“A resuscitation of a long-futile push for railcar scrappage tax subsidies may be under way. While the effort is in its infancy, and the outcome remains speculative, we see success as less of a long shot than it has been at any time in the past. This would be positive for railcar suppliers, including Trinity and Greenbrier, and metals companies such as Schnitzer Steel, Commercial Metals Company, Nucor Corporation and Steel Dynamics.”
Those are Cowen and Company’s key takeaways from its collaborative report on transportation OEMs, by Cowen Transportation OEM Analyst and Vice President Equity Research Matt Elkott, along with Adam Kramer, Chris Krueger, Tyler Kenyon and Jeffrey Rossetti.
“Multiple channel checks we conducted indicate that a number of key industry stakeholders may be reviving a push for legislation, which would likely be attached to a broader bill, that would provide tax subsidies for scrapping old, idle railcars,” said Elkott. “A glut of about 526,000 railcars, or 31.5% of the North American fleet, is estimated by the Association of American Railroads (AAR) to be in storage. In a normalized cycle, cars in storage can be in a 15% to 25% range; and in 2014, at the height of the crude-by-rail expansion, the metric dipped just below 10%, a level we regard as full utilization.
“Today’s elevated idle car population is the culmination of several factors. Rail traffic has come in well below expectations for the good part of the last two years, declining about 4% in 2019 and about 13% thus far this year. Over roughly the same period, Union Pacific, Norfolk Southern and Kansas City Southern became the latest Class I’s to roll out Precision Scheduled Railroading (PSR), which is now near full implementation industry-wide. On the railcar-build front, we estimate that seven of the past 10 years represented above-replacement-demand production, fueled in part by capital deployed by financial investors unable to find better yield alternatives. The pandemic is the latest inflammatory factor to the industry’s existing wounds.”
Success Remains a Lofty Goal, But Less So Than in Prior Attempts
“Around the time of the Great Recession, when a similar oversupply burdened the industry, some stakeholders started a conversation about seeking scrappage tax subsidies, albeit not well-known or documented,” the analysts noted. “It did not go far; and ultimately it was not needed—the crude-by-rail boom would eventually fuel the biggest demand recovery and subsequent build cycle in industry history. No readily visible signs of a similar expansion exist today. As such, we believe builders will exert a more serious effort to obtain government tax incentives this time. Additionally, the industry’s lobbying apparatus may be more effective today, with the Rail Security Alliance, which includes freight railcar manufacturers, having contributed to the legislative miniaturizing of China Railway Rolling Stock Corp (CRRC) in the U.S. (see our rail freight and transit equipment discussions in Cowen’s July 17 U.S.-China trade deep dive The U.S. & China In The Ring of Fire – Ahead of the Curve Series + Video).
“The Railway Supply Institute (RSI), which was key to starting the conversation during the Great Recession, will likely have an integral role in any progress made today. Another reason why the chances of success may not be as slim this time relates to the current political environment and the seemingly unquenchable thirst for registering wins. The railcar building and leasing industry, at roughly $10 billion of revenue, is small enough to be able to benefit from even a modest appropriation while giving the legislative and executive branches bragging rights for having lifted a whole industry.”
Tax Subsidies Aside, We See a Lease Rate Recovery In Sight
“We expect railcar spot lease rates to bottom late this year and begin a gradual recovery in 1H21,” the analysts said. “This should be driven by three primary factors: 1. Decelerating rail traffic declines in 2H20 and a swing back to growth beginning in 2021. 2. In the railroad industry, the resiliency of the industry-wide, far-reaching capacity rationalization by the Class I’s as part of PSR has not yet been tested in a growing traffic environment and could lead to service hiccups, something that would be a driver of equipment demand. 3. Increased scrapping within parts of the industry’s idle railcar population that are inching toward obsolescence, such as DOT-111 tank cars and certain types of grain and box cars, even without tax subsidies.”
Cash For Clunkers Could Be A Marginal Help For Steel
“While the size and scope of such a program remains uncertain, we believe a ‘Cash For Clunkers’ program, whether intended to increase the scrappage of railcars and/or autos, could offer marginal short-term tailwinds for the domestic steel industry,” said Kenyon, Cowen’s Metals and Mining Analyst. “The 2009 $3 billion Car Allowance Rebate System (CARS), which ran from July 24, 2009 to Aug. 24, 2009, led to the scrappage of more than 700,000 vehicles. The benefits of this program were challenging to isolate considering the program ran in the middle of a broader steel restocking cycle which ensued following the financial crisis in late ‘08/early ’09.
“Increased scrappage of railcars and/or vehicles would likely lead to an increase in high-quality scrap availability enhancing margins for auto salvage yards and scrap processors. The largest direct beneficiary in our coverage universe would be Schnitzer Steel, whose Auto and Metal Recycling (AMR) business buys end-of-life vehicles—with parts sold to retail customers—and railcars, both of which are consumed in the company’s scrap processing operations which sell scrap to global EAF steel producers. Captive metals recycling arms of Commercial Metals Company, Nucor and Steel Dynamics could also benefit at the margin. Incentivized purchases of new railcar and/or light vehicles to displace a proportion of scrapped equipment/vehicles could provide an uplift for sheet, plate and SBQ mill products demand. Beneficiaries of increased automotive and/or railcar production include Cleveland-Cliffs Inc., Nucor, RS, Steel Dynamics, TimkenSteel and United States Steel.”
2021 Is Infrastructure Year
“Fiscal policy has been off the charts in 2020 with 2021 showing little signs of slowing,” said Krueger, Strategist, Cowen, Washington Research Group. “There will be at least three ‘must pass’ bills in 2020 that could carry a ‘cash for clunkers’: 1) Phase 4 bill (likely by mid-August); 2) late-September bill to keep government from shutting down (and extend the highway bill), and; 3) lame duck catch-all bill post election to close out 2020.
“If it misses these three, the big Phase 5/infrastructure bill that will follow in 1Q21—regardless of election outcome in our minds—is probably the most likely legislative vehicle. The expiring highway bill already guaranteed an infrastructure bill … the pandemic and recession have made it all the bigger and broader. Buckle up.”