Seeing these sites firsthand helps one understand the struggles and accomplishments of the railroad over the past 150 years. There have been many.

All of this railroad talk, however, is not just for history buffs. In fact, it is extremely relevant in today’s market…

In early April, Berkshire Hathaway Inc. announced that it decided to jump into the railroad business by revealing that it had bought up shares of three of the four North American railroads: Burlington Northern Santa Fe (BNI: NYSE), Union Pacific (UNP: NYSE) and Norfolk Southern (NSC: NYSE). The Oracle’s fresh look at the railroad industry has gathered its fair share of attention from investors.

There’s a way you can piggy-back on this renewed interest in all things train-related with a $600 million company that plays an intricate part in rail transport. It all begins with coal…

Coal has once again (and it looks like it will for some time) become a main source of energy, over which this country and so many others have become desperate.

Coal is now on the forefront of the green energy wave. The technology is there to separate raw coal into three parts: Mercury-sulfur, CO2 and purified syngas. The mercury-sulfur is — then separated into its two elements. Mercury is used in various items ranging from diffusion pumps to batteries and advertising signs. Sulfur is used in many products such as pulp and paper products and even fertilizer. The harmful CO2 is injected safely underground. Most important part is the clean coal that is burned to create a clean energy source. This process has already been tested and used in many states in the Northwest and is starting to pop up across the rest of the country.

Of course, this coal needs to be shipped from the mines to these clean coal plants. The ownership of this transportation is in just a few companies’ hands. The railroads have already been exploited. Berkshire’s April disclosure made sure of that, but railcar manufacturing has not yet hit its peak. In fact, the company that leads the industry, FreightCar America (RAIL: NASDAQ), is trading at a significant discount.

FreightCar has manufacturing plants in Illinois, Pennsylvania and Virginia, which are in the Great Appalachian Coal Region. This region is known for its quality and quantity of coal– in fact, it is the best in the country in both aspects.

FreightCar looks to capitalize on this. After all, coal-carrying cars make up 96% of its production. And over the past three years, FreightCar has managed an 81% market share of coal-carrying car manufacturing.

Foreign demand is also a factor. BRIC (Brazil, Russia, India and China) are in high demand of natural resources including coal. China, more specifically, is estimated to import about two million tons per month by the end of this year, causing an ever-growing strain on other countries to transport the coal from their mines to their ports to China as fast as possible. This means more coal-carrying car production, which is good business for FreightCar.

FreightCar management mentioned during its first quarter conference call this year that they are looking into building plants in India, the third-largest coal producing country. This of course would be all big news considering both the demand for coal transportation and the geography of India and China.

A company that does good business but is already quite overpriced is still useless to a smart investor. But a company such as this one with a great market niche as well as a cheap price tag is obviously something to look into. With it trading at under five times its earnings, FreightCar does seem extremely cheap. Companies sporting super-low P/Es almost seem like a thing of the past. When you do come across one that at first glance seems to be trading at a hefty discount to its peers, it usually signals something has actually gone horribly wrong.

But that’s not the case with Freight Car America. Its current P/E is close to its five-year low. Its financial situation is in great shape with no debt and over $147 million in free cash just sitting waiting to act on an opportunity abroad. In fact, it currently has over $16 of cash per share on hand.

Not only is it cheap now, it is still growing at an impressive rate. Its sales grew 56% last year and its earnings 182%. In fact, one of the reasons it may be carrying such a low P/E is because investors are wary its 2007 sales can’t meet its 2006 numbers. The ‘07 earnings growth estimate is small compared to this past year’s, but with talks of Indian plants, these estimates don’t mean much in the long haul.

Either way, FreightCar America is certainly a good company to look into, as this clean coal concept grows nationwide and the worldwide demand stays high.

Until next time,
Jim Nelson
June 7, 2007

Value Investing in the Railroad Industry was originally featured in the Penny Sleuth.