Textainer Group Holdings Limited (NYSE:TGH) Q2 2022 Results Conference Call August 2, 2022 11:00 AM ET
Company Participants
Tamara Bakarian – Director of Investor Relations
Olivier Ghesquiere – President and Chief Executive Officer
Michael Chan – Executive Vice President and Chief Financial Officer
Conference Call Participants
Michael Brown – Keefe, Bruyette, & Woods
Liam Burke – B. Riley Securities
Operator
Thank you, and welcome to Textainer’s Second Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will be provided at that time. As a reminder, today’s conference call is being recorded.
I will now turn the call over to Tamara Bakarian Director of Investor Relations with Textainer. Please go ahead.
Tamara Bakarian
Thank you. Certain statements made during this conference call may contain Forward-Looking Statements in accordance with U.S. Securities Laws. These statements involve risks and uncertainties, are only predictions and may differ materially from actual future events or results. The Company’s views, estimates, plans and outlook as described within this call may change after this discussion. The Company is under no obligation to modify or update any or all statements that are made.
Please see the Company’s annual report on Form 20-F for the year ended December 31, 2021, filed with the Securities and Exchange Commission on March 17, 2022, and going forward, any subsequent quarterly filings on Form 6-K for additional information concerning factors that could cause actual results to differ materially from those in the Forward-Looking Statements.
During this call, we will discuss non-GAAP financial measures. As such measures are not prepared in accordance with generally accepted accounting principles, a reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures will be provided either on this conference call or can be found in today’s earnings press release.
Finally, along with our earnings release today, we have also provided slides to accompany our comments on today’s call. Both the earnings release and the earnings call presentation can be found on Textainer’s Investor Relations website at investor.textainer.com.
I would now like to turn the call over to Olivier Ghesquiere, Textainer’s President and Chief Executive Officer, for his opening comments.
Olivier Ghesquiere
Thank you, Tamara. Good morning, everyone, and thank you for joining us today. I will begin by reviewing the highlights of our second quarter results, followed by additional perspective on the industry. Michael will then go over our financial results in greater detail, after which we will open the call for your questions.
We are very pleased to report our best ever quarterly net adjusted income and adjusted EPS on the back of solid revenue, exceptional gain on sales and continued disciplined expense management with EPS further benefiting from the impact of our increased share buyback activity.
For the quarter, we delivered lease rental income of $203 million, adjusted net income of $79 million and adjusted EPS of $1.63. These numbers compared to the first quarter lease rental income of $199 million, adjusted net income of $73 billion and adjusted EPS of $1.48.
The consistent improvement of our financial metrics demonstrates the resilience of our business model in the current normalizing environment as we benefit from our long-term lease contracts and take advantage of market opportunities to sell older containers at a substantial profit.
As we navigated the second quarter of the year, which is traditionally the industry slow season, demand for containers was subdued with limited lease out opportunities as shipping lines now operate with sufficient inventories. This follows a prolonged period of container fleet expansion driven by the mobilization of virtually all container ships available throughout the world.
Congestion continues to remain the central focus of global container shipping with an estimated 12% to 14% of total ship capacity currently tied up as a result of logistical bottlenecks, labor shortages and COVID disruptions. Overall shipping volumes have come down from the peak but remain much higher than pre-COVID, causing spot rates on the TransPacific to decline over the recent months.
Globally, ocean freight rates are now roughly in line with last year’s level, but remains historically very high, which continues to support healthy performance of our customers in spite of rising bunker costs.
The best example of this is probably the Shanghai Container Freight Index, which is approximately four times higher than pre-pandemic levels. In this environment, shipping lines have reduced their intake of new containers and are holding on to existing units.
As a result, our average fleet utilization for the quarter was stable at 99.6% and currently stands at 99.5%. We have only seen a small increase in redeliveries of mostly old sales age container, which have helped us achieve record gain on sales of $23 million for the quarter.
As our customers position themselves for the summer months, they are choosing to hang on to older and as cheaper containers as new production units remain much more expensive – Production of new units at factory has moderated substantially to about 300,000 TEU per month with shipping lines placing over 70% of recent orders.
Total factory inventory of new containers has increased slightly to 850,000 TEU with limited factory orders resulting in reduced lead times. Given the slowdown in lease-out opportunities and relatively short production lead times, Textainer is maintaining a minimal level of container inventory until demand picks up again.
