GATX Corporation

Please stand by. We're about to begin. 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 Sherry Hallerman. 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 of Tom Ellman, Executive Vice President and CFO, and Bob Lyons, Executive Vice President and President of Railwalks 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 discussed in GATX's 2019 Form 10-K, and 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 $238 per diluted share. This compares to $101.5 million or $275 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 to 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, Real North America's fleet utilization remained high at 98.7% at quarter end. and renewal success rate was 71.8%. We built up 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've placed all 8,950 railcars from our 2014 Trinity supply agreements and nearly 1,450 railcars from our 2018 Trinity supply agreements. We've also placed close to 3,400 rail cars from our 2018 Greenbrier Supply Agreement. As mentioned last quarter, all supply agreement deliveries for 2020 have been placed. Remarketing income in a 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 remains strong, and GHX Rail Europe continued to see steady demand cost of 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 GHX Rail Europe and GHX Rail India experienced delays in new rail car 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 and Partners finance affiliates, predominantly due to remarketing activity in the quarter. Finally, as noted in the earnings release, the shape of the economic recovery remains uncertain. And as the impacts of COVID-19 evolve, we expect pressure on lease rate, 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. To signal for a question, please press star 1 on your telephone keypad. Also, if you are using a speakerphone, please make sure your mute button is turned off to allow your signal to reach our equipment. A voice prompt on your phone line will indicate when your line is open. Once again, it is Star 1 at this time for questions.

And our first question will come from Allison Poliniak with Wells Fargo.

Hi, guys. Good morning. Could you talk to – I know you mentioned, you know, obviously a significant pressure on lease rates, but maybe a potential trend in lease rates that you experience this quarter – And just if there's any sort of mixed 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, call it 8% to 9% between Q1 and Q2. So no real significant differential between card types impacting the LPI in the second quarter. Now, 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, obviously, outside of that band, but given everything that's going on with COVID-19, the impact, the economic impact, not that far outside the band.

Understood. Just a second. Just with the amount of inflation in the secondary market over the past few years, you know, I would suspect that these to market, that there'll certainly be a loss in terms of what they'd have to take, or it might fall short of what they want. You've been through these cycles before, and there's obviously, with the secondary markets, Does this one feel different? Is there something structurally different with this one, or would you expect some of these opportunities to come to fruition over the next few months?

Well, I would say the feel, the only thing I can really equate it to would be the Great Recession 2008, 2009, and 2010. where it did take a little while for some of the asset owners at that point in time to kind of reach a point of capitulation. So that may occur again. Again, as you point out, a lot of people did pay relatively high prices for a number of the cars in their portfolio, and, you know, there will be a point of realization that, you know, that's not recoverable. And you run into the issue of whether or not they're willing to do that. Some of the sellers are willing to do that, take that pain and move on. You know, we found opportunities, significant opportunities in 2008, 2009, and 2010. We feel they're out there again. Whether or not they happen, that we do not control. But certainly there's some portfolios out there that would be of interest. Great. Thanks for the talk.

Go ahead.

The other thing I'd add is in 2000, 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 Stevens.

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 FPR's rail car delivery forecasts, they're anticipating supply to start contracting. As you think about those trends, you know, 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? We'd 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 timeframe on it, given all of the factors that come into play. whether it's the economic environment, potential for a second wave here of COVID-19 issues, a whole host of things that could come into play. So I'm hesitant to try to put a timeframe on it. What I will tell you is that I think while the delivery schedule, 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 a year or two of building below the replacement level. There has to be a more, in our view, a more dramatic reduction in output to help bring the market back into balance.

Okay. Makes sense.

And then, you know, maybe shifting to RRPS, you know, 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 and 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, you know, 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 and 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, you know, 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 compared to the ability to continue cutting costs on that front?

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 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. That's really helpful, Keller. Appreciate the time. Thank you.

And next, we'll go to Bascom Majors with Sesquihana Financial Group.

Yeah, 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. You know, you're putting books out there as a seller. Can you talk about the depth of that market? Is it the same bidders you typically see, or is that evolving? And, you know, you had alluded to maybe – pretty ample access to capital when you're looking out to acquire fleets, seeing 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. This is Bob Lyons. And I would separate the the two types of sales into very distinct buckets. The ordinary, as you go, secondary market activity, whether it's GATX or somebody else who's in the market, typically those packages are going to be anywhere between, call it 500 cars to 2,000 cars, on many different leases, many different riders. And so it's very common to see those, whether it's from us or others, in the secondary markets. That's very different than somebody going out to sell a portfolio of 5,000 to 20,000 or more rail cars 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 course sales in the secondary market, we did – We 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 and 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 down, the appetite's 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-sell analysis in times like now tends to be lean, puts us more in the direction of holding, and we're fine doing that, and we're capable of doing that. And 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. In these processes on the large portfolio side, are you seeing an evolution in And who's bidding? Is it more private equity money? Is it, you know, the infrastructure tag investors that historically have cheaper capital and lower return requirements? You know, the answer is we just haven't seen anything of size to attract that kind of interest and transparency in these types of questions. That's fine. I just don't understand what you guys are seeing. Thank you.

Yeah, I'll take that, Brian. That's what you've seen over the last, five or six years or financial players entering the market. They don't necessarily have a low funding cost, but they seek real cars as passive investments because they like to perceive yield. You've also seen some of the bank financial players that build platforms and big, very low funding costs in the industry. And in our opinion, both categories have spurred excess investment in the industry beyond what is needed. And pullback 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 Elcott with Cowan.

