Triton International Ltd (TRTN) 2017 Q2 法說會逐字稿

Good day, and welcome to the Triton International Second Quarter 2017 Earnings Release Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Mr. John Burns, Senior Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you, Allison. Good morning, and thank you for joining us on today's call. We are here to discuss Triton International's Second Quarter 2017 Results, which we reported yesterday evening.

Joining me on this morning's call from Triton are Brian Sondey, CEO; and Simon Vernon, President. Before I turn the call over to Brian, I would like to note that our prepared remarks will follow along the presentation that can be found on the webcast on the company's presentation section of our website.

I would also like point out that this conference call may contain forward-looking statements as the term is defined under the Private Securities Litigation Reform Act of 1995. It is possible that the company's future financial performance may differ from expectations due to a variety of factors. Any forward-looking statements made on this call are based on certain assumptions and analysis made by the company that it believes are appropriate, and any such statements are not a guarantee of future performance, and actual results may vary materially from those projected.

Finally, the company's views, estimates, plans and outlook as described on this call may change subsequent to this discussion. The company is under no obligation to modify or update any or all of the statements that are made herein despite any subsequent changes. These statements involve risks and uncertainties, are only predictions and may differ materially from actual future events or results. For a discussion of such risks and uncertainties, please see the Risk section located in the company's Annual Report filed on Form 10-K with the SEC on March 17.

With these formalities out of the way, I'll now turn the call over to Brian.

Thanks, John, and welcome to Triton International's Second Quarter 2017 Earnings Conference Call. We've included a presentation to go along with this call. I'll start with Slide 3.

Triton is taking advantage of favorable market conditions to drive strong performance. We generated $58.8 million of adjusted pretax income in the second quarter, an increase of 38% from the first quarter. The increase in our profitability reflected improvements in many areas, including strong growth in leasing revenue, a large drop in operating expenses and increased gains on container disposals. Market fundamentals are currently very favorable, especially for dry containers. Trade growth in 2017 has been higher than expected, leading to increased demand for containers. At the same time, container supply has been constrained due to low production last year, reduced purchasing this year by many shipping lines and other leasing companies and production disruptions, driven by tighter environmental regulations in China. As a result, the container supply-and-demand balance is strongly in our favor, and many of our operating metrics are historically high.

We are also using the strong market, our competitors' limitations and our unique financial and operating capabilities, capturing an outsized share of attractive investment opportunities that will generate many years of enhanced profitability and cash flow. Our ability to take full advantage of the strong market, rapidly rebuild our profitability and aggressively ramp up investment, while also simultaneously working through our merger integration, highlights the strength of our franchise, our extensive capabilities and the disciplined way we invest and run our business.

Triton declared a dividend of $0.45 per share this quarter, as we continue to share our strong cash flow with investors. And looking forward, we expect market conditions to remain strong through at least the end of the year.

I'll now hand the call over to Simon Vernon.

Thanks, Brian. We will now look at the current market environments and our performance over the second quarter. The positive momentum in the market that Brian has just talked about can be seen when looking at the next few slides.

Beginning with Slide 4, you can see containerized trade growth has continued to strengthen in 2017. This is providing support both for our customers in terms of better cargo growth and for us, as more demand is created for both our depot stocks and new production inventories. Many of our customers are now reporting growth in the 5% range with the prospects remaining encouraging looking forward to 2018. During the last quarter, steel prices have started to climb again, and this has kept pricing for 20-foot containers delivered in the second and third quarters in the $2,100 to $2,200 range, with the prospect of pricing for October delivery could increase slightly.

All container factories in China have now converted to waterborne paint application and as expected, we're continuing to see productivity impacted during this process. We are also expecting to see a period of closure for some factories during the Golden Week holiday in China that begins on October 1 to convert paint drying boots ahead of more severe winter conditions.

