Textainer Group Holdings' (TGH) CEO Philip Brewer on Q2 2014 Results - Earnings Call Transcript

| About: Textainer Group (TGH)

Textainer Group Holdings Limited (NYSE:TGH)

Q2 2014 Earnings Conference Call

August 7, 2014 11:00 AM ET

Executives

Hilliard C. Terry – Executive Vice President and Chief Financial Officer

Philip K. Brewer – President and Chief Executive Officer

Robert D. Pedersen – President and Chief Executive Officer of TEM

Analysts

Gregory Lewis – Credit Suisse Group

Doug R. Mewhirter – SunTrust Robinson Humphrey

Christopher Carey – FBR Capital Markets & Co.

Operator

Welcome to the Textainer Group Holdings’ Second Quarter 2014 Earnings Call. My name is Joe and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Executive Vice President and Chief Financial Officer, Hilliard Terry. Mr. Terry, you may begin.

Hilliard C. Terry

Thank you Joe. And welcome to our 2014 second quarter earnings conference call. Joining me on this morning's call are Phil Brewer, TGH’s President and Chief Executive Officer. At the end of our prepared remarks, Robert Pedersen, TEM President and Chief Executive Officer will join us for the Q&A.

Before I turn the call over to Phil, I'd like to point out that this conference call contains forward-looking statements in accordance with U.S. securities laws. These statements involve risks and uncertainties are only predictions and may differ materially from the actual future events or results.

Finally, the company views, estimates, plans and outlook as described within this call may change subsequent to this discussion. The company is under no obligation to modify or update any or all statements that are made.

Please see the company's Annual Report on Form 20-F for the year ended December 31, 2013, filed with the Securities and Exchange Commission on March 19, 2014, and going forward any subsequent quarterly filings on Form 6-K for additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements.

I would also like to point out that during the call, we will discuss non-GAAP financial measures. As such measures are not prepared in accordance with generally accepted accounting principles, a reconciliation of the non-GAAP financial measure to the most directly comparable GAAP measure will be provided either on this conference call or can be found in today's earnings press release.

At this point, I would now like to turn the call over to Phil for his opening comments.

Philip K. Brewer

Good morning and welcome to Textainer’s second quarter 2014 earnings conference call. I'm sure many of you have noticed that we released second quarter financial results yesterday instead of this morning. Trencor our 48% shareholder issued its quarterly earnings statement in South Africa yesterday earlier than expected. Their release incorporated references to our yet to be reported earnings.

As a precaution, Textainer issued its earnings press release earlier than normal after becoming aware of the disclosure and discussing the matter with a New York Stock Exchange. We are pleased with our second quarter results and the strong increase in container demand we saw during the quarter. Our average weekly container booking increased almost 50% from the first quarter to the second quarter and this strong demand has continued through to-date.

Our depot container inventory has decline by 42%, since its high point in March. We’ve not seen such a rapid pick up and container demand since 2010. Our utilization, which bottomed at 93.6% at the end of March, is now 96.4% an increase of almost 3% in four months. Several members of our senior management have recently met with our shipping line customers around the world. Based on these discussions we believe that the demand we are seeing will continue through at least the third quarter.

Lease rental income grew to $123.6 million a 7.2% increased compared to the year-ago quarter and 2.5% increase compared to the first quarter of 2014 due primarily to growth in the size of our owned fleet. Adjusted net income was $40.2 million for the quarter.

Our year-to-date CapEx is much better than we expect at beginning of the second quarter. We have invested more than $658 million in containers for delivery during 2014, including $598 million to acquire more than $314,000 TEU during this year. This 2014 CapEx include $65 million invested in purchase leaseback transactions and $44 million to purchase 38,000 TEU of previously manage containers. We now 77% of our fleet a new record.

Notwithstanding the strong increasing demand, rental rates remain under pressure. For the same reasons we have mentioned in the past such as easy access to financing by all lessors, low new container prices and low interest rates. The turnaround on container investments has declined as a result although our margins our new investments have not suffered to the full extent of the decline in rental rates, because of our ability to reduce our funding costs and due to timely purchasing of new containers.

Nonetheless, we have not pursued all of the transactions we have been offered and have not won all of the transactions we have pursued. This has been especially true with refrigerated containers where our new container CapEx is below budget and at a run rate below 2013, due to our unwillingness to match lower than expected returns.

In addition to pursuing only those deals we find attractive, we are also committed to remaining the lowest cost operator in the industry. Our overhead cost for containers are approximately half the cost of our public competitors. We declare a dividend of $0.47 per share which represents the dividend yield above 5%. Keeping in mind of the dividend yield on the S&P 500 is below 2%, we believe we provide an attractive return to our shareholders.

