GATX Corporation

Good morning. My name is Colby, and I will be your conference operator today. At this time, I would like to welcome everyone to the GATX 2022 third quarter earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press the star, then the number one. Thank you. I will now turn the call over to the Head of Investor Relations, Sherry Hellerman.

Thank you, Colby. Good morning, and thank you for joining GATX's 2022 Third Quarter Earnings Call. I'm joined today by Bob Lyons, President and CEO, 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 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. Earlier today, GATX reported 2022 third quarter net income of 29.1 million or 81 cents per diluted share. This compares to 2021 third quarter net income of 40.1 million or $1.11 per diluted share. The 2022 third quarter results include an impairment charge of 10.8 million or 30 cents per diluted share associated with our decision to exit the rail business in Russia. Year-to-date 2022, net income was $107.5 million, or $299 per diluted share. This compares to $82.1 million, or $228 per diluted share, for the same period in 2021. The 2022 year-to-date results include net negative impacts of $55.2 million, or $1.54 per diluted share, from tax adjustments and other items. The 2021 year-to-date results included net negative impacts of $43.1 million, or $1.20 per diluted share from tax adjustments and other items. These items are detailed on page 13 of our earnings release. And now I'll briefly address each segment. Rail North America's fleet utilization was 99.6% at quarter end, and the renewal success rate was 87.2%, reflective of the continued strong demand for rail cars across our fleet. Once again, we saw sequential improvement in absolute lease rate during the third quarter. The renewal rate change of GATX's lease price index was positive 37.5%, with an average renewal term of 33 months. We continue to successfully place new railcars from our committed supply agreements with a diverse customer base. We've placed over 4,000 railcars from our 2018 Trinity supply agreements. Additionally, we've placed over 7,650 railcars from our 2018 Greenbrier supply agreements. Our earliest available scheduled delivery under our supply agreements is in the second quarter of 2023. Earlier this month, we announced the new multi-year agreement to purchase 15,000 newly built cars, the largest committed rail car order in our history. We are pleased to have the new agreement in place, as these new cars will continue to strengthen our competitive position. The secondary market for rail cars in North America remains active. Rail North America's marketing income was $9 million in the quarter, and 76.7 million year-to-date. Turning to Irel International, the rail car leasing markets in Europe and India remain very strong, and fleet utilization was above 99% at quarter end. Furthermore, GATX Rail Europe continues to experience increases in renewal lease rates versus the expiring rates. In portfolio management, the Rolls-Royce and Partners Finance Affiliate is performing as expected in an uncertain environment. As borders reopen this year, global passenger air traffic has improved, but remains below 2019 levels. We continue to identify opportunities to make attractive investments in today's environment. Total investment volume across our businesses was $203.4 million in the quarter and $887.9 million year-to-date, primarily focused on rail assets globally. As noted in the earnings release, reflecting strong operating performance to date and our outlook for the remainder of the year, We expect 2022 four-year earnings to be in the upper end of the previously announced guidance range of $560 to $6 per diluted share, excluding any impact from tax adjustments and other items. Those are our prepared remarks. I'll hand it back to Colby so we can open it up for Q&A.

At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. We'll pause just for a moment to compile the Q&A roster. Your first question comes from the line of Allison Poliniak from Wells Fargo. Your line is open.

Hi, good morning. I just want to revisit some comments. You know, I know just going back, sorry. Fluidity, you know, certainly could impact the need for cars. I think your prior comments alluded to the fact that there was still a lot of demand that you felt that could support rail car interest, you know, should fluidity start to come back. You know, the economic environment is changing pretty rapidly, it seems. Just are you still comfortable with that thought? Any changes there? Just would love some thoughts there. Thanks.

