GATX Corporation

Ladies and gentlemen, good day and welcome to the GATX 2021 First Quarter Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Sherry Hellerman, Director of Investor Relations. Please go ahead, ma'am.

Thank you, David. Good morning, everyone, and thank you for joining GATX's 2021 First 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 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 2020. GATX assumes no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances. Before I provide a quick recap of our first quarter results, I'd like to remind everyone that our annual shareholders meeting is scheduled on Friday, April 23rd, at 9 a.m. Central Time, and will be held in a virtual-only meeting format. Earlier today, GATX reported 2021 first quarter net income from continuing operations of $36.5 million, or $1.02 per diluted share. This compares to 2020 first quarter net income from continuing operations of $47.2 million, or $1.33 per diluted share. Our first quarter results are consistent with our expectations coming into the year. At Real North America, The operating environment remains competitive due to an ongoing market oversupply of rail cars. Rail North America's fleet utilization was 97.8% at quarter end, and our renewal success rate was 77.7%. During the quarter, the renewal rate change of GATX's lease price index was negative 18.1%, with an average renewal term of 30 months. We continue to successfully place new railcars from our committed supply agreements with a diverse customer base. We have placed our 8,950 railcars from our 2014 Trinity Supply Agreement and over 2,300 railcars from our 2018 Trinity Supply Agreement. Additionally, we've placed nearly 5,900 railcars from our 2018 Greenbrier Supply Agreement. virtually all supply agreement deliveries for 2021 have been placed. As we indicated in our release, we continue to look for opportunities to grow our North American asset base in order to serve our customers with high-quality rail cars. To date, our commercial team has placed over 1,000 additional rail cars outside of the supply agreement to be delivered by mid-2022. We also capitalize on a healthy secondary market to optimize our fleet through rail car sales, generating remarketing income of approximately $16.4 million in the first quarter. Within Rail International, GATX Rail Europe continues to see steady demand across the fleet, with utilization remaining high at 98.2% at quarter end. Rail International's investment volume was over $44 million during the quarter, as GATX Rail Europe and GATX Rail India continue to expand and diversify their fleet. Turning to portfolio management. First quarter segment profit was down year over year, primarily driven by the Rolls-Royce and Partners finance affiliates. As COVID-19 continues to negatively impact global passenger air traffic, Capitalizing on challenging market conditions to acquire assets with promising growth opportunities, in January of this year, we commenced a program of direct investment in aircraft spare engines that will be managed by RRPF. Our year-to-date investment total in this program is approximately $350 million. All engines have been placed on long-term leases with strong airline customers. And those are our prepared remarks. I'll hand it back to the operator so we can open the line for Q&A.

Thank you. Ladies and gentlemen, at this time, the floor is open for your questions. If you would like to ask a question, you may do so now by pressing star 1 on your touchtone phones. If you are on a speakerphone, please make sure that your mute function is disabled to allow your signal to reach our equipment. Again, if you would like to ask a question, please press star 1 now. And our first question comes from Allison Paliniak with Wells Fargo.

Hi, good morning. Just going back to the LPIA, I know it's a mixed number, but you did note in the release that it was primarily due to the energy-related car types. Is there a way to dissect that versus sort of energy versus others at this point, or is it too challenging?

Hi, Allison. This is Tom. As you know, when we provide information on the LPI, we try not to get too granular because it's really trying to indicate an overall look at what's going on from a market perspective. And our guidance coming into the year was 5% to 15%, and that remains unchanged. We always talk about not reading too much into a single quarter's LPI and since a small number of unusual transactions can always cause some volatility quarter to quarter. Our expectation for the remainder of the year still continues to be 5% to 15% for the full year. Of course, across the LPI, market lease rates, whatever you want to talk about, the energy sector continues to weigh down rates.

Got it. So maybe asking another way, should we just assume that it was a little bit more energy weighted in terms of the renewals this quarter versus the balance of the year to get back up there into that 5 to 15?

Yeah, Allison, I would not necessarily draw that conclusion about the specific weighting this quarter versus the remainder of the year.

Got it. Got it. And then just in terms of general market trends and lease rates, Is there any way to kind of help us understand how far off of normal we are today relative to what you're renewing right now?

Sure. Lease rates for most car types remain well below long-term averages, with the non-energy-related tank cars down about 15% to 25% versus long-term averages. Non-energy-related freight cars are down a bit more than that. And then the energy-related rail cars continue to be down 50% or more versus long-term averages.

Got it. Thank you. I'll pass it along.

Thank you. Our next question comes from Justin Long with Stevens.

