CAI International, Inc.
Q4 2017 Earnings Call Transcript

Published: 15 Feb 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the CAI International’s Fourth Quarter 2017 earnings conference call. [Operator Instructions] As a reminder, today’s conference is being recorded. I would now like to turn the call over to Mr. Timothy Page, Chief Financial Officer. Sir, you may begin.

[Timothy Page:]

Good afternoon, and thank you for joining us today. Certain statements made during this conference call may be 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 of the Company made during this discussion regarding its views, estimates, plans, outlook or strategies for the future. I'll now turn the call over to our President and Chief Executive Officer, Victor Garcia.

[Victor Garcia:]

Thank you, Tim. Good afternoon, and welcome to CAI's fourth quarter and year end 2017 conference call. Along with our earnings release today, we have also posted on our website under the Investors 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 the 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 fourth quarter of 2016. Container lease-related revenue increased 33% from the fourth quarter of 2016, as a result of investments in our own fleet and higher utilization. Railcar lease revenue increased 12% as compared to the fourth quarter of 2016 and 24% compared to the third quarter of 2017. During the quarter, we reported net income of $36.6 million or $1.81 per fully diluted share. As stated in our press release during the quarter we recorded a onetime tax benefit related to the reduction in U.S. corporate tax rates of $16.9 million and a non-recurring non-cash tax charge of $1.1 million. Excluding the net tax benefit, our net income for the fourth quarter was $20.7 million or a $1.3 per fully diluted share, an increase of 18% from the third quarter of 2017. The increased profitability came primarily from our container leasing segment as a result of continued high utilization of approximately 99%. Higher gain on sale of container equipment and additional investment in new container related assets. Demand for new containers has remained very strong, and we have not experienced the usual decline in utilization that occurs during the seasonally weaker months beginning in December and continuing into the first quarter. For 2017 we invested $487 million in new related equipment and expect 2018 to be a strong demand year based on the ongoing high utilization of the existing worldwide fleet and expect to continue strengthen the world economies, particularly in the United States and Europe. However, while demand is expected to be strong, we have seen additional competitors active in the market, which has resulted in some decrease in the returns on new investment. The first quarter is typically not the highest demand part of the year, so it is uncertain how aggressive our completion will be on new investment as the year progresses. Our rail segment continues to work through a difficult market environment. However, we experience increased activity and increase for our equipment in the fourth quarter, and we believe that the market has begun to improve from more categories of equipment. Lease rates have remained below our target level, but we are seeing some improvement and are looking for opportunities to increase lease rates on equipment available for lease. During the fourth quarter we leased out 243 new rail cars and have commitments to lease out a further 564 new rail cars in the first half of 2018. We believe rail velocity has slowed on the U.S. rail road network due to weather event and increased energy related traffic. We believe that this along with cost containment efforts by the railroads should create increased demand for equipments. Moreover, we believe the increased economic activity in 2018 from the corporate tax reduction and regulatory changes implemented during last year, should create increased demand for rail cars. Our logistics business reported a loss for the quarter, primarily due to our truck brokerage operation. In the third quarter we changed management of the unit and began integrating it with our domestic intermodal business. Although out results are disappointing, we have revamped the group with new leadership and expect to improve results in 2018. Our results in the fourth quarter were also affected by tropical storms that occurred in the Southeast during the quarter. Overall, however, we have seen a very tight market for logistic services due the improving economic conditions in the United States and a tightening supply of trucking capacity as a result of the implementation of electronic logging. We expect 2018 to be a very strong demand year for containers as the world economy continues to expand and lessors continue to operate with high utilization. Offsetting that positive expectation is the uncertainty around increased competition from container equipment lessors who are now active in the market. Moreover, we expect lower gain on sale of equipment this quarter due to a lack of equipment availability. We also expect interest costs to increase this quarter and throughout 2018 due to the ongoing equipment investment we are making and more importantly due to expected increases in floating and fixed interest rates. We are expecting to refinance more of our debt from floating interest rates to fixed interest rates this year to mitigate the potential for higher interest rates later in the 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:]