Yeah, so a couple different things embedded in your question. First of all, we do continue to believe that if rail performance improves, that there are some loads that the industry will – will move, that they're not moving right now because of some of the challenges with the rail network. We continue to see shippers wanting to move more by rail, but they need to see the service improve before they can do that. Also embedded in there is kind of customer sentiment about what's going on in the market. And I think it's important to note that we continue to see a significant difference between the new car and the existing car markets. customers clearly feel that they need to maintain their fleet size, so they're very reluctant to return cars. This fact, combined with the tight supply situation, has resulted in strong existing car pricing. The number of industry idle cars in storage is down around 17%. But I want to contrast that with the new car market. Customers are also generally reluctant to increase their fleet size. For the past couple quarters, we've noted that the new car market has been more competitive as builders and lessors aggressively compete for those limited new car opportunities. This dichotomy between the new and existing car market has persisted this quarter, and if anything, it might even be a bit more pronounced because of the macroeconomic uncertainty that you mentioned.

Allison, it's Bob. I'd also add to Tom's comments, too, that there was a market study out very recently that that indicated of those customers shipping by rail, over 60% said they would ship more if the fluidity and service levels would improve. So we feel very comfortable that that kind of pent-up demand or potential demand is still there.

Great. Great color. Thanks. And then I guess in line with that, you know, I know term is a weighted and average number. really hasn't moved? You know, are customers pushing back a little bit more just given the uncertainty out there in terms of term? Is it just due to specific car types out there? Just any color there would be great.

Yeah, so from a goal perspective, one of the things we've been talking about is with the rate improvement, we're really looking to, at least in certain car types, where the lease rates are strong, start pushing that term out a little bit. I'm sure you're referring to the fact that the LTI term for the quarter was 33 months. As you know, this is weighted based on total fleet size. As you would expect, some of the shorter lease terms in this group included energy-related cars that carry commodities like coal, ethanol, and LPG. If you look at the average renewal term for all Q3 renewal activity, just weighted on the total activity in the quarter, that number would be 49 months. So we are, on an activity basis, seeing some success taking that term up.

Great. Thanks so much. I'll pass it along.

Your next question comes from the line of Matt Elcott from Cohen. Your line is open.

Good morning. Thank you. My question is on the secondary market, given how strong it's been for a long time. Is it safe to assume that valuations, especially with interest rates rising, valuations would start to moderate next year?

Yes. So, Matt, as you mentioned, the secondary market really has held up despite the rising interest rates, and we expect it to remain strong for the foreseeable future. In almost any interest rate or economic environment, the impact of inflation over time and the straight-line nature of depreciation results in economic values that exceed NBB. This is evidenced by the fact, if you look at Rail North America over the last decade, the lowest year we had in terms of gain on sales was $39 million. Having said that, this year is going to be a record year for marketing income. We mentioned that we expected it to exceed last year's total of $80 million. Our decisions are always made. by optimizing fleet considerations and economic considerations, and we'll continue to do that going forward. But as far as interest in cars with leases attached, it remains very strong.

Yeah, Matt, adding to that, we're in the market all the time, both on the buy and sell side. So that frequency gives us a lot of visibility into other bidders, demand, what the appetite level is, and it remains very healthy at this point in time. Now, looking into 2023, we would expect, given what we're seeing here in the fourth quarter, for that to continue. But as you well know, it's a pretty uncertain macro environment, so we'll update everybody on that when we get into the end of the fourth quarter.

Got it. And then given the big agreements you guys just signed, the supply agreement for 15,000 cars, first of all, can you talk about how much of this is for replacement and how much is it for growth? And since you have this big agreement locked in now, does it kind of free you up a little bit more to do more sales rather than investments in the secondary market going forward given the strength continues even if it moderates a little bit?

