GATX Corp

NYSE:GATX

Earnings Call Transcript 2019-Q3

[Operator]

Good day, and welcome to the GATX Third Quarter Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Jennifer McManus. Please go ahead.

[Jennifer McManus, Senior Director-Investor Relations]

Good morning, everyone, and thank you for joining GATX’s 2019 third quarter earnings call. I’m joined today by Brian Kenney, President and CEO; Tom Ellman, Executive Vice President and CFO; and Gokce Tezel, Executive Vice President and President-Rail International.

Please note that some of the information you’ll hear during our discussion today will consist of forward-looking statements. Actual results or trends could differ materially from those statements or forecasts. For more information, please refer to the risk factors discussed in GATX’s Form 10-K for 2018. GATX assumes no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances.

Earlier today, GATX reported 2019 third quarter net income of $45.1 million or $1.25 per diluted share. This compares to 2018 third quarter net income of $47 million or $1.22 per diluted share. Year-to-date 2019, we reported net income of $154.6 million or $4.22 per diluted share. This compares to $162.1 million or $4.21 per diluted share for the same period in 2018.

2019 year-to-date results include a net deferred tax benefit of $2.8 million or $0.07 per diluted share related to an enacted tax rate reduction in Alberta, Canada. 2018 year-to-date results include a net negative impact of $5.8 million or $0.15 per diluted share attributed to costs associated with the closure of a railcar maintenance facility in Germany. These items are detailed on Page 12 of our earnings release.

Now, I’ll briefly address each segment. The operating environment in Rail North America has been challenging, given car load volumes relative to 2018 and the continued oversupply of certain car types. However, we produced strong financial results in the quarter.

Due to excellent execution by our commercial team, Rail North America’s fleet utilization remained strong at 99.2% at the end of the third quarter. Our renewal success rate was 75.2%. During the quarter, the renewal rate change of GATX’s Lease Price Index was negative 7.7%, which is in line with our full year LPI expectations. The average renewal term associated with the LPI was 40 months. Absolute lease rates across our fleet were relatively flat quarter-to-quarter, with lease rates for most tank car types remaining near long-term averages and lease rates for most freight car types remaining relatively weak.

We continue to successfully place new railcars from our committed supply agreements with a diverse customer base. We have already placed 8,450 railcars from our 2014 Trinity supply agreement and over 1,000 railcars from our 2018 Trinity supply agreement. Additionally, we have placed over 2,000 railcars from our 2018 Greenbrier supply agreement. Our earliest available scheduled delivery under our supply agreements is in the third quarter of 2020.

The secondary market for railcars in North America remained active in the quarter. Rail North America’s remarketing income was $4.5 million during the quarter, bringing total remarketing income for the year to $41.2 million. Within Rail International, GATX Rail Europe is seeing strong demand across the fleet, with utilization increasing to a historic high of 99.4% at quarter end. During the third quarter, Rail International’s investment volume was approximately $51.8 million as GATX Rail Europe and GATX Rail India continued to take delivery of new cars and grow the fleet.

Portfolio Management’s results were primarily supported by the excellent performance of the Rolls-Royce & Partners Finance affiliates. Demand across engine types remains strong and the market for engine sales is robust. American Steamship Company is performing well and is benefiting from continued high water levels. ASC is currently operating 11 vessels.

Finally, GATX repurchased nearly 616,000 shares for approximately $46.7 million during the third quarter. Year-to- date, we have repurchased over 1.7 million shares for approximately $130 million.

Those are our prepared remarks. I’ll hand it over to the operator so we can open it up for Q&A.

[Operator]

Thank you. [Operator Instructions] And we’ll take our first question from Allison Poliniak with Wells Fargo.

[Allison Poliniak, Wells Fargo]

Hello guys, good morning.

[Brian Kenney, President and Chief Executive Officer]

Good morning.

