Gatx Corp Q1 FY2022 Earnings Call

Good day, ladies, and gentlemen, and welcome to the GATX 2022 First Quarter Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Shari Hellerman, Director of Investor Relations. Please go ahead.

Thank you, Kit. Good morning, everyone. And thank you for joining GATX's 2022 first 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. We begin our call this morning with an overview of our first quarter results, followed by prepared remarks by Brian and Bob. Afterwards, we'll open the call up for questions. Before we begin, 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 earnings release. Those discussed in GATX's Form 10-K for 2021, and in our other filings with the SEC. GATX assumes no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances. Today, GATX reported 2022 first-quarter net income of $75.8 million or $2.10 per diluted share. This compares to 2021, first quarter net income of $36.5 million or a $1.02 per diluted share. 2022 first quarter results include a net negative impact of $11.5 million or $0.32 per diluted share, which represents GATX's share of a net impairment charge at the Rolls-Royce & Partners Finance affiliates associated with aircraft spare engines in Russia. Also included in the quarter was a net positive impact of $3 million or $0.08 per diluted share related to an enacted tax rate reduction in Austria. These items are detailed on Page 10 of our earnings release. Our first quarter results reflect strong demand for rail cars across our global rail businesses. At Rail North America, fleet utilization remained high at 99.3% and our renewal success rate was 80%. We have now seen seven consecutive quarters of sequential increases in absolute lease rates. Furthermore, the pace of lease rate increases accelerated this quarter. The renewal rate change of GATX's lease price index was positive 9.3% with an average renewal term of 30 months. We continue to successfully place new rail cars from our committed supply agreements with a diverse customer base. We have placed nearly 3,600 rail cars for our 2018 Trinity supply agreement. Additionally, we have placed virtually all 7,650 railcars from our 2018 Greenbrier supply agreements. Our earliest available scheduled delivery under our Trinity supply agreement is essentially in the first quarter of 2023. The secondary market for railcar remains very strong. Rail North America remarketing income was approximately $66.4 million during the quarter. This represents the vast majority of our expected remarketing activity for 2022. Rail International performed well with high fleet utilization of 99% or above and continues to experience increases and renewal lease rates versus the expiring leases. Turning to Portfolio Management, first-quarter performance was in line with expectations. Our Rolls-Royce and Partners Finance affiliates continue to operate in a very challenging and uncertain environment for global passenger air travel. Finally, GATX's total investment volume in the first quarter was over $370 million, with a focus on our railcar assets globally. Before I turn the microphone over to Brian, I'd like to remind everyone that our annual shareholders meeting is scheduled on Friday, April 22nd, at 9:00 am, Central Time. It will be held in a virtual-only meeting format. With that, I would now like to turn the call over to Brian.

Thanks, Shari. As many of you know, last December I announced my retirement as the CEO of GATX after 17 years, effective at our 2022 annual shareholders meeting. As Shari said, that's in two days. So that makes this my 91st and last earnings call. I want to say it's been interesting and challenging, and honestly, it's been fun to work with all of GATX's shareholders and analysts over the years, and I do hope you feel as though I was honest and transparent in my communications with you. It's been even more of a pleasure to work with the extraordinary employees of GATX over the last 26 years. They are without a doubt the best team in the industry, and I want to say they're led by an equally strong senior leadership team in Tom Ellman, Deb Golden, Kim Nero, Gokce Tezel, and Paul Titterton. And as the head of that team, the new CEO of GATX is Bob Lyons. Bob and I have worked together at GATX for over 25 years, and I can tell you he's more than ready for this job. So, without further delay, let me hand it over to the incoming CEO. Bob?

