– Phill Namara
Rolling stock is a term used in the railway transportation industry to refer to any vehicle that can move on railroad. These vehicles include locomotives, freight wagons and passenger coaches. The rolling stock market is undergoing significant transformation characterised by increasing automation and fuel efficiency. Europe’s $59bn1 rolling stock market is expected to grow at a 3% CAGR over the next 7 years to $74bn by 2026, with the majority of growth driven by the proliferation of driverless trains according to a report from Allied Market Research.
The industry is characterised by four types of players: infrastructure managers, systems integrators, manufacturers, and railway operators – as shown in the image above. When rolling stock need to be upgraded or replaced, railway operators submit an RFP to system integrators who work with manufacturers to deliver the project. The system integrators, like Siemens, Bombardier and Alstom are global, vertically integrated suppliers of rolling stock – so they can perform both integrations and manufacturing. As such, they have developed technologies and specific market expertise such that they win the majority of European RFP’s and have an established reputation for sound project delivery. Despite their incumbent market positions, over the last three or four years, China’s state-owned rolling stock manufacturer CRRC and Stadler Rail have been successful in incrementally stealing market share from these global giants.
Stadler Rail (SRAIL on the Swiss Stock Exchange), is a pure play railway rolling stock manufacturer that specialises on regional and inter-city train units and trams. Rolling stock encompasses high speed trains, multiple units (intercity and regional suburban trains), passenger coaches, locomotives and metros. They are the number two producer of electrical multiple units and number four producer of diesel multiple units in their strategic markets in Europe. At first glance, anyone would think this a great business due to its strong market share in its niche product category. However, often the executives responsible for these businesses are not satisfied with high market share within a niche product category and instead take on significant execution risk trying to enter new markets – unfortunately Stadler Rail is demonstrating the symptoms of this common “illness”.
A structural trend in the rolling stock industry is increasing complexity of integrations. When a train is being built, it must be designed for the tracks and system it is meant to run on. Further, signalling systems integration is becoming increasingly complex, driven by requirement for traffic optimisation across the network. We believe, eventually networks will become more “intelligent” and trains will become more automated. The complexity in integrations is further magnified by the fact that railway systems and signalling in each local market is different, down to each city and region in every country in the world. As a pure play rolling stock manufacturer in a niche segment, Stadler Rail is structurally disadvantaged when it comes to integration of its rolling stock into existing infrastructure as they lack sophisticated proprietary signalling capabilities and up until recently had to source their signalling capabilities from their larger vertically integrated competitors – the aforementioned system integrators.
Today, Stadler Rail is bidding aggressively for more complex contracts against these incumbents in new geographies. This leaves them with significant execution risk as they are technologically disadvantaged compared to their competitors and worse still, they face cost disadvantages due to their higher unit cost of production and reliance on third-party suppliers. We have seen this thesis play out in the UK, where Stadler won a contract in 2016 for delivery of trains in late 2019. Stadler initially failed to deliver the trains on time and once they managed to do so, it was found out that the trains were unable to be integrated into the existing railway infrastructure due to issues arising from parts from a supplier. As a result of their operational and execution problems, Stadler Rail is haemorrhaging cash as they are invoicing less and less of the revenues that they are recording. In the second half of 2019, they only invoiced 78% of the revenue they generated largely due to that delayed UK contract. This operational inefficiency has caused Stadler to burn on average €100m each half-year since 2018.
As Stadler Rail continues bidding for contracts laden with execution risk and burning cash at an alarming rate, we leave it as an exercise for readers to determine whether this strategy could potentially pay off in the long-run for Stadler, as the complexity of integrations hastens and we move into an increasingly automated future of rolling-stock.
Source: Allied Market Research 2018
The Montaka Global Funds are short Stadler Rail. This article was prepared on June 22, 2020 with the information we have today. Our view may change and it does not constitute formal advice or professional investment advice. If you wish to trade Stadler Rail you should seek financial advice.
Phill Namara is a Research Analyst with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.