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

Good afternoon. It's Tom Wadewitz from UBS. I will be facilitating the fireside chat with Trinity and -- Trinity Industries. It's a pleasure to have Eric Marchetto and Jessica Greiner. So Eric's the CFO of Trinity; Jessica does the Investor Relations, the VP of Investor Relations. Eric is going to provide some prepared remarks and provide some kind of framework on Trinity. And then I've got a good list of questions. And we're happy to take questions from the audience as well if you want to sit -- submit them through the conference website. And with that, Eric and Jessica, thank you for joining us and spending time with us. Let me turn it over to you, Eric.

Thank you, Tom. It's a pleasure to be here today. This is my first time to present at this conference. I look forward to doing it in person in the future. Earlier this year, Trinity appointed a new CEO, Jean Savage. I am also new in my role. I became the CFO on April 1 of this year. And we're committed to engage with our investors and share our story. I'll provide some brief comments and summary update of information from our April first quarter call and also some comments around the COVID-19 crisis. First, a few points on the -- for the company. Many of you may be familiar with Trinity, we're known as Trinity Industries. We own a market -- we own market-leading businesses in railcar products and services in North America. We've experienced a lot of change over the last few years in honing our rail-focused strategy and our unique rail platform. Our platform boasts one of the industry's largest leasing companies, combined with a captive manufacturing and maintenance footprint. We also pride ourselves in our innovative service solutions. The last 12-month revenue is about $3 billion. Our last 12 months EBITDA is about $690 million. We have an enterprise value of about $6.6 billion at the end of the first quarter. The synergies from our platform are the biggest driver for our long-term value creation, which yield significant cash flow. This cash flow is both meaningful as it enables reinvestment in the business while returning substantial capital to our shareholders. In the last 12 months, our business model has yielded double-digit free cash flow yields, underscoring our ability to do both. We expect the cash flow generation to remain healthy, even in the midst of our COVID-19 crisis, and I'll discuss that more shortly. And in honing our rail focus strategy, management is executing on a number of optimization efforts to enhance the performance of the business and accelerate Trinity's position as a market leader for railcar equipment and related services. These optimization efforts have been focused on the organization, our operations and also on our balance sheet. We've made a lot of progress in these areas, which has positioned us well to respond to the COVID crisis. Let me address 3 key points that are on top of your minds. First, the impact of COVID-19 on our business and the actions we're taking to address it; our scenario assumptions for managing our business performance and capital allocation decisions amid the market uncertainty; and the financial resiliency of Trinity's platform, our cost structure and our liquidity position; and the strength of Trinity's leadership team to manage through this crisis. First point on the COVID-19 impacts. We're very proud of the function of our employees and our railcars perform in sustaining our communities. Our railcar assets deliver agricultural products, medical-grade chemicals, energy products that have really kept the economy going during this crisis. We're designated as an essential business. We've taken significant steps to ensure safety and business continuity for our businesses. We've instituted policies and procedures that adhere to the CDC and WHO guidelines, including social distancing, cleaning and sanitizing, restricting visitation in our facilities and establishing a remote framework for arrangements for corporate and services workforce employees. By our analysis, about 80% of our customers operate as essential businesses or critical infrastructure. We've maintained our ongoing operations. We've experienced no significant production delays or no production delays or services to date, and we will continue to work closely with our customers to understand their needs. Our procurement teams are monitoring our supply chains for potential disruptions and to date, we have not had any. As part of our assessment of the COVID crisis, we have reevaluated the potential for lower railcar volumes and equipment demand in the near term. We are already in the process of reducing our footprint from the industrial slowdown in 2019, but we took further action and reduced our manufacturing workforce by a total of 30% from year-end. In the first quarter, Trinity executed and identified administrative cost reductions as part of our continuing focus on cost structure. Fortunately, the optimization initiatives were timely and advantageous, given the COVID-19 crisis. When combined with the actions taken in the second half of 2019, total reductions in SG&A and other administrative costs are nearing $60 million. The second point is our scenario assumptions and our capital allocation framework. We're starting from a position of strength. However, given the limited visibility on future demand for our business, we have withdrawn our financial guidance. Following the rapid market deterioration, we modeled several scenario analysis on our cash flows to evaluate the strength of our balance sheet and our liquidity. These scenarios also provide a framework to guide our capital allocation decisions in the current market environment. We thought it'd be helpful to give investors some context behind the scenarios that we performed on the financial position and the condition of the company as guideposts. In completing this analysis, we stressed our balance sheet and liquidity against various scenarios as deep or deeper than those experienced during the financial crisis in 2009 and 2010. Our base case scenario assumes the economy reopens, will remain open in the near term. Railcar loadings will begin to improve sometime in and around the third quarter. In this type of environment, we would expect that our lease fleet utilization will remain around 95%, that our backlog delivers as planned, that we transact a modest amount of leased railcar portfolio sales, and we achieve our SG&A optimization target. In our stress case, if COVID-19 continues to restrict the recovery in the market into 2021, we have modeled the potential for deferrals of our backlog, utilization to drop below 90%, and the inability to transact railcar sales in the secondary market. The closer our financial performance resembles our stress case, our capital allocation framework will shift toward preservation. The more our performance reflects our base case scenario, our capital allocation will enable continued and prudent investment in the business. We expect to maintain our liquidity position in the base case scenario. In either scenario, the financial synergies of the rail platform yield positive operating cash flows. Through all of our assumptions, Trinity's platform was very resilient, which leads me to the financial resiliency of our platform. Our platform is demonstrating that it's built to deliver and sustain. During railcar down cycles, the long-term nature of the contracts in the Trinity's Leasing business protect the company from short-term market disruptions and are critical to the relative stability and cash flow generation of the company. As of the end of the first quarter, we had committed available liquidity of $760 million. In addition, we expect to receive $300 million in tax refunds this year, resulting from the reinstatement of the tax carry loss provisions and the CARES Act. This is a cash tax benefit, and it's the result of the significant tax-advantaged synergies within our platform and combining the leasing and manufacturing businesses. As further liquidity options, the company has unencumbered assets of approximately $1.5 billion, available for monetization through leverage or secondary market transactions. When considering the company's debt maturity profile, the additional levers we have to unlock capital, we believe our balance sheet and financial strength enables us to navigate the COVID-19 pandemic. We have had consecutive -- we have paid dividends in 225 consecutive quarters. Our confidence in the cash generation of Trinity's platform supports our commitment to shareholder returns, including in the midst of the coronavirus pandemic. Management and the Board of Directors are aligned on our expectation that the synergies of the rail platform enable meaningful reinvestment in the business, while continuing to support substantial return of capital to shareholders. Our base case calls for $450 million to $600 million of reinvestment in the company and $150 million to $200 million of returns to shareholders. There are a number of levers within our control for capital allocation within our stress case to preserve liquidity, if necessary. In closing, COVID-19 will be a challenging hurdle to overcome as we continue to -- our pursuit of longer-term goals, closely monitoring available capital and liquidity needs to continue the best course of action. We are balancing these decisions against our longer-term goal for balance sheet recapitalization. That being said, and regardless of the point in the cycle, we find ourselves, the synergy of the rail platform and the cash flow generation are the driving force behind Trinity's value creation for shareholders. Our platform is built to deliver, and we believe we are in a position to withstand the current market environment and deliver long-term value to our shareholders. Tom, I'll turn it to you for questions.