[Allison Poliniak, Wells Fargo]

Could you touch on maintenance expense in North America for us? I think if I remember correctly, it was supposed to be up 7% to 10%. It seems like it’s trending a little bit below that. So just want to see if there’s like a Q4 event? Or if it’s just running a little lighter than you expected?

[Brian Kenney, President and Chief Executive Officer]

Sure, Allison. It’s Brian. And you’re right, we did say maintenance expense would be up 7% to 10% entering 2019. And it’s only up about 3.5% gross through the third quarter. Looking ahead, we do expect more tank compliance work versus last year in the fourth quarter. We expect a little more commercial churn in the fleet, and that could drive more maintenance expense. But having said that, we’re still running favorable to expectations in other areas that drive maintenance spending. So it doesn’t look like gross maintenance expense will increase as much as we originally anticipated anyway. So for example, railroad repairs are running favorable to expectations. We’re realizing savings from closing some of our less-efficient maintenance locations. And actually, we’re more productive in our own network.

So in addition, and it probably doesn’t get enough attention, we tend to look at maintenance on a net maintenance basis, and a big positive factor is our repair revenue. The mix of repairs we’re seeing in 2019 is such that we can contractually charge more for the work that we’re doing, and we’ve gotten more efficient from a systems perspective in identifying that liability work and collecting on it as well. So while we expect gross maintenance to be up, certainly not as much as we originally expected for the reasons I’ve said, and when you combine that with favorable experience in repair revenue, we anticipate understanding – underspending our original maintenance expectation for net maintenance as well, and that’s really a good new story this year.

[Allison Poliniak, Wells Fargo]

That’s great. And I guess in line with that, is the other revenue, I’m assuming that like similar quarters, the repair revenue coming in which is elevating that number a little bit?

[Brian Kenney, President and Chief Executive Officer]

Correct.

[Allison Poliniak, Wells Fargo]

Okay. And then last same thing with remarketing income, seems like it’s trending a little bit below what you anticipated. Again, is it sort of a true-up Q4? Or is that just coming in a little bit less than you thought? I think we had thought $65 million was that number.

[Brian Kenney, President and Chief Executive Officer]

Well, we said we could approach. I believe, coming into the year, we said we could approach last year’s number, and that’s why I hate talking about it quarter-to-quarter because we don’t necessarily control the timing and it doesn’t fall evenly you know the story.

[Allison Poliniak, Wells Fargo]

Yes.

[Brian Kenney, President and Chief Executive Officer]

But we do expect some of the fourth quarter, but I what say we probably won’t get to what we thought the original expectation was. I don’t think we’ll get that close to last year’s number, but there’ll still be a healthy number given the market.

[Allison Poliniak, Wells Fargo]

Great. Thank you so much.

[Operator]

We’ll take our next question from Justin Long with Stephens.

[Justin Long]

Thanks and good morning. So, I wanted to follow up, Jen, on your comment about absolute lease rates remaining pretty stable sequentially. I was wondering if you could provide a little bit more color on tank versus freight and if that comment would apply to both of those markets, just kind of stable trends sequentially. And then going forward, as we think about 4Q and early next year, any reason to believe that this kind of stable trend will not continue?

[Tom Ellman]

Justin, this is Tom, and I’ll take that. So as you know, we entered 2019 cautiously optimistic. And despite a variety of challenges, including PSR, tariffs, decreased railcar loadings, increased railroad velocity, the year has generally played out as we’d expected. And as we’ve talked about on the last couple of earnings calls, the tank car market has been a little bit stronger than we originally expected, and the freight car market’s been a little bit weaker. Specifically addressing lease rates, the tank car lease rates for most tank-car types were about the same this quarter as they were last quarter. But those spot lease rates are up about 10% to 15% versus a year ago. One exception to that, same exception we talked about last quarter, is the legacy flammable liquid tank cars, where our Q3 lease rates are flat versus Q2 but down about 15% to 20% versus Q3 2018. And as we discussed, this is primarily due to customer preferences for the newer DOT-117 tank car.

