GATX Corp (GATX) 2005 Q2 法說會逐字稿

Good morning. My name is [Sarah] and I will be your conference facilitator today. At this time, I would like to welcome everyone to the GATX second quarter conference call. [OPERATOR INSTRUCTIONS. Ms. Johnson, you may begin your conference.

Thank you, Sarah, and good everyone, and thank you for joining our second quarter conference call. With me today are Brian Kenney, President and CEO of GATX Corporation, and Bob Lyons, Vice President and Chief Financial Officer. I'll provide you with a brief overview of the numbers, which were presented in our press release this morning, and Bob will offer some additional color on our outlook. Then we'll open it up for your questions.

Before we begin, I'd like to draw everyone's attention to the forward-looking statement contained in our press release. The factors outlined in that statement also pertain to today's call. Today we recorded second quarter net income from continuing operations of $34.5 million, or $0.62 per diluted share, compared to second quarter net income in 2004 of $19.7 million, or $0.38 per diluted share.

Net income from counting operations for the first six months of 2005 was $62.9 million, or $1.14 per diluted share, compared to $39.4 million, or $0.06 per diluted share, in the prior year. As we note noted in the release, the 2005 second quarter and year-to-date net income includes $0.12 per diluted share after tax of expenses associated with liability management, which is consistent with what we outlined in our first quarter release and call.

As you can see in our second quarter results, positions in the markets we serve are increasingly positive and in many cases are exceeding our expectations from earlier in the year, particularly in rail and marine. In rail, the demand for rail cars across the board has strengthened, and renewal rates on the basket of our most common car types increased for the fifth quarter in succession. Lease renewal rates in the second quarter were 15% higher than the expiring lease rate, up from a 9% increase in the first quarter and a 3% increase for the year in 2004. Utilization on the fleet remained at 98%, reflective of a robust rail market.

Air broke even in the second quarter of 2005 and results for both the quarter and the year-to-date included a pre-tax operating lease expense of $4.8 million related to the restructuring of the lease with the bankrupt airline, ATA. The Air portfolio is essentially100% utilized, and lease rates on most aircraft types continue to recover. Rates were rolling into our fleet as we complete our renewals for 2005 and begin our 2006 renewal tasks.

Results in specialty finance were again strong and primarily driven by continued positive performance from the marine joint ventures and a larger marketing gain form the managed portfolio. Higher than anticipated utilization in charter rates and shipping have boosted results in our marine joint ventures and contributed significantly to our overall net income. Investment volume for the quarter and for the year-to-date was below 2004's very strong levels. We invested $94.2 million in the second quarter this year, compared to$264.5 until in 2004.

In the second quarter the of 2004 we took delivery of three new aircraft, which accounts for nearly $100 million of the difference between the investment volume year-over-year. In rail we acquired more than 1,200 cars during the second quarter of 2005, down from 2,500 in the second quarter of 2004. New car prices have remained very high, indicative of the strong market but making purchases in the spot market fairly unattractive. We're maintaining a very disciplined approach to investing in this market, something that Bob and Brian can comment on further during the Q&A.

Portfolio quality remains high with $1 million in net charge asset impairments in the second quarter and non-performing investments in a manageable level. Overall, we feel very positive about our markets through the balance of the year, and to give more color behind our outlook I'll turn it over to Bob before we got your questions.

Thank you, Rhonda, and good morning everybody. Given the change in the outlook I thought it would be helpful to provide some additional commentary on that topic. In discussing where our earnings outlook is today, it's helpful to revisit where we were coming into the year. I'll focus on the business units, because as many of you will recall, there were a number of large, positive items unique to 2004 that flowed through our income statement at the corporate and other line.

Back in January we outlined the following earnings outlook: in 2004 we earned $60 million in rail, and based on positive trends we expected rail's income to improve in 2005; in air we earned approximately $10 million in 2004, and we expected the '05 earnings to be in the same range; in 2004 specialty had a very strong year with $41 million in net income, and we did not expect to achieve this level again in '05 so we were looking for a decrease in specialty.