As illustrated by our very strong quarterly performance, the resale market continues to be supported by the continued shortage of older containers being redelivered. Even if prices may have eased for 40-foot high cube containers, they have strengthened in some part of the world for 20 food standard units, which we commonly sell for more than their original cost 14 or 15-years ago.
Our supply situation for older containers is unlikely to materially change over the peak season, we are optimistic that resale prices will remain elevated over the summer before reducing somewhat towards the later part of the year.
This scenario will depend very much on whether any drop in consumer demand will be sufficient to reduce congestion, given the many supply constraints that remain in place. Although some of the COVID lockdowns in China may have been lifted in Shanghai, in particular, several other restrictions remain that hinder fully efficient logistics flows.
New events may further delay a return to normalcy, such as the recent 48-hours warning strike by German port workers, the risk of a rail strike in the U.S., though currently delayed by presidential executive order or the possibility of industrial action related to the ongoing longsome negotiation on the U.S. West Coast.
As we look out to the coming months, we see a continuation of the currently well-supported market with likely additional disruptions in the world of shipping. We are optimistic that container utilization will remain elevated and that we will continue to demonstrate resilient performance for our business going forward, given the following business drivers.
Overall demand for cargo remains well above pre-COVID level as underlined by the U.S. consumption, which was unexpectedly up for June. Our average remaining lease maturity is now in excess of six-years versus less than three-years historically providing for substantial locked-in cash flows.
Exposure to expired leases, which have not reached the end of their economic life, has been considerably reduced, and today represents a much smaller portion of our portfolio at about 3% of our fleet based on net book value.
Furthermore, our customers continue to renew most maturing leases given the alternative of higher-priced new containers. Resale prices will remain historically high for as long as the supply of older containers continues to be limited. We expect supply chain to remain under pressure and subject to further disruption with the risks of industrial action increasing worldwide.
Additionally, the current global inflationary environment should benefit us as an asset owner by supporting lease rates and retail prices longer term with minimal cost to us given our large existing fleet and fixed and hedged debt.
Finally, during the quarter, we repurchased over 1.4 million shares or 3% of our outstanding common shares with our Board of Directors further increasing our share repurchase authorization by an additional $100 million.
Given the current climate of low CapEx, allocating some of our significant cash flow to continue share repurchases and continues to be an attractive use of our capital and has enabled further improvement in earnings per share and other financial metrics.
In closing, we are pleased with our performance for the second quarter. The current economic situation creates uncertainty and market challenges, but we remain optimistic with our outlook for the rest of the year.
Textainer continues to optimize capital allocation in this slower growth period while preparing for future market cycle opportunities. Our balance sheet remains strong with healthy liquidity and efficient capital structure and fixed rate and hedged financing and demonstrated expense control and efficiency.
I will now turn the call over to Michael, who will give you a little more color about our financial results for the second quarter.
Michael Chan
Thank you, Olivier. Hello, everyone. I will now focus on our Q2 financial results. We had an incredibly strong second quarter as our significant and high-quality CapEx investments, strategic financing enhancements and expense management over the last two-years have combined to provide strong long-term performance, cash flow generation and overall resiliency.
We have also been able to take advantage of the excellent resale market to generate exceptional gain on sales for the quarter. Q2 adjusted net income was $79 million, 8% higher than Q1. As Olivier mentioned, this was Textainer’s highest level of adjusted net income to-date.
Q2 adjusted earnings per diluted common share was $1.63, a 10% increase from Q1, driven by our strong Q2 performance and accretive impact from increases to our share repurchase program. We are also very pleased that this results in an annualized Q2 adjusted ROE of 20%.
Q2 lease rental income was $203 million, a higher level than Q1, driven primarily by growth in our fleet size, particularly from long-term finance leases, which continue to be an important component of Textainer’s lease portfolio.
Our utilization rate remained high, averaging 99.6% during Q2, reflecting continued strong demand for our on lease fleet. We expect Q3 lease rental income to be at a stable level versus Q2.
As previously noted, given the tremendous level of CapEx investment in 2021 and as our customers absorb the supply, demand for new containers has moderated this year. Although we continue to see our stemming from our customer relationships and strategic placements at key locations.
