Market Overview

Rail Equipment Sector Eyes Mergers, Lease Renewal Rates

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Rail Equipment Sector Eyes Mergers, Lease Renewal Rates

A number of rail equipment lessors and manufacturers have been merging and consolidating in recent months as a way to leverage themselves against marketplace changes brought about by precision scheduled railroading (PSR), an operational model that seeks to cut costs.

Among them, railcar manufacturer Greenbrier (NYSE: GBX) acquired the manufacturing segment of American Railcar Industries in April as a way for Greenbrier to solidify its role as a supplier of covered hoppers and tank cars. In February 2019, Wabtec's (NYSE: WAB) merged with GE Transportation to ramp up its market presence as a rail component manufacturer specializing in automation and locomotive upgrades, according to Matt Elkott, an analyst with investment firm Cowen. Meanwhile, Trinity Industries (NYSE: TRN) spun off its non-railcar business last year to focus on fleet growth, Elkott said.

While PSR could eventually lead to a net reduction in railcars in service among the Class I railroads deploying the operational model, railcar lessors can still benefit in the post-PSR landscape by taking advantage of how the railroads replace and reorganize their fleets, Elkott said.

"Consolidation could benefit not just the participating parties but all other players. It could right-size production capacity in the face of tempered demand and improving rail velocity, freeing up capital by eliminating redundant resources, and boost the builders' pricing power," Elkott said in a May 9 research note.

For instance, Norfolk Southern (NYSE: NSC) appears to be attempting to reduce the number of different types of boxcars in its fleet, with a possible eye towards deploying newer, higher capacity railcars that complement the company's PSR efforts, he said.

Meanwhile, Wabtec said last month that its acquisition of GE Transportation will leverage Wabtec's efforts to market automation technologies to the railroads.

"We have combined Wabtec's freight and transit components with GE Transportation's locomotive manufacturing and service capabilities… So far, we're seeing a strong cultural fit, which is enabling a seamless combination of our businesses" and could lead to fully automated operations in the Class I network, Wabtec chief executive officer Ray Betler said during his company's first quarter earnings call on April 25.

Railcar utilization in 2019

One way to analyze how PSR will affect rail equipment and manufacturing is to look at data on railcar orders and the number of railcars in storage. But since NSC, Union Pacific (NYSE: UNP) and Kansas City Southern (NYSE: KSC) have begun to implement elements of PSR only recently, more data over longer terms will be needed. Railcar orders and railcar utilization rates can also be affected by the same near-term factors affecting rail volumes, such as consumer demand and the general health of the U.S. economy.

For now, Elkott estimates that railcar orders could fall 33 percent in 2019 to 39,739 orders amid tempered decline and buyers taking a wait-and-see approach this year as PSR takes hold. The decline is also partly attributable to one-off orders placed by lessors in 2018. But railcar orders could grow 21 percent between 2019 and 2020 to 48,200 orders. Both 2019 and 2020 estimates are below the 2005-2018 annual average of 59,800 units, he said.

While railcar orders could soften this year, the number of railcars currently in storage could drop in 2019 as volumes pick up during the spring and summer, according to analyst Bascome Majors of the investment firm Susquehanna Financial Group.

The number of railcars in storage fell in April 2019 for the first time in months, according to Majors' analysis of data from the Association of American Railroads. Railcars in storage declined 0.7 percent between March and April to 341,747 railcars. Of that, the number of open hoppers in storage fell 6.8 percent while covered hoppers fell 1.5 percent and flat cars fell 9 percent, Majors said. Railcars that saw their storage numbers increase in April included boxcars, whose storage rates grew 8.4 percent, an gondolas, which grew 2.9 percent. Storage rates also rose for intermodal wells, tank cars and refrigerator cars.

"Railcar utilization rose in April for the first time since October [2018], breaking a six-month negative streak," Majors said. "One month does not a trend make, but we continue to see potential for utilization to rise [and storage to fall] this spring and summer as rail volumes recover out of winter," Majors said in a May 3 research note.

Elkott agreed that railcar utilization could grow this year, despite his forecast for fewer railcar orders.

"I am actually modeling for orders to also improve in the remainder of the year compared to the relatively low level we saw in the first quarter," Elkott said.

Trinity expects its renewal rate in 2019 for its leased railcar fleet to increase 13 percent from 2018. The company also said it is seeking to be a "prudent and opportunistic buyer" of railcars for the secondary market.

The company also reaffirmed its support of PSR, saying the changes will enable the rail industry to compete long-term.

"While railroads usually reduce the number of railcars available apart in their new lines, this does not necessarily or directly translates into an increase in railcars and storage," Trinity commercial officer Eric Marchetto said. "Instead, this exchange places more onus on the shippers to provide their own railcars, a great opportunity for a leasing company to fill this need."

Image sourced from Pixabay

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