Since publishing my cautious piece on the Greenbrier Companies Inc. (NYSE:GBX) in early December, the shares are down about 12%, against a loss of 5.3% for the S&P 500. Since the Coronavirus scare has obviously impacted both the S&P 500 and Greenbrier, an apples to apples comparison reveals that Greenbrier has underperformed significantly. That said, I think a company that was a risky investment at $28 may be a great investment at $24 so I thought I'd check in on the name. Also, the company has since released financials, so it's worth another look at this stage. Finally, in early December I recommended that investors sell puts in lieu of buying shares, and I thought I'd check in on that trade and compare how put writers fared relative to people who simply bought the shares on December 4th. For those few people who missed the bullet points above, and who are too impatient to read to the end, I'll state the point upfront. I think investors would be wise to continue to avoid Greenbrier. I'll go through my reasoning below.
Since I last looked in on Greenbrier, the company has announced financials, so that requires some commentary. In my estimation, there are a few notable things that jump off the page from the latest 10-Q relative to the same period a year ago. First, in spite of the fact that total revenue climbed in the period by just over 27%, net earnings attributable to Greenbrier shareholders absolutely collapsed, and is down just over 57%. The reason for this relates entirely to the fact that there was just under $10.4 million less in net gain on disposition of equipment. So, stripping out the impact of this noise, the company's profitability was very similar in the most recent quarter as compared to the same period a year ago. The result of this is that the company generated $.23 per share on a larger number of shares outstanding, putting the payout ratio over 108%. Given that 2019 wasn't exactly a banner year for the company, it's a bit worrying in my estimation that the company is performing similarly.
Additionally, it's worth noting that the manufacturing business was a standout, with revenue up over 39%. The problem is that manufacturing costs rose by just over 39%, revealing challenges at scaling this part of the business.
So, in sum, I'd say that the financial performance here was adequate, and not extraordinary by any stretch of the imagination. Given that I think Greenbrier overpaid for the manufacturing assets of ARI, I see some financial risk here. Goodwill and intangibles currently represent about 10% of the capital structure, and I think there's a risk of this being taken down over the next few years. I'd like to be compensated for taking on that financial risk with an inexpensive stock price.
Source: Company filings
As I've said many, many times on this forum and elsewhere, I think a great company can be a terrible investment if the investor overpays. Additionally, a challenged company can be a great investment if it's bought at a sufficiently low price. Thus, I think the price investors pay for the stream of future cash flows that companies represent is of significant importance, and must therefore be considered separately from any analysis of the business. When I look at a potential stock, I want to only buy when the market is exceptionally nervous, because that's when it's possible to pick up great companies at bargain prices. I judge whether the market is sufficiently nervous in a host of ways, ranging from the simple to the more complex. Most simply, I compare the ratio of price to some measure of economic value. The more an investor is being asked to pay for some measure of company wealth, the lower will be their subsequent returns in my view. For that reason, I'm obviously looking for low ratios. I think the following picture is worth 1,000 words.
The above chart is instructive in my view, because it's an example of the profit potential of insisting on buying shares when they are inexpensively priced. In early 2016, when investors were eschewing the name, it would have been a great time to buy, as the shares went on to perform well over the next 30 months. By contrast, buying at current valuations has been an unprofitable strategy. The fact that P/E has generally risen over the past few years while share price has languished is a testament to the fact that earnings are slowing. In my view, investors need to be compensated for this, and current prices are inadequate compensation in my view.
Options vs. Stocks
My regular readers know that I'm generally of the view that for years now, it's been hard to find stocks that are at reasonable prices. By nature, I'm also quite impatient, so the notion of sitting and waiting around for stocks to drop in price is tedious in my view. This is obviously less of a concern in early March 2020, but it is still an issue in my estimation. For these reasons, I've advocated selling put options on a number of companies, including Greenbrier. I think it might be instructive to compare the (admittedly very short term) performance of the short put strategy against the long stock trade.
At the time I wrote my latest article about the company, the puts I recommended (June expiry, $20 strike) were bid-asked $.95-$1.10. In spite of a loss of three months of time value, after the fall in share price, these are currently bid-asked at $1.35-$1.55. This means that if an investor wanted to be released from the obligation to buy Greenbrier at $20, they would suffer an approximate $50 per contract loss. For my part, I wouldn't recommend this strategy, and would instead welcome the exercise. Greenbrier shares haven't traded at $20 since 2013, and at that price, the P/E multiple drops to 9, and the dividend yield climbs to 5.2%, excluding the premium received. Given that a loss is only a loss when you realize it, I'm comfortable at the moment.
By contrast, the shares have lost ~$3.70 per share since I published the latest article. It's true that an investor only ever realizes a loss when they sell, it'll obviously be more challenging to enjoy a great long-term return from a base of $28 per share. For these reasons, I continue to prefer the strategy of selling puts on overvalued shares. Additionally, I prefer selling puts to simply waiting for the shares to drop to $20, as that waiting is interminable, and there's no guarantee that they'll ever reach that level.
In my view, shares of The Greenbrier Companies Inc. remain overpriced, and I would recommend that investors continue to avoid the name. The company is performing in line with 2019, and that's not good in my estimation in light of the fact that 2019 saw the lowest profitability in several years. Additionally, as I've written about extensively elsewhere, I think the company overpaid significantly for the ARI manufacturing assets, and that presents the possibility of a goodwill impairment in future. All of this would be fine if investors were compensated for these risks with an inexpensive stock price, but shares are trading near multi year highs on a P/E basis. History may not repeat, but it certainly rhymes, and every time shares traded at these levels in the past, they went on to underperform. That said, I would still be willing to buy the shares at $20 as they represent good value at that level in my view. Put options allow investors to lock in this price while earning some premia in the meantime. Although my puts have become more expensive, they have done much better than share ownership over the same time period, and I expect this trend to continue. I think selling puts on overpriced stocks is a great strategy, and I think Greenbrier is a great example of that strategy at work.