The combination of these factors combined with some cost improvements at the corporal level resulted in our $1.60 to $1.70 EPS estimate with a $0.10 per share tax benefit. So what's changed to result in the outlook, EPS outlook, of $1.90 to $2.00, in that range. Our outlook for air is unchanged so let's talk about rail and specialty. First, we entered the year expecting improved income at rail. While we did enter the year expecting improvement in rail, the performance has exceeded our expectations and the outlook for the balance of the year is positive. Rates have improved nicely as Rhonda has mentioned, but in reality we expected that coming into the year as the underlying market was gaining momentum.

The real change in rail has been driven by the expense line; namely, maintenance expense. Through the first half of the year, maintenance expense has come in well under our expectations. Some of that will reverse in the second half of the year as we undertake more car conversions, but the base maintenance expense from the cars we see and we work on every day has been lower than anticipated. And why is that?

Well, when cars come up for lease renewal we assume that a large percentage of these cars, say 65-70%, will stay in the hands of existing customers. The balance of the cars are assigned to a new customer, and often these cars go into a shop before being delivered. That's what we refer to as fleet churn. In 2005, market demand is so strong that more customers than expected are holding onto cars and we're not seeing nearly as much fleet churn. This cuts down on the number of cars going through our shops and holds maintenance expense in check. That's a positive for GATX and one that's been stronger than we anticipated. As a result, while we expected rail to post stronger income in '05 than '04, the level of improvement is above our original expectations.

The other major factor driving our improved outlook -- earnings outlook, is specialty. You'll recall from my earlier comments that coming into the year we expected specialty's net income to be below '04s $41 million. Based on a very strong performance through the first six months of the year, we now expect specialty will exceed their '04 income levels. This is driven mainly by marine income, and this can best be tracked by looking at specialty's share of affiliate income line on the segment income statement, as marine is the main driver of this line.

We have a number of marine JVs that have performed very well for us, primarily due to high levels of demand and charter rates as Rhonda had mentioned. This was the case in '04 and we expected solid, but gradually declining income contributions from marine in '05. In fact, through the first six months of '05 our income from marine has actually strengthened. Year-to-date our share of affiliate income at specialty, again, driven mostly by marine, is $22 million. That matches the full year level of income from 2004. So overall within specialty, we have gone from what we thought would be a negative income variance in '05 versus '04 to an expected positive variance.

One final point I'll add on our results is that while we had a strong six months in terms of marketing income, we're only marginally ahead of where we were in 2004 at this point in terms of gain. So when you look at why we have surpassed '04 year-to-date results by such a wide margin and why we expect '05 results to exceed our earlier expectations, it's due primarily to the fundamental demand, day in, day out, for our assets. That's encouraging and bodes well for us going forward.

In summary, we entered the year feeling positive about our markets particularly in rail, where we were gathering momentum. That optimism and our operating fundamentals continues today and we're looking forward to the second half of the year. With that, let's go Q&A.

[OPERATOR INSTRUCTIONS]. Your first question comes from [Tom Kleb] with UBS Financial Services.

Hi Rhonda, Bob, Brian.

Good morning.

The question is with the lower SG&A. and the head count reduced, can the company get 20 or 30 cents -- 20 or 30% bigger in the same head count? Is this a kind of a constant thing, that we can be a bigger company and really not increase the head count or the SG&A expense from here?

Yes, I feel that we can have a lot of growth without substantially increasing our costs. Yes, I believe it's in place.

Okay. And the second question I had, when we go to the remarketing income is that [inaudible] generous just for specialty finance? In other words, with the higher scrappage in rail cars, assuming they sold above their stated book value, is there a remarketing income category there that would just be in the rail earnings or how do you treat that?

The scrap income is actually in the other income line, Tom.

Right.

So, there is a small amount of scrap in there, about $3 million in the quarter for the first -- sorry, second quarter of 2005, and that's down a little bit from last year when scrap prices were a little bit higher and we were scrapping more aggressively.

And the last question I have is the -- going forward, this lull in the reinvestment is rail cars, is it likely to continue for another quarter or two? In other words, finding lease opportunities for new cars or our secondary market cars?

