Gatx Corp Q4 FY2022 Earnings Call

At this time, I'd like to welcome everyone to the GATX 2022 Fourth Quarter and Full Year Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. Shari Hellerman, Head of Investor Relations, you may begin.

Thank you, Chris. Good morning, everyone, and thank you for joining GATX's fourth quarter and 2022 year-end earnings conference call. I'm joined today by Bob Lyons, President and CEO; Tom Ellman, Executive Vice President and CFO; and Paul Titterton, 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 earnings release and 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. I'll provide a quick overview of our 2022 fourth quarter and full year results, and then I'll turn it over to Bob for additional commentary on 2022, as well as our outlook for 2023. After that, we'll open the call for questions. Earlier today, GATX reported 2022 fourth quarter net income of $48.4 million or $1.36 per diluted share. This compares to 2021 fourth quarter net income of $61 million or $1.69 per diluted share. The 2022 fourth quarter results include a net negative impact from tax adjustments and other items, of $0.18 per diluted share. The 2021 fourth quarter results include a net positive impact from tax adjustments and other items of $0.11 per diluted share. For the full year 2022, GATX reported net income of $155.9 million or $4.35 per diluted share. This compares to net income of $143.1 million or $3.98 per diluted share in 2021. The 2022 and 2021 full year results include net negative impact from tax adjustments and other items of $1.72 per diluted share and $1.08 per diluted share, respectively. Details related to tax adjustments and other items can be found on page 13 of our earnings release. As noted in the release, we currently expect 2023 earnings to be in the range of $6.50 per diluted share to $6.90 per diluted share. With that, I will now turn the call over to Bob.

