2023-03-09 17:39:12 ET
Summary
- The financial results are better in some ways than they were in 2021, but the company has not yet returned to pre-Covid levels of profitability.
- The financial state of affairs is actually much worse today than it was 9 years ago. I think the dividend is barely covered.
- Why would an investor take on all the risks of this business and be paid 166 basis less than the risk free rate for their efforts?
Shares of Trinity Industries, Inc. ( TRN ) are down about 12.5% against a flat market since I sold my shares in mid-December of last year. A more mature man than I could probably avoid bragging about this, as such a person would know that such behaviour is unseemly. I’m not that mature, so there may be some barely disguised bragging peppered throughout this article. Anyway, I’ve been long this stock in the past, and I’m not adverse to being so again, so I thought I’d review the name yet again to see if it’s worth buying back in. After all, holding all else constant, a stock trading at $26 is a much less risky investment than the same stock when it’s trading at $30. Given that the company has reported final year results, I’ll review those, and will compare them to the valuation.
We’re all busy people. The weekend is nearly here, and I assume that most of you are trying to decide between the many eye poppingly cool things available to you. Will it be “date with supermodel” or “plan a trans-Atlantic ballooning trip?”, for example. I am also busy, since I have to buy some new dice for Sunday night’s game of Dungeons and Dragons. Either way, we’ve all got distractions, and, as a consequence, I offer a thesis statement so you can learn my conclusions immediately, and get out rather quickly before you get exposed to too much “Doyle mojo.” You’re welcome. I think the financial results here are, in some ways, better than they were last year, but the multi-year trend is very distressing in my view. Revenue has been on a rather steep decline for years, and debt levels have exploded higher. While this won’t likely imperil the dividend in 2023 or even 2024, the debt repayment schedule for 2025 is punishing in my view. If rates remain elevated for longer than is generally believed, this could be troublesome. In spite of this, the shares aren’t objectively cheap, so I recommend continuing to eschew the name. Finally, the world of investing is inherently relativistic. If I buy “X”, I’m by definition choosing not to buy a host of “Ys.” With that as context, why would I take on more risk than I would with a one-year treasury and get paid 166 basis points less for my troubles? Thus ends my “thesis statement” paragraph. If you read on from here, that’s on you. I don’t want to hear any moaning in the comments section about my incessant bragging or the fact that I spell words like “behaviour” properly.
Financial Snapshot
The latest financial results have been reasonable in my view, neither great nor terrible. For example, when compared to 2021, revenue in 2022 was higher by about 30.4%. Although net income was lower, that is largely a function of the fact that in 2021, the company earned a $131.4 million gain on discontinued assets. Stripping out that one time event, and net income would have been about $10 million, or 20% higher than it was in 2021.
At the same time, it must be said that the company has yet to recover to pre-pandemic levels. Revenue and net income in 2022 were lower than 2019 by 28% and 56% respectively. Also, there’s about $725 million more debt on the balance sheet today than there was in 2019.
The capital structure continues to deteriorate, and I should point out that long term debt has grown at a CAGR of about 5.3% since 2014, while sales have declined at a CAGR of 8.7%. That is not a great trend in my view.
Dividend Sustainability
I love financial history as much as the next well-adjusted accounting nerd, but when it comes to investing, people are obviously more interested in the future. One thing that affects the future of an equity is obviously the dividend, and whether or not it’s sustainable. Although I’m very much an “accruals guy”, when it comes to looking at dividends, I focus on cash. Specifically, I want to compare the size and timing of future contractual obligations with current and likely future sources of cash. Let’s start with the obligations.
I’ve plucked the following debt repayment schedule from page 85 of the latest 10-K for your enjoyment and edification. We see from this , that this calendar will be a relatively light $242 million repayment this year, $655.9 million next year, and then ramp up to just under $1.5 billion in 2025. I’m obviously concerned about the extent to which these payments crowd out potential dividend payments.
Trinity Industries Debt Repayment Schedule (Trinity Industries 2022 10-K)
Against these obligations, the company has about $79.6 million cash on the balance sheet, and has generated an average of $415.6 million in cash from continuing operations over the past three years, while investing an average of $172.4 million. I should point out that CFO from continuing operations in 2022 was only $9.2 million, down from $615 million the year before. Additionally, CFI was actually positive in 2021 as a consequence of the gain on discontinued operations, mentioned above.
