As many readers of the “Financial Edge” know, the end of 2015 saw the purchase of General Electric Railcar Services, one of the largest and in some ways oldest of the operating lessor companies that lease railcars to their customers on primarily shorter (think seven years and less) lease terms.
Wells Fargo Rail (formerly First Union Rail) purchased the majority of the cars and locomotives, and Union Tank Car Company (a unit of Warren Buffet’s Berkshire Hathaway) purchased the tank railcars and railcar repair shops. This is a dramatic change in the railcar leasing marketplace.
I had a chance to sit down with Wells Fargo Rail President Barbara Wilson and ask her about the acquisition, the outlook for the company and how she views today’s railcar leasing market.
Financial Edge: Post-GE acquisition, what’s the size of WFR?
Barbara Wilson: We were delighted to close on the acquisition of GE Railcar Services on Jan. 1, 2016. This acquisition allowed us to expand our available fleet of rail equipment by more than 77,000 railcars and 1,000 locomotives. In addition, on that date we rebranded the company to Wells Fargo Rail. We are very proud to take on our parent company name. Our fleet of equipment available for lease now totals more than 174,000 railcars and 1,800 locomotives. That fleet is very diversified, but heavily focused on freight cars. At this time we own fewer than 10,000 tank cars but look forward to growing that portion of our fleet to continue to support the needs of our customers. In addition, we manage more than 20,000 railcars on operating leases for other owners.
FE: To which market segments do you feel is WFR particularly exposed right now? Is that exposure something that immediately begins to require active management, or as a result of the overall scale of WFR do individual market segments not move the needle in the way they used to in the past?
BW: Our present railcar fleet diversification largely mirrors the diversification of the North American railcar fleet. Therefore we do have meaningful exposure to coal, sand, grain and centerbeams. As you know, the strong U.S. dollar has negatively impacted virtually all commodities that get exported. We see weakness in the volumes of those commodities (steel, scrap, grain etc.) and therefore reduced demand for railcars to move those commodities. We have a very small tank car fleet, and our Packing Group 3 tank car fleet consists of fewer than 2,500 cars, so our exposure to the new tank car design regulations is very limited. Our locomotive operating lease fleet consists primarily of high quality four-axle road and switcher units. Presently there is some weakness in demand for those units due to the decrease in rail freight volumes.
FE: In what markets does WFR maintain limited exposure? Do those markets, now in retrospect, offer you vindication vs. the peer (or previously peer) group that is also working to grow?
BW: We are clearly underweighted in tank cars. That is because we entered that market late and were very selective in the equipment we acquired. Prior to July 2013 no one saw the significant new equipment specifications coming for flammable liquid tanks, so our position is somewhat a result of luck, not planning. Today we see the tank car market as very attractive to invest in. We hope to expand our customer base through investment in the tank car market and are committed to supporting the needs of our existing customers through investment in the tank cars that they require.
FE: GE had made market noise for years about selling its operating lease fleet, and throughout your career you had participated in a number of evaluations of that fleet. What made the final push successful this time around?
BW: We were fortunate that in April 2015 the management and board of directors at GE corporate decided to exit the financial services business and focus on industrial technology businesses. The GE Rail business was put up for sale as a result of that decision, not due to specific qualities of the GE Rail business. Once we saw the detail and the quality of the GE Rail fleet, we knew it would be a very complementary and accretive acquisition for our business. Most important, we believe that our acquisition of the fleet allows us to better serve our customers. With a significantly larger inventory of assets, we are much better positioned to have the railcars and locomotives needed by our customers, allowing us to be a better strategic partner to them.
FE: Are there risks in a relationship business of being too big?
BW: The breadth of our fleet means that we serve many different customers in many different businesses. The Wells Fargo vision is,“We want to satisfy our customers’ financial needs and help them succeed financially.” In the rail operating lease business, that requires us to have the assets that our customers need to operate their business. Wells Fargo has committed a large amount of capital to the rail operating lease business with the goal of better serving the needs of our customers. We believe customers in our all business segments can be better served, and save time and money, if they bring their rail equipment needs to one trusted provider that knows them well, provides reliable guidance and advice, and can serve their full range of equipment needs through a wide choice of products and services. That is why we have made billions of dollars of investments in all railcar types, why we have a fleet of locomotives available for lease, and why we provide management services to owners of railcar assets that need a hands-on, fully in-house staffed asset management partner.
FE: Will the market see some large offerings of excess product from the WFR to begin rebalancing the fleet or to reduce exposure to certain markets?
BW: As you can imagine, the integration of the GE Rail fleet into our legacy fleet will take some time. That integration requires that we fully understand the needs of our customers and analyze how our existing fleet aligns with those needs. Our company has not historically been a large seller in the secondary market because of the impact that selling has on our customer base. By the second half of this year we will be in a much better position to assess our fleet mix and answer the question on future asset sales.
FE: With a company this size, does it become harder to grow? Do your return criteria change going forward?
BW: We have made a significant long-term commitment to the rail equipment operating lease business. As you know, this is a cyclical business that requires a large capital commitment and reasonable return expectations. Over the long term it is a relatively low risk business that provides core assets to meet the needs of railroad shippers throughout North America. Wells Fargo Rail has the largest fleet of any rail operating lessor; however, we see continued opportunities to thoughtfully grow our fleet to support the needs of our customers. This growth will occur through buying new railcars, and railcars and locomotives in the secondary market. We believe that soft markets, like the one we are currently in, provide us opportunities to acquire assets at attractive prices, often from small competitors who need to sell assets due to liquidity issues. Because we look at asset returns over a long period of time, assets acquired at depressed prices in soft markets often show better returns over time than assets acquired at the peak of a hot market. We have capital that we have committed long-term into a business that we like long-term.
FE: How do you see the 2016 market for operating lessors? Are we headed into a cyclical downturn in rail?
BW: Rail equipment demand in the aggregate tends to follow railcar loadings in the aggregate, and 2016 is off to a soft start for both. Crude oil and sand shipment volumes are down meaningfully due to weakness in the energy space, and coal volumes remain depressed due to numerous new regulations combined with mild weather. Add in the strong U.S. dollar, which has depressed all exports, and we are clearly experiencing significant headwinds in the business. However, significant investment in the petrochemical space is providing solid demand for plastic pellet cars that we expect will continue for the next several years. The reality is that in the operating lease market our leases typically are several years in length, so we do not feel the immediate impact of a weak market in the utilization (and earning power) of our equipment. We aim to stagger the maturities of our lease portfolio to mitigate demand risks.
FE: There's a lot of talk about rail market growth generally. With the crude by rail phenomena having done its best imitation of a supernova, what will drive rail expansion in 2017 and beyond?
BW: The rail market equipment has historically grown at about the same rate as GDP. The CBR phenomenon was driven by a unique and not likely repeatable set of demand drivers. As we look past 2016, the plastic pellet car fleet will grow to service the new plants built in the Gulf, and tank car replacements will need to be built for some portion of the tank car fleet that does not meet the new regulatory specifications. Then of course, annual railcar replacement demand gives us a baseline for new railcar builds. Each year a portion of the North American fleet is casualtied or retired, and that requires new replacement railcars to be built. Finally, in many sectors, larger capacity railcars are more economical to utilize, and we see shippers demand for larger railcars pushing some of the older, less commercially desirable railcars into retirement. We view the slow and steady growth of the rail equipment market as a positive and healthy market to continue to invest our capital.