Description

Hi, all --

I feel like one of those guys running around in 2008 buying Alt-A mortgage REITs while shouting, "IT'S NOT SUBPRIME!", but -- TEXTAINER IS NOT A SHIPPING COMPANY! It's the world's second largest container leasing company. They lease containers to container shipping companies. Container ships are how the iPhones get from Shenzhen to Long Beach. Containers are the 20' or 40' long square cuboids that hold the iPhones. They sit on the container ship, which is a foamy-throated sea-stallion of the whale-road straining at the bit as it gallops to some strange doom. A picture should clear things up:

The containers are on top, the big blue thing is the foamy-throated sea-stallion of the whale-road.

Return Expectations

Due to my cautious nature, I don't want use the phrase "base case", but it's not hard to see TGH doubling over the next three years. There's a lot of leverage, so a zero is can't be ruled out, but the chances of distress in the short or intermediate term are remote. 

 More Introductory Blather

I'm going to divide this write-up into two sections, "Valuation" and "The Setup", doubtless to be followed by a "Misc." section; hopefully enough industry and company background will leak through these rubrics to allow the reader to determine if the idea is of further interest.

A quick statistical summary:

Here are some resources:

Latest slide deck, from which I'll be liberally copying:

Textainer Investor Presentation 2013 (seekingalpha.com)

I'm referring to SeekingAlpha because they seem to do a better job of curating presentations than most companies.

TGH competitor Triton was written up here by lars last year:

Value Investors Club / TRITON INTERNATIONAL LTD (TRTN)

I'm not doing the "incorporation by reference" thing, just acknowledging prior art.

SA has CC transcripts for both TGH and TRTN. Well worth the read. They're brief, both management teams come across as rational straight-shooters, and they say pretty much the same things, which is reassuring.

I haven't been able to track down any of TGH's ABS indentures, but here's an S&P rating for their latest securization:

12054242.pdf (spglobal.com)

This of interest because it gives background from someone who isn't a stock tout, and provides some insight into TGH's funding.

Valuation

Textainer is a specialty finance company. I value these on book multiples, because speciality finance companies are (usually) moatless businesses where all you need is industry knowledge, industry connections, and access to capital to get up and running.

There are reasons, though, to think Textainer might be worth more than book:

1: There are some capital-light(er) sidelines kicking around, like container trading and 3rd party container management.

2: The industry structure is rational:

I don't think I need to belabor the point, but the manufacturers in particular have been very cartelly lately.

3: This is a scale business with a large logistics component, you can't just run it out of Excel, you need to able to move, handle, store, etc. millions of large heavy objects all across the globe. I don't know if that counts as a moat, but it's definitely a barrier to entry.

4: The asset class is attractive, as a look at their ABS pricing shows. It's just great collateral: secular growth of 5%/year, no obsolescence risk, short lead times keep supply and demand from getting too out whack, reasonably stable residual values, etc.

On the other hand, TGH is in some sense competing with its customers, who are perfectly capable of buying their own containers, and in fact do; container ownership is about 50/50 between shipping lines and lessors. This severely limits how much they can get away with, and also means that they're not in charge of their own destiny. Right now lessors have 50%. In 10 years, will that still be 50%? Or 30%? Or 60%? Who knows? As a result, I'd be reluctant to pay a huge multiple because there's no way to avoid the melting icec ube risk.

On the other other hand ... TGH is absolutely worth a premium to book, because 50% of book consists of leases put on over the last two years, which was the biggest container ship -- and container! -- boom of all time. Here's a chart to show cap-ex for the last 10 years:

2020, 2021 & Q1 2022 is capex is about $3.5B, vs net book value for the fleet of $7.2B.

As you're probably aware, the supply chain has been massively f*cked for the last two years (a pretty thorogh analsys is available here: Disruption in the containerized logistics value chain | McKinsey ), effectively reducing capacity and leading to exploding demand for containers. Here's container production:

and pricing:

Here's a chart of freight rates:

Just a massive, massive boom. 

TGH and competitors did quite well during this period, mostly due to a higher asset base, maxed out utilization rate, and increased gain on sale. The real benefits, though, which are going to persist for years, are due to changing lease terms. Remember, TGH can't just gouge its customers, no matter how much they might want to. Instead, they --

In order to understand what's going on here, let's step back and take a look at "Classic Leasing". TGH would buy a container for $2K, lease it out for an inital 5 year term, maybe lease it out a couple of more times absent a renewal, and then sell if for $1K after 13 years. You'd wind up with something that looks like this:

(WARNING! These cash flow schedules are completely made up, and are intended to illustrate the principles involved, not any transaction that TGH might actually have entered into.)