Thank you, Brian. Good morning, everyone. And I'd be remiss if I didn't at least take a moment and thank Brian for his leadership during the past 17 years and for his service to GATX for 25 plus years. As Brian noted, this is his 91st and final earnings conference call at GATX. During that time, he set a very high bar for honesty and direct answers, and I think many of you know that and appreciate it. That carried over in the way he led this company with a clear and direct strategic vision, all centered around disciplined capital deployment. Many of us here at GATX have taken those lessons to heart, and we're eager to carry them forward. Thank you, Brian. During today's Q&A, we'll likely get a number of questions regarding the impact that the war in Ukraine is having on our various businesses. Rather than try to address each one of those as they come, I thought it would be helpful to give you a summary upfront. So, bear with me while I do that. To start, our thoughts and prayers go out to all of the millions of people who have been impacted by the war. As we consider the impact on our business, our thought process is pretty simple. This is first and foremost a terrible humanitarian crisis. To try and spin a positive out of this is not the way we think at GATX. The impacts on each of our businesses vary, but our approach is the same. We stand by our commitments; we'll work constructively with all of our constituents. We put our employee safety and well-being first, and we'll navigate this turmoil the same way we have through a number of crises during our 120 plus years in operation. With a large business in Europe, we have employees who are directly affected by the crisis. Many of you know, we are the leading railcar lessor in Poland and have a large railcar facility in Ostróda, with a number of employees based in Warsaw. Many of those employees are volunteering to assist with the influx of those displaced from Ukraine, and in some cases have taken in refugee families. GATX is providing financial assistance to those who are doing so, and we'll continue to encourage our employees to assist where they can. Personally, I'm incredibly proud of our employees and their commitment to help those in need. In Rail North America, rising steel costs are impacting new car costs and scrap prices. This started well before the war but certainly with the war and all its turmoil, steel prices have remained elevated. Logically, this should result in higher lease rates on the installed base of railcars, and in certain cases it definitely has. However, the ultimate driver of lease rates is the balance or imbalance between supply and demand of railcars. This equation continues to improve, but it varies across car types. Elevated new car costs are making new investments in the spot market more challenging, so generating investment volume at attractive returns will be a bit more challenging. Also, in some cases, customers are not willing to add cars at significantly higher lease rates, so they are holding off on new car orders. That results in a reduction in new spot opportunities. That said, we are seeing some opportunities and we're going to remain disciplined, focused on adding assets at attractive prices where we can generate an attractive risk-adjusted return for our shareholders. We have seen some delays and lower inventories of certain railcar components, particularly those that are stainless steel as a result of a dramatic increase in nickel prices. For the most part, we've built safety stock and we're managing through delays with minimal disruption. From a segment profit standpoint, the impacts of the crisis are not having any material impact on our North American results and are not expected to this year. Internationally, rising costs and supply chain issues are having a more acute impact on the businesses. Again, from a segment profit standpoint, that's not the case, but operationally, there are some topics to discuss. At GATX Rail Europe, we're working with customers and suppliers to constructively address the situation and supply chain issues. At this time, we do not anticipate any material delay in our expected new car delivery schedule. Lease rates continue to move higher in Europe, and we'll ensure that we're receiving a fair market rate on those renewals, but without price gouging or attempting to capitalize on any customer's particularly challenging situation. In India, the same situation exists regarding steel prices, new car costs, and components. Demand for new wagons in India has been and continues to be very strong. The team there is working closely with railcar builders and customers to ensure that we lock in costs, delivery, and lease rates on a number of new wagon transactions. We'll continue to diversify and grow the fleet. While the supply chain issues are a challenge, I'm confident we will see very solid investment volume in India in 2022. We have a small railcar leasing business directly in Russia: 380 cars, three customers, three employees, and approximately $20 million of total investment. Our main concern has been and will always be the well-being of our employees. We're doing all we can to ensure that we're complying with sanctions and countersanctions to the fullest extent possible, and that our employees can run the business accordingly. We made this investment years ago for option value in the event that the investment environment in Russia improved. Clearly, that's not happening. We'll consider the appropriate course of action from here. For now, the business is operating, and customers are paying their leases. Lastly, at RRPF, the war in Ukraine, and the struggles following Omicron have continued to put significant pressure on international air travel. As noted in the press release, RRPF wrote down the value of three engines we had directly on lease in Russia because the probability of recovery is very low. The longer-term impacts on demand for international air travel, and therefore for engines that RRPF manages, are unknown at this time. What we do know is that air travel has always recovered from global shocks. In fact, it was on a more positive trajectory before the dual challenges of Omicron and the war. We're confident that longer-term air travel will return to a positive trend line. With that, let's go to Q&A.