Freight cars. The weakness that we’ve seen all year is persisting. And on average, they were down about another 5% to 10% versus Q2 and around 20% versus a year ago. However, it’s worth noting that there’s a lot of variability among individual freight car types. In some individual car types, like small cube covered hoppers for frac sand, center beams for lumber, are down even more than that 20% on a year-over-year basis. As we approach Q4, the macro trends are pretty consistent with what we’ve seen so far this year. Railcar loadings for Q3 were down 4.3%, 2.6% if you exclude coal, significant declines in a variety freight car types, relatively more positive for some of the key tank car types like chemical and petroleum products. They had a more favorable comparison than those freight car types I mentioned. So we would expect the environment to be similar in Q4.

[Justin Long]

Okay. That’s really helpful, Tom. Thanks. And I know one item that you’re watching pretty closely is the tank car backlog, and it’s a little tricky looking at the industry data because there are some multiyear orders in there, and I know, you have some multiyear orders in that backlog. But can you just share what you’re seeing on tank car lead times today and your view on the lead time that’s needed in order to sustain lease pricing that we’re currently seeing in the market?

[Tom Ellman]

Yes. So as you know, the actual backlog numbers are expected to come up this week. The Q2 backlog was 69,000 railcars, about half of which were tank. The tank car lead time has moved around a little bit over the course of the year. Right now, I would say for most tank car types, it’s between about nine and 12 months. Freight cars has been somewhat shorter. In general, I would still call it around nine months but there’s pockets of availability even earlier depending on what production run a given builder is doing. That sort of nine to 12- month range for the tank cars appears to be enough to keep things stable. To get them to go up, you’d want to see some get over a year. And shortening much beyond where it is now, we’d look for more challenges.

[Justin Long]

Okay. Thank makes sense. And one just final modeling question. On remarketing income, just curious, did your expectation for 2019 change versus what you were expecting last quarter?

[Tom Ellman]

If you recall on last quarter’s call, we mentioned we might be a little short of the 2018 total. So our guidance reflects that expectation.

[Justin Long]

Okay, perfect. Appreciate the time.

[Operator]

We’ll take our next question from Matt Elkott with Cowen.

[Matt Elkott, Cowen]

Good morning, thank you. Tom, you mentioned customers’ preference for the DOT-117 tank car. Is that strictly for the DOT-117J, the newly built variety? Because we are hearing that Union Pacific maybe – may start demanding the use of DOT-117J specifically for highly flammable liquids like BNSF did a while back. Is that something you guys are hearing? And does it mean that it – this makes you hesitant to invest in any retrofitted variety of the DOT-117?

[Tom Ellman]

Yes. Those are great points. So first of all, it’s a sequence. You’re absolutely correct that the general customer preference is for the 117J, followed by the 117R, followed by the legacy car type. As you know, GATX early on announced that we had no intention of retrofitting any of the legacy flammable liquid cars because we were very confident that customer preference would go – would ultimately go away from that. As far as the DOT-117J versus the R, there’s two different ways that you can retrofit depending on whether or not the car is already jacketed. GATX has participated in the relatively inexpensive retrofit just a couple of thousand dollars to retrofit a CPC-1232 cars that were jacketed. We have stayed away from the much more expensive retrofit for cars that were non-jacketed for exactly the reason you’re highlighting. And it just – when this first started, we indicated that we would definitely be retrofitting doing the inexpensive retrofit, and we had to evaluate further the more expensive retrofit of the CPC-1232 non-jacketed car and exactly the items that you’re talking about has made it very unlikely that we would pursue that. And I know a lot of our competitors have but an area that GATX has stayed away from.

[Matt Elkott, Cowen]

Tom, that’s very helpful. And can you remind us how many DOT-117s, I guess, both R and J, you have in your fleet right now?

[Jennifer McManus, Senior Director-Investor Relations]

We have about 3,200 DOT-117s and we have probably less than 100 DOT-117Rs, and those are really, as Tom has mentioned, the very inexpensive retrofits.

