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In 1956, Malcolm McLean invented the first standardized shipping container. This dropped the average global cost per ton of loading for shipment from $5.86 to only $0.16. This was the dawn of the shipping container industry. It has always been efficient, but in today's market it presents an incredible opportunity. This article will identify and analyze the fundamentals that make the container lessor industry so strong.

Positive catalysts for the container leasing industry

Long trend of trade growth:

According to Clarkson Research Studies, global containerized shipping volume has increased at a CAGR of 8.8% from 1988 to 2012. This greatly exceeds the rate of worldwide economic growth. It is believed that this exceptional sustained growth rate is due to outsourcing of labor to low cost areas. Goods are shipped to the low cost area for assembly and then shipped back to the place of sale.

While some would argue that China's days of being the cheap source of labor are coming to a close, there are plenty of low wage emerging nations to take its place. Expect outsourcing and general world trade to continue to outpace the world economy's growth. Demand for shipping, and therefore shipping containers, is strong and growing, but we must also consider supply.

Well, supply of containers is more or less unlimited as it can be manufactured at will. With little barrier to supply, one might be concerned that container fleets could be devalued. However, the strict quality regulations on containers limit useful life to somewhere around 5-10 years. Consequently, supply is always in flux and a sufficient number of units are produced to meet but not exceed present demand.

(click to enlarge)

While the shipping vessels can handle significantly more containers, the supply very closely mirrors demand. There is both an upside and a downside to the supply chain efficiency.

Upside

This production efficiency has historically entailed superb utilization with very few containers not being leased.

Full leasing maximizes revenue and limits depreciation and fleet turnover by allowing a smaller fleet.

Downside

Ad-libitum production provides shipping companies with the ability to skip the middle-man by simply buying their own containers. There are times when this materially hurts the container lessors, but there is presently a major factor in their favor: the shipping companies have more pressing capital demands.

Modern ships, particularly the very large ones with (10,000 + Twenty foot Equivalent Unit {TEU} capacity) have greater cost efficiency. Several Shipping lines have spent capital acquiring these superior ships and are aggressively pursuing the capture of market share. As the shipping companies battle for market dominance it has two positive effects on the container lessors:

  1. A greater ratio of leased to owned containers

  2. Increased overall container demand

Let us look at each of these a bit more in-depth.

Increasing Leased to owned ratio

(click to enlarge)

An increasing percentage of the world's shipping containers are owned by lessors.

Increased overall demand for containers

Since the larger, newer ships can provide a unit cost advantage, particularly when shipping at capacity, there is a drive to consolidate shipping lines. In a free market economy it seems implausible that one of the involved parties would simply concede their market share. Instead, each of the major companies is more likely to attempt to be the one to which the shipping along a given route is consolidated.

During this transitionary period I believe the shipping lines will lease containers beyond their current demand, more in line with the market share they are attempting to capture. If this happens, the losing company may be left with a fair number of unused containers. Unlike in the past where leased containers + owned containers was almost perfectly in-line with demand for containers, the current competitive shipping environment could make leased containers + owned containers surpass demand.

Summary of industry Fundamentals

  1. World trade is growing consistently which increases shipping demand.

  2. Shipping companies are fighting for market share, so each is inclined to spend capital on superior ships and networking rather than on owning containers.

  3. In their attemps to capture market share shipping companies may lease units beyond their present need in line with their projections of higher market share.

Together, these factors mean an increased size of the container pool and an increased percentage of that pool being owned by lessors. In other words, the container leasing industry's demand is extremely healthy in the near future.

With so many positive catalysts in the shipping and shipping container industries, it is worthwhile to examine the various choices for investment within them. I believe the container lessors will outperform the shipping companies for two reasons:

  1. The aforementioned competition for market share among shipping companies could reduce their profit and increase lessor's profits

  2. Fluctuations in the cost of steel (as described below)

The steel advantage

As legal standardized containers consist primarily of steel, shipping companies are adversely affected by an increase in the value of steel. A rising price/volume of steel will directly increase the cost of shipping. The container lessors, however, are somewhat immune to fluctuations in the market price of steel. While an increase in the price of steel raises the cost of replacing their units, it also increases the rental rates and the resale value. Increased costs are balanced with increased revenues. The lack of senstivity to commodity prices relative to the shipping companies is a driving force in the lower volatility of container lessors.