Our Q2 CapEx investment totaled $230 million, a decrease from last quarter, but in line with our expectations due to the current demand environment. In total, we have deployed $727 million in CapEx through the first half of 2022. However, we continue to anticipate very limited CapEx opportunities for the rest of the year as our customers currently have enough container inventory to support their vessel operations.
With this lower demand for new equipment, new box prices have continued to reduce from prior year peak levels. Current quoted new container prices are at about $2,600 per CEU, still well above historical averages and continue to support our high utilization and resale prices.
Q2 gain on sales at $23 million was significantly higher than Q1. This was primarily driven by an increase in sales volume sourced from slightly higher redeliveries of mostly sales age containers from expired lease contracts. While resell container prices have slightly reduced with new box prices that remained favorable during the year, and we expect a continuation of this attractive price environment.
We, therefore, expect continued outlay to gain on sales, while the current quarter’s results will be hard to beat. Q2 direct container expense of $7 million increased from the previous quarter due to higher maintenance, handling and storage fees, resulting from slightly more container turn-ins which supported the strong gain on sales performance in Q2.
We expect Q3 direct container expense to be consistent with Q2, if container redelivery volumes continue at these levels. Q2 depreciation expense was $73 million and is expected to remain mostly flat in Q3 as most recent CapEx was deployed under financings.
Q2 G&A expense of $13 million increased from Q1. Q2 G&A expense included additional IT system project and enhancement costs associated with our new ERP system and higher incentive compensation costs resulting from improved performance.
Q2 interest expense of $38 million increased by $2 million from Q1 due primarily to the financing of recent CapEx within a higher interest rate environment and rate increases impacting the small and hedge portion of our debt financing. We expect interest expense to gradually increase due to the current rising interest rate environment.
However, with limited CapEx investment options in the near-term, and while continuing to follow our capital allocation policy with a greater focus on share repurchases, we may temporarily delever to some degree, our unhedged revolving debt later in the year with our available liquidity.
Our Q2 average effective interest rate was 2.62%, a slight increase from 2.57% in Q1. Even as market interest rates have risen, we have remained well positioned to mitigate this with 91% of our debt fixed or hedged to fixed with an average coverage tenure relatively consistent with our long-term fixed rate leases.
Let’s now turn to our share repurchase program, which continues to be a key component and a significant focus of our capital allocation policy. We repurchased over 1.4 million shares during Q2, an increase of 48% versus Q1 to further drive shareholder value to our investors.
We have repurchased 5% of our outstanding shares through the first half of 2022. Since the inception of our program in September 2019, we have repurchased nearly 22% of our outstanding shares.
We are pleased to announce that our Board has authorized a further increase of $100 million to our existing share repurchase program. We expect to remain active as it relates to future repurchase activity with $120 million available for Q3 and onwards under our program.
We are also pleased to announce that the Board has approved and declared a cash dividend of $0.25 per common share payable on September 15th to holders of record as of September 2nd. In addition, our Board has also approved and declared a quarterly preferred cash dividend for both our Series A and Series B perpetual preferred shares, payable on September 15th to holders of record as of September 2nd.
Looking now at our balance sheet and liquidity. We continue to enhance the quality of our strong balance sheet with our attractive lease portfolio that provides long-term fixed rate cash flows now averaging 6.7 years of remaining contractual lease tenor and covering 76% of the remaining depreciable life of our fleet on an NBV basis. This is also well supported by fixed rate and hedged to fixed long-term financing structure.
This very stable and ongoing liquidity generation in addition to our well-structured bank facilities and $312 million in cash reserves, inclusive of restricted cash provides Textainer with a very resilient operating platform that will provide significant long-term value.
In closing, the first half of the year has produced very strong results for Textainer. We are well positioned to navigate potential short and medium-term market fluctuations as our contracted revenue and profits are well protected due to our long-term lease contracts and fixed rate and hedged financing policy.
Given potential economic uncertainties and limited expected CapEx opportunities, we do expect some performance stabilization in the near-term, but our liquidity generation remains strong and our core business model has been improved over the last several years to remain resilient in this climate.
We will continue to strategically assess the environment, investing only in opportunities in line with our long-term profitability objectives. And again, if there are limited container investment opportunities, we will prioritize our capital allocation towards our shareholders through ongoing share repurchase and dividend programs.
This concludes our prepared remarks. Thank you all for your time today. Operator, please open the line for questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question comes from Michael Brown of KBW. Please go ahead.
