New Regulations Could Further Buoy Railcar Companies

BMI View: Railcar companies look set to benefit from more stringent regulatory standards on tank cars used for crude transportation in North America. While recent regulatory changes have largely been priced in by markets since we highlighted this view back in February, should the US follow Canada's lead with more stringent regulations, there could still be upside for the share price of companies like Greenbrier and Trinity, if to a lesser extent than we had previously seen.

We had previously highlighted our expectation for more stringent crude-by-rail regulations to be put in place in North America, and that this would likely benefit railcar companies, suggesting potential for upside to the share price of companies like Trinity and Greenbrier ( see 'Railcar Companies To Benefit From Forthcoming Regulations', February 13). Since then, we have seen 37.4% gains for Trinity, whilst Greenbrier is up 26.6%, as the Canadian government has moved to put in place rules requiring the retrofitting or replacing of older tank cars.

More Stringent Regulations Coming Into Force...

Huge Push Higher For Railcar Companies
Greenbrier Share Price (USD), RSI & MACD

BMI View: Railcar companies look set to benefit from more stringent regulatory standards on tank cars used for crude transportation in North America. While recent regulatory changes have largely been priced in by markets since we highlighted this view back in February, should the US follow Canada's lead with more stringent regulations, there could still be upside for the share price of companies like Greenbrier and Trinity, if to a lesser extent than we had previously seen.

We had previously highlighted our expectation for more stringent crude-by-rail regulations to be put in place in North America, and that this would likely benefit railcar companies, suggesting potential for upside to the share price of companies like Trinity and Greenbrier ( see 'Railcar Companies To Benefit From Forthcoming Regulations', February 13). Since then, we have seen 37.4% gains for Trinity, whilst Greenbrier is up 26.6%, as the Canadian government has moved to put in place rules requiring the retrofitting or replacing of older tank cars.

Huge Push Higher For Railcar Companies
Greenbrier Share Price (USD), RSI & MACD

More Stringent Regulations Coming Into Force...

While the rail industry has been a major beneficiary from the North American shale boom, with insufficient pipeline infrastructure encouraging a surge in demand for transporting crude via rail, a spate of accidents has prompted a series of new regulations in both Canada and the US. Most recently, regulators' focus has turned to ensuring optimal safety standards of tank cars. Namely, while in line with the 2011 standards, new cars are being built to a higher safety code, the rail industry has been unwilling to take on the substantial expense of immediately retrofitting its older cars to the same level. However, the Canadian Ministry of Transport announced significantly more stringent standards on April 23 rd, to close the loophole. Specifically, the new regulations mandate the removal of 5,000 of the "most vulnerable" DOT-111s from conveying crude, gasoline and ethanol, to go into force as of May. Meanwhile, 65,000 DOT-111s must be upgraded or retrofitted with thicker steel walls within three years.

Crude-By-Rail Demand Booming
US - Terminated Carloads of Crude Oil on US Class 1 Railroads

While the DOT-111s could be temporarily shifted to the US, which has yet to pass similar regulations, their ability to move will be limited, as after May 2017 even trains that originate in the US will be denied entry into Canada if they do not meet the safety standards. Moreover, a recent statement by the US Department of Transportation indicates that they will be proposing a comprehensive rulemaking package with "options for enhancing tank car standards" in the next week. This is perhaps unsurprising, as while US regulators have previously been much slower to act, given how much traffic crosses the border, the announcement by Canada increases pressure on the US to push through new standards on a quicker schedule.

...With Benefit To Railcar Companies

Ultimately, we believe railcar companies will be the major beneficiaries of the new safety regulations. A report by the Canadian government suggests that there are around 228,000 of the older DOT-111 cars still in service in North America, with 92,000 of them to be used to carry 'flammable liquids'. While the US Railway Supply Institute estimates that almost 34,000 tank cars can be made every year, these are not necessarily just going to replace older cars coming out of service, but also to meet the new demand. Indeed, shippers looking to buy railcars already face a substantial backlog due to high demand for transporting crude via rail given both its flexibility and the insufficient pipeline capacity in the US and Canada on the back of the shale boom, and the new regulation will only bolster demand. With firms like Greenbrier having already begun to position themselves to take advantage of the new regulations - announcing plans to design 'tank cars of the future' in recent months - the recent and forthcoming requirements are likely to ensure that the railcar companies' already burgeoning orderbooks remain full.

Overbought After The Rally
Trinity Share Price (USD), RSI & MACD

Given overbought technicals we remain unwilling to enter a bullish position on railcar companies in our macro-industry strategy. Indeed, given the huge rally already, we believe that a large chunk of the gains have already been priced in. That being said, further changes in the regulatory environment could have a significant impact. Namely, thus far, the US government has been a laggard in bringing online new regulations. Should it suddenly begin to move more quickly - requiring a rapid phase-out of the DOT-111s in line with the move by the Canadian government - this would increase demand even more substantially for tank cars, and could see these companies' share prices take another dramatic leg higher.

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This article is tagged to:
Sector: Oil & Gas, Country Risk
Geography: North America, Canada, United States
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