Sure. The size of the agreement is very similar in terms of the number of cars we'll take delivery of on an annual basis to the one we've had in place for the last five-plus years. And if you think about what we scrap in a given year, anywhere between 2,000 and 3,000 cars a year, sometimes a little bit more if the scrap environment warrants it. You can look at the agreement that we have in place as our base load, our base need, and keeping the fleet essentially at the size it's at today. To use your term, it is more of a replacement order. That said, we have a lot of flexibility inside the order in terms of what car types we'll take delivery of, so the mix of the fleet can change over time. We'll be opportunistic on that front. And I would say we have full flexibility to continue to order on top of that and would expect to. More in the spot market, meeting customer demand, there will be deliveries in excess of 3,000 cars a year that are embedded in this order.

That makes sense. And then, Bob, my next question was going to be, I'm so sorry if I missed it, but did you guys quantify the absolute lease rate improvement in the third quarter?

We did not, but I can do that. So this quarter marked the ninth consecutive quarter of increasing lease rates. The increase this quarter versus last quarter was fairly modest, less than 5%, with no real material difference between tank cars and freight cars.

And that percentage change is something you would expect as we continue to get longer, you know, each quarter progresses because the bar is, the denominator is getting, is rising each quarter.

Okay. So the actual real strength of the market really hasn't changed much, but where the comp gets difficult, because I think last quarter you got mid to high teams, I believe, if I remember correctly.

Yeah, one thing we always caution against is overemphasizing a single quarter. To put it in context versus a year ago, most tank car types are up between about 15% and 25%, and most freight car types are up between about 30% and 70%. So you're seeing a lot of strength. It's just, as Bob mentioned, and just to repeat, it's just as you look at a single quarter, as you continue to have that level of success over a nine-quarter period, each time the increment is – you're starting from a higher base.

Got it. And, Tom, is there a way to gauge, like, how much of these absolute rate improvements quarter over quarter – are tied to just the broader inflation in the market versus dynamics specific to the rail car industry?

Well, as we've said before, with regards to the recovery we've seen here over the course of the last few years, or last year, 18 months, it's been more of a supply-side driven improvement. And again, this kind of gets to the point that Tom referenced with regards to the bifurcation between the existing car market and the new car market. So there definitely is an inflation impact there. We're still optimistic based on the dynamics right now, which really point to customers holding on to their existing cars. That's obviously come through not only in our utilization, but our very high renewal success rate and the lease rate improvement that we've seen. They're compelled to hold on to those assets. We don't see that changing anytime soon. especially given the replacement cost of going out and buying new assets in this environment. So we think we're in a very good position to continue to capitalize on that.

Great. Thanks a lot. Thanks, Tom. Your next question comes from the line of Bascom Majors from Sesquihanna. Your line is open.

Thanks for taking the questions. You've talked about the enduring strength in the secondary rail car market in North America. Can you parse that out between... how some of the interested parties' behavior seems to be evolving or frankly not in the books that you put out and how people seem to be bidding and what the quality and depth of those bids looks like. And, you know, by parties, I mean, you know, I don't know if it's financial buyers versus operating really less, or is it really any way you want to slice that up between the people who participate in these auctions? Thanks.

Yeah, Baskin, it's Bob. You know, the depth of the market continues to be pretty solid. And I'm speaking here from the standpoint of a seller in the secondary market. And as I mentioned, we're active on both sides. But as a seller, what we're seeing is the depth of the market continues to be pretty strong. A lot of different buyers interested in the different pools of assets or lease transactions that we have in the marketplace. And what we're seeing is the fact that if you have a longer-term quality asset on a good lease with a good credit, you'll get ample significant interest from the secondary market, from the buyers there. And it's a little bit more difficult to kind of slice them up between the financial players or other operating lessors, but we don't see a lot of new interest, but those that are in the market today and have been for a long period of time continue to have an interest in adding assets.

Thank you for that. And maybe on another market participant thought, can you talk about the quality or the implied returns and the competition from the captive OEM lessors. Just curious if you're seeing the leases put in the market by some of the builders evolve this cycle versus prior cycles, and has that changed any way in the way that you operate in the market?