Thank you. We'll take our first question from Justin Long with Stevens. Please go ahead.

Thanks, and good morning. And Brian, congrats again, it's been great working with you. Last quarter, you provided some specific line item guidance by segment that supported your 2022 outlook. I know the EPS range didn't change, but were there any of those underlying assumptions that moved materially, or would you say the trends so far this year are tracking relatively aligned with all the different businesses?

Hey Justin, this is Tom. For the first quarter, everything was very much in line with our expectations for each of the segments. We expected to see a continuing strengthening in the Rail North American market, and indeed, we've seen that. Similarly, in both Europe and India, those markets have been strong, and they've continued to be so. We continue to face a lot of uncertainty with the Rolls-Royce JV as global air travel, which is very dependent on the global recovery from the pandemic continues. Then you have the additional challenges of predicting how the Russia-Ukraine conflict will impact air travel. However, for the first quarter, that was also in line with our expectations. So, as you go segment by segment, there is really nothing that changed materially for our full-year expectations, which is why we've made no change to full-year guidance.

Okay. That's helpful to clarify. And as we think about the elevated level of North American remarketing in the first quarter and the implied drop-off in remarketing over the rest of the year, does that in any way reflect an outlook for softer demand in the secondary market, or is this purely a function of timing around what you had available to sell in the first quarter and the level of demand you saw?

Justin, it's Bob. The secondary market remains incredibly strong and we expect to continue to see that through the balance of the year. As we indicated coming into the year, we thought the majority of the remarketing income would occur in the first half of the year solely due to the schedule of what we had available on the market, and that was reflected in the first quarter. Even on the smaller sales and packages we have in the marketplace, we're continuing to see an ample number of buyers and a very good demand for the underlying assets. Assuming there's no capital market disruption, our expectation is that will continue through the balance of the year.

Okay. And I guess the last quick one, you've referenced a sequential improvement in absolute lease rates and an acceleration there. Is there a way you could quantify that?

Sure. I think you recall last quarter, Justin, in Q4 versus Q3 2021 on a total basis, we were in the high single-digit range in terms of sequential lease rate increase. This quarter, it's in the mid-to-high teens, with the freight car side of the business seeing the highest demand. So, a little bit higher on freight carriers, a little bit lower than that on tank. But in the mid-to-high teens, Q4 to Q1 of 2022. So, very good upward trend.

Great to hear. I'll leave it at that. I appreciate the time.

We'll take our next question from Bascome Majors with Susquehanna, please go ahead.

Yeah, thanks for taking my questions. Just to follow up on that last piece. Can you talk about where you are versus the long-term trend line on some of your major car types? Just if that is inflecting in any way, in the way you've spoken about in the past, that would be helpful. Thanks.

Sure. Well, it definitely varies across car types. Even though we've seen the biggest uptick in rates in freight over the course of the last few quarters, I would say in general we're still seeing some of those rates below the long-term, what we would determine and view to be the long-term equilibrium rate. Tanks are there or above, in many cases, particularly for more general service tank cars. The power of the fleet we have is that with over 160 different car types, we can really target the specific categories where we're seeing the best demand and the best dynamics, and we'll continue to do that. There are investment opportunities out there. For sure we had very significant investment volume in the first quarter, but it will be very targeted.

Thank you for that. Shifting back to Europe, if I recall about half of that fleet is involved in mineral oil, which is a variety of refined products in crude and maybe 20% in LPG. When you talk to your customers, given the change in the potential energy landscape in Europe, where does that create long-term opportunities and risks for the capital you have deployed there?

