CAI International, Inc.
Q1 2017 Earnings Call Transcript

Published: 21 Apr 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the CAI International First Quarter 2017 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this call is being recorded. I would like to introduce your host for today's conference Mr. Timothy Page, Chief Financial Officer. Sir, please go ahead.

[Timothy Page:]

Good afternoon and thank you for joining us today. Certain statements made during this conference call maybe forward-looking and are made pursuant to the Safe Harbor provisions of Section 21E of the Securities and Exchange Act of 1934 and involve risks and uncertainties that could cause actual results to differ materially from our current expectations including, but not limited to, economic conditions, expected results, customer demand, increased competition and others. We refer you to the documents that CAI International has filed with the Securities and Exchange Commission, including its Annual Report on Form 10-K, its Quarterly Reports filed on Form 10-Q and its reports on Form 8-K. These documents contain additional important factors that could cause actual results to differ from current expectations and from forward-looking statements contained in this conference call. Finally, we remind you that the Company’s views, expected results, plans, outlook and strategies as detailed in this call might change subsequent to this discussion. If this happens, the Company is under no obligation to modify or update any of the statements the company made during this discussion regarding its views, estimates, plans, outlook, or strategies for the future. I will now turn the call over to our President and Chief Executive Officer, Victor Garcia.

[Victor Garcia:]

Good afternoon and welcome to CAI’s 2017 first quarter conference call. Along with our earnings release today, we have also posted on our website under the investor section a presentation on our results and our view of the state of our company and industry. We will not be going through specific slides in this prepared remarks, but can address any questions related to the presentation on this call. For the quarter, we reported a revenue increase of 22% from the first quarter of 2016 and lease related revenue increased 4%. During the quarter, we reported net income of 5.3 million or $0.27 per fully diluted share. As we mentioned in the press release, during the quarter, we experienced a couple of noteworthy items. We recognized 2.2 million of income from insurance related to lost income from the Hanjin bankruptcy. We also recorded an unexpected equipment loss of 1.3 million related to a US lease and sale customer that sold the containers we had on lease without paying for the units. The net result of these two items increased our net income for the quarter by $900,000. We are excited about the momentum we had during the quarter and what we expect for the remainder of the year. The results reflect our ongoing efforts to increase utilization of our fleet in order to increase revenue, reduce costs, and improve profitability. The efforts over the past two quarters are now benefiting us and we expect continuing improvement over the course of the year. During the quarter, we increased our average owned container fleet utilization to 95.7% compared to 94.3% for the fourth quarter of 2016. Utilization in the first quarter typically declined and the increase reflects the strong demand for equipment we are witnessing. The utilization of our owned container fleet is currently 96.9% and we expect it to increase further during the second quarter when we expect utilization to exceed 97%. Because of the strong market environment we have invested in new containers that we have placed on leases with attractive rental rates. We have invested 61 million in containers in the first quarter and are committed to an additional 56 million for delivery in the second quarter. All of which are already booked for lease. Per diem rates are currently three times the level they were this time last year and the relative returns are much improved. We expect that the improvement in returns will continue for the rest of the year as we expect supply to be constrained due to limited availability of capital in the industry. Our shipping line customers are telling us that they are more optimistic about demand for cargo in 2017 as compared to 2016 which should also increase demand for equipment this year. Beyond investment, we are also very focused on improving the return on our existing assets. As such we have continued to increase prices on the sale of used containers and expect by the second quarter of this year we are likely to report a gain on sales compared to the losses we have incurred in recent quarters. In March, we essentially broke even of used container sales and has since increased prices going into the second quarter. We are also seeking opportunities to increase per dime rates on low per diem leases that are expiring. We believe that with improved returns on the sale of equipment, higher utilization of the current fleet, higher lease rate renegotiation and the ongoing new investment, our earnings will accelerate in each of the following quarters. our aim is to reach annualized double-digit return on equity by the end of the third or fourth quarter of this year. Earlier this month, we renegotiated the delivery schedule of our multi-year railcar purchase program, deferring approximately 25% of our 2017 $95 million committed railcar investment into 2018 with most of the remainder being deferred to the third and fourth quarters of this year. This will help us to optimize our investment returns this year since the container market is currently providing better returns on investment than rail. We do believe that the rail market is improving. We have had success in entering into attractive lease renewals and a level of increase for rail equipment is increasing as rail velocity has declined due to increased energy related traffic and bad weather in the first quarter. The number of rail cars that carry sand for fracing has continued to increase and it is expected that all idle sand cars will come out of storage during the second half of the year. We expect there to be new rail car orders for sand cars which will take manufacturing capacity out of the system and likely increase demand for rail car types we have on order. We are already seeing some improvement in lease rates on some of the cars being delivered this year. Our logistics group faced some difficult market conditions in the United States during the quarter due to subdued overall economic activity and aggressive pricing from asset owning transportation companies. However, we continue to add new customers in volume and there continues to be growing cross-selling opportunities between container leasing logistics and rail. We think each of these segments benefits from the other and enhances the value to their respective customers. We expect that cooperation and momentum to develop further in 2017. In summary we believe we are very well positioned for what looks like a strong year for container equipment. We expect to continue to increase utilization and the benefits from improvement in new investment returns should result in improving quarterly results over the course of this year. I’ll now turn the call over to Tim Page, our Chief Financial Officer to review the financial results for the quarter in greater detail.

