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GATX Corporation (NYSE:GMT)

Q2 2008 Earnings Call

July 24, 2008 11:00 am ET

Executives

Rhonda S. Johnson – Director, Investor Relations

Brian A. Kenney - Chairman, President & Chief Executive Officer

Robert C. Lyons - Chief Financial Officer & Senior Vice President

Thomas Ellman – Chief Commercial Officer, Rail

Analysts

Robert P. Napoli - Piper Jaffray

John Hecht - JMP Securities

Paul Bodnar - Longbow Research

Arthur W. Hatfield – Morgan Keegan

Richard B. Shane, Jr. - Jefferies & Company

Jordan Hymowitz – Philadelphia Financial

Operator

Welcome to the GATX second quarter earnings call. (Operator Instructions) At this time I’d like to turn the conference over to Rhonda Johnson, Director of Investor Relations.

Rhonda S. Johnson

With me today are Brian Kenney, President and CEO of GATX Corporation; Bob Lyons, Senior Vice President and Chief Financial Officer and Tom Ellman, Chief Commercial Officer for Rail. I hope you all have had the opportunity to review our press release. I’ll provide a brief overview and then we’ll open up for your questions.

Before we begin I’d like to remind you that any forward-looking statement made on this call represent our best judgment as to what may occur in the future. The company's actual results will depend on a number of competitive and economic factors some of which may be outside the control of the company. For a discussion of these factors I refer you to our 2007 Form 10-K filing.

Now here are the numbers. Today we reported net income from continuing operations of $40.9 million or $0.82 per diluted share for the second quarter 2008. In the second quarter of 2007 we reported net income from continuing operations of $43.5 million or $0.79 per diluted share. Year-to-date we reported net income from continuing operations of $93.1 million or $1.85 per diluted share compared to $80.5 million or $1.44 per diluted share in the same period 2007. The 2008 year-to-date results include a $6.8 million or $0.13 per diluted share benefit from the reversal of tax reserve which we reported in the first quarter.

As noted in our press release our rail portfolio continued to perform well despite the weak market. Our utilization is still high at 98% thanks in part to an increase in scrapping. When a car comes off lease or into the shop for repairs we evaluate that car under our economic repair limit model to determine whether to repair or to scrap the car. With scrap prices almost 80% higher than scrap prices at year end more and somewhat younger rail cars are being designated for scrap. Gain from our scrapping activities are found in other income on our income statement.

The LPI renewal lease rates improved nearly 6% over the expiring rate and lease terms were an average of 63 months. While the renewal rate change in the second quarter was positive average expiring rates are rising making comps more difficult and nominal lease rates are declining off of recent highs. We continue to expect nominal lease rates, LTI renewal rate variance and utilization to trend down as the year progresses.

In Europe demand remains strong across rail car types and backlogs as the manufacturers lengthen. Our wholly owned tank car fleet at GATX Rail Europe and AAE Cargo our freight and inter-modal car joint venture have continued to advance in the strong market. We started to see some signs of economic weakening particularly in the German economy; however, we have yet to see any material impact on our operations.

In specialties the marine joint ventures and commercial engine aircraft leasing joint venture with Rolls Royce continued to provide outstanding return. Vessel utilization and day and charter rates remained strong in the first half of the year. We anticipate some softening in the ocean-going shipping market later in 2008; however, returns remain excellent. We also saw additional investment opportunities compared to the first quarter in both industrial and marine equipment.

ASC continues to see robust demand and improving freight rates in its market. The comparatively rainy spring and summer have increased water levels on the Great Lakes allowing ASC improved operating efficiency; however, the rapid rise in diesel fuel prices a portion of which cannot be passed on to customers, dampened results. Moreover an adverse litigation judgment further impacted results by $2.9 million. That said demand for vessel capacity remains solid and we expect it to continue through the remainder of the sailing season.

Investment volume picked up in the second quarter primarily in new rail cars and marine and industrial equipment. We did not repurchase stock during the quarter choosing to retain our equity capital for potential investment opportunities. Any further stock repurchase activity will depend on the size and probability of any investment.

