The biggest fear in investors’ minds right now is the end of quantitative easing (QE). The prospect of the Federal Reserve calling a halt to all that lovely fresh money being pumped into the markets is quite terrifying to all the liquidity junkies out there.
However, the only reason the ‘taper’ is on the cards at all is because the US economy is showing signs of recovery.
The housing market is on the mend. Retail sales are ticking along nicely. Unemployment is falling. And the big game-changer – the shale gas revolution – is helping keep inflation down and will boost growth in years to come. So the fact that the Fed is even considering pulling QE is actually good news.
Trouble is, a lot of this good news is in the price – and more. On cyclically-adjusted earnings, the S&P 500 trades on a p/e of 22. That makes it expensive by historic terms. And that suggests it’s very vulnerable to any pullback in QE.
If only there was a way to profit from a potential recovery in the US, without getting completely hammered if the QE taps are switched off.
Well, I believe there is…
Finding a margin of safety
The Fed will only pull QE from the markets if it thinks the US recovery is solid enough. One way to reduce the downside risk from the end of QE, without giving up potential upside from a US recovery, is to buy a stock with a decent “margin of safety”. That is, one that is so cheap, it should have room to go up regardless of what the rest of the market does.
The sector I’m looking at is the freight industry. This business is very sensitive to economic conditions. It’s pretty obvious why this is.
Before you buy a finished product it needs to be moved from the factory to the warehouse (or shop). And the factory itself needs to receive raw materials before production begins.
When the economy is growing rapidly, sales will rise and firms will expand production. This means that more freight needs to be transported. When the economy is doing badly and goods are sitting on shelves and firms are cutting back, there’s less need to move things around the country.
So demand for freight services is a great barometer of an economy’s health. According to the Cass Freight Index, North American spending on freight fell by over a quarter from the summer of 2008 to early 2010. However, it has now surged back, and is well above the pre-crisis preak.
How railways have profited from the shale gas revolution
One of the big beneficiaries of the freight recovery has been the railways.
US firms have a limited number of options for transporting goods. If they want speed, they can use planes, but they’re expensive. Shipping is the opposite: it’s very cheap, but extremely slow (and useless for moving goods inland).
In between these two extremes you have trucks and trains. Trucks tend to be a bit quicker, and more flexible. However, the trucking industry is facing some tough problems. Rising oil prices over the past few years have pushed up costs. And salaries have been driven higher too, because despite high unemployment in the States, it’s proving hard to find people willing and able to do the job.
The rail industry, on the other hand, is in something of a sweet spot. Trains have always been cheaper and better for transporting heavy goods. But recent changes in the business have increased the attractions of rail freight even further.
Rail companies have built huge advanced terminals, called ‘inland ports’. These can deal with large volumes efficiently. As well as cutting costs, they also speed up the process of getting goods from A to B.
Railways are also doing well from the shale boom. With production growing much faster than there are pipelines to shift the stuff, firms are turning to trains to make up the difference.
In the US, the amount of oil transported by train has risen tenfold between 2008 and today, to nearly 100,000 carloads of oil every three months. The same is happening in Canada, only on an even bigger scale. In three years, the amount of oil transported by rail has risen from just over 8,000 tonnes a year to 4.3 million in three years.
Of course, future growth won’t be so rapid, as the construction of new pipeline infrastructure begins to catch up with the flood of oil from North Dakota. However, both refineries and pipeline companies are still spending money to build rail terminals and track, which suggests this is more than just a temporary stopgap.
How to profit from the US rail boom
One firm that will benefit from the uptick in the rail industry is American Railcar Industries (NASDAQ: ARII).
As the name suggests, it focuses on the railcars themselves. It offers a variety of services, including design, manufacture, leasing and maintenance. The fact that it’s involved in most of these processes enables it to control costs, undercutting its rivals.
As well as conventional containers and hoppers, it also has been working hard to develop its tank railcars, which transport crude oil. Thanks to the shale oil boom, demand for this segment has been growing particularly fast. It also has started to expand overseas, launching a joint venture in India to take advantage of the growth in demand there.
Revenue has grown by 41% in the last three years, and is expected to rise by 11% in the next year. Despite this, it trades at a price/earnings ratio of just under ten, with a dividend of 3%.
• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.
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