Thank you, Shari, and thank you all for joining the call today. I'll provide some brief comments on 2022 performance versus the outlook we had coming into the year, and then try to provide some additional color on the 2023 guidance we gave in this morning's press release. Before jumping in, I want to thank our employees for their continued focus and the effort they've put forth over the past year. Across GATX and all of our businesses, Rail North America, GATX Rail Europe, GATX Rail India, Trifleet, and our engine leasing business in partnership with Rolls-Royce, everyone performed at a very high level. I fully expect we'll carry that momentum into 2023, all with the goal of continuing to generate attractive risk-adjusted returns for our shareholders. So, let's start by looking back first at 2022, and I'll try to do so briefly. We outperformed our initial expectations for two key reasons. One, Rail North America performed better than planned. And two, Portfolio Management did the same. So, let's look a little bit more specifically at each one of those. At Rail North America, in the middle of 2022, we updated our earnings guidance based on strong secondary market activity. That continued in the back half of the year, so for the full year we came in higher than planned. We took full advantage of the opportunity to continue to optimize our fleet. Second, the lease rate environment for existing railcars was very favorable. There were a host of factors that led to this. But one of the key things was that customers were very focused on retaining the cars they had in their existing fleet. Therefore, lease rates increased throughout the year and lease revenue came in stronger than planned. Our commercial team did an excellent job. Third, with demand for existing railcars as high as it was, you end up with a very high renewal success rate, which we indicated in the press release. And when there's less churn in the fleet, there are fewer service events, which positively impacts expected maintenance expense. So, in summary, at Rail North America versus the expectations we had coming into the year, we ended up with higher remarketing gains, higher revenue, and lower net maintenance expense. And that's a very good recipe for a solid year. All of those factors led to Rail North America reporting a substantial increase in segment profit for the year. Within Portfolio Management at our Engine Leasing joint venture, the story is pretty straightforward. We entered the year mired in the pandemic, so our outlook was fairly muted, potentially even negative. But during the course of the year, international air travel recovered. And while it's still well below pre-pandemic levels, the trend was helpful. And that led to Rolls-Royce & Partners Finance, our joint venture, posting higher operating income and having to deal with fewer customer credit issues than we assumed. Those factors drove higher than planned segment profit at Portfolio Management. The performance of those two segments enabled us to overcome lower than expected segment profit at Rail International. While demand was very strong, Rail International had to contend with significant market disruption. In Europe and India, the teams had to deal with the fact that the war in Ukraine led to significant supply chain issues. That led to railcar deliveries in Europe and India being delayed versus our plan. We also had FX rates quite volatile and serving as a headwind. But I would like to note that in the face of these challenges, our teams did an outstanding job managing our business day to day. And we are very positive about our prospects internationally. My last comment on 2022 is that we invested over $1.2 billion in our core markets. So, despite rising asset prices, we continue to find opportunities to put capital to work at attractive returns. That’s a testament to our team, to our customers, and to the reach we have into the markets in which we participate. Much like railcar renewals, a lot of our investment volume comes in very small lots. It’s a hallmark of what we do at GATX and one that enables us to continue to drive returns. Let’s turn to 2023; as Shari noted, we expect EPS to be in the range of $6.50 per diluted share to $6.90 per diluted share. The midpoint of that range implies another year of double-digit EPS growth versus the adjusted 2022 results. This would represent another very strong year, especially following the exceptional EPS growth of approximately 20% posted in 2022. So, let’s move on to some of the main drivers for the year ahead. Within Rail North America, we expect another very good year in terms of lease rates. We are looking at the LPI rate coming in above the 23% we achieved for the full year of 2022. With the full year impact of last year’s rate increases flowing into this year and continued increases in rates, we see lease revenue up $30 million to $45 million in the year ahead. We reduced net maintenance expense sequentially in each of the few years. Our operational team has done a truly outstanding job. We are fully maximizing the investments and efficiency improvements we made in our shop network. However, we will feel some inflationary pressure in 2023 and that, along with slightly higher service events and railroad repairs, leads us to our expectations that net maintenance expense will increase $5 million to $10 million in 2023. As interest rates continue to rise over the course of the last year, it did not have a significant impact on our financial results last year. But, it’s more meaningful in 2023. We are not economists. We don’t play the bottom market. We don’t try to predict where interest rates will go because we’ll certainly be wrong. But they are going to be higher in 2023 and we will feel more of that impact at Rail North America. So, where we sit right now, we see total interest expense at Rail North America increasing $15 million to $30 million in the year ahead. We had very, very strong performance in the secondary market. Demand for our assets remains very high. It’s one of the benefits of having a highly diversified portfolio. We can bring assets to market that are of interest to other investors regardless of the cycle or interest rates or other macro events. We see that continuing in 2022, and we expect remarketing to come in at the same heightened levels that we saw this past year. So, incorporating these factors, we expect segment profit at North American Rail to increase up to $50 million over 2022 already strong results. At Rail International, we anticipate positive contribution to segment profit growth from both GATX Rail Europe and GATX India. In Europe, as I mentioned, demand for wagons is very strong. And we are looking to add 1,300 to our fleet in 2023, similar to the past year. Hopefully, that turns out to be a cautious expectation, but it’s the correct one to take right now given the supply chain issues that continue in Europe. Importantly, our team in Europe has done an outstanding job of moving lease rates higher. Many of you know rates are stickier in Europe, and moving them up is a challenge. But the team there is delivering. In India, the overall rail market continues to develop. And we are seeing strong demand across every wagon type. Quite frankly, the only issue for us in India right now is whether we can get access to wagons to keep pace with demand. There is a more limited manufacturing base in India. And we are working closely with all of our suppliers to ensure that we have access. We are looking to add over 1,800 wagons in the year ahead following the addition of roughly 1,000 in 2022. Based on strong demand internationally, we see segment profit at Rail International increasing $10 million to $15 million in 2023. At Portfolio Management, the biggest driver obviously is our engine leasing activity both at Rolls-Royce and Partners Finance and through our direct investments. As we noted in the press release, we added $150 million worth of engines to our directly owned portfolio in the fourth quarter. We will see the impact of that in 2023 alongside continued contributions from the existing directly owned engines. Also at the joint venture level, we expect to see continued albeit gradual improvement in air travel and a steady improvement in the health of international airlines. As a result, we anticipate continued growth in operating income. And we see overall segment profit at Portfolio Management increasing $10 million to $15 million in 2023. Let me comment on a couple of consolidated line items. We have held the line very well in SG&A in recent years. But unfortunately, inflationary pressures everyone is facing will manifest themselves in higher SG&A expense at GATX in the year ahead. We plan to fill some long-vacant positions and we will see higher wages across the board. So SG&A is forecast to increase approximately $10 million in 2023. But on the flipside, on our other expense line where we recognize our pension expense, we expect to see a decline of $10 million. So, those two, SG&A and other expense, are expected to largely offset each other. With our tax rate coming in at a similar level to 2022, the items I just mentioned drive our earnings guidance of $6.50 per share to $6.90 per share. Looking at investment volume, we again anticipate being north of a billion in 2023, which will be another excellent year. We are going to have to work really hard to find those opportunities just like we did this past year. But with the team we have in place and our global footprint and franchise, I am confident we will be successful in doing so. A final comment on the guidance and the assumptions that I just outlined: this is one of the most unpredictable environments I have ever dealt with at GATX in my 25 years here. The war in Ukraine continues on, interest rates and inflation remain at elevated levels, and global supply chain issues, while they may not be as acute as they were over the last 12 months, are still an issue. In North America and Europe, there is economic uncertainty. Will we lapse into a recession? Will we have a soft landing? Will we avoid a recession? I mention this because that adds variability to the assumptions I have outlined. But to be perfectly clear, we feel very good about the position we are in regardless of how these macro factors play out. We will continue to communicate with you clearly on our outlook as the year progresses. On this call, we usually get a question about dividends. So, let me address that now. 2023 marks our 125th anniversary at GATX, something we are extremely proud of. We are equally proud of the fact that we have paid dividends now consecutively for 104 years. Few companies can match that mark. We have a regularly scheduled Board meeting this Friday during which time the Board will consider the dividend policy going forward. But of course, we understand how important the dividend is to our shareholders, and we value our shareholders, all of you, and especially those that have been supportive of GATX for decades. So, please look for an announcement on the dividend at the end of the week. To close, before we go on to questions, while I thanked our employees at the onset of the call, I especially want to thank our employees who work on our maintenance network. We have over a thousand people around the globe in our operations network, and they have worked diligently, efficiently, and most importantly, safely straight through the pandemic. They are essential workers and they've been in the shops five or six days a week without fail. They have been instrumental to our success, and we appreciate all they do. So, thank you. And with that, let's go to Q&A.