Given the above, and given that we’re in a world where the company spends about $207 million on interest while earning about $60 million, I’d be willing to buy for the dividend, but the shares would need to trade at a very reasonable price in my view.
Trinity Industries Financials (Trinity Industries investor relations)
The Stock
If you subject yourself to my stuff on a regular basis, you know that I consider the stock and the business to be distinct from each other. The business manufactures railcars, for instance. The stock is a piece of “electronic paper” that gets traded around and buffeted by a host of factors, some of which have nothing to do with the business. One of the things that affects the performance of a given stock, for example, is the crowd's ever-changing views about the desirability of "stocks" as an asset class. There's no way to prove this definitively, as it's an obvious counterfactual, but an interesting argument could be made to suggest that the 11.75% loss on Trinity shares since I took chips off the table would have been worse if the market was not merely flat since then. The stock may be affected by central bank activity, which may not have much of a bearing on the business over the long term. Additionally, the stock may be affected by a “shoot, aim, ready” reaction to a disastrous derailment like the one that happened in East Palestine, Ohio recently, even if the company is not at all implicated in the disaster.
These are some of the reasons why I consider the stock to be a thing distinct from the business. The former is often a poor proxy for what's going on at the company, and I think it's possible to profitably exploit this disconnect. In my view, the only way to successfully trade stocks is to spot the discrepancies between what the crowd is assuming about a given company and subsequent results. I absolutely hate to have to remind you of this, but I’ll do so for the benefit of my narrative, that the shares are down sharply since I sold, because I spotted the discrepancy between price and what would be likely future results. So, when I buy, I want to see a stock that the crowd is somewhat pessimistic about, that goes on to exceed expectations. When the crowd is pessimistic, the shares are cheap, which is why I try to buy only cheap stocks. So today the work involves deciding whether or not the shares are reasonably priced.
I determine whether or not a stock is cheap in a few ways, ranging from the simple to the more complex. On the simple side, I look at the ratio of price to some measure of economic value, and I want to see a stock trading at a discount to both the overall market, and to the stock’s own history. In case you don't have my recent trades memorized for some reason, I’ll remind you that I took Trinity chips off the table when the price to sales ratio was at 1.45, and the price to book was about 2.5 and the dividend yield was about 3%. Fast forward to the present, and this is the state of the world.
Source: YCharts
Source: YCharts
Source: YCharts
Depending on how you measure it, the shares are between 16%- 23% cheaper, and the dividend yield is higher by about 20%.
My regulars know that I find ratios instructive as a starting place, but I also want to try to understand what the crowd is currently "assuming" about the future of a given company. If you read my articles regularly, you know that I rely on the work of Professor Stephen Penman and his book "Accounting for Value" for this. In this book, Penman walks investors through how they can apply the magic of high school algebra to a standard finance formula in order to work out what the market is "thinking" about a given company's future growth. This involves isolating the "g" (growth) variable in this formula. In case you find Penman's writing a bit too thick, you might want to crack the spine on "Expectations Investing" by Mauboussin and Rappaport. These two have also introduced the idea of using the stock price itself as a source of information, and then infer what the market is currently "expecting" about the future. Applying this approach to Trinity at the moment suggests the market is assuming that this company will grow at a rate of about 6.7% in perpetuity from current levels. I consider this to be a very optimistic forecast, especially since the company hasn’t yet returned to pre-Covid levels of profitability. Last time I reviewed Trinity's stock, the market seemed to be assuming a growth rate of ~6%, so things are slightly more optimistic at the moment.
Everything’s Relative
In the world of investing, everything is relative. If we buy X, we’re by definition eschewing a whole host of Ys. In my view, the most rational approach to this involves finding the way to earn the highest return while taking on as little risk as possible. Given this, I think it’s worthwhile to remember that you can earn 166 basis points more in the risk free one-year Treasury than you’re going to be paid on this stock. Being paid less in dividend income to take on more risk doesn’t make much sense to me, and so I’m going to continue to avoid these shares and will instead park my capital in the risk free instrument.
For further details see:
Continuing To Avoid Trinity Industries, Inc.