Periodic harvesting from existing railcar fleets is an occurrence that is almost as regular as planting cycles for commodities moved by railcar. In this context, the term “harvest” means to sell certain assets at a profit and to take gains on past successful investment decisions or, alternatively, to eliminate or to pare down positions in less optimal or non-earning assets (not always profitable decisions).
Harvesting equipment from a portfolio does several important things. Perhaps most important, harvesting is an opportunity to take some profits and realize the benefits of good investment decisions. Harvesting for profit is like a pat on the back, a way to say “good job!” Harvesting for profits allows companies invested in rail assets to “pop” cash (book) gains to the bottom line as needed to help smooth out balance sheet issues that may arise quarter to quarter or at the end of a fiscal cycle.
In the same way that futures provide a point of view on the current market for wheat, corn, or soybeans, the harvest season in rail equipment gives a window to any potential seller about the health of the overall rail market, the depth and breadth of the current pool of rail investors. Organized asset sales provide a barometer on asset valuations, on whether there is optimism or pessimism regarding the lease market for railcars, and on the number of new entrants that might be in the operating lessor market. Sophisticated equipment lessors know that being one step ahead of your competition is helpful in a tight market like the one that exists today. Harvesting is one way the savvy investor does reconnaissance on the competition.
A secondary reason that companies engage in harvesting is that putting equipment up for sale provides owners real-time data on asset values. For all the collective knowledge a company may have (real or hypothetical), nothing is more fundamental than real-time market knowledge provided through a competitive bid process to tell an investor what its assets are worth.
For a large operating lessor, a sale of one group of 4,750 cubic-foot covered hoppers will provide a “real-time” value for every 4,750 in that lessor’s fleet. Off this data, a lessor may adjust those values to account for differences in lease term, lease rate, and lessee credit quality.
Additionally, obtaining knowledge about the value of the equipment in a lessor’s fleet is as important today as it ever has been. Readers of this column are certainly aware of the growth in demand for cars for hauling frac sand and of the overwhelming demand and massive uncertainty regarding DOT 111A tank cars. For covered hoppers hauling sand, some investors are expressing concern that an almost two-year-long backlog is trending toward overbuilding. A harvesting event that includes small-cube covered hoppers can provide a market-based opinion on the asset, limit exposure, and monetize positions taken before a shift in the balance between supply and demand.
For DOT 111A tank cars, the situation is potentially magnified. Investors have the same potential concerns about overbuilding (due to the potential for pipelines to replace crude by rail opportunities). There are additional concerns that stem from the impending DOT equipment specification changes that are currently in the comment stage. While the final result of the DOT specification change is unknown, all parties can generally agree that crude oil being moved in 30,000-gallon non-coiled and non-insulated tank cars will have to move to a new or modified car. All lessors that have exposure to this market are at a crossroads. In the next two to three years, they will need to decide if cars need to change service, be modified, or be scrapped—tough decisions when you are talking about (depending on the lessor) up to thousands of cars in a fleet. Using the market at large to provide feedback on the risk and reward profile of investments in those asset classes sounds like a shrewd maneuver right about now.
As with everything in the railcar equipment market, there is plenty of rumor and information sharing. A keen eye and ear might let you know what the market is thinking even if you are on the sidelines during this year’s equipment harvest.
Questions? Dnahass@railfin.com.