Gatx Corp Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. Good day and welcome to the GATX 2020 Second Quarter Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Shari Hellerman. Please go ahead. Thank you, Paula. Good morning everyone and thank you for joining GATX's 2020 second quarter earnings call. I'm joined today by Brian Kenney, President and CEO; Tom Ellman, Executive Vice President and CFO; and Bob Lyons, Executive Vice President and President of Rail North America. 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 included in our release and those discussing GATX's 2019 Form 10-K and its 10-Qs for 2020. GATX assumes no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances. Earlier today, GATX reported 2020 second quarter net income from continuing operations of $37 million or $1.05 per diluted share compared to net income from continuing operations of $60.3 million or $1.65 per diluted share in the second quarter of 2019. Year-to-date 2020, we reported net income from continuing operations of $84.2 million or $2.38 per diluted share. This compares to $101.5 million or $2.75 per diluted share for the same period in 2019. The 2019 second quarter and year-to-date results include a net deferred tax benefit of $2.8 million or $0.08 per diluted share related to an inactive foreign tax rate reduction. These items are detailed on page 13 of our earnings release. During the second quarter, GATX completed the sale of American Steamship Company. Accordingly, this business segment has been reported as a discontinued operation and all prior periods have been recast to conform with that presentation. Income from discontinued operations are detailed in our earnings release. And now I'll briefly address each segment. In the second quarter, COVID-19 and the associated economic downturn had a negative impact across all of our business segments. Despite the difficult operating environment, Rail North America's fleet utilization remained high at 98.7% at quarter end. The renewal success rate was 71.8%. We built out our well-diversified fleet, full-service capabilities, and excellent execution by our commercial team. The lease rate environment was very challenging and pressure on lease rates was considerable across all car types and commodities. During the quarter, the renewal rate change of GATX's lease price index was negative 28%, and the average renewal term associated with ALPI was 31 months. We continue to successfully place new railcars from our committed supply agreements with a diverse customer base. We placed 8,950 railcars from our 2014 Trinity supply agreement and nearly 1,450 railcars from our 2018 Trinity supply agreement. We have also placed close to 3,400 railcars from our 2018 Greenbrier supply agreement. As mentioned last quarter, all supply agreement deliveries for 2020 have been placed. Remarketing income in the quarter was $4.5 million bringing Rail North America's total remarketing income for the year to $31.5 million. Turning to Rail International. The lease rate environment in Europe remained strong and GATX Rail Europe continued to see steady demand across the fleet with utilization of 98.4% at quarter end. Rail International's investment volume during the second quarter was approximately $50 million. In the quarter, both GATX Rail Europe and GATX Rail India experienced delays in new railcar deliveries primarily due to COVID-19-related interruptions at manufacturing facilities. In Portfolio Management, results were driven by the solid performance of the Rolls-Royce & Partners Finance Affiliate, predominantly due to remarketing activity in the quarter. Finally, as noted in the earnings release, the shape of the economic recovery remains uncertain. As the impact of COVID-19 evolves, we expect pressure on lease rates, renewal activity, and asset utilization to continue across all of our business segments. Those are our prepared remarks. I'll now hand it back to the operator for Q&A.

Thank you. Our first question will come from Allison Poliniak with Wells Fargo.

Hi, guys. Good morning. Could you talk to, I know you mentioned, obviously, a significant pressure on lease rates, but maybe financial trends in lease rates that you experienced this quarter? And just if there's any, sort of, mix issues within the LPI that we should be mindful of?

Sure, Allison. This is Bob Lyons. Good morning. The pressure I would say sequentially was equally shared between tank and freight. So if you look at Q1 to Q2 both tank and freight lease rates were down about 8% to 9% between Q1 and Q2. So no real significant differential between car types impacting the LPI in the second quarter. We came into the year - at the beginning of the year we said we expected the LPI would be down anywhere between negative 10% and negative 20%. So negative 28% for the quarter is obviously outside of that range, but given everything that's going on with COVID-19 and the economic impact, it's not that far outside the band.

Understood. Just a moment. Given the inflation in the secondary market over the past few years, I would expect that there will likely be a loss in terms of what they have to accept, or it might fall short of their expectations. You've experienced these cycles before, and there are obvious changes in the secondary market. Does this situation feel different? Is there something structurally unique about it, or do you anticipate some of these opportunities will materialize in the coming months?

