This is Justin Long with Stephens. We'll go ahead and get started with the next fireside chat. Next up is GATX. Very excited to have them back at the Nashville conference this year. Joining me from the company is Tom Ellman, CFO. Shari Hellerman with Investor Relations is in the room as well. This will be a fireside chat format, so I will get started with questions, but if anyone in the audience has questions, feel free to raise your hand, and we'll take those as well. T om, thanks for being here, and I thought a great way to get started would be to just take a step back. You know, if I think about the North American, you know, railcar leasing environment, we've seen rates increase for over three years now, coming out of the pandemic.
Could you just provide some context on where we sit today from a rate perspective versus long-term averages?
Yep. So, Justin, as you noted, we've had three years of consistent quarter-over-quarter rate increases, but that was from a pretty low base. We really started to exceed the long-term averages sometime in 2022, and as we sit here today, the vast majority of car types in the fleet are at rates that are above long-term averages. I would say car type by car type, maybe between 5% and 25% above those long-term averages. Obviously, that varies by car type, but as a general rule, the tank car types are probably at the higher end of that range, and the freight car types are probably at the lower end of that range. The only real exceptions to that are some of the energy-related cars.
Coal cars are still below any kind of long-term average or replacement level. Small cube covered hoppers that move frac sand, same situation, and then the legacy flammable liquid tank cars. The next generation tank cars are doing very well, but the legacy ones, the ones that have to be out of the fleet by 2029, those would be another example that are below.
I think you said on the earnings call, about a third of your fleet has repriced to more attractive levels, so we've still got a ways to go. Is that what gives you confidence that, you know, we'll see kind of a positive LPI number or positive rates versus expiring rates for an extended period of time, which I would define as years?
Yeah. So, you're right that that topic got touched on in the last earnings call, and just to provide some context of kind of how that estimate of a third of the fleet repricing in a stronger environment came out. As I mentioned, 2022, we'd call sort of the first year of a strong market. On our website, we have a great slide which divides the market into stronger and weaker markets, and so 2023 obviously has been strong. I f you think about somewhere in the order of magnitude of a fifth of the fleet expiring each year, that's kind of how do you get to that third level, one-third of the fleet level.
We certainly think conditions are right to continue to have a strong market. Justin, as you know, we always give guidance for each year on our January earnings call, and we'll give more specific guidance at that time. T he situation that we've seen with the strong market continues to be the order of the day. And as you also alluded to, if you look historically, most up markets and down markets kind of last in that three- to four-year range. So if history was an indicator, W e'd be in the earlier part of that right now.
Okay. What are you seeing in terms of just inquiry levels from your customers? You know, the economic backdrop is somewhat uncertain. A lot of the transportation companies have had a challenging year, but the lease dynamics stand out as being favorable. So there's just some mixed pieces in the market, but I'm curious what you're seeing real-time.
It continues to be a pretty strong environment for the existing cars, and really what it comes down to is we have 160 different car types in our fleet. And car type by car type, there really is a situation where demand is exceeding supply for those. People need to hang on to the cars they have. Our renewal success percentage has been in the 80s. Anything over 75% is historically strong, and that really puts you in a good position for that renewal negotiation to both take that lease rate up and to extend lease terms. The LPI lease term is around 60 months now. If you look at that historically, you know, the highest it's been is in the upper 60s, low 70s.
We're moving towards the upper end of that range. You know, there's a lot of reasons for continued confidence. If you look at those Core Car loadings, that number has kinda hung in there. You certainly have a situation where historically higher scrap rates and historically high new car prices are putting an upper bound on how much overbuilding conceivably could be done. If there is any kind of improvement in railroad velocity, we think we'll continue to see freight on the sidelines that wants to move in and take up any of that demand. Like I said, the inquiry levels have been strong, and we expect that to continue.
And just given where we are from a rate perspective, I guess the next area of focus is pushing term, and we've started to see that in some of the numbers. How much runway do you feel like there is in that area?
Yeah, so it's a tough one to precisely name. We certainly have been pushing it for a while, and even over the course of this year, you saw it go from the 50s to the 60s. I mentioned the kind of what the upper end of that has been, in the upper 60s or low 70s. So if history is a guide, there might be a little room, but probably not all that much to extend it. But even holding that would be strong.