Thank you, Victor. Good afternoon everyone. Total revenue in the quarter was $94 million, as compared to $90.2 million in the third quarter, an increase of 4%. As mentioned by Victor, we recognize the onetime net tax benefit of $15.8 million in the quarter related to the reduction in U.S. corporate tax rates as a result of the Tax Cuts and Jobs Act and the nonrecurring non-tax charge. Excluding this net tax benefit net income in the quarter was $20.7 million as compared to $17.6 million in Q3, an increase of 18%. Excluding the impact of the net tax benefit, net income per fully diluted share in the quarter was $1.3, compared to $0.90 in Q3, an increase of 14%. The annualized run rate return on equity based on the average equity in the quarter was approximately 15.6%. Consistent with the first three quarters of this year the significant incremental growth of net income in the fourth quarter of 2017 was driven by the strength of our container business. I'm going to focus most of my remaining comments on the container results for the quarter and what our expectations for the container business are for the coming quarters. Container lease revenue was $65.6 million in Q4, an increase of 6% as compared to Q23 The increase in container revenue occurred primarily as a result of several factors. First, the average utilization of our own container fleet increased from 98.2% in Q3 to 99% in Q4. We expect that average utilization in the first quarter of 2018 will exceed the 99%, as utilization today stands at 98.2%. Second, we benefited from a full quarter's worth of per diem revenue from the approximately 109,000 TEU of new factory equipment we leased out over the course of the third quarter; third, we benefited from a full quarter's worth of per diem revenue from a $36 million portfolio of used containers that we acquired during the third quarter; and lastly, we leased out approximately 30,000 TEU of new factory containers in the fourth quarter with a book value of approximately $58 million. While we expect to continue revenue growth in the Container business, there are some headwinds that will impact the bottom line leverage we are likely to realize. Firstly, we had a gain on the disposition of used containers in Q4 of $2.8 million, which was $1.1 million more than the gain we realized in Q3. Although average sale prices remained strong, we anticipate it will be difficult to maintain the volume of sales in future quarters due to the lack of equipment available for sale. As a result, we expect our gain on sale to reduce in the first quarter of 2018. Second, as a result of the improvement in utilization, we've seen monthly container storage costs drop to only about $100,000 in December of 2017. That's a decrease of $1.8 million or 94% as compared to what it was in March of 2016. We expect container-related storage costs to decrease a little bit more in Q1 but the rate of decrease will be less because we're approaching full utilization; third, because the vast majority of our year-to-date pretax income has been generated by internationally sourced container operations, which is subject to a low U.S. to low non-U.S. tax rates, our consolidated tax rate, excluding the one-time items mentioned earlier, had decreased to 1.7%. We're expecting that effective tax rate for 2018 may increase slightly. Overall, consolidated G&A expense in Q4 was $11.5 million, excluding the credit related to contingent earn out considerations of $1.6 million, G&A expense in Q3 was $12.4 million. A $0.9 million quarter-to-quarter decrease in G&A expenses related primarily to a reduction in bad debt expense. We expect a run rate level for G&A expense in 2018 to be in the range of about $12.5 million per quarter. Interest expense in the quarter increased to $15.1 million from $14 million in Q3, just primarily a function of the impact of the Fed rate increases during the year and their impact on floating rate portion of our debt and $119 million increase in our funded debt as a result of the investment we made in new containers. Interest expense in the coming quarters will increase as total debt levels increase, as we pay for container investments we made in Q4, and will also increase with increasing LIBOR. We are planning to increase the level of our fixed-rate funding to take advantage of the low differential between our current floating rate funding costs and the current fixed yields available in the long-term markets. During the quarter, our own container fleet increased approximately 21,000 CEUs as compared to the end of Q3. For the full year, our own container fleet has increased 195,000 CEUs or 19%. At the end of Q4, we had approximately $2.3 billion of revenue earning assets, consisting of $1.8 billion of containers and $441 million of railcars. We invested approximately $127 million in Q4, $80 million of which was in railcar – was in containers and $47million of which was in railcars. At the end of the fourth quarter, we had total funded debt net of restricted cash and cash held in variable interest entities of approximately $1.6 billion, an increase of approximately $120 million from the end of Q3. At the end of December, the undrawn amount available to us under our container-secured revolving credit facilities was $447 million, undrawn rail commitments were $228 million. During the fourth quarter, we issued approximately 890,000 shares of common stock through an aftermarket offering, receiving net proceeds of $29.1 million. That concludes our comments. Operator, please open the call of questions.

[Operator:]

Certainly. [Operator Instructions] Thank you. And our first question comes from the line of Bob Napoli with William Blair. Your line is open. Our first question comes from the line of Michael Webber with Wells Fargo Securities. Your line is open.

[Michael Webber:]

Hey good afternoon guys. How are you/

[Victor Garcia:]

Good.

[Timothy Page:]

Good.

