All right. Awesome. Thanks, everyone. This is the last one of the day: Railcar Manufacturing and Leasing portion of the Industrials Conference. My name is Andrej Tomczyk, sitting alongside Trinity's CFO, Eric Marchetto. Eric, thanks for being here today.
Thank you. Appreciate it.
Maybe just to kick off, before jumping too much into the question-and-answer session, you want to just provide an overview of Trinity and.
Sure. Love to. Thank you. So Trinity is a Railcar Lessor, enabled by rail manufacturing. We operate in North America principally, serving the North American industrial economy. Most of our customer base is industrial shippers. We have a large lease fleet, one of the largest on our balance sheet, about 110,000, 112,000 railcars. We also have what we call RIV partners, which is Railcar Investment Partners, of another 32,000 railcars, which gets us to that kind of 145,000 railcar fleet. So we have scale in the market. We also have a captive manufacturing business. We're one of the larger railcar manufacturers serving the North American market. We also have a growing services business, our maintenance services business, which is there to help maintain our lease fleet and also the fleets of other strategic customers. We also have a growing services business, logistics and transloading.
That is a growing aspect of our business. And we have a parts business, large OEM. It makes sense that we have a parts business. We've been focused on growing that as well.
Yep. That's a great overview. Maybe just I wanted to start off a little bit higher level. Your last Earnings Call, you talked about sort of the potential for fog clearing, and that's sort of been a hang-up on sort of railcar demand in terms of tariffs, specifically driving in fog due to tariffs, was one of the comments, and it's uncertainty, which has really been the main theme, I think, over the last six months to a year, for not just you, but broadly across transports as well. I'm curious if you could share sort of specific macro indicators that you guys are watching to keep an eye out for when we could sort of get through that fog and maybe when we could see a better railcar ordering environment. What catalysts would sort of drive that environment?
Yeah. Sure. So the fog I'm referring to is going into 2025. We were pretty bullish on things picking up right after the election a year ago. We thought we were going to have tax policy clarity. We thought we were going to have regulatory clarity, and then the tariff talk started, and the tariff talk had an impact on our industry and our business fairly dramatically, and why is that? About a third of rail traffic is related to international trade, and so anytime you're talking about trade policy, if a third of your business is related to international trade, that's going to have an impact, and that's kind of across all of our segments. When you look at the way we look at the market, we look at the market as chemicals and refined products, energy, agricultural products, metals and mining, and then consumer.
All those have an impact, especially on the agricultural side and the chemical side from tariffs. From a language standpoint, tariffs have kind of uncertainty has kind of replaced tariffs. People now, I think, are tired of talking about tariffs, and so they just call it uncertainty. And we're seeing that. Where that translates for us is we see inquiries. We see our inquiries for new and existing railcars at fairly steady levels, but they're not converting the orders, or it's taking them much longer to convert the orders. So it's kind of that uncertainty index that we have in terms of people talking about demand, but not converting it to actual orders. And I think it's just when you're having to underwrite these are long-term assets, and generally, these are big projects that people are talking about.
You can underwrite a better tax policy, but you can't underwrite a tariff policy yet or what's going to be the impact, and that can change the economics of these investments.
Maybe just I wanted to sort of shift back to your broader model. You've pushed more into leasing, and so I want to get to that sort of philosophy of yours. What is it about leasing that's sort of attractive? And you've obviously pushed into that market. So you're still a large manufacturer, 50% roughly of the backlog in North America. And so how do you balance those priorities, and what is your ultimate sort of goal as a company?
Sure. And so when you're talking about railcar assets, they have a 50-year statutory life. They're long-lived assets. They're real assets. They're made of steel and steel components. And when we look at where the market has gone and why we want to lease more, we principally serve the industrial customer base and the industrial shipper. And how they procure their railcar is typically through leasing. Over 55% of the North American fleet is leased or is owned by lessors, and those are principally leasing into the industrial shippers. And so that's really how we see that demand. We think that with leasing, you really have the ability to control more of the narrative, control more of the capital invested. We like having the manufacturing with it. It gives us access to what we think are the best designs and the best products.
We're able to have it. There's some efficiency in having those two things together. Some customers may be looking to buy a railcar or lease a railcar. They're going to call us either way. Having that large lease fleet, our demand for railcars goes through that existing lease fleet. So we think we're a more efficient market provider in that regard. We're not building a new railcar if we have an existing one that will serve a need. So the result is it's more efficient from a capital deployment perspective. And ultimately, it should be higher returns on the business. We think having the two businesses together should translate into a higher return on equity over a cycle.