Turning to Slide 5, you can see the dry van new production inventory at factory yards during the second quarter decreased to well below 400,000 TEU, which is the lowest level we have seen since 2010. Most of the leasing company stocks shown were already committed to customers, and a large portion of these are our own. This level of inventory remains extremely restricted, given the fact that we're still only in the middle stages of the peak season for lease-outs.

Taking July 1 as a start date and looking forward to the end of October, we have approximately 435,000 TEU of new production dry containers built or on order at the factories, of which 370,000 TEU or over 85% were already committed to customers and are being placed on hire during July and August and over the next few months. This new investment and on-hire activity will continue to grow through the end of the year as we place new orders to match customer demand and secure further long-term deals. We've also seen depot inventories for both us and our competition decreased to very low levels, with the majority already booked by our customers.

Moving to Slide 6. We expect this positive momentum we have seen during the last few quarters to be maintained as we move deeper into the third quarter and on into the fourth. Dry container pickup activity remained near-record levels for the second quarter, and the shortage of containers in the market relative to demand is translated into much higher levels of utilization. Our overall fleet utilization is now about 97.5% and is still driving. We are also seeing improvements in reefer performance, driven by the fact that there's been limited investment in new equipment in this sector over the last 18 months.

Our average lease rates in the fleets have been on a downward trend for 5 years now, but the very powerful turnaround in both market dynamics and market lease-rate levels has helped to stabilize this trend. More positive signs should be seen in the months ahead. As we discussed during our last earnings call, one of the main beneficiaries of this combination of stronger demand in the leasing side of our business, overall reduced supply and higher container prices has been our resale business. Averaging -- average selling prices for our used dry containers in the second quarter were up 20% from the first quarter, and up by over 40% from the second quarter of last year. We expect dry container sale prices will continue to increase for at least the next few quarters.

Slides 7 and 8 clearly show the role the Triton has played in supplying and servicing our key shipping-line customers during the last 12 to 13 months since our merger. Despite stronger-than-expected trade growth, overall investment in new containers remains modest, especially compared to production levels seen in 2014 and '15. New container orders have been limited this year by production constraints related to the conversion of container factories to waterborne paint application, and the financial constraints that a number of our customers and competitors that have restricted their orders despite the acceleration of container demand. Triton has filled the resulting supply gap by leveraging our unrivaled financial and operating resources to deploy close to $1.9 billion of new capital, and purchase in excess of 1.1 million TEU of new and used equipment since our merger in July of last year. We estimate that just over 2,700,000 TEU of new dry vans would have been produced for shipping lines and leasing companies for the third quarter of last year through the end of July this year. Our 822,000 TEU of new dry container production shown in the graph represents close to 30% of this total output and roughly 50% of dry container production ordered by leasing companies.

As you can see -- as you can also see from Slide 8, on hires for our new dry container production have dramatically accelerated in the second quarter as the peak season for cargo movement growth increased demand for containers, and again, we have more than 370,000 TEU of new dry containers already committed to go on hire from July onwards. Looking at just the leasing sector overall for the last 4 quarters, we believe that our market share is somewhere close to 50%. During this time, all of the main shipping lines have had significant requirements for new containers, and our customers have come to rely on Triton to provide valuable and unique service and supply.

We estimate the lifetime equity returns for our dry van new production will be in the high teens to over 20%, depending on whether we apply full or marginal SG&A costs. These investment returns are well protected by lease terms ranging from 5 to 11 years, and lease provisions that restrict future redeliveries to demand location centered on China. Most importantly, for the last 12 months, we have seen a continuous strengthening of the supply-demand balance, ongoing increases in container pricing and a very strong rebound in per diem levels. This is obviously extremely powerful in terms of deploying new production and attractive lifetime returns as we have seen from the last 2 slides, but more valuable over the short term is the positive impact this continues to have on utilization, higher sale values for the containers we retire and much stronger negotiating prospects when extending and repricing expired leases. We are also continuing to see much improved lease-out terms and per diems for business generated for our in-fleet containers leased from our depot network.

With that, I will hand the call over to John.