Thank you. Our first question is from Justin Long with Stephens. Your line is open.

Thanks and good morning.

Good morning.

I wanted to start with the question on the trend you're seeing in absolute lease rates. It sounds like you saw another increase sequentially in the fourth quarter, but I was wondering if you could quantify that. And then, on the guidance for the LPI to increase more than it did in 2022, what's the underlying assumption for how lease rates trend sequentially from here just on a quarter-to-quarter basis going forward?

So, this is Paul speaking. We're going to bifurcate that; I'll take the first part, and Tom will take the second part of your question. So, with respect to absolute rates when we think about sequential improvement from the previous quarter, broadly speaking, for both tank and freight cars, we are seeing sequential improvement in the low teens. That's going to vary by car type, but certainly substantial sequential improvement in lease rates.

So then, for the LTI, going forward, we would expect to see a level similar to what we've seen through the course of this year, where, quarter-to-quarter, it varies, but a steady drumbeat of increasing lease rates.

Okay, very helpful. And then, I wanted to ask about RRPF as well, just because the contribution went up pretty significantly in the fourth quarter relative to the third quarter. When you look at that $25 million contribution, is there a way to help us understand how much of that is recurring earnings versus remarketing income, and then any thoughts on remarketing expectations specific to RRPF this year?

Yes, Justin, so you've been following us a long time and know that that remarketing piece, just like it does in the rail business, can move around quite a bit quarter-to-quarter. So, first of all, just to give you the numbers, for the fourth quarter the operating piece was about $12 million and the remarketing piece was about $13 million. That going forward, Bob mentioned in his opening comments that we expect increasing contribution on segment profit. And we will see that on both sides. Again, calling the exact timing and magnitude of the remarketing is something that's pretty challenging.

