2023-06-06 17:34:22 ET
Summary
- Trinity Industries, Inc.'s shares have fallen 13% in the past three months, but the company's financials and capital structure have deteriorated, making it a less profitable business than in previous years.
- The company's dividend is not well-covered, and even if it were, the yield is still lower than the risk-free rate, meaning investors are taking on more risk with lower returns.
- Despite the stock being 21% cheaper than three months ago, I still recommend avoiding it due to the state of the capital structure, ambiguous valuation, and the availability of better alternatives.
It’s been just under three months since I told the world that I’m continuing to avoid Trinity Industries, Inc. ( TRN ) in an article with the very original title “Continuing to Avoid Trinity Industries, Inc. Since then, the shares are down about 13% against a gain of about 9.3% for the S&P 500. While that’s gratifying, I feel the need to return to this name. After all, a stock priced at $22.35 is, by definition, a less risky investment than that same stock when it’s priced at $25.62. Additionally, the company has released financials again, and those deserve some scrutiny. If, in addition to a cheaper stock, the financials have improved, that would be a very compelling story in my estimation.
I put a “thesis statement” near the beginning of each of my articles so you won’t be obliged to wade through the entire thing to get to the point. I do this because coming up with new ways to make your life easier is the first thing I think of when I wake up, and it’s the last thing I think of before I sleep. If I can take all of my insights, and jam them into a single paragraph that’s free of my silly jokes or tiresome bragging, I’ll do so, because I think it’ll make your life better. You’re welcome. I’m still avoiding Trinity. The company’s capital structure has deteriorated massively, and this is a much less profitable business than it was only a few years ago. I think the dividend is not well covered at this juncture. Even if the dividend were well covered, the yield is still lower than the risk-free rate. In my view, investors in this stock are taking on far more risk than they would with a risk-free treasury, and being paid less for their troubles. That’s not a great combination in my view.
Financial Snapshot
The most recent quarter has been a good one in some ways in my view. In fact, relative to its peer The Greenbrier Companies, Inc. ( GBX ), the most recent quarter has been quite good on the profitability front. Both revenue and net income are up quite nicely. In the case of the former, it’s up by 35.75%, and the latter has swung from a loss of $700 thousand in the first quarter of 2022 to a positive $4.4 million this quarter. Unfortunately, that’s where the good news ends in my view.
The most recent quarter was great compared to 2022, but if we were to compare the most recent quarter to the same time in 2019, we’d be disappointed by the results. Although revenue in Q1 2023 was about 6.1% higher than the same time in 2019, net income was lower by about $26 million. The company generated about $4.4 million in net income this quarter, and paid about $21.1 million in dividends. This obviously isn’t sustainable.
Debt is not a solution to this shortfall, though one might think the company is treating it as such, given that the company has about 9.5%, or $480 million more debt on the balance sheet today than it did this time last year. This is one reason why the interest expense is up 43% or $18.6 million over the past year.
I think the company needs to take some steps to deleverage the balance sheet before the debt problem grows. I’ve had conversations with fellow investors about this stock, and they’ve suggested that the company should suspend the dividend to take care of debt. The problem is that such a move would be symbolic only. This is because the $80 million or so the company spends on the dividend represents only about 1.4% of long term debt.
All that written, I’d be happy to take on the risk of buying back into this stock, but the valuation would have to be fairly compelling in my view.
The Stock
Those who subject themselves to my stuff regularly know that I consider the stock and the business to be two different things. For instance, the business buys inputs like steel, and produces freight cars for sale. The stock, on the other hand, is a slip of virtual paper that gets traded around the public markets. This stock represents a claim on the future revenues and profitability of the business, but you wouldn’t necessarily know that from the way the thing gets traded around. Put another way, the stock’s price movements are more volatile than most changes in the underlying business.
In my experience, this volatility is troublesome, but it’s also the source of potential profits. The only way to make money trading stocks is to work out the assumptions that are currently embedded in price, and trade against those assumptions when they are unreasonably optimistic or pessimistic. Paying attention to what’s known by most other investors at the present is relatively useless as current news is already “priced in.”
Additionally, I think it’s worth noting that buying cheap stocks tend to lead to higher returns. Not only are cheap stocks lower risk because they have far less to drop in price, they also offer greater potential reward, because it’s easier for the companies of these stocks to outperform low expectations.
My regulars know that I measure “cheap” in a few ways, ranging from the simple to the more complex. On the simple side, I like to look at the ratio of price to some measure of economic value, like earnings, sales, and the like. I previously eschewed the shares for a number of reasons, including the fact that the dividend yield was lower than the then risk-free rate. Fast forward to the present, and here’s the lay of the land.
Source: YCharts
Source: YCharts
Source: YCharts
We see that the dividend yield is about 22% higher, but is still about 80 basis points lower than the risk-free rate . The shares are about 21% cheaper than they were only three months ago, and have fallen to near pandemic lows on a price to sales basis. Interestingly, to me at least, the shares are relatively elevated on a price to book basis.
As I suggested above, I like to trade based on discrepancies between current expectations and price. One of the methods I use to work out what current expectations are comes to us courtesy of the work of Penman’s “Accounting for Value” and Mauboussin and Rappaport’s “Expectations Investing.” Both of these works assume that you can infer what the market is “thinking” about the future based on the current price. When I last applied this approach to Trinity, the market was assuming a growth rate of about 6.3%, which I considered to be very optimistic. Today, that expectation has come down to “only” 5.25%. This is “less bad”, but is still quite optimistic in my view.
Given that the risk-free rate still offers superior returns, and far superior risk adjusted returns in my view, I can’t recommend buying these shares. The state of the capital structure, the ambiguous valuation, and the fact that there are viable alternatives are enough to keep me away still. Obviously, if any of this changes, I’ll reconsider, but for now, I will continue to avoid.
For further details see:
Trinity Industries: Paying You Less While Borrowing More