Thank you, Simon.

Turning to Page 9. On this page, we have presented the consolidated results for the second quarter compared to the first quarter. As noted earlier, our adjusted pretax income of $58.8 million is up sharply from $42.7 million in the first quarter, as the improvement in market conditions led to significant improvements in nearly all financial line items.

We experienced strong top line revenue growth, with leasing revenue increasing over 6%, driven largely by the pickup of over 230,000 TEU of new dry containers and over 45,000 TEU of depot units, contributing to the 1.2% increase in average utilization over the first quarter. We also experienced a small increase in our average portfolio lease rate, reflecting the current solid price environment for dry containers. This improvement of non-hires and lease rates was partially offset by a drop in fee and ancillary revenue as the continued strong market conditions resulted in a much reduced level of container redeliveries and related fees.

In-house sale jumped to $9.6 million, up $4.5 million from the first quarter. This increase was driven by improvements in both disposal prices and volumes. Average dry container disposal prices for the second quarter were up approximately 20% from the first quarter. Second quarter dry container disposal volumes jumped by more than 30% from the first quarter as we moved into the seasonally stronger sales period, and the higher sale prices moved closer to our expectations, leading us to take the breaks off disposal volumes. Approximately half of the disposal gains resulted from the recapture of prior period markdowns of our assets held for sale when container disposal prices were lower. While we expect disposal prices to remain strong, the benefits of recapturing prior period markdowns will be lower in future quarters.

The increase in depreciation expense is generally in line with new containers going on hire. Interest expense increased nearly $7 million or 11%, reflecting an increase in our effective interest rate of roughly 20 basis points. About half of the increase in our effective rate was due to the increase in LIBOR and our unhedged floating-rate portfolio. We also increased the portion of our debt portfolio that is fixed rate from an average of 77% in the first quarter to 82% in the second quarter. In addition, we are experiencing jump in commitment fees as we build that capacity ahead of large CapEx payments.

Direct operating expenses dropped by over $6.5 million from the first quarter, as the strong dry container demand continues to push the level of off-hire units to very low levels, generating sizable storage cost savings and reducing the levels of repair and handling costs.

Administration costs decreased by $1 million. Bill day remain elevated relative to our long-term expectations as we continue to maintain extra back-office staff necessary to operate 2 separate IT systems. We successfully integrated the 2 systems in May. We also continue to experience a high level of professional fees as we integrate the legal and operating structures of the former entities. In addition, our current strong results have led to above target levels from incentive compensation.

Turning to Page 10. Here we've presented the June 30 balance sheet with the related purchase accounting adjustments. These purchase accounting adjustments were recorded with the closing of the merger last July, using the very low container values and market lease rates at that time. If these entries were to be made in the current market, the overall impact would be close to 0 or potentially positive.

Turning to Page 11. Our aggressive investment has been supported by a significant amount of new financing activity, and we have found strong support in this regard in the bank, ABS and private placement markets. In total, we have raised over $1.7 billion of financing commitments. We remain focused on matching the long-term nature of our leases with long-term fixed interest rate financing to minimize the refinancing risk and lock in the spread of our long-term lease portfolio. We achieved the fixed interest rates with either fixed-rate debt facilities in the ABS and private placement markets, or by using long-term interest-rate swaps to convert floating-rate bank facilities to fixed rate. At the end of June, we had $6.8 billion of debt outstanding, of which 84% was fixed rate, with an average remaining duration of over 4 years.

Turning to Page 12. Looking forward, we expect the favorable market conditions to continue to provide positive earning momentum for the third quarter. For leasing revenue, we expect average utilization will increase further, but we are approaching the maximum level for dry containers, and we expect large volume of new dry containers to go on hire as customers pick up units under existing commitments.

On the expense side, we anticipate ongoing improvements in direct operating expenses due to lower storage expenses, and we expect improvements in our administrative expenses as we realize synergies associated with the completion of our systems integration in May. By the end of the third quarter, we expect to be approaching a projected run rate of synergies. For our gain on sale line, we expect further increases in disposal prices, but the benefits of the reversal of prior period impairments will shrink.

