In March, Railroad Financial Corporation hosted the 22nd Rail Equipment Finance Conference in Palm Springs, where 325 railroaders, lessors and financial professionals gathered to hear presentations where industry insiders predicted continued strength in the railcar building sector.
Historical Precedents
Those of you reading this who are in your late 40s, 50s or older, and who financed rail equipment during your early careers will remember the late 1970s and early 1980s. This was a period of significant overbuilding of railcars due to artificial tax and regulatory initiatives that saw the annual “build” in North America materially exceed 100,000 cars in the late 70s. (Nearly double the build in prior years.) The fallout from this overbuilding saw cars built for $40,000, sold for less than half that amount a few years later as they sat rusting to the rails parked with no employment and no hope of employment. There is a good chance that your doctor or dentist lost money in tax-affected limited partnership investments in railcars during these years.
They weren’t alone. By the mid-1980s, the industry saw a significant decline in the number of railcar builders and lessors and in the growth of others. Industry staples like Itel were gone and new players like General Electric Railcar Services were on the rise. More money was lost on railcar investments during this period than ever before or since.
But there is a “truism” that if you hold onto long-lived rail assets long enough they will recover their inherent value to the rail industry. In proof of this, virtually every owner of railcars or locomotives that lived through this period (and in many cases grew feeding on the debris of failed lessors) was healthy and making money by the late 1980s when the market had recovered.
What we have experienced since that time is a fairly regular market cycle for railcar and locomotive building in North America. The duration of these cycles? Approximately seven years. During the early and mid-1990s railcar building increased, to levels regularly in excess of 50,000 units. In the early years of this decade, they plummeted to as low as 17,000. It seemed to those of us who were observers, this “heating up” and “cooling off” of the railcar and locomotive markets was more or less a permanent fixture of the rail industry.
Now, in 2007, we are in the second, or possibly third, year of a boom market in railcar and locomotive construction, and the trend lines suggest this time things may be different.
A New Trend?
In late 2005, I began predicting an alteration in the usual seven-year cycle of rail equipment building. This wasn’t a terribly difficult prediction to make given the massive order books of the railcar and locomotive builders at that time. What was a bit of a “reach” was the prediction that this building “high” would continue for a second year and into the future at construction rates that, while moderating year-to-year, were still likely to represent totals materially higher than historic averages. At Rail Equipment Finance 2007, the number of industry pundits that presented and who were predicting continued strength in the railcar building sector outnumbered those predicting material declines by 10 to 1.
The question is why is this happening? What does it mean for the Monitor’s readers with investments in rail equipment and/or interests in pursuing near term rail equipment transactions? Most importantly, how long will these phenomena last and will the current high values (and equipment prices) hold up in the long term?
To attempt to answer those questions we need to look at the likely reasons for the current build rates. There are a number of reasons for this increase in rail equipment building, but the most important ones in my mind are the significant increases in rail traffic and the significant decreases in the velocity of rail traffic in North America due to a variety of operational and structural reasons.
Simply put, more people are trying to put more traffic on a system that is already significantly overloaded and, in the absence of some massive Federal program to invest in rail infrastructure (virtually all present investment is private by the railroads), nothing is likely to change between now and the end of the decade.
Faced with their traffic moving slower, railcar users, whether industrials who own their own cars or lessors building cars for shipper use, are voting with their dollars for the newest, most efficient equipment capable of greater loads when they invest in rail equipment. The last “peak” of railcar building in the mid 1990s saw significant investment in retrofitting older cars for longer service and greater loads. At this point in time, that is not happening to any material degree in this market. “Buy new, buy big and buy efficient,” seems to be the mantra driving the market and, barring some difficult-to-predict economic calamity, these views are likely to be those of the marketplace for the coming years.
(And that prediction is without taking into consideration the needs of new industries such as ethanol and new customers such as new users of compliance coal or increased users of intermodal shipping as long haul truck moves convert to COFC or TOFC moves.)
Locomotives — A Special Case
While it is true that the builders of diesel-electric locomotives for North American service have markets and market cycles that have, in some cases, tracked railcar building cycles and in other cases have not, we believe a similar surge in building new locomotives will be visible through the decade. (Both builders are building at capacity —
1,300+ total units.)
Why? The seven “Class I” railroads in North America are presently in the middle of re-equipping their locomotive fleets, both to cope with increases in traffic as well as to usher in the next generation of fleet “work-horses” that will carry traffic 20 years into the future. There are a variety of reasons for this decision to re-equip. They include:
So What Is an Investor to Do?
Assuming that many of the readers of this article are funders trying to determine where to put scarce marketing resources, the question presents itself as to whether the effort to get “up to speed” on today’s rail equipment finance market is worth the likely reward.
If you are in this situation, I have some thoughts both as a former funder and a present financial advisor to equipment finance end-users:
If you are a current investor in railcars and locomotives (as am I personally) what is the view of your future?
Good luck!
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