Okay, maybe I'll pause for a moment. Any questions from the audience? Okay, if not, I'll keep going. I've got plenty. P erforming maintenance work in-house for the North American lease fleet, I feel like is a big part of the value proposition for your company. Can you kind of provide some context on where we are today in terms of the percentage of maintenance events that are done in-house, and what that opportunity to increase that number could look like?
Today, we're right around 80% of the maintenance being done in our own facilities. That's down actually a little bit from last year when it was a couple percentage points higher. But it's up materially from historical, which, depending on year, was kind of somewhere between 55%-70%, and that's been as a result of a multi-year series of process improvements and investments at the shops, doing things like adding storage track, increasing cleaning capability, increasing finishing capability, to really drive more work into our own facilities, where on a fully loaded basis, the costs are less expensive than lower than they are on the contract shops, and certainly on a variable cost or incremental basis, materially lower. So something we've really been working to do.
The upper bound of that might be somewhere around 90%. There's always gonna be some number where, either just the geographic reality of how far, something is from one of our shops or a really unique car type, you probably can't get to 100%, but, but 90 is a realistic goal.
I know there's a lot more tank car compliance work that's occurring in the industry. Is there any color you can provide on, you know, the number of tank cars that are coming due for that compliance work? You know, what, what's due this year, what's due in future years, maybe what that bell curve looks like, or maybe it doesn't look like a bell curve, however you would describe it.
It is a big driver year to year over what some of the variability will be. It's a really difficult question to get precise on because the need to do that compliance work has outer bounds, but you can do it early. And actually, one of the things that we saw this year, where we have a little more demand in our own facilities than we thought we might coming into the year, is a little more of that happening a little sooner than anticipated. T here's nothing in particular, at least as it relates to our fleet, that I would point out.
I think the industry fleet is in for a period of time where it's gonna be a little bit higher and could be some challenges for anyone that really has to utilize that third-party network to a large degree. But for our fleet, there's nothing in particular that I'd point to.
I guess on that point, does that enhance the value proposition for GATX, given that, you know, work is coming due?
Yeah. So, so it certainly helps with our own cars. And the way we operate our shops, they're really designed primarily to service the GATX fleet. T he investment that we've done is to be able to do as much as we possibly can in our own facilities. Just because of the way work comes in, there will be periods of time where we have excess capacity, and we would use some of that excess capacity to serve other cars. We haven't done a lot of that historically, but we certainly would be interested in doing a bit of that going forward. But again, it's gonna be more opportunistically when there's space available, once we've served our own fleet, as opposed to really investment with the specific objective of doing more third party work.
Okay. I have one more on North America, and then we'll shift to some of the other businesses, which, you know, ten minutes in-
Mm-hmm.
I think it's faster than usual. But when you look at the railcars in storage numbers that come out every month, I know there can be some seasonality, but you know, there's this debate going forward about improving rail service and velocity and what that could mean for railcars in storage versus better volumes and truckload conversion. What's your view on where that kind of industry utilization metric goes in the next 12 months or so? Do you have an opinion there?
Yeah. R ight now we're at about 19% of cars that haven't had a loaded move in 60 days, which is down materially from the peak, which was over 30%. As far as what will happen going forward, what we really think, again, without getting too specific about 2024, that the dynamics are gonna continue to be favorable for a while. And you talked about some of the velocity issues. There are kind of two things that are noteworthy there. One is, when you see a decrease in velocity, it's generally relatively sudden and driven by some triggering event. You have a natural disaster, you have a merger, you have something like that, where you need a lot of cars suddenly.
So that velocity decreases, and then that's augmented with additional cars. When it goes the other way, it tends to happen a little more gradually. The improvement comes from hiring and training people, conceivably making some investment, doing some things that happen more gradually over time. B ecause of that, often you can work in any kind of change that happens through the adjustment of the build cycle, s o you don't see the same kind of upward movement or downward movement. What I will say is we have seen some improvement recently, and you've or, you know, shippers might—some of the shippers might say, less bad as opposed to more good.
But we haven't seen any change in customers' interest in renewing cars and looking for incremental cars, which seems to lend some credence to the idea that there is a certain amount of freight on the sidelines. A s you might have some velocity improvement, that should be picked up with some additional traffic going onto the rails.