It's Brian, so I can take that. There is a whole shift we've made over the last few years to invest more on the freight side, and that's a lot to do with the green movement in Europe and their goal of becoming carbon neutral by 2050 and favoring those car types. But there are continuing opportunities, as you pointed out, in mineral oil and LPG, and even in petrochemicals, where a big part of our fleets have been seeing tremendous demand. We've seen tremendous demand for the last two years on that fleet. There are a number of reasons for that, which we've talked about over the last two years. As far as additional demand from the war in Ukraine, it's probably having an impact on demand. It's hard to quantify how much since the market has been so strong anyway over the last two years. Even if you could identify that demand, as Bob alluded to in his opening, you'd be careful how you respond to it. You help your best customers. You avoid short-term opportunities and trying to capitalize on a tragic situation. What we're trying to do right now is assess how trade flows may be changing. That assessment is happening in real-time, and how sustainable those changes may be in the flows in Europe. Remember, these are 40-year assets, and you have to think very long-term about where you put them. With the changes you're seeing in Europe right now, we're just assessing where this might be going and how sustainable it is.

Thank you for that early comment on a complex situation. Just last one on the buyback. I mean, you've talked about being selective on capital deployment into real assets. Your own stock is also at the higher end of its historic valuation, similar to the assets that you invest in. Can you talk about how to balance investment in equipment versus investment in your own stock versus maybe just being opportunistic and saving dry powder for an environment that may be more fruitful for a long-term investment in a year? Thanks.

Great. Bascome, just to put some numbers around some of it. We still have $128 million remaining on our authorization from the Board as of the end of the quarter. Our capital allocation framework calls for us to prioritize attractive investment opportunities while ensuring a solid investment-grade rating and maintaining access to attractively priced capital. We return any excess capital to the shareholders. We've done that consistently via dividends and more recently via stock buybacks. We completed about $9 million of stock repurchase during the quarter. More significant stock repurchase always remains an option if it becomes more challenging to identify investment opportunities that provide an appropriate risk-adjusted return, and we'll continue to have those discussions with our Board of Directors as we do each quarter.

Thank you. We'll take our next question from Matt Elkott with Cowen. Please go ahead.

Good morning. Thank you. And, Brian, congratulations again on the accomplishments that you've had at GATX and your upcoming retirement. And, Bob, congratulations on the new role, looking forward to working with you in the new capacity. I was hoping you guys would talk about how you perfect the balance between taking advantage of a very strong secondary market without risking having your core lease revenues being challenged in the long term, especially as, I guess if you would have to maintain a similar lease revenue level, you would have to tap into the secondary market or newly manufactured railcars, which are also very elevated. So just wondering how you make those decisions, and if we could expect the activity to subside significantly in the back half of the year based on your guidance?

Sure Matt, it's Bob. To begin with, we always look at what we're potentially going to sell in any given year from the standpoint of the overall portfolio and portfolio optimization. There are various reasons we target particular cars for sale. They're all quality assets usually on lease to very solid customers. We look at the value of holding those versus what the value may be in the secondary market and how they fit in the context of GATX's overall portfolio. There's no particular target by quarter or anything in that regard. We're looking at what's the best value for the GATX shareholder long term, whether it's to hold those assets, continue to lease some, own them over time, or if the market is willing to pay a price that exceeds what we view as our hold value. There's a mathematical element to it, as you probably expected given how we think in terms of return and how we look at the value of assets, and then there's the commercial aspect. Our sales force is involved and also looking at the portfolio to make a determination on the best candidates for sale. That process won't change based on what's going on in the secondary market.

Got it. And I know you've got your EPS guidance unchanged. But given how strong the secondary market has been and the big transaction in the first quarter, do you think there's upside to your original guidance for remarketing income?

Well, I've been doing this a long time, as Brian and Tom have as well. If I look back over the course of the last 20 years, there are probably maybe one or two rare instances where GATX raised guidance in the first quarter. We typically like to get a much better sense for the fundamentals and the lay of the land as we go through the first half of the year. We'll do that assessment here as we go through the second quarter. But I'm very encouraged by the trends we've seen in the first quarter and the performance we posted today.

Got it. That's very helpful. And then I had a quick question on average terms. Can you talk a little bit more about why they've been stubbornly low despite, I mean, you doubled the percentage improvement in spot lease rates on a quarterly basis in the quarter, but average terms have not really risen that much? I know we're nowhere near the crude-by-rail era, but average terms rose to above 60 months during that phase.

