CAI International's (CAI) CEO Victor Garcia on Q4 2016 Results - Earnings Call Transcript

| About: CAI International, (CAI)

CAI International, Inc. (NYSE:CAI)

Q4 2016 Earnings Conference Call

February 14, 2016 5:00 PM ET

Executives

Timothy Page - Chief Financial Officer

Victor Garcia - President, Chief Executive Officer, Director

Analysts

Helane Becker - Cowen and Company, LLC

Brian Hogan - William Blair

Doug Mewhirter - SunTrust Robinson Humphrey

Operator

Good day, ladies and gentlemen. And welcome to the CAI International Fourth Quarter 2016 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. [Operator Instructions] As a reminder, this conference may be recorded.

I would like to introduce your host for today's conference Mr. Timothy Page, Chief Financial Officer. Sir, please go ahead.

Timothy Page

Good afternoon and thank you for joining us today. Certain statements made during this conference call maybe forward-looking and are made pursuant to the Safe Harbor provisions of Section 21E of the Securities and Exchange Act of 1934 and involve risks and uncertainties that could cause actual results to differ materially from our current expectations including, but not limited to, economic conditions, expected results, customer demand, increased competition and others.

We refer you to the documents that CAI International has filed with the Securities and Exchange Commission, including its Annual Report on Form 10-K, its Quarterly Reports filed on Form 10-Q and its reports on Form 8-K. These documents contain additional important factors that could cause actual results to differ from current expectations and from forward-looking statements contained in this conference call.

Finally, we remind you that the Company’s views, expected results, plans, outlook and strategies as detailed in this call might change subsequent to this discussion. If this happens, the Company is under no obligation to modify or update any of the statements the company made during this discussion regarding its views, estimates, plans, outlook, or strategies for the future.

I will now turn the call over to our President and Chief Executive Officer, Victor Garcia.

Victor Garcia

Good afternoon. And welcome to CAI's fourth quarter and full year 2016 conference call. For the quarter, we reported a revenue increase of 18% from the fourth quarter of 2015 and lease related revenue decreased by 4%. During the quarter, we reported net income of $0.7 million or $0.04 per fully diluted share. The four quarter results reflect our focused efforts to reposition and dispose of non productive idle assets. Our priority is to release capital in low return assets and position our fleet for high utilization and financial returns over the coming quarters. As such our results this quarter were negatively impacted by the loss on sale of equipment and cost and incentives to have our equipment repositioned for lease.

Most of the loss on sale occurred in the first half of the quarter on equipment that was negotiated for sale in the third quarter. We expect our focus on eliminating idle assets and increasing utilization will benefit our results in the coming quarters. Our utilization of owned equipment has already increased from 93.9% at the end of the third quarter to 95.6% today. We increased utilization during a quarter that historically has been a weak demand quarter for utilization declines from the prior quarter. Our idle fleet has declined by over 50% from its peak in the first quarter of 2016.

With current trends and commitments for lease and sale, we expect our utilization to increase further to 97% to 98% in the coming months. We expect to have the benefit of increased lease revenue, lower storage cost and handling. And better results on a sale of equipment due to fewer assets for sale and higher average selling prices. Our storage cost in December decreased by over 40% compared to the peak in the first quarter and we expect that monthly amount to decline further in the coming months as utilization increases, leading to significant annualized cost savings. We also expect repositioning cost to reduce in the coming months as sale volume is decreased from their peak in the fourth quarter of 2016. Many of the underlying trends that negatively affected the container industry has reversed over the past three quarters. Container prices have increased 60% from the lows experienced in early 2016 and currently stand at around $2,100 for a 20 foot container. Per diem rates on new and depot equipment have doubled as demand for equipment has strengthened along with the increase in utilization and new container prices. Per diem rate have not only improved to reflect the higher container price but the per diem rates reflects the higher yield on the investments being made than what was being experience earlier in the year.

These positive trends in per diem rate should reduce the pressure on renewal rate on expiring contract. We believe that the tightness of the market and improved rate environment will continue over the coming months particularly if as expected container factories closed for several weeks in the second quarter for to retool for the changeover to water bond paint production. The changeover is occurring during a period of time when demand for container production begins to increase, which should create a significant though temporary shortage of equipment.

