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September 2008
When two of the largest leasing companies decide to sell their fleets and exit the rail-car leasing industry, is this a good business in which to invest? Are these two companies seeing problems on the horizon before everyone else? It would not be the first time that an industry leader cashed out before the market turned sour.
So what’s up? New rail-car prices, for one thing: After jumping more than 25 percent in 2005 from pre-recessionary levels in 2001, prices are again on the rise. With steel costs rising in recent months almost as much as they did in 2005, new rail-car prices are almost certain to surge at least another 15 percent, or more than $10,000 per car.
Higher prices for new cars mean higher prices for older equipment — “a rising tide lifts all boats,” as they say. Maybe the short-term returns from a quick sale are just too attractive to ignore, provided the two lessors can find a buyer willing to pay the true value of their fleets.
Such a buyer would have to consider problems rail-car owners might face in the future. Technological obsolescence of the fleet is a potential issue if railroads try to increase their line capacities by increasing the per-car allowable gross weight on rail to 315,000 pounds from the current 286,000 pounds.
However, railroads have a few other ways to increase their capacities without experimenting with higher weight limits and accepting the high capital costs required to handle heavier loads. It is unlikely they’ll need the 315k cars for quite a while, if ever.
Electronically controlled pneumatic brakes are one option; they could enable railroads to increase line-haul capacity. Moreover, the capital costs would be much lower — and shared with rail-car lessors. At $4,500 per car, a lessor of a large fleet might incur costs of more than $500 million just to meet new railroad running requirements. However, such costs most likely would be spread over many years, and there would be some offsetting maintenance savings and revenue gains to justify the investments.
A more serious concern might be a shift away from leasing and toward ownership. The probability of continually rising lease rates could prompt more than a few current lessees to consider buying rail cars in order to better manage equipment costs. There are no signs of such a sentiment shift at present, and since any buyer, lessor or user will face the aforementioned problems, it’s unlikely that car ownership will become more attractive than leasing for most lessees.
For lessors, the possibility of higher lease rates presents an upside for the industry that has only recently come into focus. For most of the past 25 years, increasing car prices were matched by decreasing interest rates, and lease rates for new rail cars have stayed relatively constant. As a consequence, lease rates for older equipment declined due to capacity and maintenance issues. While it is unlikely that rail-car values will appreciate as lease rates climb, they almost certainly will depreciate at a slower rate.
The current car surplus notwithstanding, there seem to be more reasons to buy into the rail-car leasing industry today than there are to cash out. Railroads appear to be enjoying a financial revival, increased traffic levels appear to be a long-term trend and the high risks of car ownership appear to be balanced by the potential for high returns.
It is doubtful that either GE or CIT see any problems ahead — they might be considering selling their fleets for other reasons. Perhaps they’ll change their minds and stay in the business, after all.
Toby Kolstad has been in the railroad industry for more than 30 years, with stints at Illinois Central Gulf Railroad, Denver & Rio Grande Western Railroad, a car builder and lessor. Currently a consultant on rail-car matters and president of Rail Theory Forecasts L.L.C.
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