Railroad Industry Pessimism Has Left Greenbrier Undervalued

July 8, 2015 |

Rail stocks have taken a beating recently as concerns over slowing North American energy production and low fuel prices have cut shares prices 10-20% this year. Greenbrier has been a part of that trend, and has lost 20% since June 1. That drop has left Greenbrier significantly undervalued: The company has the catalysts in place to prosper in a cyclical industry, namely strong market share prospects, disciplined management, and most importantly a strong order backlog. A potential short squeeze adds another dimension, as does the company’s bargain status compared to similar Westinghouse Air Brake Technologies Corp., a.k.a. Westinghouse a.k.a. Wabtec (WAB).

Railroad Weakness

In the past three months, the market has been unkind to railroad stocks. Using Stock Rover, we can easily see how Greenbrier (in blue) has fared compared to other rail car manufacturers, the largest railroads themselves, and the industry as a whole. In the first graph, we can see that the industry is off 5.8% over the past three months, and the five largest North American railroads – Union Pacific (UNP), Canadian National (CNI), CSX, Norfolk Southern (NSC) and Canadian Pacific (CP) – are for the most part down significantly more than that. In the second graph, I’ve compared Greenbrier to its chief rivals: Trinity (TRN), FreightCar America (RAIL), American Railcar Industries (ARII), and Westinghouse. Only Westinghouse has managed to hold its value during the period.

Greenbrier and RailroadsGreenbrier and Railcar Manufacturers

While Greenbrier’s recent share price decline has been pretty normal for rail car manufacturers, their P/E looks pretty good compared to their peers (see graph below). While GBX trades at a premium to Trinity and ARII, that’s because those companies are both expected to lose sales and earnings next year, while GBX is expected to grow sales 6% and earnings 8%. RAIL has a high P/E because they barely make money, and WAB trades at a premium due to their low double digit growth prospects and safe balance sheet.

Greenbrier Railcar Price/Earnings

Incidentally, Greenbrier has a much smaller P/E than most Class I railroads, as you can see in the chart below. Investors looking for exposure to the railroad industry might want to consider Greenbrier as an indirect way of getting that exposure at a more affordable price. Greenbrier’s forward P/E for 2016 is a meager 7.3.

Greenbrier Railroad Price/Earnings

Greenbrier’s Strengths

How do we know the market is wrong about Greenbrier? First, the company has a $4.86 billion order backlog, according to their CEO, which will ensure the plant keeps running through at least 2017. The company offers a diversity of services within the railroad sector, including leasing, repair, and manufacturing of tanker and cargo cars. New safety regulations in the US and Canada for oil transport cars will also ensure strong demand for new or retrofit tankers through 2020, and Greenbrier is well-positioned to service that demand. It’s not often that the government requires customers to purchase a company’s product, but Greenbrier (and Westinghouse) are in that privileged position.

Further, Greenbrier’s margins, while not the best in the industry, are improving. Management says it’s on track to meet its 25% ROIC goal by mid-2016, and ROIC is already the best it’s been for the company in the past 10 years. As you can see below, the company is also setting 10 year records for margins and return on assets (the current values are at the top).

Greenbrier Margins

Greenbrier has also been working to clean their balance sheet over the past several years. In the chart below, you can see that Greenbrier has gotten their debt/equity ratio above water and significantly cut their debt. The company has also been building tangible equity and is increasing their cash on hand. Over the past several quarters, dividend has remained constant at $0.15 per share, and will likely remain at that level. With this balance sheet strength, management has recently explored an acquisition, the terms of which are protected by a non-disclosure agreement. However, management could not get the price down to something they were comfortable with, which gives me confidence they won’t overpay going forward.

Greenbrier Balance Sheet

Finally, the potential for a short squeeze adds another compelling factor to Greenbrier’s stock price. About 35% of the company’s shares are sold short; I think largely due to fears that cheap oil will hurt railroads, and thus Greenbrier. This short interest has deflated the company’s share value. New oil car safety regulations should provide solid income streams for both Greenbrier and Westinghouse, and investors could consider Greenbrier a cheaper way of getting exposure to rail car demand. While Westinghouse does have a slightly stronger balance sheet and margins, as well as a stronger 2016 forecast, it is more than twice as expensive as Greenbrier. For context, Westinghouse’s P/E of 25 is above the S&P 500 average of 21.

Investors should be wary that Greenbrier has historically been a volatile stock: The company has a 3-year beta of 1.90, meaning that, on average, shares move 1.9 times as strongly in the same direction as the market. In the past year, beta has been 2.3, indicating even stronger movement in the same direction as the market. Investing in Greenbrier is not for the faint of heart.

Conclusion

Railroad stocks have taken a beating recently, which has accentuated Greenbrier’s undervalued status. The company has a secure income stream thanks to safety regulations and a $5 billion order backlog, and has been cleaning their balance sheet while improving their margins. Greenbrier provides investors indirect exposure to railroads at an affordable price, as well as the potential for a short squeeze. Ultimately, I believe in Greenbrier’s management to deliver solid results over the next few years, and the stock is quite cheap for a company with that kind of performance. Greenbrier makes a lot of sense for a long-term value investor.





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