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

Well, good day, and thank you for joining me for Trinity Industries' company presentation. I'm Jessica Greiner, Vice President of Investor Relations for Trinity. I've been with the company for almost 12 years now, serving most of that time in our Investor Relations capacity, working very closely with our management team discussing strategy and communicating with our investors. I do want to let you know that this presentation is an excerpt from our second quarter investor presentation. It was filed following our second quarter earnings call, and it's available to you in its full context on our Investor Relations website. We will not cover every slide today from the conference presentation in this prerecorded webcast, but I do want to point you to some of the non-GAAP numbers that you'll see, where in the appendix you'll find the reconciliations of those numbers. In the presentation today, I'll give you an overview of Trinity's businesses and a few of the considerations for new investors to the Trinity story. I'll also provide an update from our second quarter call in regards to how the company is managing during the pandemic. I also do have to make one quick housekeeping item as our presentation does contain forward-looking statements. I won't read this whole paragraph to you, but please note, any conditions or outlooks of our business, those can be found in our Form 10-K. Now let's get to the fun part of our presentation. Trinity is in the middle of a very exciting transformation. We've been shifting our business model from our former diversified industrial holding company to more of a focused operating model of our market-leading rail businesses. Trinity is in the top 5 of railcar leasing companies in North America, and we're also a leading rail manufacturer with last 12 months' revenue and adjusted EBITDA of $2.8 billion and $660 million, respectively. Our go-forward strategy is really centered on a unique collection of rail businesses that creates a very strong platform, and we leverage these products and services to create solutions for our customers, which is really the end user, the industrial shipper. Our business model does also throw off quite a bit of cash. When you look at our last 12 months' free cash flow generation before lease fleet investment, it's yielding approximately 30% free cash flow yields based on our market cap yesterday. So when you look at the value of our leasing company and you look at our market cap, management does believe Trinity is undervalued relative to the intrinsic value of our assets. And we've been very active in repurchasing our shares since our spin-off as part of our capital allocation process. So let's look at Trinity's investment thesis and why we believe our company is a value growth and a capital return story. When you consider the investment spectrum, we do believe there are both sector-specific and company-specific reasons that make Trinity an attractive investment. We'll touch on some of these in a little more detail later, but let's go through them now. The -- when you look at the industry, railcars are an integral and valuable part of the North American supply chain, delivering essential goods to market that support our everyday life in our communities. This is a foundational element to our sustainability commitment. Not only do railcars play an essential role in society, railcars are the most environmentally friendly land-based mode of transportation, and they're nearly 100% recyclable through scrap and salvage. So it's got a really nice ESG story when you think about the purpose of the company in the longevity business. The health of the railcar industry is also strongly correlated to North American GDP, given the fundamental drivers for demand being industrial production and domestic consumption. Our rail platform is comprised of leading market positions, providing both organic opportunities for growth and encompassing attractive long-lived railcar assets, which support our valuation. When you look at the railcar equipment on Trinity's balance sheet, we have leased railcars of approximately $7.2 billion. Railcar assets are 35- to 50-year-lived assets, and they really hold their value over their life given the steel content and the low technological obsolescence within the equipment. Railcars are also a natural hedge to inflation and interest rate risk as lease rates typically increase over the life of the asset. Company-specific reasons for our investment considerations, we have substantial commercial and financial synergies that -- for example, increasing our customer touch points and enhancing the company's cost and tax advantage position. We'll talk more about these synergies momentarily, but they're a big reason into the next investment consideration, which is the significant cash flow generation. I've already mentioned our double-digit free cash flow yield. So we believe our business model really puts the company in somewhat of a position of -- we can have our cake and eat it, too. We -- our cash flow generation allows significant reinvestment in the business while also returning meaningful amounts of capital to shareholders. And finally, management and the Board are aligned with shareholder interest with a strong corporate culture of premier performance. We've long maintained a long-term view of shareholder value creation while managing through the short-term changes that we have from the economy. I'd like to talk through the next few slides to give you a better sense of our commercial strategy and the railcar industry. As we really think of ourselves more than just a manufacturing company or a leasing company, we really see ourselves as a rail services and solutions provider to industrial shippers. Our railcar platform, the vision is to be that premier provider of railcar products and services in North America. However, our objective in doing that is to optimize the ownership and usage of railcars over their full life cycle. And we believe we're ideally positioned to do that because as owners of these assets, as the provider and servicer of the solutions, we're aligned with our customers and offering them better solutions that increase the attractiveness of moving goods by rail, enhancing their business models, lowering their rail supply chain costs and ultimately bringing more of that modal share of ton miles back into the railcar network. So when it comes to the railcars, I mentioned we build them, we lease them. We also maintain and service railcars through these platforms. We manage railcars on behalf of institutional investors, and we trade regularly in the secondary markets as well. With all of this business, we have a unique