Q2 2023 Trinity Industries Inc Earnings Call

Speaker 1: Good day and welcome to the Trinity Industries second quarter and six months ended June 30, 1993 results conference call.

Speaker 1: All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad.

Speaker 1: After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then 1 on your telephone keypad. To withdraw your question, please press star then 2. Please note this event is being recorded.

Speaker 1: and predictions of future financial performance. Statements that are not historical facts are forward looking.

Speaker 1: Participants are directed to Trinity's Form 10-K and other SEC filings for description of certain of the business issues and risks.

Speaker 1: a change in any of which could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements.

Speaker 1: I would now like to turn the conference over to Lee Ann Mann, Vice President of Investor Relations.

Speaker 1: Please go ahead.

Speaker 2: Thank you, operator. Good morning, everyone. We appreciate you joining us for the company's second quarter 2023 Financial Results Conference Call.

Speaker 2: Our prepared remarks will include comments from Gene Savage, Trinity's Chief Executive Officer and President, and Eric Marchetto, the company's Chief Financial Officer.

Speaker 2: We will hold a Q&A session following the prepared remarks from our leaders.

Speaker 2: During the call today, we will reference slides highlighting key points of discussion and certain non-GAAP financial metrics. The reconciliations of the non-GAAP metrics to comparable GAAP measures are provided in the appendix of the supplemental slides, which are accessible on our Investor Relations website at www.trend.net. These slides are under the Events and Presentations portion of the website.

Speaker 2: along with the second quarter earnings conference call event link. A replay of today's call will be available after 1030 a.m. Eastern Time through midnight on August 8, 2023. Replay information is available under the events and presentations page on our investor relations website.

Speaker 2: It is now my pleasure to turn the call over to Jean.

Speaker 3: Thank you, Leanne, and good morning, everyone.

Speaker 3: Our second quarter results reflect positive trends in our business despite some downside in our broader operating environment.

Speaker 3: We'll provide more details on how those factors impacted our financial performance. Still, we remain confident in our business's continued momentum and growth as we enter the year's second half. We have line of sight to hire revenues on both sides of our business.

Speaker 3: with increased deliveries, rising lease rates, and continued improvement in our operating margins. Please turn with me to slide 3 to discuss today's key messages. We are reporting second quarter consolidated revenue of $722 million.

Speaker 3: a 73% year-over-year improvement. Our second-quarter EPS from continuing operations was 23 cents, of 16 cents sequentially, and 9 cents year-over-year on an adjusted basis.

Speaker 3: Our leading indicators for our business, namely the FLRD on the leasing side and the manufacturing side backlog, are favorable and give us visibility into strong revenues in 2023 and beyond.

Speaker 3: Despite these favorable indicators, we are reducing and tightening our 2023 adjusted EPS guidance to $1.35 to $1.45.

Speaker 3: This adjustment is primarily due to the outside impact of the strengthening Mexican peso on our manufacturing business.

Speaker 3: higher interest expense, and continued inefficiencies.

Speaker 3: Our revised guidance assumes a substantial improvement in the back half of the year from better efficiency.

Speaker 3: However, we do not have line of sight to our previously issued guidance range without a significant pullback in the strength of the Mexican peso, which we are not anticipating in 2023.

Speaker 3: Let's turn to slide four and discuss the rail market and a commercial overview.

Speaker 3: Like last quarter, overall rail traffic trends are negatively impacted by intermodal volume.

Speaker 3: Through the first 26 weeks of the year, rail carload volumes improved just 2% year over the last year, outperforming the 4% decline in total traffic shown in the slide.

Speaker 3: While the increase in railcar storage in the quarter is consistent with expected seasonal trends, the North American fleet ended June with the lowest active rate since early 2022.

Speaker 3: Fleet storage levels remain well below the five-year average, but improving network fluidity prompts some normalization.

Speaker 3: We're willing to take this trade-off as we believe a more efficient rail network will benefit from gaining modal share and driving longer-term sustainable growth.

Moving to the bottom of the slide, we continue to see high fleet utilization and a very strong teacher lease rate differential or FLRD.

which are good predictors for rising lease rates in the future.

Our fleet utilization was 97.9% and the FLRD was 29.5% with lease rate strength, especially in pressure tank cars and large cover hoppers.

While rail traffic trends are important in our business, the critical driver is lease-suite utilization and rising lease rates.

which have seen significant improvement.

Put more directly, the strength in our business has been supply-led, which provides confidence in the durability of cash flows.

On the manufacturing side, orders and deliveries were strong in the quarter.

We delivered 4,985 rail cars in the quarter and booked orders for another 4,770.