Okay, and just, lastly, to clarify on that Portfolio Management guidance for 2023. You talked about a $10 million to $15 million increase in segment profit. I know you've got the incremental contribution from the engine investments that will be wholly owned. So, does that imply that RRPF is relatively flat year-over-year?

No, it doesn't. So, that contribution is in total, and you would expect to see about somewhere in the order of two-thirds one-third RRPF contribution to GEL contribution.

Great. Very helpful. Thanks so much for the time.

The next question is from Matt Elkott with Cowen. Your line is open.

Good morning and thank you. I have a question about the average term. In the past, during strong upcycles, you've seen terms reach as high as 70 months, although that was back in the third quarter of 2007. Can you explain why the average terms have not increased as much as one might expect in such a robust environment?

Yes, Matt, the LPI term for the quarter was about 34 months. And as you noted, it's been in the low-30s all year. Last quarter, we noted that the LPI term is starting to get pretty disconnected from the actual renewal term on a fleet-wide basis. So, last quarter, we gave you that number; we provided that average renewal term for all quarterly renewal activity. And for Q3 that was 49 months. For the fourth quarter, it's 61 months. And for the full year, it's 52 months. As is the case with all of our statistics, we caution against an over-reliance on any single quarter. So, I would focus much more on that 52-month year-to-date number much more so than the quarterly number I provided. As we look forward, we would expect, directionally, that term to increase in 2023.

That's very helpful, Tom. As you expect another strong year of secondary market activity, do you have any insights on whether you can maintain the same size of your leased fleet? Will you be using your existing supply agreements in manufacturing, considering the challenges of adding to the fleet in such a strong secondary market?

Yes, so this is Paul. I'll start, and I think Bob may chime in as well here. But, yes, I mean, at the end of the day, first of all, we're economic animals. So, we are going to invest and divest based on what the economics tell us. We'll buy when we can generate a positive NPV from buying, and we'll sell when we can get a higher price than our hold value. So, with that having been said, we are conscious of the benefits of scale in our business, and we believe we can maintain those benefits of scale. I'll add actually that within the secondary markets, we are seeing some increasing ability for us to be successful while sticking to our investment discipline. And so, I'm cautiously optimistic that we're going to see more success in the secondary markets. Certainly, the indications are that we're seeing that right now.

Yes, Matt, just to add to Paul's comment too, I've been encouraged actually on both sides of the secondary market as 2022 unfolded. We’re seeing similar trends here in the early part of 2023 for opportunities to sell, but also to be a little bit more successful in our bidding activity on the buy side.

Are these encouraging signs for potential acquisitions in the secondary market coming from larger fleets or smaller privately held fleets?

It can be either. And given our activity and our presence in the market, we see portfolios and we see the kind of offering packages from both, the big and the small sellers. So, it's both. We've seen, I would say, that the success rate has also been driven by the fact that we've seen some offerings of assets that are of particular interest to GATX where we have a unique view on trends over the long-term. So, we've been able to ferret out some pretty good buying opportunities.

Got it. Bob, are you surprised that secondary market valuations have held up so strongly despite the interest rate increases?

Well, at a high level, I'd say yes because I guess I wake up being pessimistic. But you would think with rising interest rates that that would somehow eventually lead to less activity in the secondary market, but we haven't seen it. Currently, investors are clearly still searching for hard assets with a very good yield attached. We have high-quality assets with high-quality customers on long-term leases, generating very strong cash flow. So, there's still a robust market for those.

And I'll just add too. This is Paul speaking again. We've been very successful recently in attaching more cash flows to those assets in our portfolio. We've used this strong market to originate attractive leases which will allow us to restock the portfolio for potential future sales going forward. So, that's one of the benefits of a strengthening market like this is it allows you to continue to reload your potential future secondary market offerings.

Got it. Thank you, Paul. Thanks, Bob, Tom, and Shari.

Thank you.

Thank you.

The next question is from Allison Poliniak with Wells Fargo. Your line is open.

