When last I wrote on Greenbrier (NYSE:GBX), I was, at best, tepid on this manufacturer of rail cars and parts for the railroad industry. Although the environment for railroad capex is pretty solid as major carriers like Union Pacific (NYSE:UNP), CSX (NYSE: CSX), and Norfolk Southern (NYSE:NSC) continue to enjoy solid operating cash flows (despite struggles in the coal business), Greenbrier has long lagged rivals like Trinity (NYSE:TRN) and American Railcar (Nasdaq:ARII) in terms of metrics like margins despite good market share.
Management has been saying the right things about prioritizing margins and reducing the capital intensity of the business. Along those lines, a serious restructuring of the Wheel and Parts business is a good move forward, and the new emphasis on tank cars should pay dividends. But as this quarter proves, this is a company where I think investors need to be careful about giving too much benefit of the doubt ahead of real signs of progress.
Disappointing Third Quarter Results
Although there were some positive points to the quarter, it's hard to call this report a success for Greenbrier.
While revenue did improve almost 3% sequentially, it was down 15% from last year and almost 7% below the lowest estimate on Wall Street (about 14% lower than the average). Manufacturing revenue plunged 22% as the number of railcars delivered plunged almost 45% as the company continues to have its issues getting tank car production ramped up. As readers can see from those numbers, though, the newer cars certainly do offer advantages in terms of pricing. For the fiscal third quarter, the oft-lamented Wheels, Repairs, and Parts business delivered nearly 5% revenue growth, while the leasing business was basically flat.
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Despite the significant decline in revenue and volume, gross margins held up pretty well. Manufacturing gross margin actually improved about 10bp from the year-ago quarter and improved slightly from the prior quarter as well. The Wheels gross margin did decline some, leading to an overall decline in gross margin of about 70 basis points. SG&A expenses were down on a year-over-year basis, but operating income fell about one-quarter after adjusting for impairments and equipment sales. Adjusted EBITDA rose 9% for the quarter and largely matched expectation. All told, Greenbrier salvaged what could have been an ugly quarter with good expense control.
Tank Cars Leading The Way, But Improved Performance Is Vital
As the revenue numbers might suggest, executing on the opportunity in tank cars is huge for Greenbrier. Once a strong player in intermodal cars, Greenbrier has adapted to the realities of the market, a market that wants tank cars to transport crude from the Bakken. According to data from the Railway Supply Institute, tank cars were more than 80% of first quarter industry orders and represent about 85% of the industry backlog. With another 5,500 units put on order this past quarter, it's critical for Greenbrier to get its tank car production ramped up – this is likely to be a multi-year cycle, but it's time to start delivering.
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At the same time, it looks like management is accepting that selling the Wheels business isn't very likely. To that end, the company has named new executives to lead both the Wheels and Repairs/Parts businesses, along with plans to close 8 of 38 shops. According to management guidance, this will fulfill a quarter of the company's goal of freeing up $100 in capital.
The Bottom Line
Management deserves credit for reasonably good execution on margins, even though the Street seems more disappointed about the revenue shortfall. Even so, I have my doubts as to how effectively the company will compete against American Railcar, Trinity, and Berkshire Hathaway (NYSE:BRK.A) in tank car construction – there's certainly plenty of business to go around, but Greenbrier doesn't have all the time in the world to get its margins and capital position right.
I will certainly acknowledging the opportunity that Greenbrier has to do better, and that any such outperformance will flow through to the profit and cash flow numbers. Assigning a 7x multiple to the next twelve months' EBITDA, fair value for Greenbrier seems to be at around $25.60. That's decent potential relative to today's price, but I would emphasize the importance of better execution for this story working out for investors.