Greenbrier's Thorny Valuation

Apr. 9.12 | About: The Greenbrier (GBX)

Rail traffic may be a little twitchy these days as coal shipments plunge, but railroads and railcar leasing companies continue to rebuild their fleets after a major plunge during the recession. While Greenbrier (NYSE:GBX) undoubtedly has a lot to gain from this multi-year cycle, the question of fair value gets a little tricky.

Another Strong Quarter

Certainly Greenbrier is making hay while the sun shines. Revenue jumped 60% this quarter as the company saw a 68% increase in car deliveries. More specifically, the company saw a better than 100% increase in car manufacturing revenue, while wheel service/refurbishment revenue rose about 7% and revenue from the leasing operations rose about 15%.

Profitability also dramatically improved as the company better covers its fixed costs. Reported operating income came close to tripling, while adjusted EBITDA more than doubled. All in all, the company handily surpassed the average sell-side EPS estimate, though the outperformance in revenue was not quite as large.

Other Details Looking A Little Wobbly

As mentioned, car deliveries jumped from last year's level to 3,700 this quarter. New orders and backlog, though, were less strong. Admittedly these numbers can bounce around quite a bit, but orders of 3,600 cars is liable to disappoint (even though it more than doubles the prior quarter's orders). Likewise, the backlog is a good news/bad news story - there are fewer units in the backlog than expected, but the ASPs are higher than expected.

Are The Good Times Fading?

Greenbrier, along with other rail equipment companies like Trinity (TRN), FreightCar America (RAIL), and American Railcar (ARII), saw an incredible rebound in orders in 2011, as industry-wide car orders roughly tripled. While backlogs are still about one-third below prior peaks, there are some reasons for caution.

For starters, the percentage of cars in storage is creeping up - up to 19.6% in the last month (according to the Association of American Railroads). What's more, coal shipments have been exceptionally weak as utilities switch to natural gas and find their coal stockpiles large in the wake of warmer winter weather. With more than 30% of Class 1 railroad revenue coming from coal, that's a problem.

Now, how much of this really affects Greenbrier? Whereas FreightCar has a significant business in coal cars, and Trinity and American Railcar operate here as well, Greenbrier does not. In fact, Greenbrier largely specializes in intermodal cars (particularly double-stack cars) and intermodal traffic continues to be a significant growth market for the railroads.

All in all, then, Greenbrier should be in pretty good shape. Not only should the company benefit from ongoing expansion of intermodal operations at customers like Union Pacific, but lessors like General Electric (GE) and GATX (GMT) need to rebuild and refurbish their fleets.

Valuation Still Thorny

Greenbrier's business should be in good shape for at least the next 12-18 months. That doesn't mean that the valuation analysis on Greenbrier is so straightforward, though.

Greenbrier frankly has a lousy history of translating revenue into free cash flow or earning a good return on its capital. Only four of the past ten years has seen positive free cash flow, and three of the four were trivial. Moreover, in the same past ten years, Greenbrier has never earned its cost of capital.

Bulls will say that it's different this time and that the company is going to enjoy multiple years of improved free cash flow. Perhaps so, but that makes any forward-looking cash flow model a complete guess.

Turning to EBITDA, the stock looks considerably more interesting on this metric. Although I don't favor EV/EBITDA analysis for industrial companies, the difficulties with the DCF approach don't leave much choice. Based on a 7x multiple to fiscal 2012 EBTIDA, Greenbrier shares look as though they should trade into the low $20's. Given the company's strong positioning in the growing railroad intermodal market, these shares are still worth a look for risk-tolerant investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.