Triton International: Preferred Shares Offer Good Value (NYSE:TRTN)

Introduction

Triton International (NYSE:TRTN) is one of the largest container leasing companies in the world. The company benefited from a surge in demand for shipping containers in the past few years and has been able to purchase and lease out new containers at advantageous rates and for above-average leasing terms. This improves the earnings visibility going forward while I expect the reported free cash flow to exceed the reported earnings as Triton’s business model is very scalable: it can purchase new containers when the demand is high and long-term lease agreements are in place. And when the world economy is slowing down, the capex drops off a cliff if there are not a whole lot of new containers required to keep the fleet maintained.

A strong performance in the third quarter and excellent visibility

Triton currently owns approximately 8 million container-equivalent units and as you can see below, the total number in its fleet has been stagnant after a very strong growth in 2021 when the entire world resumed trade.

The sudden surge in demand for container shipping services has come down tremendously and the current rates are pretty much back to the levels before the 2021 surge.

That’s fine as Triton can easily scale back its acquisition of new containers: if the demand isn’t there to place new containers immediately on longer term leases, Triton just doesn’t have to order new ones. Additionally, the cost of new containers has dropped pretty substantially as well thanks to the declining steel price, which means that Triton would not have to spend as much as in 2021 on new containers (although the capex is still higher than the depreciation expenses). If the demand for new containers from its lessees increases without seeing an increase in the steel price, Triton’s operating margins could slightly expand (assuming new lease terms will also come in lower than the 2021 leases) as the cost of new containers has decreased by almost 50%.

During the third quarter of 2022, Triton reported a total revenue of just over $424M from its leasing activities. The net operating income exceeded $260M, and approximately 10% of the operating income was generated by the sale of leasing equipment.

The interest expenses remain pretty high (but very manageable) and the pre-tax income came in at $206.5M resulting in a net income of $190M. From this amount, we still need to deduct the preferred dividend payments and the underlying net income attributable to the common shareholders of Triton was just under $177M or $2.90 per share.

Looking at the 9M 2022 results, the net income attributable to the common shareholders was $542M for an EPS of $8.60. This means that we should see a full-year EPS of very close to or even exceeding $12 per share if one would use the year-end share count (rather than the average share count during the year).

Looking at the cash flow statement, Triton reported an operating cash flow of $1.44B in the first nine months of 2022. This was boosted by a $418M contribution from working capital change while we should still deduct the $39M in preferred dividends and the lease payments (which should be around $50M) based on the lease expiration schedule.

This means the adjusted operating cash flow was approximately $930M. That was still sufficient to cover the $890M in total capex and the $673M in net capex after taking the sale of second hand containers into account.

I own three series of the preferred shares

In August 2021, I passed on investing in the newest issue of preferred securities by Triton International. The company’s preferred shares became more interesting in the second half of last year, and I currently own three of the five issues after being able to purchase the 8% yielding preferred shares B (NYSE:TRTN.PB) below par, for an effective yield of in excess of 8%. I also own (NYSE:TRTN.PC) and (NYSE:TRTN.PD)

The income statement already showed the preferred dividends are very well covered: in the first nine months of 2022, Triton only needed 7% of its net income to cover these preferred dividends. And even if the average interest rates double to 5.5% over the next few years, Triton would still need less than 10% of its net income to cover the preferred dividends, so I’m not too worried about the affordability.

Looking at the balance sheet, it is clear the containers are mainly debt-funded (which is pretty normal given the multi-year leases and good earnings visibility), and as there is about $730M in preferred equity, this still means there is in excess of $2.5B in common equity ranked junior to the preferred shares.

The debt appears high but keep in mind this is a strong cash flow business. The annual sustaining capex is just $925M and based on the Q3 results, Triton is generating about $725M in normalized free cash flow before paying a dividend.

Investment thesis

I think the argument can be made that both the common shares as well as the preferred shares are attractive here. The common shares will allow investors to participate in the impact of the $400M share buyback plan and higher earnings thanks to the excellent visibility results while the preferred shares offer income-oriented investors an attractive investment possibility as it offers an additional layer of safety.

I have written out of the money put options on Triton in the past, but they all expired out of the money. I am very happy with my exposure to the company’s preferred shares as it provides a solid dividend income in the low-maintenance section of my portfolio.