Okay. Great. Thanks, Eric. Let me start with just maybe a question about how we think about the car types and customer types, where there is a constructive outlook, whether that's because the car type is old and there's a good level of kind of replenishment demand, or whether there's just a more stable market, like grain? But if we look at the -- I think you said in the first quarter, the backlog, something like just below 13,000 cars. What are the primary car types or customer types within that? And then maybe you could give us a thought on how you might think about which markets might have a better growth outlook.

Yes, sure. First, in terms of what's in the backlog, at least from our perspective and what we have visibility on the industry, the markets that are in the backlog, generally, there's 2 big drivers there. There's replacement demand, which historically has been a very large demand driver for new railcars. And then there's some growth elements. The growth elements are mainly around the petrochemical space and it's mainly around plastics, with the low natural gas prices in North America, we've seen significant capital investments in the North American plastics capacity. The result of that is they need railcars, those are -- that's all growth of the business. And those -- generally, those projects, you have long -- a lot of visibility in those. And so those orders get placed for delivery in the current year, in forward years. On the -- you mentioned agriculture. In terms of -- in the current environment, agricultural products and railcar demand has been fairly resilient. There's probably more replacement demand in the agricultural market. There's significant amount of the industry backlog, probably about 5,000 cars of our industry's backlog is in -- is slated for agricultural service. That grain fleet, for the most part, is fairly well utilized. And it's one of the older fleets in the industry. So there are certainly, in the near-term years, a good replacement demand that will come from the agricultural side, specifically the covered hoppers for grain. In terms of inquiry activity on grain cars, I think, certainly, there are -- that's a car type that Class Is would look to add, also leasing companies and also shippers, and we are seeing inquiry levels for those car types currently from all those business channels.