Good morning. Thanks, guys. My question is on the average lease revenue per car for North America. It looks like it's held pretty much flat on a quarter-to-quarter basis and down only slightly year-over-year despite the accelerating LPI declines over the last few quarters. You know, for Q2, does that mean that you guys had fewer cars coming up for renewal in the quarter? Or, you know, how do you think about reconciling the two? 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 sold close to 4,000 cars. We scrapped another 2,000, close to 3,000 on top of that over the course of the last year. So the mix changes routinely, and that can have an impact on the average revenue per car. That said, Tank cars in general are holding up fairly well in terms of the demand side. We're seeing customers want to hold on to those cars, but they're negotiating very hard on rate. 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 on 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. These are helpful insights, Bob. Thanks for that. Just one more follow-up question on the – use rate side, what do you guys think needs to happen for the downward momentum in use rates to end and, you know, for us to potentially see a bottoming out of spot use rates? Is it rail traffic infecting positive? Is that the first thing to look for? That would certainly help, and I would say the economic impact 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 have felt very strongly that that's been the case now for a number of years. So we need to see that spigot dialed back. That will also help lease rates going forward.

Hey, Matt, and 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 a 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.

Yeah, that's a very important point also, Tom. I don't think we've seen an environment where all the Class 1s industry-wide are implementing PSR while rail traffic is growing at the same time. So that remains to be a test, I think. Thanks so much for the input. Thank you.

And once again, it is Star 1. If you do have a question, 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, you know, was there a marked change in lease income received from 1Q to 2Q? And then maybe you could touch on, you know, how that impacted, if at all, in the RRPS as well. Thank you.

Yeah, it's true. And I 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.

Yep. So the – thanks, Brian. The pace of deferral requests has slowed pretty dramatically as the quarter went along. And really, the financial impact is nonexistent because any of the – for the most part, any of the deferrals that we've granted – Revenue is straight-lined. So it's a cash flow, but it's a timing issue, and the numbers are relatively small. We've had approximately 50 requests on a customer base of 850. For some type of restructuring or deferral, anything we do tends to be very either NTD positive for GATX or we get some other commercial benefit. We've approved less than half of those. so not a significant number, and the deferrals have been relatively straightforward. I will add, you know, we've had some customers, the small cube market, particularly in sand service, has been significantly pressured. Some of the customers there are under a lot of strain, and so we've seen a little bit more of an impact there as we've dealt with a few restructurings on the sand customers. And then I think I'll probably turn it over to Tom to talk about our RPF.

Okay. 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 requests – Similar in North America, split between those who asked for rate reduction, those who asked for temporary rate holidays, deferrals. GHX Rail Europe's closed about half of those requests with no modification at all. And the other half are 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, rent reductions. One looked for a cancellation, I know of. And 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 good in Rail International in both jurisdictions. And after the COVID spike and related closures getting restarted, I think, you know, it's pretty good, pretty good so far. Tom, what about RRPS?

Yep. So from a trend perspective, it's really the same story at RRPS. That's what Bob and Brian both mentioned. Of course, RRPS started with many more deferral requests. On the first quarter call, We mentioned that a little over half of the airline customers had made some sort of deferral request, which was typically looking for three to six months of rent deferral. And 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, you know, 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 railways did.

Okay, no, that's very helpful color. And in terms of the, you guys had noted that, you know, a competitive environment was, or I guess, you know, increased competition, things like that, everybody kind of fighting for utilization. Is that, is that it kind of, did that improve towards the end of 2Q? Or is that, you know, the environment right now, there's really been no change there? Can you just talk about that quickly?

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 placement. It's going to be extremely competitive. A number of lessors are going to be going after that business. 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. And the customer base that we have, we see them consolidating the number of lessors that they're dealing with. So time and again, we're in a position where we're able to displace competitors. So hence the reason utilization has stayed 98% plus. and we've done well on renewal success is 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.

And 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 continue, in fact, we realized release rate increases in the first half of the year, including in the second quarter. You know, as this continues, as things get restarted, we anticipate it'll 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 of the 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 Sounds like restarting, is there a range to kind of think about for, you know, outside of any, you know, maybe asset purchases, anything like that?

Yep. 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 food acquisition opportunities. And it's that last one that's, you know, the hardest to predict. We've talked about that several times on the call, on one that stuff shakes loose. But investment value for the whole company, we would expect to be probably in the mid-800s, 800 million for the year. Okay. Thank you very much.

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

Hi. Thanks for taking my question. Could you just review the number of cars in storage at the moment? And we'd 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 kind of 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 sleep 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 calibrate that around. That data doesn't go too far back in history, but at its 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% or the 13% level for quite some time, and it was only in the, you know, 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 rule of thumb you guys use, you know, every 1% increase in GDP is, you know, X number of incremental demand for cars?

Not necessarily because it really, not all cars are created equally. There's 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. Okay. Appreciate the insight. Thank you. Sure.

And we'll go to a follow-up from Bascom 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 three and a half years delivery 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 that GATX would look at over the next 6, 12, 18 months. Thank you.

Sure. Baskin, it's Bob. Yeah, both the Trinity and Greenbrier agreements that we have run through 2023, so we're in good shape on those. And 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 wouldn't really get into too much detail on timing of when we approach that and how we approach it.

Thank you. Thank you.

And that will conclude our question and answer session. I'd like to turn the conference back over to Ms. Kellerman 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.