[Timothy Page:]

As we related in our earnings release, Victor further described in his comments we've seen a dramatic improvement in the fundamentals of our container leasing business. Total revenue in the quarter was 81.5 million, an increase of 5% as compared to Q4 2016 and an increase of 22% as compared to Q1 of 2016. Approximately 85% of the year-over-year increase in total revenue was driven by increased logistics revenue primarily as a result of our acquisition of two logistics businesses during 2016. Container lease revenue increased by 7% as compared to Q4 2016 and 3% as compared to Q1 of 2016. Included in container lease revenue in the quarter was a $2.2 million charge for per diem revenue reinsurance recovery related to the Hanjin bankruptcy. Absent this recovery, Q1 container lease revenue grew 3% versus Q4 2016. The increase in container lease revenue between Q1 and Q4 occurred primarily as a result of the increase in average utilization from 94.3% to 95.7%. The increase in utilization in Q1 is significant and it's a good indicator of the level of tight container supply as we generally see utilization declines in Q1. Utilization is currently at 96.9%, 1.2% better than the average for Q1. We expect utilization to continue to rise in Q2. While we have a strong customer order book for new factory equipment, the utilization increase in Q1 I just mentioned was largely driven by the lease out of depot equipment as there was limited lease-out of new equipment in Q1. We expect and are already experiencing an increasing pace of new container lease-outs in Q2, which when combined with increasing utilization of depot equipment will accelerate container revenue growth in Q2. Rail lease revenue of 8.0 million in Q1 was flat with Q4 of 2016. We expect Q2 rail revenue to be similar to Q1 while the rail market continues to face pressures as a result of an imbalance of supply demand for railcars. We have been successful in negotiating some new leases that will commence later this year and are cautiously optimistic that demand and the rate environment are beginning to improve. Logistics revenue increased 4% in Q1 versus Q4 of 2016. Gross margins improved from 14.9% to 16.7%. Most of the improvement occurred in March and we are optimistic that with somewhat positive overall economic trends combined with the organic growth [ph] initiatives we have implemented will lead to increasing topline growth in our logistics business. Depreciation expense in Q1 was 28 million, 0.5 million greater than Q4 of 2016. Included in depreciation expense in the quarter was a 1.2 million impairment charge related to a customer default. Adjusting for this charge, we would expect depreciation expense in Q2 to be similar or slightly higher as we begin to depreciate new container equipment that goes on lease. Loss on sale of rental equipment in Q1 was $0.9 million as compared to $4.7 million loss in Q4 of 2016. As a result of the improving utilization and aggressive disposition of used equipment in 2016, we are now seeing rapidly increasing used container prices, up over $225 in Q1 versus Q4, a 37% increase. our total proceeds from sales in the quarter were virtually the same as Q4 of 2016, but we sold about 25% fewer CEU. We expect to see a continuation of the trend of rising prices and improving gains on sales in Q2 and expect to realize a modest gain on the disposition of container rental equipment during Q2. Container storage expense in the quarter decreased to $2.3 million as compared to 3.6 million in Q4. Container storage expense is now running approximately $1 million per month less than at the same time as last year. Q2 container storage expense is expected to decrease again, with the current trend in increasing utilization. Handling and other expenses decreased in the quarter of 0.4 million due to lower repositioning costs and other costs associated with the higher level of sales activity we experienced during the second half of 2016. G&A expense in Q1 was 10.7 million as compared to 6.9 million in Q4. In Q4 there were several items related to - there were several items related to contingent consideration an incentive compensation that reduced G&A expense. Adjustment for these items, Q1 was basically flat with Q4 of 2016 and represents a run rate level for G&A going forward. Interest expense in the quarter was 11.7 million, 0.5 million higher than Q1, reflecting an increase in LIOR and increased borrowings in rail. Our weighted average interest cost for the quarter was 2.84%. our effective tax rate for Q1 of 2017 was 11.6% as compared to an average of 38.9% for 2016. Given the expectation that a larger percentage of our earnings in 2017 will come from the low tax rate container business, we would expect that the overall tax rate for 2017 will be in the 10% range. At quarter end, our total container fleet consisted of 1.2 million CEUs, 0.3% higher than at the end of the fourth quarter and 2.9% lower than Q1 of last year. our own container fleet was 1 million CEUs at the end of the quarter, 1% higher than at the end of Q4 and flat with Q1 of last year. We expect the fleet size to increase over the coming quarters as a result of new container investment and a decrease in the volume of used container sales. At the end of Q1, we had 379 million of book value of rail assets. We ended the fourth quarter with approximately 1.6 billion of container revenue assets, 1% higher than at the end of Q4 and 3% less than Q1 of last year. We invested a total of $74 million in Q1, 63 million was for containers, 11 million for rail cars. We currently have 54 million of container purchase commitments for delivery in Q2 and expect to purchase additional containers in the coming months. Based on current equipment costs and lease rates, these container investments are expected to contribute 25% ROEs over the next five years. We have contractual commitments to purchase $71 million of rail cars during the remainder of 2017, 70% of which is a Q4 2017 commitment. At the end of the first quarter, we had total fund to debt, net of restricted cash and cash held in variable interest entities of approximately 1.44 billion, flat with Q4. The amount of our undrawn rail container revolving credit facilities at the end of Q1 was approximately 533 million. That concludes our comments operator. Please open the call for questions.

