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Tickers in this Article: RAIL, GBX, TRN
FreightCar American (Nasdaq: RAIL) is experiencing a decline in orders and backlog that is hurting its sales. The company was primarily a coal railcar manufacturer (96% of its business), though now it is trying to diversify beyond coal-carrying railcars. The strategy is designed to help the company overcome the cyclical nature of its business. So, what are the prospects for success?

Recent Results
Sales for the first quarter of 2007 were $322 million, which is up 10% compared to the same quarter of last year. Earnings per share were $1.82 compared to $1.71 for the prior year's quarter. These results look good on the surface; however, there are some growing problems that will cause serious problems for RAIL's stock price, unless the company can generate substantial new sales.

Additionally, free cash flow was a negative in the latest quarter. The prime reason was due to receivables from two customers that were collected after the end of the quarter. While this corrects the problem, it also indicates that RAIL is currently subject to potential problems when sales slow.

Backlog Declining
The table below shows the annual history of RAIL's backlog and sales beginning the year 2003 (only the first quarter is shown for 2007). Backlog and sales grew from before 2003 through 2005. In 2006, backlog started to fall as the company delivered more railcars than it received in new orders. Since it had a very strong backlog coming into 2006, the company experienced growing sales as it delivered a record number of railcars. However, new orders for railcars were less than half of the cars it delivered. This trend in declining orders continued into the first quarter of 2007. If the company does not get a significant number of new orders soon, it will have to substantially reduce its production of railcars, which will radically lower sales in the coming quarters.

In the coal carrying business the order rate for new coal cars is primarily driven by the demand from new or expanded coal plants, rather than the general economic conditions. Since it takes several years to build a new coal-fired generation plant, investors should not expect new orders for coal cars to take place until six to nine months before the plant comes online. The company also receives orders from railroads who are replacing their older coal railcars. There were many of these orders recently, which means investors should not expect new sales of coal cars to come until the first half of 2008 at the earliest.

RAIL's new CEO Christian Ragot, who assumed the role on April 30, 2007, is attempting to add non-coal carrying cars to the portfolio to diversify the company's product offerings. One year ago almost all of the cars the company produced were coal-carrying cars, compared to 77% in the first quarter of 2007. This resulted in 22% of the company's revenue coming from non-coal-carrying cars. In the first quarter the company experienced approximately a 50-50 split of new orders between coal-carrying cars and non-coal-carrying cars.

At the present time, the company is building new intermodal rail cars (railcars that piggyback truck trailers) in addition to coal cars. It is also testing an intermodal articulated car that management believes will be positively received. Intermodal cars represent approximately 40% of the cars used in the North American train system. On the down side, this is a competitive arena with several other companies involved including Greenbrier Companies (NYSE: GBX) and Trinity Industries (NYSE: TRN). Also, demand for intermodal cars is closely related to the strength of the overall economy of the United States. As a result, the strategy to broaden its focus to non-coal-carrying cars should help RAIL to grow its business in the long term. In the mean time, investors need to be ready for lean times as it will take a time before investors see growing new sales and backlog from the product offering.

The Bottom Line
RAIL is facing a slow down in the production of railcars that will cause sales and profit to decline by the third quarter of 2007. At present, the company is facing difficult times until sales of new railcars start to increase. Since the sale of intermodal cars is closely tied to the overall economy and to the construction of new coal-powered generation plants for coal cars, RAIL will have to find ways to adjust to lower sales and profit for several quarters at least. Investors should be prepared for disappointing sales and profit numbers in the quarters to come.

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