Lastly, we expect the $2 million net negative impact of purchase accounting we experienced in the second quarter to switch to a small positive impact in the third quarter.

I'll now return you to Brian for some additional comments.

Thanks, John. I'll continue the presentation with Slide 13. In general, we expect market conditions to remain favorable. Trade growth remains higher than expected, and we're continuing to experience strong leasing demand. Inventories of new and used containers are extremely tight. Most shipping lines continue to rely heavily on leasing, and we have a very large number of containers committed to attractive leases that will go on hire over the coming months.

There are some risks to our positive outlook. Fuel prices in China have been volatile and could pressure container prices and lease rates if they fall sharply again. We're also seeing more leasing companies become active investors in new containers, which will eventually lead to more aggressive competition. We continue to be wary of increased protectionism as a threat to global trade, and we'll face elevated risks of default until the bulk of our shipping line customers return to sustained profitability. On balance though, we are optimistic, and expect our operating and financial performance will continue to increase.

Slide 14 shows our current expectations for adjusted pretax income in the third quarter. We expect our profitability to increase from the second quarter to the third quarter mainly as we benefit from a full quarter at very high utilization levels, and as ongoing new container pickups drive growth in leasing revenue. We also expect purchase accounting to shift from a small net expense in the second quarter to a small benefit in the third.

I'll now wrap up the presentation with a few summary comments on Slide 15. Triton is taking advantage of strong market conditions to achieve strong performance. Our adjusted pretax income increased 38% from the first quarter to reach $58.8 million in the second. Our key operating metrics are up sharply, and we're building a long tail of enhanced earnings and cash flow by leveraging our unique supply capability to capture a very large deal share in this attractive market. We're also using the strong market to further separate Triton from our competitors. We continue to have significant scale, cost and capability advantages over everyone else in our industry, and our unique ability to fill the supply gap this year and meet our customers' critical container need has reinforced our position as a supplier of choice for the world's largest shipping lines.

I'll now open up the call for questions.

(Operator Instructions) Our first question will come from Ken Hoexter of Bank of America Merrill Lynch.

Brian, great insight on the continued turn on the market over the last couple of quarters. But Simon, let me ask you a question on your review there. You talked about lease rates kind of stabilizing. Just given the tightness in utilization up at 97.5% the end of the quarter, why are we not seeing maybe a greater spike in that -- in the lease rates? Is that something that just given your long-term, long-tail contracts takes time to blend in? Or are we seeing -- or is there some other reason out there?

What I was referring to was average rates across the whole fleet, and obviously for the majority of containers, they're on lease, we have high utilization. And to move that figure, it just takes time in terms of leases expiring and then per diems being renegotiated. And then also seeing the influx of this new business we're doing at higher-than-average per diem levels, that can obviously make a positive contribution too. But it just takes a little bit of time to move if you like the kind of supertanker that we are, just because so much of the fleet is on fixed-term leases at the moment and to move the dial upwards in terms of per diems just takes a little bit of time.

And then maybe just one other thing, Ken, and even for leases that are expiring, typically, our customers have what's called a bill down period, which is a 6 -- typically 6- to 12-month time to bring the containers back where they can continue to hold them at the same rates. And so even for expiring leases, it can take time to get the higher market rates reflected.

Wonderful. And then, John, on the direct operating expenses, maybe you could delve into that a little bit more. You talked about some of the lower storage costs. Is that something that given the tightness in the market that you -- we should see remain at these lower levels for an extended period of time here? Or maybe you can talk a little bit more about that direct OpEx?

I think some of the key drivers to that is utilization, storage costs and repairs. And again, on both items we're seeing average utilization went up in the third quarter -- second quarter. We expect it to do the same in the third quarter. Obviously, we're getting to a level on the dry containers that's very high. So it is limited improvement from there as far as storage goes. That said, we -- sales stack continues to go down. And repairs, I mentioned that the number of redeliveries is very low, so repairs stay low. How long that lasts, I guess, it's -- how long the market will last.