The secondary market, it sounds like it remains pretty strong as well. I mean, no signs of that changing anytime soon?
Yeah, no, it really has, a nd there, the important thing I wanna note is that that is an important part of our business, regardless of where we are in the cycle. I f you look over the last 10 years, we've averaged about $63 million a year of gain on asset sales, and that has varied to as low as about $39 million and as high as a little over $100 million. I t really is a material component all the time. T he reason for that is, we sell for a variety of reasons, but one of which is fleet optimization. We really pride ourselves on having the most diversified fleet in the industry. Again, 160 different car types.
One of the ways we maintain that diversity is, if we're long in a certain car type or long in a certain industry, that becomes a sales candidate. Additionally, we're always looking at, what does the market think about a given car type versus what we think about it? If we think that the market is valuing it higher than what we would value the projected cash flow stream over its life, it becomes a sales candidate. No matter what's going on in the overall market, there are always some car types that are particularly strong and some car types that are less strong. T here's always something in that area to go ahead and sell. The consistent gain there really speaks to how well railcars hold their value.
It's really worth noting that the amount of sales that we choose to do and the amounts of gains we generate aren't necessarily beholden to what's going on in the market overall. There's always some level of opportunity to generate those gains.
Great! Well, let's take a question here, and then I'll pivot.
You can go ahead.
No, go for it, Jordan.
Okay. So you've got 30% of your revenue is international at this point. Of that 30%, how much is Europe, how much is India, and how much other? Maybe specifically address the corporate revenue.
Yeah. I n general, what I'll do is I'll talk about the car counts because the revenue is similar to that. I n Europe, we're just under 30,000 cars. In India, we're over 7,000 cars.
Yeah.
Yep. And, and what has happened over time is the Indian part of the fleet, on a percentage basis, has grown the fastest. We actually were the first ones to introduce railcar leasing to India. We worked with the Indian government and the Indian Railways to introduce the leasing scheme that would be used for private leasing of railcars. W e, we started in 2012. It took us about 5 years to get to 1,000 cars, a nd since that time, we've probably averaged about 1,000 cars a year. There is every reason to believe that that pace of growth will continue or even accelerate. The key driver to that in India has been two things. One, when the government and the railways allowed private leasing, they don't do it for every car type at once.
Car type by car type, you get approval. A s we've gotten more approval, that has allowed for more growth in that area. T he other is just people getting comfortable with the concept of leasing. It was new, you know, new to the industry when we introduced it. The reason I say, if anything, it could accelerate, is because one of the things the Indian government would like to do is encourage traffic to move from the roads to the rails, a nd one of the challenges to that is the Indian rail network is primarily a passenger network, and so the freight trains have to give way, have to yield to the passenger trains. And so that makes rail even more challenging than road and even a little less reliable.
But the introduction of dedicated freight lanes, which is what the Indian government is working on, will help alleviate that. And they've already spent about $10 billion to date, to do that, to have lines that are solely dedicated to freight traffic a nd as that investment continues, and as those lines, those rail lines come online, it should be even more impetus for growth in the Indian market.
7,000 of all of our cars is what percent of all, both total cars and what percent of cars are able to be leased? Is it, like, 20% of them?
A very high percentage of total leased cars and a very low percentage overall. T he Indian market as a whole is something just short of about 300,000 cars. The vast majority of cars are owned by the Indian Railways.
Sorry, just to clarify, it is an Indian government program that would be charged with building out that network or are they partnering with private businesses there to do so?
That is correct. It's the Indian Railways putting the money to work.
Maybe we could talk about Europe as well, while we're on that topic, and you can answer a similar question on future growth in Europe and how you're thinking about the cadence of that growth. I know similarly, they're focused on truck-to-rail conversions.
Yeah. T he growth in Europe has obviously been slower than the growth in India, and that one of the underlying drivers of that is actually something that makes the market very attractive as a lessor. J ust to provide some context, I want to compare it to North America.I n North America, opinions vary, but we would call the replacement level of demand at something on the order of 35,000 cars. Some others might pick a slightly higher number. The build capacity in the industry is much higher than that. At one time, it might have been 80,000 or 90,000 cars. There's been some rationalization, so it's less than that today. Nobody would know exactly what it is, but probably on the order of 2X what we think of as the replacement demand.