Michael Brown
Great. Olivier, you made an interesting comment that congestion is tying up about 12% to 14% of shipping capacity. I was hoping to hear how that would compare to prior periods relative to maybe a year ago or year-end. I would just be interested to see how that has evolved? And it sounded like your view there is for congestion to really see a significant relief, it would probably have to come from maybe a softening of the demand from the U.S. consumer. Is there anything else you think there that could alleviate some of that congestion related pressure here or is that really the main driver here? And unless that abates congestion will likely stick around for a while?
Olivier Ghesquiere
Yes. Thank you, Mike. Our view is very much that the likelihood that the congestion sticks around is much more likely than the probability that congestion goes away and to answer your first question – the first part of your question, sorry. I think that at the peak congestion probably reach a level of about 17% to 18%, but it has been reasonably stable at the present level of 12% to 14%.
And I think the way we look at it is that the current congestion is very much a supply issue. As we see for other elements in the economy with inflation, in particular, supply plays a very, very big role and even if demand is easing, those supply constraints remain in place. And in our case, what is really impacting congestion is really the inland logistics part of the overall supply chain.
And we continue to see a shortage of truck drivers, shortage of workers in the various warehouses, tension with railway operations and so on and so on and those problems are not only limited to the U.S., they are really worldwide and that is really the main reason why we continue to see congestion remaining in place and only easing very, very slowly.
And actually, we see the probability of congestion increasing suddenly again if there are unexpected events like another situation in China where some of the ports have to lockdown due to COVID or some major storms that is delaying some ships. All of that could still play a big role and in our view it means that the congestion is unlikely to go away very soon.
Michael Brown
Okay. Great. Very helpful. And I was hoping to get some additional thoughts from you guys about the trajectory of some of the fundamentals here going forward. So Michael, I appreciate the comments for the third quarter here. But I guess what I’m trying to think about is beyond that. And obviously, you guys don’t have a crystal ball on how things could evolve from here. But based on what you know today, it certainly seems like the lease rental income line will certainly see much more kind of flatter trajectory from here and then as containers maybe turn and start to pick up, I suppose there could be some upper pressure on the direct expenses, but it does sound like you guys are seeing a lot of demand in the resale market. So maybe that doesn’t see much of an impact, and it is really more about selling those containers and that keeps utilization rate high. So I know there is a lot of pieces there, but I guess I would like to just hear a little bit about your thoughts as you think maybe beyond 3Q and how those lines could ultimately play out here from what you know today?
Olivier Ghesquiere
Yes. No. And as you say, there are so many moving pieces. But if we try to go from the first piece, which is obviously the top line and the revenue line, in a situation where we are limiting CapEx or have fewer opportunities, very clearly, we are in a situation where we are reaching kind of a plateau and our revenue is not going to grow because we are not putting more capital to work, we are not buying more containers that are being placed in working service.
So very much depends on what I would say, the normal attrition. And we always have an element of older containers, as Michael was mentioning, that get redelivered because they are really at the end of the life, and those are the containers that we sell.
So we probably have a situation here where for a few quarters, we are unlikely to see the revenue grow, but we get very old containers back that we can sell for a nice profit and that is certainly a positive element.
And the way we see the market is that it will probably take a few quarters to absorb the volume of containers that have been supplied to the industry. But 2023, remember, is when a lot of shipping lines are taking deliveries of new ships. Now new ships will require obviously more containers to operate.
But more importantly, in 2023, most shipping lines will have to comply with new CO2 emission regulation, which essentially will force them to sell slower. And this is where we are seeing those new ships arising and essentially maybe alleviating some of the congestion.
But at the same time, slowing slower, meaning that the overall demand for container is probably likely to start going up again towards the middle of 2023. And that is we think that we probably have opportunity to start growing our top line. But in the mainline, we see very much what I will call soft lending kind of scenario for container lessors in this environment.
Michael Chan
Yes, Mike, sorry to interrupt Mike, it is Michael here. And as you know, while before – from the lease rental income standpoint, where it may be more stable, the cash flows will continue coming in. So it’s certainly an issue of what do we do with the cash and as you can imagine, and you probably hear in our messaging, if the CapEx opportunities are not as robust, we wait for them, we direct a lot of liquidity towards our capital allocation policy, which dictates a return on capital to shareholders by way of the buybacks. And of course, the dividends as well, we will hold a certain amount of cash, dry powder handy for certainly that uptick that will happen actually in the future.