So it sounds like, I guess, the covered hoppers in general, whether they're kind of jumbo or whatever for plastics or what you would use for grain would be the big area of demand?

Yes, and there's a few other pockets. There's some -- on the tank car side, there's a lot of specialty tank cars. There's also whether that's pressure cars or cars for hazardous commodities or more niche products that there's always a baseload of demand for those types of car types. And that's generally replacement driven more than it is growth driven.

Right. Okay. How do you think about the -- looking at prior cycles, what the time lag is typically between improvement in rail volumes and then when the railroads start to pick up in ordering railcars in prior cycles? And then maybe I can ask you about whether PSR kind of changes the -- that relationship.

Sure. So this quarter, I think I talked about it on our earnings call, and if you look at the railcar loadings, this quarter, railcar loadings are going to be 20% to 25% lower this quarter than they were the second quarter last year. That's an unprecedented change in demand. And so kind of what we saw in the last downturn that may not be relevant in this demand environment with that backdrop. But generally, I think people are a little more optimistic that this is more temporary in nature than what was happening in 2009, 2010. In terms of timing, it always depends on mix, but -- and of recovery but generally speaking, we need railcar delivery or railcar loadings to stabilize. I expect that will happen in the third quarter. Then you're going to see existing railcars kind of firm up and some of the surplus or underused railcars will start to get used up more. You'll start to see increases in existing fleet utilization. And then the last thing to come would be new railcar orders. The new railcar orders will certainly be the laggard in that. You'll see other indications of improvement before you get to that. In terms of -- if history is any indication, that can be 2 or 3 quarters before -- once the railcar loading start to improve before the orders start to improve. But that depends on -- depending on what levels they are, sometimes an order or two can influence the sentiment in the market quite dramatically. All right. Then -- sorry, PSR, let me talk about PSR.

Yes. Yes. I mean PSR has clearly contributed to a large level of cars being parked even prior to the COVID impact. So how does that affect your view of both the kind of large inventory of parked cars and then also, I guess, broader PSR in general?

Yes. And so I have a bit of a contrarian view on PSR. And in terms of -- and contributing -- let's end it with contributing to the impact on surplus railcars. But first, PSR, if you looked at modal share, if you look at modal share and rail share of modal share, rail has continuing -- has lost a lot of modal share over the last couple of decades. And that's in the backdrop of, it's the lowest cost land-based mode of transportation. It's very environmentally friendly. It's sustainable, and yet it's lost share. And I think that's the result of a service gap, and it's generally the result of rail has historically not been really predictable in terms of service levels. And so as supply chains get tighter, as people focus more on just-in-time inventory, the volatility in rail doesn't really support that. And the result is we've lost some modal share. I think PSR is -- gives us the opportunity as an industry to maintain and potentially regain some of that modal share that we've lost. Unfortunately, some of the Class Is, all you hear about is operating ratio and driving down that operating ratio. But the tenets of PSR, precision scheduled railroading, there's more about service than it should allow railroads to regain some of that share and actually grow. And when you think -- when you hear of some of the early adopters of PSR, I'm encouraged that we're starting to hear more of that sentiment, more of that color coming through, specifically with the Canadian railroads and even in the U.S. with CSX, they're starting to talk more about growth and regaining modal share. And that's a good indication and a good sign long term for the business. In terms of PSR and what it's done to driving -- to reducing or increasing the railcars and storage, and a lot of that has been, I think, general economic activity. Railcar demand -- railcar loadings have fallen. Generally, when railcar loadings fall, the railroads get more efficient, and I think the PSR just contributed to that. Moving the same amount of freight faster is going to require less railcars, no doubt about that. But generally, I think it's more about the reduction in the freight being moved than the speed that the freight is moving that's contributed to the railcars and storage, which if we can regain some share, that will reverse it. The other piece of PSR that's a bit of an opportunity for us is, railroads will most likely acquire fewer railcars. They're going to push that responsibility of providing the railcar to their industrial shipper. Recently, that gap has been filled by operating lessors. So we think there'll be an opportunity to lease more railcars into that industrial shipper base. But we need other things to stabilize before that really starts to crystallize and do any real gains.

Right. Okay. Let's see. The -- on your -- the first quarter call, there was some discussion on frac sand and crude, and I think you commented about taking the crude cars out of your backlog. But in the lease book you have, I think it was 8% that was -- I think it was maybe 8% of the lease cars that were frac sand, with the last load and 4% crude. How do you think about the impact? I guess are those cars -- because the lease is multiyear, you don't see a negative impact for a period of time? Or would you see the impact from that develop fairly quickly in terms of pressure on overall lease fleet utilization?