Hi, good morning. Just want to go to that algorithm that you guys have historically provided in terms of rail velocity and cars needed online. I know you were sort of come up broken last year, but as we sort of entered this year, how are you viewing that? We could be in a situation of, I would think, accelerating velocity, potentially, and freight coming down the other side of it. So, would just love your perspective on that if that's a risk as we look out to the back half? Thanks.

I think it's going to be challenging to predict railroad velocity. The railroads are currently making efforts to hire and enhance service. We are not in a position to forecast what will happen with velocity on their behalf. However, we maintain the belief that there is freight available that is not currently moving but could enter the network if service improves. When we consider the potential for enhanced velocity and better network fluidity, we don't view it as a negative as we might have in the past. We believe there is freight eager to be transported by rail that will move once service is improved. Overall, we feel more optimistic about the possibility of improving velocity than we may have in previous cycles.

Yes, and I would like to add to Paul's comment that, as we have stated in the past, increased velocity and more opportunities for the railroads are not something we view negatively. We want our customers to choose rail as their preferred option. It is not ideal for customers to feel frustrated because they cannot transport their products by rail and seek other alternatives. We feel much more positive, and as Paul mentioned, we are more optimistic about the fact that if velocity improves, we have heard from customers that there are products ready to be shipped by rail.

Great. That's helpful. And then just a question on boxcars, it seems like there's been a structural decline in terms of a lot of scrappage not necessarily surprising, but just want to understand how you view that period. I see you investing, but maybe not at the level of the scrappage rate. Is there a size that maybe you're too large right now, just any thoughts on that fleet overall?

No, actually I would say quite the opposite. We've been investing in boxcars, as has the industry. We're not alone in that. We're going through a cycle because there were a huge number of boxcars built in the 1970s, really up through 1981, and those are scrapping out. So, what we're seeing here is the aging out of the fleet and then the replacement investment in higher-capacity newer cars to address that. We think that replacement demand is attractive. We also think that, to the extent we see more modal shift to rail, particularly ESG-driven modal shift in the future from companies that want to reduce their carbon footprint, the boxcar could really be a beneficiary of that. So, I would say right now, for us, the boxcar portfolio has been a good portfolio for us. And we're hoping and expecting it continues to be a good portfolio for us.

Perfect. Thank you.

The next question is from Bascome Majors with Susquehanna. Your line is open.

Looking at the portfolio, can you talk a little bit about where lease rates are versus your assessments with the long-term average?

We can now report that for most of our portfolio, lease rates are generally above their long-term averages. Certain car types are higher while others are lower, but overall, lease rates for tank cars are slightly higher than for freight. In general, we are at least a bit above our long-term averages across the portfolio.

And as you look forward and think about positioning the portfolio, can you talk a little bit high-level about your priority of rate versus term this year, and where you're really pushing harder?

So, as we are in all rising rate environments, particularly when rates get above our long-term averages, we are going to work with our customers to incentivize them to choose longer-term leases. This is a playbook that we've repeated in every upcycle. And we're going to continue to push on that now.

It seems that you are more optimistic about investing in North American rail assets now compared to the recent quarter. Can you share some insights on this? What has changed in terms of opportunities in sales, and how are asset valuations shifting? Any additional details would be appreciated. Thank you.

Sure, Bascome. I would say that regardless of market conditions, GATX is always looking to add assets to our portfolio, especially rolling stock. We have made acquisitions in both up and down markets. Our decision depends on the attractiveness of the underlying asset and the economic return we can achieve. Our diverse fleet ensures we are familiar with all types of assets. We are committed to expanding our portfolio, which is highly scalable. We aim to acquire new assets but will only do so in a disciplined and selective manner. We likely have access to most portfolios or assets that are available. We make purchases when it aligns with our criteria and meets our requirements.

It seems like your enthusiasm for something happening sooner rather than later is different from what we've seen in recent quarters. I'm trying to understand if there are new assets available or if valuations are generally decreasing, and I want to reconcile that with your excitement about generating significant remarketing income in the North American rail business. Thank you.