I don't really feel like it's a lull. The comment in the press release is really to more of a global statement that asset prices have risen sharply across our markets, especially in rail and marine. And as we said in rail before, if you look at car costs from two years ago versus today, due to the price of steel, due to the prices, due to manufacturing backlog, they have increased, substantially, as much as 30, 40% or more. So all we're saying is fortunately, we have our CPP program, committed purchase program, that gives us a very advantage car cost for our baseline car needs.

But what we're seeing now is car demand is so high, that even our best customers are asking for more beyond the committed purchase program. So we're being careful about that, as far as that is 30, 40 year asset, and if you buy it wrong you can't recover. So we will fill our customers' needs, our best customers' needs, we'll strategically protect our position. So we will do some spot purchases. We're just saying we're going to be careful about that. I don't think it's really a lull. I mean, last year we invested half a million dollars in rail; this year we have a similar target and we're going to try to get there. So we're adding a lot to rail. It's just that I really to want drive the discipline home about not participating in an irrational market, and so we're just being careful about how we invest.

Is it a fair assumption to make, Brian, that the replacement value of the total rail portfolio is probably substantially greater than they're on the sheet for at this point?

I think that's a fair assessment, but it's also nothing that I think -- you can't bet on that being a long-term phenomena as far as the manufacturing backlog and the very high price of steel and the unavailability of components. That's the point we're trying to make here. So as you look out for a thirty year asset in a very high car cost today, you have to make some pretty aggressive assumptions on renewal rates after that first lease to justify it.

So yes, if you market to market it would probably be lot higher today, but making that assumption on a thirty year purchase can be a little dangerous. So like I said, we have the committed purchase program, we have a lot of cars delivered, we are doing spot market purchases, we're just trying to do that more strategically.

The only reason I brought it up, Brian, was because is there a leading indicator that lease rates will continue to pressure upwards, the theory being that we're going to get higher lease rates based on replacement value rather than what they're on the sheet for.

Yes, I mean that's a good point. The price of steel, high price of steel, high priced components, that eventually has to show up in lease rates. Lease rates are up substantially, renewal rates are up substantially; the price of steel and the price of components has to be contributing to that although it is hard to identify how much. And so yes, we don't see lease rates trending down yet. We don't even see them leveling off at this point. And even if it did, we'd still have revenue increases over the next couple of years as we renew lower rate leases from years before, so it's a pretty attractive revenue forecast right now.

I think that's an important point to make because we haven't had the opportunity yet and we will over the course of the next couple years to reprice cars that were really done at the depth. So if spot prices didn't increase from where they are at today, which we think they will continue to trend up a bit, but even if they didn't we'd still been in a positive revenue variance.

By the way, is it also true that the return on investment therefore on older cars is at least as good or greater than on newer cars?

It's a good question because what you're seeing us do more over the last year is focus on those secondary markets, used car purchases, because at least until recently prices on those type of cars hadn't caught up to the new car prices. So, yes, in a lot of cases we see better return on secondary market used cars.

Thank you very much.

Your next question comes from [Bob Napoli] with Piper Jaffray.

Good morning and congratulations. The other side of the cycle is clearly upon us. With regards to the pricing outlook, the pricing improvements, I mean, obviously, I would guess that we're not going to see the same kind of delta from quarter to quarter that you did this quarter. But as you start, when do we hit the depths, when do the cars -- are we -- how many quarters are we from the lowest of the low prices, I guess, on rail cars?

Well, the market really went into its low point in late '02 and into '03. And so if you kind of layer on top of that, the rollover of our fleet with about -- call it 25% of the-- 20-25% of the fleet reeling over each year, we haven't gotten to those cars yet. And while we did try to manage term effectively during that period to stay somewhat shorter on the best equipment at the depth of the market, our customers are very smart and so they were trying to push the other way. So we were able to bring term down a little bit during that period. It wasn't by an awful lot.

So the average term on those, Bob, would be like four years? A little shy of four years?

Right.

Okay. So you still have until the end of '06 then, the pricing gap then should continue to improve?

