Ride the Rails With This $10 Turnaround Play
We're taking a small position in a rail name with an improving outlook. Here's the ticket to getting onboard this contrarian train.
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For our next covered call trading idea we are highlighting a bit of a contrarian and turnaround play. The options against this pure-play manufacturer of aluminum and steel railcars have good liquidity and are quite lucrative.
FreightCar America, Inc. RAIL manufacturers box cars, covered and open-top hoppers, gondolas, intermodal, non-intermodal flat cars, and most recently tank cars from its primary production facility in Northern Mexico. The company produces aftermarket parts from its facility in Johnstown, Pennsylvania.
The stock has lost about a third of its value since the election in early November. The drop has been primarily driven by a revenue miss in the company's most recent quarterly report as well as the potential tariff policies of the incoming Trump administration. The latter is certainly somewhat understandable as its production facilities in Mexico are a key part of FreightCar America’s future and expansion plans. The vertically integrated facility was completed in late 2020. FreightCar America currently has approximately 10% of the overall North American railcar market. This could be ramped up substantially in coming years given the capacity of these facilities which are fully online.
As mentioned, the other headwind to the shares over the past couple of months is the company missed third-quarter revenue expectations. That said, sales were still up more than 80% on a year-over-year basis. The "miss" was also due to the timing of some railcar deliveries. Indeed, management did not lower full-year railcar delivery expectations as a sign of confidence on that front. Revenues are prjected to end the year up 60% in 2024 over 2023.
One other negative is the company’s high cost of debt in the way of high-yield preferred shares. It should be noted that FreightCar America carries no long-term debt. It is anticipated that management will recapitalize the balance sheet by entering into a significantly lower interest rate working capital facility and using the proceeds to retire the high interest preferred. When this happens, it should be a significant positive for the shares, in my view.
After losing money in 2023, FreightCar America is expected to swing to a profit of around $0.25 a share in 2024 and the current analyst firm consensus has that profit tripling in 2025. With the recent decline in the stock, RAIL is trading for just over $10 a share. The median analyst firm price target is in the mid-teens and an insider purchased just over $250,000 worth of shares in mid-November at slightly higher prices.
All in all, we believe the company and stock are positioned as a continued turnaround story in 2025. Once uncertainty around tariff policy is resolved, I expect the shares to head higher.
Option Strategy
This is how one can initiate a holding in RAIL with a covered call order. As a reminder, covered call orders involve buying an equity and simultaneously selling just out of the money call strikes against the new position.
Using the June $10 call strikes, fashion a covered call order with a net debit in the $7.90 to $8.10 a share range (net stock price - option premium).
This strategy provides downside protection of just over 20% with upside potential of 25% even if the equity falls some over the five-and-a-half-month option duration.
Please note that due to factors including low market capitalization and/or insufficient public float, we consider several of RAIL to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.
At the time of publication, Jensen was long RAIL.
