumes are up 6% QTD, following a 3% increase in 4Q20, which ended nearly two years of mostly declining traffic. We expect rail traffic to increase in the mid-single digits this year.

— We would not be surprised to see some rail service hiccups created by a confluence of factors: higher volumes, winter weather disruptions, and the fact that 2021 should be the first year ever that sees traffic growth at the same time that substantially all railroads are implementing some iteration of PSR.

Additionally, scrap prices have warranted a higher degree of equipment retirements, and the PSR headwinds to railcar demand are already largely reflected in the current operating network. What’s more, we would not be surprised to see some rail service hiccups created by a confluence of factors: higher volumes, winter weather disruptions, and the fact that 2021 should be the first year ever that sees traffic growth at the same time that substantially all railroads are implementing some iteration of PSR.

Our insights on both TRN and WAB follow.

TRN Outlook

• TRN’s stock is up approximately 112% since the April low, including an approximately 20% increase this year alone, creating a difficult setup for earnings such that the company would have to report all but a banner quarter and strong outlook commentary for a pullback to be averted. Meanwhile, we believe the Thomson Reuters 4Q20 consensus EPS estimate of a $0.05 loss is too low and includes one extreme outlier. Conversely, the Factset consensus estimate of $0.15 may be too high. We view consensus as $0.11, above our estimate of $0.05.

• We believe that the ongoing improvement in freight market and rail equipment fundamentals will not have a material positive impact on the fourth-quarter results, but will instead gradually benefit the company each quarter of this year and into next. However, we don’t think that it’s a foregone conclusion that TRN will issue specific 2021 guidance, and if it does, it will likely be on the conservative side. This is partly because, according to our channel checks, manufacturing orders have not yet shown the type of improvement this year that would be commensurate with the improvement in industry fundamentals (but we believe orders will begin to increase materially before the end of first-half 2021). In 4Q20, industry orders were an anemic 3.4K units. We have lowered our 4Q20 order forecast for TRN to 1.2K units, from 2.0K units.

We believe that the ongoing improvement in freight market and rail equipment fundamentals will not have a material positive impact on TRN fourth-quarter results, but will instead gradually benefit the company each quarter of this year and into next.

• The positive news about lease rates is already out, with GATX noting 5% increases in 4Q20 and 3Q20. We would expect TRN to note similar low-to-mid-single digit increases, but not more.

• All this being said, we believe TRN’s 2021 outlook remains intact, and our unchanged $0.80 EPS estimate is still above consensus of $0.67. We are raising our 2022 EPS estimate to $1.38 (consensus $1.04), from $1.25, as the lagging nature of leasing should mean that the progressively improving industry fundamentals could have a long-lasting impact. Our SOTP price target rises from $30 to $34.

WAB Outlook

• We are raising our 2021 and 2022 EPS estimates to $4.35 (consensus $4.33) and $5.00 (consensus $4.88), from $4.20 and $4.90, in large part to reflect what we see as improving North American freight fundamentals. Our price target rises from $86 to $90 based on our new 2022 EPS estimate and an 18x multiple—up from 17.5x in order to reflect our increased confidence about the freight recovery as well as a more favorable U.S. policy environment, which should bode well for federal transit spending.

• We see little risk to our 4Q20 EPS estimate of $1.03, which is largely in line with consensus. We expect the quarter-end backlog to remain stable. In 3Q20, the backlog of $21.4 billion was largely flat sequentially, an encouraging sign in the current environment. The freight backlog was just shy of the prior quarter, while transit was up modestly. (See my column, “Election ‘Blues’ Could Benefit Rail Suppliers,” in which I detail Cowen’s view that transit concerns are overblown.) Not only did WAB remain the only company in our transportation equipment (both rail and truck) and machinery coverage to provide guidance in October after resuming the practice in July, but the company actually raised guidance modestly.

• As noted earlier, we would not be surprised to see some rail service hiccups created by a confluence of factors: higher volumes, winter weather disruptions, and the fact that 2021 should be the first year ever to see traffic growth at the same time that substantially all railroads are implementing some iteration of PSR. Such disruptions could have a positive effect on WAB’s aftermarket business, including DC-to-AC locomotive models and other equipment upgrades given limited built-in redundancies in the rail network currently.

• WAB is our best ESG idea in the transportation equipment sector. Roughly one third of its revenue is components and services for the inherently energy-efficient transit rail industry, while the remaining two-thirds are locomotives, components, and services for freight rail, which is 3x-6x more energy efficient than truck freight transportation. In addition to that, the company is investing in new technologies. In 3Q20 it received an order for transit hybrid locomotives for New York City and its first zero-to-zero order for a Class I railroad; and management noted that it is having many conversations on new locomotive technologies with customers in the U.S. and other world regions. (Also, see my column, “Election ‘Blues’ Could Benefit Rail Suppliers.”)

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