[Michael Webber:]

Hey Victor I wanted to just start out first with maybe some of your comments around the slightly more competitive environment in 2018. We've been talking about this in general for the space for the, I guess, the better part of six months. I'm just curious, I know it's the central time of the year it's probably a bit tougher to really gauge. But does it feel materially different, say today, than it did in November, December? Maybe give us a bit of a more of a real time feel on who you're bumping into when you're looking at deals and to what extent you think, specifically, some of the public – the public players are back in the market but the Chinese, the larger Chinese players, whether they are out and really active in the market?

[Victor Garcia:]

Yes, so I'd say we see more cost before, not every – we don't see all of the market participants aggressive in the marketplace, but we do see a couple of additional players that are much more aggressive and it's kind of reflected in the market. I wouldn't say that the rates have gotten to a point that being unattractive overall. But, certainly, a lot more compared to than they were in the better part of last year.

[Michael Webber:]

Sure. And, I guess, maybe thinking about those rates and even looking at kind of the asset values, that kind of 21 50 I guess when I look at maybe slightly more competitive rates and asset values that are roughly in line – maybe taking a slight step down from Q4. How much of that is, you think, a function of just the thin tapes? Right. If I think about asset values and maybe rates or yields, coming down in lockstep, is that a function of manufacturers trying to pee that a bit and maybe the fin tape within pricing. I guess how real are these data points just given where we are seasonally?

[Timothy Page:]

Well I think on the production side, I think it's not a thin line. I think there has been a fair amount of ordering and leasing out. We've actually seen, relative to other periods, a more active first quarter than we would have seen otherwise. So I think the pricing for containers, which is roughly speaking, $2,150 to $2,200 on a 20-foot equivalent is a good solid number. It may actually increase over the course of the year if demand materializes the way I think we think it likely will materialize because I think the manufactures will be in a position to potentially raise crude of prices. And there has been a fair number of deals that have been done. And like I said, we've seen a couple of players who weren't active last year, who are much more aggressive than where the market was a year ago.

[Michael Webber:]

Got you. Okay. Just Tim a couple from me and I'll turn it over. You raised pretty material capital by [indiscernible] offering in Q4, particularly given the size of the company. Just curious, when you think about your capital base here and the opportunities that you think is evolving kind of in front of you in 2018, how comfortable do you feel, maybe if you look at your capital base and organic cash flow and the remainder of that authorization, in terms of your ability to execute on everything you want to look at?

[Timothy Page:]

Well, ultimately, it all depends on how robust the market is the demand for the equipment. We feel comfortable right now, but if the market is strong then we need to evaluate whether we need additional capital to take advantage of the opportunities that market would be presenting.

[Michael Webber:]

If you were to look at maybe a year that was similar in terms of kind of total CapEx, how would you feel heading into that kind of a year with your current mix?

[Timothy Page:]

A normal CapEx year, we don't believe that we would need to raise any capital.

[Michael Webber:]

Okay.

[Timothy Page:]

I think I'm extremely bullish on the potential demand for this year. I think it has the potential to be one of the true breakout years, and I say that because of the starting point for which we're at.

[Michael Webber:]

Okay.

[Timothy Page:]

And the fact that that we are seeing good increased economic growth, particularly in the U.S. and Europe, and if you put those two factors in place, we think it's going to have the potential to be a standout quarter – a standout year. And in that case, we would want to take advantage full advantage as much as we can of that situation. But the opportunity we have is that the way we've decided to raise capital, we can meter it out if assuming the right – the appropriate price is there to meet our ongoing demands without having to dilute our capital base.

[Michael Webber:]

Right, okay, that’s helpful. I appreciate that. And then Tim just on Slide 11, you’ve got your mix of floating versus fixed. And you talked about potential kind of counteracting modest headwind there. Can you give – is there an ideal ratio we should be thinking about in terms of what you'll be looking to synthetically fix that if you can?

[Timothy Page:]

Well, we’re now in the range of 60% float, 40% fixed and certainly I think we would like to flip that and possibly go a little – maybe a little bit more fixed.

[Michael Webber:]

Great, okay, that’s helpful. I will turn it over. Thanks for the time guys.

[Timothy Page:]

Thanks.

[Operator:]

Thank you. And we do have a question from the line of Bob Napoli with William Blair. Your line is open.

[Bob Napoli:]

Thank you. Can you hear me?

[Victor Garcia:]

Yeah. Hi, Bob.

[Bob Napoli:]

Hi. So just on the – I mean, obviously, last year was one of the better competitive environments that you've probably seen that happened quickly, and you're putting on assets that probably returns above your targets, I would guess. With the increased competition are the ROEs still in your target – are they in your target range or below your target range? I think you would put out a pre-tax ROE target of 20% to 25% for container and 16% to 24% for rail. And I think rail is below that it seems to be getting a little better. But how are the – how much of the returns adjusted?

