2021 Guide to Equipment Leasing: The Elephant in the Room Takes LeaveWritten by David Nahass, Financial Editor
RAILWAY AGE, JUNE 2021 ISSUE: Welcome to the 2021 Guide to Equipment Leasing. Let’s start out by addressing the space in the room left by the exiting elephant: The U.S. economy and its residents clearly are looking forward to the end of the pandemic era and the opening of the economy.
In anticipation of growth and expansion, companies are looking to build up inventories while trying to manage congestion at the ports of Los Angeles and Long Beach. Commodities (including lumber), although gently pulling back from recent highs, have been surging. Rail loadings have risen above 2020 levels (how couldn’t they?), but languish below 2019 levels (which were lower than 2018).
For the 2020 Guide to Equipment Leasing, in the heat of the pandemic, three operating lessor executives answered a few questions about the current state of and future of operating leasing and the railcar market. As the world rolls out of the pandemic, the same three executives answered similar questions to see how their point of view may have changed in the past 12 months. The participants are Jeff Edelman, President, Infinity Transportation; Greg Schmid, Managing Director-Rail, RESIDCO; and Jeff Lytle, President, Rail Division, CIT. Here are the questions, and their answers:
• How has the lease market changed in the past 12 months? Will this trend continue? For context I am thinking about lease rates, railcar demand, the impact of steel and scrap prices and the fact that general freight loadings (except intermodal), while certainly better than 2020, are still below 2019 levels, which was a down year from 2018.
Edelman: There has been an acceleration year over year with respect to demand, pricing and inquiries. A year ago, I think everyone in the market was concerned with the pandemic and how long it would last, and worried about managing the downside. There is a lot of pent-up demand that has resulted in significant activity so far this year. The scrap and steel markets have spiked and led to opportunities; however, it may offer mixed results in time should pricing persist. On the one hand, this will lead to an acceleration of retirements for aged, impaired and obsolete cars, which we view as a positive. However, the velocity in these markets makes it difficult to project price escalators for steel and scrap surcharges tied to new car manufacturing, which may mute a significant build cycle and recovery.
Schmid: The market has improved dramatically in 2021. Re-stocking of shipper inventory will take time, so we predict an improving market for railcars into 2022. Railcar demand as well as lease rates are well above levels from a year ago. Demand is certainly outstripping supply in numerous commodity types. The percentage of railcar scrapping will probably be double that of normal levels this year, assuming scrap continues to be above historic levels. Legacy railcars should continue to see improved lease levels because new car costs are higher than normal. The pandemic has also reduced some new car builders’ capacity because of plant shutdowns as well as personnel shortages. PSR is still a long-term concern for lessors, however.
Lytle: A year ago, there was great uncertainty about pandemic impacts, so it’s encouraging to see how much markets have recovered since then. While certain sectors remain challenged, we’ve seen improvements in multiple areas—notably in covered hoppers (excluding small cubes), railcars serving the steel industry, and certain tank car types. Despite the challenges, I believe the lease market still has room to run as the railroads pivot to growth. Steel and scrap prices may impact how customers think about alternatives to their current fleet. With new railcars becoming more expensive, I would expect lease rates for existing railcars in some markets to reprice favorably from an owner’s standpoint. Higher scrap steel rates also may drive some car owners to accelerate their scrapping activity, which could tighten supply and present attractive replacement opportunities for car owners in certain markets.
• As a result of the pandemic, are you seeing any fundamental changes in the lease market?
Edelman: I think we are seeing immediate high demand driving things right now. I don’t believe it’s a fundamental change. Rather, it’s a positive cycle, with the question being: How long it will last?
Schmid: We really haven’t seen any fundamental changes. However, in the short term, the marketplace appears to be in a robust phase. We see it more as market normalization.
Lytle: The pandemic tested car owners on their ability and willingness to withstand the downside of the cycle. We are watching closely as other car owners consider how to navigate from here. I anticipate there will be investment opportunities for both new and existing rail equipment and portfolios during the rest of this year and beyond.
• What are you feeling about the future of railcar leasing? Is rail a growing business?
