UPDATE: 2/4/2016 - An update here @ 27.57. I'm up 33%+ since writing the article (two weeks ago) and it's within 90% of my intrinsic value target. I like the company and the management and I HATE paying short term taxes. Even with those points considered, I'm selling here as my safety has eroded in the past two weeks. I might be selling early, I don't know. I'll re-think this if we see it dip back down.
Greenbrier Companies (NYSE:GBX) has fallen by 55% over the last 12 months. It's fallen by about 68% if you stretch that out to 15 months. This price change does nothing but induce nausea, so let's introduce some context. To quickly recap, Greenbrier is mainly in the manufacturing, sales, and leasing of railcars (all types excluding coal). The company also has a small marine business and an axles and wheels business.
The GBX crew has done a nice job changing (for the better) and growing the company over the past decade, helped by some fantastic tailwinds. The company has grown revenue by about 150%, doubled its market share (defined as a % of industry backlog) to about 30%, and has significantly de-levered within the past few years. Net debt is maybe 0.5x earnings before all the bad stuff. GBX company is currently operating at peak profitability. It has revenues close to $3 billion, NI at about $229 million (net margin of 7.8%), operating cash flow of about $190 million and FCF (depending on how you define it) of about $90 million. Its ROE, ROA and ROIC are all beautiful at 35, 13, and 21 respectively. The stock is trading at a P/E of 3, and that seems to be the problem.
Let's allow Howard Marks, chairman of Oaktree Capital, to explain:
- Rule number one: Most things will prove to be cyclical.
- Rule number two: Some of the greatest opportunities for gain and loss come when other people forget rule number one.
The interesting thing in this specific case is that it looks like everyone has internalized Marks' advice (as opposed to Mr. Market's normal behavior of temporarily believing trees do grow to the sky). The opposite problem could be going on here. Mr. Market is guaranteeing these trees won't grow to the sky, and I fully agree. The market is doing its job as a forward-looking mechanism and predicting the swinging pendulum. I'm simply wondering if it's over-predicting, and perhaps that future pendulum has swung too far. Based on the price, "everyone" knows it's cyclical and is suspecting cyclicality in Greenbrier's business.
I've followed GBX, Bill Furman (Greenbrier's long-serving chairman and CEO) and crew for about 10 months or so. I like the business (albeit cyclical), and if I had to, I'd wager that it'll be around for the remainder of time - but the market seems to HATE it of late. It's only gotten worse in the more recent past. The past three weeks have seen a ~40% drop in share price after a non-surprising earnings report. The price probably fell (I'm speculating here, because the only sure reasons prices move is due to an imbalance of sellers and buyers) based on comments about the backlog and the continued fall in oil prices. But the market is forward-looking, and those things were fairly obvious - "everyone knew", or at least it "should" have been inferred. Was this not priced in? Is this simply what happens when investors begin to view the entire market as the glass half empty versus the glass half full?
During the past 10 months, the business looks like it went from "everything's perfect" to "everything's probably okay, we're not dummies and we know cycles exist, and if it's not okay, we're pretty prepared in the way we've diversified revenues, de-levered, and moved to a low-cost manufacturing outfit". In the investing world, this kind of reasoning doesn't seem to be happening lately. When Mr. Market is acting loco, reasonable responses can be expected to be less reliable and not so common. So, in Mr. Market's eyes, did the business just go from "flawless" to "hopeless"? If so, why? The pendulum is swinging (or has swung), and rather quickly. Not just in GBX, but in the "market" over the past few weeks (two weeks, to be precise and hone into pain). As an investor, there is a lot of difficulty in understanding events, their significance and their potential ramifications. In part due to our psyches, what contributes to them, what the "market" is up to and the chance that multiple negatives are happening to us at once (like entire portfolio draw-downs, various markets doing strange things simultaneously, sell-side opinion, Fed action, China, David Bowie, whatever). To borrow words from Howard Marks, "Investors can usually keep their heads in the face of one negative. But when they face more than one simultaneously, they often lose their cool."
The psychology here is tough. I do know that investors' optimism has deflated some, negativity is now being weighed and prices have moved lower (probably because of it). Caution is showing up (which is a very good thing), and perhaps some of us can now act less cautious than we were required to a couple months ago.
So, for those of you that can, and will, think in decades rather than years, I'm proposing that GBX might just be a bargain. But maybe not. I'm genuinely curious. The business has changed a lot over the past four years, and I really do drink some of Furman's Kool-Aid that Greenbrier is a better business than it was four years ago, whether we're talking about the top or the bottom of a cycle.
So, what does bargain mean?
I think GBX is probably worth its book value at some discount plus the cash flows it can produce over the next X amount of years. Here's how I see it through a written DCF. (Caveat: DCFs are hard, and they are not deity, and they're usually wrong. GBX earnings will be lumpy, but we have to start somewhere.) Because of this, I will apply a pretty nice discount to help with (not solve) my almost-guaranteed errors.
- GBX just delivered about $90 million in FCF. Let's say that for the next five years, that FCF diminishes by 25% annually, i.e., negative 25% annual compounding. Meaning that in year five, we're looking at about $21 million in FCF.
- Let's also assume that in years 6-10 FCF grows at 7% off that $21 million base.
- In year 11, we'll sell the business for 8x cash flow (reasonable?).
- We'll use a 10% discount rate and no terminal (forever) growth.
- Assuming shares outstanding stays at 32 million after 10 years.
- Book value is $900 million today, but let's say the actual book is maybe $750 million.
(All current numbers pulled from the company's October 2015 10-K and January 2016 10-Q SEC filings.)
So that gets us at about $33 today, if my model was spot on. I guarantee it's not, so let's apply a 40% margin of safety. That puts it at about $20. Today (Friday, January 15), I got a small limit order filled at $20.85.
Put another way, there might be 55%+ upside to "fair value".
Or if you'd like it visually:
|Initial Cash Flow||$90,000,000|
|Terminal Growth Rate||0%||Discount Rate||10%|
|Shares Outstanding||32,000,000||Margin of Safety||40%|
|11 (Sale @ 8x Cash Flow)||239,639,112.113||$83,997,215|
|Current Book Value||$750,000,000|
|Shares Outstanding in 11 years||32,000,000|
|Value per share||$33|
|Margin of Safety Value||$19.87|
Disclosure: I am/we are long GBX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.