[Operator:]

[Operator Instructions] Our first question is from the line of Doug Mewhirter of SunTrust. Your line is open.

[Doug Mewhirter:]

First, do you expect any more insurance claims payments, [indiscernible] I calculated about, it might be owed about 3 million and you got about 2.2 million. I don't know if you would expect anything to come in, in 2Q or 3Q.

[Timothy Page:]

We do expect additional insurance payment, this was an advance payment on the claim that we're allowed to get after six months of submitting an initial claim. We do expect it on the anniversary date that will submit the remainder of the claim and will get paid either in the third or fourth quarter.

[Doug Mewhirter:]

Tim, just I missed, you said - what was the net book value or rail car assets, again? I missed it when…

[Timothy Page:]

380 million of purchases or the 11 million of investment in the first quarter, total net book values 379 million.

[Doug Mewhirter:]

379, okay thanks. On the average yield, it looks like it picked up on average from fourth quarter to first quarter which is very encouraging. You probably still have a few of those super high priced leases rolling off from vintage 2011, 2012, but now you actually have some lower priced leases rolling off too. It sounds like you're getting some accretion on that. Based on all of those expiration, what's rolling off and rolling on, do you think you can improve the average yield based on what's coming on versus what's going rolling off.

[Victor Garcia:]

We do, we expect not only with what's coming off, what's going on, but the new investment should push up the average yield on the whole portfolio.

[Operator:]

Thank you. Our next question is from the line of Brian Hogan of William Blair. Your line is open.

[Brian Hogan:]

A lot of encouraging trend, macro and business specific sharp change on such a short period of time. And I guess one of the most eye popping comments that I saw you making, you made like the sharp improvement to a double-digit ROE third and fourth quarter. I guess the primary question is like what are the drivers to get there, I mean you reported on an adjusted basis $0.23 this quarter. And by my calculations, [indiscernible] report roughly $0.60 per quarter to get to that double digit. What are the main drivers to get to that $0.60, is it a lot a gain on sale, is it just a lease yields, just what are the puts and takes?