Yes. I wouldn't read too much into the average term right now at this point, Matt. That number can get skewed by a few renewals. What I will tell you is we are in very targeted instances, stretching term. We're now at a point in time where, in certain car types, the market lease rates are at a level that we think it makes sense to lock in long-term, and we've been successful in doing that. But that one number that's provided can get skewed by a small number of transactions.

There are opportunities to increase the term of leases to take advantage of the current improving lease rate environment.

Yes. We do that analysis literally on a weekly basis. So we're making new terminations in various car types based on where we think we should be on the term spectrum, and over the course of the last three to six months, we've seen more instances where it makes sense to go longer, and we've been successful in doing that.

And just one last question, Bob. I was hoping you guys would talk a bit about your exposure to the different types of rail traffic. Rail traffic as a whole is still down, but coal, chemicals, and materials like stone, sand, and gravel are performing strongly, while most other categories remain stubbornly weak. What does the current rail traffic outlook mean for you regarding your fleet?

Matt, the real key, as you know from watching this, is that intersection of supply and demand. If you look at the idle cars in storage, it continues to come down. At a macro level, that's why you're seeing the improvement that Bob has been talking about in terms of lease rates. If you go commodity by commodity, you're really going to see the same thing for most commodities. The exception continues to be some of the energy markets where there's still some excess supply with our competitors. As you look at our utilization, we're fully utilized. Commodity by commodity, you have to look at that intersection of the two rather than just loadings in isolation. Historically, the supply side drives the cycle much more than the demand side.

That makes sense, and much of the rail weakness is intermodal, which is almost half the rail traffic, and I believe your intermodal exposure is fairly limited; is that correct?

Yes, Matt, we have a little over 3,000 cars.

Got it. Thank you, Shari. Thanks, Tom. Thanks, Bob. Thanks, Brian. Appreciate it.

Thank you.

We'll take our next question from Allison Poliniak with Wells Fargo. Please go ahead.

Good morning, everyone, and congratulations, Brian, on your next phase. I wanted to expand on the last question. I believe you mentioned the importance of supply and that rail velocity is currently facing challenges. What is your perspective on this at the moment? Should we anticipate some volatility as that velocity hopefully improves over time, with the imbalance starting to shift? I'd appreciate any thoughts you have.

Sure, Allison, and I think for sure you could see some volatility at times of low velocity like this. Historically, customers might push to solve that with more railcars, but we're seeing less of that these days. Given the situation in the marketplace, some customers are looking for alternatives off the rail which could come back, and would likely come back if there was more fluidity in the market.

Great, that's helpful. And then I just want to touch on maintenance. I think, Bob, you had mentioned you felt okay with the component side of it. Was there any volatility there that maybe would smooth out for you for the year? Are you having to catch up on maintenance on that side?

From a first-quarter perspective, our net maintenance numbers came in right in line with what we had anticipated, maybe even a little bit below. But yes, we have seen even in our own network a few more challenges with regards to COVID-related work outages during the first quarter, though nothing that disrupted overall operations. We're certainly hearing that from the Class 1 railroads and some of the third-party maintenance providers. It's an issue for sure, but one we've been able to navigate. With our tank and specialty freight cars, we do over 90% of that work in-house these days, giving us much better control and not as much dependency on third parties.

Great. Thank you. I'll pass it on.

We'll take our next question from Marla Backer with Sidoti. Please go ahead.

Thank you. So given the current situation, can you remind us of how you see your fleet competitively positioned after spending $1 billion to expand it per annum over the past couple of years? How do you see your fleet in terms of size, average age, and diversification relative to what's available right now?

I have always believed that we have the best fleets in North America. Our fleet is highly diversified, not reliant on any single car type or commodity, and is heavily spread across a high-quality customer base with long-term leases. This fleet has been developed over many years and is not something that can be easily changed by recent investments. It can't be easily duplicated, and we have a level of diversification that is unique. Regarding the average age of our fleet, it won't change significantly. Each year, we retire some cars and add new ones. Given the scale of our fleet, it is challenging to move that average age dramatically. Moreover, I don't see any gaps in the market, and I don't think we are overexposed in any area. Overall, our fleet is in an excellent position.