New container prices are approximately $2,000 per TEU. We estimate the new current new build inventory factories to be approximately $530,000 TEU. This level of inventory is perfectly manageable representing about two months of demand during normal market conditions.

We expect it consistent with the past several years. Container lessors will purchase slightly more than 50% of total container production. Used container prices continue to decline, there are down approximately 25% from a year-ago quarter and 5% year-to-date. These declines have resulted in reduced gains on sales of our owned containers as well as negatively affected are trading business.

Although further declines are possible, we believe we are near a bottom. However, we do not expect used container prices to increase from the current level in the near term. It is important to keep in mind that even after this price decline, used prices are approximately equal to 50% of the current new container price, which is attractive on the historical basis and an excellent residual relative to most other transportation assets.

We are optimistic about the third quarter. We expect to see a sequential improvement in rental revenue and normalized adjusted net income as second-quarter bookings are picked up. We expect our utilization to continue to increase but not to the same extent as during the second quarter.

Keep in mind that only 4% of is subject to long-term leases that will expire this year. Perhaps more importantly, unlike some of our competitors, we have been a consistent buyer of new containers over time. We do not have years during which an unusually high percentage of our leases will expire.

Looking forward, only 6% of our fleet is subject to leases that expire in 2015 and 7.5%, in 2016. We believe the structure of our fleet and the terms of our leases positions us well to address reprising risks over the coming years. New container prices are close to the cost of production. Manufacturers have been unwilling to sell at prices much if at all below current level.

The returns on containers purchased at today's prices can be expected to increase over time as the containers depreciate and especially if interest rates in our new container prices rise. Given the relatively low purchase prices, today's containers also have reduced to repricing and residual value risk, compared to the higher cross containers purchased in 2010 and 2011. Our low 2.3 time leverage, gives us operational flexibility and dry powder for strategic opportunities. We look forward to benefiting from the future growth of our industry.

I would now like to turn the call over to Hilliard.

Hilliard C. Terry

Thank you, Phil. This quarter we saw a good growth in lease rental income due to a 14% increase in the size of our own fleet and increased utilization. Management fees were down year-over-year given the lower fleet performance and the smaller managed fleets as a result of recent managed fleet acquisition. We had a 50% decrease in gains on sales, resulting from lower used container prices.

Lower resale prices also put pressure on the margin and in our trading business, which was down year-over-year, in spite of the increased in volumes of containers sold. Nevertheless, this was up from the loss we reported last quarter. As Phil stated earlier, we believe resale prices are near the bottom, but we do not expect prices to rebound much in the near term.

Excluding the cost of trading containers sold, total operating expenses were up 18%, year- over-year, primarily due to increase in direct container expenses and depreciation expense. Direct container expenses increased due to the increased size of our own fleet and higher associated storage, repositioning, maintenance and handling expenses. A little less than half of this increase was due to recovery expenses related to problem less fees.

As utilization continues to improve and recoveries lying down, we should see a sequential improvement in direct container expenses. Depreciation expense was $42 million for the quarter, up $8.3 million or 24% year-over- year largely as a result of our largely owned fleet. Annualized depreciation expense increase from 4.0% to 4.3% of average gross container asset value.

As I mentioned last quarter, this increase and depreciation expenses due both to fully depreciated old containers being sold and replaced by more expensive new container. And the fact that PLBs has become a major source of supply for our retail business. As you may recall, PLB containers are depreciated while trading containers are not.

The final factor is the increase percentage of reefers in our fleet. Between one and 1% and 2% more of our reefer containers original equipment cost is depreciated annually compared to dry and freight containers.

Bad debt expenses were $700,000 or about a half a percent of revenue. We saw a 9-day improvement in DSOs versus last year, reflecting continued diligence over our credit and collections processes.

Our interest expense including hedging cost is $23 million for the quarter, almost flat versus the year-ago quarter in spite of a 12% increase in our average debt balance. Consistent with the analyst models and peer results, we have excluded 6.4 write-offs of unamortized financing fees that we highlight last quarter from our adjusted net income and our effective interest rate.

Our average effective interest rate which includes hedging costs is currently 3.39% down 29% basis points when compared to the year ago quarter. We have continued to lower the company's funding cost with our recent refinancing and going forward we will continue to benefit from these reduced financing costs in the second half of this year and beyond.

Currently, the duration of our debt is aligned with the duration of our lease portfolio; about 80% of our debt is fixed or hedged, consistent with the percentage of our fleet subject to long-term leases. The weighted average remaining term of our fixed or hedged debt is about 38-months. The weighted average remaining term of our long-term leases is about 40-months. We are opportunistically looking at ways to extent the duration of our debt with minimal impact on our overall borrowing costs.