Well, it's not an exact science, but, yes, it should continue to improve. As I said before, if spot rates don't move from where they are at today, which we don't think will be the case, we do I think they're going to continue to trend up. But if they didn't we would still have a positive revenue, we believe, variance here going forward, for quite sometime.

Yes Okay. Now that didn't show up -- if you look at the least income in rail it didn't show up -- the revenue didn't go up that much, quarter other quarter. I guess, I mean, should we see a jump in that lease income number next quarter then?

Well, if you look year-over-year, lease income is up, over $25 million.

Yes, that's true.

When you factor out -- we bought LLP at the end of last year. So if you look at least income, it's up close to $40 million. A portion of that is attributable to the locomotive fleet. If you back that out, we're still north of $25 million in lease income. That's a very big number.

Okay. That's fair point. With regards to air, you prominently displayed in your press release that air prices are improving. Income, I guess, is improved, ex the charge but kind of stable. What is the outlook for the air business?

I think the -- we didn't change our outlook for full year on air from an income perspective --

Right.

-- so we're --

And that includes the hit, I guess, that you took?

-- correct, that's right. And we had similar -- we had some impairments last year as well. So we're feeling a bit better about where the air market is today. There are still some credit events but they appear to be less intense, and we have alternatives for those aircraft when we do run into a carrier that has difficulty. Rates on the best equipment continue to trend up, but just given the status of many of the carriers in the industry, around the globe, much more so here in the U.S. than outside of the U.S., but we still remain a bit cautious on the overall fundamentals of the business.

Where is the pricing today versus -- the pricing on new leases today versus maybe -- I don't know how you look at it -- the average price of your portfolio or the aircraft that are repricing over the next two years?

Well, it's a bit tougher to do in air, Bob, because in rail, where we have 20 to 25,000 repricing events a year, in air we only have maybe 15, and the aircraft are very unique depending on where they are in their cycle times and other factors. But we have seen lease rate's on the best equipment, when you adjust for floating interest rates, up 10% or more from just where they were a year ago.

Okay. Ten percent from a year ago but from the trough, that's, like, 20%?

Yes, that or more.

Okay. With regards to the affiliate earnings, a big number this quarter and you talked about it. Is that a -- I mean, is that -- is there anything unusual in the affiliate earnings number or what's kind of a run rate? Can you look at that as a run rate, give us a feel for a run rate in the affiliate earnings?

Well, the affiliate earnings, if we are just talking about specialty, there wasn't anything unusual in there. They did $9 million in the first quarter in affiliate income, 12 in the second. As I said, we thought it would kind of level off; it actually improved in the second quarter and it looks pretty solid through the balance of the year. In rail they did have -- within one of our joint ventures at Southern Capital they did have a gain on some locomotives that were sold there, so that boosted the second quarter number by a few million, but I would look at those two separately. Air, typically, has more of a run rate and specialty, now that is primarily marine, also should be as well.

The air number, the 11.8, does that include any of the management fees? Is there any management fee income or anything like that in there?

No.

Is that a run rate number, the 11.8?

That number also includes a couple of engine sales at our Rolls Royce joint venture, so it's a couple million as well.

And then on the growth side, I guess, now, the challenge -- and you guys are being very -- obviously, you could grow if you wanted to, you could just go out and buy assets but you're being disciplined. But I just wondered what your thoughts are on asset growth. I mean, you do have a lot of built in earnings -- without asset growth over the next, it sounds like, maybe, through '06. But, clearly, you want to grow assets at a reasonable pace. What is -- when would you expect to start seeing some growth in your assets?

I would divide it by the markets that we operate in.

Right.

Rail, I think you saw close to 10% asset growth last year. This year we have a similar total dollar target, I'm not quite sure what the percentage is. So rail we're going aggressively. Air -- and the reason I don't want to comment on the combined entity is because air, that's not the objective there. I mean, the objective there is to manage more assets and decrease our balance sheet exposure. So although we want to be very active the market in buying and selling and managing aircraft, we want to do it for others so you won't see asset growth there.

