American Railcar bond 6.74 yield to call 7% yield to Maturity in 30 months.
American Railcar is a leading North American designer and manufacturer of railroad cars including intermodals, hoppers and tank cars for products including grains, chemical and ore transportation. They have recently vertically integrated their offerings from basic manufacturing to include fleet repair, parts, maintenance, refurbishing and leasing. Based in St. Charles, Missouri, American Railcar can trace its roots back to over 100 years. In the late 1980’s, they were spun off to their own entity.
At Durig Capital, we have developed a process to review, select, purchase and monitor corporate and world bonds on an ongoing basis. Enclosed is our review, along with supporting documents, showing why we believe this corporate bond makes sense in our clients’ portfolios. We reviewed thousands of separate corporate bond listings to find what we believe is currently the best corporate bond for investors. The following includes our selection criteria.
Step 1 – Yield Curve at 3-7 Years Out
As investors seek more secure returns, select lower rated bonds have recently returned to higher yields, especially relative to US treasury yields. Most fixed income investors share a common fear, one of inflation in the longer term market. Given the large increase in money supply we are advising our clients to keep bond maturities on the shorter end. While we believe that inflation pressures continue to build, we acknowledge that this incubation process might not be realized in the very short term and have set our fixed income horizon to examine issues that mature within the next seven years.
One of the largest concerns regarding bond issues we have seen from investors is current yield. Furthermore, finding corporate debt in this market that offer investors sufficient yield while not paying large premiums to par has become more difficult. Although this American Railcar’s note is trading slightly over par, $101.03, the 7.5% coupon is attractive. Overall the yield to worst for this note is 6.74 % were it to be called in two years at par. We seek these shorter term notes that present investors with a higher current yield.
Step 2 -Profitability
Second Quarter Highlights
- Total revenues for the second quarter of 2011 were $111.9 million as compared to $61.2 million for the second quarter of 2010.
- Railcar shipments for the second quarter of 2011 were approximately 1,040 railcars as compared to approximately 370 railcars for the same period in 2010.
- Gross profit was $13.3 million for the second quarter of 2011 as compared to $2.6 million for the same period in 2010.
- Net earnings for the second quarter of 2011 were $0.6 million or $0.03 per share as compared to a net loss of $5.9 million or a loss of $0.28 per share for the same period in 2010.
- Adjusted EBITDA was $10.9 million for the second quarter of 2011 as compared to $0.8 million for the same period in 2010.
- The Company’s backlog increased to approximately 5,290 railcars at June 30, 2011 from approximately 1,050 at December 31, 2010. The Company’s backlog at June 30, 2011 includes approximately 640 railcars for lease.
- Subsequent to June 30, 2011, the Company has received additional orders for over 2,200 railcars, including 435 railcars for lease.
With American Railcar’s main manufacturing business having many significant barriers to competition, they used this core enterprise as a launching pad to grow several ancillary businesses that provide better business predictability. One interesting item to note is that over the last two years, the repairs and services industry has provided strong growth for them. Repairing railcars is one of two major strategies to help diversify the company away from the deeply cyclical nature of their railcar manufacturing business.
The second major strategy they have adopted is the addition of railcar leasing options. This makes good business sense and may become a material part of the overall business. After the last deep recession and its affect on American Railcar’s bottom line, this new addition might provide a valuable annuitized income stream.
Step 3 – Debt to cash ratio.
American Railcar has a strong debt to cash ratio. This is one of reasons why we chose to review this bond in depth. Cash and equivalents as of the end of last quarter, June 31, 2011, were $301 million. The debt issue being reviewed is the only issue on the books and was issued for $275 million. If the need were to arise, American Railcar could pay off the long term debt simply with the cash on hand. American Railcar has a similar cash to long term debt position as another company we follow called Blyth Inc. We are attracted to issuers that have the large amounts of cash on hand as cash helps them utilize more flexibility in achieving their goals.
Step 4 – We like companies that have profitable and growing business.
During this extended downturn we desire flexibility, profitability, and growth in a business. When we find firms that have multiple layers of debt, it can be very hard to decipher who is on the top rung of the lien ladder. American Railcar currently has only one corporate bond outstanding and this helps us to believe that this superior position class of debt in times of trouble would not be competing against many other layers of debt holders were liquidation to occur.
They currently have a market cap of about $367 million. With the $275 million of outstanding long term debt, they have a 1.33x equity to long term debt ratio. A ratio above one means that the firm has more market value of equity than they have long term debt. They have some flexibility to raise capital should they need but this also is below our norm.
There may be some hidden value for bond holders in the balance sheet. Mature industries such as railroads and services have been established for quite a while. American Railcar can trace their history back over 100 years although they have been independent since the 1980’s. 100 years ago, the rail industry developed on the out skirts of town. On the books, American Railcar has over $181 million in property, plant and equipment. Typically these numbers are below market prices due to when they were purchased and depreciation. Without going into too much superfluous detail, the property may be able to return fixed income investors capital were ongoing fiscal health became a problem. Either way, the book value of the property alone covers about 65% of the outstanding debt.
Step 5- We like high yields.
This issue from American Railcar is priced to yield to worst of 6.74% should it be called at par on March 1, 2013. The yield to maturity for this issue is 7.034 % maturing on March 1, 2014. Similar maturing US T-bills are yielding about 0.31 %, meaning American Railcar is yielding about a 6.5% spread, or about a whopping 22 times higher than the benchmark bonds.
Step 6- Important Risks
This bond does have more risk associated with it than others we have reviewed in the past. They have a short record of positive net income. But even in times when they were not profitable, they were quite capable at conserving the majority of their cash reserves.
There is one person that controls a majority of the equity. The billionaire investor Carl Ichan owns about 54% of the outstanding equity as last reported, and is the Chairman of the Board. Although this may or may not be a positive item in itself, it is material that such a renowned investor has such a large and active involvement. Given that he has taken on a much higher risks to rewards position in America Rail cars, the evident belief that the underlying stock has real value leaves our bond clients additional room for comfort, as Ican appears very well financed with many additional connections.
The underlying business appears to be making numerous strides in the right direction, as it is returning to profitability.
This issue has been given a Caa1 rating by Moody’s and a B+ by S&P. This issue may not be of suitable credit quality for certain individual’s portfolios, based on these credit ratings. Simply because the coupon the note is 7.5% does not guarantee that this return will be realized. Should cash flow problems arise, interest and principal returns may be curtailed, reduced, or eliminated.
This is not by any means an all inclusive list of risks. An individual suitability review should be conducted for each prospective purchaser.
We believe that we have identified a favorable bond from a business encompassed with a large competitive moat, cash generating profitability, a high cash position, a flexible balance sheet, underlying property values, and is positioned within a lagging industry. Therefore, this bond could be considered for enhancing one’s fixed income portfolio. The possibility for this bond to generate an over a 6% yield for its less than three years maturity is also quite attractive. Although this issue currently has a Caa1/B+ rating, we believe it is well positioned and have included it as a position in selected fixed income portfolios.
Yield to Worst (Call 03/01/2013) 6.74 %
Yield to Maturity 7.03 %
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Disclosure: Durig Capital clients currently own these bonds.
To know more about this American Railcar bond call our fixed income specialist at 971-327-8847.