Description

Trinity Industries Inc. (TRN) - $14.00 on July 1, 2009

                                                                                                                                           FY 2009            FY 2010

Price:                                                       $14.00              EPS:                          $1.00                $0.38   

Shares Outstanding (in M):                     78.6                  P/E:                           13.8x                36.0x

Market Cap (in $M):                                 $1,074              EBITDA (in $M):        $400                 $329

Net Debt (in $M):                                     $1,604              EV/EBITDA:               6.7x                  8.2x     

Enterprise Value (in $M):                        $2,679

Company Description:

Trinity Industries, Inc., through its subsidiaries, provides various products and services for the industrial, energy, transportation, and construction sectors primarily in the United States. Its Rail group manufactures and sells railcars and component parts, such as auto carrier cars, box cars, gondola cars, hopper cars, intermodal cars, specialty cars, and tank cars. This group also offers railcar parts used in manufacturing and repairing railcars, such as auto carrier doors and accessories, discharge gates, yokes, couplers, axles, and hitches. The company's Railcar Leasing group leases tank cars and freight cars, as well as provides management services. Its Construction Products group produces concrete, aggregates, and asphalt; manufactures highway products, as well as beams and girders used in highway bridge construction; and distributes construction aggregates, such as crushed stone, sand and gravel, asphalt rock, and recycled concrete. The company's Inland Barge group offers various inland barges and fiberglass barge covers; dry cargo barges, including deck barges, and open or covered hopper barges that transport various commodities, such as grain, coal, and aggregates; and tank barges used to transport liquid products. Its Energy Equipment group manufactures tank containers and tank heads for pressure vessels, propane tanks, and structural wind towers.

Summary:

• § This is a very controversial story that we believe is completely misunderstood and is not being properly valued
• § TRN's capital structure is misunderstood as well as its asset value. TRN is not over leveraged as some believe - in fact it is more likely under leveraged.
• § The stock screens expensively at first glance however on a sum-of-the-parts analysis TRN is very cheap
• - If you discount the Leasing businesses book value by 20% and apply a 1.1x multiple (multiple of closest publicly traded leasing peer) on that it implies an equity value of $1.5bln which is greater then the entire company's market cap.
• - We realize the manufacturing businesses fundamentals are not great but getting it for free is compelling.
• - A sum of the parts analysis on the manufacturing business suggests that it is worth equity value of roughly $950m on '09 and $500 on '10
• - Furthermore TRN has a 25% equity stake in a leasing business that they formed named TRIP. TRIP has a value of roughly $1.00/share or more
• § TRN should see improved margins from its leasing business based on the fact that it will be making significantly less sales of its lease car fleet in this environment which carries lower margins.
• - The leasing business is terribly misunderstood for a number of reasons:
• o People believe it is over leverage however based relative to its closest publicly traded peer it is clearly underleveraged based on assets to book value
• o Its closest publicly traded peer has a price to book value of 1.1x - significantly higher vs. TRN. Yet TRN's Leasing business has a similar if not more favorable balance sheet vs this peer.
• o There are concerns that the assets either are or will be impaired. Railcar assets have an extremely long life and hold their value very well. Based on current lease rates and utilization rates there would have to be significant downside for these assets to become impaired.
• § Lease contracts have a term of 5 years. This suggests that only 20% of the fleet is rolling off in any one year. So lease rates while down year over year are still flat to potentially up from five years ago.
• § Utilization rates in the latest qtr were 98.4%. Last cycle they reached 94% and the industry roughly 90%. Utilization rates would have to reach
• § The manufacturing business is weak but there are some offsets.
• - Construction products should improve given we are now entering a more seasonal period and stimulus will eventually begin to help. Furthermore mgmt was very disappointed that the segment had negative margins in Q1'09 and mgmt does not expect that to continue.
• - Barge will be weak going forward given too much capacity in the industry, backlog is deteriorating, and mgmt has already admitted last qtr was peak for revenue and margins.
• - Energy Equipment should begin to pick up. The company has solid exposure to the wind market with a substantial backlog of $1.3bln.
• - Railcar manufacturing will continue to be weak for the remainder of this year and most likely next. Management expects to sell about 5,000-10,000 cars this year and less next year. However, mgmt has taken a number of steps to offset this weakness with cost initiatives and plant closures.
• § Company should generate solid FCF this year. Last yr the company had negative $128m of free cash flow vs Q1'09 of positive $57m. Compensation for mgmt this year is based on an incentive target of $281m of cash flow and capex has been cut significantly.

Capital Structure by Segment:

• § TRN debt / cap at the end of Q1'09 was 46.6% and Debt / EBITDA 2.6x
• - The manufacturing business debt / cap was 63.7% and Debt / EBITDA was 1.2x
• - The leasing business debt / cap was 41.7% and Debt / EBITDA was 5.6x
• o This compares to its publicly traded leasing peer of 72.4% and 5.1x

TRN Leasing Business vs. Publicly Traded Peer:

• § Rail assets / book value is 1.6x for TRN vs. its peer leasing company of 4.9x suggesting TRN is actually underleveraged to the contrary of what many believe.
• § Furthermore the balance sheet metrics for TRN are just as, if not more favorable then its peer.

Health of Railcar Leasing Business and Assets:

• § Lease contracts have an average contract term of five years suggesting that about 20% of the fleet is up for renewal each year.
• § Based on TRN's publicly available filings you can calculate that in Q1'09 their lease rates were roughly $608/month. This is down year over year by about 4.3% and sequentially by about 3.7%
• - Given lease terms run five years on average lease rates were probably flat to up from 5 years ago while spot rates are down on the magnitude of roughly 25%
• - This shows that lease rates are less sensitive to the business then many may believe.
• § Utilization rates are key to maintaining solid free cash flow and margins not lease rates. Last cycle utilization rates were 94% for TRN and 90% for the industry. Utilization rates would have to slip to 75% or lower for TRN to take an impairment charge on its lease fleet assets due to the long life of these assets and the relatively stable long term lease rates.
• § Currently (as noted in the chart above) TRN has a lease fleet of 47,650 cars valued on its balance sheet at roughly $57,110 / car. Lease rates within the industry are determined by multiplying 80bps by the value of the first car leased - for example if a railcar is valued at $50,000 the lease rate would be $400/month ($50,000 x 0.008 = $400).
• § Based on TRN's lease rate in Q1'09 of about $608 this would imply a value / railcar of $75,998 ($608 / 0.008 = $75,998). This would imply a 33% difference between current market value and what the value is on the balance sheet - a lot of room before the asset becomes impaired.

TRN's Leasing Business Balance Sheet:

• § The debt on the leasing business is predominantly non-recourse debt

Valuation:

• § Sum of the parts valuation suggests an implied value of $31/share based on valuing the manufacturing business on an EBITDA basis and the leasing business on an multiple of book value.
• § Applying the same valuation methodology to CY'10 yields an implied value of $20/share - still significant upside to the current price

• § If you discount the book value of TRN's leasing business by 20% (to be conservative) and put a 1.1x multiple on it that implies an equity value of $1,482m (vs current market cap of $1,074m). You are essentially getting the manufacturing business for free.
• § We believe the shareholder base of TRN is more of an industrial focused investor base vs its publicly traded leasing peer of more financial investors. The two different investor groups value leasing business differently and that is partially the reason we believe TRN is not being valued properly.

Catalyst

See above.