[Matt Elkott, Cowen]

Got it. Thanks, Jennifer. And my other question is, I think you guys had about 18,000 cars total renewing in 2019. Can you give us a number for next year?

[Jennifer McManus, Senior Director-Investor Relations]

We’re actually not going to give that to you until our Q4 call. But directionally, you can assume that it’s going to be closer to where we were at this year versus the last few years, where it’s been at a lower level.

[Matt Elkott, Cowen]

Okay. And any – is the – a percentage of cars renewing, does it have any outsized thesis to certain markets next year or is it pretty diversified?

[Jennifer McManus, Senior Director-Investor Relations]

I would assume that it’s fairly diversified as it has been. The one area that we’ve dealt with, that we’ve talked about publicly, has been our coal car renewals just because we’ve been going short on those. Outside of that though, I wouldn’t anticipate anything. It’s going to be very diversified in what we’re renewing.

[Matt Elkott, Cowen]

Okay. And then you guys talked about part of the reason why your fleet utilization has stayed strong despite rail traffic declines and worsening utilization in the industry. Part of the reason is displacing competitors. Does that apply to both operating lessors and financial owners of railcars? Or is it – are you more effective at competing with one or the other?

[Tom Ellman]

Well, I mean overall, utilization’s been above 99% all year long. So we’re doing a pretty good job, regardless of who we’re competing against.

[Matt Elkott, Cowen]

Great. Thank you very much.

[Operator]

We’ll take our next question from Matt Brooklier with Buckingham Research.

[Matt Brooklier, Buckingham Research]

Thanks. Good morning.

[Tom Ellman]

Good morning.

[Matt Brooklier, Buckingham Research]

Yes, so just wanted to follow on, if we look at asset disposition gains, it sounds like it came in just a little bit below your expectations. Still a very solid number, but considering the trajectory of the market, where we’re at now, do you have a directional sense, where asset disposition gains could be in 2020?

[Tom Ellman]

Yes. So in general, just like the last question about the expirations, we’ll provide guidance on 2020 in next quarter’s call.

[Matthew Brooklier]

Okay. Fair enough. And then if we look at the change in the LPI within the range you originally provided. For the year down seven-ish was and you would likely call this out if there had been anything, but is that kind of reflective of the current market or was there anything extraordinary in the number this quarter?

[Tom Ellman]

Yes. So, as you know, we always caution people not to look too closely at an individual quarter. For the three quarters, Q1, we were positive 5.2%. Q2, negative 2.8%, and Q3, negative 7.7%. At the beginning of the year, we expected the full year to be somewhere between negative 10% and positive 5%. And obviously, those three numbers indicate that we’ll be right in that range. So I wouldn’t read anything in particular into this given quarter versus the other two.

[Matthew Brooklier]

Okay. Helpful. And then just lastly on the SG&A side, I don’t know if you touched on this, but it looks like that you had targeted savings of, I think, about $10 million as we went into the year. It’s still trending down but maybe not as much as the original number. Maybe, give us a little bit of an update in terms of your thoughts there and maybe where the fourth quarter should shake out. Thanks.

[Tom Ellman]

Yes, you’re absolutely correct. Coming into the year, we said we expected to be about $10 million lower than 2018’s total of $191 million, and we also commented on this briefly on last quarter’s call. Year-to-date, through the first three quarters, we’re at $136 million, which is roughly in line with our expectations. But we continue to feel that we might fall a few million dollars short of the goal for the year partially due to the higher-than-expected sales incentive compensation related to our commercial success on lease renewals. And as we mentioned, we’ve also restructured our maintenance organization in 2019 to improve our capabilities, and more of those savings will end up in maintenance cost than in SG&A, as we originally thought. And just in general, the fourth quarter tends to be a little bit higher than the first three. So for all those reasons, although we’ll be down, we probably won’t achieve our $10 million goal.

[Operator]

We’ll take our next question from Justin Bergner with G.research.

