From the May 2106 issue of Railway Age: “It never hurts to keep looking for sunshine,” Eeyore once said. However, in the rail economy, it’s the end of first-quarter 2016, and the market is mired in a slump.
Check in with any car lessor today and you’ll find that lease rates for cars across almost every sector in the market are significantly off highs and showing little hope for resurgence.
One year ago, for the 2015 Guide to Equipment Leasing, the new DOT-117 tank railcar mechanical specifications for cars hauling crude oil and ethanol and the retrofitting of older DOT-111A “legacy” cars and CPC-1232 cars was the issue of the moment. Who would retrofit tank railcars, what would be retrofitted, how much would it cost and most important, who would pay for it?
Today, with crude seemingly marginalized as a rail commodity, some tank railcar retrofits are being done, but the cost for doing the retrofits remains wildly divergent based on car type, design and scope. The broken promise of a long backlog of cars waiting for retrofit has been put to the side as bigger market issues have taken precedence.
So what is on the minds of rail investors and lessors today? Primarily it’s the general sense of weakness in the market. Even with projected railcar manufacturing for 2016 at somewhere between 50,000 and 60,000 units, there is a sense of gloom that permeates the market. Remember that before the crude and sand boom and bust, a build year of 40,000 or more railcars was considered to be robust.
Today’s lease and manufacturing market lacks optimism. When asked about what, if any, bright spots there are in the market today, one lessor said, “In both commodity and car type, on a macro basis the [railcar] market is extremely difficult. On a micro basis, some opportunities exist, but they are harder to find and occasionally harder to close.”
The macro headwinds in the rail economy are well documented: a strong US dollar having a negative impact on commodity (grain, steel, coal) prices and their export, and low-priced oil and natural gas impacting coal rail loadings, domestic and Canadian frac drilling, oil sands production and the movement of sand and crude by rail in North America. Never mind the generalized global economic weakness where we can’t determine if the Chinese economy is growing or shrinking and where many central banks are working overtime to promote economic growth through the use of low or even negative interest rates. Put all together, and in spite of what on the surface seems to be a fairly healthy U.S. economy, economic headwinds in the rail economy are strong and far-reaching.
Back to railcar leasing: What is a lessor to do when the market softens and opportunities are limited? The same lessor noted, “On a down cycle, we look for opportunities, as companies change their equipment positions and realign, we look for investment and growth opportunities that would suit our commitment to the market today.” Strategically sound in theory, but like many things, difficult in execution. 2015 began as a year of high asset prices. In the second half of 2015, new car prices and lease rates on many railcars classes began to or continued to trend downward.
However, even as the market began its transition, high prices for secondary market assets (the market for the sale of used assets), driven by investor appetite and low interest rates, have remained lofty. Typically, used car prices follow the trajectory of new car prices. Late into the second half of 2015, certain used railcars, on lease, were selling for prices that equaled or exceeded their cost when new.
When asked about whether there have been any reductions in the prices of used railcars, this lessor said, “Broadly speaking, not yet. There have been some scattered indications that it might be beginning to happen. The declines are not as broad across product lines or as abrupt on a percentage basis as new car price reductions that we have seen for buyers willing to place orders for new cars today.”
What is behind the curtain that allows purchasers of used cars to hold the value up? Three things: One, the used cars are in service (and therefore more difficult and more costly to return/replace). Two, every railcar purchaser hopes in some fashion that lease rates will always increase and never, ever decrease. Three, historically in the long term, railcar assets continue to increase in value even through the cyclical highs and lows of the rail market.
This oasis of used car valuation optimism in the face of such doom and gloom is fueling the rumor that there may be additional re-alignment in the railcar lessor marketplace. The rail economy is a cyclical one, so savvy investors look to position themselves during a downturn in hopes of being prepared to capitalize when the cyclical market begins to stretch upwards.
