Greenbrier: Potential Europe Risks, Time To Consider Taking Profits (NYSE:GBX)

Investment thesis: Following an over 60% gain in Greenbrier’s (NYSE:GBX) stock price in the past year, the inevitable question is whether there are enough significant drivers, both internal as well as external, to push this stock higher from here. Internally, the company continues to operate well, financially, and it is earning new contracts and expanding its orders tally. Externally, it looks somewhat more complicated at the moment. On one hand, resource scarcity, including oil supply constraints that may arguably be on the horizon, favors rail transport, which is more energy efficient. On the other hand, the economic fallout in Europe from the Ukraine war risks undercutting investment in rail transport infrastructure expansion and renewal. Europe is a significant market for Greenbrier. Given the still decent long-term prospects, but also an arguably higher risk profile, I am starting to look at taking advantage of the decent run in this stock and taking some profits, while any significant decline in this stock, especially if it is due to temporary external factors should still be seen as an investment opportunity.

Greenbrier finished last fiscal year with decent financial results and an increase in its orders backlog, but the latest quarter shows signs of slowing down.

Greenbrier’s full-year results for 2023 confirm the company’s steady growth in revenues & deliveries.

An early indication of where deliveries might be headed going forward, namely its orders backlog, suggests that there may be a slowdown in growth on the horizon unless a sudden surge in demand materializes in the next year or so.

When we look at its deliveries versus its orders backlog situation, the gap between deliveries for the year and the backlog has shrunk from just under 11,000 units in 2022, to 6,000 units last year. Last year’s orders backlog rose to a level that slightly surpassed 2019 levels. I doubt that there will be much improvement in this regard for the current fiscal year. If delivery growth continues on the same path, we will probably see the orders backlog shrink to less than one year’s worth of deliveries at some point next year.

For the first quarter of fiscal 2024, Greenbrier saw deliveries of 5,700 carts, while the number of new orders came in at 5,100. We cannot assume that a single quarter makes for a trend, but it is perhaps an indicator of a slowing business environment, especially when coupled with the results we saw during the previous fiscal year.

Revenues increased by just over 5% in the first quarter of the fiscal year compared with the same quarter from a year earlier. This also suggests that Greenbrier is now settling into a less spectacular growth pattern.

Net earnings came in significantly better for Q1, 2024 compared with the same quarter of 2023, at $33.2 million, compared with a $17.3 million loss. Its earnings margin is 4.1% of revenues, which is decent, but overall somewhat on the thin side, leaving very little room for increased costs, or having to discount its sales due to competition.

Its overall debt situation has deteriorated somewhat.

Its interest costs, together with foreign exchange costs, increased from $19.6 million in the first quarter of 2023, to $23.2 million for the latest quarter. The interest burden is manageable, coming in at under 3% of revenues.

Positive & negative external factors to be aware of.

• Resource scarcity & efforts to control emissions work in Greenbrier’s favor.

I last covered Greenbrier in 2022 and also bought some stock late last year, with the overall long-term positive outlook I laid out two years earlier in mind. Just to recap the positive long-term external factors case for Greenbrier’s stock, there are two somewhat related trends happening at the moment, namely the efforts to reduce emissions to combat climate change, which also plays indirectly into efforts to reduce demand growth for arguably scarce resources such as crude oil.

It is the latter issue of crude oil supply constraints which, in my personal view, plays a more significant role in Greenbrier’s positive long-term outlook. The climate change issue is the one grabbing all the headlines, since most arguments in favor of reducing our reliance on hydrocarbons, including crude oil, center around this issue. My take on this subject is that while policymakers prefer to talk about the need to cut oil demand to address climate change, behind the rhetoric there are ongoing concerns about energy security that drive energy policy toward reducing our global dependence on oil. The latest indication that suggests our worries are justified is that the EIA is now forecasting a near-stagnated shale industry. This is very important because shale oil contributed to most of the global growth in crude oil supplies in the past decade and a half. EVs are the best choice for reducing oil demand for personal transport, while in freight transport, the most practical thing to do is to increase rail transport capacities.

• The effects of the Russia-Ukraine conflict threaten Greenbrier’s European sales prospects while raising costs for its European operations.

As I pointed out in my 2022 article on Greenbrier, the war in Ukraine did bring some benefits to the European rail transport industry. Ukraine’s growing need to transport grains and other goods overland spurred some rail transport expansion investments. Greenbrier has sizable facilities in Romania & Poland, thus well-positioned to benefit. Though over 80% of Greenbrier’s sales are domestic, 18% are foreign, and a significant portion of those foreign sales are in Europe. Greenbrier does not break down its foreign sales by region, but looking at the facilities in Europe versus Latin America, it seems that its exposure to Europe is higher. For instance, Astra Rail in Romania has about 2,000 employees and yearly revenues in the $200 million range. Greenbrier’s Europe segment may not be a make-or-break for the company, but a significant slowdown can cut into sales, revenues, and profits, making it less likely for the company to be able to maintain growth.