[Victor Garcia:]

Well, I don’t think that's the returns that are being out there today that we would see 20%-plus ROE kind of returns. I think we’re talking something probably closer to the mid-teens ROEs.

[Bob Napoli:]

Okay, and that’s on an after tax basis and I guess you only have a 4% tax rate.

[Victor Garcia:]

I mean, it depends on the way – on let’s say we’d just really look at on a pretax basis but the effective tax rate is pretty low.

[Bob Napoli:]

Right. Okay, and then the railcar business, is there – I mean, you’re seeing improvements. I know it’s been tough and I know you have a lot of rail equipment on order. Is that business at a – I mean, will that – can that get to a double-digit ROE on a run rate basis, on a pretax basis this year?

[Victor Garcia:]

Well, this year, I don’t know about this year, but certainly as we kind of target that we expect it to be in the low teens after-tax. So, I mean, what’s encouraging is that we are getting a lot more activity than we were before, multiple increase for equipment. We are starting to push up rates where we think there is the opportunity and particularly since our available equipment is coming down. And so, we’re pretty encouraged by the improvements that we’re starting to see there. It’s doesn’t change overnight, but still, a fair amount of – a lot of competition out there in available equipment. But we are seeing on more equipment types better returns.

[Bob Napoli:]

Okay, and just on the ATM, the capital you raised at a nice premium to book value, there's lots of demand. I mean it makes sense to raise equity when you’re getting high ROEs, less sense when the ROEs come down. So I would – and certainly stock having sold off and going now your book value is $27 – $27.50, it’s a nice increase in book value. I would imagine that you would pull back on that ATM if would see a tighter competitive environment and with the stock being closer to book value?

[Victor Garcia:]

Well, we’re not going to comment on specifics about what if anything we’re going to issue. But I will say clearly we’re going to look on all of those factors that you just mentioned our share price what is trading for, what the market opportunity is, what the market investment return is. So, we’ll take all of those things into account. I mean, we – two years we’re buying back shares at high single-digits or low double-digit prices. So, we’re very conscious of trying to maximize shareholder return and we will continue to do that.

[Bob Napoli:]

Thank you. I appreciate it.

[Operator:]

Thank you. And our next question comes from the line of Helane Becker with Cowen. Your line is open.

[Helane Becker:]

Thanks, operator. Hi, guys. Thank you for this time.

[Victor Garcia:]

Hi.

[Helane Becker:]

Hi. So I just had a couple of questions. And my first question is on Slide number 12 where you have half year debt maturity coming due in 2020, so they go current in a year from now. And I know it’s still a long time away. But are you thinking about as we go through the year potentially refinancing those early?

[Victor Garcia:]

We’ve had – I mean the facilities that comprise the majority of that, our facilities that we have had in place since almost the inception of the company, so we have some very large revolving credit facilities, but to your answer your question, specifically, yes. We’re looking at different opportunities to turn some of that exposure out as well as discussions with lenders about extending that those underlying facilities further out.

[Helane Becker:]

Okay. And then in terms of increased competition, have you seen anything out of the HNA Group SeaCo. The HNA problems have been well reported and I am just kind of wondering if they spin back in the market or they’re still away?

[Victor Garcia:]

We hate commenting about specific competitors, but to answer your question specifically we have not seen them being extremely active in the marketplace.

[Helane Becker:]

Okay, thank you for answering that. The other thing I was wondering if I notice that two big shipping companies, I think Evergreen and Yang Ming ordered like 20 ships recently each. And there seems to be almost 100 on order. And as you know, Victor, I don’t cover that shipping side, so I am not sure about the lead times for ship. But I am just kind of wondering as you think about those ships coming in, does that cause – I mean obviously, they’re going to need containers for container ships. Does that cause demand – or when does that demand starts to materialize? I guess this is my first question. And my second question is obviously container leasing companies will see a big part of that or does that wind up leading to an overcapacity of situation?

[Victor Garcia:]

Well, we always see one of the issues related to shipping has been that there's been relative to demand is many times where there's an over ordering of shipping – of ships, relative to when that demand comes in. It is a growing overall business and so it’s hard for our customers to gauge exactly how that’s going to be and who else is going to order. The order book has increased. The companies you noted have announced that they are going to increase their specific ship orders. For some of these guys it’s important because you have got to keep your cost down and a lot of my ordering in some of the very large ships. So in order to stay competitive, you need to order those big ships. They’re also part of alliances and I'm sure that there are agreements on contribution of certain amount of capacity into those alliances. We do look at the implications for credit when we see our customers making big obligations like that. What we also have seen over time is if when the market appears to be oversupplied, they have historically delayed the actual delivery of some ships and so to try to wait that out. It doesn’t create an oversupply if we talk about that term generally in containers. Well, when there is an oversupply of ships, it does not necessarily mean that there is an imbalance in containers. So the order cycle on a ship could be up to four years and on containers it’s four to six weeks. So a big difference in how have to gauge as an industry the expected supply and demand.