I would compare it to the Great Recession of 2008, 2009, and 2010, when some asset owners took time to reach a point of capitulation. This could happen again. Many people paid relatively high prices for the cars in their portfolio, and there will come a time when they realize that recovery is not possible. The challenge is whether sellers are willing to accept that and move on. During 2008, 2009, and 2010, we found significant opportunities, and we believe they are present once more. However, we cannot predict if they will arise. Nonetheless, there are some portfolios that would be of interest.

Allison, this is Brian. The other thing I'd add is in the Great Recession, I would say there wasn't the same access to capital as there is today. So in a lot of those situations that we added to our portfolio back then, we were hit. Now it could be more competitive since everybody seems to have access to capital. So we'll have to see.

Got it. Understood. I’ll pass it along. Thanks.

And moving on, we'll go to Justin Long with Stephens.

Thanks, and good morning. So maybe to follow up on the lease rate commentary in North America. If we look at rail volumes, while down substantially year-over-year, we have seen some sequential improvement here in the last month or two. Also, if you look at FTR's railcar delivery forecasts, they're anticipating supply to start contracting. So as you think about those trends, how long do those trends have to continue before you feel like we can kind of hit a bottom in the lease rate environment? Is that something that you think is possible at some point in 2020, or is that 2021? Would love to just get your thoughts around that outlook.

Sure. Justin, this is Bob. And I'd say, it's very difficult to put a time frame on it, given all of the factors that come into play, whether it's the economic environment, the potential for a second wave of COVID-19 issues — a whole host of things that could come into play. So I'm hesitant to try to put a time frame on it. What I will tell you is that I think, while the delivery schedule of the FTR numbers have come down and the backlog has come down, you can't lose sight of the fact that this market was oversupplied for years and years. That will not correct itself with just a year or two of building below the replacement level. There has to be, in our view, a more dramatic reduction in output to help bring the market back into balance.

Okay. Makes sense. And then maybe shifting to RRPF, the contribution there was only down slightly on a sequential basis, it held up a lot better than we anticipated. In the prepared remarks, there was a mention of remarketing. Is there a way to help us think about how much of that $22.6 million impact in the quarter came from remarketing? And any way to think about that line item going forward based on the deferrals that you've seen in the market thus far and what you expect for remarketing going forward?

Justin, hi, this is Tom. And so for the second quarter, about two-thirds of that was related to gains in residual realization. So as we commented in the prepared remarks, a significant portion. In all markets, that tends to be pretty lumpy. So it's difficult in any market to predict exactly how that's going to come in. But based on what we've seen both in the second quarter and then even year-to-date, because it's worth noting the year-to-date number; the $46 million there, about $26 million of that was related to gains in residual realization. So it's something that we've seen throughout the year, and we would expect to see more of that going forward, but quantifying the magnitude of it is always a challenge.

Okay. Understood. And maybe the last question on SG&A. As we think about the business pro forma for the divestiture that you announced, Tom, is there a way to think about the SG&A run rate in 3Q? And how much of an opportunity you have on that and the ability to continue cutting costs on that front?

Yes, yes. So coming into the year, we noted that we expected SG&A to be roughly flat with 2019's number, which was $188 million. If you adjust for the ASC sale, SG&A from continuing operations would have been projected to be almost $180 million. In the wake of COVID, we implemented certain cost reduction measures and eliminated discretionary spending in areas like hiring, consulting, travel, and entertainment. And then over the course of the year, we also expect some incentive compensation savings. Together, we expect these measures to result in $15 million to $20 million of additional savings. So you can see that we expect more substantial SG&A savings in the second half of the year.

Okay. Great. It's really helpful color. Appreciated that.

Thanks.

And next, we'll go to Bascome Majors with Susquehanna Financial Group.

Yes. Thanks for taking my questions here. I wanted to go back to the earlier question on the M&A environment as an acquirer and maybe take a step back. When you're putting books out there as a seller, can you talk about the depth of that market? Is it the same bidders as you typically see or is that evolving? And you had alluded to maybe pretty ample access to capital when you're looking out to acquire fleets being a big difference today versus 12 years ago when you saw some opportunities, maybe anything about the buy side, what you're seeing in processes and the depth of that market? And is it evolving any versus what it's looked like over the last few years? Thank you.

