Horrendous News From The Greenbrier Companies But Some Green Shoots

Summary

• In the recent run up we have advised our membership that we were selling into strength.
• The Q2 results were awful on the top line, and manufacturing margins were terrible.
• Better sequential profitability in wheels and parts, as well as financing actual drove a loss that was lower than expected.
• Second half of 2021 looks positive for rails.
• This idea was discussed in more depth with members of my private investing community, BAD BEAT Investing. Learn More »

Photo by Kemter/E+ via Getty Images

Prepared by BAD BEAT Investing senior analyst Tara

The Greenbrier Companies (NYSE:NYSE:GBX) is a stock we have traded up and down numerous times. In the recent run up we have advised our membership that we were selling into strength. Selling into strength is a key tenet of our trading approach, and our gains were rather sizable so it was prudent to manage the position. Today the stock looks to get hit hard following its earnings, which were horrendous in our opinion, though it is worth noting that immense year-over-year weakness was expected. As terrible as the headline numbers and margins were, the most recent quarter showed a few key strengths worthy of discussion, and several ongoing weaknesses to be aware of. We believe that there remains some upside in rails here in 2021, but would not commit fresh money unless shares fall to the $30 range.

Pretty nasty year-over-year comparison

Based on the stock's reaction this morning to the just reported quarter, Q2 was rather weak. Oddly, the headline numbers were mixed, despite some notable weakness in profitability metrics. Losses were expected, but losses were not as bad at the consensus. A touch of good news there. Greenbrier's ongoing efforts to transition to a more efficiently run operation to drive performance had been starting to materialize, but although the year-over-year comparisons were expected to be weak, this was a rather bad report.

Based on headline results, it may appear that these transition efforts were not successful. We reject that notion. There remains a lot to be done to reduce merger integration expenses and boost operational efficiency. COVID weighed as did some weather impacts. But the global economy is starting to pickup and the outlook, while cloudy, appears to have some green shoots. We expect the stock to see some pressure this week, but should do well over the next 12 months. We think the stock is headed back to over $50 this year. On this target, shares are a buy, but we think you wait for a pullback. Otherwise hold.

Management continues to be looking to protect the near-term and longer-term financial health of Greenbrier in light of the economic consequences of the pandemic and an industry downturn. But that turndown seems to be making a turn as 2021 moves on. While maintaining cash flow and liquidity are essential components of Greenbrier's current operating strategy, these metrics were just poor in Q2 despite modifying its cost structure by reducing operating expenses and capital expenditures. The negativity all stemmed from a poor top line, which was cut in half from a year ago. Ouch.

Revenues sliced in half from last year

Q2 revenues fell once again, though much more than expected. The revenues were $55 million below our expectations. Just a horrendous miss. We expected revenues to fall but this was eyepopping. Our expectations were based on the trends in Q4 and Q1, as well as guidance and backlog numbers. A lot of pressure did continue on existing orders and anticipated deliveries. However, it was much worse than expected. Revenues will continue to see some near-term pressure but rails stand to do well later this year.

Revenues came in down 52% year-over-year to $296 million. We were a bit surprised by the degree of this miss, and we were more conservative than the consensus. Consensus was missed by over $80 million. This is a massive miss. Despite reopening ramping up, improved economic activity, rail activity was still weak, in part due to COVID, and in part due to some weather impacts.

While rail loading volume is picking up, operating problems came from a range of sources, including winter weather slowing deliveries and production. Order activity was challenged in the quarter. The company is entering its Q3 with railcar order activity that is depressed but expected to improve. Deliveries were 5,100 in Q2, while in the quarter, 2.800 orders for new rail cars were received, and this impacted the backlog, which is still strong. Orders originating from international sources accounted for over 40% of the activity in fiscal 2020, and this mix did impact the average sales price of order activity.

The backlog remains strong

The backlog remains a key indicator to keep an eye on. We continue to believe that the Street has some concerns here. We think the market is valuing the company lower because it expects a prolonged period of low volumes for orders and deliveries despite a big backlog.

The market is now pricing in continued pressure on orders because of a sizable backlog, rail data, with fear of big declines in future orders if the economy does not rebound. In this case, backlog increased. While the company delivered 2,100 railcars, order volume, which can be tough to predict, was 3,800 in the quarter. Demand is starting to return, and there is a solid backlog.

The backlog remains a key indicator and this is because the more backlog there is, it is a measure of future cash flow generation and earnings. Here in Q2, with lower delivery volume the last two quarters, new railcar backlog was 24,900 units with an estimated value of $2.5 billion. Looking ahead, we expected new orders to ramp up as economic activity picks up. This was probably the worst quarter we will see, but profitability trends were interesting despite the horrendous miss on revenues.

Earnings fall but beat consensus which was a positive

Gross margin recently began expanding thanks to cost savings initiatives. Margins had crept back up to the double-digits, but recently have been trending lower. Overall margin fell to a new low of just 6%, falling 410 basis points from a year ago. Ouch. A lot of this was attributed to increased costs associated with severe weather and delivery delays.

There was a decline in the manufacturing segment versus the sequential quarter and the year-over-year comparable quarter. This is the main segment and has the greatest impact as it drives the most revenue, and it barely broke even. We expect margins to improve from here. That is a positive. Gross margin was just 0.9% in the manufacturing segment which dropped from Q1's 9.0%. This was a new low and there were inefficiencies here, lower demand, lower deliveries, and severe weather costs.

While manufacturing was very weak, we saw some positive news elsewhere. Margins improved in the wheels, parts, and repairs segment as well. They went up to a 6.9% margin, from a 3.9%. Operating margin also improved from the sequential quarter to 3.4% from -0.3%. There were higher volumes in wheels and parts, though declines and repairs. Finally, leasing and services saw a nice margin improvement from 35.8% to 56.6%. All in all, this was better than expected in this segment, but was more normalized than we had seen in the prior quarter.

With the better than expected margins in the two smaller segments it offset the horrendous margins in manufacturing. It all led to EPS beating expectations by $0.07 and consensus by $0.10. Still it was a loss in the quarter, with the company losing $0.28 per share.

Take home

The quarter was weaker than expected as a whole, especially in manufacturing. The COVID-19 impacts are waning, though severe weather was a problem this quarter. We expect this is the bottom in terms of quarterly performance this fiscal year. We expect the second half of fiscal 2021 to be stronger than the first half. Economic activity should pick up and we should see increased production rates and stronger activity across the business. The backlog remains solid for many quarters to come. We expect improvement in 2021. We think new money should wait for a pullback, but do expect the environment for railroad stocks to improve this year.

Analyst’s 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.