insight into the market, and that data-driven insight really allows us to analyze market dynamics and allows us to be very intuitive in looking at our markets and looking at our pricing strategies, new product development and new service offerings as well. On Slide 7, we're looking at the North American supply chain. Again, I mentioned rail is a big component of freight ton miles within the industry. When you look at all of the essential goods moved by rail, it really affects every major market. We depend every day on food, treated water, energy-generating commodities and medical-grade products. And all of these goods are delivered through the railcar supply chain. Our commercial business also spans 5 major markets. When we look at the railcar industry, there are numerous submarkets within each of these 5 commercial end markets, but they're all heavily based on industrial manufacturing, production, consumption -- domestic consumption, infrastructure and construction. So when you consider the end markets, it's very easy to see why railcar loadings are Buffett's #1 leading indicator of the health of the general economy because it touches on every facet of life within our economy. Our business model also delivers to the needs of each channel. Our unique platform really broadens our reach to serve railcar owners. I mentioned that industrial shippers are really our focus in looking when we're determining our products and services. However, they're not the largest owners of railcars. Actually, railroads and leasing companies own the vast majority of railcars in North America. But because of our commercial offering in our platform, we tailor our commercial solutions to each of these customers. Let me just quickly comment about the types of customers that use railcars. You can see big names on here like Dow, Cargill, ADM, the major Class I railroads. These are significant customers with financial wherewithal, so it's -- we -- over time, we've had very low bad debt expense, which is also a key benefit when you consider our financial performance. We've talked about the commercial aspects of the company. Let's dive into the financial value from an investor's perspective. I mentioned Trinity has unique synergies that offer compelling competitive advantages and also generate significant cash flow. When you look at these synergies, we break them up into 2 categories, the financial synergies and the commercial synergies. From a financing standpoint, having both the leasing company and the manufacturing together gives us cost-advantage growth. When we add to the lease fleet, Trinity's investment in that railcar is at our manufacturing cost. We also have an RIV platform, which stands for Railcar Investment Vehicles. These are third-party institutional investors that want to own the railcar, but have a passive stake in the management of that asset. And it enables us to grow our fleet, retain that management fee, but utilize a lower hurdle cost of capital in growing that portfolio. Another key financial synergy is the tax advantage of lease fleet investment. Our lease fleet investments result in tax NOLs that shield our production and manufacturing income. So that's -- it's a big opportunity, especially as you go through the high points of the cycle. There are a lot of leasing companies that have similar tax shields, but because we generate significant earnings during the cycle, that lease fleet investment protects that. On a cash basis, we pay very little federal income taxes. We also have lower relative administrative cost and operational cost as we operate as one company versus having a stand-alone manufacturing and leasing company. On the commercial side, we have higher touch points with our customers. I mentioned we serve across the railcar market, and that provides us that cross-selling opportunity of service offerings and new solutions that can grow our revenue basis. I also mentioned the market intelligence that we get by having insight into the different facets of the market that give us those data points that allow us to make data-driven decisions on pricing and production and capacity. It's also very key, low-risk organic growth opportunities through the sales channel of our commercial team. Most leasing companies, if they want to grow, have to place orders with railcar manufacturers and be "in line" for a railcar. It's very rare they get to time a order for a railcar with their end user, the lessee, whereas Trinity's customers come direct through our commercial platform. If they want a railcar and we don't have it in our lease fleet, they're in the front of the line in that manufacturing production. Most importantly, when you look at these cash flows, these synergies create a significant amount of cash that we believe will continue to support strong reinvestment in the business while enabling meaningful cash flow to -- return of capital to shareholders. When you look at our free cash flow before lease fleet investment, the chart on the top right, it shows we have significant cash to fund our future growth and still return capital to shareholders. Let me give you a couple of data points. In the last 12 months, we've invested $104 million in our business, $450 million in our lease fleet investment and still returned over $280 million to shareholders through the form of dividend repurchases. That's over 10% of our market cap. Our lease fleet investment is capital-intensive. However, it's most -- it's important to recognize that, that lease fleet investment is an equity capital investment that impacts the cash flows as we typically finance that investment in a 70% to 75% LTV. So big -- a lot of our investors today, as we've seen our investor base roll over, have really focused on the cash flow generation of the company. I mentioned Trinity is in the middle of a transformation. We're highly focused on unlocking value for shareholders from our business. As we've transitioned our company, we're placing more focus on returns and cash flows from the business versus earnings growth through the cycle. And that's the shift in that mindset from being more of a leasing company versus the manufacturing company. Following this shift in the business strategy, management put in place a multiyear average ROE target that aligns the company with a mid-teen ROE performance expectation at the end of that time period. This target was put in place before the impacts of the COVID-19 pandemic, which will create pretty significant headwinds in order for us to accomplish that 3-year performance target by the end of next year, but we do believe we're taking the necessary steps to accomplish this goal in due time. When you look at the ROE target, the performance improvement is really