So TGH shells out $2K, leases at a 10% cash-on-cash return for 5 years, gets a goose egg for a year due to the container being off lease and releasing costs, releases at 9%, another goose egg, and then finally squeezes in a couple of more years at 8%. Although made up, this example more or less matches the container life-cycle analysis provided in the slide deck.

"Boom Leasing" might look like this, where the upfront container cost is higher but the lease extends for the life of the box:

Returns are a bit higher despite the same inital cash-on-cash rate, but risk-adjusted returns are much higher, due to the absence of re-leasing risk and the resale value being a smaller portion of total cash flows. To get a sense for the significance of this: Utilization rate is a key metric for container lessors, because an off-lease container is not just not generating revenue, it's actively creating expenses due to the need to store it, move it, market it, etc. As of Q1, 75% NBV of the fleet was leased for the life of the asset. Absent a credit event, this puts a pretty hard bound on how low utilization rates can go.

So the "Boom" business is clearly worth more than book. How much more? Hard to say with any precision, but I'd say at least 20%. If 50% of the business is "Boom", then it seems like intrinsic value here is at least 1.1x book, or some 40-50% ups from here. That's a large but not extreme discount, why am I wasting the club's time with this, which bring us to ...

The Setup

The setup here is really simple: The stock is trading at a material discount to book and an even steeper discount to intrinsic value and they're going to buy back tons of stock, and if the business slows down, as I think it will, they'll buy back even more stock by converting used containers into cash. Why do I think they're going to buy back tons of stock? Well, they've *been* buying back stock. They've bought back stock at a significant premium to book; in Q1, they retired ~1MM shares at $38 while putting ~$125MM into increasing the fleet size. They'll tell you that they like buying back stock; read the transcripts, here's a random quote from the latest CC:

"I think the important element here is that we love buyback. We've made no mystery of that. [....] We continue to see our share price as attractive and therefore buyback as being an attractive investment for us."

The stock was around $35 at the time.

But the main reason they're going to buy back tons of stock is: This is not shipping. In shipping, your assets cost $150MM and have names like "Sylph of the Sea".  In container leasing, your assets cost $2K and have names like "WBAM00012048". In container leasing ... Let's say you've got an extra $50MM kicking around. You call up all your customers and ask, "Do you guys want to lease any containers?" If the answer is, "No", you stare at the $50MM some more and then pick up the phone again to ask, "*Might* you want to lease any containers soon?" If the answer is still, "No", then you buy back stock.

I don't want to overstate things. I'm not claiming that management is maniacally focused on increasing intrinsic value per share. If they can place new containers on commercially reasonable terms, they'll do that instead. Getting them to sell assets at 95% of book to fund a tender offer at 60% of book ... hahah, as usual, good luck with that. But they absolutely understand capital return. The only other thing they have to do with the cash is to shoot for an IG rating, which would be nice but can't be priority #1 at these levels.

How much stock could they repurchase? Management provides this amusing analysis in their slide deck:

For extra fun, you can replace the $55MM NBV of container disposals with the $300MM they're likely to dispose of over the next 12 months, leading to the conclusion that they could potentially repurchase more than 50% of the stock in the next year.

More realistically, let's assume that buybacks will be funded from earnings, with any excess going to shore up the capital structure. What might steady-state earnings look like? A real rough and ready estimate is to annualize Q1 and replace gain on sale and direct fleet expense (DFE is mostly cost of off-lease containers), the most variable & subject to mean reversion line items, with the #s from 2019, AKA "The last normal year". 

Q1 net income for common annualizes to $290MM. Normalizing gain on sale takes us down to $250MM. Normalizing direct fleet expense knocks off another $20MM, so we're down to to $230MM. Note that this results in steady-state EPS of $4.8. Another $50MM goes out the door in common dividends, leaving $180MM for share repurchases, so about 15% of the stock a year gets taken out. The market has shown that it can ignore 10% repurchases for an extended period of time, but I think 15% is too much, and also personally think management will find a way to scrounge up another $20MM/year, taking us to 18%. If earnings perform as I hope, you don't need multiple expansion for this idea to work, but if repurchases work the way I hope, multiple expansion is a certainty, because without multiple expansion TGH is earning $8-$10/share 3 years down the road.

That's the good part of the setup, now to address the negative part: Why so cheap?