Okay. Thank you. And then in your prepared remarks, when you were commenting on the geopolitical situation, you specifically mentioned some obvious markets, Poland, for instance. Are you seeing any change as this war persists? Are you seeing any kind of widening radius regarding changing patterns as a result of what's going on?

I can take that. Yes, we are seeing changes, but we just don't know how permanent and sustainable they are. For instance, some of that started before the war with embargoes on gas imports from Russia, especially through Belarus and other factors. While we're seeing changing flows, we don't know how long that will last. We're conducting real-time assessments. Overall demand is very strong in Europe for all our commodities and all our cars.

We'll take our next question from Justin Bergner with Gabelli Funds. Please go ahead.

Good morning and congratulations, Brian, on a great career at GATX and welcome to the CEO role, Bob.

Thank you.

My first question just relates to the remarketing gains on sale. What would have to happen at this point for you to sell meaningfully more cars than you originally envisioned when you provided your annual guidance three months ago?

We're always out testing the market, so if we saw any development among the buyer universe where the level of aggressive purchasing increased dramatically from where it's at today, we might reassess if there were other cars in our portfolio that made sense to sell.

Okay, great. That's helpful. Secondly, you mentioned in your prepared remarks about the spot market dynamics. Could you provide a bit more color there? Were you mainly referring to the inability to get additional cars to provide additional leases on a spot basis, or were there other drivers at play?

It's not so much the supply side; we can access cars for sure. It's the cost of the car and the related lease rate that we would require to buy the car at today's price and put it out on lease. Our customers are very sophisticated; they run their fleets quite efficiently. They look at if car prices have increased 30% or 40% versus last year, what the relevant lease rate would be for GATX to make that investment. Sometimes, they might hold off, which is why we've seen such high demand for the installed base of railcars. The alternative to the installed base is buying new, and those costs are pretty high right now.

Okay. Excellent. And then lastly, outside of railcars, are you seeing any new additional investment opportunities, whether it's direct engines or for Trifleet or other areas, or is it pretty expensive still across most asset classes?

In Trifleet, they've seen similar trends regarding new asset prices. Costs for tank containers are up materially from where they were a year or 18 months ago. We had a good quarter from an investment standpoint, and we're continuing to see very good demand there, and we're encouraged by the early returns from our ownership of that business. We have to remain focused on ensuring attractive returns and not taking on undue residual risk given the heightened prices. We continue to look for opportunities in the aircraft engine side as well. We very much like this asset class long term but need to be mindful of how much volume we take in the current environment.

Great. Thank you. And best of luck in the new role as CEO.

Thank you, Justin. Appreciate it.

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

Thanks for taking the follow-up. At the beginning of the year, you talked about the LPI being in a range of 5% to 15%. Reflecting on the earlier comment about the acceleration you're seeing in lease rates to start the year, is that still the right range for the LPI?

Yes. Where we sit right now, Justin, we're still thinking in that plus 5% to plus 15% range. We were right in there in the first quarter. Many of the trends we saw in Q1, we had already anticipated and accounted for in our thinking around that guidance. We'll update you in the second quarter, but as of right now, that's still an appropriate range.

Okay. Last one from me: There's been a lot that's changed from a macro perspective to start the year, including the conflict in Russia and Ukraine. When you take a step back, could you update us on your thoughts around the multi-year trajectory for the railcar leasing markets in both North America and Europe, and how you're thinking about those two cycles long-term?

Sure. Let's start in Europe. The dynamics there remain quite attractive, and we've been able to generate, relative to North America, consistently more attractive return on investment in Europe. We think that trend will continue. The ongoing push in Europe toward green initiatives, moving more product from truck to rail, will be beneficial to us into the cycle. I'm very encouraged about what we can do with the outstanding platform we already have there. In North America, it's more challenging to predict the cycle. But right now, we're experiencing a long run of negative lease rates, and it's turned positively; we're working aggressively to make the most of that opportunity and stretching terms where appropriate. The trends are positive.

Okay. Thanks again for the time.

Thank you.

At this time, we have no one else in the queue. I would like to turn the conference back to Shari Hellerman for any additional or closing remarks.

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

Ladies and gentlemen. This concludes today's conference. We appreciate your participation. You may now disconnect.