Edelman: Our team is optimistic about the future of railcar leasing, but also realistic with respect to yield, maintenance and administrative costs and market volatility. While I am sure there will again be large build cycles over time, I’m not sure that reflects a growing business environment. There are car type retirement trends on the horizon. However, it is unlikely there will be a one-for-one replacement due to modal and market shifts, elevated manufactured pricing and efficiency initiatives, and consolidation with railroads.
Schmid: The railcar leasing business is a mature business, with numerous new entrants in the marketplace competing to deploy capital in large amounts. The railroads have become much more efficient through PSR and other initiatives. PSR over the longer term will shrink the number of cars needed in the industry, but hopefully the railroads will begin to be more aggressive in getting new lanes of opportunity.
Lytle: Once again, we’ve seen the importance of being well capitalized to withstand the down cycles, and to execute on growth opportunities. While I don’t think all railcar leasing companies will grow, I do see growth opportunities for those with patient capital and a relentless focus on long-term customer relationships.
• As a result of the pandemic, do you see any changes in the way companies will address their future railcar needs?
Edelman: The lesson of the pandemic for shippers may be the value and flexibility with leasing vs. ownership. Assuming a diversified lease expiration profile, shippers and railroads have the opportunity to trim the fleet in challenging times. As long as lessors follow the same approach in managing expirations, both parties have the opportunity to manage through challenging times.
Schmid: I don’t think so. There is a possibility that railroads and shippers may increase their percentage of leased vs. owned fleets in order to retain maximum flexibility. The railroads have been encouraging shippers to get their own cars, if not part of their (the railroads’) core fleet demographic, but this relates more to PSR than to the pandemic.
Lytle: Several new companies are employing what I would call asset-light business models. While there may be some interest in that approach, we know customers often need equipment quickly. There’s simply no substitute for your long-time, trusted partners when it comes to fulfilling that critical railcar need. We spend a lot of time in front of our customers to understand their railcar needs so we can position our portfolio to serve them best. Responsiveness is critical to our customers, and we design our commercial processes to deliver fast results.
INFRASTRUCTURE BILL MERRY-GO-ROUND
The Biden Administration came out guns ablaze in late March with a $2.3 trillion infrastructure bill. There continues to be an ongoing debate in Congress on a partisan level about the size of the bill, the impact on corporate tax rates, the lengthy repayment term (15 years!), and on the scope and priorities of the total proposal.
While there is a ceiling ($2.3 trillion) and a floor ($928 billion from House Republicans) between competing proposals, the broad gap in amount remains a concern. Usually, goal posts suggest that a deal is at hand. With such a wide gulf between the posts, and an incredibly diverse and somewhat divisive set of priorities, the resolution looks a little fuzzy right now. However, other than continuing some current grant programs, freight rail will not receive any major direct benefits from anything falling into the infrastructure bucket.
Best hope for rail to benefit from such government largess? An increase in loadings in commodities used in work approved by the bill. Think aggregates, cement and finished steel. That’s good news. However, stuck in the craw of railroad management is the premise of subsidizing—through higher corporate taxes—government infrastructure projects and technology (e.g., electrified over-the-road vehicles) that compete against rail for freight dollars.
HOT ROLLED STEEL SHAKES UP NEW CAR PRICING
The increase in the price of hot rolled steel, which has soared in 2021, is heavily impacting pricing in the new railcar market. Originally thought to be a runup with a slow decline, indications are that today’s high price runup may have some longer-term grip to it. Prices have effectively tripled since August 2020 and are expected to stay in a range suggesting a 2x increase until the middle of 2Q2022. Railcar purchasers got a bit of sticker shock when prices reset to adjust for higher commodity costs. Some purchasers are seeing increases of 15% in the cost of a new railcar.
Why does this matter, if you’re not in the market for a railcar right now? The railcar-purchaser-friendly cocktail of low steel costs, low interest rates and weak demand has held lease rates down for some time. While rates have not started to increase yet (see “Around the Market,” to follow), railcar owners and manufacturers could see an improvement in lease rates driven by increasing new car costs. Historically, used car values and lease rentals loosely track the new car market. Shippers accustomed to lower rates that never seem to increase might look to lock in today’s rates before the impact of steel pricing hits the balance sheet.
