The hydraulic fracturing revolution and shale boom has been all about improvements in oil and gas technology — improvements which have helped unearth some of the largest deposits of energy anywhere on the planet and put America on the path to energy independence.
However, the hottest piece of gear helping producers in regions like the Bakken or Marcellus shale isn’t 1,000-horse-power fracking pumps or multi-direction drill-heads.
It’s good ol’ fashioned railcars.
As refiners and energy producers have struggled to get access to mid-continent crude oil in the face of non-existent pipeline infrastructure, they have turned to the relatively low-tech option of rail travel to move crude oil where it needs to be. Quite simply, that’s causing a boom in demand for tank cars.
Historically, less than 1% of all crude oil production has been delivered to U.S. refineries by rail. However, with gushers on the ground now, energy producers as well as refiners have turned towards the railroads as a way to get their products to market. Over the last five years, shipments of rail oil have soared by a staggering 7,000% to 88.9 million barrels.
Tank cars are essentially big containers on wheels that are used to transport all sorts of liquids — everything from crude oil and various chemicals to corn syrup and milk. More importantly, because of the boom in shipping oil via rail, orders for these cars continue to surge.
In the fourth quarter of 2012, the tank car producers received orders for over 11,000 new railcars, while analysts had been expecting less than 10,000. Firms like Valero (NYSE:VLO) and Phillips 66 (NYSE:PSX) have decided to bite the bullet and purchase tank cars in order to take advantage of lower Bakken-based crude, so the order backlog for tank cars continues to rise as well.
According to FTR Associates, there is currently a backlog order of roughly 47,000 tank cars for the manufacturers. And in the last quarter of 2012, only about 4,500 tank cars of those were delivered. Additionally, the time between an order to be processed and the cars to be manufactured has now lengthened to around 18 months.
Plus, analysts expect the rising tank car orders to continue for a few more years as various pipeline infrastructure in unconventional regions continues to be poor. For investors, that means betting on the railcar providers for some portfolio locomotion is a good place to start.
With that in mind, here are two companies that could keep chugging along in the near future:
American Railcar Industries
Activist investor Carl Icahn is generally on the money when it comes to finding new trends. That could help explain his ownership stake in American Railcar Industries (NASDAQ:ARII) … and why he made an offer to buy its rival Greenbrier (NYSE:GBX). American Railcar has been making tank cars for over 150 years and (get your “U.S.A! U.S.A!” chant ready) is the only U.S. company that still manufactures them domestically. ARII has a pretty decent backlog of over 7,000 rail cars — of which tanks make up the bulk — and is expecting demand to be very strong for the rest of this year.
The kicker for American Railcar is that the firm not only builds cars, but also leases the equipment to its customers. Short-term lease rates have jumped as high as $2,500 a month — more than four times the normal rate. Producers are seeking to limit risk in case the boom doesn’t last long as pipelines are built. At that rate, tank cars have a five-year payback instead of the normal 30 years.
ARII currently pays a decent 2.4% dividend and trades at a forward P/E of just 12.
Trinity Industries (NYSE:TRN) makes a whole host of products including highway guide rails and inland barges. However, it’s also the biggest railcar produce. In order to meet surging order demand, Trinity began converting wind-tower factories to train car production last year. Overall, railcars make up about half of its revenue, with tank cars making up 20%.
Like American Railcar, Trinity has been increasing its leasing operations to take advantage of those historically high day-rates. As such, Trinity projects that its full-year earnings will climb as much as 91% built on the backs of increased tank car production.
However, Trinity could also be a play on the eventual pipelines that get built in the unconventional energy regions. In addition to railcars, the firm makes a whole series of high pressure tanks and storage vessels, like the kind needed in energy gathering systems. That could make Trinity a play for now and later.
TRN currently can be had for a P/E of 11 and offers 1.1% dividend yield.
As of this writing, Aaron Levitt did not own a position in any of the aforementioned securities.