GATX Corp (GATX) 2006 Q3 法說會逐字稿

Good morning. My name is [Randy], and I will be your conference operator today. At this time, I would like to welcome everyone to the GATX third-quarter earnings conference call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS). Thank you.

Ms. Johnson, you may begin your conference.

Thank you, Randy, and good morning, everyone. Thanks for joining us for our third-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 will provide a brief overview of the highlights in our press release that you reviewed this morning and then I will turn it over to Brian to give you a little more color on the recent announcements regarding our aircraft leasing business. Then we will open up for your questions.

Before we dive into the numbers, I would like to remind you that any forward-looking statement made on this call represents our best judgment as to what may occur in the future. The Company's actually results will depend on a number of competitive and economic factors, some of which may be outside the control of the Company. These factors are detailed in our 2005 Form 10-K(A) filing.

Now, let's review the numbers. Today, we reported net income from continuing operations of 42.6 million or $0.74 per diluted share for the third quarter of 2006, which compares to net income from continuing operations of 31.7 million or $0.57 per diluted share. Year-to-date, we reported net income from continuing operations of 122.8 million or 2.14 per diluted share, compared to 96.2 million or $1.74 per diluted share in the same period and 2005.

As Brian will detail for you in a moment, we signed a definitive agreement to sell the majority of our aircraft leasing business. Together with the sale of 27 previously targeted-for-sale aircraft and our interest in the Pembroke joint venture, this will essentially result in our exit from the aircraft leasing business. Therefore, the segment previously known as Air has been reported as a discontinued operation and all prior periods have been restated to conform with that presentation.

In discontinued operations, we recorded a loss of 54.2 million or $0.87 per diluted share in the third quarter of 2006, which included a write-down related to the sale of approximately 63 million after-tax. This compares to income of 2.6 million in the third quarter of 2005. Year-to-date, we recorded a loss of 46.2 million or $0.75 per diluted share, including a write-down of 69 million after-tax. This compares to income of 1.4 million in the same nine-month period of 2005.

Our third-quarter and first half of 2006 results in continuing operations reflect continued strength in our market. In rail, utilization remained at 99% and we continued to have great success in renewing rail cars with existing customers. The renewal lease rate on a basket of our most common car types improved 19% over the expiring rate, and lease terms were extended to an average of 72 months, a move that is expected to temper future volatility in Rail's financial results. Moreover, we purchased nearly 2000 cars during the third quarter, both new and in the secondary market, and placed an advanced purchase order with ARI for up to a total of 4000 cars beginning in 2008.

Europe continues to post improving financial results and we are beginning to see additional fleet growth opportunities in that market.

Specialty continued to grow lease income and in each of 2005 and 2006 year-to-date had exceptionally strong marketing income. Specialty's 2006 results also reflect, as expected, a slowdown in 2006 joint venture income from the marine portfolio, down from the record levels in 2005 but at levels that continue to generate an outstanding return.

Our Great Lakes shipping operation, ASC, completed its first full quarter of operation following the acquisition of six vessels from Oglebay Norton in early June. All vessels are in full operation in our fleet. ASC continues to see robust demand in its markets and its vessels are fully utilized, and it looks like this will continue to be the case in 2007 as well.

Let me just briefly walk you through earnings guidance. Last quarter, we stated earnings of $3.10 to $3.20 per diluted share on a GAAP basis. This estimate included approximately $0.40 per diluted share from Air, both income and benefit from shedding off depreciation on those Air assets targeted for sale back in December. Removing that $0.40 related to discontinued operations from earnings, our outlook for 2006 continuing operations remains $2.70 to $2.80 per diluted share. This earnings guidance includes approximately $0.25 per diluted share of benefit from tax-related and the previously mentioned affiliate hedge.

We continue to see strong performance at Rail and Specialty. While we see some signs in railcar supply that we are monitoring, demand from our customers remains robust, and we expect that the market environment will remain favorable.

So with that, let me turn it over to Brian for some additional comments on the sale of Air.

Thanks, Rhonda. As she said, I'm going to briefly explain the rationale behind our pending sale of GATX Air. Now, it's on probably an obvious statement, but the reason we are selling our Air business now is because of the value that we will realize from the sale is greater than the value we believe we will realize from continuing to run the business.

Now, in the Air business, we have always had a number of disadvantages versus the leading players in the aircraft leasing business. Those were primarily a lack of scale and a higher cost of capital. Those two factors are important in aircraft leasing because it's very much a commodity business. There's very little in the way of service in those leases.

Now, despite those relative disadvantages, the Air employees actually made pretty good progress the last two years in generating fees, generating management opportunities, turning the portfolio over in an improving market, and lowering costs. That was all in an effort to boost their financial return. They were pretty successful in that effort, and they had transformed GATX Air into more of a service business that was a little was reliant on scale and cost of capital. But despite that progress that they had made, if you looked ahead, our ability to generate fees and management opportunities in the future was uncertain, given the inherent volatility in the aircraft leasing market.

In addition, our relative cost disadvantage, especially when we order new aircraft, makes it difficult to maintain the presence in the market that you really need to develop attractive new opportunities, whether they are fee-based or otherwise, that would help us grow the business profitably.

Lastly and probably most important to me, the ever-present and extreme historical volatility in that business and the resulting effect that we've seen in the past on GATX's efficient access to capital made that business not a great fit for a company like us. Now, conversely, the buyer, in this case Macquarie Aircraft Leasing Limited, they believe they have a scale and cost of capital to grow the business, and they are reflecting that in the price they're going to pay GATX.

So that's the reason we are selling the aircraft business. It leads to a few questions we might as well discuss right now. The first is the question about how we will redeploy the proceeds. As we said in the initial announcement, we will tell you that once the transaction is closed and we actually have the proceeds. I know that's a pretty unsatisfying answer to a lot of people out there right now, but I think, rest assured that, until we can give you the specific details, we are considering the full spectrum of options. All of those options are geared towards balancing the needs of our customers with those of our shareholders and trying to enhance the long-term prospects for the business.

The other question we've been asked is whether the sale is accretive? You know, my best answer is yes, absolutely; it's immediately accretive from an economic perspective. But I also realize that's not what people are really after there. They want to know whether it's accretive from an EPS perspective in 2007. Those of you that know me and know us very well know that this short-term question is not as important to us as the long-term impact of the sale and it really depends on how we redeploy the proceeds. Probably the best example is if we were to take the $500 million that we expect in proceeds and we immediately invested them in railcars, put it out in an attractive lease at a good rate, it would be a great investment from an economic perspective, but it would also be dilutive in 2007 from an accounting perspective because of the way that operating leases account. So, we need to get the answer on how we will eventually redeploy the proceeds, and we will know more about that, we will then know more about the effect on EPS.

I am convinced that the sale of GATX Air is absolutely in the best interest of our shareholders. In the long run, our earnings stream and our access to capital should improve, should demonstrate less volatility. That will help us realize profitable growth in our Rail and Specialty businesses. Those are businesses in which we can compete from a position of strength. So it's really just another step in the execution of the strategy that I laid out in early 2005. That's to focus and grow the businesses in which we have unique understanding of the underlying assets, where we provide valuable service around the asset, and where I think we have a sustainable, competitive advantage.

I am also pleased that we are selling GATX Air to someone that is not only hiring most of our employees but they will ask them to grow the business, and I know that's what they want. So in the end, I believe this transaction will turn out very well for both parties.

Why don't we go ahead and open it to questions.

Randy, I think we are ready to take questions.

(OPERATOR INSTRUCTIONS). Bob Napoli, Piper Jaffray.

A couple of questions. First of all, and I know you're going to give us a lot more detail, I would expect, about what your plans are for the capital when you get the capital, but just with regards to the rating agencies who have you on outlook for upgrade or double upgrade, I believe that they understand that you guys will, at least with part of this money, buy back some stock and that's included in their thinking, or is that not correct?

You know, with the comments we've made, Bob, this is Bob Lyons. The comments we've made to the rating agencies are the same we've made to anybody else, that at the time as we get closer to the actual closure of the sale and have the cash, we will make the determination or the proceeds. But like you, they are fully cognizant of the fact that we are considering everything across the spectrum, but there's nothing in detail.

I mean, it looks like your leverage ratio adjusted for, looking at the pro forma you guys put out would be, if you were able to take all the cash and pay down debt, even taking the off-balance sheet debt, you are at 2-to-1 or just shy of 2-to-1 leverage, which (multiple speakers).

Well, you've got to include the off-balance sheet as well. (multiple speakers) gets you back more into the 2.5 range. But yes, it's sitting at 3.6-to-1 today. Obviously if you redeployed all of that cash back into debt repayment, you would drop your leverage substantially. We are taking into consideration, obviously when we think about the options here, what the right mix would be longer-term. But we haven't made any determination yet at this point.

Yes, we have a target out there, Bob, of an A-, A3 eventually rating, and we're not going to do anything to affect our access to capital. So we will discuss all of the options, but that's the target.

From a reinvestment perspective, I mean you guys have been pretty cautious on investing heavily into the rapidly rising prices of railcars. Although you do start to be seeing some opportunities I think in Europe or better performance in Europe, are there opportunities that you are aware of that you will go after in the railcar sector through acquisition in Europe or the U.S.? What opportunities are there for you to reinvest this capital and generate the kinds of ROEs that you are generating today in your Rail and Specialty businesses?

There are opportunities out there to invest the money. There are probably properties out there for sale. We are not going to overpay for them. Whether there's something out there where we can deploy the entire 500 million right off the bat, I would tend to doubt that just because we're going to maintain our investment discipline.

I've got to say, we have invested $500 million approximately, per year, the last two years in our rail business. I think this year will actually be even better than that. So I'm not really worried about how we're growing assets; I think that's going fine with our current investment discipline. I am not going to focus on trying to blow it out as fast as I can into railcars and pay up in a manner that's not appropriate. But are there investment opportunities out there? Yes, and I think you'll see our investment levels increase this year, by the end of the year.

Thanks. Then last question, I will let others ask questions, on pricing, up a very strong 19%. I mean, I think you're going to have positive pricing comparisons pretty clearly for another six or seven quarters. Is 19% just kind of an unusual number or is that kind of the range we're looking at if prices hold up for the next few quarters?

Well, as you know, Bob, we haven't really pegged any particular, we provide the data every quarter but we don't have a target or put anything out with regards to what we expect. 19 is as high as we've seen at any point since we moved into positive territory back in the middle of 2004. You know, there were a number of cars in that portfolio that rolled over coming off a particularly low rate. So I wouldn't put that out there as the benchmark, but I would agree with your comment that we feel we're going to be in positive territory for a good number of quarters here.

Brian, you talked about increased speculation, I'm sorry, in one of your quotes. Is that something new, or are you seeing, can you talk about seeing some opportunities, but you talk about higher speculation. Can you maybe be a little clearer on (multiple speakers)?

Sure. I mean, if you listened to the last earnings call, there were questions and discussion on last quarter's call about what indicators are we monitoring, beyond economic indicators, to determine where the business is going. We talked about, well, you see a lot of it in the press release and we talked about renewal success and renewal rates and term.

This is another thing that we monitor, and that's the amount of speculation in the market at any one time to figure out if we think we are getting to the peak. So I'm not really trying to sound an alarm here. As you see, the numbers are as strong as they've been and continue to be. It's just that there is, the last quarter or two, there seems to be increased speculation that has led to a few idle cars in some segments of the freight market, specifically aluminum coal cars, small (indiscernible) covered hoppers, some center beams; there are idle cars out there that are relatively, that are either new or recently manufactured.

We are also starting to see some holes in these delivery schedules. They talk about the long manufacturing backlogs, but for instance our guys believe that if we ordered coal cars today, we could get delivery within six months. We've been offered some positions recently for near-term delivery of plastic pellet cars. So it does look like speculation is increasing by some other parties out there. Once again, there has been zero impact on our portfolio. All our cars, for instance on the small cube covered hoppers we speculate as well. All of those cars are placed at higher rates for a long term.

So, once again, we're not trying to sound an alarm here. All of our cars are placed and things are going great. It's just that it is an indicator that we look at, and if you look at what might happen if there were increased speculation as cars were to renew at that [type] of 2007, there could be more competition for it. So it's just another thing that we monitor.

John Hecht, from JMP Securities.

Thanks for taking my question, guys. I guess just diving a little bit more into the renewal rate, can you maybe dissect how much of that 19% was associated with price increases from Q1 versus maybe pricing decreases in the four year ago period? Is there any way for us to figure that out?

Well, we don't really disaggregate, John, as you know, a lot of the detail there for a host of different reasons, including competitive reasons. But the normal rates between Q2 and Q3 do not change materially. It was really, what drove that is cars coming off lower rent from, you know, the comparative rent that they came off of was lower than the comparative rent of cars coming off in Q2. So we did get a nice bump in the back at renewal. We try as much as we can to take mix out of the equation by formulating the basket but it's not, you can't do that with 100% precision, so there's always car types in there that could, a big renewal what have you that might be able to swing things a little bit. But it was a particularly strong quarter.

Yes, I would add some color around that and don't be too swayed by the 19% versus last quarter. It feels the same. I think Bob gave a good answer there. You try to take out volatility by constructing the basket; you can't be entirely successful. It doesn't feel any different.

Okay, so topline demand is to suggest that price stability is intact?

Yes, that's a reasonable, yes, it's a good statement.

Then you guys, you bought a little more, or at least you received a little more this quarter; you scrapped a little less. Can you give us a little bit of color and terms of how much of the purchases were from the secondary versus the primary market, maybe any commentary on what you're seeing out there in terms of opportunities to buy?

Sure. I mean, if you look at the quarter, we did about 1950 cars, as you see in the press release. About 1000 of those were new and about 900 were used, in the secondary market, so you know, kind of half and half there.

Then in terms of the scrap and sold, a little over 500 of that 787 number were scrapped and the remainder was sold. So far this year, we've grown the fleet by almost 1000 cars.

Of that 1000 new, how much was from the '02 forward purchase?

We don't have that broken out specifically.

I will say, qualitatively, the fleet group and the sales group have done an excellent job trying to generate business from existing customers through sale leasebacks on their existing fleets. That's one of the ways you try to use your new car purchases to generate new business opportunities with your customers, and we are starting to see some success there.

Can you guys give us what the ROE in the Rail division was during the quarter?

It would have been approximately 20%, John, 19, 20% on an annualized basis.

Then the last question, I appreciate you guys answering all these. Did you make any investments in the Specialty division during the quarter?

Yes, we did, but it was relatively small. It was about 10 million.

Thanks very much.

K.C. Ambrecht, Millennium.

Both Bob and John asked my questions. Great quarter. Thank you.

Thomas [Glett], UBS Financial.

Fellows, was the retention of the Rolls-Royce partnership purposeful on your part or did it not fit in what Macquarie wanted?

Very purposeful on our part, Tom. That has been a very strong investment for us. It's one that's managed by the Rolls-Royce teams.

So we are just passive on that?

Well, we obviously participate in the management of the board activity of the business, but really the day-to-day business is run by Rolls-Royce. They have done an excellent job, built a portfolio. It's been a great investment for us; it's one that we can retain and fold into Specialty. It fits the profile of what we like, long-lived assets with a very strong asset expertise with a knowledge partner.

And a service component.

And a service component. It fits everything, the profile of everything we like to invest in. So that was one that, there would be any number of interested buyers for that business, but it's one that we've opted to retain.

Therefore also will absorb maybe some capital along the way at good returns going forward?

It really would depend on, it is a strong cash flow generating venture right now, self-funded. Absent any significant development there, I would say it would continue to self-fund.

Number two, how worried are you about the sluggishness in the chemical shipments year-to-date? Does that pose a danger for '07 or not? What's your take on that?

Well, actually it's (multiple speakers) we talked about that over the last year. I mean, high energy prices have been killing them. Actually, you see some of the announcements in the third quarter, it looks like it has improved a little bit. Especially I think in particular I saw DuPont had some nice earnings. But as far as how it affects our business with their higher fuel costs and Chinese imports and all that, I mean there is some insulation there. The cars that we have for chemical customers, first of all, they are leased for a term. Generally in this market, they've been reluctant to let those cars go when they come up for renewal because, given the manufacturing backlog, they may not see those cars again because they can't get ahold of other cars. Another mitigating factor is, even if they did return cars, generally we've been pretty able to place them into other types of service. So there's a lot of mitigating factors there. So far, it has been pretty strong.

If you look at the change like quarter-over-quarter, it was down 2.5% in the second quarter, but it actually rebounded a little in the third.

I guess what I'm really asking is, is there a linkage there when that number turns up and when you guys would probably commit more capital for railcar orders?

I don't think there's going to be a direct link there. I mean, there's so many other things that figure into that investment decision and it starts with the cost of the car, actually.

Right.

The third question I have was just a general question. Bob used to put out this thing that showed the railcar, tank railcar business especially, as being a rational oligopoly between you and Union Tank Car and I believe GE Credit. Is there any threat to that conceptual viewpoint in your opinion?

Well, we still provide that data on our Web site, Tom. The market share data is still out there.

I meant going forward, though. Is there any threat to that?

Well the pie chart has moved around a little bit. The Big Three players are still the same. Trinity has become a bigger lessor, on top of being a manufacturer, so they have built their lease fleet, so we have seen some increased activity, but in terms of any significant one or two player, I would say no.

Right. As an add-on question to that, does it bother you that one of your suppliers, Trinity, is also now becoming a bigger factor in the lease market alongside you?

Yes.

(LAUGHTER). Thank you!

[Brian Saltokoff], Banc of America.

Hello? We can move onto the next question then.

Art Hatfield, Morgan Keegan.

Good morning, everyone. This is Logan in for Art. Most of my questions have been answered. But just real quickly, on the hedging gain or benefit on the rail side, can you go over exactly what they are hedging? Is that kind of a normal activity that just kind of swung in your favor this quarter?

In terms of, first of all, we own 37.5% of a European freight car leasing company called AAE. It has been a very successful investment for us; we've held it for many, many years. As part of their ongoing financing activity, they routinely enter into interest-rate cap blocks, etc., just in the ordinary course of business. This situation was, I would say, a bit unusual as the hedge they have in place doesn't qualify for hedge accounting. It could have easily have gone the other way, depending on where interest rates went. So we felt it was appropriate to break it out. But it's not, we are not in the business of trying to generate hedge gains. So, it's unusual and that's the reason we break it out and don't view it really as kind of a normalized income.

Great, that's helpful. Then, secondly, on the Specialty side, you obviously moved the JV over to the engine-leasing JV. Were there any other moving parts there? Were there aircraft that you retained, did they move over, or have they, where are they now, or where they always in Specialty?

They were always in Specialty. We just showed them in the Air updates that we used to put out because we wanted you to get the full spectrum of our Air portfolio. So, they've always been included in Specialty and in the share affiliate's earnings.

Great. Then my last question, guys, looking at your guidance of 2.70 to 2.80 and then based on the 2.14 for the first nine months, the midpoint of that guidance is a good bit below what you did this quarter and even backing out some of the gains or some of the benefits from the hedging. Is there anything we are missing here or is this just taking a conservative approach to the fourth quarter?

No. If you look at our remarketing income in the quarter, we had a significant amount, you know, 7.5, 1 million, about half of that from Rail and half from Specialty. Neither group is anticipating any material remarketing in the fourth quarter. So, that's what gets you to the difference.

Bob Napoli, Piper Jaffray.

On the Specialty business, can you, what is the effect of the Rolls-Royce business? How much did that add to earnings? Is that a predictable revenue and earnings stream?

It's relatively predictable and it's basically, if you look at the share of affiliate earnings line for the third quarter, it's about $4 million added there. That's a pretty average revenue stream for them. Occasionally, you may have bumps up if they were to have any remarketing of engines or anything like that.

They only point I would add there, Bob, is another attractive element of Rolls-Royce is that it has been a very consistent performer, even straight through 9-11. So, they have continued, they don't have the volatility at nearly of the aircraft leasing business, so we anticipate they will continue to be a very solid and consistent contributor on a go-forward basis. (multiple speakers)

Great. That 4 million essentially drops right to the bottom line, right?

That's correct. On an after-tax basis, that would be correct.

On an after-tax basis?

Well, that's 4 million pretax.

Okay, yes.

Correct.

Right, okay.

But not that we don't absorb some SG&A, Bob, to manage that business. But it's not a significant number.

I think, in Europe, you had said, I think you said last quarter that the European railcar business had price increases for the first time in a while last quarter. Did I hear that correctly? What is the, what earnings do you generate out of Europe and your railcar business? What is the outlook for that business?

We don't break out the European earnings. It is a significant contributor to Rail's worldwide income. I guess, as we get rid of Air, we will take a relook at all of our segments and that may change, but right now, we do not break that out for segment purposes.

As far as price increases, I think they've realized pretty good increases on new cars, less so on the existing fleet. I know they are trying to work on that. It's a little, there's seems to be a little different business model than in the States, where when new car prices rise, new car rates rise; the existing fleet rises with it. That hasn't been the case historically as much in Europe. I know they are concentrating on that. What I said in the second quarter was their investment level and the attractiveness of certain investments, especially in the mineral oil and LPG markets, have increased over the last year. So if I said comparatively speaking to the U.S., in general we are seeing better spread-type investments materializing in Europe right now on a relative basis.

Okay. My last question would be I guess on Air. When you sold off Air, when you made (indiscernible) and it seems to make a lot of sense, but it does, and I did wonder. You have a company called Air Lease I guess out there that's trading at over 2 times book value. Did you look at possibly, I'm sorry, Air Castle spinning off the Air business into kind of the structure that Air Castle has? It seems like that might have brought a lot more value to shareholders than selling the business outright.

We looked at every alternative for the Air business and this one we thought was, by far, the most attractive. I believe we have somebody here that actually paid for the platform, and most of the other transactions out there I don't believe that has been done, as opposed to a pure asset valuation.

Okay, thanks.

Kent Mortensen, Thrivent Asset Management.

Good morning. Just following up on Bob's question on Europe, what can you talk at least a little bit about utilization trends in Europe?

Yes. On the tankcar fleet in Europe, which is what we own outright in Europe, the utilization is approximately 94% right now. In our freight car business that we refer to, where we own 37.5% of, I believe utilization is closer to 97%, so both very highly utilized, not as much as in the States but the trend has been good.

What were those last quarter, just for a comparison?

There wouldn't have been any material change from the past quarter, but if you went back, you know, maybe a year or 18 months ago, you would see, on the tankcar side, that number marching up very nicely and materially to the 94% it's at right now.

As our Polish fleet has been integrated and is taking on more of a Western business model, the utilization has improved. We've gotten rid of some cars that we didn't like, and so yes, it has improved on the tankcar side. The freight car side has been strong for quite some time.

Okay, fair enough. Just kind of a broader question and it's really for me really not understanding the business probably as well as I should, but I've been hearing that the rails have been spending a lot on CapEx, but it has been mainly on kind of rail line improvement versus rolling stock and they've actually been decreasing their CapEx on rolling stock. Is that basically a strategy on their part to kind of improve returns and really turn over the ownership of leasing stock to people, or to rolling stock to people like you, or is it just improved utilization on their part? Is that (multiple speakers)?

I just think it's where their capital is best spent right now is improving their infrastructure because it has been stressed. (multiple speakers) that is correct.

So that's a positive trend for you, really, I would think.

It should be.

There could be some nice opportunities there.

In terms of acquiring assets from them, potentially?

Potentially, but really it's more of kind of a longer-term trend.

Remember, on the tankcar side, rails own virtually no tank cars.

Okay, fair enough. Great. Thank you.

(OPERATOR INSTRUCTIONS). [Brian Saltokoff], Banc of America.

Sorry about earlier; I had stepped away. Of the $80 million equity hit that you had anticipated in the September 28 8-K, how much of that has been booked in Q3?

Virtually all of that has been booked in Q3. Obviously, as we get to closing, there could still be some movement around that number, but by and large, what has been booked has been booked.

Thanks.

At this time, we have no further questions.

Okay, thanks, everyone. We will talk to you again next quarter. I am available all day if you have any additional questions.

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