Makes sense. I wanted to shift a little bit to company-specific questions and maybe starting more on leasing dynamics. Your future lease rate differential in this past quarter saw a noticeable drop. It's still up 9%. So your new leases are being signed 9% higher than your expiring leases, but the prior quarter, that was 18%. And you did attribute some of the moderation to the higher expiring lease rates relative to some moderation in the market rates. And I think there's some mixed issues in there as well that you noted. So could you maybe just talk through that and where you expect that FLRD to sort of trend, given sort of the mix as well?
Sure. So let me first just kind of explain that metric. And so it's a future lease rate differential. What we're doing is taking the current rates that we contracted for different car types in the current quarter and comparing that to those same car types, their expiring rate over the next four quarters. So it's designed to give you a predictor on kind of the opportunities. If all things remain, what should happen to changes in lease rates, which ultimately would lead to changes in revenue? We think it's a good metric. It's not a perfect metric, but we think it's a good metric. In terms of why it changed quarter over quarter, I think you hit the highlights. We have seen some railcar lease rates moderate. We have seen some of the mix of expiring rates going forward are a little bit higher.
And so those two things are contributing to a lower metric. Mix within car types matters as well. We're doing this over 22-24 different car types. There's a lot more different car types within our portfolio. So you get a little bit of that as well. And then modestly, we're starting to see some lapping. So we've had a good lease rate environment for about the last 14 or 15 quarters. We've started to reprice some of those. And so where you had that 20%-30%, even 40% future lease rate differential in quarters past, as those lap each other, that'll naturally start to come down. What that metric means and why I think it's important. Think about it. If we were repricing our fleet, our entire fleet every year, it would basically be the inflation rate that we're seeing in lease rates. We don't do that.
Generally, this last quarter and this year, we've generally averaged about 48 months on renewal terms. And so you're going to have a little bit of it'll be a little bit lumpy. You'll price that railcar four years from now. So you're going to have three or four years of inflation or change the next time you price it. So that contributes a little bit. I would expect the future lease rate differential to remain positive to healthy. And I'm fairly bullish on lease rates going forward. And let me expand on that. So if we look at over the last 20 years of railcar asset prices, you've seen about 3%-4% of inflation in those asset prices on an annual basis over the last 20 years. Take that same period and look at the same car types.
You've seen rental inflation of 1%-2%. So asset prices have moved up faster than lease rates. And that's in an environment that, if you look at Treasuries or benchmarks, whether it's the 10-year Treasury, for example, is right about 4.1% today. Over the last 20 years, that's probably pretty good to be on par with what it's been over that time frame. So as I look forward, I'm pretty bullish on what lease rates should do with the asset prices coming up and lease rates not going up as much. I think that tells me there's a lot more room for inflation and rental rates going forward.
And I think that's a really good point. And just if you sort of because you're sort of starting to lap, right? Like you said, the COVID higher rates, but you do have this environment where new car prices are going higher. And you could run into a point where you're going to reach a recovery level in maybe freight markets at a time when you're starting to really re-sign these new contracts, also when these prices are going up. So are you going to be able to continue to re-sign the FLRD at a higher rate two years down the line? Or it seems like you could because, like we just talked about, the lease rates seem to be supportive based on the asset prices themselves.
I mean, how do we think just relative to the post-COVID trend in a couple of years after the full book is sort of re-signed?
Yeah. It's a great question. And I think it starts with, like you said, the new railcars and new lease rates. And if I think about inflation and I think about the inputs on a cost of a new railcar, steel prices, labor costs, energy prices, really labor and energy having impacted and steel as well. I don't see any of those really coming down. I think there's still going to be some inflation there. And so I think that's going to mean new railcars in the future are going to be at least, if not more expensive than today, just given inflation. And so that's going to lead to lease rates on those new railcars needing to be higher as well, which allows the existing fleet to continue to price up. And we see some of that proof points in the secondary market.
When we sell assets out of the secondary market, we're seeing a healthy pricing environment on those assets. And I think it's because buyers are assuming that lease rates are going to go up in the future. So they're underwriting higher lease rates in their investment decision, and that's supporting the value that we're seeing. And I think it's all these fundamentals that matter. And what makes it all happen is the fleet's imbalance. So you think about that North American fleet. North American fleet has shrunk this year through three quarters. We've scrapped over 30,000 railcars. We've built about 23,000 railcars as an industry. So it's been disciplined in a flattish environment. If you look at all the public leasing companies, the ones you can get stats on, everybody's running relatively high fleet utilization. So there's not a lot of slack in the market in a flattish industrial environment.