Income taxes for the quarter were approximately $800,000 resulting in a 2% effective tax rate for the quarter. Our effective tax rate varies from quarter-to-quarter due to discreet one-time items, as we stated last quarter we now expect our annual effective tax rate to be in the low to mid single-digits.

Adjusted EBITDA was 106 million in Q2 similar to last year. EBITDA remains a clear indication of our continued strong cash generation. Adjusted net income which excludes unrealized gains and losses on interest rate swaps and the write-off off of unamortized financing fees for the quarter was $40 million, resulting in adjusted EPS of $0.70 per share.

As Phil mentioned earlier, our dividend was $0.47 per share. As a reminder, some or all of such distributions maybe treated by use tax holders as a return of capital rather than dividends. Finally turning to the balance sheet. As of June 30, our cash position was $102 million withstand by liquidity in excess of $500 million. Total assets were $4 billion and our debt-to-equity ratio was 2.3 to 1.

For your attention I would now like to open the call up for questions. Joe, can you inform the participants of the procedures for the Q&A.

Question-and-Answer-Session

Operator

Yes. Thank you. (Operator Instructions) And our first question here comes from Gregory Lewis from Credit Suisse. Please go ahead.

Gregory Lewis – Credit Suisse Group

Yes, thank you. Good morning gentlemen.

Philip K. Brewer

Hey, Greg how are you?

Gregory Lewis – Credit Suisse Group

Good. Phil, you mentioned some comments and I'm looking for you to elaborate a little bit more around them. You mentioned that the overall cost of Textainer’s containers is potentially roughly half the cost of its peers, I mean if you could provide a little bit more color around that?

Philip K. Brewer

Sure, Greg. It wasn't the cost of our containers is half the cost of peers. Generally we calculate our overhead cost or TEU per day and looking at the information provided by our public peers and looking at our own information, which is disclose in the presentation on our investor website. You will see that our costs are less than our peers.

Gregory Lewis – Credit Suisse Group

Okay. So you're referring to operating costs?

Philip K. Brewer

Yes.

Gregory Lewis – Credit Suisse Group

Okay, thanks. Thanks for clearing that up. And then I guess I had another question. So it looked like in the second, well it didn't look like it happened, in the second quarter utilization started to move up nicely. Yet, as I look at direct container expenses, that also moved higher. I would think typically when utilization goes up, those expenses would go down. Was there something that happened in the quarter or was it more of a function of the timing of the boxes going back to work?

Hilliard C. Terry

Well, Greg this is Hilliard. If you look at sort of the sequential compare, I did mention that part of what was going on was from bankrupt less fee recovery costs that were included in the direct container expenses. So that sort of had an offset impact. The other thing is that I also mentioned that the handling maintenance repositioning expenses also did increase and that’s just a function of our fleet is larger. But if you look at sort of what would be impacted on a sequential basis, things like storage that is down sequentially.

Gregory Lewis – Credit Suisse Group

So if we were to strip out those items, I mean is it safe to assume that going forward, utilization – direct container expenses should look more like the second quarter or the first quarter? I guess what I'm wondering is, are we going to continue to see these charges related to bringing boxes back to service in the back half of the year?

Robert D. Pedersen

I would expect some of those costs to wane in the back half of the year, Greg. And as utilization continues to increase, I think you will start to see a better sequential compare on direct container expenses.

Gregory Lewis – Credit Suisse Group

Okay, guys. Thank you very much.

Operator

Thank you. Our next question here comes from John Mims from FBR Capital Markets. Please go ahead.

Christopher Carey – FBR Capital Markets & Co.

Hey guys, this is Chris Carey on for John Mims. Thanks for taking my question.

Robert D. Pedersen

Hello, Chris.

Christopher Carey – FBR Capital Markets & Co.

Hey, how are you? Thanks for taking my question here. And just kind of going on the general operating backdrop here and specifically on the utilization, we saw that nice uptick in the quarter here and you did mention in your prepared remarks that you expect utilization to increase but not necessarily to the same extent as in the second quarter. Are you talking about more on a sequential basis year-over-year? How should we kind of think about that comment, as we head into the second half of the year?

Hilliard C. Terry

The reason I made that comment is simply because we’re up 3% from the low point in March, we are now about 96% utilization. Clearly, we can't go up another 3%. I don't see us returning to the 99% level we had back in 2010. But we do expect to see utilizations continued to go up, especially as the containers that have been booked for leased out over the course of the second quarter and through today, are picked up during the remainder of the third quarter.

Christopher Carey – FBR Capital Markets & Co.

Okay. Yes, that makes sense. And just kind of on that point, demand is clearly accelerating here. But as we head into the third, fourth quarter, are you guys seeing sort of any indications of an early peak season? Or is this kind of organic demand or just wondering how you guys are kind of thinking about the second half of the year just from more of a peek perspective?