I think 3 reasons, mostly:

1: The long term benefits stemming from the recent boom don't sell themselves. "We extended our lease terms" does not scream, "To the moon!".

2: A lack of appreciation for containers as collateral and what the boom has done for shipping companies credit profiles.

3: Recession fears.

#1 is self-correcting. #3 is ... well, there's risk and opportunity here. Here's a chart of TGH's lease maturities:

"Expired" and "2022" are a good chunk of the fleet. To explain what "expired" means -- lessees have the option to keep a container hanging around for a year after the lease maturity. This is called the "builddown period" for reasons that are unclear to me. I think the point is that lessees are supposed to drop the container off at a particular location, so the builddown period gives them a year to get the thing from Lima to Ulan Bator or wherever. Needless to say, everyone has been taking maximum advantage of the builddown period due to the container shortage. Full-disclosure wise, I'm underwater here on my entry point at a 15% discount to IV, when "expired" and "2022" looked a lot more like "opportunity" than "risk". That balance has shifted over the last few months. *Right now*, though, used container prices are at a level where TGH is still booking gains -- in fact, the last tick was up -- so the "sales age" bucket is still in the money  but there's about $1.2/share in downside if things go south fast and hard. *Right now*, lease rates are way above the depressed levels of the "expired" vintage, so renewal should increase profitability, but that's only if the leases get renewed at all. *Right now*, ships and containers are still in tight supply and congestion is high as we enter peak season. 

That chart is 3 months old. Right now, it looks like we've got another 3 months of above average markets. So things should average out okay even if the global economy slumps. If the "expired" bucket does wind up causing problems, it wouldn't invalidate the thesis -- becuase of course nothing ever invalidates the thesis -- but it might make me want to clip my fair value estimates by a couple of bucks.

On #2 -- Shipping liners are generically B-BB credits. But they're all flush with cash from the boom and have months to years of high rate charters still on their books. Any kind of credit event is years away. There will inevitably be problems at some point down the line. This gets us back to, shipping containers are great collateral. ABS investors are willing to take down 80% at spreads of 100-150, which presumably includes an esoterica/liquidity haircut. Containers are operating assets, not financial liabilities. I'm not an expert in international bankruptcy or maritime law, but have heard that there are ports that take a very dim view of deadbeats, like they'll sieze the ship so TGH can get its containers off.

The nightmare scenario is for a liner to go tits up and cease operations altogether. This actually happened with Hanjin Shipping back in 2016. Textainer was overexposed to the name. Hanjin, along with prior management mistakes, which can take long time to run off, is why TGH has underperformed Triton by so much for so long. But although unpleasant, the Hanjin bankruptcy was nowhere near a near-death experience. TGH wound up getting 95% of its containers back, so call it something like an 80% recovery in a worse-case scenario. And what the world learned from Hanjin is, letting a major shipping blow up is a bad idea, so I really don't expect a repeat.

So credit losses are inevitable, but remote and will be managable. (This is the part where I scream, "BUT IT'S NOT SUBPRIME!"). 

To sum up: TGH has significant upside in benign scenarios and a lot has to go wrong for me to say, "Not cheap" instead of "Not as cheap as I thought." It could turn out to be a zero. I suggest diversification or some kind of short position in shipping liners to mitigate this.

Miscellaneous

I don't think EBITDA is a relevant metric here, because the D&A all goes right out the door as contractual amortization to Textainer's creditors. This is the current portion of their long term debt.

There are some analytical challenges that data providers are likely to get wrong:

1: Preferred stock.

2: The container management business should probably be zeroed out, with the profits being treated as a reduction in G&A. This is particularly challenging over longer periods of time; Textainer used to 50/50 owned/managed, but they've been brining the managed fleet in house over time.

3: 25% of book is finance leases. For consistency, I suggest reclassifying these as operating leases. The finance leases increase credit risk, because it's possible for a debtor to claim these as financial obligations instead of operating assets, although this has never happened and is unlikely to.

4: There are a few other stumbling blocks which I'm forgetting about right now.

I'd like to see more insider ownership.

The stock has a dual listing in South Africa. Although public in the US, it was controlled by an SA conglomerate, until they spun the shares off to their shareholders.

I can't get annual EPS below $3 in the absence of catastrophic credit events, so it's trading for less than 10x likely trough earnings, which is pretty good.

The price used in the analysis a day stale and about 3% lower than the last close.

Yours,

Bowd

Catalyst

 Buybacks, the world not ending.