Every once in a while, a single stock can become a Wall Street battleground as investors and hedge funds face off with big bets for or against a single company. One stock that has become a Wall Street battleground is railcar manufacturer The Greenbrier Companies (NYSE:GBX). According to The Wall Street Journal, more than 32% of the company's shares floated on the market are sold short, making it one of the 25 most shorted companies on the New York Stock Exchange.
What has so many people betting against this company? Let's take a look at why short interest in Greenbrier has grown so much and whether those with a bearish bet on the stock are right.
The short sellers' case
Greenbrier's business is inextricably tied to the broader railroad industry. Unfortunately, that hasn't been the best industry to be linked to lately. Over the past couple of years, three of rail's largest cargo types -- coal, oil via rail, and frack sand -- have all fallen significantly. While frack sand has come back strong in recent months, oil via rail remains weak as pipeline capacity gets built out in shale basins across the U.S. and coal continues its long slide as consumption from power plants dwindles. For Greenbrier, less total demand means that the fleet of railcars needed to handle these particular cargos -- hoppers and tank cars -- is waning. This matters because hoppers and tank cars comprise the vast majority of railcar demand.
If this were just a cyclical thing, then it would be hard to justify such a short position as every cyclical business goes through peaks and troughs. The trouble is, though, that coal is such a huge part of the rail volume mix that this secular trend toward lower volumes could have a profound impact on overall hopper car demand that other products such as grain and frack sand simply cannot offset.
Another component of the short thesis is that Greenbrier hasn't exactly been the best over time at converting revenue to profits, managing its debt load, or generating a return for investors. When a company carries around that much baggage, it can be hard to prove to Wall Street that things are different this time around.
Defending the stock
There are two ways to poke holes in this short case. The first is to look at the macro trend of rail. While there is no doubt that coal's decline and the shift away from oil via rail to pipelines will make it challenging for Greenbrier and others in the near term, there are reasons to be optimistic. Even though tank car use isn't quite as robust as it once was, the fleet of tank cars needs to be turned over. A few high-profile oil via rail crashes highlighted that much of North America's rail cars didn't meet necessary safety specifications, and any new railcar built after 2015 now has to meet new Department of Transportation specifications. The users of these tank cars are going to have to migrate to these new spec cars -- imagine another disaster, and it's discovered the company was using older cars -- and that should help to drive tank car demand through this down cycle.
It's also worth noting that Greenbrier has also diversified its business to do more than just new railcar manufacturing. Its wheels and parts business also provides it with access to the decrease rail market. This is important because intermodal transportation and the cars to move it -- flatbeds -- is a booming business and will likely continue as freight transport has a significant cost advantage over other transportation methods.
The other component that makes this short thesis hard to swallow is that Greenbrier has changed materially in the past couple years. I know the term "this time it's different" is typically the precursor to investors losing a lot of money, but the numbers suggest that is the case. The one aspect that stands out the most is its financial health. Today, Greenbrier has more cash on the balance sheet that total debt outstanding, and its total debt-to-EBITDA ratio is a modest 1.5 times -- a decent metric for a capital-intense manufacturing business.
It also looks as though the company has its costs under control much more than ever before. Even though sales have tumbled recently, management has been able to cut costs enough that gross margins have expanded. Perhaps these metrics are just short-term aberrations, but they suggest this company is in a much better position to handle this downturn and be ready for the next expansion phase.
What a Fool believes
I'm not a huge fan of shorting stocks in the first place. But for a company's stock to be short-sell candidate, the business should be structurally flawed in a way that it probably isn't going to recover. Greenbrier just doesn't look like that kind of company. Its margins are noticeably better over the past year or two compared to prior downturns, and some of the company's strategic moves have yet to play out fully. Moreover, its stock already trades at a low enterprise value-to-EBITDA ratio of 3.9 times. Yes, things can always get worse and there is always a chance the stock could slip, but the odds of a significant drop where short-sellers could make a killing seem much lower than Greenbrier riding a wave of improving performance in the future.