In my opinion, the container leasing companies are the best angle for investment in the shipping industry in the present market conditions. This narrows our focus to the five major players.

Company (ticker)

Market Capitalization

Price/2013 Earnings*

Annual Dividend Yield

Gatx Corp. (GMT)

$2.399B

15.91

2.43%

TAL International Group (TAL)

$1.496B

9.82

5.79%

Textainer Group Holdings (TGH)

$2.322B

10.39

4.10%

CAI International Inc. (CAP)

$650mm

8.10

0.00%

SeaCube Container Leasing (BOX-OLD)

$468mm

8.32

5.22%

*As estimated by SNL Financial

What is fascinating about this industry is that the products are so interchangable. All containers of each type are made to fit certain specifications and are nearly equivalent. This makes it rather difficult to differentiate the companies. Each has access to the same industry fundamentals, produces virtually the same products and writes similar leases. How can we decide which security is best?

There are a few major factor's that differ:

  1. Market share

(click to enlarge)

As the note in the bottom left corner of the graph states "colored regions are overlapping and not stacked". I want to clarify this point as it may otherwise appear that CAP and TAL have very little market share.

We can see that GMT has the largest share, but what matters more is how much share the investor is getting relative to the price of the security. Dividing the value of equipment under leases by the market cap of the respective companies will produce market share per cost. I believe this metric to be crucial in such an interchangable industry.

Company

$mm of equipment under leases

Market Cap.

Equipment under lease/Market Cap.

GMT

$4,654,400

$2.399B

1.94

TAL

$3,249,374

$1.496B

2.172

TGH

$2,916,673

$2.322B

1.256

CAP

$1,210,234

$650mm

1.862

BOX

$961,232

$468mm

2.054

*Data from SNL Financial as of 12/31/12

Investors buying TAL get the best bang for the their buck. Each dollar spent on TAL stock acquires $2.172 of equipment under lease. By this metric TGH seems to provide the worst deal giving only $1.256 per dollar, but there is more to the story. Much of the extra equipment comes from high leverage.

Company

Debt/Equity

GMT

2.87

TAL

4.23

TGH

2.16

CAP

2.76

BOX

5.37

TAL's huge volume of equipment under lease comes froms its aggressive leverage and Textainer's relative lack of equipment under lease is consequent to its conservative balance sheet. There is no clearly superior security, instead it comes down to the investor's goals.

Investment choices

I would not suggest buying GATX, as it is vastly overpriced relative to the other four, which all have cheap valuation. BOX also fails as a solid source of exposure to this sector as it is in the process of being bought out by the Ontario Teacher's Pension Plan. It may be an opportunity for arbitrage in the event of a disparity between market price and ultimate buyout price, but such a trade would lie outside the scope of this article.

The three remaining companies each represent an interesting prospect.

TAL International Group provides the most exposure to the sector per dollar invested as well as the most upside, but its leverage makes it riskier. It also has an excellent yield at 5.79%

Textainer is the more conservative version of TAL. It too gives a nice yield at 4.10%. If everything goes well fundamentally for the container leasing sector I suspect it will underperform relative to TAL, but your money will be far safer here.

CAI International is the growth play. It pays no dividend, instead reinvesting all earnings into operations. This allows it to nearly match TAL's "bang for the buck," without taking on so much debt. Investors simply have to be willing to forgo distribution.

The best choice for an investor will undoubtedly depend on their individual goals. For risk averse investors it may be to not invest in these at all. While the revenues of the containor lessors has been quite consistent, the shipping companies have material volatility. It is not outside of the realm of possibility that some of these companies could default on their container leases. As the shipping lines continue to condense market share, the downfall of even a single company could have an enormous negative impact on lessor's earnings.

The Bottom Line

The container leasing industry has numerous fundamental catalysts in addition to cheap valuations. I would advise doing your own research on this exciting sector. If you want exposure and can tolerate the risk be sure to select the security that best fits your goals.

Disclaimer: 2nd Market Capital and its affliated accounts are long TAL and TGH. This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.

Source: Lucrative Prospects In Shipping Containers