In specialty, we are investing, we're investing in marine, for instance, and we're being very disciplined about what we're investing there. So I think what you will see there is the curtailment and the run off you've seen over the last couple years, you'll see that reversed and head in the other direction, here, if we're successful. But even looking -- let's look over the long-term. The type of markets we operate in we're not going to be telling people we're going to grow at 15% a year. That's where you get yourself in trouble. It's mid-single digits, or better, type of growth over the long-term.

Numbers question. Do you have managed assets by sector at the end of the quarter?

Yes. The managed portfolio we've got aircraft is about 26% of the portfolio, marine is 3%, power is 32%, rail is 23%, real estate is 15%, and other is 1%. And that portfolio size is about $675 million.

I'm sorry, I meant for the overall, for the overall company. I'm sorry, I could get that off line, the $6.5 billion in managed assets.

Yes, we'll actually, we can post that up to the website.

Great.

We do have all that back up.

Thank you.

[OPERATOR INSTRUCTIONS]. Your next question comes from [David Rosen] with Green River.

Hi, guys. Just a couple quick questions related to some of the numbers that you had just given earlier on, the specialty, but unfortunately I didn't catch them. But quickly, the share of affiliates earnings in specialty, that's primarily marine?

Yes.

So in your other you have $40 million in marine operating revenues, so you have your marine split between specialty and other?

Yes, in other it reflects our American steam ship company, which is the Great Lakes shipping operation.

Okay. So -- okay. And then of the 675 you said, could you give me that split one more time?

That's on our specialty managed portfolio where GATX doesn't have any ownership interest in the assets; we manage it for third-party owners.

Okay.

The aircraft is 26%, marine is 3%, power is 32%, rail is 23%, real estate 15%, and other is 1%.

Okay. And if I am looking at the 675, where is -- is that revenue stream, that $34 million from specialty in this quarter? Is that --

You would see this -- this would be reflected in asset remarketing income. Whenever we have -- and whenever one of the owners of one of these assets wanted to sell something out of the portfolio you would probably see that appear in asset remarketing income as residual sharing fee. And then where else you would see it would be in the fees line, and that would be for the ongoing management of that portfolio.

What kind of fees do you get from management on average? Is it like 1% of total assets?

First of all, we don't talk about that number publicly, there's not -- for a host of reasons, but I would say it varies contract by contract. There's ten or so portfolios that that we manage. And what I would also add, too, is the fee income is really not the main driver for doing managed portfolios. We collect a fee. We charge a fee to cover our SG&A. But, really, the upside for us when there's an event within one of those portfolios where an asset is sold or a transaction takes place; very similar to what happened this quarter with the $12.8 million fee we generated within specialty from the managed portfolio.

So that 12.8, it's actually not on an asset that you own?

Correct.

So how much in assets under specialty, I guess, excluding -- maybe including marine and then other do you currently still own?

Our own portfolio is around $444 million.

That's $444 under specialty. And how much of that $444 million is marine?

Thirty-nine percent.

Okay. And just again, to validate that, that 39% of that marine, 100% of that shows up in your share of affiliate earnings?

Yes.

Okay. Thank you very much.

Sure.

You have a follow-up question from Bob Napoli with Piper Jaffray.

Question on the -- your return on equity was -- I think there was some unusual items in an unusually strong quarter. But you're targeting -- I guess -- what would be the return on equity target? I think you had mentioned a 1.15% and when do you think you can get there? You could actually kind of hit it this quarter, but when is sustainable 15% ROE --

And that's the question, you have to pull out all the non-operating income over the last year. That's a 12 month trailing number. So yes, that's why that is so high. If you pull out the non-operating income it's less than half of that. The target, you're right; the target is 13-15%. How fast we can get there is how fast we can fix the air business. The air business still is returning 2 or 3%. And we've discussed our strategy around that of managing more assets and participating in the market recovery. So that's the question is how fast we can get there, but the target is 13 to 15%. I don't think it's unattainable. I don't have it out there for the [expletive] of it, I mean, we're going to get there.

With regards to the converts, when are they -- are they callable? Or when can you force conversion of those converts?

Well, there's two converts in '02 and in '03. The first one is really an '08 event. What I'd also add on those is we're getting a pretty nice yield on those right now.

Getting what?

We're getting a pretty nice yield on those right now.

