Prepared by BAD BEAT Investing senior analyst Tara
We recently told you that we were selling the strength in The Greenbrier Companies (NYSE:GBX). This was less because we felt the stock had room for growth and more because our gains were so sizable that we wanted to manage the position. This is prudent money management, and something that we stress to all of our members. Today shares are down 10% following its earnings, after being up in the premarket. The most recent quarter showed key strengths and several ongoing weaknesses to be aware of. We still hold a position here and will resume selling if shares return to the mid-$30 range. Where would we buy? Sub-$25. Thus, it is a hold here. So what are we seeing?
Most recent quarter
Based on the stock’s reaction to the just reported quarter, Q4 was not very well received. Much like in the last two quarters, Greenbrier’s efforts to transition to a more efficiently run operation to drive performance are starting to materialize. Based on headline results, it may appear that these transition efforts were not reflected in the results. While it is true that there remains work to be done to reduce merger integration expenses and boost operational efficiency, with the global economy slowing thanks to COVID-19, pressure was felt. The outlook remains cloudy. While the economic outlook is mixed, we do still expect the stock to do well over the next 18 months.
Make no mistake, the next quarter or so will still be tough. Management is focused on preserving the near-term and longer-term financial health of Greenbrier in light of the economic consequences of the pandemic and an industry downturn. Maintaining cash flow and liquidity are essential components of Greenbrier’s current operating strategy. In fiscal 2020, management adjusted its cost structure by reducing operating expenses and capital expenditures. Greenbrier closed 13 rail production lines in fiscal 2020 and is continuously adjusting capacity to align with an evolving demand outlook. The global workforce was reduced by over 6,500 employees, or by about 40%, including both staff and production employees. Let us discuss the metrics we will look for in 2021 going forward using Q4 results as a guide.
Revenues fell again
When we look to the sales figures, we noted Q4 revenues fell once again, though less than expected. The revenues were $50 million above our expectations. We expected revenues to fall much more heavily. Our expectations were based on the trends in Q3 carrying over to Q4. A lot of pressure did continue on existing orders and anticipated deliveries. However, it was better than expected. Revenues will continue to deteriorate in the next quarter or so.
Revenues came in down 30% year over year to $636 million. We were a bit surprised. We do note that consensus was surpassed by $38 million. We were more conservative than the Street on reopening hopes, but still expected far less revenue. Let us dig deeper.
We see some strengths that emerged in the quarter as well as some notable weaknesses. The company is still doing all it can to strengthen its core North American market, continuing international diversification, and growing the business. The top line was well above expectations, but there was strength in some lines. The company has been working hard to complete the integration of its massive acquisition in North America. We are seeing Greenbrier’s international expansion contributing to each quarterly result and is helping make up for a weak North American freight railcar market. International markets are providing the company with new sources of revenue and a diversification of the backlog.
Order activity was decent in the quarter and comprised of a broad range of railcar types. The company is entering its Q4 with relatively decent railcar order activity. As for some actual data, deliveries were 5,100, while in the quarter, 2.800 orders for new rail cars were received, and this impacted the backlog, which is still strong. Orders originating from international sources accounted for over 40% of the activity in fiscal 2020, and this mix did impact the average sales price of order activity.
The backlog remains strong
The backlog remains a key indicator to keep an eye on. We continue to believe that the Street has some concerns here. We think the market is valuing the company lower because it expects a prolonged period of low volumes for orders and deliveries despite a big backlog.
The market is now pricing in continued pressure on orders because of a sizable backlog, rail data, with fear of big declines in future orders if the economy does not rebound. In this case, backlog increased. While the company delivered 5,100 railcars, order volume, which can be tough to predict, was 2.800 in the quarter as we noted. Demand will not return overnight, but there is a solid backlog. The backlog is a key indicator and reflects future cash flow generation and earnings. Here in Q4, with lower order volume the last two quarters, new railcar backlog was 24,600 units with an estimated value of $2.4 billion. Looking ahead, you must watch for trends in new orders. What about profitability?
Earnings missed surprisingly
Gross margin erosion had been an issue in recent quarters, but recently began expanding thanks to cost savings initiatives. Back in Q3, gross margin increased to 14.1% from 13.8% in the sequential Q2 2020 quarter. It is also up from 12.0% in Q1. But here in Q4, we saw a disastrous margin. It was only 10.5%, way below the 12-14% we thought we would see. There was less syndication activity and operating inefficiencies in manufacturing and wheels, repair & parts.
There was a decline in the manufacturing segment versus the sequential Q3. Gross margin was 9.4% in the manufacturing segment which dropped from Q3’s 13.8%. We are still well above the lows of 6.9% in Q2 2019. Operating margin fell to 5.4% from 10.5%. There were inefficiencies here and decreased syndication activity.
For a few years, the wheels, repairs, and parts segment has been burdened with high costs. Margins worsened here. They fell from an 8.6% margin, down to 6.0%. Operating margin also fell here to 1.3% from 4.6%. There were lower volumes in wheels and repairs. Finally, leasing and services saw margins rise from 37.4% to 53.2%, because Q4 had no externally sourced syndication volumes which are lower margin. All in all, this was better than expected in this segment. Further, all of this is what you need to watch going forward. It all led to EPS missing our expectations by $0.15 and consensus by $0.14. The EPS came in at $0.16, down sizably from Q3’s $1.05.
The quarter was weaker than expected as a whole. The COVID-19 slowdown in orders and activity is temporary, but may persist into early 2021. While order volume was low this quarter, it rebounded from Q3. The backlog remains solid for many quarters to come. We expect improvement in 2021. We are holding here, and plan to sell in the mid $30s, but would be buyers sub-$25.
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Disclosure: I am/we are long GBX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.