2023-10-26 18:09:54 ET
Summary
- Trinity Industries stock has dropped 18.4% in the past two months, making it a potentially attractive investment at its current price.
- The stock has a dividend yield that is greater than the 10-Year Treasury Note, and if the dividend grows at half the rate of the past decade, investors will enjoy 24% more cash flows.
- The shares are currently cheaply priced and have historically performed well at their current valuations, making it a compelling investment opportunity. However, the company's debt overhang remains a concern.
It’s been just shy of two months since I recommended investors avoid Trinity Industries ( TRN ), and in that time the shares are down about 18.4% against a loss of about 5.6% for the S&P 500. This obviously gives me a chance to brag, which is great for my fragile ego, but it also means that I’m obliged to review the name yet again. After all, a stock trading at $20.10 is definitionally less risky than the same stock when it’s trading at $25. In my previous missive, I compared this stock to the 10-Year Treasury Note, and found the stock wanting. I’ll go a bit more in depth today by reviewing the relationship between the dividend and the cash flows from the Treasury Note. After all, the yield has jumped approximately 24% over the past couple of months. At some point, the dividend on the common will represent better value, and I want to work out whether today is that point.
I’ll come to the point and point out that today is, in fact, that point. I will be buying back into Trinity Industries this morning, considering this to be one of my more speculative investments. This is one of those rare stocks that has a dividend yield that’s greater than the 10-Year Treasury Note. If the dividend grows at half the rate it did over the past decade, investors will enjoy 24% more cash flows than the holders of the 10-Year Treasury Note. Additionally, the shares are very cheaply priced at the moment. Over the past decade, they’ve been approximately this cheap on two other occasions. On both of those occasions, the stock has gone on to perform well. I don’t think history repeats, but I think it rhymes. The combination of higher cash flows, with the potential for a capital gain makes this too compelling an investment for me to pass up. I need to offer a caveat at this point, though. I remain troubled by the capital structure here, and will keep my position size pretty small here until such time as the company makes some efforts to pay down debt. While I think the dividend is secure, the debt overhang threatens further growth.
Trinity Industries Stock v Treasury Bond
In the relativistic game of investing, I think it’s a useful exercise to work out what cash flows each investment can provide, and then make a determination about which is the superior based on various risks and uncertainties. I assume in the following analysis that an investor is going to prefer more cash to less, and that an investor will seek the safest returns.
We see from the following that if Trinity’s dividend doesn’t grow from current levels, the stock will generate about $58 more than a Treasury Note .
Treasury v Trinity zero growth in dividend (author calculations)
It’s worth pointing out, though, that over the past decade, the dividend has grown at a CAGR of 7.6%, in spite of the guardrail lawsuit that hung over the company. Thus, I think we should factor in some growth. I’m a fan of conservatism, though, so I’m going to assume a dividend growth of 3.5% over the next decade.
Treasury v Trinity at 3.5% Dividend Growth (author calculations)
Under this scenario, the stock yields an extra $240 over the next decade. This isn’t a king’s ransom, obviously, but it’s at least positive.
Whether the dividend grows from here, and by how much is less relevant to me than the fact that it at least offers investors a positive risk premium. Given that, I’d be willing to buy this stock if the valuation makes sense.
The Stock
It’s all well and good for the stock to yield greater income than the risk free rate at the moment, but if the valuation is excessive, there’s no point in buying. In my view, the likely drop in share price over the next decade would wipe out any extra income earned on the dividend. Thus, the shares should be cheaply priced. To put the valuation in context, it might be helpful for me to point out when I’d be willing to buy this stock, and when I would sell. In case you don’t have my trades burned into your long term memory, I’ll remind you that I bought Trinity when the PS ratio was 1.283, in spite of a relatively paltry 3.94% dividend yield. This paltry yield was acceptable to me at the time because the 10-Year Treasury Note was only yielding about 3.64%. After a 32% gain, I sold when the PS hit 1.454 and the yield dropped to 3%. For context, the 10-Year Treasury Note yield was about 3.58% at the time I sold. So, I bought when the yield was higher than the risk free rate, and sold when it dropped below it, and things worked out well enough.
Fast forward to the present, and the shares are trading at a PS ratio about 47% below the rate it was when I last purchased these shares. Additionally, they’re trading very near a decade low per the following:
Source: YCharts
While I don’t think history repeats, it certainly rhymes. Over the past decade when shares have reached their current valuations, the stock has gone on to perform rather well. In my view, the combination of cash flows greater than the risk free rate, and potential capital gains, makes this too compelling an investment to pass up. For that reason, I’ll be buying a few hundred shares this morning, and will buy more if the shares drop even further in price.
Let's Remember the Risks
I think it behooves all stock investors to recognise the fact that we're taking risks that aren't to be found in the 10-Year Treasury Note. This is why we demand greater potential returns from our stocks. I think it's worth remembering that there's pretty substantial risk on the balance sheet here. As I pointed out in a recent article, debt is currently about $480 million, or 9.5% greater than it was in 2022. This is why interest expenses have exploded higher by 43%. This will crowd out dividend increases if debt isn't reduced from current levels. Although the stock offers greater returns, they come with greater risk, which is what an investor should expect in my view. This is why I'm keeping my purchase relatively small, and why I'm characterising this as a "speculative" trade.
For further details see:
Taking A (Speculative) Position In Trinity Industries