In the case of this specific downturn, the timing for the turnaround remains unclear. Our lessor identified the same by saying, “It’s always difficult to forecast a change in the cycle, but given the current market for most commodities and an economy that seems to be weak in manufacturing and infrastructure (roads, bridges and housing) construction, I would expect this to last for a couple of years. While that is a generalization, even though some commodities recover faster than others, rail is the last group to suffer in a downturn and the last group to respond in a recovery. Those of us who have been through several cycles know that recovery can occur quickly, but I see no basis for that in the immediate future.”
With market headwinds in several markets, most notably, oil, coal and sand, where will the market rebound originate? We hear the question in the marketplace: What is the next great growth opportunity in rail? The answer has been and continues to be intermodal. But for many operating lessors, the intermodal market is not an investment option and the market narrows even further at its weakest points.
Asked about car types not open for investment, our lessor said, “Absent longer-term lessee commitments, there’s unlikely to be interest in coal cars and large non coiled/non insulated tank railcars. Given the lease rates for small-cube covered hoppers, it’s going to take a while before there will be much interest in investing in those cars.”
Manufacturers have indicated that new-car order inquires are stable (albeit at a lower rate than a year ago) and seem to have stopped declining. For some of the brighter spots in the market, such as plastic pellet hoppers, orders continue to be placed, as new manufacturing facilities get committed once their financing is arranged. With so few bright spots in the market, the money in the market may easily level set into these pockets of optimism, create further weakness by overbuilding those segments and thereby extend the length of the downturn.
There are so many factors at play that can influence the market for cars and their lease rates, beginning with the Federal Reserve’s stated plan to begin increasing interest rates mid-year 2016. Investors should expect that lease rates will more than likely flounder around at current levels. Working hard to keep cars active and employed will be as challenging as the return negotiations in which lessors engage when markets soften. As we heard from one lessor, the general consensus suggests that today’s market will continue at least through the end of 2017 (some sources believe 2018 is the first chance for a rebound). Typically, a two-year downturn has been the norm; this cyclical slump might challenge that standard.
As lease rates languish, lessors will look for opportunities to move rates higher as the market allows while rates will move lower if the current state of the market continues apace. Right now, an Eeyore style approach of “No Expectations, No Disappointments,” disappointingly, seems just about right.
Round the Market
A general weakness in the market is leaving many market segments floundering and those with cars ready to lease frustrated by overall weakness and the low rates for railcars on lease today. Here’s an update on cars and lease rates:
Tank Railcars for Crude: Oversupply, increasing pipeline capacity, lower oil pricing, an end to the Brent Crude/WTI (West Texas Intermediate Crude) price spread, rail tariffs on cars that are not DOT-117A standard and impending regulatory changes in tank railcar design have all combined to leave the lease market for tanks for hauling crude and ethanol on the ropes. Rumors of cars in storage in the thousands have investors, lessors and lessees wondering when a recovery might occur. If a car gets leased, and that’s a big if, we hear rates of $500 per car per month full-service, but there’s a lot of hope in that number. When does this market recover? Back to the 2014 speculator’s paradise? Probably never. However, consensus suggests that 2018 could be a year when regulatory issues are settled and oil pricing may rebound to where CBR has a more relevant role in the car leasing marketplace, albeit likely not to the peak levels of late 2014.
Tank Railcars (Non Crude): Pressure tank railcars continue to suffer from oversupply, but the medium size range of tank (20,000-25,000 gallon) railcars continues to show strength vs. other tank railcar types and other asset classes. New-builds continue to push capacity into the market. Older “legacy” cars are most at risk as the bubble in tank railcars that have no chance for retrofit or that might be subject to tariff continues to grow as cars come off lease. For newer cars, lease rates continue to hold steady in the mid- to high-$800s today, down from $1,100 to $1,400 a year ago. Older cars continue to show strength, sitting in the $600s. Grab it while you can, as those opportunities may become less frequent in the near term.
