|Shares Out. (in M):||29||P/E||14.5||50|
|Market Cap (in $M):||1,271||P/FCF||14.5||50|
|Net Debt (in $M):||0||EBIT||209||49|
|TEV (in $M):||1,271||TEV/EBIT||6||25|
|Borrow Cost:||Available 0-15% cost|
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Greenbrier (GBX) Short
Greenbrier stock has run to $45 from $30 pre-election and ~$25 a year ago. The bulls think the stock will rebound from general economic improvement and that the railcar manufacturing business is at a trough with deliveries likely to bottom in 2017 and trend back towards the “long-term” average of 50,000 cars by 2020 (GBX showed the following chart in their January earnings conference call). Plus, the stock spiked nearly 20% on the call after management stated that consensus earnings estimates for the year ending August 2018 were too low.
The reality is that the demand growth is about flat, the industry is just now exiting a five-year period of overproduction, there are ~100,000 excess cars in storage, lease rates are weak, train velocity (and car turns) have climbed, and the average age of rail equipment is at a all-time low. GBX (and TRN and ARII) are still benefitting from strong orders placed during the boom that are allowing them to earn above-normal profits per car despite the decline in railcar deliveries in 2016/2017 from 2015.
I expect GBX earnings to trend towards $0 per share over the next two years and think that their normal earnings power is closer to $2.00 which I don’t expect them to reach until near 2020-2022.
From 1997 – 2015, industry deliveries averaged about 50,000 cars (see below). It seems that the justification for most sell-side and industry forecasts is simply taking the historical average and claiming this is a cyclical industry. But, when you think through the supply/demand for each car type, I think the normal delivery level is closer to 40,000 cars. And, for covered hoppers and tank cars its likely not to reach that level for another five years, at least.
First, take a look at the history. There was a period of strong orders from 2005-2008 and then again from 2012-2016. An important concept for the railcar industry is that all car types are different – a covered hopper can’t carry oils or chemicals and a tank car can’t carry grains or boxed goods. So, you can’t just look at the total fleet or orders and try to come up with an estimate of normal railcar demand. In 2005 – 2008, the boom was driven by demand for ethanol cars and also a general shift towards aluminum cars (which is less talked about but has proven to be a fad that hasn’t continued). Then, in 2012-2016, the oil industry supported a boom in oil tank cars and covered hoppers that carry fracking sand.
The background on why oil companies and shippers were ordering all these tank cars is also important to understanding why the Railcar OEM’s were able to earn such outsized profits.
Tank Car Demand Increased For a Few Main Reasons:
While there was a decent amount of pipeline takeaway capacity from the Bakken, most of it went south towards Cushing. But, because the spreads between Brent (the price that refiners on the East and West Coast pay) and Bakken oil were wide, there was an incentive to ship oil east and west.
In the Bakken, with $90 oil, it was easy to understand why oil companies (and shippers) were ordering tank cars and paying any price for them. Using CLR as a proxy, their operating costs per barrel were about $40 per BOE. At $90 oil and $5 gas, they were realizing about $75 per BOE. So, that’s $35 of operating profit. It cost ~$12 to ship east and west. With 650 barrels of oil in a tank car, they were making ~$15,000 of profit per railcar load. Given, they could turn the car about 2x per month, they payback period for a $125,000 tank car was near four months!
Railcar loading terminals could be built in around six months, quicker than pipelines that would take three years and need regulatory approvals.
This, combined with strong demand for covered hoppers, led to significant pricing power for the railcar OEM’s and incentivized them to add capacity to build more than 80,000 cars in 2015.
Source: Railway Supply Institute
How Many Cars Are Needed?
There are 1.6 million cars in the railcar fleet. Below you can see the numbers by car type and by age. There are roughly 400,000 cars over 30 years old and a car typically lasts for 40-50 years (depreciation schedule tends to be 40 years). If you assume that all the cars older than 30 years get replaced evenly over the next 10 years, that would be a normal level of ~40,000 cars. But, that doesn’t account for any growth in the fleet or account for the excess cars that are currently in storage.
I estimate that normal annual railcar demand is just below 40,000 cars based on the following assumptions for each car type.
Note: Data as of 2014, but still useful for age analysis.
Comments on Each Car Type (Supports the 40,000 Normal Delivery Estimate):
Box Cars – paper and wood products. There are 60,000 cars older than 40 years but these cars probably have the longest life because they are the least complex and can easily get repaired. Over the past 10 years, the average deliveries have been averaged just 1200 cars per year. Shipments carried by these cars have been declining about 3% per year for the past 15 years. I estimate 1500 normal shipments per year.
Covered Hoppers – grains, dry chemicals (plastic pellets), minerals (sand and stone). As of 3Q16, there were 560,000 covered hoppers (according to the Umler Equipment Index), up from an average of 515,000 from 2010-2013. This is a result of 80,000 cars that were delivered, driven mainly by an increase in orders for small hoppers that carry frack sand. Demand for these cars only grows slightly and I estimate there are 40,000 too many cars. Over the past few years, about 10,000 cars have been scrapped (equal to ~10% of the 40-year old+ fleet of cars. And, the backlog for these cars is still at 36,000 cars. So, even though my normal estimate for these cars is 15,000 per year, it may take 5+ years of below normal shipments before that level is reached.
Open Hoppers / Gondolas – carry coal, minerals, and metals. Demand for these cars has been declining at a 3% CAGR over the past 15 years. I’ll take the Economics over Politics and bet this continues. Even though there are 120,000 cars older than 30 years in this class of cars, the average deliveries have been just 5,000 cars over the past eight years. I estimate 6,000 cars for normal deliveries.
