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The Greenbrier Companies Inc.: Stocks, No. Options? Yes (NYSE:GBX)


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The shares of The Greenbrier Companies Inc. (GBX) are basically flat since I put out my “avoid” piece, against a gain of ~19% for the S&P 500. Much has happened over the past ten months, obviously, so I thought I’d look at the company again to see if it makes sense to buy at current prices. As is frequently the case, I’ll try to make that determination by looking at the financial history here, and by looking at the stock as a thing distinct from the underlying business. Finally, I will write about put options because I love to write about put options.

Welcome to the “thesis statement” section of the article, dear readers. At this point, I totally ruin the drama and the excitement of this article by giving the main plot points away. If you’d prefer to wait to uncover the mystery as it unfolds, I recommend skipping this paragraph. For those of you who are left, prepare for spoilers. Although I think the dividend is well covered here, I think the shares themselves are too richly priced.

Thankfully, the options market presents an opportunity, and I will be availing myself of that. For those who are not interested in generating premia by selling puts, I recommend sitting and waiting at this point. I think “price” and “value” can remain unmoored for some time, and I think price is far above value currently. For people who don’t participate in the options market, I think it would be prudent to wait until price falls to match value. History suggests that there’s a strong correlation between price paid and subsequent returns. Not buying now will produce a preferable outcome in my view.

Financial Update

I’ve written about a great many companies over the past few months, and a recurring theme is that 2021 saw enormous improvements relative to 2020, with all of the latter’s strict lockdowns. Greenbrier is an outlier in this regard. While many companies saw rebounding revenues, Greenbrier’s top line declined by ~37.5%, and its bottom line dropped fully 30%. This represents the continuance of a trend that was in place since before the pandemic. Revenue peaked in 2019, and net earnings peaked a year before. Thus, I don’t think it reasonable to assume that we’ll get much in terms of growth from this company. The age of the DOT-111 upgrade seems to be past, at least as perceived by the equity market.

It’s not all terrible at Greenbrier, though. The backlog grew pretty substantially to ~$2.8 billion, up from $2.4 billion in 2020. In addition, the capital structure remains relatively strong, with cash representing fully 54% of the revolving notes and notes payable. In my view, it’s very unlikely that this company will run out of cash anytime soon. For that reason, I think the dividend is safe for the foreseeable future. For that reason, I’m willing to overlook the lack of growth and buy the shares at the right price.

Source: Company filings

The Stock

Welcome to the part of the article where I disqualify most investments from consideration because they’re too richly priced. This frustrates some people for some reason, but the fact remains that whether a stock is a “good” or “bad” investment largely depends on the price paid. I think the actual stock price history here would go a long way to demonstrate that reality. The investor who bought these shares exactly 1 year ago, has seen a return of ~32% since then. The investor who bought identical shares only 3 months later is basically flat on their investment. We have this idea that a stock is either “good” or “bad.” This isn’t true in a vacuum. A stock is good only when we don’t overpay for it.

For that reason, I’m bordering on paranoid about overpaying for an investment, and I try to insist on only ever buying cheap. I determine whether or not shares are cheap in a few ways, ranging from the simple to the more involved. On the simple side, I look at the ratio of price to some measure of economic value, like sales, earnings, book value, and the like. Ideally, I want to see shares trading at a discount to both the overall market and their own history.

On that basis, shares of Greenbrier are pretty richly priced. In case you forgot, one of the reasons I decided to avoid the shares was because the PE was sitting around ~53.5. On that basis, it’s still morbidly expensive in my view, per the following:

Chart
Data by YCharts

Source: YCharts

It’s easier to read the price to sales chart, as the series is less volatile. On that basis, too, the valuation is on the relatively high side. We should note that the last time the shares traded at current valuations on a price to sales basis was 2015. The years subsequent to that were not good for shareholders.

Chart

In addition to looking at the relationship between price and value, I like to try to understand what the market seems to be “assuming” about the future of a given company. As my regular reader-victims know, In order to do this, I turn to the work of Professor Stephen Penman and his book “Accounting for Value.”

In this book, Penman walks investors through how they can isolate the “g” (growth) variable in a standard finance formula in order to work out what is currently assumed about long term growth, holding other variables like price and book value and earnings forecasts constant. Applying this approach to Greenbrier at the moment suggests that the market is forecasting a long term (i.e. perpetual) growth rate of ~16% here. This is wildly optimistic in my view, and given all of the above, I can’t recommend buying at current prices.