Thanks, and good morning. And just to follow up on that line of questioning, I know in the release you talked about sequential improvements in lease rates, but Maybe, Tom, could you put some order of magnitude around that comment for both tank and freight and what you've seen year to date?

Certainly. So the market lease rates for most tank and freight car types were up very modestly again this quarter. I would say an increase of up to about 5% for most car types, whether it's tank or freight. And as you alluded to, Justin, this is the third quarter in a row that we've noted small lease rate increases. And each of the quarters, it's been somewhere in that 5% range.

Okay, that's helpful. And I know the full-year guidance didn't change, and the comment was made that the first quarter results were in line with your expectations coming into the year. Last quarter, you gave some fairly detailed guidance by segment. Anything notable that's changed within some of those assumptions by segment, either positive or negative since January?

Justin, no. Really, the first quarter is proceeding pretty much as we expected, so there's nothing that I would point to in terms of changing our viewpoint coming into the year.

Okay. And last one for me is on the acquisition environment. I know you have stepped up the investment dollars into the spare engine business, and you alluded to that. But just thinking about the pipeline for deals, specifically in the rail car space, could you talk about, you know, what you're seeing out there? Are you seeing activity pick up? Are you seeing some larger deals come to market? Just a general update would be helpful.

Yeah, Justin, it's Brian. You know, there's never discussed individual opportunities, obviously, but I think Some of the larger portfolios that would be willing to sell are still trying to come to grips with the valuation of their fleet. So I'd say that's where the state of the market is.

Okay. I'll leave it at that. I appreciate the time.

Thank you. Our next question comes from Steve O'Hara with Sedodian Company.

Hi. Good morning. Thanks for taking the question. I'm just curious. I mean, I know you guys, I think you redeemed the bond in the first and second quarter, but cash in the balance sheet and, you know, obviously corresponding debt increased significantly. Is there other, you know, things that are being worked on or is that something that, you know, you'd expect to deploy or you do expect to deploy? Or maybe you can talk about how you expect to deploy it right now.

Yes, Steve. So as we've been talking about for a while, we think this is the kind of environment where there can be attractive investment opportunities. We talked about a couple of those in our press release, specifically the investment in the aircraft engines and then some of the agreements we reached on placing non-supply agreement cars. But we did have a big cash balance at the end of the first quarter of about $960 million. But it's worth noting that this has already come down a bit. As you know, the capital markets have been very favorable. In February, we wanted to take advantage of the exceptionally low lease rates we were seeing, so we went to market with the two tranche issuance. We issued $400 million of 10-year notes with a coupon of 1.9% and $300 million of 30-year notes at a coupon of 3.1%. Much of the proceeds from those issuance already have or will be used to pay off higher debt. On April 1st, we redeemed $300 million of 4.85% notes that were due in June. We also provided notice that we will redeem $150 million of 5.625 retail notes due in 2066 when they become prepayable at par on June 1st. In addition, in early April, we prepaid nearly $135 million of outstanding bank term loans. So given our planned investment in Valium and another $300 million of debt maturing in November, we'll likely raise additional debt later in the year. So in addition to the investment opportunity, it really is noteworthy, some of those redemptions coming up.

Okay. Thank you. And then just like you mentioned in the press release about the non-supply agreement CARs, Can you just explain that to me a little bit? That's kind of new from what I can tell, but I don't know if there's something, maybe it's something that you guys do pretty regularly.

Yeah, so there's three different ways that we add cars to the fleet during the normal course. One is through the supply agreement. A second one is through spot business, new cars, where we simply go out and get quotes from builders. and then award those to the builder that we get the best deal from and place those with the customer, and then acquiring existing fleets, existing cars usually with leases attached. And this environment has been good to do that second one. So we wanted to comment on some of the investment. It's worth noting that those are all non-energy-related cars.

Okay, okay. And then maybe just on RRPF with the direct investment, is that what's in the least revenue within portfolio management now? Is that the direct investment? And then, you know, do you still kind of think, you know, are your thoughts still the same around the portfolio management guidance that you gave last quarter? Sure. for the full year given that increased investment, or is there anything else kind of at play?

Yes, Steve. So we noted last quarter that we expected to do more of this type of investment. So, yes, the additional investment was contemplated in the guidance that we provided. And as far as the financial statements, yes, the majority of that lease revenue that you see in the portfolio management segment is related to those engines.

Okay. All right. Thank you very much.

Thank you. Again, if you would like to ask a question, you may do so by pressing star 1. Our next question comes from Justin Bergner with G Research.

Good morning, Brian. Good morning, Tom.

Good morning.