Sure, Bascome. This is Bob Lyons. And I would separate the two types of sales into very distinct buckets. The ordinary secondary market activity, whether it's GATX or somebody else who's in the market, typically those packages are going to be anywhere between 500 cars to 2000 cars on many different leases, many different riders. So it's very common to see those, whether it's from us or others in the secondary market. That's very different than somebody going out to sell a portfolio of 5,000 to 20,000 or more railcars and sell it as an ongoing business, sell it as a large asset sale. That's a different buyer universe for something of that magnitude. On the first side, kind of, the ordinary core sales in the secondary market, we did see a reduction in activity in the second quarter. As you can see just from the remarketing numbers that we had, we did have some sales. We had roughly $4 million of remarketing income in the second quarter, and some of those sales in transactions were agreed to post the coronavirus impact. So there is activity. But the breadth and depth of the buyer universe has declined, I would say, pretty materially. There were still people looking at packages, looking at opportunities. But the biggest issue we hear is just the general uncertainty in the marketplace, whether it's the economy or the North American rail market, is making some of those buyers hesitant, and they've moved to the sidelines. Now, that said, investors remain interested in rail assets. They're great assets to own. The appetite is there, but the ability to invest near-term is pretty limited. And so, it's very difficult to kind of predict or estimate some of the remarketing income we may see in the second half of the year. If we have a second wave of COVID-related issues and the economy remains where it's at today, a lot of the investors are going to stay on the sidelines. And if things improve, you could see some of those investors come back pretty quickly, because they're really attractive assets. The underlying customer base is solid. And as Brian mentioned earlier, capital is really cheap. And so, you'll see people come back out and get back into the market for buying assets. Either way, we're in a good position. Our hold and sell analysis in times like now tends to be lean, putting us more in the direction of holding, and we're fine doing that, and we're capable of doing that. If it begins to point to selling a little bit more, we have the portfolio and the organization to make that happen. So we're in a good spot there. On the larger portfolios, again, different buyer universe, cheap capital, so any sizable portfolio, I think, is going to generate interest. But again, given the environment, doing the valuation work can be a bit of a challenge.

Thank you for that comprehensive answer. And in these processes, on the large portfolio side, are you seeing an evolution in who's bidding? I mean, is it more private equity money? Is it the infrastructure tagged investors that historically have cheaper capital and lower return requirements? And if the answer is, we just haven't seen anything of size to attract that kind of interest and in transparency in these lines of questions, that's fine. I just want to understand what you guys are seeing. Thank you.

Yes, I'll take that. It's Brian. That's what you've seen over the last five or six years for financial players entering the market. They don't necessarily have a low funding cost, but they seek railcars as passive investments, because they perceive yield. You've also seen some of the bank financial players that build platforms at a very low funding cost in the industry. In our opinion, both categories have spurred excessive investment in the industry beyond what is needed, and pull back by those players would be healthy for the market now. That's an obvious statement when you look at the oversupply in the market and the low lease rates over the last few years, especially now. So it's hard to tell if they'll show up, if some of these portfolios that are troubled hit the market. There's just not the data out there lately to suggest they'll be there or not. I suspect that there's still some interest. And, as we've already talked about, there's excellent access to capital.

Thank you.

And moving on, we'll go to Matt Elkott with Cowen.

Good morning. Thanks, guys. My question is on the average lease revenue per car for North America. And it looks like it's held pretty much flat on a quarter-to-quarter basis and down only slightly year-over-year despite accelerating LPI declines over the last few quarters. For Q2, does that mean that you guys had fewer cars coming up for renewal in the quarter? Or how do you think about reconciling that?

Well, Matt, it's Bob. First of all, I'd say, it's a little difficult to look at the average revenue per car kind of quarter-to-quarter. I would be hesitant to draw too much of a conclusion from that, because the mix changes all the time. If you look, for example, over the course of the last year, we've sold close to 4,000 cars. We've scrapped another 2,000-3,000 on top of that over the course of just the last year. So the mix changes routinely. That can have an impact on that average revenue per car. That said, tank cars in general are holding up fairly well in terms of the demand side, and we're seeing customers want to hold on to those cars, but they're negotiating very hard on rates. Every renewal, every new car placement is seeing a lot of competition. Our customers are very smart. They know the market conditions and they're going to use that to their advantage. Hence the reason we're trying to stay short, as you saw in the term. The freight rates have been – rates on freight cars have been challenged for a long time. So those rates went into this market already in a pretty depressed state, and they've stayed down relatively well.

