It really hit the fan Friday after Trinity Industries (TRN) seriously lowered 2016 earnings, sending TRN stock spiraling downward. Friday’s tailspin cut several dollars off a stock price that had already lost 19% in the past three months alone, and another 10% in the nine months before that.
The mid-cap is best known for its railcar business and, as everyone who doesn’t live under a rock knows, the demand for railcars has seriously slowed in the past year as oil prices retreated to below $30 a barrel.
There’s not much the company can do about the price of oil, so down go margins as management scrambles to figure out how to keep the business on the rails until things improve.
That puts TRN stock holders on the hot seat: Do you hang on and ride out this downturn or do you cut and run?
In afternoon trading Friday, TRN was off 23% on eight times the normal volume, suggesting that many existing shareholders aren’t waiting around for an explanation from CEO Timothy Wallace.
Who can blame them?
The Ugly Side of TRN Stock
One minute Trinity announces 2015 earnings per share of $5.08 on revenue of $6.4 billion, and the next it’s expecting a 60% drop in 2016 earnings as weakness in the industrial economy has taken a toll on its railcar group, its biggest segment by far.
It’s going to be so bad management expects a one-third drop in the railcar group’s operating margin to 15% on revenue of $3.1 billion. In comparison, the railcar group’s 2015 revenue was $4.46 billion. Whether we’re talking revenues or operating profits, there’s no way to sugarcoat these numbers. They’re butt ugly.
Trinity Industries, right now, is a burning building where people are fleeing to safety. There will, however, come a day when that building is rehabilitated and tenants move back in. You want to be there before this happens, not after. The price of oil will rebound, and with that, as will demand for railcars.
Now, to explain why Trinity Industries is the best way to play an oil rebound, let’s consider the other parts of its business — construction products, inland barges, energy equipment and railcar leasing and management — in relation to its railcar manufacturing.
First, let’s make sure we’re comparing apples to apples by excluding intersegment sales.
In 2015, the railcar group sold $4.46 billion in railcars, but that included $1.16 billion in sales to its leasing business. Its operating profit was $932 million minus $260 million from sales to the leasing business. Excluding those, the railcar group generated an operating profit of $672 million on $3.3 billion in revenue; the other four businesses excluding intersegment sales generated $919 million in operating profits on $3.1 billion in revenue.
What’s important to note here is for every dollar the railcar group generated in revenue in 2015, it made 21 cents; while the other four businesses made about 30 cents per dollar of revenue.
The Bottom Line on TRN Stock
Even with the cut in guidance, the leasing business is expected to generate $300 million in operating profits on $700 million in revenue in 2016. Meanwhile, the railcar group is expected to generate the same $300 million on $2 billion in revenue. The other three businesses might contribute $150 million in operating profits in 2016, about half what they did this past year, which brings the grand total to $750 million. Knock off $125 million for corporate expenses (in between the corporate expenses in 2015 and 2014) and we’re left with around $600 million. Interest and taxes eat up another $280 million, bringing the total down to $320 million in net income, or $2.13 per share.
The company’s guidance calls for something between $2 to $2.40 per share, so we’re in the ballpark.
Two years ago, I recommended TRN stock along with four other mid-caps … at the time it was trading at almost $50. That’s a huge miss on my part. In my defense, oil prices were much higher, with a barrel of West Texas Intermediate going for three times the current price. I don’t think anyone could have predicted the tumble oil would take in 2014 and 2015.
Could TRN stock go lower? Absolutely.
However, opportunity often comes disguised in the form of misfortune, or temporary defeat. Napoleon Hill said that, and I believe it absolutely applies to Trinity Industries at this moment in time.
It isn’t pretty now. But those rushing into the burning building will be rewarded in one to two years.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