So you have this build-bust cycle that happens in North America. You don't have that in Europe, and one of the key reasons you don't have that is the replacement demand and the production capacity are similar, both something on the order of 15,000 cars a year. Y ou don't have that boom-bust cycle. T hat's really good for optimizing the performance of your fleet, and it's one of the reasons that even during COVID, lease rates in Europe stayed steady, and increased even. But it does present a challenge as you try to grow the fleet because there's only so much capacity out there to build incremental cars. Now, there is an opportunity to try to grow inorganically. There are some challenges there from a regulatory standpoint.
You have both EU and then individual countries that take a look at the competitive dynamics, and if we were to buy a big player, that would certainly be challenging. What might be possible is about 25% of the market or so is very small players, and there could conceivably be some opportunities to try to grow inorganically that way. But the growth that you see in India with the new cars really adding to the overall fleet, that's harder to see in Europe just because of the capacity versus the replacement demand.
Can I, can I follow up?
Yep, absolutely.
In the aircraft engine business, there's a company called Aptiv Security middleware that's predominantly well talking about PMA parts and things of that nature, also in the aircraft engine business. Have you thought about the PMA parts business? Is there into that type of ability to do that?
Yeah. T o be clear, what we do in the aircraft engine business is where there's two different ways that we participate. The first is with a joint venture with Rolls-Royce, and that joint venture has about 400 engines. Those engines, we earn revenue two different ways. The first is leasing the engine to a airline for use when the on-wing engine requires maintenance. And depending on the engine type, the recommendation is to have between 8% and 15% of the engines as spares available. The other way that we earn revenue through that JV is through leasing engines back to Rolls-Royce, the parent, who uses them as part of their TotalC are maintenance program.
Ultimately, it's the same use for the engine, but what happens there is the airline doesn't want to have to deal with and manage all the complexity, so they pay Rolls a fixed fee. Rolls provides whatever maintenance is required and also sources a spare engine from them. O ne of the ways they source those engines is by leasing from the joint venture. The other way we participate is direct engine leasing for our own account, and we started that fairly recently. We're up to about 29 engines for our own account, $700 million in net book value.
Those engines also, about half of them are leased directly to airlines, the same way the first part of the JV, and then the others are used as a part of a non-dedicated group of engine, a pool, which also is managed by Rolls-Royce and provides an engine when maintenance is required for one of the engines in the participating airlines. And the revenue stream from that comes from the total flight hours for engines of a given type. So in a very small way, the JV participates in the aftermarket parts business, but that's a small part of what they do overall. And the GATX participation is gonna continue to be really focused on the engines as a whole.
So you don't anticipate it being more aggressive than those?
No.
Okay. Well, I actually wanted to go down the road of aircraft engines and spend some time on that, particularly given what you've done from a wholly owned engine perspective recently. Could you just share your thoughts? I don't know if there's been any change on the annual investment that you could make to grow that wholly owned engine fleet.
Yep. So right now, we're at about 700 billion, 700 million. Billion would be a big number. $700 million of-
Change my model.
Net book value for those, and it's 29 engines. On our second quarter earnings call, we indicated that we might be able to do about $200 million-$300 million a year going forward, and would look to do that.
And how would you compare the returns right now in doing that versus the traditional railcar leasing business in either North America or internationally?
Yeah. T he returns on the aircraft engine business are higher than they are in the rail business, A nd really, it comes back to the fact that that has been a growing market since we entered it. Pre-COVID, air passenger miles doubled about every 15 years. The percent of engines that were leased went from about 10% when we started the JV, to 50% today. So growing market, growing percent of leasing. It's really been a really attractive environment. And then the competitive advantage of being partnered with Rolls-Royce on Rolls-Royce engines has really allowed for some strong returns in that business. W e would expect that to continue going forward.
Within the railcar space, the highest returns would be in the Indian market, also the highest risk area. The lowest returns would be in North America, and then Europe would be in the middle.
Okay. When you think about the recovery in global air travel and the impact that it has on your aircraft engine business, both wholly owned and the Rolls-Royce JV, what's the typical lag time? It was helpful to get some details around the mix of the fleet, but you know, what we're seeing right now is recovery. Is that fully reflected in the results of those businesses this year, or 50% reflected? Can you give us some context there?