Sure. Sure. You do -- first, you did get the numbers right. Our crude -- we don't have any crude or frac sand exposure in our manufacturing backlog. We do have exposure, when you look at last contents of our lease fleet, of 4% crude and 8% frac sand. And I kind of view the -- even though those -- both of those markets are energy related, I kind of -- I view them a little bit differently. On the tank car side, the crude oil railcars, a lot of those railcars have already been remarketed into other flammable services or other services, a lot of downstream petroleum products or things like ethanol or diesel, et cetera. And those tank cars are generally a little more general service in nature. And so there's about many, many products that go into those railcars. So from that standpoint, I think that will work itself out. You're right in terms of the longer lease terms and also the credit profile of those counterparties is still generally pretty strong. And so I'm not worried about -- or I'm less concerned about credit defaults, things like that. When you look at the frac sand fleet, we talked about that being about 8% of our fleet having the last contents of frac sand. But that's a little bit of a different story. That fleet has grown dramatically over the last decade. That fleet's about 125,000 railcars, and frac sand is the lion's share of that fleet. So there -- while there are other markets that can go -- that those railcars can go into, it's going to take a little longer term, and there's probably not one solution for it. So that's going to take more time. And then as we've talked about on the call, the credit profile, we've had a few defaults in that fleet over the last year or so. And the credit profile of some of those customers is not nearly as strong with the current environment, what's going on with North American shale drilling being very low levels. So that's certainly a headwind to that part of the fleet.

Right. Okay. How does the frac sand assumption fit into your 95% base case and the 90% downside case? What do you -- do you assume that you don't find a home for those cars in the downside case? Or how do you link that frac sand and crude into the 2 scenarios you talked about?

Yes. Frankly, without getting into a lot of details, I'm not sure in our base case or our stress case should be able to identify a lot of differences in our frac sand assumptions for this year. They were both -- we recognize the environment that, that space is in currently, both in our base case and our stress case. So I think the changes in utilization from our base to our stress are going to be other markets other than frac sand.

Tom, this is Jessica. We talked in our last quarter conference call, while frac sand is about 8% of the fleet, to Eric's point, it's a much lower number of the overall lease revenue because lease rates within that space have been hammered pretty hard over the last couple of years, given the current environment anyway. So from a P&L impact, cash flow impact, it's already challenged. And so it's not the bigger driver, to Eric's case, in either the base or the stress case.

Right. Okay. Great. Jessica, that's helpful perspective. I did have a question come in that is related actually to kind of credit ratings and the kind of, I guess, historically or maybe a 2014 kind of BBB- and then you've fallen below the, I guess, the investment-grade level. So is there a desire to get back to the investment-grade level? Or how do you think about credit rating? And what's your desire and the importance of that is to your business?

Yes. The way we financed our lease fleet, we've done a lot of our -- most of our financing our lease fleet is through the ABS market, which relies more on the underlying credit of the lessees and the diversification that's built into that fleet. So the downgrade by S&P doesn't directly impact our financing costs while -- the way we finance our fleet. Now all things being equal, I'd much rather be investment-grade than not. It does open up other avenues for financing options for our business. It's just what's the cost of that, how the rate agencies view us as a leasing company and a manufacturing company. Sometimes it's a little inconsistent with what the balance sheet reflects, and so we're about maximizing returns and improving the returns of the business and continuing to grow the business. Hopefully, we can do that in a way that's consistent with improving the ratings, but it's not the priority of management currently.

Right. Okay. Great. Let me ask you a little bit about how you weave maintenance into what you offer to customers. I think one of the things that we have seen and I don't know if this is a direct impact to you or if it's peripheral, but we've certainly seen with PSR efforts at the railroads, that there have been large reductions in the mechanical workforce. That's true at Union Pacific, that's true at Norfolk Southern. And I think the varying degree is also a rationalization of the car maintenance facility and locomotive maintenance facility footprints as well. So I guess the -- as you think about your approach to maintenance and the service you offer, is there an effect or an opportunity for you related to that? Or is that really peripheral in terms of your approach to how you offer service and what you're doing with maintenance?

Yes. It's a little bit more on the edges. We're certainly -- we are in -- Trinity is investing in our maintenance capabilities. We've expanded our maintenance network, our captive maintenance network, and that's really more about service levels for our lease fleet, for our customers and being able to control more of those maintenance events and control the service levels that those maintenance events are performed under. And so we feel it's important to do more of that in our own shops. The railroads decline -- getting out of some of the maintenance, yes, that's generally running repairs on equipment. They're still going to be doing those running repairs. I think those changes are less traffic related and more structural for the railroads. But on the -- especially on the tank car side, that's the railroads don't really do tank car maintenance. And that's really where we're investing in our maintenance footprint is the ability to do and control more of the maintenance for our tank car fleet.