[Victor Garcia:]

We knew that obviously this is an area where investors have some interest, so we did provide a presentation on our website. If you look on Page 11 of our website, we tried to give you an estimate of how we expect some of the different line items to move and where we would expect them to be. These are all estimates, but we think it's a combination of new investment, higher utilization, repricing of leases, some -- the switch over from losses on equipment sales to equipment gains. And we think that those things are -- all of those dynamics are moving in that direction and we do think that the market's going to be tight, both for the sale of equipment as well as leasing of equipment such that there will be an upward bias in the in the demand for both types of assets.

[Brian Hogan:]

All right. I appreciate it. I'll take a closer look at page 11. I haven’t made it there yet. I also find it very encouraging that you said 20% ROEs in your current container investments and it was very encouraging. I guess with that confidence in the outlook and the stock trading below book value, substantially below book value, what are the thoughts about buying back stock.

[Timothy Page:]

We're always looking at what is the right opportunity in terms of what can we get on incremental investment as well as the value of our shares, because we still have an open possibility of repurchasing shares and we’ll continue to look at it.

[Brian Hogan:]

All right. On the lease yields, I guess several things here. On the recent decline on the price of steel, obviously is a headwind, but you see the strong demand, we have limited supply. A lot of puts and takes there. Are these lease yields sustainable at these levels or are they going to go higher? Obviously, with the peak season coming up, what are your views there?

[Victor Garcia:]

Okay. It’s a good question and I think it's something that is pertinent to where we are today. So if you've been following steel prices, certainly, they've crested and now they're coming down almost on a daily basis. The question becomes how much further will steel prices go. I would say, at current levels. We believe that the dynamics that we have in place will largely remain in place and that's because as opposed to last year, there is underlying demand for equipment. So there will be a need for new investment and the market is very tight in terms of supply and demand. And so I do think that the yields on investment will continue to be strong. I think that the container sale prices will continue to be strong because of the delta between the costs of a new container at current prices are significant enough that it still will create an upward bias on used container sales. So as to where we are right now, I think the dynamic is still the same. If steel prices were to continue to fall further and reach the lows of where they were 18 months ago, then I think the dynamic might be a little bit different. But certainly, we're seeing still strong demand for containers. We're expecting that the price of containers will be coming down, but not to the degree at which steel prices are coming down.

[Brian Hogan:]

Great. Very helpful. And then on the competitive front, I mean I know you mentioned it a little bit in your presentation that as well. Some competitors are constrained on their -- from a balance sheet perspective, but I guess can you kind of elaborate on what's going on in the competitive front, who's active, how competitive is it?

[Victor Garcia:]

I won’t go into specific companies because we don't deem that to be appropriate. But we’ll see -- what I will say is, we see a couple of other competitors in the marketplace. And so there's probably three competitors out there that we are competing for business. I think there's a dynamic that's occurring that came to ahead with the Hanjin bankruptcy. I think that that obviously created some constraints, but it also was on top of what we believe would be the result of over investment and over competition over the last two years where a lot of leases were done on what we would term uneconomic rates and borrowing money in order to do that and I think those balance sheet constraints are going to be longer lasting than the Hanjin effect will be, because when you put a container at an uneconomic rate for five years, you have to wait five years before you can reprice that asset. And it's a five year old asset at that point. So what you get is still uncertain. So I don't think that those cash flow dynamics are going to change over a quarter or two and that's why we believe that the market will continue to be constrained because the level of ordering will likely be more guarded than it was in the past.

[Operator:]

Thank you. Our next question is from the line of Helane Becker of Cowen and Company. Your line is open.

[Helane Becker:]

Thanks, operator. Hi, Tim. Thanks for the time. Just two questions I think. One is, did you say what you’re thinking about in terms of CapEx for the full year? I think you said 48 million in the first quarter and maybe 50-ish million for the second, but can we extrapolate that out for the full year then?

