Trinity Industries, Inc. (TRN) Earnings Call Transcript & Summary

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Hi. Welcome back, everybody. We're excited to have Trinity Industries as our next presenter at the Wells Fargo Industrial Conference. And for those of you, I'm Allison Poliniak, I'm a senior analyst covering industrial technology as well as transportation here at Wells. With us today from Trinity Industries is Jean Savage, the President and CEO of Trinity who took the helm in February 2020, it's an interesting year for sure. Before I go into Q&A, just for any of you that have questions for the team, please e-mail me at [email protected], and we'll do our best to get the questions in front of Jean.

So Jean, certainly an interesting year for you, managing through a pandemic, introducing a new business strategy. I guess 2 parts to this, one, really, what surprised you about the Trinity industry model as you kind of walked into this? And then second, as you introduced this new strategy in the midst of a pandemic , no less, what has been the support or reaction from the existing team on the ground at Trinity? Any thoughts there?

Sure. Well, first, Allison, thanks for having us here. It's great to be on your conference. But when I walked in, what I was surprised most about was just the potential of the platform that we have. And then the organization's eagerness to institute the changes that we really needed to make. So last year, we did a lot of org structure -- organizational structure work, and that was done to unlock some of the synergies that we have from being the designer, the builder, the manager and the maintainer of these railcars. We definitely have some more work to do, but we're well down the path on that. During the unsettling time, the other thing that surprised me was people didn't want to slow down. They want to speed up. So it really helped us accelerate getting that new strategy in place and starting to take off on some of these initiatives to get us to where we need to be for that up cycle. So the last thing I'd say there is the other thing the past year did for us was it showed the resiliency of our model, especially the leasing business. And it just solidified for the employees why we were making the changes we were making in the company. So overall, I know it was horrible for the economy, it's been bad for the industry. But for Trinity and for the journey we're on, it really helped us speed that up.

Great. And I would say one thing what we've been hearing over the past 1.5 days is this industrial recovery, it seems firmly underway. The potential to accelerate in the second half. A lot of concern really about the supply chain, right? Can we ramp quickly enough to do that? And with a lot of the structural as well as cyclical costs that Trinity put forth, what's your view on Trinity's ability to react in some sort of environment that's accelerating here?

Sure. Well, first, I would agree that the economic indicators are definitely showing all the signs of a recovery. I think that what we're still feeling and seeing though is our customers are concerned about some of the supply chain, so if it's lumber, if it's steel, if it's a chip. And they're still making a few decisions or hesitating to make some decisions on getting some new cars out there or going ahead and taking that plunge. For us on the supply chain side, we've done some things along with the cuts we made. So we've done over 65% reduction in our plan. That's huge, right? That's a large reduction. At the same time, though, we have been upgrading our systems to reduce the need to add back people once we see the cycle come back. We've been outsourcing our lower value-added fabrications to the supply base. We've been implementing additional automation and robotics into our systems. All these things lessen our need to ramp as high as we've done in the past to hit the same quantity of railcars. So pretty excited about that along with continuous improvement throughout the organization instead of slowing down accelerated. So we think that we can handle an upturn in the cycle. We can do that pretty well as long as everyone doesn't want their car first quarter of next year. And if they do, we think that will give us an advantage to get some price, right? The space will be more valuable. But I think it's going to be more spread through the year. And with that, we're pretty confident we can make it happen.

Perfect. And I haven't been shy over the years with my love for leasing. It's clearly a great business. And certainly, the nice thing about your strategy -- or one of the important elements of the strategy that you laid out is leasing's really driving the growth here. Could you maybe walk us through how you think about managing that lease really to obviously continue to grow, remain disciplined and kind of keep that controls over the long term for Trinity.

Sure. Well Allison, as you mentioned, we really have transitioned from an earnings company to a cash flow and returns company. And with that, leasing is the linchpin for us to make that happen. When we're doing that, the first thing we think about is existing lease fleet. So for us, if we get a car in our fleet that will meet the customers' needs, we're going to put it to use first. Then we'll think about adding a car either from the secondary market or a new car. We've shown that discipline through the last year, and we've done that at the expense of having some cars go through the manufacturing facility. But we needed to do that to rightsize that manufacturing system to be the enabler for the leasing system, not the driver, on what's going to happen within the company. Some of the other things that we've talked about is we've got to make sure that we have the right returns for that lease fleet. For transact and earn, we're going to hold that lease fleet. We've got earnings or we've got lease rates that are above our cost of capital. For the transact part of that, we're going to sell to secondary markets, and we're going to go to people who have lower cost of capital. And we've been doing that throughout the history of Trinity, and I think you'll continue to see us do that. We can get that origination fee. We can also typically get the maintenance fee that goes along with building those cars and transacting, and that's beneficial to us to know what's going on in the industry. Another area I'm going to talk about from the lease fleet is we've been working on doing more of the maintenance in-house. Right now, we've got about 55% of that maintenance in-house. We think we can get up to 70% with the existing footprint that we have. That gives us lower total cost for managing that fleet. It also lessens the lease abatement that we have because we can turn them quicker through our own facilities and get them back out to the customer. So lots of benefits going there. And I guess the last thing, I'll say one more is we also have the ability to take cars that may be underutilized in the existing markets that they're in. We can modify them. We're doing that currently, and we can get them back in to new markets where there's higher demand for those cars, so we can keep that utilization right up.

