Volume II, Issue 2 (released on October 13, 2015)
This report was finalized on October 13, 2015 and it is an introduction article that was only sent to Newsletter subscribers and not published anywhere else on the internet besides from here. This article was written so that it could be submitted to a pitch contest, and it is meant to be a precursor to a longer, in-depth article on GBX.
I believe that the best entry point for a long position in GBX would be in the $30.00 - $30.50 price range.
Full Disclosure: I did not own shares of GBX when this report was published, however, I intend to purchase some shares immediately before my longer article on GBX is sent to my Newsletter subscribers.
- The Greenbrier Companies, Inc. stock (NYSE: GBX) has already discounted a sharp cyclical decline in demand for the railcar manufacturing industry, however, such a decline is unlikely to be as severe or as long-lasting as most investors expect.
- GBX is trading at an attractive value from a long-term investor’s perspective.
Company Description and Background: GBX is a designer, manufacturer and marketer of railroad freight car equipment in North America (with limited operations in Europe and Mexico). GBX operates in three business segments: Manufacturing (80.2% of LTM sales); Wheels & Parts (15.9% of LTM sales); and Leasing & Services (3.9% of LTM sales). GBX is the second largest of four publicly-traded railcar manufacturers in the Industrials sector that collectively accounted for approximately 94% of total U.S. railcar manufacturing backlog as of June 30, 2015. GBX’s three major publicly-traded competitors are Trinity Industries Inc. (TRN), American Railcar Industries Inc. (ARII), and FreightCar America Inc. (RAIL). TRN is the industry leader with 39.6% of the total deliveries as of June 30, 2015, with GBX accounting for approximately 26.4%.
Analysis: Sentiment towards railcar manufacturers has turned extremely pessimistic over the last year. The four major railcar manufacturers saw their share prices fall by an average of 45.2% from their respective highs in September 2014. Of the four, GBX was hit the hardest with its share price falling by 51.0% from its high of $77.45/share on September 19, 2014. With this decline, GBX’s current share price of $37.94 has already discounted a sharp cyclical decline in demand for newly manufactured railcars. However, with a 1-year upside price target of $49.00/share (+29.1%) and a 1-year downside price target of $33.00/share (-13.1%), long-term investors have an attractive potential return/risk ratio.
- GBX has already discounted a sharp cyclical decline in demand
Railcar demand is cyclical. Over the long-term, rail traffic either increases or decreases with the expansion or contraction of the U.S. economy. However, over the short-term, rail traffic can be highly dependent on drivers such as commodity prices.
One can attribute the 2015 selloff in the industry to the approximate 56.8% decline in the spot price of Crude Oil WTI since June 2014 and year-over-year declines in monthly rail traffic; as a result analysts anticipate significantly lower demand for tank cars over the next 1-2 years, with consensus estimates expecting GBX’s total sales to plateau in FY 2016 and decline 16.6% in FY 2017. When crude oil production increased rapidly from 2009 to early 2015, U.S. rail traffic followed suit due to higher volumes of crude oil transported by rail. Rising oil production, coupled with a steadily strengthening economy, significantly increased demand for new railcars (tank cars in particular), lifting the total backlog in the railcar manufacturing industry from 10,462 units on December 31, 2009 to 142,837 units on December 31, 2014 (a CAGR of 68.7%). While some analysts are justly concerned by the fact that total quarterly orders for new railcars reached an all-time high of 42,900 in Q3 2014 before declining to 19,786 in Q2 2015, there are still many catalysts preventing a downturn from being as severe as most investors seem to anticipate.
