GATX Corporation

Good day, and welcome to the GATX 2020 Third Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to the Director of Investor Relations, Sherry Hillerman. Ms. Hillerman, please begin.

Thanks, Casey. Good morning, everyone, and thank you for joining GATX's 2020 Third Quarter Earnings Call. I'm joined today by Brian Kenney, President and CEO of and Tom Ellman, Executive Vice President and CFO. Please note that some of the information you'll hear during our discussion today will consist of forelooking statements. Action 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 its 10Qs for 2020. GATX assumes no obligation to update or revise any forelooking statements to reflect subsequent events or circumstances. I'll quickly recap our third quarter financial performance and then hand it over to Brian for a short discussion on Rail North America's maintenance operations, as well as the Rolls-Royce and Partners Finance Affiliates results. Earlier today, GATX reported 2020 third quarter net income from continuing operations of $48.2 million, or $1.36 per diluted share. This compares to 2019 third quarter net income from continuing operations of $37.2 million, or $1.03 per diluted share. Year-to-date 2020 net income from continuing operations was $132.4 million, or $374 per diluted share. This compares to $138.7 million or $3.79 per diluted share for the same period in 2019. The 2020 third quarter and year-to-date results include a net negative impact of $12.3 million or $0.35 per diluted share related to the elimination of a previously announced tax rate reduction in the United Kingdom. The 2019 year-to-date results include a net deferred tax benefit 2.8 million or 7 cents per diluted share related to an inactive tax rate reduction in Alberta, Canada. These items are detailed on page 14 of our earnings release. In the second quarter of 2020, GATX completed the sale of American Steamship Company. Accordingly, this business segment is reported as discontinued operations and prior periods have been recast to conform to the current presentation. Now I'll briefly address each segment. At Rail North America, our fleet utilization remained high at 98.2% and renewal success rate was 58.1%. Although absolute lease rates for most car types were flat to slightly higher compared to the second quarter, we expect lease rates to remain under pressure given a continued oversupply of rail cars in the market and carload volumes relative to 2019. Third quarter renewal rate change of GATX's lease price index was negative 29.4%, reflective of the ongoing challenges in the marketplace relative to the strength of the expiring lease rate that generally commenced at the height of the market six to seven years ago. The average renewal term associated with the LPI is 29 months. As noted in the earnings release, despite higher fleet churn as a result of lower renewal success in the quarter, Our maintenance cost performance was better than expected, which Brian will address further in his remarks. We continue to successfully place new railcars from our committed supply agreements with a diverse customer base. We have placed all 8,950 railcars from our 2014 Trinity Supply Agreement and over 1,670 railcars from our 2018 Trinity Supply Agreement. Additionally, we have placed over 3,470 rail cars from our 2018 Greenbrier supply agreement. Our earliest available scheduled delivery under our supply agreement is in the second quarter of 2021. Remarketing income at Rail North America was $7.9 million for the quarter and $39.4 million year-to-date. Within Rail International, Both GATX Rail Europe and GATX Rail India saw steady demand for rail cars during the quarter. GATX Rail Europe maintained high fleet utilization at 98.2%. The lease rate environment in Europe remained supportive of small increases in renewal lease rates for most car types. GATX Rail India grew its fleet to over 4,000 rail cars while maintaining utilization at 100%. Rail International's third quarter investment volume was approximately $45 million. Turning to portfolio management, results were primarily driven by a transaction at the Rolls-Royce and Partners finance affiliate involving the refinancing and sale of a group of aircraft spare engines, which Brian will also cover in his remarks. So with that, I'd like to turn the call over to Brian.