First question for me is just to build on the questions about the direct engine investment. So was that 350 all complete as of March 31st? And sort of how should we think about your intentions and capabilities to further expand that level above the current 350?

Yep. So I'll start and then let Brian add to if he has anything. But all $350 million of that was completed in the first quarter. And as we mentioned last quarter, our intention is to invest in the most attractive engine types with the best customers on long-term leases. So it's difficult to predict exactly how much more of that we'll be able to do, but it's certainly our intention to continue to look for that kind of business.

Yeah, Jess, we're investing in great equipment at really attractive cost. The engines are on long-term leases. You know, you have that hook to the service component of the total care package from Rolls. And this is the strongest airline credits in the world. And lease rates are attractive. There's conservative residuals. This is just great business for GATX, so we'll try to do as much as we can without relaxing those investment parameters.

Okay. This might be an unusual question. I'm not sure if you can answer it. But, I mean, are these investments accretive initially, or is the intention more that, you know, you'll lock up a lease and then – I don't know, five to ten years later, the environment will have improved and there'll be much more accretion.

Yeah. So as Brian noted, these are incredibly attractive economically, but they're also accretive from year one from an accounting perspective.

That's a great point. That's a great point. We always look at, whether it's rail cars, engines, whatever, we'll always look at the best way to optimize the value. So it's a good question.

Okay. And just a quick one here. No repurchases in the quarter, right?

That's correct.

Okay. And then lastly, clearly there's a lot of activity going on with the Tier 1 rails, including this morning with Canadian Nationals overbid for Kansas City Southern. How do you view... what a transaction between either of the Canadian rails and Kansas City Southern could mean for your business and the general, I guess, rail car supply chain.

Yeah, I can take that, Justin. From an equipment perspective, let's start there first on that level. If the deal is approved, the first deal, our exposure to any fleet consolidation concerns as a result of the merger are very small. I think between CP and KCS, we have less than 900 cars on lease to the two of them combined. With CN, it's probably also less than 900 to them directly. So, it's just not a material equipment exposure for GATX. But I think you're also asking about the bigger picture and, you know, one remain kind of neutral here. But any merger that has the potential to create new rail traffic and potential new car demand is obviously going to be a good thing for a diversified less source such as GATX. So, We'll see what deal goes through, whether it goes through and which one, and we'll have to wait to see if that actually happens, but potentially a good thing for car demand.

Okay, thank you.

Thank you. Again, to ask questions, star one. Our next question comes from Matt Elcott with Cowan.

Good morning. Thanks for taking my question. Can you guys talk about what type of what type of cars would benefit if there's an infrastructure bill?

Yeah, so the infrastructure bill that's been announced, I think it's $2 trillion, that is north of $600 billion that's going to rail systems, road, bridges, and ports. But almost all that rail spending is earmarked for passenger rail, so it's public transit, it's Amtrak, And that's great, right? I'm saying highways, bridges, roads, ports, that's sorely needed, but it's really how they pay for it that we'll be watching. But there's not anything really earmarked for freight rail transportation. It's more elsewhere.

But some of the building materials, I would assume that maybe there's some demand for open hoppers or even potentially conversion of the frac sand, cars to cement and industrial sand. Could we expect any of that activity to happen?

Yeah. So, Matt, you know, obviously it's not – the bill is not passed and, you know, not sure what the finished form will be. So it's speculative to think about which individual car types. But certainly if you're building steel and aggregates, and any of the feedstocks related to those would certainly benefit if there's increased infrastructure spending. So we'll have to see how it plays out.

That makes sense. And, Tom, just one last question on industry utilization. I think the number is 77% right now as of this month, right? The best it's ever been, I think, is 90% at the height of the crude by rail time, which was a crazy time. Do you have a view on what full utilization is? I mean, is it 85%? Is it 90%? Is it 80%?

Yeah, Matt, you know, we've talked about this before. It's really hard to hone in on exactly what that might be. It's certainly lower than where it is today at the end of the quarter at about 23%. A good guess might be in the mid-teens somewhere, but honestly, it is a little bit of a guess. We have to see it all play out.

And then just a quick reminder on the underlying assumptions of your guidance. You know, the rail recovery has been mainly intermodal and grain. It's actually down next to those two. Is that what you guys assumed when you gave guidance last quarter?

Yes. So what we've been talking about and alluded to it on the first question is we've seen three quarters in a row of small improvement in spot lease rates. A lot of the industry metrics you just talked about, idle car count, are improving, loadings have kind of hung in there. We're not seeing a big increase in any kind of capacity or anything like that. It looks like, at least right now, it'll be slow and steady. So that's what we modeled in, an expectation that that will continue throughout the course of the year. The uncertainties around what happens with the degree in nature of the COVID recovery is some of the reason for the range that we provided. But again, as I noted, through the first quarter, things are proceeding largely as we expected.