Yes.

So to the extent whether they're [inaudible] or not, you'd have to get inside the head of a convertible holder.

Right. Yes. Okay. I mean those -- I mean they are both in the money, I guess, as we speak.

Yes. The '02 is a 3409, the '03 is a 2423. The '03, obviously, is puttable in '08; 13 and 18. '08 for cash, and 13 or 18 for cash or stock.

Okay. And with the earnings ramping up the way they are do you have any thoughts on your dividend or is that something you have any thoughts of bringing back up or do you like building capital?

Well, as we've -- the dividend is obviously a Board decision. I can't speak for the Board. But from general comments on that, they review that policy in conjunction with a number of other strategies we have in place or trying to implement to ensure that we have solid financial position and we can grow in the markets we're in and provide an attractive, risk-adjusted return at the same time. So in short that decision is not one that is really made in isolation. Right now our primary objective, as you know, is to strengthen the financial base and prove our credit profile and continue to grow in our core markets. And we think to the extent that we can move our credit rating up, the long-term benefits to GATX and the shareholders are very, very positive. So that's the primary focus right now, and any change in the capital policy would be made in that light.

That said, we did indicate back in '04 when it was dividend was reset at $0.80 per share annually that we would certainly consider in the future increasing the dividend to the extent it was warranted by financial performance and was consistent with the objectives. So I can't add too much more to that right now, but I would say that we understand the importance of the dividend to the shareholders; I think that's clear by the fact we've paid it every quarter since 1919. Not too many companies can make that statement. And the Board will continue it look at it regularly.

Thanks.

[OPERATOR INSTRUCTIONS]. Your next question comes from [Jiping Lee with Tenor Capital Management].

Hi. I have a two questions, one related to the dividends. What's your target pay-out ratio?

Well, when we reset the dividend back in January of '04 we said, historically, GATX has paid out -- if you'd looked at the 40-year prior period -- just over 50% of it's income. And that was a range that -- somewhere in that range was where we felt comfortable given the markets we're in, that we could generate -- continue to generate sufficient equity capital to adequately grow the business going forward.

Okay.

But we don't make changes to the dividend quarterly; it's something we think very long and hard about.

Can I ask about your convert? Someone asked that question earlier. You have a 2007 convert which is 7.5% coupon, which is a very high coupon considering where your credit rating is. I was just wondering has the company considered to retire that convert earlier?

We can't retire it earlier. Has the company considered doing some transaction with holders to potentially refinance or early retire that convert? Our focus on refinancing has been primarily on secured and unsecured debt that we've taken care of here over the course of the past year. To look at the convert is a different analysis and a pretty expensive and uneconomic one right now.

Okay. Thanks.

You have a follow-up question from Tom Kleb with UBS Financial Services.

Brian, one last question. And I know I harp on this it seems like each quarter, but basically give us your sense of the aircraft leasing coming out of the trough. I mean, is it possible that GATX, we could go through the whole recovery and not increase the air portfolio? Give me some take on your side because you were with American and you know the whole thing, obviously.

I was disappointed you didn't ask me the question.

Yes, that's why I asked it, I guessed that.

The market is recovering. Bob talked about lease rates coming up and I've talked about wanting to lessen it as a percentage of our overall asset base. But once again, I don't want to confuse that with not growing the portfolio or the earnings space. We do want to participate in the market, buy aircraft, sell aircraft, manage aircraft. And actually, the air group has had, for a change in strategy, some pretty impressive results just in the first six months. They brought on two major initiatives in the second quarter; one to sell aircraft and one to manage aircraft into a troubled carrier. So they are responding pretty well.

Right.

We just don't want to grow our balance sheet. So I mean, I'm looking at growing -- I look at growing the business a different way; I'm just looking at not using our balance sheet, but we do want to get bigger and we do want to manage more assets. And I see them responding.

Okay. Thank you.

At this time, there are no further questions.

Thank you, Sara, and thanks everyone for participating. Bob, Brian, and I are around for the rest of the afternoon if you have any follow-up questions. Thanks.

This concludes today's GATX second quarter earnings conference call. You may now disconnect.