When things do recover, historically, if we're talking about a softer environment, then fleet utilization will be lower. There'd be surplus assets. We're not seeing that today. In the past cycles, when that demand comes back, the existing assets, the surplus would soak up that demand. You don't have those existing assets to soak up demand, which is why I'm really bullish about what will happen when things do start to improve.
And so definitely, I think the supply environment is helping considerably as well. And I mean, you guys, your last call, you raised guidance partly based on the gains on sale. And so maybe just talk a little bit about how that's going now, near term, if that's still what you guys are seeing out there. And given those dynamics, is that something you would expect to continue for the foreseeable future, like into 2026? Should we continue to expect those gains?
Yeah, so we did raise our guidance on secondary market gains to $70-$80 million. We went into the year with $40-$50 million of gains in our guidance. So certainly, we've seen an increase. And as I mentioned, when you look at why the market's good, the other lessors are not speculatively buying railcars. There's not. New car demand is down. Companies still have growth goals or growth mandates. And so the place they can get their growth is in the secondary market. And so we're seeing steady demand. It's got breadth. It's got depth. And like I said earlier, we're seeing people price in higher rental rates going forward, which is supporting the valuations that we're getting. So from that standpoint, I think that environment's going to continue. We're not giving guidance for 2026 yet.
But on our call, we did talk about that the market is good, and we're looking to opportunistically access that market. And that environment has remained. I mean, when you look at it, all these benefits in these long-lived assets, they don't always come through on the income statement. But when you look at just the embedded value in our fleet, we talked about the asset inflation of railcars over the last 20 years. Our fleet's 14 years on average. And so I believe there's a lot of value embedded in that fleet that doesn't necessarily flow through on the income statement. It flows through when you sell railcars and you get these gains, but it doesn't flow through on what's remaining on the balance sheet. And that's where I look at the fleet and the return profile of the fleet going forward.
I'm optimistic that it'll continue to improve.
Makes sense. I mean, relative to the book value, asset prices are much higher today.
They are.
Maybe just shifting a little bit to manufacturing, I wanted to touch on the backlog and sort of the pipeline you have in your order pipeline. You currently have about 50% of the industry backlog. Maybe just talk a little bit about the makeup of that backlog and how it's trended. I know it's sort of depressed today, but is it just based on the customer ordering decisions being delayed? And so that's sort of a delayed demand environment, or could the backlog sort of remain under pressure for a certain period of time? In other words, could there only be a certain amount of years that these shippers could hold off on ordering these cars?
When you look at railcar demand and what the driver on new railcar demand, replacement demand is the biggest driver today, especially in a flattish industrial economy with not a lot of growth. And replacement demand is relatively predictable. These railcars have a 50-year statutory life. Their economic life is typically something less than the 50 years. It's predictable, but you can't predict it down to the quarter, down to the calendar year. And so while we know that there's assets that are going to get replaced, each individual owner makes a decision on when they're going to retire that asset and replace it. In the current backdrop that we've already talked about, this uncertainty, you can wait a year or two or a quarter or two. You can't wait five years, but you can wait some period of time.
I don't think that demand is that those orders that are not happening. I don't believe that gets destroyed. I think it continues to just move out to the right, and it's future opportunities, but I feel that's the biggest driver that will, when that starts to come back, that'll be the biggest driver for new car demand.
Just on manufacturing, so you guys' margin target there this year, 5%-6%. Can you talk about sort of where that's been in the past in historical downturns, what the levels are at today versus past downturns, and then maybe where you expect that to trend in a depressed delivery environment next year if that sort of is the base case for you?
I don't like your term depressed, but okay. If you look at these production levels where we're at from a historical perspective, I'm very proud of the margins that we're achieving at this part of the cycle. We've done a lot of work in taking cost out. We've done a lot of cost take outs this year and in the past. We've also continued to invest in technology and automation that will improve our margins. The biggest cause of degradation that we've had in our margins this year has been volume. And that's hard to overcome. We've overcome some of it. But that is the opportunity as well. When the volume does return and it does pick back up, we'll get that coming back. And we'll get that coming back, and we'll also benefit from the things that we've done to take out costs and improve our profile.
