Greenbrier's Dividend Entices, but Could Be Derailed by a Tough Economy

Dividend yields can be enticing. No arguments there, but as we saw last week with the shares of Briggs & Stratton there are times when a dividend yield that is too good to be believed is just that. The lesson learned from the big drop in BGG shares that stemmed from a sharp earnings cut and a slashing of its quarterly dividend by 60% is to be skeptical when a company's dividend yield is far richer than it has been in the past. This means getting under the hood to understand why the shares might be trading at current levels, especially if it means they've been on a downward slope, as was the case with BGG shares. In order to avoid another such debacle, let's do some investigating. We've received a fair amount of data of late that point to a slowing domestic manufacturing and industrial economy. Some of the data stem from the Federal Reserve, including last week's July Industrial Production report that showed a 0.4% decline in the manufacturing component and revealed manufacturing capacity utilization sat at 75.4% exiting the month. Add to that report the declining ISM Manufacturing Index figures and data from the Cass Freight Index, truck tonnage data and weekly railcar loadings and there is little doubt over the vector of the domestic manufacturing economy. Getting back to that 75.4% manufacturing capacity utilization level, it tells us there is ample excess capacity in the manufacturing economy. Generally speaking, when that level nears 85% we tend to see companies stepping up their capital spending in order to head off capacity utilization levels that are too tight. In light of the speed of the economy, it's rather unlikely that we are going to see companies such as Union Pacific , Norfolk Southern and Kansas City Southern step up and by more freight cars when there is ample slack in the system. And yes, the speed of the economy is showing up in the year-to-date decline in weekly rail traffic data reported by the American Association of Railroads, which is translating into falling orders for new railcars. Generally speaking, investors want to avoid rail car manufacturing companies such as Trinity Industries and Greenbrier Companies during periods of falling industry backlog levels and go long them when the backlog levels stabilize, patiently waiting for the next upcycle in demand. During periods of falling demand, those companies and their competitors tend to aggressively price new rail car orders to win business in order to keep their manufacturing lines up and running. During periods of rising demand and climbing industry backlog levels, these companies not only tend to obtain firmer pricing but also gain manufacturing efficiencies as their production runs become longer. At present we are seeing eroding backlog levels, which is the canary in the coal mine, especially for Greenbrier shares. I say this for two reasons. First, Greenbrier's backlog fell to 26,100 cars exiting its May quarter from 28,600 at the end of August 2018. In the May quarter its new orders equaled the number of rail cars Greenbrier produced, but there, too, its new order level has been drifting lower in recent quarters. Considering the current speed of the domestic economy, the uncertainty we are seeing in the global economy and troubled U.S.-China trade relations, the probability of further declines in new rail car orders is rising. And that's not even scratching the surface of any potential economic recession in the U.S. Now let's get back to the topic of dividend yields. Greenbrier shares are offering a dividend yield near 4.3%. That's far more attractive than the 2.3% yield the shares carried last February, but -- you knew there was a but coming -- the underlying fundamentals have eroded further since then. Complicating matters for Greenbrier, it recently completed its acquisition of the manufacturing business of American Railcar Industries, which means it meaningfully increased its exposure to the cyclical domestic rail car manufacturing market. Greenbrier paid $410 million for the business, an amount that per the 8-K filing was comprised of $60 million in cash on hand, $300 million under its term loan and $50 million in a new convertible promissory note. The good news is that even after utilizing that $60 million in cash, Greenbrier had roughly $300 million in cash on its books, far exceeding the $32.5 million in annual dividend payments it would need to make to shareholders. The bad news is that during the last recession Greenbrier terminated its dividend and did not reinstate it until mid-2014. Based on where we are in the business cycle, the prudent move would be to look for other dividend-paying companies that have far less economically challenged business models.

Greenbrier's Dividend Entices, but Could Be Derailed by a Tough Economy

The rail car maker is likely riding into a slower period of demand for its products, which investors should keep in mind when considering it as a dividend play.

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