Got it, helpful insights, Bob, thanks for that. Just one more follow-up question on the lease rates side. What do you guys think needs to happen for the downward momentum in lease rates to end and for us to potentially see a bottoming out of spot lease rates? Is it rail traffic inflecting positive? Is that maybe the first thing to look for?

That would certainly help. And I would say the economic activity, industrial activity in North America will be the biggest indicator for sure. But I'd also say the second thing and I touched on this already is just the sheer supply of cars coming into the marketplace. While the backlog has dropped, our view is still there are too many cars being produced for this market. And I have felt very strongly that's been the case now for a number of years. So, we need to see that spigot dial back; that will also help lease rates going forward.

Matt, just to add to that, if we did see an uptick in demand given what the railroads have done in terms of really cutting back, there is the potential that an increase in traffic would slow down the system a bit and you'd have a follow-on demand for cars because of that.

Yes, that's a very important point, also Tom. I don't think we've seen an environment where all the Class I industry-wide are implemented PSR while rail traffic is growing at the same time. So that remains to be a test, I think. Thanks so much for the insight.

Thank you.

Moving on we'll go to Steve O'Hara with Sidoti & Company.

Hi, good morning. Thanks for taking the question. Can you just talk about in terms of deferrals that you may have had in the quarter, I guess within the various portfolios was there a marked change in kind of lease income received from Q1 to Q2? And then maybe you could touch on how that impacted if at all the RRPF as well? Thank you.

Yes. I'd tell you what since we have Bob on the call, let's let him start with Rail North America and we'll cover the rest of it.

Thank you, Brian. The number of deferral requests has decreased significantly as the quarter progressed. The financial impact is negligible because, for the most part, the revenue from granted deferrals is recognized evenly over time. It's more about cash flow and timing, and the amounts involved are relatively minor. We've received around 50 requests from a customer base of 850 for some form of restructuring or deferral. Most actions we take tend to either be beneficial for GATX or provide some other commercial advantage. We have approved less than half of those requests, so the overall figure is not substantial, and the deferrals have been quite straightforward. I should mention that some customers in the small cube market, particularly in the sand service sector, are facing significant challenges. We've noticed a slightly greater impact there with fewer restructurings among the sand customers. Now, I think I’ll hand it over to Tom to discuss RRPF.

I'd say well, I'll do Rail International first. So Rail Europe we've received requests from about 40 customers. As you would expect, the majority of the customers seeking relief are mineral oil customers because it is 53% of the fleet, and you've seen the drop in prices. So the request is similar to North America split between those who have for rate reductions and those were after temporary rate holidays and deferrals. GATX Rail Europe has closed about half of those requests with no modification at all. The other half were closed with granting a few months of extended payment terms. So really, very little economic effect; I'd say it's less than $100,000. It's just timing of a few months. Rail India, similar, they've received a number of requests most looking for temporary rent deferrals, rate reductions one look for cancellation I know of. They've reached agreement with most of their customers as well. And generally the same pattern, a few closed with no change at all, some minor rent deferrals. I think there was one canceled delivery case. So again, the economic impact of those actions is well under $100,000. So they're hanging in there pretty well in rail international in both jurisdictions, and absent a COVID spike and related closures getting restarted, I think it's pretty good so far. Tom, what about RRPF?

Yes. So from a trend perspective, it's really the same story at RRPF as what Bob and Brian both mentioned. Of course, RRPF started with many more deferral requests. On the first-quarter call, we mentioned that a little over half of the airline customers have made some sort of deferral request, which was typically looking for three to six months of rent deferral. As we noted on that call, similarly, the accounting impact really doesn't show up because as long as it's a deferral, you continue to accrue that rent. We've really seen a slowing down in those requests, and it's really at the same level now as it was at the first quarter. The thing to keep an eye on, obviously, with the global aviation situation is as COVID continues, does that change? And we're keeping our eye on that, but as far as the second quarter went, it dramatically slowed just like the rail business.

Okay, that's very helpful information. Regarding the competitive environment, you've mentioned the increased competition, with everyone vying for utilization. Has that situation improved towards the end of the second quarter? Or is the current environment unchanged? Could you discuss that briefly?