Regulatory changes and replacement schedules aid GBX. The Company is proactively taking advantage of the DOT’s new, recently announced tank car safety regulations, established in response to numerous high profile tank car accidents, which require updated safety specifications for new tank cars built after October 1, 2015 and the retrofitting of older cars on a prescribed 2-10 year schedule. GBX is currently the only manufacturer that already produces and delivers tank cars meeting all new safety requirements, and the new regulations should help the Company gain market share in the next five years as customers order more of its “tank car[s] of the future” (a 1.6% increase in market share through the end of 2020 is projected in the Base Case). In addition, as manufacturers recently focused on building higher margin tank cars to meet demand to transport oil, the number of old railcars in the U.S. “fleet” not used for transporting oil increased rapidly due to delayed replacement. Researchers estimate there are more than 250,000 aged rail cars in use over 35 years old; as railcars have approximately a 50-year lifespan, many will need replacement in the next decade. In sum, oil industry demand for tank cars crowded out orders for other types of cars; the drop in tank car orders will be replaced by demand for railcars compliant with new safety regulations and the normal replacement of aged railcars of all types.
- GBX is trading at a very attractive price from a long-term value investor perspective
Concerns about railcar demand and GBX’s relative strengths caused the Company’s stock price to decline to the point that it is trading at a significant discount to its implied share price, even if one assumes that the railcar manufacturing cycle has reached a peak. Two different valuation methodologies were used to derive GBX’s implied share price; a Comparable Companies Analysis and a Discounted Cash Flow analysis.
Comparable Companies Analysis: This analysis was done using the following valuation multiples; EV/Sales, EV/EBITDA, EV/EBIT, and P/E. All of the valuation multiples for the four comparable companies that were chosen (TRN, ARII, RAIL, and WAB), and the implied share price ranges derived from the Comparable Companies Analysis, can be seen in Appendix Image #1. After further analysis, it was determined that EV/EBIT was the best valuation multiple for comparison in the industry and was chosen as the valuation multiple that would impact the final implied share price calculation.
Discounted Cash Flow Analysis: Three different operating scenarios were created as part of the DCF analysis: 1) Base Case, 2) Bull Case, and 3) Bear Case. Appendix Images #2-4 depict the DCF models for each operating scenario. Due to the fact that GBX’s Manufacturing segment is by far its largest in terms of percentage of total sales, projecting its performance was a critical part of the DCF analysis. The main driver for the segment’s sales is how many units GBX can deliver, and the DCF analysis sought to value GBX as if industry-wide annual railcar deliveries were about to decline from the all-time high projected for 2015 down to a “normal” (mid-cycle) year in terms of the number of units delivered. The average annual number of units delivered for the last 20 years (1995-2014) and the last 28 years (1987-2014) served as estimates of a “normal” year of deliveries. Projections for the number of industry-wide units delivered for the next six years (2015-2020) can be seen in Appendix Image #5. The projections for units delivered were meant to be conservative and they incorporate analysts’ bearish estimates for future deliveries. In order to project the Manufacturing segment’s sales, both a “market share” of the total number of units delivered and the segment’s Sales Per Unit Delivered were projected for each calendar year and then converted back into numbers representative of GBX’s fiscal year ending August 31st. The Base Case projections for GBX’s market share and Manufacturing Sales Per Unit Delivered can be seen in Appendix Image #6.
Ultimately, as shown in Appendix Image #7a and 7b, a final implied share price of $48.68 was derived by assigning weightings to the implied share prices calculated by combining the results of the Comparable Companies Analysis with the DCF analysis in each of the three operating scenarios (using weightings). The final implied share price was then rounded up to reach a 1-year price target of $49.00/share, and the 1-year downside potential price target was set at $33.00 ($0.40 below the final implied share price in the Base Case scenario), which resulted in Potential Return/Potential Risk ratio of 2.2 to 1.
Risks: Even though GBX is well-diversified in the types of railcars it manufactures, it disclosed (in its Investor Presentation in May) that 38% of its backlog, as of March 31, 2015, was composed of tank cars; GBX thus is at risk of dependence on oil prices (and oil production) rising over the next two years if it hopes to receive new orders to replenish that the units delivered that were once part of that backlog. GBX also is at risk of customer concentration. In GBX’s 10-K filing for FY 2014, it reported that in 2014, revenue from two customers, CIT Company (CIT) and TTX Company (TTX), “accounted for approximately 41% of total revenue, 21% of Wheels, Repair & Parts revenue and 49% of Manufacturing revenue,” and receiving such a large percentage of total sales from two customers presents the risk of deteriorating customer relationships or cancelation of orders.
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