Covered Hoppers for Grain: The strong U.S. dollar had led to a weak export market and an abundance of grain on the ground or in storage. There was some building in this segment, but that has (mostly) come to an end as lessors and car owners cannot receive a reasonable return on their $80,000-plus investment at this time. Long-term prospects remain strong for a fleet in need of revitalization, but the time for this market is not now. How off balance is this market? On April 12, 2016, The Wall Street Journal reported that due to costly rail transportation, the strong dollar and low water borne transport rates, corn imports are surging even as record harvests leave farmers with an oversupply of product. Lease rates? Jumbo cars are leasing in the mid- to low-$400s full-service, while 4,750 cubic-foot cars are in the low to mid $200s full-service. Opportunities are few and far between.
Covered Hoppers for Sand and Cement: Like its fraternal twin, crude oil, cars for hauling sand are confronting significant oversupply troubles. The lease market is weak and likely to get weaker until the price of oil and natural gas rebound to sustainable levels. If you listen to the earnings calls of companies in the business of supplying sand, you can get some window into how bad this picture is right now. A crude price rebound is required to get oil rigs in service and prices and volumes back to pre-2015 levels. It also seems that some new-car backlog still remains in this car type; adding more assets to the party is likely to extend the price depression. In addition, the opening of new railcar manufacturing capacity will also provide some drag. Lease rates? We hear sub-$300 for lease opportunities full-service but don’t count on any more than a handful of opportunities and all of those being pursued by a significant number of suitors.
Cover Hoppers for Plastics: Cheap natural gas (sub-$2.00 per million BTU as of 4/15/16) continues to support planning and development of facilities (ethylene crackers and production plants) for polyethylene. At the 2016 Rail Equipment Finance Conference, experts predicted a need for 18,000 new plastic pellet hoppers to haul all of the planned plastics manufacturing capacity. New car lease rates are quoted for 5 – 7 years in the high $600s per car per month full-service. Older (5,800 cubic foot) cars are bringing in full-service rates in the high $400s. Need a worry? Here’s two: One, many plant manufacturers built their own cars for purchase or long-term lease and short-term cars may be in excess once the market reaches parity. Two, sustained low oil prices have compressed the spread and cost benefit provided by natural gas as a feedstock. The viability of the investment is getting a second look at some announced facilities.
Boxcars: Another market bright spot. Utilization in the boxcar fleet has been running high and market dynamics (velocity, turn times, loadings volumes) have continued to support this market. The supply of boxcars is supporting the volume of the business, and there are 4,000 cars to be built in the current railcar backlog, mostly being ordered by TTX. Lease rates are in the low $600s full-service, if you can find fixed rate leases. Per diem structures really rule the day here.
Mill Gons and Finished Steel: Even with recent improvements to $230 per ton for Chicago No. 1 heavy scrap, weaker scrap volumes and weak domestic steel production continues to be a significant drag against this market. This market really suffers as a result of the global weakness (decreasing demand for U.S. scrap) and the strong dollar (making U.S. scrap less competitive and foreign steel cheaper). Older cars (pre-1990) are leasing for high $200s full-service, which will give at least some income above and beyond the cost of maintenance, while newer cars are in the $400s. Per diem leasing is available here as well, but revenues are inconsistent.
Coal Cars: Wither King Coal? Most industry sources suggest and agree that coal’s continued demise, as the baseload power supply, is inevitable and unavoidable. Rail velocity improvements leading to lightening fast cycle times are keeping about 35,000-45,000 cars in storage on the western and eastern Class I railroads. Until natural gas breaches the $3.00/MMBTU level and a weaker dollar allows for U.S. export coal to compete with Australia and South America, investors should expect more events like the Peabody Coal bankruptcy to occur. (Three cheers for regulated utilities, anyone?)
Longer term, global coal consumption will provide a destination for U.S. coal as domestic coal-fired power generation decreases, but the headwinds against coal today need to decrease. Government regulation rules all, so changing political winds could also improve coal’s prospects. Leasing? $100 per car per month net is about the best you can do today. Most investors will take that lease rate gladly (and in some cases less) if only to avoid the day-to-day accumulation in storage costs.
As Eeyore said, “We can’t all and some of us don’t. That’s all there is to it.”