The rail market remains very challenging but we see some improving fundamental trends. We believe production capacity for new railcar is being significantly reduced and there is limited incremental ordering of equipment. Rail velocity which is an important factor in railcar demand has also slowed due to weather related issues and from improving energy related traffic including coal shipping. A level of our inquiry has increased over the past few weeks.

During the fourth quarter, we leased out 200 railcars and we are focused on placing the equipment we have on order on attractive leases. The utilization of our railcar fleet remained strong at 95% for the quarter and most of our railcars remained under long-term leases that should provide steady revenue and earnings over the coming quarters.

During the quarter, our logistics business faced a challenging environment due to the slow growth of the U.S. economy and low freight rates by shipping line. As a result, the peak season freight demand has been limited and competition has remained strong. However, we are making steady progress in growing each of our logistic services and cross marketing opportunities amongst our company. We continue to see our logistics capabilities is providing us a competitive advantage and increasing our asset utilization and returns. We are excited about how we are positioned for what we foresee as an improving market. We have a lot of momentum in our utilization and expect improvements in our financial results. Based on the ongoing congestion and capacity issues, we are encountering in many depot locations around the world, we believe we are in a relatively better position in reducing idle equipment as compared to the industry as a whole. We will remain disciplined and looking at new investment to achieve attractive returns and remain focus on enhancing overall cash flow.

I'll now turn the call over to Tim Page, our Chief Financial Officer to review the financial results for the quarter in greater detail.

Timothy Page

Thank you, Victor. Good afternoon, everyone. Earlier today, we reported our 2016 fourth quarter results. Because market conditions have changed dramatically during the year and in particular during Q4, I am going to focus most of my comments on Q4 and the current run rates of various income statement accounts rather than on full year 2016 results. Container lease revenue in the quarter was $49 million basically flat with Q3 of 2016 and 8% less than Q4 of 2015. The variance with Q4 of 2015 reflects the decrease in average lease rates. The lower lease rates what we experienced in 2015 and 2016 were a function of both general slowdown in global intermodal trade over the past two years, as well as the dramatic decrease in new container prices that occurred beginning mid-2015, which hit a low point in Q1 of 2016 when new standard 20 foot dry van containers cost approximately $1,300. As Victor mentioned new 20 foot container prices have subsequently recovered and are now in $2,100 range. As a result, per diem rates for new 20 foot dry van containers have almost tripled since the beginning of 2016. As we make investments in new containers and renew existing leases, we are cautiously optimistic that we will see the downward trend in average lease rates update and turnaround.

Rail lease revenue was $8 million in the quarter and was 5% greater than Q3 and 42% greater than Q4 of last year. As we enter 2017, the lease market for rail equipment continues to be challenging due to excess manufacturing, capacity and soft demand, consequently we believe the growth rate in our rail lease income will be impacted over the next several quarters. Our rail lease revenue accounted for 14% of our total lease related revenue in the quarter compared to 9% in Q4 of last year. Rail operating income in the fourth quarter was flat that of Q3. Rail EBITDA in the quarter increased to $5.9 million versus $5.6 million in Q3, and $4.6 million in Q4 of last year. However, rail pretax income decreased to $1 million in Q4 as compared to $1.4 million in Q3 as a result of $0.4 million increase in interest expense due to an increase in LIBOR and increase in the average leverage based margin applicable to our floating rate credit facility and the conversion of $50 million of floating rate debt to long term fixed rate debt during the quarter.

Total revenue in the quarter was $77.3 million, 1.5% lower than the third quarter. The decrease primarily attributed to the normal holiday related slowdown in logistics business. Depreciation expense in Q4 was $27 million as compared to $29.9 million in Q3. After eliminating the impact of impairment charges, depreciation expense in Q4 was $26.5 million as compared to $27 million in Q3 and was in line with our expectations. Loss on sale on rental equipment in Q4 was $4.7 million as we sold a record number of containers during the quarter realizing $22 million in proceeds. Average selling prices were generally in line with Q3 and began to improve in the later part of Q4, a trend that is continuing in 2017. We would expect that in Q1 of 2017 the strong market for leasing depot equipment will significantly reduce the volume of our sales activity. This reduction in volume combined with an improving market from a price perspective should result in a significant improvement in the profitability of our container sales activity.

Container storage expense in the quarter decreased to $3.6 million as compared to $4.5 million in Q3. The December storage expense was approximately $1 million about $0.8 million less than the monthly rate at the beginning of the year, and reflects not only the improving utilization trends but the high volume of used containers sales we've accomplished over the past year. We expect the decreasing trend in storage cost to continue in the first quarter of 2017.

Handling, maintenance and other related expenses were $5.7 million in Q4 versus $4.3 million in Q3, an increase of $1.4 million or 33%. $0.4 million of the increase is a result of the increase in our rail fleet and related maintenance cost. The remaining $1 million of the increase is container related specifically handling cost related to the high level of container sales and depot lease sales that occurred in Q4, as well as repositioning cost as we move containers from low demand areas to areas where shipping companies would pick up the containers for lease. The handling cost related to container sales are expected to decrease in Q1 as the volume of sales will decrease. Similarly, we expect the volume of repositioning will also decrease in Q1 of 2017.

G&A expense in Q4 was $6.9 million as compared to $11.1 million in Q3. Q4 G&A expense included a credit of $2.8 million related to an adjustment to future considerations related to acquisitions. We would expect G&A to run approximately $10 million per quarter going forward. Interest expense in the quarter was $11.2 million, $0.3 million higher than Q3. And as I mentioned earlier reflects an increase in rail related interest expense.

Our effective tax rate for 2016 was 37% and was impacted by non-recurring tax charge related to the sale of a subsidiary in Q2 of this year. Adjusting for this non-recurring charge, our effective tax rate for 2016 was approximately 23%. It's somewhat difficult to predict the effective tax rate for 2017 because it's ultimately depended on the mix of container, rail and logistics pretax income. That said we expect our 2017 full year tax rate to be in the 16% to 18% range.

At quarter end our total container fleet consisted of 1.2 million CEUs, 0.5% lower than the end of Q3 and 3.9% less than Q4 of last year. Our owned container fleet was 1 million CEUs at the end of the quarter, 0.4% higher than at the end of Q3 and 1.5% lower than Q4 of last year. We expect the fleet size to increase over the coming quarters as a result of new container investment and a decrease in the volume of used container sales.

Average owned fleet utilization for the quarter was 94.3% as compared to 94% in Q3 of 2016 and 91.9% in Q4 of last year. Utilization at the end of Q4 was 95.2% and is currently at 95.6%. A very encouraging trend in light of the fact that the increase occurred during usual seasonal slow period and despite the fact that we also had to deal with the return of containers related to the bankruptcy of Hanjin.

We ended the fourth quarter with approximately $1.5 billion of container revenue assets, 1% less than at the end of Q3 and 5% less than Q4 of last year. We invested a total of $81 million in Q4; $43 million was for railcars, $38 million was for containers. During Q4, given a significant improvement in lease rates and a high level of demand for new containers, we purchased some standard dry box containers for the first time in over a year.

As of the end of Q4, our rail fleet consisted of a diversified portfolio of 6,459 railcars with a net book value of $370 million. Rail now represents 19% of our total revenue earnings assets. We've contractual commitments to acquire approximately $100 million of new railcars during 2017. The vast majority of this commitment is in the second half of 2017. As of today, we've either already purchased or committed to purchase approximately $58 million of containers for delivery in Q1 and Q2, most of which we have lease commitments for.

At the end of the fourth quarter, we had total fund to debt net of restricted cash and cash held in variable interest entities of approximately $1.44 billion, an increase of $24 million compared to the end of the third quarter. The amount of our undrawn rail and container revolving credit facilities at the end of Q4 was approximately $535 million.

That concludes our comments. Operator, please open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Our first question comes from the line of Helane Becker with Cowen and Company. Your line is open. Please go ahead.

Helane Becker

Thanks very much operator. Hi, gentlemen. Thank you so much for the time. I just have a couple of questions here. One is just with respect to containers. I just want to make sure I understand the CapEx forecast for this year. So you've already committed to I think you said $58 million or $81 million?

Timothy Page

$58 million

Helane Becker

$58 million, okay. So that's the level of spend, what are you thinking for the full year?

Victor Garcia

It's going to, Helane; it's going to be depended where the market is. We are taking it quarter-by-quarter and what returns are but we traditionally haven't provided kind of full year CapEx spend. But if you look historically we spent in total CapEx say $250 million to $350 million. I would expect for us to be in that kind of range. That would include rail in that.

Helane Becker

Okay. So all right and should we think about like one fifth rail, four fifth containers or how should we think about that like do you want to grow rail as a percent of total revenue?

Victor Garcia

At this point rail is about $100 million, that's committed and that will probably be the amount we are focused on just investment. We are not looking to do anything incremental beyond what we've already have or committed. So all of the incremental would be container related.

Helane Becker

Okay, got you. And then just on and actually there was one other sort of little thing that I was wondering about. Okay, so the question that I am getting a lot and lot of and I know it's early days yes so perhaps you cannot really comment is with respect to changes in trade policy and changes in tax rate and so on. And I am just wondering if you guys have thought about it. Have you talked about it at support level with how you are potentially preparing for some of these changes including maybe border adjustment taxes and maybe it doesn't affect you but I sure get that question a lot.

Victor Garcia

Okay. It's a difficult question and there is still a lot of uncertainty as to how things are going to play out. I'd just generally say infrastructure spending in the US will help our rail business. So we would expect the rail market to be a beneficiary of kind of any kind of domestic infrastructure investment. On the intermodal side, if the positioning is such that to open up more market for freer trade and that is the end result, it will be a positive. If it truly becomes more protectionists there will be obviously some negative consequences to that. How are positioning our company for that is we are placing our equipment on very long-term leases with creditworthy counterpart so that our results should not be negatively impacted if there is a slight slowdown in world trade.

Operator

Thank you. And our next question comes from the line of Brian Hogan with William Blair. Your line is open. Please go ahead.

Brian Hogan

Good afternoon. Quick question on capital allocation. I noticed in the fourth quarter there weren’t any share repurchases and obviously of the rail commitment and you are talking container CapEx, so one, do you expect to grow this fleet, the container fleet. And obviously we know your rail CapEx but I mean then with -- why weren't there a share repurchase in the quarter given your dislocation to your book value. I understand leverage is consideration as well but just kind of walk through the capital allocation.

Victor Garcia

Okay. In the fourth quarter we had a lot of uncertainty in the quarter particularly leading up to the quarter. So with the Hanjin situation being unresolved and although we had much less exposure, it was a lot of uncertainty about what was going on in the market. And we felt like it was important to focus on just doing what we did which was enhancing our cash flow by getting rid of idle assets and using that cash to make the commitments that we've already committed to. And we had committed already on some rail purchases and some other investments. So that was the priority. I think we still have an open share repurchase program. It's still something we are looking at. But as we go through after year and we look at the environment and the opportunities, we'll make that wait but certainly we still look at share repurchase as something that we are actively looking at.

Brian Hogan

All right. The yield, you said the per diem rates have tripled after beginning of 2016, where that in relation to the corporate average and then just long term where they at and I think Tim I think you mentioned it should alleviate the pressure. Is that, do you think like a mid 2016 bottom in the yield or have we seen the bottom given the move?

Victor Garcia

Well, we've seen the incremental leases that we have been doing both depot and new manufacturing have been rising. I would say the new lease rates on manufacturing equipment would be back to what traditionally had been our average before. So we think as we put those assets on, it will start increasing the average lease rate. We are also looking and had some success already in repricing assets that are coming off lease into higher leases. It's our customer by customer discussion but we are actively looking at doing that to start increasing the average lease rate.

Brian Hogan

All right. The secondary market values, you said you sold a lot and there obviously upward pressure from the prices of new containers and impact of utilization. Do you expect that loss to turn into gain? I know you said you don't expect to sell those many but how big is the game and can you comment on that please?

Timothy Page

Very well could be but it's little early to tell. I would just say the loss that we reported in the fourth quarter, in our mind it's more of it came to where we -- result of decisions that were made in the third quarter. So in July and August we had a great on selling on lot of equipment that have been sitting idle in bad locations and the way we recorded, it takes a lot for the customer to actually pick up. So that -- a fair amount of that equipment got actually recorded into October as opposed to the third quarter. So those numbers are reversing. We are increasing our prices across the board. We are gaining -- gains on sale assets that we are selling. And we are seeing that trend continue and I would not be surprised for us to actually reverse the losses as we go into 2017. I wouldn't expect that to be the case in the first quarter but there is certainly the possibility from the second quarter onwards, depending again how the market plays out. But we do have much less equipment available to sell. So it is a matter of whether or not we have the equipment available.

Brian Hogan

And final question for now. Historically you have been able to generate healthy ROE double digits at least mid-teens if not up into 20s, single digit ROE at the moment, how soon can you get back up to one do you believe you can get to double digit and then how long it get to take there? What is long term ROE look like?

Timothy Page

Our focus is to bring our return on equity to the mid-teens. And we have a focus plan to try to achieve that. A big part of that plan is already what we've done over the course of the last two quarters and just eliminating a lot of assets that were not being productive. The normal cycle of our equipment coming in and out of -- in and out of the fleet would expect to see just a normal attrition rate over the next two to three years. What we are looking to do is to try to expedite that and see where exactly our low yielding assets are and try to put a plan together to do something about those assets to kind of bring forward as soon as we can return back to where we believe the target level should be.

Operator

Thank you. [Operator Instructions] Our next question comes from line of Doug Mewhirter with SunTrust. Your line is open. Please go ahead.

Doug Mewhirter

Hi, good afternoon, good evening. For a couple of bigger picture questions. First, I know it's Chinese New Year or maybe it's actually past that but I know when we talked this time last year there was actually an improvement in utilization and the numbers seemed to be going the right away. And it kind of caught the entire industry leaning the [wrong way] because it's actually-- the shipping line is trying to front run the Chinese New Year by pushing orders ahead. And even the shipper got caught unaware because it was the people shipping the good they were trying to rush orders in. Is it a little bit -- is the dynamic different in terms of supply demand in and around Chinese New Year? And how is that exit been from Chinese New Year in terms of supply demand this time around?

Victor Garcia

I think the market feels different than it did last year. We really have seen steady demand since the Hanjin bankruptcy which was at the end of August. That continue right up to Chinese New Year and what we see there has been a traditional kind of slow period after that but the enthusiasm with which we are finding our customers, their positive outlook and what they are demanding in terms of equipment, it feels like the market will be much stronger. And I think part of it is the demand side but it's also we are starting off with a pretty tight supply demand mix and so the amount of available equipment out there is tight to begin with and customers are seen with the increasing container price, the market just tight so the amount of idle equipment at the factories is about half or less than half of where it was in prior period. So we have somewhere around 400,000 CEUs at the factory. So everything is pretty tight and we have customers picking up equipment from the factories almost as quickly as they are being delivered.

Doug Mewhirter

Okay. That's helpful. Thanks. And speaking of Hanjin, are you worried or are you seeing a dynamic of now that the Hanjin boxes that are being slowly recovered by you and your larger competitors that there is the risk that they will be flooding the secondary market if they have to be recovered in bad locations and while they may not be yours, the other company selling them may kind of tank the secondary market or is that supply, excess supply being better managed and it's not going to shock the system as much as maybe a worse case scenario.

Victor Garcia

The part of our reasoning for trying to be more aggressive in the third quarter, fourth quarter particularly post Hanjin was because of that concern that there would be a lot of equipment potentially off the marketplace that would be depressing prices. We haven't seen it. It's been a few spotty places. I would say from what we are seeing in terms of a global availability of equipment, at least in throughout our network, we are not being negatively impacted by equipment being sold that is related to the Hanjin bankruptcy. So we have so many locations in which we sell, we can position equipment in many locations. I would say almost across the board what we are seeing is a trend towards increasing prices.

Doug Mewhirter

Okay. Thanks. That's helpful again. And lastly, you or Tim perhaps the lot of your Hanjin related losses should be covered by insurance. You have any update into either the timing of that settling of the claim which I heard originally would be towards the end of 2017 at best or the amount of the claim that you would expect to recover based on your current recovery rates.

Victor Garcia

I think we are not get into the amount. We would expect -- usually there is one year anniversary that you have to meet before you can submit your claim. We expect that we will submit our claim at the one year end anniversary mark. So that would be at the end of August. And we are expected to be paid shortly thereafter.

Doug Mewhirter

Okay. Thanks. That's helpful. That's all my questions.

Victor Garcia

And I'll just add that we expect not to have any additional P&L impact from Hanjin other than what we reported in the third quarter.

Operator

Thank you. And that is all the questions I am showing. And I'd now like to turn the conference back over to President and Chief Executive Officer, Victor Garcia.

Victor Garcia

Okay. Thank you everyone for being on the call. As I said in our remarks and in a discussion afterwards, we are very positive about the direction at which the business is going. We are very heartened by the increased utilization and the trends we are seeing in terms of lease rates and new investment return. So look forward to reporting our first quarter results in the coming months. Thank you everyone.

Operator

Ladies and gentleman, thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Everyone have a great day.

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