Great. Thanks, Sherry. Good morning, everyone. As Sherry said, I want to provide some color on two items that have had a large positive effect on our earnings in 2020. And then we can go ahead and open up the line for your questions. So the first one concerns Rail North America's net maintenance expense. And coming into 2020, we expected net maintenance to trend higher by about $8 million to $13 million. That's a 5% to 7% increase versus 2019. The main driver of the increase was the commercial churn that we expected in the North American rail fleet, given the ongoing weakness in the market, and this was pre-COVID. By commercial churn, we mean a lower renewal success percentage on expiring leases. That resulted in more cars being assigned to new customers to keep the fleet utilized, and traditionally that has meant more maintenance expense as expired cars often enter our maintenance network to prepare them for new customers and or new service. So as predicted, we have seen the higher commercial churn as we move through 2020. And this churn has been exacerbated, obviously, by the fallout from COVID-19. In fact, if you look in the third quarter, our renewal success was 58.1%. That's a full 17 percentage points lower than a year ago. However, year-to-date, net maintenance expense has remained flat to 2019. So there's a number of reasons for this favorable performance, most of them good. One of them perhaps a little counterintuitive, but let me touch on those relevant reasons. So the first one, as we move through 2020, we continue to become more successful at increasing the amount of repairs done in our own network versus the third-party shops. So you've heard us talk about this before. We have this goal of moving as much maintenance work as is practical into our own shops. That's where we believe the safety, the cost, the quality, and the delivery metrics are all superior. So as an example of the progress we've made, if you look at the third quarter alone, we set up 96% of our tank car work and close to 90% of all of our cars to run through the OWN network. So that steadily increasing volume has to drive down our unit repair costs in the OWN network. We're going to continue to push on this initiative. The second one is increasing the efficiency of our internal processes and our systems, actually. And they continue to improve our ability to make sure that the type of work done on similar cars is consistent across the network. And when we can charge for that work, that we consistently bill and collect the proper amount. Now, I've alluded to this before. These initiatives have been driving down our costs for the last year or two. Obviously, we'll reach a plateau when we ever achieve complete uniformity across the network, but we're not quite there yet. Third, a little unpredictable, as always, are railroad repairs. They are lower than anticipated. coming into 2020, but it appears that the railroad's attention and manpower appears to be directed to other areas. So, the expense is down year over year. And lastly, on the maintenance side, and as I said, perhaps a big counterintuitive is the fact that sometimes the commercial churn in the fleet can cause maintenance expense to decrease versus expectations. So, actually contradicting what I just said a little earlier, but there have been some cases in 2020 where the market is weak enough that we've had an We've made that economic decision to scrap older cars when customers return them at lease end, rather than incur maintenance expenses to prepare the cars for a new customer. So why do we do that? We simply did not see a lease, a new lease, being profitable enough to provide a return on an investment in maintenance. So this is most common on the older cars, and especially our boxcar fleet, which, as you know, is quite old relative to the rest of our fleet. So, for example, coming into the year, we plan on maintenance expense to be incurred on target older boxcars because we anticipated being able to sign and track new leases. Instead, the market weakened further due to COVID, and we ended up scrapping the cars when they came off lease. So that reduced maintenance expense versus expectations in 2020, but there's a downside to that in that it removes planned boxcar earnings from future years. So that's probably the best example of where reduced maintenance expense can be a little misleading. But nevertheless, I'm really encouraged by our maintenance performance, and I think that lower spending trend will continue in the fourth quarter and actually beyond. The second topic I wanted to quickly touch on is the large gain on sale at RRPF. That's that spare engine leasing partnership with Rolls-Royce. We highlighted it in the press release, as Sherry said. Now, we frequently realize residual gains in this business, but it's been in a variety of forms. So older engines have been torn down and profitably sold for parts. Excess maintenance reserves have been released at the end of leases and taken income, and we have sold engines on lease to third parties in the past. So similar to North American Rail, you can manage customer exposure, equipment exposure, renewal schedule exposure. You can optimize all that in the secondary market for engines. It's quite liquid. The gain in the current quarter, though, was both large and unique, and I wanted to explain what it was and not let it mask otherwise difficult operating environment in that business. So As we've said in the past, at RRPF, the portfolio consists both of engines that are leased directly to airline customers around the world, but also engines that are leased back to Rolls-Royce, generally so Rolls can use them in support of their total care program. In this particular instance, there was a large group of engines leased to Rolls-Royce where approximately $300 million of debt was coming due for refinancing in 2020 and 2021. So obviously refinancing rates have increased pretty dramatically for air-related businesses, So in this case, it made sense to restructure the current lease to Rolls-Royce into a new long-term lease, sell many of these engines with the leases attached to third-party investors, and then use the proceeds to pay down the vast majority of the related debt rather than refinancing it at higher credit spreads. So once again, that addressed a number of goals for the JV. We reduced refinancing risk, we reduced some equipment risk, even lowered our exposure to Rolls-Royce from the JV. But the value realized on the sale generated a gain of 68 cents per diluted share in the quarter, and it was actually an outstanding value, probably more reflective of a pre-COVID environment. So I wanted to call it out because a similar transaction on the engines, at least a roll, is unlikely to happen in the near future. But it does reflect the value embedded in the engine portfolio longer term. So I hope that helps explain two of these standout items in the third quarter earnings. Operator, we can go ahead and open it up to questions now.