[Timothy Page:]

Well, we haven’t provided a lot of guidance. I think the last time we were asked about this in the last quarter's call, we said we would expect that we would be in line with prior years and prior years we've been in the $250 million to $300 million range. I would probably say those estimates are likely to go up, given what we're seeing in the demand and the opportunities. But we don't have specific guidance that we would provide.

[Helane Becker:]

Okay. And then the other question I had is, with the shutdown earlier this, I guess in March, right, the factories in the north had to close to convert over, have you seen that they've, a, come back on line, are people confident ordering and taking delivery of these containers if the paint is not going to come off and what are -- I'm assuming that that shutdown added to the tightness of supply, but can you just kind of give us a little update on that?

[Victor Garcia:]

Sure. Not all factories close. Some of them are closed retooling. Those that have closed for retooling or have reduced their production won't be back up at full levels until June. So that April and May will be constrained in terms of supply. As far as the quality of the manufacture and the pain, we spent quite a bit of time and we have our own team at the factories looking at all of the different production and making sure that the quality is as we expected to be. So we don't expect any issues with it.

[Helane Becker:]

Okay. And then are there other limitations to supply that would last throughout the year or would you say that's maybe the biggest one?

[Victor Garcia:]

No. I don't think the waterborne payments is the biggest restriction. I really do think that the biggest restriction will be that both in the broader leasing environment, balance sheets are constrained and I think that that constraint is going to really curtail investment and our customers because of their freight rate environment that lasts several years. Still would like to see more dependent on leasing rather than owning their own boxes. And as I said that one of the -- although there are other alternative sources of financing for containers in the leasing community, this sector is really the only sector that provides on demand inventory. And so that's part of the value proposition that we, as our company, provide to our customers is when they're looking for equipment, we have it readily available. There is no other financing source that could provide that or has provided that. So we think that that lack of on the ground investment could create some tightness as we get into the second and third quarter.

[Helane Becker:]

Right. Okay. That makes sense. Okay. And then my last question, this one I got earlier today from somebody, the consolidation in the shipping lines, among the shipping lines, does that wind up, I mean can you just sort of tell us how that works when they consolidate, do they just kind of scrap the oldest containers, do they become less focused on getting containers from you guys as they work through their maybe overabundance of containers, like how should I think about reading these stories about these guys consolidating and then knowing how it affects your business?

[Victor Garcia:]

Sure. Well, generally as a rule, we like more customers rather than fewer customers. So, consolidation is something that we've known for a long time is destined for the shipping business. But that being said, what we've seen amongst those companies that have consolidated so far or have announced some kind of merger is that the acquirers have tended to be more dependent on leasing than the company is being acquired. So in that sense, it's a good fortune the way it's played out, because I think it may create more opportunity on a combined bases. And so time will tell. As far as how they handle their own equipment, I would think -- I don't think there might be a difference of philosophy on how long they're willing to and how they operate their equipment. But the initial effect is they try to streamline their operations and try to get more use out of it, so there could be some efficiencies gained in how they use their equipment. But as that kind of plays out, it'll just be going back to the expected normal demand, incremental demand that they need for containers and whether they lease or buy more of their own, we’ll go back to what’s their corporate philosophy, do they want to own those boxes or they feel like their capital is very used elsewhere and would rather lease the boxes.

[Operator:]

Thank you. [Operator Instructions] Our next question is from the line of Donald McLee of Wells Fargo. Your line is open.

[Donald McLee:]

Hey guys. I just had one quick follow-up question on the container CapEx. I think you'd already pre-purchased about 57 million for H1 ’17. So how does that compare to the 63 million of investment in Q1. And then the $56 million commitment for Q2?

[Timothy Page:]

Okay. Well, between the two, we've committed and invested 110 million thereabouts. So that’s -- we're constantly looking at the market and ordering. So we would expect we're just going into what is typically the stronger part of the year. So we would expect to continue to increase our investment over the course of the next three or four months. Q2 isn’t over with from a delivery perspective. So we can still place orders and get some more equipment in Q2.

[Donald McLee:]

That's fair enough. And then one more quick one, just given the improvement in market conditions and then some of the balance sheet restrictions for your competitors, has that created any potential access to capital advantages that you might look to capitalize on?

[Timothy Page:]

Access to capital advantages, I’m not sure I understand what you mean.