Michael Brown
And I guess just on that point on capital allocation. You had a record amount of share buybacks this quarter. with some opportunities to actually invest in CapEx. So if the outlook here for CapEx is a bit softer. Is there an opportunity to actually increase the pace of buybacks. And I guess the one element I didn’t hear you guys touch on is the dividend. You are on the kind of one-year anniversary or so of the implementation of the dividend is raising the dividend, something that you guys are also contemplating when you think about capital allocation?
Olivier Ghesquiere
Yes. As you pointed out, we restated the dividend almost a year-ago now and we will definitely review that, that is something that is being actually reviewed by the Board on a quarterly basis. We stated when we stated the dividend that our intention was to make sure that dividend would be very stable and sustainable for the long-term and that our intention is to have that dividend evolves with the performance of the company. And I think it is fair to say the performance of the company is certainly more solid now than it was a year ago and a lot more solid than it was two-years ago.
And I think that as Michael mentioned, we really are in a situation where the decision we have to make is how to best allocate our capital. And if we don’t see the right opportunities to buy more containers, definitely returning capital to shareholder is the main target here. And I must say, as my personal opinion here is that buyback remain extremely compelling, given the level at which we are trading.
We are not even trading at book value. Actually, right now, we are generating 20% ROE. So certainly, buyback remains a great investment. And I think that the increase in our buyback allocation authorization by $100 million, it is certainly prove that we consider that being a good allocation of our cash flows.
Michael Brown
Understood. Yes well said. Thank you Olivier and Michael. I will leave it there.
Olivier Ghesquiere
Thank you.
Michael Chan
Thanks Mike.
Operator
Our next question comes from Liam Burke of B. Riley. Please go ahead.
Liam Burke
Olivier, a priority now for you is to look at re-leasing expiring charters here. How has the re-leasing activity been in terms of both duration and what rates you are getting on those agreements?
Olivier Ghesquiere
The re-leasing activity has actually been very strong. I think if you compare, we have a slide in our investor presentation. If I’m not wrong, it is on Slide 10. You can see that the number of expired leases that are not as sales age has reduced tremendously because we have actually renewed a whole lot of containers.
Actually, over the last quarter, we renewed more than 100,000 CEU. All those containers have been renewed on what we call life cycle lease, meaning that they will remain on lease until they reach the age probably of 14 or 15-years depending on the contract. So that is very positive, and that was also done with a slight improvement in the rental rate.
I think what really matters very much for us going forward is the fact that new containers remain historically at an elevated level, which means that for shipping line, it makes more sense to renew existing leases and existing containers because they are simply a lot cheaper than taking on new container into their fleet.
So we remain quite optimistic that renewing those containers that are not sales age will continue to move favorably. And at the same time, those containers that are at sales age whenever we can get them back.
And the last two quarters, I think we have been in a situation where we have been trying to get those containers back so we could sell them and realize the substantial gain on sales those containers were actually very happy to get them back so we can continue to sell them in the current environment.
And I think if you allow me a little word about the retail market, I think we are seeing a very similar situation where again, the supply is the issue here. There is not a huge supply of secondhand containers. There has been a slight increase compared to what it was the last quarter, for example. But that market remains start of supply, which means that container secondhand container sales price remain historically extremely elevated.
Liam Burke
I just wanted to touch on that point as well. I mean the net gain on sales sequentially was way up even though there is a scarcity of containers that would mean that the resale prices are continuing to come – to move up.
Olivier Ghesquiere
I don’t think they have come up that much. If anything, they are stable or declining very slightly what has come up with the volume. We have received a few more of those containers in particular from one contract where we have been adamant with the customer that we did not want to extend the lease and that we wanted to take those containers back because we wanted to sell them. So that is really what has helped us over the last quarter.
Liam Burke
Great. Thank you Olivier.
Olivier Ghesquiere
Thank you Liam.
Operator
[Operator Instructions] This concludes the question-and-answer session. I would like to turn the conference back over to Olivier for any closing remarks.
Olivier Ghesquiere
Well, thank you for joining us today. I’m very much looking forward to updating everyone on our progress during the next call. Good-bye.
Operator
This concludes today’s conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.
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