[Justin Bergner, G.research]

Good morning.

[Tom Ellman]

Good morning.

[Justin Bergner, G.research]

I have a handful of questions here. First off, maybe Jennifer and Tom, you could just remind us what the repurchases were in the third quarter? I think you provided them but they came out a little fast.

[Tom Ellman]

Sure. So, just highlighting overall the stock buyback, our current authorization is for $300 million, $170 million of which are remaining. Through the first three quarters, we’ve done $130 million. Earlier in the year, we indicated an intention to do approximately $150 million in 2019, and we still expect to that.

[Justin Bergner, G.research]

Okay, great. And then in the third quarter, was it 616,000 shares for $47.6 million or did I mishear that?

[Jennifer McManus, Senior Director-Investor Relations]

You did hear that right, Justin.

[Justin Bergner, G.research]

Okay.

[Jennifer McManus, Senior Director-Investor Relations]

616,000 shares.

[Justin Bergner, G.research]

Okay. I think on the last call, there was more of an interest looking forward taking advantage of the weaker market to do car purchases in the primary or the secondary market. Could you sort of update us on how that looks? What are the sort of opportunities you’re seeing or not seeing? And how the competitive nature of that stands?

[Tom Ellman]

Yes. So, any time that there is a downturn in the market, we certainly look to purchase opportunistically. If you look at how the year has played out so far, we haven’t been able to find enough of those opportunities that economics that are attractive to us. So, our CapEx looks like it’s going to be in the, sort of, mid to higher end of the range that we’ve been at the last several years between $600 million and $800 million other than years where we do some extraordinarily, like the Element transaction last year or the GE boxcar transition – transaction a couple of years before that., So certainly, on the lookout for those opportunities. But right now, we’d expect our CapEx, absent something like that materializing, to be in the historical range.

[Justin Bergner, G.research]

Okay. Thank you. And then in terms of the sequential lease rates, are there any car categories where you’re seeing sequential lease rates improving? I think maybe last quarter, you highlighted some – that there might be some smaller categories of tank cars that we’re seeing some improvement. Is that still the case? Brian

[Brian Kenney, President and Chief Executive Officer]

Yes. The strongest part of the market is really the non-flammable tank cars and it’s strongest in that they’re staying flat. So there is no particular car type that I would highlight as having any kind of material spot rate increases.

[Justin Bergner, G.research]

Okay, understood. And then lastly, in the Rolls-Royce joint venture, maybe you could just describe a little bit more about what’s transpiring? You mentioned strong engine sales, I assume that’s third-party engine sales. Is that sort of the driver, the primary driver, of the year-on-year improvement? Or is it more of the lease rates on the existing engines being leased?

[Tom Ellman]

Yes. So, when you look at Rolls-Royce, just because of the timing of those remarketing gains and certain maintenance expenses, while we tend to very much look at the year-to-date comparisons because they’re more meaningful than quarter-to-quarter. And the year-to-date comparisons for Rolls, both on just the leasing of the engines and on remarketing gains, are up slightly.

[Justin Bergner, G.research]

Okay. And you’d expect that to continue? Or is there anything that is sort of on the horizon that could change that dynamic?

[Tom Ellman]

Yes. the underlying fundamentals are continuing to be very good for that business, and we expect strong performance.

[Justin Bergner, G.research]

Great. Thanks for taking my questions.

[Operator]

We’ll take our next question from Steve O’Hara with Sidoti &Co.

[Steve O’Hara, Sidoti &Co]

Hi, good morning.

[Brian Kenney, President and Chief Executive Officer]

Good morning.

[Steve O’Hara, Sidoti &Co]

Just on – in terms of the revenue within Rail North America, it was down, I think, like 2% sequentially. Average number of cars was down, looks like about 1% sequentially. Was the revenue – I guess I’m just wondering about the revenue decline there, was that due to more locomotives and boxcars? Or is that more due to the timing of when you get cars in and re-lease and so forth?