So longer term, we have a guide out there, a three-year target of 9%-11% margins. We're probably not in the volume environment that's going to enable that in the near term, but certainly, as volumes recover and get back to more of that replacement level demand, those targets were based on replacement level demand, not a super cycle. I see that as being very achievable.
So, in other words, even if demand sort of shoots over replacement, you could shoot above that sort of.
Volume is a big driver in that, yeah.
Maybe just on the parts business, if an environment does inflect positively, do we feel the parts business impact more in that environment, or is that sort of an enabler already today in the business?
The parts have been a good story for us. We've grown that business a lot. It's an enhancer to our margins. It's still relatively small, but it's growing. And the whole dynamic between our parts business and our maintenance business and our fleet, we continue to get better at that each and every day. And so we have our embedded fleet of 145,000 railcars. We shop most of those railcars in our maintenance network. Our maintenance network utilizes our parts business to help with throughput, to help with having the right parts. We make margin all along the way. And so that is a real returns enhancer for us. We just want to keep growing it.
Maybe just broadly shifting to the capital allocation strategy and your fleet investment, you're sort of on track for your net fleet investment target, $750 million-$1 billion between 2024 and 2026. Could you just discuss the balance between investing in the fleet for growth versus sort of opportunistic secondary market activities, returning capital to shareholders? And then does that change depending on the macro?
Yeah, so you describe it. We have a lot of levers to pull. Generally, we add 30%-40% of what we manufacture to our lease fleet. We want to continue to, if customers want and have demand for railcars on lease, we want to be able to serve that demand. We have several outlets for that demand if it outkicks our appetite for capital investment. The first one we have is our RIV portfolio and those sidecar investors that we have, that 32,000 railcars on our balance sheet or off our balance sheet. Those are investors that want railcar lease returns, and we're able to manage investments for them, put portfolios together, generate fee income. And that is a way we stabilize our balance sheet and kind of manage that capital allocation, so that's a lever that we have. We can also sell in the secondary market.
We can also buy in the secondary market, and we've been very active on both as a buyer and a seller where we see opportunities to create value, whether it's either selling railcars or buying railcars, and buying a railcar and being able to, we may be able to buy a railcar that has a servicing event in a year or two. Others may run from that asset. We don't because we have a maintenance footprint that can handle that, and so we see that more as an opportunity than a risk for us and an opportunity for us to continue to add value, so those are all things that we do. When you get into the broader capital allocation, so we manage our net fleet investment through originations and also syndications and sales, whether it's in the secondary market or RIV partners.
And then we look at what we're going to do with shareholders. And so we want to grow our fleet. We also want to do the right thing for our shareholders. We raised our dividend yesterday. Seventh consecutive year, we've raised our dividend. We raised it $0.01 a share per quarter. So we went from $0.30 a quarter to $0.31 a quarter. And through the third quarter, we bought back approximately $60 million in share repurchases this year. And if you look since 2020, this current management team has been in place. We've been very active in buying back shares. I think we have a very good track record of buying back shares. And we do it when we think the time is right.
All that is, we use capital allocation to manage our way to the average cost of capital because we're a big capital user with our lease fleet. We want to make sure that we have the right cost of capital to compete and to create value. Those are all the levers that we pull to do that.
Maybe just you mentioned the secondary market a little bit, and I wanted to talk about specific car types, if you're seeing any sort of green shoots on specific car types, and then maybe what are the cars that sort of remain challenged, and what are the drivers behind those two?
In a low order environment that we've been in, it's all relative, right? This last quarter, if you look at our deliveries that we had in the quarter, it was certainly trended higher with had a higher mix, especially tank cars. While that is a relatively small number of railcars in the grand scheme of things, in this environment, that mix matters more with the low volumes, and so we continue to see that. Generally, replacement demand is the driver on a lot of that. Some of it's on the chemical side, but generally, that's replacement demand. We're still seeing opportunities in some of the energy space, whether it's with renewables or some of the different basins of domestic crude production. Generally speaking, and then also on the covered hopper side, we still see opportunities there. Overall, the market's been relatively muted from a catalyst.
Replacement demand's the biggest piece of it, and that's kind of across all different car types.
I think you guys have done a good job at sort of taking costs out of the business where you can in the sort of not depressed volume environment, but pressured volume environments, and specifically in SG&A too, you guys have done a lot of work there. As we think going forward to 2026, what are the extra sort of initiatives that you guys are taking or looking at to sort of keep cost in check?