[Donald McLee:]

Well, specifically in the debt market side, has there been any shift where kind of you guys aren't overcapitalized with purchases over the past two years where you might look to maybe more aggressively purchase boxes?

[Timothy Page:]

Well, we are, we are and we're being driven mostly by what the demand is and what the returns are. As far as financing, we have committed financing in place. So it's not an issue of whether or not we can get capital. We have the capital in place. It's really our view on the expected returns on the investments. And so far, they've been pretty strong. In terms of forward order book, we believe that we have the second largest forward order book of the container, lessor, so relative to our market share, we have been taking advantage of the position that we have to having the ability to invest.

[Operator:]

Thank you. Our next question is from Brian Hogan of William Blair. Your line is open.

[Brian Hogan:]

Well, a couple of follow ups. The logistics business, can you elaborate on the competitive environment there and then I guess the gross margins there is like 16.7%, a nice step up from the 14.9 in the 4Q. Is that a sustainable level? And then kind of with that, with the logistics business, obviously you changed the name of the business, what kind of synergies do you expect from that, what's your strategy there. Can you just kind of elaborate on the logistics business please?

[Timothy Page:]

Okay. The margins, we would expect to be at those levels you mentioned or maybe I would say just around those levels. It really depends on the composition of the different services we provide. We are looking to consolidate under our CAI logistics brand. We've consolidated one entity into there. The synergies and cross selling opportunities are occurring regardless of the brand name, we’re constantly sharing information about the services that our customers need and finding opportunities that all of these products then allow us to do it, including with our existing asset base. So that's as much as we'd like to talk about the opportunity on containers and the investment and the returns we’re immediately getting. I will say both what we're seeing on our rail business and our logistics business in terms of the customer acceptance, the name recognition, the opportunities that we're working on, it's a really very fulfilling thing because we can see the value that we're providing to our customer base and that's what we think will be the strength of our company as we move forward.

[Brian Hogan:]

All right. And then shifting to the rail business, the yields there have kind of come under pressure, but I think as I saw on a slide in your presentation there, they might be shifting a little bit, particularly with the sand and the grain demand, I guess what it your strategy there? Have you shortened terms as rates have come down or it's your strategy there?

[Victor Garcia:]

Well, we're trying to work through what is a downward trend in the market or a downturn in the market. I would say one, we're continuing to look at the investment coming in and the types of equipment that we could -- that are needed in the market in trying to find the best opportunities. I will say with our deferral of this, it gives us a little more time for the market to improve. I do think it's improving. We aren't seeing more inquiries all the time from customers and there's a number of markets within the rail car leasing segment and we're trying to serve those markets. We have been willing and have held on with the units in storage, waiting for a better market opportunity, particularly as we expect in the second half of this year for the car types that we have that the market will be improved. And so it's better for us not to lock in the lease rate and just hold the equipment idle for a few months. But it’s -- even with that, we’re getting customer wins. It's heartening to us that we're becoming more and more known every quarter in the market with the customers, with the suppliers. We have a lot of product to offer. So it's a steady growth business. We think the value of the franchise will be proven over time. It's a customer by customer attainment and we're gaining a very good reputation as a company that is investing in its fleet, giving high levels of service and attention and frankly in that railcar leasing space, I don't think that there are a lot of players out there providing that kind of attention.

[Brian Hogan:]

Appreciate that. The last one, you mentioned the 2Q gain on sales to be like -- to be modestly positive. I guess going into the back half of the year, what are your expectations on those?

[Victor Garcia:]

Brian, it's really hard to say in part because look, we think that the sale prices should continue to rise and we're positioning our assets even in this market for better markets and so we're trying to put equipment into the highest sale markets we can. The question will really become how much equipment is available. We have less and less equipment to sell. Customers are holding on to more and more equipment. So the volume of equipment that we're going to have to sell is a big question mark. So we're -- we think that the trend will be a positive trend in terms of a gain. The significance of that will be how much equipment do we really have to sell.

[Operator:]

Thank you. And that concludes our Q&A session for today. I’d like to turn the call back over to Mr. Victor Garcia for any further remarks.

[Victor Garcia:]

Thank you everyone for joining us on our first quarter call. We look forward to reporting on our second quarter in a few months. Thank you.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone, have a great day.