Before leaving this section, though, I feel the need to hold the analyst community’s collective feet to the fire a little bit on this one. Apparently, the mean estimate for EPS in FY 2022 is ~$2.28 and in FY 2023, it’s $3.52. That would be a remarkable turnaround from the most recent EPS of $.96. The analyst community is known to be a “glass half full” group, but this forecast is extreme, even for them.

Options As Alternative

Just because I don’t want to buy at current prices doesn’t mean I don’t see value here. As I stated above, I think the dividend is sustainable, and I’d be happy to own this slow grower if the yield were attractive enough. This presents me with a choice. I can either wait for shares to drop sufficiently in price for them to be attractive, or I can sell some put options to generate some premium immediately.

The former approach is boring, and the latter is what I consider to be a win-win trade. I characterise it this way because the investor benefits from all potential outcomes. If the shares remain above the strike price, the investor simply pockets the premium and moves on. If the shares fall, the investor is obliged to buy, but does so at a price they decided was a good one. Given that I set my strike prices well below the current market price, being “obliged” to buy cheaper is definitionally superior to simply taking the market price.

My preferred puts here are the June expiry and $35 strike. These are currently bid at $.95, which I consider to be a reasonable premium. If the shares remain above this strike over the next six months, the investor simply pockets the premium. If the shares drop below $35, I’ll be obliged to buy at a price that, holding all else constant, represents a PE of ~16 and a dividend yield of ~3% and a perpetual growth rate of -2%, which I consider to be nicely pessimistic. I’m happy to collect the premium, and/or buy the shares at a net price of $34.05, hence “win-win.”

At this price, the embedded growth rate is ~-2%, which I consider to be nicely pessimistic.

It’s my hope that you are as “stoked” about the prospects of short puts in general, but I think we also need to think about risk. The reality is that every investment comes with risk, and short puts are no exception. We do our best to navigate the world by exchanging one pair of risk-reward trade-offs for another. For example, holding cash presents the risk of erosion of purchasing power via inflation and the reward of preserving capital at times of extreme volatility. The risks of share ownership should be obvious to readers on this forum.

I think the risks of put options are very similar to those associated with a long stock position. If the shares drop in price, the stockholder loses money, and the short put writer may be obliged to buy the stock. Thus, both long stock and short put investors typically want to see higher stock prices.

Puts are distinct from stocks in that some put writers don’t want to actually buy the stock – they simply want to collect premia. Such investors care more about maximizing their income and will be less discriminating about which stock they sell puts on. These people don’t want to own the underlying security. I like my sleep far too much to play short puts in this way. I’m only willing to sell puts on companies I’m willing to buy at prices I’m willing to pay. For that reason, being exercised isn’t the hardship for me that it might be for many other put writers. My advice is that if you are considering this strategy yourself, you would be wise to only ever write puts on companies you’d be happy to own.

In my view, put writers take on risk, but they take on less risk (sometimes significantly less risk) than stock buyers in a critical way. Short put writers generate income simply for taking on the obligation to buy a business that they like at a price that they find attractive. This circumstance is objectively better than simply taking the prevailing market price. This is why I consider the risks of selling puts on a given day to be far lower than the risks associated with simply buying the stock on that day.

I’ll conclude this rather long discussion of risks by looking again at the specifics of the trade I’m recommending. If Greenbrier shares remain above $35 over the next six months, I’ll simply pocket the premium. If the shares fall in price, I’ll be obliged to buy at a price ~27.6% lower than the current level. Both outcomes are very acceptable in my view, so I consider this trade to be the definition of “risk reducing.” I know. It’s strange for me to conclude a discussion of risk by writing about how these reduce risk, but it’s a weird world.

Conclusion

I draw a simile between Greenbrier and a cork floating in the Atlantic Ocean. It’s got no significant forward momentum, but you can’t sink it. I think the dividend is secure, and I think the returns investors will enjoy (or not) in future largely depends on the price paid. The problem is that the price currently being paid by investors is associated with future terrible returns on the stock. Just because now isn’t a good time to buy doesn’t mean there aren’t opportunities here, though.

I think the options market presents a win-win as described above, and I think it would be prudent to enter a position on that basis. I’d be very happy to buy at a net price of $34.05, so I’ll be selling these, and I would recommend others do the same. If put options aren’t your thing, I think the best thing to do at this point is to not buy until price falls sufficiently to align with value.



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