Yeah. So we have taken a significant amount of cost out of the footprint, both on the cost of goods sold side and on the SG&A side that you referenced. This year, it's about $40 million year over year. Some of that is changes in variable compensation, but a lot of that is people and taking costs out. We think we're going to be able to keep that cost out because we keep investing in technology, AI, things like that that are going to keep giving us more operating leverage in the business, whether it's on the shop floor or in the back office. We see opportunities there. And so we really want to take advantage as we add scale and as things improve, that more of that drops to the bottom line.
I wanted to shift. We have five minutes left here, but I wanted to touch on this bigger topic here of potential Class I railroad consolidation. Your thoughts on sort of what's the balance between rails becoming more efficient versus taking share and sort of how that might impact the broader leasing business and then separately manufacturing business?
So first, let me just say it will take several years for that to whatever the outcome is. It's going to take a few years for that to come to fruition. But when you look at the opportunity and you look at the pain points that shippers have, you look at the loss of modal share that the rails have had over the last 20 or so years. Shipping by rail is complicated. And interchange points add friction to that complication. And what we've seen is that when one railroad interchanges with another, even in a PSR environment, it gets worse. And that worse service gives shippers less confidence. Their loads are less predictable, and so it's harder for them to plan their business. And what we've seen on the margin is they have shifted away.
So if you start reversing that and you start reducing the number of interchange points, making it easier to move goods by rail, improving the predictability, improving the service levels, that should give customers an opportunity to add more. We've seen through different surveys that rail shippers want to do more. So that's encouraging. The proof is going to be in the pudding in terms of what happens. If the railroads, if they come together and they focus on improving those service levels, improving the turn times, improving the predictability, it can be very positive for modal share growth and growth for both lease assets and new railcars. It'll come down to what the incentive structure is for the railroads and how they're going to be incented. If they want to grow volumes, it'll be good. If they just price their way to prosperity, it will be less good.
Okay. Sounds like we'll have to wait some time to see anyway, but definitely an interesting topic, I think. Maybe just I wanted to talk about the because the manufacturers have consolidated yourself over the years quite considerably, and leasing, we are starting to see some more consolidation there as well. Curious, after the big competitor announced the deal in the space, how you see that sort of impacting the broader leasing market. Is it better that maybe a financial lessor is taken out of the market, maybe put in the hands of an operating lessor? Is that better for lease rates? Maybe just talk about the broad impact on the industry or if it may not be that big of a change.
I think it gives GHX more scale, more volume, and scale is important. And so from that standpoint, it will help them. The fleets are very complementary. And so I don't know that it really does a lot from a competitive standpoint. To your point on financial versus bank lessor versus more of an operating lessor, certainly different cost of capital profiles. So that'll be interesting to see what happens there. Overall, I think they're a very good operator. And so from that standpoint, I'm not that worried about it. They're a big customer of ours as well. And so we have a very good relationship. So net net, it should be good for us.
Yep. And just to finish up before I give you an extra minute to say some final words, on a recovery scenario, wanted to get to this earlier, you will have to sort of bring back heads and labor in some ways. Maybe talk about the time it takes to bring back labor relative to what you expect for demand. And then can you share sort of what incremental margins look like for you on a recovery in the manufacturing portion?
So we've proven that we can get labor back when we need to. We'll be prudent about how we do it. The longer it takes, the longer the recovery happens, the more risk that puts to bringing that labor back. But that's life. But generally speaking, we've been able to get that labor. Hopefully, we'll need less of it coming back because of some of the things that we're doing now. And so all of that is fine. In terms of the incremental margin, I'll just leave it at I don't know that I can answer that directly, but I'll just say that volume improvements are a big driver and margin improvement. And so that will be a big catalyst. It kind of depends on what it comes back. It's not going to be linear.
Right. That makes sense. Well, it looks like we're pretty much at time, but do you want to say any final words?
I'll just say I talked earlier. Thank you for everybody's time and attention. I just want to, in this environment, people tend to focus on the new manufacturing side a lot, which is fair. But when you really look at our business and where our capital is, I think it's important to look at that lease fleet. I talked about kind of that embedded value in the lease fleet that we're seeing. I think that really speaks well to the opportunities that we have for future value creation in terms of a lease fleet that's 14 years old that you've seen a lot of asset inflation over the last 20 years. You've seen some rental inflation, but I think we would expect to see more. That bodes well for the returns on that business going forward.
Yeah. Well, thanks again for coming. Appreciate your time.
Thank you. Appreciate it.
Thank you.