Textainer Group Holdings Limited (NYSE:TGH) Q3 2022 Results Conference Call November 1, 2022 11:00 AM ET
Tamara Bakarian - Director of IR
Olivier Ghesquiere - President and Chief Executive Officer
Michael Chan - Executive VP and CFO
Conference Call Participants
Liam Burke - B. Riley FBR
Michael Brown - KBW
Climent Molins - Value Investor's Edge
Thank you, and welcome to Textainer's Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be provided at that time. As a reminder, today's conference call is being recorded.
At this time, I would like to turn the call over to Tamara Bakarian, Investor Relations for Textainer Group Holdings Limited.
Thank you. Certain statements made during this conference call may contain forward-looking statements in accordance with U.S. securities laws. These statements involve risks and uncertainties, are only predictions and may differ materially from actual future events or results. The company's views, estimates, plans and outlook as described within this call may change after 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, 2021, filed with the Securities and Exchange Commission on March 17, 2022 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 any forward-looking statements.
During this 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 measures to the most directly comparable GAAP measures will be provided either on this conference call or can be found in today's earnings press release. Finally, along with the earnings release today, we have also provided slides to accompany our comments on today's call. Both the earnings release and the earnings call presentation can be found on Textainer's Investor Relations website at investor.textainer.com.
I would now like to turn the call over to Olivier Ghesquiere, Textainer's President and Chief Executive Officer, for his opening comments.
Thank you, Tamara. Good morning, everyone, and thank you for joining us today. I will begin by reviewing the highlights of our third quarter results, followed by additional perspective on the industry. Michael will then go over our financial results in greater detail, after which we will open the call for your questions. We're pleased to deliver yet another quarter of very strong results, continuing the positive momentum from our record performance last quarter. For the third quarter, lease rental income grew to $205 billion, driven by CapEx deployed earlier in the year. Additionally, we continue to benefit from exceptional gains on disposals of older containers. Adjusted EBITDA was $193 million, a slight increase from last quarter and adjusted net income was $77 million.
EPS reached a new record at $1.64 per diluted share as a result of our strong income and lower share count from our continued buyback program. As we had anticipated, the demand for new container was muted in the third quarter as shipping lines now operate with sufficient container inventories following robust fleet expansion over the last two years and an overall softening of cargo volumes. Contrary to historical seasonality, many retailers opted to ship holiday season merchandise earlier in the year due to anticipated global supply chain bottlenecks and some have reduced orders over concerns of tempered consumer spending. In the absence of traditional summer rush and despite cargo volumes that remain above pre-pandemic levels, spot ocean freight rates have decreased as rapidly as they went up two years ago.
In what appears to be the start of the much-anticipated normalization, port congestion has now dropped to just under 10% of global ship capacity and shipping lines have started to increase brand failing to better manage freight capacity and focus on their contracted business, which remains highly profitable. In a healthy sign that container industry players are not looking to add further capacity to the market, new orders placed at container factories in October slowed to their lowest level in three years. As a matter of fact, many factories in China have remained shut after the traditional Golden Week holiday and plan to remain closed until the end of the year.
This should allow for the total container inventory at factories which is primarily owned by shipping lines to decline from its current level of about 1.1 million TEU. Whilst high, this level of inventory represents about 2% of the world container fleet, which is not unheard of. As stated previously, Textainer continues to pursue a disciplined investment policy, focusing on back-to-back leasing deals and holding a low level of uncommitted factory inventory that has remained stable at approximately 40,000 CEU. Looking at our existing container fleet, shipping lines have started to redeliver mostly all sales age containers, they have kept active in the previously buoyant environment.
As a result, our average fleet utilization for the quarter declined slightly to 99.4% and currently stands at 99.1%. This uptick in redelivery has allowed us to capitalize on continued favorable resale market conditions, higher disposal volumes, albeit at lower average sales price per unit have translated in a third quarter gain on sales of $23 million, in line with last quarter's record figure. As we look out for the coming months and into 2023, we see a continuation of this normalizing market condition and remain optimistic that we're well positioned to navigate this changing terrain and focus on our business fundamentals and long-term objectives.
Overall cargo volumes remained higher than pre-pandemic, even as ocean freight rates normalize, a high number of containers are still required to satisfy the current demand. Congestion is easing from previous hikes but remains elevated and therefore, supply chain remains susceptible to external disruption, such as industrial action and cope lockdowns that warrant spare capacity. New environmental regulations taking effect in 2023, they have less impact than expected but will nevertheless result in slower steaming overall and higher container requirements. We expect shipping lines to continue to focus primarily on returning other containers that are past their normal retirement age, helping us maintain the young age profile of our fleet and allowing us to generate cash from container resale.