Sure. And on that front, I would say, there hasn't been a significant change when you look month-over-month in the second quarter. It's competitive; very competitive any way you slice it, whether it's a renewal or a new car replacement, it's going to be extremely competitive. A number of lessors are going to be going after that business. The key for GATX is the fact that we have a highly diversified fleet. We have a lot of flexibility on our order book in terms of the type of cars that we can place in the customer base that we have, we see them consolidating the number of lessors that they're dealing with. Time and again, we're in a position where we're able to displace competitors. Hence the reason utilization has stayed 98% plus. We've done well on the renewal success where we are displacing competitors and winning that business, and a lot of the deals we're winning are relatively small. Any new car order, for example, that's a 1,000-car order is going to get everybody in the industry bidding on it. We've done very well on 50- and 100-car-type placements, and we have the customer base and the relationships and the commercial organization to make that happen. But it's competitive any way you look at it.

In Rail International, I'd say competition probably increased during the quarter. I mean, it started out with that market in much better shape relative to North America. But as things continued — in fact, we realized lease rate increases in the first half of the year, including in the second quarter. As this continues and things get restarted, we anticipate it will be a little tougher in the second half of the year, perhaps some pressure in certain markets. So I wouldn't expect healthy lease rate increases. And I think there will be some idle cars out there in certain other markets. So competition will probably be a little bit tougher in the second half of the year in Europe.

Okay. And then just, how do you think about investment volume for the year? Is there a range you could give us given maybe things are it sounds like restarting, is there a range to think about for outside of any maybe asset purchases or anything like that?

Yeah. So as you know, our investment volume on the rail side comes both from our supply agreements from spot new car purchases, and then of course from fleet acquisition opportunities. It's that last one that's the hardest to predict. We've talked about that several times on the call on when that stuff shakes loose. But investment volume for the whole company, we would expect to be probably in the mid $800 million for the year.

Okay. Thank you very much.

And next we'll hear from Barry Haimes with Sage Asset Management.

Hi. Thanks for taking my question. Could you just review the number of cars in storage at the moment? And would love to just get your view that if GDP kind of got back on track and started growing normally again, how many quarters will it take to get storage back to normal levels just to get a rough feel? Thanks.

Yeah. Just to be clear, are you talking about the industry-wide idle fleet count?

Yes, yes. Exactly.

Yeah. So that number is — obviously it's moved up sharply to 31.5%. Not all of those cars are in storage, first of all. Those are cars that have not had a loaded move in 60 days. So it definitely overstates the number of those cars that are actually in storage. But it's what the industry data point is and the one thing everybody can work off of. I'd calibrate that around that data doesn't go too far back in history, but at low point it was probably 12% or 13% in a normalized very solid market. So you have quite a ways to go before you can get back down to that level. You need GDP to go up and you need some material scrapping activity on a number of those cars that are really in the weeds and aren't going to move again. So I wouldn't look for that number to get back down to the 12% to 13% level for quite some time. It was only in the low 20s pre-coronavirus. So there's plenty of work to be done there to bring that number back down.

And just one quick follow-up. Is there a role of then you guys use every 1% increase in GDP is x number of incremental demand for cars?

Not necessarily, because really not all cars are created equally. There are hundreds of different types of cars in the fleet. We have over 160 in the GATX fleet alone. So it really — there is no easy math on that number. Sure.

And we'll go to a follow-up from Bascome Majors with Susquehanna Financial Group.

Yeah. Thanks for taking my follow-up. I just wanted to reach out and ask how you guys are thinking about the long-term new car supply. I realize you have another 3.5 years deliveries scheduled from your two new car suppliers. But typically, there will be some strategic extensions and things like that in down markets. I'm just curious if that's something that GATX would look at over the next six, 12, 18 months? Thank you.

Sure. Bascome, it's Bob. Yes, both the Trinity and Greenbrier agreements that we have run through 2023. So we're in good shape on those. I won't get into specific timing with regards to how we think about either extending those or putting new agreements in place. But we're always looking for opportunities, obviously in challenged markets to cut the best deal for ourselves and a deal that works for the manufacturers as well. But I wouldn't really get into too much detail on timing of when we approach that and how we approach it.

Thank you.

And that will conclude our question-and-answer session. I'd like to turn the conference back over to Ms. Hellerman for any additional or closing comments.

I'd like to thank everyone for their participation on the call today. Please reach out to me with any follow-up questions. Thank you.

Thank you. And that does conclude today's conference. We'd like to thank everyone for their participation. You may now disconnect.