The hard thing about tying in the financial performance is how important the remarketing side of that is. What I will tell you is the average remaining lease term in that business is about three and a half years. T hose are long-term leases. W hat I would say is when COVID started, we thought that the recovery in the wide-body international traffic would take till, you know, 2025 or so. So we're a year plus ahead of schedule. W e're, you know, starting to see some of those positive results. But just like there was a lot of resiliency when things turned negative, it takes a while, given the lease structure.
It is worth pointing out that there will never be a bigger test of resiliency than what we had in COVID, when air passenger traffic went to zero, and that business held up.
It feels like there's a similar dynamic with this business versus, you know, North American railcar leasing, where there could be an extended period of time where we see re-renewals kind of priced higher. Is that a fair way to... Is it fair to make that comparison?
I think it is, and like I said, we're at. I'm sympathetic to you on your modeling. Where it gets hard is because, again, how important those, the remarketing side of that is.
Can you give some context just historically, when you look at the profit contribution from the JV, what percentage of that has been tied to remarketing?
For the current year, a little over 50% of it is from operating income, a little less than 50% of it's from remarketing. If you look over the last four or five years, that remarketing piece has been as low as about 45% or so and as high as about 70% or so.
Okay. Got it. And I'm guessing was the high during COVID or just because the-
Correct
core earnings came down?
Yep.
Okay. Maybe we can shift to Trifleet. It's a business that doesn't get a lot of airtime. It's a recent acquisition, but just looking at the numbers, it seems like there's been a better-than-expected ramp. I s that fair, and can you just talk about, you know, where that business is tracking versus what you thought when you completed that deal?
Yeah. At the highest level, it's pretty much on par for what we thought. When we purchased that business, and just to put it in scale for everybody who might be less familiar, it was about $200 million. I t's materially smaller than the other businesses that we've been talking about. Right after we purchased it, there was a pretty significant increase in the cost of a new tank container. And just like in any of our other businesses, that helps on the renewal side. That market is maybe at the beginning of a little bit of a downturn. Generally speaking, the tank car, the tank container business follows the dry bulk container business, and the dry bulk containers have had a little bit of a weakness.
We haven't seen it yet in the tank container side, but we anticipate that it's probably coming, and maybe we're seeing the very beginnings of it. T he combination of the early, a little bit better than anticipated and maybe a little bit of challenge now, I would say overall is pretty much in line with expectations.
Okay. Any other questions from the audience? Jordan?
Yeah. T here's beginnings of a complete nearshoring going on here, and there's also the largest other things relocating hundreds of factories up in Ohio and Mississippi, and things of that nature. Maybe more than we usually have. I'm just wondering if you could pontificate what role rail could play in that. If you're getting more calls or questions, whether it's high-use plans in Ohio or, you know, where we're going here. I s there a, is there a growth channel for rail in the Upper Midwest that you're operating from specifically for you?
Some of those questions probably better directed to the railroad 'cause we're derived demand from when they have primary demand. But in general, what I'll tell you is anything that leads to an increase in needs for railcar loadings, a good thing for our business. If you look historically, though, the railcar loadings have been amazingly consistent, and we have a slide on our website where we show what we call Core car loadings. And what that does is it excludes some of the single commodity or limited commodity car types, best example is coal, which has been in secular decline for a long period of time, and tries to mirror the broad array of different car types that our fleet carries.
Year-over-year, it's up 2.6% versus a year ago. But over the long period of time, it's amazingly flat. You saw it decline a bit during the Great Recession, and then almost immediately come back. Then you saw it decline a bit during COVID and almost immediately come back. Th e cyclicality in the industry is very much supply-driven. S ticking with that demand side, you know, one of the reasons for that, we believe, is that the actual underlying demand for railcars to move freight traffic is something higher than that line would indicate. But the competitive position that the railroads have taken, focusing on PSR, focusing on operating ratio, has really not been a growth-driven approach.
Now, there's some commentary that could lead one to believe that that may be changing and there may be more growth coming. Haven't seen it yet, but were it to happen, of course, that would be a very, very good thing. But I think the key driver will be an approach to growth by the railroads, and any underlying demand pickup in the underlying economy would only help that. But the first step really needs to be an aggressive attempt to go get that growth.
