2023-09-26 13:42:08 ET
Summary
- Greenbrier's recent financial performance is impressive but still weaker than its historical peaks, and it will take time for the company to expand profitability metrics.
- The company's balance sheet is below average, and the company will likely prioritize balance sheet improvement over consistent dividend growth or buyback programs.
- The stock's upside potential is limited, and it is currently priced close to its intrinsic value.
Investment thesis
Greenbrier (GBX) delivered a stellar financial performance in the latest fiscal quarter and the stock price rallied massively after the earnings release, leading to the year-to-date outperformance compared to the broader market. But recent financial performance is far weaker than the company's historical peaks. The last five years were very complicated for the company with consistently negative free-cash-flow margin, which significantly undermined Greenbrier's financial position. That said, it will take multiple quarters for the company to expand its profitability metrics to its historical peaks and I expect that the increased free cash flow will need to be allocated to the balance sheet improvement first, not to massive dividend growth or substantial buyback programs. Moreover, my valuation analysis suggests that the upside potential for the stock price is very limited. All in all, I assign the stock a "Hold" rating.
Company information
Greenbrier is "one of the leading designers, manufacturers, and marketers of railroad freight car equipment in North America", Europe, and South America. The company is also a manufacturer and marketer of marine barges in North America.
The company's fiscal year ends on August 31 with three reportable segments: Manufacturing, Maintenance Services, and Leasing & Management Services. The company's by far largest segment is Manufacturing, contributing almost 90% to GBX's sales, according to the latest 10-K report.
Financials
I have mixed feelings when I look at the company's financial performance over the past decade. On the one hand, GBX demonstrated a solid 6% revenue CAGR, which is impressive for the mature industry the company operates in. On the other hand, substantially shrinking profitability metrics despite solid revenue growth is a red flag to me. This might indicate that something is potentially wrong with the business model, and maybe it's even become obsolete.
As you can see, in the two last fiscal years, the operating margin became razor thin at below 3%. This is notably below the past decade's average of 7.9% and way below the operating margin peaks achieved in FY2015-2016. The business is relatively capital-intensive and requires notable investments in capex. That said, the free cash flow [FCF] margin has been negative in four of the past five fiscal years. That is another red flag to me. Consistently negative FCF undermines the company's financial position. Indeed, GBX is in a substantial net debt position, and the leverage ratio is above a hundred percent. Short-term liquidity ratios seem to be in good shape, but I am not comfortable with the covered ratio, which is below 3.
Having a below-average balance sheet together with consistently negative FCF in recent years does not give the company much opportunity to keep shareholders happy. GBX pays dividends, but the consistency of payouts is weak, according to Seeking Alpha Quant . The current forward dividend yield is close to 3%, which could have been attractive if the company had a consistent dividend growth track record. With unstable dividend growth, the 3% dividend yield looks worse than the yield currently offered by U.S. Treasuries. Due to the FCF and balance sheet weaknesses, stock buybacks are also insignificant compared to the scale of the business.
GBX released its latest quarterly earnings on June 29, when the company topped consensus estimates. Revenue demonstrated solid growth momentum with a 31% YoY increase. The adjusted EPS followed the top line and expanded notably from $0.09 to $1.02. The operating margin expanded notably YoY, from 2.4% to 6.2%. Despite a massive margin expansion, it is still two times lower than the peaks demonstrated by the company seven years ago.
Such a renaissance occurred after the company announced its updated strategic plans on the Investor Day held in April 2023. At this event, the management shared its major strategic goal for the long term:
Our goal is to leverage our market-leading position and focus on execution to deliver strong performance, reduce cyclicality, and drive shareholder returns.
And the latest quarter's financial performance already demonstrates to us that margin expansion is indeed important for the management. I think that the company's large scale and extensive diversification of its facilities make it well-positioned to improve its financial performance. It is also important to underline that the company's business is able to serve customers throughout the whole railcar lifecycle, making it a solid "one-stop shop" choice for customers.
Overall, I like the company's new focus on delivering more value to shareholders and recent financial performance suggests that the management is firmly committed to expanding profitability metrics. It is also important that the management needed a very short period of just one quarter to significantly improve financial performance. But there is still a long road to go if the company wants to outnumber its previous profitability metric peaks. It is also important to mention that the balance sheet is not very strong and apart from dividend growth, the management will need to balance payouts with the balance sheet improvement.
Valuation
The stock price rallied almost 20% year-to-date, outperforming the broader U.S. market. Seeking Alpha Quant assigns the stock a solid "B" valuation grade because current multiples are mostly substantially lower than the sector median and the company's historical averages.
I do not consider GBX a growth stock, so the discounted cash flow [DCF] approach would not fit here. Instead, I will calculate the stock's fair value with the help of the dividend discount model [DDM]. A lower WACC would be fair for a value company, and 8% would be conservative enough. Dividend consensus estimates forecast FY 2024 payout at $1.2 per share. Dividend growth is always tricky to select and GBX has been quite unstable in recent years from this perspective. Therefore, to be conservative, I use a 5% level which is substantially lower than the sector's median historical performance.
According to my calculations, the stock's fair price is strictly $40. That said, the current stock price is very close to its intrinsic value with minimal upside potential. To conclude this part, I cannot say that GBX is attractively valued at the current stock price level.
Risks to consider
I consider the company's substantial indebtedness a significant risk to the business. While profitability metrics improved notably in the previous quarter, I am still not comfortable with how the company's operating margin compares to its substantial net debt position. Apart from apparent credit risks, GBX's high leverage also limits its ability to raise new debt finance in case attractive expansion opportunities arise.
Another major risk I see is the volatility in the commodities markets. The company's manufacturing business costs are highly dependent on commodity prices. That said, Greenbrier's profitability metrics can deteriorate significantly in case of disruptions to commodity markets which can lead to spikes in prices. In the current environment of complicated relationships of the U.S. with Russia and China, I consider this risk to be substantial.
Bottom line
To conclude, the stock is a "Hold". While the recent financial performance has been very impressive, the management still has a lot to be done to return the company to its best years. The balance sheet is also below average, and I believe it will take multiple quarters to improve the financial position to at least an average level. It is also crucial to say that the massive optimism after the latest quarterly earnings release is already priced in, and the stock has almost no upside potential, according to my valuation analysis.
For further details see:
Greenbrier: Impressive Turnaround, But Still Many Challenges Ahead