Well, I don't think our view has changed materially over the course of the last few quarters or the last few years for that matter. There's often more portfolios talked about than actually come to market. That proves true in either up or down markets. Would we be interested? Always. Are we going to be extremely disciplined? Always. I think the earlier comment really referred to smaller opportunities that we've seen—one-off asset-type acquisitions that we've been able to execute because we liked a particular asset. But as far as bigger portfolios are concerned, I don't really have any other comments to add on that. Would we be interested? Of course, but have no insight or thought on anything taking place in the market.

Thank you both.

Yes, thank you.

The next question is from Justin Bergner with Gabelli Funds. Your line is open.

Good morning, Bob. Good morning, Tom. Good morning, Shari.

Good morning.

Paul is offended, Justin, that you left him out.

Good morning, Justin.

First question would just be on some of the market dynamics. So, you talked about, I think, sequential low double-digit lease rates in tank and freight, which would have been an acceleration from my guess, the 5% or less last quarter. So, what's going on to drive that acceleration from your vantage point?

So, it's really more of the same phenomenon we've talked about in recent calls, which is to say you have an existing railcar market that is relatively tight, and that's been driven by a fair bit of scrappage. It's been driven by relatively low velocity on the part of the railroads. And it's been driven by the fact that, thanks to high new car prices and labor availability, the new car production that we're seeing is not consistent with past upswings in the market. So, you have less new capacity coming in, you've had older capacity going out, and you've had relatively low velocity, coupled with what we think is a continued robust underlying demand to move freight by rail. So, it's really all of those things that have created tightness in the fleet, and that has allowed us to increase prices.

Got you. All right. So the new car production constraints are maybe not something that was highlighted before but are part of the equation, I guess?

Yes, that is correct. I mean, if you look back to the crude boom, you had an industry that produced new cars at a rate of up to 80,000 a year. And at current production levels, the industry is going to be nowhere near that level. So, that's one of the key differences in this market.

Okay, that's helpful. And then the scrappage rate, I guess, at least on your book, is about 500 cars per quarter. That's still a healthy scrappage rate. And I assume it's reflective of what's going on industry-wide. Is that sort of a reasonable run rate going forward, or are we going to sort of go below normal scrappage given how many cars were scrapped in 2021?

Given the size of our fleet, Justin, that's a pretty reasonable number on a quarterly basis in our annualized – just based on the cars that will be aging out of the fleet. That’s about the right number.

Okay. I have a couple of detailed questions. What is the marketable security account on your balance sheet, the $148.5 million or the short-term investment number related to that?

Yes, Justin, those are treasury.

Okay. And on the tax rate, you mentioned sort of a similar going forward in that 25%-ish range, so, nothing unusual there. Is there anything as it relates to your ability to, I guess, postpone cash taxes; it gets harder as accelerated depreciation comes down?

Yes, Justin, we don’t anticipate anything materially changing as far as our cash taxes and our ability to utilize our investments.

Okay, great. Lastly, you mentioned the breakdown of the increase in expected segment profit in Portfolio Management between RRPF and the non-JV part of the book. Can you clarify that? I think I missed it. Also, regarding direct investment, are you seeing more opportunities there, or is it more of a one-off?

Yes. So, the direct investment originally was the engines that we purchased a couple of years ago. And then we added to it this quarter with an additional $150 million of investment. The combination of those two is what we are referring to with GATX equipment leasing, which is the wholly-owned aircraft engines.

And, Justin, we’ll continue to look for opportunities there as well to kind of methodically, systematically add to that portfolio. We like the asset a lot. It’s been a great return, managed by our joint venture partnership. Those are a very good fit for what GATX does well. So, with our partner managing, it’s a good equation. So, yes, we will continue to look for opportunities there.

Okay. You said two-thirds of the increase in Portfolio Management profit is likely to come from the JV and one-third outside the JV?

Correct.

Okay, got it. Thank you.

Thank you.

We have no further questions at this time. I’ll turn it over to Shari Hellerman for any closing comments.

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

This concludes today's conference call. You may now disconnect. Thank you.