These numbers and new railcar inquiry levels align with expectations and are consistent with our view of a replacement level demand.

Our backlog of $3.6 billion and current inquiry levels give us confidence in our expectations well into 2024.

Moving to slide five, I'll briefly discuss the cash flow with Eric providing more details later in the call.

Our quarterly cash flow from continuing operations was $38 million, up $128 million year-over-year.

Additionally, our adjusted pre-cash flow was $45 million, up $50 million year over year.

Our business can consistently and predictably generate a lot of cash, which is evident in today's results as we see the effect of increased production and higher lease rates flowing through our cash balance.

Let's turn to slide six and talk a little bit more about the drivers of our business segments. Starting with leasing, I've already talked about our FLRD and fleet utilization, which indicate momentum and increasing lease rates and revenue.

Because it takes a while to reprice the fleet, revenue increases are slower but more durable. We are starting to see several quarters of increased rates take effect and we are encouraged to see the top line rising.

Our renewals are coming in about 30% higher than expiring rates year-to-date. And when considering the whole fleet, our average lease rate for the quarter was the highest since 2018 and 9% higher than a year ago.

It's worth noting that we have only repriced about 30% of our fleet since the FLRD had double digits in the second quarter of 2022, so we expect to see this number continue to rise as we reprice more of the fleet upward.

While these rates are still growing, the growth rate is starting to moderate.

Our renewal success rate was an impressive 91% in the quarter, the highest since 2018, showing a sign of a healthy and balanced lease fleet. And year-to-date, our average renewal term is 55 months, which allows us to hold on to higher lease rates longer.

Our leasing and management operating margin was 39.7% in the quarter, up 430 basis points sequentially, but down year over year due to increased maintenance expense and depreciation expense

Additionally, as we have begun integrating some of our recent acquisitions, those businesses have a different margin profile and slightly decrease the overall leasing margin.

Moving to rail products at the bottom of the slide, quarterly revenue was up sequentially and year over year due to a higher volume of rail car delivery.

Our operating margin of 3.3% in the second quarter was down slightly, which was disappointing. In the second quarter, foreign exchange, persistent rail service issues, and efficiency negatively impacted our rail product margin.

Rail product's efficiency has not gotten where we want it as quickly as we'd like. We are seeing improvement in the metrics we track, but we still plan to continue the improvement.

Supply chain issues have eased, but there are still negative surprises more frequently than we have expected.

The strength of the Mexican peso impacted rail products operating margins by approximately 90 basis points in the quarter.

Although we hedge a portion of our PESA spending, our revenue is in the U.S. dollar, but we pay our Mexican workforce and several suppliers in pesos.

We are evaluating options to reduce our exposure to the peso.

Still, a persistently high exchange rate will be an ongoing drag on the rail product's margins until we can adjust our pricing and cost structure.

While the challenges persist, many indicators give us optimism.

Labor attrition has reached a much more manageable level in Mexico.

And the second half of the year requires fewer and less complex changeovers.

This will lead to the resumption of production more quickly, with the additional benefit of longer runs.

To give some context on the progression of improvement, our rail product's June operating profits was above 5% in the segment.

the highest this year. This included the foreign exchange impact.

As we said on the call last quarter, we can still expect to exit the year with a rail product margin in the high single digit range.

even after accounting for the impact of exchange rates.

This has been a focus of mine and we have been aggressive in taking the necessary steps to improve the business's overall efficiency and financial results.

I'll conclude my remarks on slide 7 and turn the call to Eric.

Trinity's pre-tax ROE for the last 12 months has improved to 10.6%.

progressing toward our long-term goal of a mid-team ROE.

We announced our third acquisition last quarter and they're focused on integrating these businesses into Trinity.

Across the board, we're pleased with the performance of our acquisition.

Holden continues to outperform our expectations with solid demand for autoracks and supporting parts.

We are early in the integration of our recent acquisition of our assigned logistics.

By combining our equipment expertise and innovation with RSI's customer-centered, well-respected logistics services, we can make Braille a more approachable mode of transportation.

These integrated service offerings will be an important step in our strategy to position the industry for mobile share growth with our railroad partners.

And before I turn the call to Eric, I wanted to quickly congratulate the team for successfully completing the financing of our Senior Notes and our TRL 2023 Term Loan this quarter.

I'll let Eric provide more details on these events.

Eric?

Good morning, everyone. I'll start my comments on slide 8 discussing our income statement and cash flows.

Starting the income statement, our revenue in the quarter of $722 million reflects higher external rail car deliveries and improved lease rates.

Our earnings per share from continuing operations were 23 cents in the quarter, a 16 cent increase over the first quarter on an adjusted basis.

We benefited from $129 million in lease portfolio sales in the second quarter.

Year-to-date, our net lease fleet investment is $214 million and our lease portfolio sales allow us to optimize our fleet and achieve our target for lease fleet investment.

Year-to-date, cash flow from continuing operations is $140 million and adjusted pre-cash flow is $81 million after investments and dividends.

We have returned $43 million to shareholders through our dividend.

Turn to slide 9, as Gene just mentioned.

We have seen a $225 million increase in our outstanding debt this year from the completion of a new corporate senior notes offering and a TRL 2023 term law.

offset by reductions in the revolver and warehouse, as well as normal amortization.

As you are all aware, the debt market has changed significantly.

which is reflected in higher interest expense.

Ultimately, we executed these deals effectively given the current environment. For our senior notes, we used the proceeds to repay outstanding borrowings under our revolver credit facility.

We intend to use the remainder of the net proceeds for general corporate purposes, which may include repayment of other debt, including the senior notes due in 2024.

Moving to slide 10 for an update on our guides.

We remain confident that North American rail car deliveries will be approximately 45,000 this year.

As mentioned, we have a backlog that gives us visibility into future deliveries and are now receiving orders well in the 2024 for most rough our types. We are affirming our net least fleet investment guidance of 250 million to put $350 million for the full year, supporting our three year outlook. Year-to-date, our net least fleet investment is $214 million, and along with investment in the fleet in the second half year, we also expect to complete a significant rail for our sale in the fourth quarter of this year. Our guidance for manufacturing cat-backs for the year.

remains unchanged at $40 to $50 million. Moving to our EPS guidance, as Gene mentioned, we are lowering our full year guidance range to $1.35 to $1.45, driven by the economic headwinds Gene outlined, namely the strength of the Mexican peso.

and a higher interest expense, and slower than expected improvement in efficiency.

partially offset by better than expected leasing profits. We set our operating plan assuming an exchange rate based on the rates in the fourth quarter of 2022.

Since then, the peso has strengthened by about 17% against the dollar and continues to gain momentum.

Given the nature of our business, we have no other material currency exposure except for the Mexican peso.

We do have hedge in place, but even after accounting for the hedges, the exchange rate variance impact has been about $10 million in the first half of the year. And pulls down our forecast.

full year forecast by an additional 18 million for a combined impact of $28 million to the downside. This flows through our rail products margin and will impact our margin as compared to our original guidance. We have limited our downside exposure to the peso from the balance of the year.

So we're still seeing the inquiry levels to support 40 to 50,000 cars a year. And if you look at our backlog, we ended the quarter with just under 50% of the industry backlog sitting on our books. So we have good visibility well into 24 right now. Yeah, I was just surprised that like, I think if this had been any other cycle with the current tightness in the fleet, we would have already seen, you know, a 50 to possibly even 55,000 car a year. But I guess it's just a more smoothed out cycle. We might have.

solid builds for, you know, two or three years to come. On the order side, your orders were solid in the quarter. Can you talk about, you know, where they came from? Was there like one or two big orders included? And can you talk about the order activity after the end of the quarter?

Sure, so when we look at the orders, it's really spread out. We're not seeing very large orders, so we're seeing consistent orders of car types that we talk about. They may be in smaller quantities than you've seen in the past when you've had a single market that is driving the demand.

So overall for us, this is really good because it gets us the ability to stabilize our manufacturing facility. But to your other point real quick, I really think that this cycle, everyone's being disciplined. There's not a lot of speculative orders and that's what we're talking about.

Got it. And just one last high-level question. You know the class one seemed determined to continue to improve velocity on other service metrics which could be a headwind to equipment demand in the intermediate term in absence of volume you know.

Given the volume outlook continues to be pretty anemic, that's basically one of the few levers they have. How concerned that this might start affecting actual underlying demands for equipment? And if it does, where would we see it first in manufacturing orders or lease rates?

So again, remember there's not one single commodity driving this demand. It is actually supply driven. So when we're looking across the board, we're still seeing good orders. If you want to pick an area where it's lighter, it's tank cars right now, so someone has to look at that and you never saw a truck driving two200 miles a day, its like completely off. So we're not seeing good orders. Again, we're five meter wide on the board.

of that. We've not seen a large increase in tank core orders, there's still some there, but it's a freight car driven demand in recovery that we're seeing. So if you look at

If you look at the biggest downside, it's intermodal. Luckily, we don't have any intermodal in our fleet, for our lease fleet. And yet we build some, but it's not a major car type that we build. So overall, we're still seeing very positive signs. And again, our outlook is well into 24.

That's good to hear. Thank you very much, Jean. Appreciate it. Thank you.

The next question comes from Justin Long with Stevens.

comes from Justin Long with Stevens. Please go ahead.

Thanks and good morning. So building on the question about orders, if you look at the industry order book, it took a pretty big step up in the second quarter versus the first quarter. How much of that would you attribute to an acceleration in the demand environment?

versus just the timing of orders. I know there can be a lot of lumpiness quarter to quarter, and I'm curious if you have any updated thoughts on industry order flow as we move through the back half. So, Justin, as you know, the orders can be lumpy to quarter to quarter, and I think that's what you're seeing.

It's never really smooth. As we look at what we believe the industry will order, we still believe it's going to be the replacement level demand. So it's going to be equivalent to getting that 40,000 to 50,000 railcars.

A year, if you look at intermodal, there were about 10,000 less.

Go ahead. So, Justin, going back to what we talked about, 10,000 orders a quarter is kind of that replacement level demand. Last first quarter was a little bit lower than 10,000. Second quarter is higher than 10,000. When you go back over the last six quarters or so, you're going to see a lot of the numbers.

And even if you remove our long-term agreement that we have with GATX, which you shouldn't, but if you did, you'd still average 10,000 cars a quarter. So we would expect that going forward, that there may be a quarter where it's lower, but I think that long-term trend is at 10,000 a quarter and we see that.

We see that going out into 2024 and beyond. And one thing to go with that again is that 250,000 cars that have to be scrapped, either from regulation or age, over the five years. So there's going to be some consistent demand there.

Okay, got it. And secondly, I wanted to follow up on manufacturing margins. It was good to hear that we've seen some improvement in June . I was curious if you could comment on July and if that improvement in margins has continued. And then Eric on...

For gains on sale, that can be such a big swing factor in the model. So I'm curious if you can give us any color on how the second half could look versus the first half, and particularly the fourth quarter because it sounds like there's a big sale coming. I'll go ahead and start a little bit when you're looking at

won't see in the second half. If you look at the efficiency improvement, we are seeing that flow over into the.

third quarter and the fact that we're not going to have as many changeovers, the fact that we have less turnover in our employees in the second half that we saw in June less turnover and also the fact that we pretty much got to our ramp point.

So we got to the volume. I think you're going to see that level out and the performance come through. The last thing I'm going to say is the reason we lowered the overall operating margin coming out in the third and fourth quarter was the fact that you're going to have FX headwinds of about 120 basis points.

in there. So the F-axis, they driving factor in the fact that we had the lower the guidance. And Eric, if you want to. Yeah. And so Justin then following up on the second part in terms of games on record sales. Yeah. And the in the second quarter, there was significant gains by 29.

Certainly, there are gains embedded in our forecast, but when you get back to getting to that net fleet investment of $250 to $350 million, you'll see in our queue, the leasing backlog is about $380 million. So we still have deliveries to our fleet and we are managing that net fleet investment.

In terms of the size of the gains, I'm not going to get into specifics, but the first half of the gains, our gains on sale, have been pretty significant. And from a directional standpoint, we're expecting fewer gains in the second half of the year. Okay, great. That's helpful. Thanks for the time.

I'm not going to get into specifics, but the first half of the games on sale have been pretty significant and from a directional standpoint, we're expecting fewer gains in the second half of the year. Okay, great. That's helpful. Thanks for the time. we've agencies too.

The next question comes from Bascom major majors with Susquehanna, please go ahead Good morning, I appreciate all the quantitative framing of how FX is weighing on both the quarter and the second half outlook

Qualitatively though, you know, we followed you for about 12 years now. I don't recall

FX coming up as a major driver of unexpected upside or downside.

really ever historically and you know apologies if we missed that I'm just curious if something has changed in the way that you either manage the business or hedge that risk where this is going to be a more meaningful driver of volatility going forward because you know the the Mexican currency has always been pretty volatile and we just haven't seen it show up in your results at least at the conference call sort of level. Thank you

Yeah, Baskinmas, if you're right, they have knocked them up. Part of it is pre-spin. We had some natural hedging in place because we were generating revenue in pesos with the non-rail businesses. So that always neutralized some of the impact.

And then if you go back over, as you referenced, the last 12 years, generally the peso has weakened against the dollar. And so it's mainly, you know, but it hasn't had the volatility where you've had 17, 18% changes in over a two quarter period. So

We've had some significant strengthening of the peso this quarter or over this year. Through the first half, it started there, we put our guidance in around 20. It's now down to below 17, so that has had an impact. It strengthened in the first quarter, we mentioned it was about a $3 million impact. The second quarter that accelerated.

to about a $6 million impact. So, and then as we looked at our guidance and balance of the year.

which some forecasts say it will weaken, but if it weakens, we'd benefit from that, and we would benefit from the peso. We have a lot more of our production in Mexico, so most of our new car production is in Mexico. Most of our overhead costs are peso-denominated, and so that does come through. We're not immune to changes in currency, especially now that more of our production is in Mexico, and that has an impact. And that comes through in both the balance sheet and that comes through in the balance sheet.

in the operating margin of the rail segment. I appreciate that. That does make a lot of sense. Maybe taking a step back, if we go back to the investor day from almost three years ago, some of the messaging was on a, you know,

variableization and in some ways of the cost structure in the manufacturing business where you might have you know higher lows and lower highs through the cycle and margins there. Now clearly that's been difficult to achieve in the supply chain disruption environment...

you and all of your competitors have been operating in over the last two and a half years. I'm curious, does the strategy still have an opportunity to work as design? Or is there a need to change some of the calculus that went into that? Do you have the right?

procedures, people, just curious if looking forward on the environment you're operating in today versus the one you plan to operate in on three years ago, if the manufacturing business could be done a little differently. Thank you.

So, Baskin, we do believe that we still have the opportunity to do what we said in the three-year plan. You mentioned some of the headwinds, the change in the environment, everything from COVID, the war in Russia, the inflationary period, all of those have mitigated the results coming through. I think the second half of this year you're going to see the manufacturing results.

to be looking to optimize our operations. They've taken a lot of the steps. We're still working on some of those programs. So look for those results as you look at the second half of the year moving into next year. And thank you for that. Maybe just to book in that conversation.

We're in year three of that period. Do you have a sense of how and when you'd like to share your next mid or long term vision for the business?

So right now we're looking at later this year most likely in the fourth quarter. You'll hear us announce that investor day and give you the update on the strategy.

Thank you for the time.

Thank you. The next question comes comes from Steve Barger with KeyBank Capital Markets. Please go ahead.

Hi, good morning. This is Jacob Moore for Steve this morning. Thanks for taking my questions.

My first one is just with the balance sheet getting to your leverage targets, can you just talk about how you're thinking about capital allocation priorities given the current environment? How do you see the best opportunities for value creation?

Yeah, Jacob, this is Eric. In terms of capital allocation, you know, that calculus continues to change. What's good is we do see opportunities to invest. We have still returned a lot of capital with shareholders. We've grown our dividend.

We've done a lot of share repurchases. We've not done any yet this year, but it's certainly been a big part over our track record. The other piece is yields are up. We're seeing the returns better. So leasing investments, the yields are looking better. We're seeing opportunities in the secondary market.

We're also seeing the opportunities to sell assets in the secondary market. So it's a very balanced approach. It's one of the good things about our business is that we have opportunities to deploy capital and we're going to do right by the shareholders. So I think that nothing changes there. We'll continue to deploy capital as the business generates significant cash flow.

Got it, that's helpful, thank you. And then just my second one's on back to your guidance. So it looks like you've increased industry deliveries to the high end of the range, the lower EPS a bit. That implies second half industry deliveries down a bit, but then on the same map, EPS up a lot. So can you just talk about the factors that you think are going to drive that sort of curve?

So the first half of the year, I think the industry is living right at 23,000 units. So we're talking about 45,000. You know, I would say that we see it kind of leveling off, not reducing as implied in that. When you look at, we do see significant margin improvement coming through. That's a factor. We have visibility.

of the orders taken, and we also have confidence in improving our performance in terms of realizing those margins into operating profit. So none of that has really changed. I wouldn't read too much into my 45,000 rail car comment.

we expect the deliveries to kind of be at that level for a longer term. Okay, understood. Thank you. And one just quick one if I could. Could you provide any clarity on expectations for cadence as we head into 24 after what's likely a lopsided 23? So overall, as we're looking into 2024, we're not giving overall guidance.

for guidance later in the year.

later in the year. OK, understood. Thank you very much for taking the questions.

Thank you. This concludes our question and answer session. I would like to turn the conference back over to Gene Savage for any closing remarks.

Well, thank you for joining us today. Despite some downside factors in the quarter, we're continuing to feel positively about the operating environment and our company's ability to execute on substantial revenue, margin, and EPS growth in the back half of the year. We look forward to sharing our progress with you.

The conference has now concluded. Thank you for attending today's presentation. You may disconnect.