Flat Cars – lumber, steel, auto. I have no variant view on these cars. My normal estimate is 6,500 cars.
Tank Cars – carry chemicals, oil, and other liquids. Tank cars have been the main driver of the last two booms. First, it was ethanol and then crude oil. From 2009 – 2012, there were an average of 320,00 railcars in the fleet. That number increased to 435,000 as of 3Q16 as 120,000 tank cars were delivered with minimal scrapping. Also alarming is that there are just ~50,000 tank cars that are older than 30 years and a delivery backlog of 18,000 cars still present. I think there may be 100,000 too many tank cars (though it’s true that a lot of those are probably built to carry oil). Given pipelines that are coming on and the crude oil tank car fleet, its likely we wont need another oil tank car for many years. For all other tank car needs, demand is flat to slightly up. It’s true that the Gulf Coast is brining on a lot of chemical crackers, but that excess supply of chemicals will likely get shipped overseas out of ports in the South, minimizing the need for rail shipments. Prior to the oil car boom, tank car deliveries averaged about 10,000 cars, which is my normal estimate.
Cars in Storage – there are currently about 400,000 cars in storage v. a typical level of 300,000 (part of the reason is the data is based on cars that have not moved for 60 days and because there tends to be cars that are used for storage, included in this data). Of the car types in storage, its most likely made up of tank cars and covered hoppers.
So even though industry deliveries have already fallen 63,000 in 2016 from 82,000 in 2017 and are expected to be ~45,000 next year, I still think deliveries are above normal levels and likely years away from a trough.
Plus, take a look at the average of rail equipment based on data from the BEA – it is at an all-time low:
Translating This to Greenbrier
GBX is still hanging on to the strong orders that were placed through early 2015. But I think those orders will finish rolling through over the next year. GBX’s operating profit per car averaged $6,000 from 2006 – 2013 on an average of 9,000 deliveries per year. Then, from 2014 – 2017E, it averaged $20,000 on an average of 18,000 cars per year. These numbers are unsustainable and I expect them to revert to historical levels, with earnings power of less than $2.00 per share.
I also tried to break down when orders from each year would actually be delivered since it is likely that the cars ordered from 2012-2014 were done at fairly strong margins. In 2014 alone, GBX received 46,000 orders and those likely will finish coming through about now. By FY2018, GBX will be delivering its 2H15 and 2016 orders, which I expect will carry below normal profits. The industry delivered 80,000 cars in 2015, but orders were just 25,000 total in 2016 and GBX captured about 40% share (above its typical market share). Based on industry contacts and comments from GATX and TRN, these orders were likely done at unfavorable pricing.
When GBX reported results in early January, they commented that consensus estimates for the year ending August 2018 were too high and the stock spiked about 20%. I think that sets the stock up nicely from a sentiment perspective to miss going forward.
If you look at Trinity’s results, they already have deteriorated as their operating profit per car has dropped from the mid $20,000 range to $13-14,000 over the past couple of quarters. Their backlog to-delivery ratio has fallen to just over 1 years coverage compared with GBX which still has about 1.5 years. This future excess capacity provides significant leverage for its customers. Frankly, I am a bit surprised by how resilient GBX’s backlog and profitability have been while I think that Trinity’s results are more representative of the supply/demand for the industry and believe they provide a decent roadmap of the future results for GBX.
Here are some other Red Flags:
In 1Q16, they admitted to building 500 tank cars without a firm order (on “spec”) as their leasing company ordered from GBX without a firm lease in hand and management confirmed that the leasing company does order on spec in normal course of business but says that they don’t include these commitments as orders or backlog before the leasing company obtains a firm lease commitment. That’s fine, but see my comments below on how their backlog numbers work.
In the quarter ending August 2016, GBX acknowledged that they had a 1200 covered hopper cancellation and that they would be receive a penalty for that cancellation. At $20,000 of profit per car that they are currently earning, that would be $24m, but in the recent quarterly conference call, they said the amount they received was minimal (related to total manufacturing profits). Again – more evidence that the backlog might not be as tight as it seems.
Stuffing Lease Fleet? Something to keep in mind about the backlog. I'm not convinced these orders are as firm as it is made out to be. Here's what’s going on. The backlog includes orders to both shippers and lessors (like an E&P or a GATX), but also includes cars that have leases attached and that will be later sold to financial firms like Element of Mitsubishi (more evidence of low interest rates encouraging poor investment allocation - as folks search for diversified yield). You can think of this like a bank that originates mortgages and then sells them later through MBS. The railcar manufacturers include these cars in their backlog, but the actual price they will sell for is not contracted. I checked with Element and they have no future purchase commitments (GBX consented that the orders aren’t fully locked in - just that they count in the backlog as long as there is a lease attached). So, there is a portion of the backlog that has a 5-year high-rent lease attached to it, but its not actually sold yet. This could be a huge risk to the manufacturers if lease or car prices roll.
You can see evidence of this on GBX's balance sheet - look at cars under leased railcars for syndication. From the end of 2013 through the end of 2015, the total of leased railcars held for syndication and equipment on operating leases increased from $350m to $500m. Admittedly, since then it has declined to $410m which shows they are getting the railcars off the balance sheet. But, this is something to watch going forward and a way they could get away with continuing to print strong profits while building their risk profile.
Convertible Debt Raise on February 1, 2017 – GBX raised $250m of convertible preferred at 2.9%, due 2024 with a $60 strike. They have a $100m 2018 convert due, but have a revolver to deal with that if necessary. They don’t need the funds currently and its unclear what the proceeds will be used for. My guess is that its for a combination of investing more capital internationally, but more importantly (and intelligently) raising the funds now while the sentiment is still positive.
Negative Earnings Revisions
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