CAI International (NYSE:CAI) reported Q4 earnings on February 16. Quarterly revenue and EPS came in at $65.7M and +$0.52 (a loss of $0.62 per share if including impairment charge), which are below consensus estimates of $68.4M and +$0.56.
A $25M impairment charge (or $1.10 per share) contributed to the reported loss in the quarter. The charge relates to value write-down for 90,200 TEU off-lease containers (~9% of total owned fleet) that are expected to be sold owing to low leasing rate and strong US dollars, which weigh on expected proceeds from selling the dollar-denominated containers. Although CAI management did not provide an outlook for potential impairment in 2016, given the expectation of Textainer (NYSE:TGH) management that additional impairment in 2016 is possible if market condition remains as is (the company also incurred notably impairment in Q4), I would not be surprised to see further impairment charge from CAI in 2016.
In Q4, CAI acquired $18M of containers, which are primarily refrigerators and specialty containers. As more containers were transferred out of fleet than new purchases, net book value ("NBV") of container fleet declined from $1.65B to $1.62B quarter-over-quarter. Average container utilization rate dropped to 90.4% in Q4, compared to 91.3% in Q3 and 93.4% in Q4 2014. The lower utilization led to higher container storage and handling costs as more containers became idle. This is reflected by increased in storage, handling, and other expenses as percentage of revenue to 12.1% in 2015 from 11.4% in 2014. Owing to weak demand and low leasing rates, the company has only $15M container purchase commitment as of Q4.
On the other hand, railcar fleet NBV grew from $177M to $234M during the same period largely driven by acquisition of $54M railcars. The strong railcar growth outweighed the decline in containers, leading to a slight increase in total fleet NBV from $1.82B to $1.85B in the quarter. As of Q4, railcar units increased to more than 5,000 and account for approximately 13% value of CAI's revenue-generating assets and 10% of total revenue (see chart below). The railcar expansion continues to pay off as average railcar utilization increased to 98.0% in Q4, compared to 97.7% in Q3 and 95.4% in Q4 2014 (see chart below), resulting in pre-tax profit of ~30% in the quarter compared to ~18% for the container leasing business. In 2016, the railcar growth is expected to remain robust as CAI has committed to purchase additional $139M railcars in 2016, which will increase railcar NBV share to ~20% of revenue-generating assets.
Logistics business also grew strongly in the quarter as the company acquired Challenger Overseas for $11M. The business has a run-rate revenue of $9M. Based on ClearPointt's full-quarter revenue of $6M in Q4, annual logistics revenue now amounts to ~$33M, which represents 12% of consensus estimated total revenue of $274M for 2016 (assuming no organic growth in logistics in 2016).
In light of the low share price, CAI's board authorized a new 1M share repurchase program, making total authorized size to 2M. The company completed 300K shares repurchase in Q4, leaving a buyback room of 1.7M shares.
As the $25M impairment charge is a non-cash item, operating cash flow remained strong in Q4. Operating cash flow margin came in at 59% in 2015, fairly steady compared to 61% in 2014 and 58% in 2013 (see chart below). Based on the consensus revenue estimate of $274M for 2016 and a conservative operating margin assumption at 55% (to account for increased storage and handling expenses if utilization continues to trend down), the company would generate $151M operating cash flow. Supposing the company to maintain its historical loan-to-value ratio of ~75%, the cash flow generation would give CAI ~$600M capex capacity, which can comfortably cover the total container and railcar commitment of $154M and the remaining authorized buyback size of 1.7M shares.
The stock now trades at 75% discount to book value, compared to TGH's 50% discount. The notable valuation gap is likely attributable to the following factors:
1) CAI's container utilization rate has been consistently lower than TGH's since early 2011 (see chart below). The result is that CAI has incurred higher storage and handling expenses to serve the idle containers, which have direct impact on margin and bottom line (see chart below).
2) CAI will have approximately ~13% of its fleet coming off leases in the next 12 months, compared to TGH's ~9%. If market per diem rate continues to be lower than the contracted rate at lease expiry, the magnitude of negative financial impact (either through lower rental revenue or impairment charge to bring down off-lease container values to their expected resale prices) would be greater for CAI.
3) The company's leverage level (i.e. debt to equity ratio of 3.1x) is notably higher than TGH's (2.4x).
4) TGH stock has a 9.8% dividend yield, whereas CAI does not pay any dividends.
However, one thing I should highlight is that the valuation gap has gradually shrunk since mid-2014 (i.e. difference in P/B multiple decreased from ~0.9x to ~0.2x), which I believe can be explained by market's recognition of CAI's growing railcar leasing and logistics businesses (see chart below). As discussed earlier, the utilization rate for railcar fleet is significantly higher than that of container fleet and the business also has a much higher margin. By the end of 2016, I expect the share of railcar leasing and logistics revenues should climb to one third of total revenues compared to ~15%-20% in Q4. Therefore, future growth of the 2 businesses could serve as a value catalyst as it may help in closing the valuation gap.
In terms of macro environment, I believe container price may be near or at trough level while container demand may still be weak throughout 2016 (please refer to my latest article for TGH). For investors who have high tolerance for price volatility, I recommend buying CAI shares now because 1) the strong cash flow profiles of container lessors (also refer to my latest article for TGH) are not appropriately reflected by current valuations and 2) the robust growth of railcar leasing and logistics businesses could close the valuation gap between CAI and its peers (the only 1 visible catalyst by far). However, as there remains no sign of container demand recovery and CAI has 13% container fleet coming off lease in 2016, weak sentiment would persist and regular investors should stay on the sideline until more positive signs emerge.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CAI over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.