Thank you. It hasn't really changed over cycles, and I'm not going to speak specifically to any one OEMs activity in the marketplace. What I will say is in any transaction, the larger it is, the more likely the OEMs are going to be actively pursuing that particular transaction if it's a new car deal. If it's a 500 or a 1,000 car order or a 1,500 car order, that's going to garner quite a bit of interest from the OEMs. GATX has built its business for decades. on more singles and doubles than that type of home run transaction. Not that we don't pursue those and not that we don't get them from time to time. But our bread and butter is the 100, 200, 300 car type order where you can see very attractive returns and you have to have the infrastructure and the commercial and the sales team in place to be able to identify those deals. We have that. and that will continue to be our focal point going forward.

Last one from me. As you look into next year, any preliminary thoughts on prioritizing lease rate or term and how that's evolving into the market? Thank you.

Well, given the macro environment we're in and the volatility we seem to face globally, it's one of the most unpredictable environments that I think most of us around here have ever experienced. I think we'll save that one for the fourth quarter and provide more color on that as we get into 2023.

And, Baskin, the only thing I'd add is, like always, whatever we do is going to be on a car type by car type basis. For ease, you know, we talk globally on these calls, but the way we manage the fleet is what's going on in each of those individual markets. Thank you.

Your next question comes from the line of Justin Long from Stevens. Your line is open.

Thanks, and good morning. Going back to the lease rate discussion, obviously there was a lot of volatility and rates on the way down and then volatility on the way up. Could you just help us understand where absolute lease rates are today versus normalized levels? And then as we move into next year, any commentary you could share on what the comp from an LPI perspective looks like?

Yeah, so let me at least start on that. So compared to long-term averages, most tank car types are up between about 10% and 20% versus those long-term averages. Most freight car types are hovering right around the long-term average, maybe a little above or a little below. For both tank and freight cars, the energy-related car types are still well below long-term averages. Next year, we always give guidance on both earnings and pricing, the OPI, on our fourth quarter earnings call.

Okay, understood. And maybe looking at the guidance this year, you said you feel more comfortable at the high end of the range now. Any color you can provide on what changed within your assumptions to drive that more optimistic commentary?

Sure, Justin. It's Bob. Obviously, with about roughly 10 weeks to go in the year, most things are fairly well-baked at this point. The one thing, and the year in general, has played out largely the way we anticipated that it would, despite a lot of macro events that I already referenced, whether it be the war in Europe, or economic volatility, rising interest rates, inflation, et cetera, in general, the market has performed very much the way we thought it would coming into the year. The one variable has been on the remarketing side. And so based on transactions that we have currently underway and expect to close by the end of the year, that has been the driver to the uptick in the guidance.

Got it. And last quick one from me. I know you took the impairment related to Russia, but anything you can share on the segment profit impact from Russia, what we've seen historically there as we model out that rail international segment going forward? And maybe you could just touch on your European business as well and how you think about a stress test of that business in a mild recession scenario.

So, Justin, I'll start with Russia, and then I'll let Bob comment on the Rail Europe business. So, as you know, that Russian business, pretty small part of the total, and on a segment profit basis, it represents less than one-half of 1%.

And with regards to the European business and the potential impact of a recession there, What we have seen historically, and I think most people, you know, or, you know, we try to stress the fact that in the European market, the lease rate structure is very different, where we tend to see pretty material swings in lease rates, as you've already referenced, you know, 10%, 20%, 30% up, down in the North American market. The European market is much more stable. We're talking about single-digit type lease. up or down, and a lot of times low single-digit, up or down, despite the economic environment. So it becomes much more of a focus on keeping assets utilized, and our team there has done a very good job of that and has the fleet at record high utilization today.

Great.

Thanks so much for the time. Thank you.

Again, if you would like to ask a question, Press star, then the number one on your telephone keypad. Your next question comes from the line of Justin Bergner from Trebelli Funds. Your line is open.

Good morning, Bob. Good morning, Tom. Good morning, Sherry.