With the war going into its third year, so is the economic confrontation between the EU and Russia, with the EU so far showing signs of getting the short end of the stick.

As we can see, the EU is currently showing signs of being more affected by the economic war it is conducting against Russia than Russia itself. The IMF dutifully forecasts that things will go in the right direction in Europe on this front shortly. We should note however that since 2022, the IMF constantly had to upwardly revise Russia’s forecasts, while the EU’s were constantly downward adjusted. Germany’s forecast for this year is already at .2% growth, versus .5% that was baked into the IMF forecast, meaning that the IMF’s next forecast will have to be further revised down.

Between a struggling economy and more and more evidence that the EU is moving toward spending a lot more on its defense, meaning that less will be allocated to infrastructure in coming years, it is entirely feasible to see a dramatic slowdown in European rail transport investments. Greenbrier can hardly hope to compensate by finding new markets because in the markets where there is significant rail transport expansion happening, such as in Russia or within the context of China’s global infrastructure-building initiatives, the markets are dominated by non-Western rail equipment manufacturers. Within the current geopolitical context, there is no hope of a company like Greenbrier having a chance to win contracts within the emerging China-led initiatives & organizations. If the European economy continues to de-industrialize a large portion of Greenbrier’s market can potentially plunge into contraction because demand for all transport services is likely to decline.

I should also mention the rising cost of production in Europe as a factor to watch for Greenbrier, along with all other industrial producers on the continent. In addition to the decades-old efforts to reduce emissions, which makes Europe one of the most expensive places to operate an industrial facility on Earth, there is also the ongoing economic divorce between the EU & Russia. The latter is the world’s largest net exporter of commodities, which makes the break in economic ties between the two a long-term burden on industrial activities in the EU since it now has to source resources from elsewhere, which mostly costs more to source.

Investment implications:

• Past performance history highlights the limited upside potential for Greenbrier investors at current stock price levels.

As we can see, Greenbrier’s stock price underperformed the wider market in the past five years. Furthermore, it failed to produce long-term gains for investors for the period. Given the potential risks I highlighted, as well as the overall dynamics of the industry, which is reflected in Greenbrier’s stock performance, there is now more potential downside for this stock than upside.

Greenbrier’s P/E ratio is well below the market average, but it is not necessarily cheap compared with industry peers.

The S&P 500 (SP500) is trading at a P/E ratio of almost 28, which is more than twice the P/E ratio that Greenbrier is currently trading at.

Greenbrier may be cheap relative to the broader market, but compared with many of its industry peers, it is not a bargain. Bombardier (OTCQX:BDRBF) for instance, which also produces planes, currently trades at a forward P/E of under 10. Siemens (OTCPK:SIEGY), which also produces rail carts, in addition to a very diverse portfolio of products it offers to markets trades at a forward P/E ratio under 11.

One can argue that since neither of its competitors in the rail cart space are pure plays, it is not an apples-to-apples comparison, which is true to some extent. However, the fact that the peers I chose to compare to are more diverse in what they offer in terms of their product lineup, also makes them arguably safer. Greenbrier is uniquely positioned to take advantage of a sizable increase in global rail transport demand, precisely because it is a pure-play, but it is also exposed to the risk of a significant downturn in rail investment to a greater extent. Siemens, for instance, would hardly notice if its rail transport equipment segment were to see a boom or a bust because it makes up a relatively small part of its overall business. Balancing the risk/reward, one could argue that Greenbrier’s stock price has gotten a little bit ahead of its financial performance, relative to industrial peers.

Conclusion

Greenbrier’s stock price has had a good run in the past few months, and it does have a compelling potential long-term growth story, mostly due to external factors. However, there is also a potential risk, especially because it has a sizable exposure to Europe, which is not a good place for a rail transport equipment manufacturer to be, given the rising costs of production for heavy industry, while the European economy seems to have entered an era of systemic de-industrialization.

My plan at this point is to start reducing my position as the stock keeps going higher, potentially selling my entire position if its stock price approaches its old record high in the mid $65/share range. Whether a decline will happen due to internal or external factors, I intend to add to my position in this stock once it declines to a point where it will have a P/E ratio in the single digits. I bought my current position in October 2023 at $33/share. It went higher faster than I anticipated, and I am ready to start taking some profits. At the same time, this is a solid company, with a credible thesis that can be made in favor of the industry it is a part of. It is also one of the few solid pure-play options within the rail transport equipment segment that also has a solid financial foundation. For this reason, even if I reduce my position in the next few weeks or months, I also intend to remain on the lookout for further opportunities to buy more stock at a more favorable entry point.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.