going to come from 2 buckets. Financially, we're working at balance sheet optimization, our capital allocation decisions. We're also evaluating which railcar assets we hold within our balance sheet versus using a third-party capital that I mentioned to fund the finance of that growth. Operationally, we've been very focused on cost optimization, improving the platform of the -- excuse me, improving the efficiency of the platform and also lowering our corporate cost. I mentioned we're moving from a holding company organization structure to more of an operating company structure. That's a lot of spans and layers as we used to operate more siloed versus that one company, one Trinity model. And these actions have really been beneficial as we were already in the midst of them as COVID-19 pandemic came down. So let's shift over to talking a little bit about the COVID-19 pandemic and how it -- how Trinity was positioned going into that current market, the COVID-19 crisis. Like many companies, our business has been impacted by the effects of COVID-19 and the impacts on industrial production and domestic consumption. These factors have drastically impacted demand for railcars, and the movement of certain essential goods and commodities have seen historic declines over the last 6 months. We are seeing positive momentum start to return to the industry, and that's a good sign for our business, but we're still below certain levels and definitely below the railcar loadings from 2019. We've been focused in 4 main areas, and these are the factors within our control. We've placed a high emphasis on the continuity of our business, our cash flow, cost reduction and capital allocation. From a continuity perspective, the company is considered an essential business. And by our estimation, over 80% of our customers are also deemed essential businesses. This has allowed us to maintain operations even in the peak of the pandemic when most of the economy was shut down. We placed a high priority on making sure we implemented the necessary protocols to maintain our operations and keep our employees and our customers safe. And we actually saw a pretty positive success rate in maintaining our productivity levels in this stage of the cycle relative to other cycles when we're having to contract our plants and we see lower efficiencies. We have a very strong balance sheet. And I mentioned our significant cash flow generation from the platform has kept trending in a financially healthy position relative to many of our industrial peers. I talked about some of the cost-reduction efforts that we have been doing as far as looking at our organization. We've reduced our headcount by approximately 35% since year-end. This resulted in almost $40 million in annualized cost savings, which we're targeting for those to become permanent as we continue to optimize that manufacturing platform and move a lot of our cyclical business structure out into our supply chain. We've also identified approximately $30 million in the annualized SG&A and other administrative savings, which are structural in nature, and we expect to execute on those by the end of the year. We've also maintained a very prudent approach to our capital allocation, which is our first priority of maintaining our liquidity and healthy balance sheet in this environment. We've still been pretty vocal about our commitment to investing prudently in our business and our willingness to deploy capital in this environment, which is truly a testament to the strength of the business model. I'm going to jump ahead to Slide 17 to give you a sense of our financial position and how we're facing the COVID-19 pandemic from a position of strength. We do have solid liquidity. We've got almost $710 million of liquidity at the end of the second quarter. That's split between our cash, our corporate revolver and our leasing warehouse. We're also expecting over $450 million in federal tax refunds as a result of changes in the CARES Act, which allowed us to utilize some of our NOL positions and carry them back to previous years, which under the Tax Care Act, they had changed those with only tax carryforward position. So we expect that $450 million over the next 6 to 18 months. Our current capital structure is split between both recourse debt at the parent company and nonrecourse debt securitized by the railcar assets within our lease portfolio. These are very attractive and flexible debt structures, and we don't have any near-term maturities. We also have almost $1.6 billion of unencumbered railcar assets on our balance sheet that we can use to monetize either through additional debt securitization or through the secondary market should we need to access that capital. In lieu of guidance on our first and second quarter conference calls, management gave some guidepost scenarios to help investors understand how we would orient our capital allocation decisions and our business behavior as market drivers change based on the COVID-19 impact on the economy. In our base case, we assume that railcar loadings continue their positive recovery trends through 2020. And in our stress case, we assume that there is a relapse in the economy and railcar loadings are negatively impacted through 2021. I think the key takeaway here is that investors have taken notice that, regardless of which scenario we find ourselves, it's our confidence in our cash flow generation from our platform that we do expect to maintain our dividends. And again, that's a testament to our business model. So in summary, it's really the synergies of the rail platform and the cash flow that are the driving force behind Trinity's value creation for shareholders. I'll end on showing you Slide 10 again in that the cash flow enables the reinvestment in the business and our ability to continue returning capital to shareholders. We do think investors are starting to take notice of these results, we have a long way to go in improving our returns, but we're very exciting about the business model. And our valuation has held up during a very challenging COVID environment. We've seen our investor base start to turn, and we're managing expectations and that we'll actually have an Investor Day likely here towards the end of the year, where our new CEO and CFO will lay out the new elements of the strategy for the business going forward and how we expect to improve those returns. We are in a position of strength to withstand the current market and deliver long-term value to shareholders. I'd like to thank you for listening today. I am available to answer any questions you may have about the company, and you can reach me at [email protected]. I look forward to engaging with you in the future. Thank you for listening.