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Greenbrier: Still A Bit Too Expensive

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About: The Greenbrier Companies, Inc. (GBX)
by: Patrick Doyle
Patrick Doyle
Long/short equity, long only, Growth, momentum
Summary

Since publishing my most recent cautious note about Greenbrier, the shares are down quite a bit. Greenbrier has since published results, so I thought I'd review them.

While revenue was up very nicely, costs rose at an even faster clip. I think the goodwill impairment we saw in 2019 is the first of many such impairments.

An alternative to waiting for shares to drop in price is to sell the puts I suggest in this article.

Since putting out my latest cautious piece on The Greenbrier Companies (GBX), the shares are down about 8%, against a gain of 3.2% on the S&P500. While that's gratifying on some level, the fact is that a company that's trading at these levels obviously presents a different risk-reward profile, so I thought I'd look in on the name to see if it makes sense to buy again. As I've said repeatedly, Greenbrier is not a company that you buy and forget. In my view, when the valuation becomes attractive, you should buy, and when it becomes stretched, you should most definitely sell. Also, the company has published financial results since I last looked in on the name, so I must update my financial analysis. While I can't recommend buying yet, I will say that it's possible to make some money here with short put options. I'll go through the specifics of this trade below.

Financial Snapshot

Given the oversupply in the lease fleet that I've written about elsewhere on this forum, I was pleasantly surprised by Greenbrier's performance in 2019. Specifically, total revenue was up just over 20% over 2018, and the wheels and repair business was the standout, having grown 28% from the prior period. Unfortunately, costs grew at 26%, so gross margin declined from $409 million in 2018 to $366 million in FY 2019. Particularly troublesome in my estimation relates to the fact that leasing and service costs increased fully 68% over last year. Wheels and repair, and manufacturing were also both up, over 32% and 23% respectively. Although the company remains profitable, profit has declined dramatically (53%) from the prior period, partially caused by a goodwill impairment charge of $10 million related to the company's repair operations. Given that I think the company overpaid for the manufacturing assets of ARI, I expect more of these in future. Note that Greenbrier paid ~$418 million for these manufacturing assets, and I clearly think they overpaid by about $220 million. In addition, cash from operations was down dramatically, largely the result of a massive ($143 million) investment in inventory.

On the bright side, the company's backlog increased just under 20% from the same time a year ago. This is the result of 10,600 ARI units being added to the backlog (bringing the total to 30,300 units). Additionally, the company has managed to remain shareholder friendly, having increased the dividend payment by 11% from 2018. This has caused the dividend payout to spike to just under 47%, which I consider acceptable, but only just.

Source: Company filings

Options to the Rescue

In my earlier, bullish article on Greenbrier, I suggested selling the March 2020 puts with a strike price of $17.50 made a great deal of sense because they were bid-asked at $1.05-$1.20 at the time. At the moment, these same puts are bid-asked at $.20-$.35, so that trade worked out relatively well.

I think it's still worthwhile selling puts on this name at a strike price far below the current market price. At the moment, I favor the June 2020 puts with a strike of $20. These are currently bid-asked at $.95-$1.10, having last traded hands at $1. Please note that the shares haven't traded below $20 per share since January of 2013, so I think the probability of being exercised at this price is remote. That said, if an investor is exercised, they will buy at a price ~32% below the current level. At that price, the PE multiple drops to about 9 times and the dividend yield climbs to 5.2%. In my view, that price represents the probability of great long term returns. Alternatively, the shares may flatline, or rise from here, in which case the investor simply pockets the premium, which is hardly a hardship.

The Stock

As I've said repeatedly, and no doubt tiresomely, one of the things I find interesting about investing is the fact that it's not only about forecasting future cash flows from a business. At least as important is the price paid for those future cash flows. It is very much the case that a great business can be a terrible investment if the investor overpays. Just ask people who bought Netflix at its peak price. For that reason, we must spend some time thinking about the shares as a thing distinct from the business itself. In my bullish article, I made much of the fact that the shares were trading at a price to tangible book of ~7 times. At that price, I think the shares are a great buy. The price to tangible is ~20% higher than that at the moment, per the chart below. For that reason, I can't recommend buying the shares at these levels.

ChartSource: Ycharts

Options to the Rescue

In my earlier, bullish article on Greenbrier, I suggested selling the March 2020 puts with a strike price of $17.50 made a great deal of sense because they were bid-asked at $1.05-$1.20 at the time. At the moment, these same puts are bid-asked at $.20-$.35, so that trade worked out relatively well.

I think it's still worthwhile selling puts on this name at a strike price far below the current market price. At the moment, I favor the June 2020 puts with a strike of $20. These are currently bid-asked at $.95-$1.10, having last traded hands at $1. Please note that the shares haven't traded below $20 per share since January of 2013, so I think the probability of being exercised at this price is remote. That said, if an investor is exercised, they will buy at a price ~32% below the current level. At that price, the PE multiple drops to about 9 times and the dividend yield climbs to 5.2%. In my view, that price represents the probability of great long term returns. Alternatively, the shares may flatline, or rise from here, in which case the investor simply pockets the premium, which is hardly a hardship.

Conclusion

In my view, Greenbrier is not a company that an investor should simply buy and forget. I think this is a company that can be quite profitable if the investor knows the underlying business and knows the trends impacting the industry. This is why, if I do say so myself, that my calls on Greenbrier have been rather good this year. I understand that this is a business that is inherently volatile, and investors do well when they buy at certain points, and then sell at other points. Just because I think the shares are overpriced at the moment doesn't mean investors must wait for shares to drop in price. The puts I wrote of above are very good trades at the moment, given that it's very unlikely that the options will be exercised in my view. For that reason, I think these (rather fat) premiums will be profitable. If the investor sells these, though, and is subsequently exercised, they'll be obliged to buy at what I think is a great price.

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

Additional disclosure: I willl be selling 10 of the puts mentioned in this article this week.