Good morning, Justin. Hi, Justin.

A couple of quick questions and then one or two substantive questions. On the quick side, did you repurchase any shares in the quarter?

We did. So share repurchase for the quarter was about $5 million.

Great. Thank you. And then on the scrappage side, with steel prices having come down and with, you know, GATX and other market participants having scrapped a more material amount of cars, you know, in the last 12 months, would you expect to be, you know, at the low end or even below the low end of that $2,000 to $3,000 range as you look out sort of on an annualized basis over the next couple quarters?

Yeah, Justin, we'd expect the total year to be pretty average, not materially above or below what we normally do, which is around 2,500 cars a year.

Okay, great. And then you mentioned, I think, that the first car available for placement was the fourth quarter of 2023 or the end of 2023, so about a year out. Is that a longer timeframe than normal for your first available placements?

Justin, just to clarify, it was the second quarter of 2023.

Oh, apologies.

Yeah, and Justin, generally speaking, we're placing cars out six months or more.

Great. So you're in kind of a normal placement cadence. Yeah. Okay. Yeah. And then lastly, a big picture question. If there was a big secondary market – I guess if there was a big portfolio that was to come into the secondary market, would GATX consider it? What would you, you know, consider to be the puts and the takes in evaluating an asset like that?

Well, we're always interested. And unsettled times, volatile times tend to bring some of those opportunities to the market. And GATX has always had a history of doing it. Pretty solid job of capitalizing on those when they come. I think Tom and I have both been here long enough, Paul Titterton, who runs our North American rail business, to remember 2008 and 2009 when the world was entirely upside down. I think we were one of the few buyers of big portfolios of rail cars at that time. Not that I'm hoping for a 2008, 2009 repeat. I'm not. But if there is unsettled times, we absolutely would have an interest. And the puts and takes always come down to the quality of the portfolio. Not all portfolios are created equally. We do an extremely deep dive when we look at portfolios, literally car type by car type, lease by lease. And that will be a very big driver to our interest level as will evaluation. So... We're not compelled to overpay. I think we have a reputation in the marketplace as not overpaying. We have a great infrastructure here that's very scalable, and we want to add assets to it over time, but we don't have to buy anything. We don't have to buy anybody's customer list or team or infrastructure, et cetera. It comes down to the quality of the assets in the portfolio and the valuations. that we believe we can pay and generate an attractive return for the shareholder. That's the story at the end of the day.

Great. Thank you.

Your next question comes from the line of Basco Major from Susquehanna. Your line is open.

Thanks for taking my follow-up. So I wanted to follow up on the Europe comments from earlier. Can you talk about the customer appetite to either grow their fleets or replace older cars with new cars in that environment, just given the economic uncertainty? And, you know, to the extent that there is some appetite for new cars, you know, with the general supply situation and cost of goods, are the OEMs able to meet your demand there, customer demand, where it's needed? Thank you.

Yeah, well, overall demand, I'm very optimistic on the European market, given the fact that there is a concerted push to move more product from truck to rail. The Green Deal is very real in Europe. The environmental benefits of rail are apparent, and they're being pursued pretty aggressively in Europe. So very optimistic on that front. You know, that said, the manufacturing footprint in Europe is far smaller than it is here in North America. And so it is, at this point in time, it's pretty strained. You know, the challenge, I would say, is not necessarily finding the next car opportunity, the next new car opportunity. It's making sure we can get delivery on a timely basis. And with the supply chain situation is pretty strained in Europe, that's become more challenging. Okay. We came into the year expecting about 1,400 new wagons to come into the fleet in Europe. We'll come in a little shy of that, not because of demand, but because of supply chain. And so we'll be analyzing all of that closely as we put our expectations out for 2023, but the demand side in Europe is very strong.

Thank you.

There are no further questions at this time. I will now turn the call back over to the Head of Investor Relations, Sherry Hellerman for closing remarks.

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.