This, combined with factory closure and a substantial reduction in new container supply as is the case since Golden Week, will contribute to rebalancing the current supply post pandemic. If history is any guide, previous downturns in new container supply have lasted between four to six quarters, and we expect that this cycle will be no different. If anything, a possible economic stimulus plan in China could provide impetus for earlier activity pickup in the intra-Asia trades. We also expect our customers to take more aggressive steps to adjust slot capacity and continue to enjoy much higher profitability than was the case pre-pandemic.
Most importantly, our overall fleet may be contracting slightly, but we will benefit greatly from our significant portfolio of longer-term profitable leases secured over the past years. We continue to be focused on our strategy of improving operational efficiency and optimizing long-term performance through market cycles. Following an incredible rally that has allowed us to deploy a high level of CapEx on long-term profitable business, we're happy to take a step back and focus on returning capital to common shareholders through our ongoing share repurchase, dividend programs. During the third quarter, we repurchased over 1.7 million common shares and as of end of the third quarter, our share repurchases since the start of the year represented approximately 8% of total shares outstanding.
Given our positioning in the business cycle and our substantial cash generation, the Board and the management team continue to see share repurchases as a very efficient use of our liquidity. In line with this, I'm pleased to report that our Board of Directors has authorized a further increase of $100 million for existing share repurchase authorization, bringing its total to $168 million available in the fourth quarter and onwards. We expect to remain both active and opportunistic in our share repurchases. In addition, the Board has authorized a continuation of our cash dividend for common shareholders at its current level of $0.25 per share, and we'll continue to reevaluate this on a regular basis with a view of optimizing total shareholder return.
I will now turn the call over to Michael, who will give you a little more color about our financial results for the third quarter.
Thank you, Olivier. Hello, everyone. I will now focus on our Q3 financial results. We had a very strong third quarter, one of Tech Standards best quarters to date. Earlier CapEx investment in the year was reflected in our lease rental revenue this quarter, and we continue to experience exceptional gain on sale results from higher turning volumes and still elevated resell prices in the secondary market. Following a period of unprecedented market conditions, which provided a Textainer, the operator dramatically improve the long-term quality of the slice portfolio and balance sheet. Our shipping line customers are now experiencing an anticipated period of normalization with reduced trade volumes and new container demand, which will continue through the next quarters.
Q3 adjusted net income was $77 million as compared to $79 million in Q2. Q3 adjusted earnings per diluted common share was $1.64 as compared to $1.63 in Q2. This was driven by our strong Q3 performance and accretive impact from increases to our share repurchase program. We're also pleased that this results in an annualized Q3 adjusted ROE of 18%. Q3 lease rental income was $205 million as compared to $203 million in Q2, driven primarily by CapEx deployed earlier in the year and the benefit of one more billing day within the current quarter. Our utilization rate remained high, averaging 99.4% during Q3.
Going forward, we expect some slight natural attrition of our [indiscernible] as older containers being returned or not replaced by new ones as shipping lines rebalanced their container fleets in line with market normalization. We delivered another quarter of strong gain on sales at $23 million, in line with last quarter's record results. This was driven by an increase in sales volumes sourced from slightly higher redeliveries of older, mostly sales age containers on the expired lease contracts. While resell container prices have continued to reduce from peak levels in 2021, they remain at a favorable level thus far. As we have noted in the past, while it is difficult to project with precision, future resell funding's and prices, we are confident in our ability to best optimize each presented resell opportunity.
Q3 direct container expense of $9 million increased from the previous quarter due to higher maintenance handling and storage fees, resulting from a slight uptick in container deliveries, which supported the strong gain on sales performance in Q3. We expect Q4 direct containing expense to gradually increase in container deliveries continue into the end of the year. Q3 depreciation expense was $73 million and is expected to remain mostly flat or slightly lower in Q4. We with tempered remaining CapEx expectations and continued to resell activity during this time frame. Q3 G&A expense of $12 million decreased from Q2. Q3 G&A expense included lower professional expenses and IT costs associated with our ERP system. Q4 G&A expense should approximate the quarterly average over year-to-date 2022. Q3 interest expense of $41 million increased by $4 million from Q2. We expect interest expense to continue to gradually increase as higher interest rates impact the unhedged component of our debt. And as we continue to roll over maturing swaps in line with our policy to hedge or fix the majority of our outstanding debt.
As we noted earlier, we expect limited CapEx opportunities in the near term, and we may elect to deliver the unhedged components of our debt financing in order to minimize the impact of higher interest rates from this portion of our debt. Q3 average effective interest rate remains well under control at 2.83%, an increase from 2.62% in Q2. We took further action to optimize our capital structure and enhance our financial flexibility in Q3. As previously announced in August, we completed an amendment to renew and extend the terms of our revolving credit facility. Additionally, increasing the aggregate commitment amount from $1.5 billion to $1.9 billion and reducing its pricing.
This places us in an ideal position, ample dry powder and the Billy Jack fast as needed when the market conditions improve again. Turning now to our share repurchase program. We repurchased approximately 1.7 million shares during Q3. This reflects an over 20% increase in repurchase volumes from the last quarter. For the three quarters ended with Q3, we repurchased over 8% of outstanding shares as of the beginning of the year. As of the end of Q3, on a program-to-date basis, we have repurchased nearly 25% of outstanding shares since the inception of our share repurchase program in September 2019. We're also pleased to announce that our Board has authorized a further increase of $100 million to our existing share repurchase program, which now has $168 million available for Q4 and onward.
Our share repurchase form continues to be a key component and significant focus of our capital allocation policy to further drive shareholder value to our investors, and we expect to remain active as it relates to future repurchase activity. Our Board has approved our continued $0.25 per common share cash dividend payable on December 15 to holders of record on December 2nd. It has also declared a quarterly preferred cash dividend for both our Series A and Series B perpetual preferred shares, payable on December 15 to holders of record as of December 2nd.
Looking now at our balance sheet and liquidity, we continue to benefit from the quality of our strong balance sheet with our attractive lease portfolio that provides long-term fixed cash flows, averaging 6.6 years of remaining contractual lease center and covering 80% of our remaining retinal life of our fleet on an NBB basis. This continues to be well supported by fixed rate or hedged to fixed long-term financing structure. This ongoing liquidity generation, in addition to our well-structured bank facilities and $253 million in cash reserves, inclusive of restricted cash, provides sustainably with a platform that will provide significant long-term value. In closing, year-to-date Q3 has produced very strong results for Textainer.
However, given potential economic uncertainties and limited expected CapEx option, we do expect some normalized performance in the near term. But our liquidity generation were paying strong. In this context, we intend to remain disciplined when it comes to evaluating capital expenditure opportunities. And we'll continue to execute and optimize capital allocation in the best long-term interest of our shareholders. This concludes our prepared remarks. Thank you all for your time today. Operator, please open the line for questions.
Ladies and gentlemen, at this time, we'll begin today's question-and-answer session. [Operators Instructions] Our first question today comes from Liam Burke from B. Riley FBR. Please go ahead with your question.
Olivier, you said the cycle typically runs about four to six quarters in terms of the supply and demand curve in terms of containers. Do you see anything in 2023 such as new vessels coming online in the second half that would pull that cycle in or at least shorten it or move it towards the shorter end of the four to six quarters?
It's a good question. But I think, Liam, what's very important here is to differentiate a little bit demand for containers from demand for shipping capacity. Because although the two are related, they may not be that directly related. And I think we're in a situation where as you know, lead times on containers are very short, and that essentially explains why supply and demand tend to rebalance fairly quickly in the container supply world, whereas the lead times for new ship deliveries are much, much longer, typically two, three years before a ship gets delivered, which really means that it's a completely different ball game.
So, we're in a situation where we have supplied a lot of containers to the market to satisfy demand over the past two years. And we have seen this normalization in terms of container supply taking shape probably since the beginning of the year. Now experience shows that although there is a little bit over 1 million TEU inventory at the factories at the moment, it takes about four quarters for that to be absorbed, especially in an environment where orders are reducing drastically. Now coming back to the point, you made about the additional ship capacity, that is an interesting one because we also believe that to some extent, adding ship will create new opportunities and will probably coincide with some uplift in the market for container lessors and container in general.
And that is because more ships essentially will give more flexibility for shipping lines to operate their fleets around the world. And they will probably decide to operate a lot of those ships at a slightly slower speed to try to save on fuel in an environment where bunker is getting very, very pricey. They will also sale a little bit slower in order to try to comply with environmental regulation. But here, I think the main driver will really be this awareness of the fuel cost. And that means that if there are more ships on the water that are sailing slower, there will be more demand for containers to be in use. So in a nutshell, I would say that although container demand is fundamentally driven by demand for cargo, there is going to be an impact because of these additional shifts that are coming for delivery starting in the second half of next year.
And on the capacity utilization, it ticked down a bit, which is not surprising. Would you anticipate a more normalized times your utilization rates to remain above historic levels?
Absolutely, I think this incredible rally that we've had over the past two years has not only allowed us to put a lot of money at work and all that has gone into very long matured contract at a very profitable IRR. Those are, so to speak, locked in for the next 10 years. But what that rally has also allowed us to do is to essentially extend existing leases into life cycle leases. And that also has meant that the average maturity on our contracts has gone from below three years on average to more than six today. And I think that's a big sign of how resilient or income or lease rental income is going to be going forward.
And I think we've been very clear in our prepared remarks about utilization rate potentially coming down a little bit. And it will. And again, it's primarily driven by container that have reached sales age, containers that shipping lights have been holding on over the past quarter over the past two years actually, and that are now being returned because they're so banged that they can't be operated and their prime candidates to be retired and to be essentially sold in the secondary market or scrap.So will we see a small decline in utilization? Yes, absolutely correct. But I think that the long-term utilization rate is going to remain very, very strong and certainly way above our long-term average of the past 10 years.
Our next question comes from Michael Brown from KBW.
So I wanted to start with kind of the durability of your earnings profile here and the right way to think about that. So you put up an 18% annualized ROE this quarter. And I suppose there is some element of overearning on the gain on sale revenue, which I'm sure will moderate over time. But how do you think about what that right new ROE is for Textainer as we move through the cycle here. And then thinking about the durability of your cash flows, as you just mentioned, is it fair to assume that again, the gain on sale is kind of the swing factor, but your EPS has a pretty durable base here that will give us some kind of visibility and again, durability into that EPS over the next coming quarters here?
We've always said that we think that the long-term ROE for our fleet should be in the region of the mid-teens. And the reason we've always said that is because that is where we effectively have been pricing containers whenever we make a new deal, we take a lot of parameters. We actually use a leveraged IRR model which takes into account all the various elements. And one main one right now is obviously interest rates. But the target that we've always aimed for was kind of like a mid-teen ROE. So we think that our ROE will also normalize around that level. And essentially, what is boosting that ROE and you're underlining it very correctly, is the exceptional gain on sales that we're experiencing at the moment. I mean they're really boosting the ROE. And the level of profit that we are achieving on resale it such that objectively, we expect it to moderate over the coming quarters. So that said, I think that the leasing revenue is very strong, very stable for the foreseeable future. And that will continue to provide very much long-term stable cash flows.
And as we have mentioned in our prepared remarks, we're really focused on buybacks in an environment where we don't see opportunities to deploy capital at the right return. The best thing we can do is to buy our own containers and our own fleet that generates 18% and is currently trading below book. So, it's definitely a very compelling argument to continue to use our free cash flow to buy back share and thereby help support the EPS in a down cycle. And when the market conditions are going to be right and things are turning, that's when we're going to move back into the investment phase of our business.
And as Michael mentioned, we're always making sure that we are maintaining ample capacity so that we're ready to move in when the market comes. We know that the market can come down very suddenly. It can also come up very sonly as we saw in 2020. So definitely, we were going through this normalization phase but we're really optimistic that this is not going to be a very long-term kind of situation, and that will be ready to start investing again in the not-too-distant future.
Actually, I appreciate that and all those thoughts. On the share buybacks, really impressive amount of activity in this quarter. If the environment, as you've mentioned, it's certainly normalizing and the investment opportunities are low currently. So is it fair to assume that the level we saw in the third quarter is probably where you could operate here in the near term. And is it actually possible that you could come in higher? Or did that kind of represent the amount of shares that you're comfortable buying in the open market? Any color there would be helpful.
As Michael mentioned, we've been repurchasing 25% of our equity since we started the buyback program, I think, a little bit over 8% since the beginning of the year. And at the pace of the last quarter, we're probably on a pace to buy back 15% of our equity on an annual basis. So, we're certainly comfortable buying back our share. We're generating a lot of liquidity. But I would refrain from giving too much guidance because as I explained, the market can change very, very rapidly. And it is something that we are reassessing on a continuous basis and the Board is -- and the management are exchanging a lot of information on those topics.
But what I can say for sure is that we were very comfortable with the level that we spent in the third quarter and that in an environment where we have no opportunities to deploy CapEx or very limited opportunities should to deploy CapEx. It certainly makes a lot of sense to focus on buyback and perhaps at the same time, keep an eye on some deleverage with moderation given the high interest rate environment we are in.
And maybe I could sneak in one more just on the credit side. What are you seeing and hearing from your customers and clearly, those spot freight rates are down sharply? How should we think about where those credit risks lie and where there could be some potential if and when there could be some potential credit issues or what are you seeing at this time and what are your expectations as you look out over the next 12 months or so.
I think that the credit risk has never been so low in our industry to be fair. I think the top 10 shipping lines in the world have generated so much profit over the past two years and actually continue to be extremely profitable. I mean ocean freight rates have definitely dropped, but they're still higher than they were pre-pandemic. And shipping lines are continuing to raking big profit. And most of them have restructured their balance sheet. I think of the top 10, there's only one shipping line that still has some debt. All the others are negative. So, we really think that, that risk will -- has pretty much gone away for the foreseeable future. And we personally see no exposure with our portfolio.
There is a situation right now with some smaller shipping lines that ventured on territory that was not their traditional territory, the transpacific and Asia-Europe routes with small ships. They are busy retreating from those trades because as rates are coming down, they can't compete with the small ships. But we have been very aware of the risk that was associated with those small shipping lines. So, we have actually not done business with them. So, we're not at all exposed to that situation that is very limited. But as I mentioned, I think the large shipping lines have never made so much money. So, we're feeling very, very secure from that point of view.
And our next question comes from Climent Molins from Value Investor's Edge.
I want to start by asking about overall capital allocation priorities in the current environment. Considering CapEx is expected to remain low for the foreseeable future, how do you plan on balancing share repurchases, which seem very accretive at the moment with potential dividend increases and deleveraging.
Clement, for that question. Great question. We looked at our capital allocation policy and approach very carefully as you can imagine, with where the shares are trading at and limited CapEx opportunities, we certainly have a primary focus on share buybacks. It makes perfect sense. It's investing in the company. We certainly are confident in the quality of the company, quality of the balance sheet and makes sense to invest we've been in as well. So that will be the part of focus. The dividends are also important as well. We continue to evaluate that. The Board evaluates that. And we think that it's important to make sure that it's certainly sustainable, which it is. And we'll look at it on a quarterly basis to see when we may adjust that rate on an ongoing basis.
In terms of de-levering, we look at that, too. There is some value in doing that. There are certain portions of the debt stack that are more expensive than others. The portion of that is unhedged. So we may target some opportunistic deleveraging there, whereby we could reduce overall interest expense. But looking at the overall capital allocation policy, I just wanted to make it clear on that, what we see in an absence of new CapEx opportunities that makes sense, one's going to look at -- we will certainly look at buybacks as a priority. And that's certainly very accretive. It's going to benefit the shareholders very, very well. Until the point where CapEx offers do you return down the road, actually.
Meanwhile, sales have remained exceptionally strong despite the lower prices due to the higher volumes but going forward, could you give us some commentary on where you see secondhand pricing stabilizing?
Yes, it's a very good point you bring up, Clement. We've always said that the gain on sales is probably the most volatile part of our income. And we are coming from a situation where we were selling a 15-year-old container at a higher price than their OEC, which is obviously not a situation that is sustainable. It's a dream like situation very obviously, but one has to be a little bit rational and realized that, that is not something that is long-term sustainable. So as predicted, the resale prices and the second and prices have started to moderate in line with the increase of redeliveries that we have observed from shipping lines. So far, it has happened in a fairly progressive way. But the trend is definitely doing there. You can see it for yourself.
I mean we achieved the same gain on sales, but with a much higher volume and a lower average price. Now going forward, we expect that trend to continue. One indicator which we like to use is the fact that secondhand pricing has always kind of stabilized at about 50% of the price of a new container. And we estimate that the price of a new container today would probably be in the region of $2,200. So taking that into consideration, we probably would estimate that secondhand prices on average would probably move towards that level of 50% of 2,200, so that give or take, 1,100, which is still substantially higher than our current residuals on a lot of those containers and that should continue to provide us with some gain on sales, but definitely gain on sales that will be more modest than what we have seen over the past three, four quarters.
[Operator Instructions] And in showing no additional questions, we'll end today's question-and-answer session. I'd like to turn the floor back over to Olivier for any closing remarks.
Thank you, everyone, for taking part in this earnings call, and we certainly look forward to updating you all on our full year results next quarter. Thank you.
Ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for attending. You may now disconnect your lines.