So let me -- and with that one, and Brian, I guess, your insight on this one, I mean, we're starting to see your -- I guess, some private capital has come back in, how do you view -- how does the industry not get into the over-ordering station that we were at before, given the euphoria we have seen once the market tightens and rate starts to climb, and how do you, I guess, keep that from rates ultimately maybe -- no, not quite collapsing, but getting under pressure again?

Yes, that's a good question. As I mentioned, we are seeing some of the competitors that had sat out the first half of this year from new investment starting to come back in. But I think, as Simon mentioned, production capacity, the factory is constrained and also, inventories are so tight that we haven't yet seen that sort of impact, lease pricing or structuring or the attractiveness of our investments. I think it's always hard to look forward too far, but we do think that even as we head into next year, that we're going to begin the year with very low levels of factory inventory, very low levels of depot inventory, and those are the things that to a large extent drive lease pricing. We're hopeful at least too that the industry learns some lessons. And I think one of the reasons why we have been able to come back so quickly as the market turned last year into this year has a lot to do with our star investment discipline. We're very careful the way we price and structure leases, and a lot of it has to do with our remarketing capabilities, and the way we keep containers on the ground in the places where our customers want them and that's where we let them come back from leases, and that allows us then to not have to panic in downturns and then quickly capitalize on upturns. And all we can say is that as our competitors or many of them at least have -- had struggled to take advantage of this market as the lingering -- impacts have lingered from the downturns that, although, we'll think about that, and be perhaps more thoughtful and cautious on how they structure new investments. But again, it's -- you have to see as we get there. Again, the fundamentals are still very strong, especially in terms of supply and demand, which I think provides a lot of support. But hopefully, we are -- we won't see the same kind of sort of frenzy when we get out a little while from here.

(Operator Instructions) Our next question will come from Doug Mewhirter of SunTrust.

First question, just a little numbers question. John, do you know what the exact amount of the lease intangible amortization was this quarter that was netted out against revenue?

I don't have it right in front of me. I think it's about $22 million.

About -- okay. And one thing I was curious about, Brian or Simon, is the fourth quarter seasonal pattern may be a little distorted this year, just because of the incredibly tight supply and demand's running a little bit ahead of expectations. And how are you sort of preparing for the fourth quarter? And do you -- and would you even see a downtick in -- that normal downtick in utilization, given that the pattern seemed to be a little distorted and the container lines are still playing catch-up?

I'll take a shot at that question. What we saw last year, and I think going back and looking historically, we've seen good fourth quarters in the past. And really, what we expect to see this year is another firm fourth quarter and that's, as you suggested, really on the back of the fact that both the North America and the U.S. and the European trades have been much stronger than in the past couple of years. And we expect a fair amount of cargo to roll from the end of September into October after the Golden Week holiday. And the firmness in the market we expect to continue deep into the fourth quarter. The other thing that we're optimistic about this year are the inter-Asia trades, which tend to be very busy during the fourth quarter and certainly, our feedback from our field offices and from our customers who participate in that market is also pretty positive. As Brian said, the other thing that's going to support that forecast is the extraordinary restricted supply of both depot and new production stocks. And what we're trying to do, and my guess is some of our competitors will be doing the same thing, is try and position ourselves so that we do have some new production stock available to meet customer demand as we go into the fourth quarter. We're certainly purchasing containers now, not to build stocks for 2018, but to sow this demand that we expect to see in the fourth quarter.

That's a very helpful and thorough answer. My last question, regarding lease terms, I know other competitors have mentioned this and you have mentioned it in the past and on this call, is that the 5-year lease term is getting stretched to 8, 9, 10. Is it being priced to the same kind of returns? Are you getting 8-year leases on -- at 5-year rate, if I could oversimplify it?