[Tom Ellman]

Yes. When you look at revenue moves on relatively short periods of time like that, just given the long-term nature of the leases, you’re not going to be able to tie any kind of revenue move to a change in lease rates. So, short-term moves like that are because of the total number of active cars on lease.

[Steve O’Hara, Sidoti &Co]

Okay. Got it. Thank you, it makes sense. And then just on the RRPF, do you know if there’s any – in terms of the issues of the max fleet, has there been any benefit or – due to that fleet being out longer than expected, has the – your portfolio benefited anymore? Or has it been just not really a factor for the – for that business?

[Brian Kenney, President and Chief Executive Officer]

No. There really hasn’t been any impact short term on that business. It’s already 100% utilized virtually. So there’s nothing to be had there.

[Steve O’Hara, Sidoti &Co]

Okay, okay. And then just looking at the – when you were talking about the maintenance expense earlier, you were talking about, I guess, gross versus net, is that what’s primarily in the other revenue line? Is that – you’re getting the revenue on the maintenance in, in that line and that’s kind of helping offset some of the maintenance expense on the – within the income statement line below?

[Brian Kenney, President and Chief Executive Officer]

That’s correct.

[Steve O’Hara, Sidoti &Co]

Okay. And then – so is this a newer phenomenon or is it – is there something different that – where you’re you able to get more flow-through to your customer occurrences then paying for maintenance? Or is this just outside maintenance work done that you guys – because you’ve taken more maintenance in-house now? Is that why that is? Thank you.

[Brian Kenney, President and Chief Executive Officer]

No. It’s not really third-party maintenance revenue, it’s with the existing leases. But it’s customer liability revenue. So whether it be a damaged lining or corrosion or certain things that the customer has a liability for, we’re getting much more efficient about identifying that and charging for it. And just the nature of the work has changed this year and last, where we were able to charge more of that contractually.

[Steve O’Hara, Sidoti &Co]

Okay, okay. And then maybe, lastly, just, I mean, you guys have a pretty good base for the economy in terms of all of your touch points. I mean, do you have – what’s your outlook on the general economy? Are you guys maybe more bullish on the economy or do you expect it to maybe – you see recession on the horizon? Just kind of curious where you stand.

[Brian Kenney, President and Chief Executive Officer]

Well, I say it all the time, I don’t have that crystal ball. I’m a pretty lousy economist. But we do track what our customers are saying and how they’re acting. And you can see demand’s still good, and it’s reflected in our extremely high fleet utilization. But I will say in the last quarter or so, it’s starting to feel like it’s losing some steam. Obviously, railcar loadings down every quarter this year-over-year basis is not a good thing. If you look at ASC, they benefited short term from the steal tariffs when they went on last year in terms of higher steel demand as imported steal went down. This year, they’re also benefiting, actually even more between that and favorable operating conditions, but you’re starting to see some things happen there as well. U.S. Steel closed the blast furnace that we serve, another one of our customers asked for a little bit of a relief on delivery.

Not enough to change our estimates but there’s a little more unsettled feeling in the economy out there, and you’re starting to see some of that in some of the states that, and that’s what we quoted in our press release. So I don’t know if a recession’s coming. I’ll say that and then in three weeks, we’ll have trade deal and it could go the other way. So, I just say it’s very uncertain out there. And as Tom said earlier, we’d like to see the tank car backlog increase, but it just sits there around this level, and people are getting more hesitant to make long-term decisions still. So until that turns around, it’s hard to be bullish on the economy.

[Steve O’Hara, Sidoti &Co]

Okay, all right. Thank you.

[Operator]

[Operator Instructions] And we have no questions in the queue at this time. I would like to turn it back over to Jennifer McManus.

[Jennifer McManus, Senior Director-Investor Relations]

I’d like to thank everyone for their participation on the call this morning. Please contact me with any follow-up questions. Thank you.

[Operator]

This concludes today’s call. Thank you for your participation. You may now disconnect.