2023-05-30 18:43:31 ET
Summary
- FreightCar America's financials show signs of improvement and the valuation is near a decade low, making it an attractive buy.
- Insiders have continued to buy the stock aggressively, which is a positive sign for potential investors.
- The stock is currently trading at a significant discount, but I advise not to buy aggressively until the capital structure shows further improvement.
It's been just under four months since I announced that I was buying more FreightCar America Inc. ( RAIL ) in a very creatively titled article called "Buying More FreightCar America", and in that time the shares have lost about $.82 per share, or 23% of their value, compared to a small .94% gain in the S&P 500. That is, as the young people say, a "spicy meatball", so I must review the position. The company has reported earnings yet again, so I thought I'd review the name once again to see if it makes sense to add more, take my lumps and sell, or hold. I'll make that determination by looking at these financials and comparing them to the valuation here.
I've been told on more than one occasion that my writing can be "a bit much." For that reason, I put a thesis statement at the beginning of each of my pieces, and these give you the opportunity to get in, get the "gist" of my thinking, and get out again before things become excessively tiresome for you. You're welcome. I'll be nibbling on FreightCar America yet again when markets open, because the financials have shown some signs of improvement, and because the valuation is very near a decade low. The combination of financial improvement, and cheap valuation is too compelling to pass up in my view. Additionally, the people who know this business best (insiders) have continued to buy aggressively over the past month. When I'm on the same side of a trade as such people, my ability to sleep at night improves massively. For that reason, I'll nibble on this stock yet again. I'm not going to buy aggressively until the capital structure shows some dramatic improvement, but I'm comfortable adding to my speculative position here.
Financial Snapshot
The financial history here has been, and currently is, troubled. This is why it's possible to buy these shares at such a cheap price at the moment. That goes without saying. Relative to the same period a year ago, revenue is down about 13%, and gross profits are down by about 26%, which is troubling. It's not all bad news, though, given that the company managed to reduce expenses at a faster rate. Specifically, SG&A expenses declined by even more, 40%, with the result that operating income swung from a loss of $655 thousand this time last year, to a gain of just over $1 million. Additionally, net loss improved from a negative $25.8 million in Q1 of last year to only $5 million during Q1 of this year.
When we compare the most recent quarter to the same period pre-pandemic, a slightly different picture emerges in my view. When compared to the same period 4 years ago, revenue was higher by 14.6%, and net loss was lower by about $9 million. Gross profit was negative 4 years ago, to the tune of $6.8 million, and it's a positive $7.5 million now. Thus, I think there's reason to be optimistic that the turnaround continues unabated.
That written, the capital structure is a source of pain in my view. When compared to the same period in 2019, total liabilities are about $72 million, or 44% higher, and cash is down by about $37 million or 57%. That written, total liabilities are about $21.5 million, or 8.4% lower now than they were this time last year. In spite of that, I won't be very aggressive in my buying activity until I see evidence of further improvement in the capital structure. That written, I'm happy to nibble yet again, assuming the valuation is cheap enough.
FreightCar America Financials (FreightCar America investor relations)
The Stock
We've been told by some well-respected investors that we're "not buying stocks, we're buying businesses." That often misunderstood soundbite sounds great, but it's obviously not true for most investors. We buy stocks, and they are not the same thing as the underlying business. For instance, a stock changes price much more rapidly than anything that happens at the underlying company. This "we only buy businesses" is great for people who have the means to buy a whole company, but the rest of us must access the future cash flows of a given business via the stock, and the stock is often a poor proxy for what's going on at the company. Put another way, the business generates revenue by selling rolling stock. The stock, on the other hand, is a scrap of virtual paper that gets traded around based on a host of factors, some of which have little to do with the business. The stock may be affected by the crowd's demand for "stocks" as an asset class. There's no way to prove it definitively, but there's a reasonable argument to be made to suggest that this stock would be lower still had the overall market not held up reasonably well over the past few months. Additionally, the demand for this stock may fall depending on what a central banker says.