Yes, sure. I mean, typically, there is a connection between lease duration and lease rates. And so as we try to push customers this year to 7 years, 8 years, even Simon mentioned 11 years, one of the reasons customers will ultimately go along with it, one is, they need the containers, but secondly, there is typically a per diem benefit to pushing out the duration. When we think of returns though, we usually think of equity returns, and when you're in a strong market like this one, where lease rates are maybe higher than average, there is lifetime value benefits of locking in more years at the current sort of high market levels and typically, we think that not only are the returns more stable as you have longer durations, but typically, also the expected returns over the life of the container are probably better, even though the per diem may be lower.

Our next question will come from Helane Becker of Cowen and Company.

I think just 2 questions. As you think about winning more than 50% or I think you said 50% of the business that's out there, what does that mean for your margins? Can we see your operating margins continue to go higher?

Well, certainly, for this new investment we're doing as I think we've mentioned a few times that the returns on the investments are -- they're certainly better than average, driven both by just the need of our customers for the containers as they have seen their freight rates go up significantly as well as just the fact that we're a very large share of the market and one of our competitors just haven't been around to the same extent. So the lifetime returns are higher than usual, but also the near-term accounting profitability is higher than usual as well. And certainly, one of the things that's driving our comments that we expect our performance to continue to improve quarter-to-quarter here is -- I think Simon referred to 370,000-or-so TEU that we already have committed to leases for -- that we expect to be picked up after July 1, and that provides an awful a lot of support for revenue growth, lease margin growth over the next couple of quarters.

Okay. And then where you talked about the risk of defaults on -- I mean, do you have customers on your -- so there's 2 parts to the question, one is, do you have customers on your watch list? And two, can -- do you have insurance for said customers? Or can you talk about your exposure there?

Well, we always have customers on our watch list. It's a -- I think it's the nature of our industry. Usually, they tend to be smaller customers, especially those that are asset lighter. But there's always customers on there. We are seeing this year a meaningful improvement in freight rates, and we expect to see a meaningful improvement in our customers' profitability. And so I wouldn't say we feel there's a huge risk of defaults from major asset-owning shipping lines this year. I think we've also seen, as I think we've talked about it in the last few calls, that the lines have taken a lot of actions to improve their sort of survivability by merging, to build scale and cost advantages. We've also seen a number of governments step up and more explicitly back their national champions, sort of in a way given the Hanjin situation. So generally speaking, we are not, say, on the edge of our seats waiting for something else to happen, especially not among the large asset-owning shipping line. But that said, the shipping lines continue to struggle with basic fundamentals, now given that they're still -- despite the higher-than-expected trade growth, still probably an oversupply of vessels. And if you look at the vessel delivery schedules, even with some improvements in trade growth, it's going to take a while, and before that, basic vessel supply and demand comes back into balance. And from a credit standpoint, we'll certainly feel better when it does.

Okay. And then the other question I had is on your leasing -- your releasing. So the container is coming off lease that you're reordering leases for, are those rates better? Or can you just talk about these rates relative to where we are today and where they were coming off lease and where they're going back on lease?

Sure. So right now that the market lease rates for new containers especially, but even for containers we're supplying, are typically above the average rates in our lease portfolio. But one of the things that we're seeing, like I mentioned to Ken on terms of lease renewals, is that the customers typically have 6 to 12 months, even after lease expiration, that they hang on to their leases -- the containers at their current lease rates. And then similarly, the other thing we are seeing is just very, very low drop-off levels. We have some charts, I think that Simon went over, that show the pickups and drop-offs of containers. And if you look at the drop-off level in the last quarter, it's exceptionally low. And so while we -- there is some positive -- on average some positive benefit of taking containers back from the existing lease portfolio and renting them today, customers know that and so they're hanging on to the containers.

This will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Brian Sondey for any closing remarks.

Yes, thank you. Just want to thank everyone for your time today and your continued interest and support for Triton International. Thanks very much.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.