Rail Equipment Finance 2011, Day Two:

PALM SPRINGS, CALIF: Close to 300 people from the mechanical, operating, financial, and supply sectors of the North American freight railroad industry are attending Railroad Financial Corporation’s 25th annual Rail Equipment Finance Conference at the La Quinta Resort & Club. The conference is organized by RFC’s Tony Kruglinski (Railway Age’s Financial Editor, top), David Nahass, and Will Geiger. Following are highlights from Day Two, a continuation of the “North American Railcar Review”:

Richard Margl, Assistant Vice President-Carload Equipment, BNSF Railway: Freight car forecasting is not for the faint of heart. The railroads take on and shed capacity throughout the business cycle, so the lease market varies in reaction to the economy and demand for railroad service. For example, one typically well-utilized car type experienced a 65% swing in monthly lease rates between 2004 and 2010. Equipment builds react to the same factors, and lease rates vary significantly as a result. Railroad car fleets experience significant non-productive costs for repositioning, mechanical, storage, re-mark, etc. The challenge is to find a better way to overcome supply/demand ambiguity and mitigate volatility over longer time horizons, and railroads and suppliers can work together to accomplish this. Capacity demand can be reasonably quantified by tracking such factors as economic growth, fleet attrition, and network velocity gains. Use of “capacity pools” can spread and minimize risk, effectively capping up- and down-side risk. We recommend scheduled reviews of deal factors. Stability enables efficient production, and deals should be structured as encourage efficiencies.

Regg Jones, Managing Director, Greenbriar Equity Group: The North American M&A (mergers and acquisitions) market is expected to grow 30% to 40% in 2011, with sponsor activity growing even faster. At present, there is ample committed capital, and private equity “dry powder” of over $400 billion. Private equity deal volumes are growing as activity recovers from recession lows experienced in 2009. Leverage levels are rising, as are purchase prices, so the deal market continues to recover. There is substantial capital available for companies that want to grow, and the debt markets are back, particularly for larger transactions. Pick your partner wisely, and look for value beyond capital. The global rail M&A market recovered in 2010, mostly through strategic transactions outside of the U.S. Greenbriar’s $325 million sale of Electro-Motive Diesel to Caterpillar/Progress Rail was the largest domestic rail transaction of 2010. EMD is one of two global locomotive OEMs. When Greenbriar acquired it from General Motors, it was a non-core GM division. It was a challenging divestiture that involved a corporate transformation. We partnered with EMD management, GM, and the labor unions to acquire the company in an exclusive process. We came to the table with a core team of financial and operating executives from our rail industry network, strong relationships with Class I railroads, and a vision for repositioning business and expanding overseas. Our strategic initiatives involved forging new labor agreements, restoring credibility with core EMD customers, and investing in plant, information systems, and locomotive technology. We wanted to drive profitable growth globally. Looking at the larger rail picture, secular forces are favoring rail: Volume growth is sustained by global demand. The railroads have pricing power, an environmental advantage, enduring economic advantages, and favorable market structure.

Sean Hankinson, Vice President-Sales, Eastern Region, FreightCar America, on the coal car market: In the electric power sector, construction on a modest number of coal-fired power plants is progressing. Electricity generation is expected to grow 1% annually through 2035, with coal’s share of this dropping slightly, according to the Energy Information Administration. There is an ample natural gas supply for the near term, keeping prices depressed. There is uncertainty over the Obama Administration’s use of EPA regulatory measures vs. its legislative agenda for energy policy changes, but the Administration continues to support funding for clean coal technologies. The recessionary global environment is starting to lift in terms of metallurgical coal markets; at the same time, Middle East unrest and flooding in Australia’s coal region is causing uncertainty in the global coal trade. Domestic coal loadings grew in 2010 over 2009 levels, albeit from a low base, and 2010 demand was only modestly above 2009 levels, lagging growth in other commodities. Despite this, coal loadings are forecasted to grow 3.1% in 2011. The number of unit coal trainsets in storage have dropped from peak levels reached in fourth-quarter 2009. Replacement of an aging steel coal car fleet continues, as older cars are being scrapped at higher than average rate. Overall, coal remains the dominant source for electricity generation. North American rail loadings have significantly improved, but coal loadings remain under pressure (2010 commodity loadings were up 9%, with coal up 2%). The railroad capital spending environment remains challenging, as investment in PTC will consume capital dollars. However, pressure is mounting on railroads and shippers to replace aging cars. Lessor results have improved, but lessors remain cautious on adding new coal car equipment until the existing coal inventory decreases.

—William C. Vantuono, Editor, Railway Age. Photos by the author