Great. And obviously, leasing is less cyclical than manufacturing, but there's still some cyclicality to it, particularly as cars come up for renewal. Could you maybe touch on -- it seemed like lease rates were trending in the positive direction. How far off of what you would view as normal? And I know it's hard because it's car type by car type on those. Do you feel we are sort of at this point in the cycle?

So you're right. Normal is depending on the market that you're in. But as we look at lease rates, we're seeing the markets where the cars are coming out of storage and the utilization going up. We're seeing those rates start to go up, right? But there's still some markets like the energy market, where there's still plenty of cars available, and those rates are definitely pressured. So the dynamics will continue to change as we see more leased cars come out of storage go into use. We haven't hit the tipping point yet where it affects the overall rate, but we are seeing momentum heading in that direction.

Understood. And you touched on the secondary market. Obviously, activity paused to some extent in the depths of the pandemic. How do you view the secondary market today? And is Trinity more of a seller into the strength of that market? Have some of those financial buyers somewhat have stepped away here? How is activity, quality of book, things that you're seeing there? Any color there that you can provide.

Sure. Well, the secondary market is definitely picking up. It's stronger than it was last year. And we are a buyer and a seller in this market. So we're looking for deals that make sense. So it's got to be at the right price and give us the right returns, but it's open. And I don't know if you know that yesterday, we filed and we had our first partner green sale there or we had $355 million of a rail ABS transaction with record spreads and coupons. We get a lot of attention. It was oversubscribed by 5x. We got some great rates there. And it's really the first green bond issuance in the transportation sector. So there is definitely appetite out there, and we're excited to be able to finally say we've got that green bond issuance there, and we hope to see many more of those.

Perfect. And I would say one thing that we were somewhat surprised about with Q1 was industry orders, right? They seem to be coming back a little quicker than we had anticipated even, even though they're still below what we would view as normal. How do you anticipate that trending? Are order inquiries accelerating for you? Quality of those inquiries improving? Is there any specific verticals that are sort of driving what could be, I would say, the increase of another up cycle at this point?

Sure. Well, we are expecting the orders to increase as the year goes on. And we said we think we'll get back to 40,000- to 50,000-car range for next year and the year after. A couple of things driving that. One, over 50,000 cars were scrapped last year in the industry. The pace that we're at this year is 50,000-plus again. So that's 100,000 cars coming out of the market. Not all of those are in low-demand areas. Some of those are box cars that absolutely need replacements right now. Some of those are green cars. So we're seeing some demand come in from those areas. Inquiries are definitely high. I told someone earlier, you could tell when the inquiries were coming in and they were general and it was what can you do for us next year? What's your timing? And when they start saying, can we have them by a certain date? You know it's starting to get stronger. And we're expecting to see that translate to more orders as the year goes on for that. Look for green market, look for the box cars. We've talked about later this year or next year, autoracks are going to be in demand. Right now, some people are holding off because the automotive companies can't get the chips. And they're saying, though, by third or fourth quarter, they're going to have those chips and they're going to ship. There aren't enough cars out there right now to be able to handle that demand, so we're going to see a swing there. And then intermodal has been extremely strong through the pandemic, and really don't see a change in that right now.

Understood. And we got a question and sort of tied to that, steel, right? How are you guys managing sort of that steel inflation. And is that driving some more interest in orders near term with the expectation that commodity inflation continues here?

Sure. So for steel, first, for the majority of our contracts, we have a mechanism in them to be able to recover any increases in those commodities for the sales price. So we're covered for the most price there. As far as our customers, some of them are hesitant to go ahead and say, do I need the car? So they're waiting until there's actually a demand that they can't meet any other way. And then they're saying, I need my car now. So that puts a little bit more pressure on getting those materials in and getting those cars built and out to the consumers. Long term, we think it's better for the industry because new car rates go up. That sets a ceiling then for the leased cars of the existing cars that you have. Next time those come up for renewal, you have some headroom to go in and negotiate and get some more for those cars. It does have a lag. It's not right away. Typically, that's going to be 3, 6, 9 months after the new car prices go up. But we think, overall, the industry is going to force some new car builds just from all the other dynamics that are occurring.

Great. And I would say another common theme we've heard over the past 1.5 days is about raising that bar on profitability, right? So a higher low and higher highs as we enter [indiscernible] cycle. Clearly, Trinity, with all the structural cost actions you put forth, maybe walk us through your vision of the manufacturing business. How you view that profitability, and kind of how we should think about that through cycles going forward.

Sure. Okay. Well, I mentioned before, leasing, we think is very stable with the returns and dividends we can give there. For manufacturing, our whole process over the strategy, development and the execution that we're doing now is to get it to where manufacturing is at least a breakeven and a trough. And then you only get the uptime as you go up that cycle as the demand goes up because we've set all of our cost basis, so we're not going to take -- go below the line of negative in earnings there, we can only go positive. So we're excited to see that happen as the cycle starts to come through. Now we're going to have to remain disciplined. And the discipline is going to be, we'll have people wanting to add back some of those costs, right, in the up cycle. And our response is going to have to be no, we have to look at throughout the cycle what those costs mean to us, and make sure that we don't put in more that we have to take out later.

Great. That makes sense. And technology, clearly, a growing theme within transportation. Maybe walk through what that means to Trinity. I'm thinking of your new introduction Trinsight going forward. How are you looking to leverage technology for growth for your business?

Well, technology is exciting. If you look at ourselves, how much do we depend on being able to Google something or get information just at our fingertips. I think the transportation industry has moved that way, too. If you look at the on-highway transportation, they have been giving them that information. So now those customers are expecting it from everyone. We are behind, and we've got to play catch-up. I think we're well positioned with Trinsight, and our participation in the industry forum to move this forward with RailPulse. So if you look at Trinsight, we use this type of data for years in our platform to manage our own fleet. So for us, it's not we're starting from ground zero. It's using what we know works, and we're starting to share that with the customers. So what can we do to help you? One, instead of signing on to 6 different railroads to find out where your cars are, sign on one place. And oh, by the way, you're not going to get 1- or 2-day old data like you do from the railroad sites. You're getting real time where it is for your fleet now. And you can see all 10,000 of those already coming up for you if you've got 10,000 railcars. That's one way. How we help them with demurrage. Again, knowing where those cars are, making sure that they're turning, that you're making phone calls and things are not moving as they should. All that helps to lower your cost. And we think we're in the best position with our platform to help customers do that. Now for our next few years, we showed slow, steady growth in that because we think it will take a little bit for our customers to understand what it means to see that value and then to draw it in. But I can say that since we came out with the Trinsight earlier this year in January, we got lots of conversations. We have 40 or 50 customers out there doing trials right now. We're getting the number of cars going on that platform going up on a daily basis. And actually, we're starting to add more people into that area to be able to onboard those customers quicker. So it's exciting. Now we just have to see it through. We've got to make sure that we're delivering the value to those customers.

That's great. That's good to know. And we certainly need to talk about returns here. It's certainly an area that you're focusing on for Trinity. You mentioned that before. I don't know -- maybe at a high level, I know it's multipronged here. There's a lot of tenets to reach that mid-teen ROE target that you're aspiring to. Is there anyone that you're certainly weighting your efforts towards that, meaning if you don't succeed in that particular area, that target's not attainable? Maybe walk us through sort of how you're thinking about reaching that target over time.

Sure. Well, first, when we set a lot of the targets, most of those levers were in our own control. So if we don't do them, we can look at ourselves and ask the question why. When you look at the financial and operational optimization, those efforts combined provided 8 to 10 basis points of overall improvement. We've been making progress in those areas since the Investor Day, and we're on track to deliver those results by the end of the planning period. Now could something unknown or unforeseen happen? Absolutely. But we think we have very strong initiatives in place that we're executing on. The expansion and growth initiatives are responsible for about 2 to 3 of the basis point improvement in the ROE. And we've been making progress in those with things like Trinsight, aftermarket parts sales, looking at other services we can do with mobile repair. We see the progress there. We don't have it heavily weighted. So I'm going to say we think we can obtain what we told you we were going to do. And out of the gate, the whole purpose of this was tell you what we're going to do. Go do it. So you believe us in the future when we say, here's what we're going to do and how we're going to make that happen, and you can hold us accountable for doing that.

Great. That's the correct answer.

And it's points, it's not basis points. So sorry about that.

And then clearly, Trinity, solid financial position on the balance sheet side. Maybe walk us through the capital priorities for your deployment. I'm assuming leasing is a big area of that. Any other things that we should be thinking about for Trinity?

Okay. Sure. Well, I would expect us to continue doing what we've been doing over the last year. We've been giving strong dividends back to our shareholders. We've been buying back stock. But we also have been investing both in the lease fleet and our operation. We got good cash flow and good cash availability that we're out there looking for the right acquisition that may need to happen. And when I say acquisition, it could be small tuck-in acquisitions from a technology standpoint, automation or robotics. But it also could be small to medium or even the large fleet if the pricing is right for that. So we're trying to keep those options open. But again, strongly, you've seen returns to the shareholders as the current place where we put a lot of that money. I don't see major changes happen unless the right opportunity comes up.

Got it. And then a question came in about potential legislation around the railcar tax benefit. Any thoughts around that? Does there seem to be some level of support for that in D.C. at this point?

There's actually bipartisan support, which is great. We have a team member who's working on that daily, making calls to Washington and trying to get more and more people involved in it. We think there is a good possibility to kick it in later this year, and be part of what will help drive some tax benefit to scrapping some of the older cars, getting more efficient cars into the rail system. So we're encouraged by that. We think if it does happen, it will be more of a 2020 play -- 2022 play, excuse me, and not as much 2021. But we think there is good potential that could happen.

Got it. And then another question came in about labor. Your ability to ramp with sort of the labor constraints that we're generally seeing in North America at this point, any thoughts around how you're managing to attract some of that talent potentially with this recovery coming at this point?

Sure. So when we look at the overall labor, remember, we don't have to add back as many people to produce the same number of cars with some of the other work we've done with the lower value-added tasks outsourcing with the robotics and automation we put in place and then also with continuous improvement activities. But right now, freight is picking up -- freight cars are picking up first ahead of tank cars. The locations where we're building the freight cars, the labor availability is better than some of the tank car side. We had an opportunity recently to be taking some people back in. We had a line around the block of people trying to come in to get those jobs. So we're encouraged by that. I'm not saying it's going to be like that forever. But right now, I think we have the ability to get back not only prior employees but skilled employees to help us as we look at the industry starting to turn.

Great. And another question's coming in, I think this is relating to leasing. How rational is the market today just given the oversupply in the leasing industry? I think you've talked about it being competitive as does GATX. Is that due to some of those less, I guess, strategic lessors that are out there? Any thoughts around sort of that competitive dynamic today?

Well, some of the recent announcements that have been made, we think they will -- some of those less strategic will become more strategic in their thought process and what they're going to build and put out into the industry. I know for us, we are viewing every single day what's the market look like, what are the assets that are out there to support those needs and making sure that we're not going to make some decisions that will cause more stress in the future. So we're thinking about that. And I think others are definitely thinking about that as they're making those decisions and what they're going to put into the industry. The other thing I'm going to say though is, I've used this with other people, as we look at growth for this industry, if we can change 1% of modal share from highway onto rail, you're talking about 45,000 more cars needed for that 1% of modal share change. And UP just had their Investor Day this week, they talked about growth. CSX, the Canadian railroads, all are talking about growth. That is terrific to hear for our industry. And as we start to move and get our supply chain resiliency and our ability to deliver repeatedly on time for those customers, I think you'll see a shift in the growth in our market.

That's great. You touched on it, and I want to ask the question, ESG. How important is it to Trinity as a company at this point going forward?

Well, we just released our first CSR report last quarter. ESG is really important. If you consider highway versus rail, there's really no comparison. Once we get that reliability and delivery there, why wouldn't a shipper use rail over using the highway product. And for us, it's all about how we make it even better for the customers. How we get lighter-weight railcars, so you can get more commodities in and use less emissions or diesel to deliver those. If you look at how we help them understand where their railcars are for delivery so they have the people in the right place when they need them to unload those cars, all of that leads to a better ESG story. And for us, internally, we're using recycled products. All of the products in the railcar can be recycled. That's a good story. When we're producing cars, when we're looking at how we use less water, how we recycle, how we're going to have less tonnage coming out of our facility. So I think overall, it's a great ESG story. We're going to help our customers tell that story, and use it in their own metrics and reporting that they do to make it overall better for the industry.

Great. And I know we're running out of time here. Any closing or last remarks that you want to leave at Trinity?

Well, again, thank you for having us here today and letting us talk about Trinity. I'm really excited about leading this company right now, leading Trinity. Now I'm looking forward to the results of all the hard work that we've been doing starting to flow through, and being able to talk about those to you all as we have these conferences and as we have earnings calls. So thank you again. I hope the rest of your conference goes well, and really appreciate the opportunity to talk with you.

Great. Thanks so much.