When I think about the level of investment, you know, I think we started this year thinking it would be over $1 billion. As of the end of the last quarter, you were $1.2 billion with a quarter to go. Do you feel like this level of investment is sustainable at the current run rate, just given the opportunity set you see in front of you?
Yeah. I t's a good question, and it's hard to answer precisely. For, for a long time, kind of our average investment was somewhere between $600 million-$800 million a year. And you would periodically see something bigger than that. Like in 2014, we bought the GE boxcar fleet. It was a higher number. In 2018, we bought the Element portfolio. It was a higher number. But we've had three years in a row now of over $1 billion, and, and really, that's driven by the fact that there are opportunities across the waterfront. We've talked about India.
We've talked about the fact that the only limit on Europe is the number of cars we can get, the investment that we've made in aircraft engines for our own account, the fact that there's a new outlet for the tank container, smaller but still a new outlet. And then, even in North America, we're starting to have more success on the secondary market, buying cars with leases attached. T he number is certainly higher than the historical levels. It's really hard to say what the new level is. We'll provide some additional commentary in January on what we expect it to be for 2024. But, you know, your directional question is, yes, it's something higher. Precisely defining that number is more challenging.
And just given the opportunities across these different businesses, I mean, there's more diversity at GATX than there has been in some time. Have your return expectations or hurdle rates as you consider some of these investments changed?
Yeah. C ertainly our approach is very consistent over time. Everything we do is a discounted cash flow model. The businesses we're in, we've, you know, we've been in for a while, so we have a good idea, like, take a railcar, for example, what it costs to maintain it over its life, what we're ultimately—what we ultimately can expect a long-run average lease rate to be. Then, depending on the business, you know, put the right cost of equity, the right leverage assumptions to come back to a return expectation. Thus far, we have not been capital constrained. We are investment grade, BBB-rated, and it's really important to maintain that. Our leverage today is about 3.15 to 1.
And the rating agencies that we talk to regularly are certainly comfortable with that being 3.5 to 1, conceivably higher for the right opportunity. W e have some room. In my time at GATX, we haven't been capital constrained. You know, if we were, that would present an opportunity to sort of reevaluate each of those assumptions. But we are incredibly disciplined in the way that we look at the individual investments, and so feel very, very comfortable that the return is adequate across the board. If we had a different demand environment, we'd reevaluate and conceivably have to take those up.
Okay. Any final questions from the audience? Maybe I'll end with just a couple more. Was there one over here? Okay.
Can you speak to your dividend payout policy?
Yep. GATX has paid a dividend uninterrupted since 1919, so very few companies can match that. Our shareholder base, the dividend is very important, something the board takes very seriously and looks at and evaluates every year to set the new dividend level. And for a number of years, the rate of increase had been about $0.08 a year. This last year, we took it up about $0.12. And all I can tell you is it's something the board will look at and consider each year and make an informed decision.
One other question I wanted to ask, and we can wrap up with, is there's been a lot of movement in interest rates. Everybody's wondering what the Fed's next move is. There's puts and takes from that for your business. What's the interest rate environment that GATX is rooting for in the next 12 months?
Yeah. W hat we really try to do is be in a position to take advantage of what actually happens as opposed to a certain vested interest. At the highest level, anything that increases the cost of a new car is good. If it makes the new car alternative more challenging to pursue, it makes the value of the existing lease higher. What I will say is we had a very long period of time where interest rates were low, so we tried to do everything we could to position ourselves for someday when they wouldn't be. And we managed to get our average maturity date out to over 8.5 years. As of the end of last year, our cost of debt was under 4%.
We have very small, less than 5% of our assets are secured, so it's basically unsecured debt. And then, less than 10% of the debt is variable. So termed out, fixed-rate debt, so really put ourselves in a position to be able to be in the best position we could in this environment. So, all I'll say is, we will look at what happens, and on the asset side or the debt side, react however we can. But like I said, if the cost of a new car goes up or the cost of the money goes up, it should make existing assets more valuable.
Okay. Well, with that, we'll wrap things up. But, Tom, thank you so much for being here.
Thank you.
All right. Thanks, everyone.