Right. Okay. How do you think about your competitive advantages in the market and as a provider of rail equipment? And also, I guess, maybe the mix of the lease and manufacturer structure?

How do we differentiate?

Yes. How do you differentiate? How do you think about driving competitive advantage?

Yes. So I think it's a couple of different avenues. One, it's our customer experience and our service levels. We are continuing to invest in more of a digital platform for our customers in order to gain more of a share of their wallet and improve and make it easier to do business with. And so because a lot of our business is full-service leasing, we think service element is a big piece of that and one that historically in the railcar leasing space has probably been a little underinvested in. And so we want to -- we think there's opportunities to invest in that and to improve that, especially as the younger workforce comes in and people expect to do more in a self-service online environment, we're pushing for more of that. And with this work-from-home environment, that's certainly -- we've seen the benefits of investing in that technology in those platforms. On the product side, it's more about differentiating our products and trying to produce and design, and design products that are going to provide an advantage that make rail transportation more efficient and more cost advantage. And so we continue to work on innovating new products. We're -- with that innovation, we're looking at also new service offerings that make railcars more efficient in terms of how they're used, whether that's from a technology standpoint, sensors, things like that, that will help the throughput and the optimization of our customers' supply chains. Those are a few of the areas at a high level that we're focused on right now.

Right. Okay. That makes sense. If we think about the potential for a cyclical rebound in 2021, I think I have the framework in mind that 2010 is potentially analogous that big move down in next freight activity, and then you follow that with a pretty meaningful increase, high single digits, 10% is I'd like to think for rail volumes in 2010, and that would be possible in 2021. In that type of a framework, kind of how quickly does your lease business respond? How quickly does utilization tend to move up, if you enter an environment that's robust following what's obviously been a very weak environment?

Sure. Yes. Well, if -- when that happens, if we're at a 95% utilization, there's not a lot of headroom to grow that up, to increase that. But we certainly can. And also, there's repricing events with the rest of fleet, that we repriced about 1/6 of our fleet on an annual basis, and those are the opportunities to improve your economic position. An important thing to remember is on fleet utilization is which category of rail equipment improves. They're not all going to improve at the same time and all railcars aren't created equal. They all -- they serve different commodity groups. Our fleet is very well diversified and so our unutilized or available railcars are spread across multiple segments and car types. But generally, I think you're going to see, like what I mentioned earlier, you're going to see railcar loadings start to increase. Then lease fleet utilization, you'll start to see impacts there, and then you'll start to see pricing improvements as well. So I think that's kind of the orderly way things will start to evolve.

Right, right. Okay. That makes sense. Just -- we've got about 2 minutes left in the discussion here. So I've got a question to kind of wrap things up with. You have had a lot of change in the last few years, extraordinary amount of change. And with your -- how is your business changing? And what do you think investors should most understand about how that -- what your business model is today and how it's changed?

Sure. You're right. We have had a lot of change. And when you think about going back to 2018, which seems like a long time ago, we spun out our nonrail businesses into Arcosa. That was all about trying to unlock value for shareholders. Our business platform has continued to evolve from just a railcar manufacturing with a lease fleet into more of a leasing company with a captive manufacturing company. I think some of the things that I'm excited about are the cash flow generation that we can generate out of our platform. And that's kind of cycle agnostic. In a strong market, we're going to generate cash flow. In a soft market, we're going to generate cash flow. And so that's really something we're focused on. As we go forward, I think what you'll hear from management pretty consistently -- one, you're going to hear from management consistently. And two, that in terms of a capital allocation framework, we want to grow. We want to continue to capitalize on our ability to originate lease assets and deploy capital in that form. But we also know we got to get our balance sheet more optimized and more appropriate for the type of company we are. And that means putting a little more leverage on the business. And as you reoptimize that balance sheet, there's going to be opportunities to return capital to shareholders while growing. So we think we can do a little bit of everything. And even in the midst of a pandemic, we expect to stay focused on our long-term goals, and we remain positioned to execute really effectively as the market accelerates.

Great. Well, Eric and Jessica, thank you so much for joining us and spending time with us at the UBS Industrials and Transports Conference. Appreciate all the insights and the time at the fireside chat and the meetings. And we look forward to being in touch soon.

Thank you, Tom. Thank you for your interest. Appreciate it.

Okay. Great. Thanks for your time. Have a great day.

Bye.