Ordinarily, youd think that manufacturing butane tanks in a mule barn would be a bad idea; and ordinarily, youd be right.

However, when J.C. Bender founded Trinity Steel in Dallas in 1933, thats exactly what he started out doing, and youd have to say things worked out pretty well.

However, it wasnt always plain-sailing. 25 years after Trinitys foundation, the petroleum industry was in decline, and competition had become cutthroat in a way that competition gets only in Dallas.

An engineering graduate of Louisiana Tech named W. Ray Wallacewho had joined the company as its 17 th employee in 1946 and risen to become the firms first president and CEOnegotiated a merger with Dallas Tank Company and Bender-Wallace Development Company, and Trinity became well, a trinity. Trinity Industries Incorporated was born.

Wallace inherited 200 workers and a business that had revenues of $2.5 million (or, for those of you counting, $20 million in todays less robust dollars), and with some smart decision-making he built the company into something of a regional powerhouse, branching out into real estate and the structural steel business in the 1970s, during which time the firm supplied steel for Texas Stadium, the World Trade Center in New York City, the Pennzoil Building, and the Balboa Bridge, as well as several large structures in Moscow.

The 1980s saw rapid expansion both in terms of the companys product lines and its geographical reach. Acquisitions in Channelview, Texas; Elkhart, Indiana; Koppel, Pennsylvania; and Pascagoula, Missouri broadened the companys scope and scale; and in 1984 it added a legendary name to its stable when it bought several railcar manufacturing plants and, more importantly, freight car designs from Pullman-Standard.

This acquisition helped the company to cement its leading position in the railroad car manufacturing business, which, as youll see when we dig a little deeper into the numbers, is the core of the firms strength and has allowed it to expand its complementary businesses into such areas as aggregates, concrete, and asphalt, as well as inland barging, propane tanks, and structural wind towers.

By 1993, the company was driving revenues in excess of $1.5 billion, thanks to the efforts of some 13,000 employees. By the end of 2013 those ranks had swelled considerably to 18,460, with revenues topping $4.4 billion. In a key industry that is highly competitive (there are over 80 manufacturers of rolling stock in the US alone), Trinity Industries has carved out a place at the very top table.

Trinity Industries Inc. (NYSE:TRN)

Trinity Industries is a multi-industry company with exposure to the railroad, energy, chemical, and construction sectors in the United States and Mexico.

The company is divided into six segments:

Rail Group (53.7% of sales): manufactures and sells railcars, including auto carriers, gondolas, hoppers, intermodal cars, and tank cars. The segment also manufactures and sells railcar parts and components.

Energy Equipment Group (12.3%): manufactures structural wind towers, storage containers, and tank heads for shipping vessels.

Railcar Leasing and Management Services Group (12.0%): leases tank and freight railcars to industrial shippers and railroads in the chemical, agricultural, energy, and other industries. The segment also provides management, maintenance, and administrative services.

Inland Barge Group (10.7% of sales): provides deck barges; hopper barges to transport grain, coal, and other products; and tank barges to transport crude oil, chemicals, and petroleum products.

Construction Products Group (9.7% of sales): manufactures highway products, including guardrails and crash cushions, along with mining industry construction equipment, crushed stone, sand, gravel, and steel products for infrastructure projects.

Insurance (1.6%): offers captive insurance and transportation services, along with other peripheral businesses.

 

As the chart shows, the railcar segment has driven the companys growth over the last four years, advancing at an outstanding five-year compound annual growth rate (CAGR) of 44.8%.

Railcars in the Drivers Seat

Ceteris paribus, railcar demand will continue to be the consistent driver of TRNs growth, as the oil and gas exploration and production (E&P) industry will continue to need more railcars to transport newly harvested petroleum from shale plays across the US. With most pipeline systems maxed out and the Keystone Pipeline in regulatory limbo, rail will continue to pick up the slack in the oil and gas transportation market.

 

Although the railcar segment already had positive tailwinds, it was given a boost a few weeks back when the federal government announced a package of new regulations to upgrade the safety of trains carrying flammable liquids. Included in the new regs is the stipulation that all 80,000 DOT-111 railcars (which are used to transport oil) need to be replaced or retrofitted over the next two years.

Although the governments having to step in could be taken as a negative, its worth noting that shipping crude oil by rail is a relatively new phenomenon. For example, in 2008 there were only 9,500 carloads of crude transported by rail. By 2013, that number had swelled to 415,000 carloads.

Considering the pace of this expansion, its no wonder that the industry is still working out the kinks; and we think that the new regulations will not only drive demand for railcars but also make the industry safer as a whole.

Even though these regulations just came down the pipeline, the industry has been preparing for this shift since 2013. This trend is reflected in TRNs ballooning railcar backlog, which has more than doubled since 2010 to a staggering $5.5 billion.

But its not just railcar demand that makes us optimistic about the industry. Key drivers of rail trafficparticularly industrial outputportend high levels of activity. While US industrial production chugged along at a healthy 2.5% growth rate in 2013, that number is expected to reach 3.1% in 2014 and 3.2% by 2015.

More industrial production means more demand for the shipping of petroleum, chemicals, and other commodities by rail; and TRNs product mix will certainly benefit from such increased activity.

We also see positive trends in TRNs Construction Products Group. Since this segment is predominantly based on state and federal spending, we were happy to see that state-sponsored capital projects are expected to reach $1 trillion by 2025. Although this spending wont deliver the explosive growth we expect from the railcar segment, we forecast that this segment will grow at a steady 3.5% per year.

Risks

Although TRN has plenty of positive trends in its favor, the investment doesnt come without risk.

The main concern is a downturn in the broader economy. Many of TRNs segmentsespecially the construction and rail businessare cyclical and are therefore subject to the whims of economic growth. Although it looks like that growth may be starting to heat up based on the most recent labor market data, the possibility of an economic slowdown is something well certainly keep a close eye on.

Second, competition in the railcar market is fierce, with companies like American Railcar Industries (NASDAQ:ARII) and The Greenbrier Companies (NYSE:GBX) constantly vying to steal market share from Trinity. Although TRN has size and scale to its advantagealong with a diversified business modelARII and GBX are more focused on railroads and will likely be TRNs chief rivals for years.

Lastly, a slowdown in hydraulic fracturingwhether as the result of lower oil prices or regulatory scrutinywould severely crimp demand for TRNs railcar business. In addition to railcars, lower oil prices would also hurt demand for TRNs wind power business.

Recent Developments

On July 29, TRN reported results of an exceptionally strong quarter in which revenues and net income grew 39% and 94% respectively. Additionally, management announced an increase in 2014 guidance, raising their EPS forecast from $3.50-$3.75 to $3.90-$4.10.

The company also mentioned that new railcar orders were on the rise and that the backlog had increased to 45,350 units, representing a value of $5.5 billion.

Additionally, TRN reported that it had put some of its nearly $1 billion cash hoard to work via the acquisition of Meyer Steel Structures, a leader in the manufacture of utility steel structures. We view the $600 million cash deal as positive, as it should help bolster the companys energy equipment segment and add approximately $325 million to full-year 2014 revenues.

Fundamentals

Compared to its peers, TRNs fundamental picture is superb: