Textainer Group Holdings Ltd (TGH) 2017 Q4 法說會逐字稿

Welcome to the Q4 2017 Textainer Group Holdings Limited Earnings Conference Call. My name is Christine, and I will be your operator for today's call. (Operator Instructions) Please note that this conference is being recorded.

I will now turn the call over to Executive Vice President and Chief Financial Officer, Hilliard Terry. Mr. Terry, you may begin.

Thank you, and welcome to Textainer's 2017 Fourth Quarter Conference Call. Joining me on this morning's call are Phil Brewer, Textainer's President and Chief Executive Officer. And at the end of our prepared remarks, Olivier Ghesquiere, Executive Vice President of Leasing, will join us for the Q&A.

Before I turn the call over to Phil, I'd like to point out that this conference call contains forward-looking statements in accordance with U.S. securities laws. These statements involve risks and uncertainties, are only predictions and may differ materially from actual future events or results. Finally, the company's views, estimates, plans and outlook, as described within this call, may change after this discussion. The company is under no obligation to modify or update any or all of the statements that are made. Please see the company's Annual Report on Form 20-F for the year ended December 31, 2016, filed with the Securities and Exchange Commission on March 27, 2017, and going forward, any subsequent quarterly filings on Form 6-K for additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements.

I would also like to point out that during this call, we will discuss non-GAAP financial measures. As such measures are not prepared in accordance with generally accepted accounting principles, a reconciliation of the non-GAAP financial measure to the most directly comparable GAAP measure will be provided either on this conference call or can be found in today's earnings press release.

This quarter, we've also included slides to accompany our commentary on today's call. The Q4 earning call presentation can be found on our IR website next to the link for this webcast.

At this point, I would now like to turn the call over to Phil for his opening comments.

Thank you, Hilliard. I would like to welcome you to Textainer's Fourth Quarter 2017 Earnings Call. We are excited about the continued progress reflected in this quarter's results.

Before I talk specifically about our results, I would like to put 2017 in perspective. We expected headwinds in 2017 due to the decline in container prices during 2016 and the bankruptcy of Hanjin. And while it was a challenging year, we overcame the challenges and are very pleased with our fourth quarter and full year financial results as well as our prospects for 2018.

Lease rental income increased 3.7% to $116.3 million compared to the third quarter. Lease rental income increased each quarter during 2017. Indeed, quarterly lease rental income was up 9% on a year-to-year basis. Lease rental income for the year was $444.9 million. After posting losses for the first 2 quarters of the year, we returned to profitability in the third quarter and continued that momentum during the fourth quarter to finish the year solidly profitable.

Adjusted net income for the quarter was $15.6 million and for 2017, was $24 million. We finished the year having invested approximately $625 million for 300,000 TEU, the second most of any leasing company. Substantially, all containers delivered in 2017 are now on lease at favorable cash-on-cash yields, and another 125,000 TEU have gone or are expected to go on lease during the first quarter of this year.

During the third quarter of 2017, we successfully completed the integration of the 182,000 TEU Magellan fleet with our fleet. We look forward to the positive impact these additions will have on our performance in future quarters.

Utilization averaged 97.4% for the quarter and 96.4% for the year and is currently at 97.9%. Our utilization increased almost 300 basis points over the course of 2017. We are very close to full utilization. With our very low depot inventory, further significant increases in utilization are unlikely.

Our lease-out to turn-in ratio for the year was 1.5:1 after adjusting for Hanjin returns. Our utilization continues to benefit from the fact that 84% of our fleet is subject to long-term and finance leases. Furthermore, the average rate of the dry freight contracts expiring this year is $0.56 per CEU, which is not only lower than the rate on maturing leases for the last 5 years but also lower than current new container rental rates.

Container prices have been relatively stable for the last year and currently, are around $220,000 per CEU. Containers ordered today will be delivered in late March or April.

Due to recent increases in steel prices, which are at 5-year highs, the increased cost of waterborne paint and the strengthening of the renminbi, we do not expect new container prices to decline from their current level. Higher new container prices support higher rates on lease renewals and used container prices on resale.

Resale prices continue to increase, but the rate of increase has moderated significantly from what we saw at the beginning of the year. Given high utilization, limited depot inventory, the relatively low level of turn-ins and stable new container prices, we expect resale prices to remain around today's high levels.

Estimates of 2017 production exceed 3.5 million TEU. 2017 reefer production is estimated to have slightly exceeded 100,000 units. Reefer rental rates remain under pressure with yields similar to dry freight containers. We believe reefer should provide a higher return and are not investing significantly in reefers until we've seen improvement in rates.

The inventory of new dry freight containers at factories is approximately 700,000 TEU, almost 70% of which belong to leasing companies. Many of these containers are already committed to leases. Worldwide depot inventory remains very low. Overall, the industry enters 2018 in an excellent condition.

The IMF projects global GDP growth of 3.9% in 2018 due in part to improving economies in several European countries and to the recent tax cuts in the U.S. Drewry projects global trade growth of 4.3%. However, if we see anything close to a repeat of 2017 when container trade grew at a 1.7x multiple of GDP growth, 4.5% to 5% trade growth this year is probable.

The financial condition of most major shipping lines has improved dramatically partly due to increased consolidation, reducing the likelihood of another major bankruptcy. Overall, shipping lines profitability is believed to have exceeded $7 billion last year. Furthermore, as the lines increase in size, so do their container needs. Today, the top 5 carriers control more than 60% of global capacity. Large lessors like Textainer are best positioned to service their needs. The increase in shipping line size has not caused them to prefer owning over leasing. Lessors purchased approximately 60% of containers produced last year. On the other hand, consolidation has concentrated our customer base. Notwithstanding this consolidation, container ship capacity growth continues to outpace demand growth due to the addition of new build vessels, reduction in the idle fleet and limited scrapping. As a result, load factors declined and freight rates weakened during the fourth quarter and the start of 2018.

On the positive side, increased vessel capacity stimulates container demand. Initial returns on new container investments remain attractive. Cash-on-cash returns remain in the double digits. However, competition for new lease outs is increasing, and returns have declined slightly recently. We are optimistic that returns will remain attractive, especially for those lease-out opportunities when a line needs containers quickly.

Historically, our industry has been very disciplined about new container investments. We believe that discipline will continue and container orders will remain in line with demand. We have a strong supply of new containers, both at the factories and on order, and are well-positioned for current and projected future demand. Having said that, we will only invest in new containers when the returns justify doing so.

We have purchased more than 100,000 TEU during the last 2 months to service our customers during the beginning of the year. We have more than sufficient liquidity to place additional orders as demand dictates. New and used container prices on rental rates are at very attractive levels. We have vested challenges faced during the first half of last year, restructured our debt, recommenced container investments and returned to profitability. Unlike the last several years, the leases maturing in 2018 have average rental rates below current new container rental rates, providing an opportunity to maintain or improve cash flow. Our economies of scale and ability to provide large quantities of containers in demand locations worldwide enable us to benefit from shipping line consolidation. We are optimistic for Textainer and the container leasing industry as we enter 2018.

I'll now turn the call over to Hilliard.

Thank you, Phil. I will review the major drivers of our results this quarter, focusing on the sequential improvement relative to Q3 2017. As Phil mentioned, lease rental income was $116.3 million, an increase of $4.1 million or 3.7% compared to the previous quarter. The increase in lease rental income was driven by higher utilization, an increase in per diems and a slight increase in the relative size of our own fleet.

Gains on sale of containers from our fleet were $8.3 million, up 4% from the third quarter of this year, which also showed healthy gains. Higher used container prices continue to drive gains on containers sold, partially offset by slightly reduced sales volumes. Fewer containers are being put to sale due to high utilization and our shipping line customers holding on to containers for longer periods of time versus returning them.

Similar to the fourth quarter, we expect volumes to possibly moderate over the next few quarters as fewer containers may be available for sale. Direct container expense was $14.7 million, up $3.7 million or 34% compared to the third quarter, and down $3 million versus the year ago quarter. The year-over-year decrease reflected higher utilization resulting in lower storage expenses.

As you may recall, last quarter, we had onetime items that reduced the run rate for direct container expenses more than normal. However, the fourth quarter contained higher-than-normal repositioning expenses due to our resale in military businesses. The normalized run rate for direct container expenses should be somewhere in the middle of our Q3 and Q4 expense, assuming no material change in utilization.

Depreciation expense was $55.4 million, essentially flat with the previous quarter and down $8.1 million or 13% year-over-year primarily due to a change in our depreciation policy and partially offset by an increase in the size of our owned fleet. Annualized depreciation expense for the quarter was 4.6% of average container cost, and we expect the run rate to remain close to this level as we move forward.

For the quarter, our interest expense, including realized hedging cost, was $28.8 million, a $1.1 million decrease from the third quarter, notwithstanding the increased borrowing and higher LIBOR rates.

During the quarter, we successfully renewed and upsized $190 million warehouse facility, reducing the spread from LIBOR plus 225 basis points down to LIBOR plus 125 basis points, and increased our advance rate, adding capacity for more CapEx. We have close to $1 billion of available debt capacity and are well positioned to take advantage of growth opportunities as we move throughout the year. We will continue to be opportunistic in our approach to the financing markets.

Our average effective interest rate, which includes realized hedging cost, is currently 3.91%, a 20-basis point improvement when compared to the third quarter.

As of quarter end, over 72% of our debt was either fixed or hedged compared to 84% of our owned fleet subject to long-term and finance leases. The weighted average remaining term of our fixed and hedged debt is 31 months, and the weighted average remaining term of our long-term and financed leases is 40 months.

The U.S. Tax Cuts and Job Act was signed into law on December 22, 2017. The income tax expense in the fourth quarter benefited from this change in tax law. The most significant effect of the law in Textainer was a U.S. federal corporate tax rate reduction from 35% down to 21%, which resulted in a tax benefit of $3.1 million on a remeasurement of the company's net deferred tax liabilities.

Increased activity and higher tax jurisdictions and a $1.2 million valuation allowance offset part of the benefit from the change in tax law, resulting in $1.2 million of income tax expense for the quarter. Going forward, we expect our annualized income tax rate to normalize in the mid-single digits.

Adjusted EBITDA was $101 million for the quarter, up 18% when compared to Q4 of last year. Our cash position increased by $54 million during the same period, some of which is due to the receipt of insurance and the balance due to cash generated by our business.

Adjusted net income for the quarter was $15 million or $0.26 per diluted common share, excluding unrealized gains on interest rate swaps and noncontrolling interest. We will see improvements on the top line as lease rental income continues to increase due to our investments in new containers.

Direct container expenses will be lower assuming no material exchange in utilization, and depreciation expense will increase due to our larger fleet size. However, interest expense is expected to be higher due to higher debt balances and possible increases in LIBOR rates. We expect our performance in the first quarter of 2018 to be slightly above the current quarter with increasing profitability as we move through 2018.

Thank you. And now I'd like to open the call up for questions. Operator, can you inform the participants of the procedures for the Q&A?

(Operator Instructions) Our first question is from Helane Becker of Cowen.

So I just have a couple of questions. Just kind of wondering, with respect to what you're seeing in the market, I think one of the concerns that I'm hearing is that there's more competition. And I'm just wondering if that's kind of the good kind or the bad kind.

Helane, good to speak with you. I'm not sure what you mean by good kind of competition or bad kind of competition, but let me take a stab at answering your question. And if I haven't addressed it, then you can re-ask it. I think when people were talking about competition, obviously, what they're looking specifically at are the yields. And I'd like to take a little step back because I think we need to have a sense of perspective here. To me, there's 3 primary drivers of the performance of Textainer and other container leasing companies at any point in time. And those 3 major drivers are, one, trade growth. And if you look at what the IMF and others are projecting for GDP growth this year, you're talking probably close to 4%. And if we see the same multiple that we saw last year in terms of container trade growth over GDP growth, you're talking about trade growth -- container trade growth that could easily be 4.5% to 5.5% this year, which would be quite strong, quite positive. So that's the first driver. The second driver in my mind, important point, are container prices. And if you look at container prices right now, they're at a high level, that's positive for the industry, that tends to support leasing over ownership and helps support resale prices and supports new rental rates that are higher than the average rental rates on existing fleets and/or the parts of the fleets that are maturing this coming year. All of that is very positive, and I believe the outlook for container prices is also positive. You've got the strengthening of renminbi. You've got steel prices at all-time highs. And frankly, it would appear that the manufacturers are working very closely together. It's something they've done in the past, but right now, they seem a little more unified than they have, certainly focused on being profitable. So container prices, also a positive. Now the third would be rental rates. And rental rates, in terms of yield, have come down. But let's put this in perspective. We're talking about yields that are in the low-double digits. This is the highest level overall that we have seen since 2012 or '13. Yes, you had an anomaly at the beginning of last year when yields were quite high. But at the current level that we still see yields, you're talking about return on equity that's in the mid-teens, yields that, in general, we haven't seen in this industry for more than 5 years. I think there's a bit of a scare factor here that is a little overblown. There is more competition. Yields have come down. Yields remain at levels that are still attractive for this industry. So I don't know if I answered your bad competitor, good competitor question. But if I didn't, I'll...

Phil, you did. I mean, I think that you did answer the question, and I appreciate the response. I'm just kind of trying to reconcile what we're seeing in the market today with your positive comments and the results that you reported. I think the other thing I'm wondering, what's the, is it, the pass-through? So as rates go up and your cost of capital increases, can you pass that on to your customers? And kind of what's the lag?

You see a few things in this industry. One, of course, the container prices. They go up and down; they're going to affect rental rates. And interest cost, which I believe is what you're referring to. As interest costs go up and down, that will affect rental rates as well. So yes, you can see a lag sometimes when somebody has purchased containers that an older price container prices go up, but they still have an inventory of containers purchased at a lower price. You may see rental rates lagging a bit before they start to rise because, although container prices have risen, you have an inventory of containers purchased at the older rates. So it's not always immediate, but as container prices and borrowing costs increase or decrease, those will ultimately be reflected in rental rates. And if there is a lag, it's generally -- you're talking about several months. You're not talking about something longer than that.

And Helane, just to add. If you look at how we're positioned and at our percentage of long-term leases, they pretty much align with or very closely mimic our fixed and hedged debt. We try to match that as closely as possible. And frankly, we're working on a deal right now that we expect to close very shortly. It's a private deal that is going to add more fixed rate financing for us, and we expect to close that hopefully, today.

Our next question is from Michael Webber of Wells Fargo Securities.

I wanted to just come back to the conversation around competition. And I think that, Phil, your comments on kind of context and perspective, I think, are warranted. Just if I look at what your historical earnings stream and I go back to last cycle, when I look at the $3.50 or $4 of earnings you guys were able to put up in 2011, 2012, is there more or less competition today than there was last cycle? I mean, given the fact that HNA is still on the sidelines that you've seen some consolidation, if we actually look at the context of what the conversation in the space today relative to last cycle, where are competitive levels?

I think the answer is there's more than sufficient competition today, Mike. I don't know if I can say it's more or less, but it -- this is a competitive industry. Pretending or saying that it's not would just simply be wrong. It is competitive. There is certainly more action now than there was, say, the midpoint of last year. There's more lessors that are participating. But I think one just has to assume, we're in a competitive industry. You may have brief periods. It was an anomaly last year when some, including us, at the first part of the year were not investing heavily in containers. And then once we started investing as well, we saw that there wasn't much competition for a while, but now there's more. This is a competitive industry, and that's not going to change over the long run.

Right. I guess, what I'm getting at is if I make the case, there were, say, 7 major competitors last cycle. In the first half or the bulk of '17, there were 4, and while 2 may be coming back to the market. If I comp where we are from a competitive standpoint today versus last cycle, which is what most of your valuations are framed upon and kind of some normalized earnings or normalized cash flow metric, it seems like it's fair to say there's less competition this time relative to last cycle. I guess, within the -- that framework, have you seen any indication that the PE, the Chinese PE-backed entities have re-entered the market in any way, shape or form?

I would simply say this that there's plenty of competition in our market. We see competitors who were not quite as active last year becoming more active now. Any deal that we have an opportunity to bid on, yet there's others bidding on it as well, so.

Okay. All right. One more, just in terms what we're seeing from your customer base. We've seen a handful of major lines, restart vessel acquisition programs, both at the kind of a small [fleet or] ship level up to larger ships and also some LNG-powered investment, which is interesting. Just as you start to see some of those lines restart CapEx programs, and you will get the share, kind of the lessor's share of incremental boxes, do you get a sense yet on what kind of investment they're willing to spend or have the ability to spend on new boxes? And do you think you'll be able to kind of continue to gain? I looks -- it seems like it works out to about a point to 1.5 points of group-wide lessor market share gains over the last kind of 8 to 10 years. Do you think that likely continues?

If you look at last year, lessors bought over 60%. I've seen different figures between 60%, 65% of the production last year was purchased by lessors. What we see right now, I'd say, I think that trend will continue through this year. I expect the shipping lines will continue to rely on the leasing companies to provide their -- the majority of their containers.

Our next question is from Doug Mewhirter of SunTrust.

The first question. In terms of utilization or just the market dynamics, how do you see that Chinese New Year shaping up this year? I know sometimes there's like a little bit of maybe trying to -- people try to jump in front of the Chinese New Year where that might artificially increase the pickups and then there may be a letdown in early March when it all kind of unwinds. But this seems like it's a pretty uniformly strong demand this year, so I don't know how you're preparing for the transition into and then out of Chinese New Year.

Yes. Olivier Ghesquiere here. I agree very much with what you said. We've seen an uptick in demand with the Chinese New Year. As is traditional, the uptick was probably not as strong as what we may have seen the previous year, but it comes on the background of pretty sustained volumes. There was a bit of congestion towards of the end of the period, the last 2 weeks where there was a bit of a shortage of trucking capacity in terms on supplying containers to the line. But what we see is very much that shipping lines are very optimistic about the volumes going forward after the Lunar New Year. We don't really see a drop in activity as pronounced as probably what that we may have seen the previous years. And what I'd like to say is that we're certainly very well positioned with our current inventory or order book to supply that positive demand.

Okay. That's helpful. My second question, just maybe a clarification. And you talked about yields, revenue yields, the cash-on-cash yields above your portfolio average. If I just want -- I just wanted to clarify. So if I were to define that yield, is the revenues divided by your original equipment costs, your gross book value without depreciation? Is that the right metric to compare between what you're getting now and your portfolio average?

Doug, I'm not sure if I used the wrong terminology. So no, the short answer is no. That's not actually what I meant. What I meant was the average rental rates on our fleet today is lower than where new container prices are currently. And the average rental rate on the term leases that are maturing this year is also lower than where new container prices are. If you have an aged fleet that is 7 years old or so like our fleet and has the significant amount of depreciation, the yield on those assets is likely to be higher than the yield on brand-new containers. The yield increases as you depreciate the asset over its life. So I wasn't speaking in terms of yields; I was speaking in terms of the absolute rental rate figures.

Okay. And I was -- I guess, I was -- that's why I was clarifying it. So -- but if you add back the depreciations, if you look at original equipment cost across your portfolio, how would that compare?

Well, right now, what we're seeing, if you look at the projected returns on equity that we expect on new container investments today, you're looking at return on equity in the mid-teens. I think others said similar returns in the industry. I think we're all looking at about the same type of return. This industry in many years past certainly generated higher return on equity than that. But in the last several years, I would say this is, compared to the last couple of years, with perhaps the anomaly of a few -- a period during just last year, that's an attractive return on equity.

We have no further questions at this time. I will now turn the call back to Hilliard Terry for closing remarks.

Thank you, operator. We appreciate everyone joining us for our Q4 earnings call, and look forward to talking to you as we progress through the next quarter. Thanks a lot. Speak to you soon.

Thank you. And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.