Overall GATX had a solid first half. As we noted in the press release we continue to expect our full year 2008 earnings to be in our previously announced range of $3.15 to $3.35 excluding the tax benefit reported in the first quarter. We remain focused not only on managing through the difficult leg of the cycle but on capitalizing on any opportunities that a difficult market may yield.

So with that quick overview I’d like to turn it over to you for your questions.

Question-And-Answer Session

Operator

(Operator Instructions) Your first question comes from Robert P. Napoli - Piper Jaffray.

Robert P. Napoli - Piper Jaffray

You are clearly in a great position to make an acquisition. Less than two times balance sheet debt to equity, that is the book at this point and I know you can’t say much but how do you think about these investment opportunities? The discussion in the market is that CIT, GE and Wachovia all have sizable portfolios and I just don’t know what, when you’re looking at investment opportunities what size is too large for you and how likely are you to make an acquisition of something that is that large or are there opportunities besides those for fleet acquisitions that are smaller that would fit better with your strategy? This is a strategy question more than asking you specifically about an acquisition that I hope you can give some color on.

Brian A. Kenney

Well that’s certainly what we prepared the company for over the last couple of years and that is why leverage is so low and it’s been our investment strategy over the last few years to not invest at the peak as dramatically as where we are now. So, yes that is a strategy. That’s what we’re looking for, to invest more aggressively in the downturn. That’s just no acquisitions, though Bob, of fleets and companies, that’s also perhaps going out there and placing the big order as we did during the last downturn. So, yes that is entirely the focus. I think we put ourselves in the position to do that and we’ll vet every opportunity fully that presents itself.

Robert P. Napoli - Piper Jaffray

But Brian I was hoping you might be able to give color on size of acquisitions that might make sense for you and this is exactly what years ago you said you were looking to do. It was different than probably what you pointed is that your market is actually in pretty good shape so far, but you have these properties out there. Can you maybe give some size, what you would prefer to invest in?

Robert C. Lyons

It’s a bit of a difficult question to answer. What I can tell you is being as big a player as we are in the marketplace we look at every opportunity that comes our way and there’s nothing that would deter us just based on size. You don’t get dictate size of portfolios that are in the marketplace so you have to respond to what’s out there and we will, as Brian mentioned, clearly vet all of those opportunities and there’s nothing that would preclude us based on size from pursuing anything that was economically attractive for our shareholders.

Robert P. Napoli - Piper Jaffray

Besides the rail opportunities are you seeing anything outside of rail that is intriguing to you at this point?

Brian A. Kenney

No. We’re not really looking to make any acquisitions of anything specifically outside of rail.

Robert P. Napoli - Piper Jaffray

These aircraft leasing companies are trading at low multiples these days.

Robert C. Lyons

We’ve been there, Bob.

Robert P. Napoli - Piper Jaffray

Last question, Europe, if you look five years down the road what growth opportunities do you have? I don’t know how you want to quantify it. What growth rate could you see in that business?

Brian A. Kenney

In terms of growth of assets it’s hard to tell, Bob. If there’s any issue right now in our European businesses it’s along the lines of rail car supply. Those manufacturers have gone from two to three years ago from being half full to being overwhelmed and the backlog is very high and the cost is dramatically higher. If you talk about strategic issues that’s one that we’re constantly thinking about and trying to get creative in the way we address it, that growth going forward. For instance we’re looking hard at putting new people in the business in the manufacturing side, we’re assembling cars ourselves in Pullman, we’re taking all kinds of actions as is our partner, our partner in the freight car business is actually backward integrated a little bit, it’s trying to ensure rail car supply. I can’t give you an exact growth rate but it is a challenge in Europe right now because of the situation over there. It’s caught up to the US very quickly.

Operator

Your next question comes from John Hecht - JMP Securities.

John Hecht - JMP Securities

I wonder if you could shed more detail on what assumptions you’re making embedded in your utilization and pricing assumptions for the second half of the year in your guidance? More detail about which, from a regional perspective, and do you expect one to fall off more than another given your outlook on the economy?

Robert C. Lyons

Tom and I’ll take a quick stab at that and then let Tom Ellman, our Chief Commercial Officer from Rail fill in the blanks. If you recall, John, at the beginning of the year we opened the year with 98% utilization and indicated at that point in time that we wouldn’t be surprised to see that come off at least a couple hundred basis points as the year progressed. We’re still at 98% so we’re running ahead of where we thought we were, partly that’s due to scrapping, but in general the portfolio has performed a little bit better than we had anticipated coming into the year. Where we stood here today mid-year we still expect utilization pressure to occur as the year progresses and I think Tom can offer some commentary a little bit more about what particular market.

Thomas Ellman

As Bob mentioned we anticipated the market softening a little bit throughout the course of the year and the biggest single area that is showing weakness continues to be the housing sector and all the cars in our fleet that are idle about a quarter of them are centerpiece cars which carry lumber. That market should continue to present a challenge for us but as far as changes from today we anticipate being able to maintain the levels of utilization that we saw coming in at the beginning of the year. We don’t see any change in decline from that original guidance, any change in our expectations from earlier this year.

John Hecht - JMP Securities

Real quick you mentioned lumber is 25% of your idle cars, what is the lumber exposure relative to the whole portfolio?

Thomas Ellman

Our total exposure to that car type, we have about 2,000 cars in that service, so out of our 110,000 total.

John Hecht - JMP Securities

Along those same lines I wonder if you can maybe provide some commentary on the market outside of your own portfolio, what are you seeing in terms of idle cars out there from your competitors, particularly in the tank car segment and maybe even outside of things has anything changed since the last quarter relative to your expectations?

Thomas Ellman

It’s pretty consistent with what we’ve been talking about throughout the course of the year. The ethanol continues to be over supplied. We’ve been talking about maybe 10% of that fleet nationally not going to work. That probably remains pretty close to accurate. The thing that has changed though is the builders have ratcheted back putting incremental production into that fleet so we mentioned that maybe late 09, 2010 we’d expect some of that supply to work its way out of the system. That appears to be on course because we’re seeing a slowdown in incremental supply there.

John Hecht - JMP Securities

Last question, Rhonda referred to a big jump in the other income related to scrapping, that you’re scrapping trains earlier in their life cycle given the increase in scrap steel prices, is this something that we should account for for a period of time going forward now given steel prices in your fleet or is that more of a one time jump in those types of revenues?

Robert C. Lyons

Like Rhonda mentioned early on this hasn’t been a [broker matic] [inaudible] increased the level of scrapping, rather it’s when a car comes in to a repair facility we make an evaluation on the future economic flows that we get from [inaudible] that car to scrapping it. With scrap prices moving upward it’s tilting more of the decisions toward the scrap side so as long as scrap prices stay where they are we’ll probably reach a little bit further down that chain on the scrapping side so I would expect the second half of year to be fairly consistent with the first half of the year. That scrapping will be exacerbated by a weaker market. You’re still scrapping old cars but as they come off lease which will happen more and more in a weak market, you saw our renewal percent is different in the second quarter, as you look at putting them out on assignment a lot of times that’s going to require service and with scrap prices the way they are that decision gets a little tougher so you may take more directly out of service for scrap in a weak market.

John Hecht - JMP Securities

Yes, that sounds like this trend is going to be dictated by scrap prices more than anything.

Brian A. Kenney

I think that’s true.

Robert C. Lyons

Fair statement.

Operator

Your next question comes from Paul Bodnar - Longbow Research.

Paul Bodnar - Longbow Research

Quick question on what you’re looking at in terms of used car, is more the profile, obviously you are heavily weighted towards tank cars, would you plan on maintaining that going forward or would you look at picking up more freight cars or non-tank cars in the market?

Brian A. Kenney

Tank cars have become a smaller percentage of our fleet over the last five years. I think we like a big diverse fleet. We like the stability that the tank car market offers, we’re a leader in the tank car and that will continue but yes, we’ll consider all car types and you might see further weighting towards freight in our fleet. That’s basically been the opportunities that have been available in the market the last couple of years as well.

Paul Bodnar - Longbow Research

Just what’s out there, what it looks like not so much to maintain a specific profile?

Brian A. Kenney

No, we’re not shooting for a specific profile. We always have internal debate about how volatile certain car types. In general freight cars are more volatile. We like the tank car market, we like being the leader there, but we’re much more focused on a diverse fleet at the right price.

Paul Bodnar - Longbow Research

What do you see in the marketplace right now, just in terms of new and used car prices? How has that changed over the past quarter?

Robert C. Lyons

The builders are continuing to struggle, you’ve seen overall backlogs come down but because of their relatively high input costs on the steel side, we really haven’t seen any decline in new car costs. In fact we’ve seen the opposite that costs appear to continue to be going upward because of the pressures they’re seeing on their supply side.

Paul Bodnar - Longbow Research

What increases have you seen out there now? 10%, 15% up? Last quarter was more of a single digit down number.

Robert C. Lyons

It’s probably in the low double digits right now.

Paul Bodnar - Longbow Research

So you’ve seen margin probably contract in manufacturers over the last year or so but their base cost is going up, which if this continues long term should spell pretty good trend for existing car lease rates across the cycle. But that’s going to make it pretty difficult in terms of buying a new car and what return you can earn on that car in leasing it outright, it’s just much more attractive for someone to lease a used car at this point?

Robert C. Lyons

And that’s exactly why we’ve tried to be so active on the long term supply agreement side so you can lock in those costs before this thing happens. You’re right, in the spot market it’s difficult to make that math work.

Operator

Your next question comes from Arthur W. Hatfield – Morgan Keegan.

Arthur W. Hatfield – Morgan Keegan

First question in the rail group, the share of affiliate’s earnings going negative, can you tell us what was going on there and if that’s a trend we’d see at all going forward?

Robert C. Lyons

Actually, Art, that was a bit of an anomaly. Operationally there’s no developments other than continued strength at our affiliates which is within rail, mostly AAE our cargo affiliate and joint venture affiliate in Europe. They did have a mark-to-market on a derivative for about $3.5 million in that range to the negative which was an unusual item in the quarter and has already essentially appears to have reversed. No particular operational trends there at all. It’s an accounting treatment on the derivative.

Brian A. Kenney

That was in anticipation of the plant financing too.

Robert C. Lyons

They hedge out fairly long term on their financing needs.

Arthur W. Hatfield – Morgan Keegan

Secondly I think it was a year ago, Brian, you were talking about maintenance expense bumping up and we’ve seen that and I think you were talking about really a two year bubble in maintenance. Am I remembering correctly and if so is that the still the case and should we see that number trend down as we move into 09?

Brian A. Kenney

No, you’ll see it probably go up in 09. What I talked about was the compliance bubble that’s sitting out there. 2008 is the start of that, it’s really going to last for about three years, probably scheduled to peak in 2009. So if you look at our compliance cars on the tank car side scheduled we have 25% more cars coming in for compliance in 2008 than 2007. Over the next three years it’s going to average 40% or more higher than the prior three years, so a real bubble for the next three years on that first structural inspection of tank cars.

The other thing I’ll say about it, Art, if you look year-to-date maintenance I believe is up $15 million from 07, a third of that is just FX in Europe so a weaker dollar.

Arthur W. Hatfield – Morgan Keegan

Finally I want to make sure that I interpret what you’re doing here correctly, but when you talk about not buying any stock in the quarter to conserve that cash, that doesn’t have anything to do with the fact that you would have trouble raising capital in the current markets we’re in, is it?

Robert C. Lyons

No, not at all, Art. It’s really just balance sheet, capital structure management. We’re not concerned about our ability to go out in this capital market and try to raise funds to do a transaction. In fact we think that’s one of the very big strengths we have in terms of ops versus other potential buyers of portfolios. We’re triple B plus, B double A one, we have very conservative balance sheet and solid capital structure and we’ve been able to access the capital market this year a couple different times already when others can’t. So our financing capabilities we believe are very strong, that’s a competitive advantage for us so not repurchasing the stock is consistent with that but it’s really just balance sheet management.

Arthur W. Hatfield – Morgan Keegan

That’s what I thought and I just wanted to make sure that was clarified if anybody had an issue. But when you look out right now, and this may be I don’t want to say a stupid question but it may be very hypothetical but what position are you in? The best way to put it is how much dry powder do you feel that you have to put to work in this environment?

Robert C. Lyons

You can see with recourse leverage where it’s at at the end of the second quarter here at 2.5 to 1 if you check the last page in the press release. I know you need to weed through a lot to get there but the leverage calc is there and it’s as low as it has been at any time in recent history and we’ve indicated that over time we would feel the business would support moving that leverage up materially. We’re probably closer more to the 4 to 1 type level which is manageable on a long term basis and any transaction that may take place in the secondary market we would do so with an eye towards maintaining a very flexible and strong capital structure.

Arthur W. Hatfield – Morgan Keegan

Finally in the same vein but given how strong your balance sheet is and the rumors are hot and heavy about all these freight cars that are out on the market potentially, do you see any real competitors for you in any potential bidding situation that develops in the market?

Brian A. Kenney

I don’t think there’s any shortage of private equity, for instance, that’s interested in entering this market as an example.

Robert C. Lyons

I would say this asset class have proven itself through cycles to attract capital because of its stability of cash flows and the underlying customer base and GATX would not stand alone in its interest in other portfolios.

Operator

Your next question comes from Richard B. Shane, Jr. - Jefferies & Company.

Richard B. Shane, Jr. - Jefferies & Company

Couple different questions, in terms of what was scrapped during the quarter what was the number of cars or could you help us understand what the utilization rate would look like perhaps without as much scrap activity?

Thomas Ellman

For the quarter we scrapped 800 cars. For the first half of the year we scrapped about 1,500 which as I mentioned earlier we’d expect to scrap a similar number the second half of the year. On the 110,000 cars in North America you can do the math on the utilization impact.

Richard B. Shane, Jr. - Jefferies & Company

Then just a housekeeping issue, do you foresee any impact from FAS 140?

Robert C. Lyons

No, nothing in particular.

Operator

Your last question comes from Jordan Hymowitz – Philadelphia Financial.

Jordan Hymowitz – Philadelphia Financial

A couple quick questions, one as you approach this year your re-pricing is going to be pretty close to zero at that point. My question is X the acquisitions, what do you think your organic growth rate is in 09 and 10, low to mid single digits? Is that a good guess?

Robert C. Lyons

Jordan, how are you defining organic growth?

Jordan Hymowitz – Philadelphia Financial

Before stock buy back or capitalized just on an EBITDA line.

Robert C. Lyons

We’re not forecasting. We don’t forecast into 09. We only give that information at the beginning of 09.

Jordan Hymowitz – Philadelphia Financial

My second question is could you quantify the make up of the Wachovia and the GE mix compared to your own? Obviously it’s a lot less, 10 cars. CIT breaks out what their mix is. Can you quantify what Wachovia’s and GE’s mix is on different car types?

Robert C. Lyons

I don’t think we’re in a position to go there. We can give you a ballpark on the numbers. GE was somewhere in the range of 140,000 to 145,000 cars. I think Wachovia’s is in the 60,000 to 70,000 range. GE is a big competitor of ours in tank, the third largest lessor in the tank car business but beyond that really not going to get into a lot of details about what’s in their portfolios.

Operator

At this time we have no further questions.

Rhonda S. Johnson

Thanks everyone participating and I’ll be available this afternoon if anyone has any additional questions.

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Source: GATX Corporation Q2 2008 Earnings Call Transcript
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