In June 2011, your erstwhile author penned a small portion of the Guide to Equipment Leasing under the tutelage of the late Anthony Kruglinski, Railway Age’s previous Financial Editor. One of the great things about North American rail is that, every so often, something old becomes something new. Back in 2011, scrap prices were around the same range, $400-$425 per ton, that they are today. In that piece in 2011, it was noted that scrappers were on the hunt for more scrap due to increasing foreign demand.
Fast-forward to 2021, and the market for scrap, while equivalent to 2011 in price per ton, reflects a completely different set of market factors. Post-pandemic and following a period of rental weakness and the crashing of the frac sand and coal markets, the 2021 market is edging on being fully supplied, even as scrap rates remain taut and motor vehicle manufacturing has decreased due to the crisis in microprocessors. Don’t blame the infrastructure bill (yet). Anticipation of the global economic rebound (including demands for finished steel) is driving export demand from China and Turkey. That is having an impact on domestic prices for steel producers operating electric arc furnaces. They rely on scrap for their feedstock. While high rates are the norm for now, don’t hold out for stability at these levels or even for $500 or $600 per ton of scrap. Follow the words of one expert who said, “The market will come down eventually. I wish it wouldn’t … I’m selling my scrap.”
AROUND THE MARKET
The surge in scrap and finished steel has not yet equated into a surge in lease rates. While there have been some improvements in certain markets, others continue to scuffle as rail looks to find its footing. Here is a summary of what’s happening around the market:
Coal Cars: While coal loadings have actually gotten up off the mat, lease rates have not followed. Net rates continue to languish below $100 per car per month (PCPM), and full-service rates are in many cases not high enough to cover the cost of maintenance. With aluminum prices stepping up along with ferrous scrap, an aluminum gondola car can be scrapped for about $12,000 (except freight charges). Look for continuing exits from this market by investors as the writing on the wall about the future of coal darkens daily.
Covered Hoppers for Sand and Cement: These are in competition with coal for the worst market today. Here again, scrapping has been taking place, but the oversupply is so significant that it’s drops in the bucket. Lease rates are low here: double digits, net and full. There isn’t an infrastructure bill big enough to revive this market. More pain ahead.
Covered Hoppers for Grain: Loadings continue to surge upwards above 2019 levels (but still below 2018). There has been some scrapping of older cars and some ordering of newer cars (CN recently ordered 1,000 cars from Trinity). 4,750cf full-service rates are low- to mid-$200s PCPM, which is up from pandemic lows. Jumbo cars are in the mid- to high-$300s, full-service. These rates might slow the scrapping of cars, even at today’s rates.
Covered Hoppers for Plastics: This market remains somewhat oversupplied by a mix of used equipment and by continued new deliveries for service in new projects still under production. Parity seems a ways off at the moment, with lease rates on newer cars sub-$500 full (sub-$450 net). Smaller, older cars are going to scuffle as demand for those cars will show more weakness. Those cars are leasing low-$300s net and may struggle to recover from there.
Pressure Tanks: This market has slid down a bit but remains stable at lower levels. Rents are in the low- to mid-$600s, full-service. Once available inventory gets snapped up, expect prices to rise from these levels when orders for new cars start to get placed.
Mill Gondola Cars: Even though scrap prices are at higher levels, scrap loadings have not fulfilled the same level of promise. Therefore, car demand remains relatively weak along with lease rates. Older mill gons (263K GRL) rates are in the mid-$200s PCPM full-service, while newer cars (286K GRL) are in the mid- to high-$300s.
Crude Oil and Ethanol Tanks: This market continues to be set with oversupply, both for older DOT-111As and 117Rs (rebuilt). Full-service rates hover around $600, but longer lease terms for these cars seem elusive. New DOT/TC-117J cars are commanding more of a premium due to cost; those are running in the high-$700s to low-$800s, full-service.
Smaller Tanks: 20Mg (20,000-gallon) tanks are costing about $700 full-service for existing cars. Prices are higher on the newer side. Looking for corn syrup? The older 17Mg car is sitting in the low-$300s full-service, while a newer 19Mg car is in the mid- to high-$500s. The 17Mg car in industrial (chemical service instead of food grade) commands a larger premium: mid-$500s, full-service.