Robert D. Pedersen

Hi, Chris, it is Robert here. We're definitely seeing stronger demand than we have seen in past years. And we are really seeing a true peak season and that could very well continue both through September but also into October. The shipping lines have seen about 8% growth between Asia and Europe and 5% from Asia to North America. And that is much better than what they estimated at the end of last year, beginning of this year, which was probably between 3.5% and 4.5% growth. So no doubt the demand and there by the pull for containers is much greater than both our customers and we envisioned early on.

Christopher Carey – FBR Capital Markets & Co.

Okay, yes, I guess that makes sense and that’s really helpful. And then just one housekeeping item and I will turn it back over. With the uptick interest expense here in the second quarter, understanding that that was partly related to the write-off, but going forward, just from a modeling perspective, I mean how should we kind of be think about that interest expense more off of the first quarter basis or fourth quarter or should we expect a slight uptick here going forward.

Robert D. Pedersen

So last quarter we talked about the fact that there was going to be a $6.4 million charge in Q2, but we expect sort of about $0.06 per share of savings in the second half. If you were to look at that annualized basis obviously it would be about $0.12 per share. Again we, may be looking at some other financings that could put a little bit of upward pressure on our financing cost and we're going to do everything we can to make sure that we keep them at the levels what they area.

Christopher Carey – FBR Capital Markets & Co.

Okay. Okay well I really appreciated the time. Thanks so much.

Hilliard C. Terry

Thank you.

Operator

(Operator Instructions) and our next question here from Mr. Dough Mewhirter from SunTrust. Please go ahead.

Doug R. Mewhirter – SunTrust Robinson Humphrey

Good morning. I had one question and I’m not quite sure how to frame it. Maybe I guess it’s the paradox of rising demand and I guess stagnant prices for lack of a better term. You said demand is up 50% net pick up activity is great and the shippers are sort of caught on their heels a little bit with demand.

And the inventories aren’t that big either, they are $0.5 million TEU but the new box prices are staying low. And lease rates are staying low. I'm just wondering, what other lever do you have to pull to sort break lose either the box prices or the lease rates? Or maybe if the answer that because box prices are so low and that it's sort of almost spurring at demand. What's the shipper alternative if demands are 50%? Is there alternative that they would just buy themselves or I'm kind of struggling to understand the supply and demand dynamic right now?

Philip K. Brewer

Well this year we expect that the lessors will provide over 50% of the containers that the industry consumes, similar to the past several years. In fact, it might be a bit more about 50% than we saw last year. So the shipping lines continue to look to the lessors to provide the containers they need.

As long as container prices stay where they are, or at around the current level, I think its unlikely that we are going to see dramatic increase in rental rates, unless and until interest rates rise, which I do expect will happen, perhaps not in the next several moths, but certainly over the course, well not certainly, but I do expect over the course of say the next year. And if and when container prices increase that’s a more difficult projection. I'm not certain when container prices will increase.

Although I do expect increase over time specifically if you look at the cost of production in China, labor costs, energy costs, et cetera it seems likely that that will happen. We have seen an anonymous amount of resistance for prices to fall below their current level, so we don’t think it’s likely that prices are going to decline much from the current level. So, over time as we see either or both interest rates and/or new container prices increase, I think you will see rental rates increase as well.

Doug R. Mewhirter – SunTrust Robinson Humphrey

Thanks for that. And maybe following under that or building on that answer, so what is preventing the factories from gaining the upper hand with regards to pricing power, if their inventories aren't that big and demand is up so much?

Robert D. Pedersen

Well, this is Robert here. I don’t think you should just correlate it to the inventories on the ground. I think you should correlate it to what is the theoretical production capacity. And that’s probably $5.5 million TEU to $6 million TEU on an annual basis. And, this year we don’t estimate more than $2.5 million TEU are going to be produced. So, I think that is the factor that is holding pricing down.

If you see a stronger trade between Asia and Europe into North America, we're seeing trends of now and hopefully continuing into 2015 and 2016, we would expect production volume to increase quite a bit above the $2.5 million TEU range that we’re seeing right now. And, if that is so we would also expect that the manufacturers who would not go to three shifts would be a little bit tighter on the one to two shifts and therefore have a little bit better pricing position.

Doug R. Mewhirter – SunTrust Robinson Humphrey

Okay thanks. That makes sense. That’s all my questions.

Robert D. Pedersen

Thank you very much.

Operator

Thank you. This concludes the question-and-answer-session. I will turn the call back over to Terry for closing remarks.

Hilliard C. Terry

Thank you everyone for everyone participating in this call. We look forward to talking to you as we progress through Q3. Thank you very much.

Operator

And thank you ladies and gentlemen. This concludes today's conference. Thank you for participating and you may now disconnect.

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