[Helane Becker:]

Gotcha. That’s really helpful. Thank you. And then my last question is just on the logistics comment, I don’t know if you made it or Tim made it with respect to changing out the logistics leadership. I feel like that was something you talked about kind of mid of last year. Was that just in your comment regarding all 2017 or just something specific happened in the fourth quarter?

[Victor Garcia:]

No, we did change our leadership of our truck brokerage operation in the middle of the third quarter. We’re pleased with the new leadership team we have in place and the direction it’s going, but it takes a little bit of time. So we’ve had – we continue to work through to rebuild some of the business that we have prior earlier in the year. But there is nothing really new from what we have talked about last quarter. We do expect 2018 to be a better period. We are gaining momentum in our domestic intermodal business and the same leadership that has been leading that is leading the truck brokerage operation. We’ve been very closely involved with some of the decisions that are being made there and I am pretty optimistic that not only will that be a growing segment for us, but strategically will continue to gain an importance.

[Helane Becker:]

Okay, and last question I promise. With respect to the returns, I think you said the containers were whatever $2,100 to say $2,300. Are you seeing a decline in like the 12% returns that you are getting? Is that what you’re referring to? Or I am not sure I understood that.

[Timothy Page:]

I didn’t say anything about 12% returns on containers. I think what…

[Helane Becker:]

No, I made that up.

[Timothy Page:]

Okay.

[Helane Becker:]

I think I've heard off.

[Timothy Page:]

All right, where I think we look at where returns are now and it’s all based on somewhat investments later on. But I think we’re looking at return on equity in the mid-teens, which is not a bad return.

[Helane Becker:]

Okay.

[Timothy Page:]

And so it’s acceptable, but it’s not quite where it was last year.

[Helane Becker:]

Gotcha. Okay, thanks very much guys. Have a nice day.

[Timothy Page:]

Thank you, thanks.

[Operator:]

[Operator Instructions] And our next question comes from the line of Doug Mewhirter with SunTrust. Your line is open.

[Doug Mewhirter:]

Hi, good evening. The first question about the railcar business. Just sort of numbers related, you have been saying how it’s been kind of a soft market and utilization was down sequentially. But it appears unless I have my numbers wrong. It looks like there is a nice sequential uptick in revenues despite a decrease in utilization and there wasn’t a ton of CapEx. So is that more of a timing issue where maybe last quarter was back loaded and this quarter was front loaded or is there anything else going on there?

[Victor Garcia:]

It’s a little bit of a combination of some of the new cars that have gone out. And also we had end of lease charges that that as equipment got returned. We charged customers for repairs and things like that. So there's a combination of factors in that number.

[Doug Mewhirter:]

Okay, that’s helpful. Thanks. And my second and final question if you look at the returns on the containers and then you have to give specific numbers, but that seems to be like a revenue yield. Would you characterize these sort of lower returns as still at or above your portfolio average blended yield and also how would that relate to what the yields on the container leases that are expected to expire in 2018?

[Victor Garcia:]

I don’t have that much expiring in 2018. But as far as the lease rates on average, you’re talking about yield and not absolute leases, absolute per diem. As our average age of our fleet is about 6.5, 7 years old, when you have a mid aged fleet like that like everybody does, the revenue yields are higher and that’s the normal function of the leasing. So in any market, our new leases right on new equipment tends to be on a lower revenue yield than what it would on the average for the portfolio. So that’s not any different. So as far as I would say we’ve probably seen a something in the order of like a 10% decline in lease rates on a yield basis from where we work for.

[Doug Mewhirter:]

Okay, thanks. And then I guess maybe reframing the question, so – with the CapEx – never mind that’s all my questions. Thanks. You answered that.

[Operator:]

Thank you and this concludes today’s question-and-answer session. I would now like to turn the call back to Mr. Victor Garcia, President and Chief Executive Officer for closing remarks.

[Victor Garcia:]

Great. Well, we appreciate everybody being on the call. We were very pleased with our results for the quarter and we’re optimistic about the coming year and we look forward to reporting our first quarter results in the coming months. Thank you.

[Operator:]

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