Got it. Thanks, Tom. Thanks, Brian.

Thank you. Our next question comes from Justin Bergner with GE Research.

Oh, good morning, and thanks for the follow-up. You know, one topic that I don't think was touched on was the environment for scrapping cars. I saw that you scrapped about 1,000 cars leading to income of about $5 million, although there might be some other small puts and takes in that category. So just maybe comment on is that a pace that is sustainable? Are you mainly scrapping cars that are fully depreciated? Are you scrapping some cars that still have more than sort of residual value on the balance sheet?

Yes. So the process that we use when scrapping cars is consistent regardless of the market or scrap prices. When a car comes into a repair facility, we look at the expected remaining cash flows from continuing to operate that car in terms of what lease rate is it likely to earn over its remaining life, what's the cost of the repair, and then compare that to the scrap proceeds. So what naturally happens when scrap prices are higher is that it tilts you, makes you a little bit more likely to scrap cars. And scrap prices have been in the low 400s for most of 2021 versus the low to mid 200s for most of 2020. So certainly that increase in scrap price is making it relatively more likely that we scrap a car. Having said that, it's important to note that this number can ebb and flow quarter to quarter simply based on what cars come into the repair facility.

Okay, understood. In terms of the income, just to understand that, I guess, minor line item, which is perhaps now a little bit less minor than normal, I guess it's non-remarketing income. net gains. And so that 5.1 million, which probably is mostly scrappage is the gains across the thousand cars or so that you scrapped in the quarter. And it would be the gains relative to whatever residual book value, which I assume would include salvage, estimated salvage value would be on the balance sheet.

That's correct. Yep. Yep. That's, As you indicate, that number is primarily scrap, and that's exactly how you calculate the gain.

Okay. And then lastly, has there been any change to your view of gains on asset dispositions in North America from when you gave your outlook at the start of the year?

No, there hasn't. As you know from following us a long time, that number can vary quarter to quarter, so we much more look at what the expectation is over the course of the full year. And what we outlined coming into the year, that it might be $35 to $45 million higher than last year, remains our expectation.

Okay, thanks for the follow-up.

Thank you. Our next question comes from Steve Barger with KeyBank Capital Markets.

Morning, guys. Thanks. Related question on the steel. Can you talk about what you're seeing for input cost inflation for steel components or anything else? And are there any issues with parts availability?

Yep. So as indicated, we buy cars both on the spot market and through our supply agreements, the majority of which is through the supply agreements. So certainly the increased price of steel is increasing the cost of the car across the board. As far as any kind of challenges with maintaining our delivery schedule, we're receiving delivery of cars as expected.

What about parts availability in the repair shops? Any issues?

We're proceeding as expected there as well.

Okay. And last one. Just any broader comments on how inflation could affect the lease fleet in terms of asset value of the installed base, what that means for rates? Does this slow down your desire to buy cars on the spot market or anything else that comes to mind?

No, I mean, in general, higher inflation is good for hard asset owners like GATX. It's historically been our front.

Understood. Thanks. Our next question comes from Steve O'Hara with Sedodian Company.

Hi, thanks for taking the follow-up. Just looking at the renewal term, I think it was 30 months in the quarter. I mean, it seems like it's been fairly low for a while. What's a typical – how do you think about a typical cycle in terms of how long that lasts where you guys typically – you know, keep that term short versus kind of push it. I mean, it seems like it's been like that for a while. I mean, obviously that wouldn't necessarily, you know, mean it would have to pick up eventually or, you know, soon, but I'm just kind of curious how you think about it.

Yeah. So, so as you point out, the term is relatively short and at the short end of what we see historically during the stronger parts of the cycle, you'll see that number up over five years and, and it really has to follow the, First, increasing utilization in the industry, which is followed by increasing lease rates. And then the last one is you start to see that term extend a bit. So calling the number of years that it stays relatively short is just another way of calling the length of the cycle. And as indicated, our expectation coming into the year was we'd continue to see that slow and steady improvement in lease rates. That continues to be our expectation. but given how far we are from historical averages, I wouldn't expect a big change in that term over the course of this year. We'll see as the recovery continues how that eventually lengthens. Okay. Thank you very much.

Thank you. At this time, we have no further questioners, so I'll turn it back to our speakers for 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.

Ladies and gentlemen, that concludes today's presentation. Thank you for your participation. You may now disconnect.