The psychology behind the car building boom: are we pressing the panic button?

Railway Age, Nov, 2004 by Anthony Kruglinski

Recently, I received a question from a reader who, in doing some industry research, came across something I wrote three years ago on the (then) dire straits of the freight car building industry. Now that we're experiencing equipment shortages and long lead times for new builds, his obvious question was, "What's going on here?" Followed by, "How can you predict these peaks and valleys?"

Unfortunately, asking either of these questions is a little like asking about the meaning of life. There are no simple answers. But, I'll do my best to offer some observations on the group dynamics--or, perhaps, group psychosis that infects the new railcar market from time to time. If you're an industry observer or participant, you may or may not agree with what 1 am about to say, but I guarantee that a good deal of it will sound familiar.

Putting the joke about "group psychosis" to the side fur a moment, the boom or bust situation that the freight car builders face--and the railroad industry suffers through with them every few years--probably does have a lot do with psychology. For instance, as I write this, the United States is grappling with an unplanned shortage of flu vaccine for the coming winter season. According to the news, 20% of Americans are expected to contract the flu, and there are long lines for the available vaccine. Panic has set in. People who had never thought they needed a flu shot--and have never before gotten one--want it, and need to have it, now! Supplier price gouging is being reported.

Look and sound familiar, freight car users? The freight car version of our "flu panic" syndrome usually occurs in the middle of an order drought when one or two savvy end-users or lessors (CIT, GATX, TTX) decide the market is right for some opportunistic buying for their long-term needs. The freight car builders--which report both new building and new order stats regularly, as well as projections perk up at the possibility of this new business. The entire rail industry looks over the tops of its eyeglasses to see what's going on. There are rumblings about a long-awaited pickup in orders. There are rumors of large deals being cut by the large market players--on "spec!" The "great" deals for the first to dip a toe in the new order-book pond start to dry up and become a thing of the past.

Then the velocity of the market kicks in and, especially if any shortage of used equipment is discerned, companies that rely on a ready supply of railcars to move freight start to take notice of the modest tightening in the market. They worry: "Am I missing something here?"

Order books fill up. Prices creep or jump--up. The industry blames the price increase phenomena on the greed of the OEMs building the cars. The OEMs blame it primarily on price increases on raw materials and from the component manufacturers. And the component manufacturers join in complaining about the costs of raw materials. Pretty soon every one is blaming everyone. No wonder the occasional observer can't easily figure out what is going on.

Now, order books are chock full, and new car prices actually look to many like someone is clearly profiteering. Spot shortages of equipment--new and used--are reported, and what started as modest value-driven purchasing has grown to speculation, which has grown to--depending on one's views overbuilding and profiteering.

Then, at some unpredictable point, the market deflates, and we're skidding back into one of the valleys that counterbalance the peaks in railcar production.

That's what normally happens. Only this time, it was worse.

In our current cycle, we have the near "Perfect Storm" of all of the above happening while at the same time the overall velocity of U.S. train movements, which is the most important factor in the existence of a surplus or shortage of railcars, is slowing dramatically due to crew shortages, etc. And just to make things really interesting, all the scrap steel (a bit of an oversimplification) in North America wants to move to West Coast ports to go to China. Is any of this particularly predictable? I'll agree that, perhaps, some of it is historically predictable. But if it is, why don't the Class I's who ultimately end up using most of this stuff for 30 or 35 years in their equally predictable business handle their equipment acquisitions in such a way as to avoid all of this drama, inefficiency, and (likely) unnecessary expense?

That, Virginia, is a different question-one whose answer is probably harder to discern than the meaning of life.

Tony Kruglinski is president of Railroad Financial Corp., a Chicago investment banking concern that facilitates railroad and rail equipment transactions. Contact him with comments and controversy at: tkruglinski@railfin.com.