So, to sum up, the business generates revenue by selling freight cars, and the stock bounces up and down based on the crowd's ever-changing views about the future demand for same. I've done best in stock market investing when I've spotted discrepancies between what the crowd thinks about the future of a given business and what actually later transpires. If the crowd is very pessimistic about the future prospects of a company, so much the better, because in that circumstance it's possible to buy it for a proverbial "song." Additionally, when the crowd is particularly pessimistic about a given company, it's possible to exceed expectations. If the company produces results that aren't an unmitigated disaster, the market may celebrate. As an aside, this has been the basis for my dating life, and it seems to have worked out fairly well.
Another way of writing "pessimistic about a given company" is "cheap." I like to buy cheap stocks because they tend to have more upside potential than downside. I measure the cheapness of a stock in a few ways, ranging from the simple to the more complex. On the simple side, I look at ratios, mindful of the fact that there is definitely a strong negative correlation between price paid and subsequent returns. Additionally, it's not guaranteed, but great returns are had when you buy stuff that's on sale. This is why I like to see a stock trading at a discount to both its own history and the overall market. When I last reviewed FreightCar America, the shares were trading hands at a price to sales ratio of .287, which was down from .326 when I reviewed the shares previously. At the moment, they're cheaper still, and the market is paying about 28% less for the shares, per the following:
Source: YCharts
We see that the shares have only rarely been this cheap in the past, and I'd point out again that this is in many ways a dramatically improved business.
You may be familiar with the idea that the current price itself is a great source of information. Embedded within the price are a set of assumptions about the future, and, by back engineering some relatively simple algebra, we can work out what assumptions the market currently has about the business. In particular, we can isolate the growth assumptions the market currently has based on current price. There are some great resources available to retail investors about how to do this, and the two that I've found most helpful in this regard are Penman's "Accounting for Value" and Mauboussin and Rappaport's "Expectations Investing." These two books do a very thorough job of outlining how an investor can work out specific growth expectations currently embedded in price. I recommend them highly.
Anyway, applying this approach to FreightCar America at the moment suggests the market is assuming that this company will grow profits at a rate of about 1% from here. In my view, that is a pretty pessimistic forecast, which prompts me to want to buy some more.
With Apologies To Orwell
All investors are equal, but some investors are more equal than others. Some investors are better at this than others. They may have access to a legion of analysts and can rely on those analysts to tease out the more obscure, but highly relevant, elements of an industry before buying. Some people may have the emotional temperament necessary to be great investors, never succumbing to the self-defeating emotions that bedevil so many investors. Some investors happen to be much better at buying and selling a given stock because they happen to work at the company in question. For that reason, they know more about the business than any Wall Street analyst ever does.
It's this last group that I want to write about. In the month of May alone, insiders have bought 118,900 shares of stock. Admittedly, only two of the purchases came from individuals, but those two individuals put $123,022 of their own capital to work in this stock in that time. When I'm on the same side of the trade as the people who know the stock better than Wall Street, I sleep a bit more soundly.
Given all of the above, I'll be nibbling on this stock, and will be buying some shares when the market opens.
Risks Of Microcap Stocks In General And FreightCar America In Particular
FreightCar America currently sports a market cap of ~$50 million, which puts it on the border between "microcap" and "nano." In case you weren't aware, investing in such stocks comes with certain risks. Chief among these, in my view, is the lack of liquidity in such names. For example, on the latest trading day, the volume for FreightCar America was 20,461. By comparison, volume on Union Pacific Corp. was 228,736, or 11 times greater. If you need to sell your stake in this business quickly, the thinness of the market here presents the risk of significant capital loss.
Additionally, this company presents two specific additional risks in my view. The first of these is that the demand for freight cars will drop. In my view, this isn't an issue at the moment, though it's something to keep an eye on. Second, margins would be very negatively impacted by an increase in input costs, notably steel . Thankfully, the trend here seems to be positive also, though we need to keep an eye on it.
For further details see:
FreightCar America: Improving Business, Cheap Stock