Description

Triton (TRTN) is the leading intermodal container leasing company, with approximately 30% global market share.  The company’s shares are currently trading at 6x 2Q’s run-rate earnings, a multiple that I believe reflects the markets perception that TRTN is a commodity, cyclical business at peak earnings.  On the contrary, I believe that TRTN is actually quite a good business (and has been steadily improved by CEO Brian Sondey), is not as cyclical as most perceive, has steady growth prospects, and is run by a talented management team.

Business quality:

In general, I think that container leasing benefits from several key structural characteristics.  The first is that while containers are absolutely critical to the operations of their customers, container shippers, they are a small percentage of customer opex (dwarfed by bunker fuel, vessel cost/depreciation, etc.).  As a result, carriers tend to place a significant focus on scale and performance (reliability from both a time and location perspective) when evaluating a service provider, vs just price alone.  The second important characteristic, and one that I believe separates container leasing from a lot of other equipment leasing categories, is that the lead time for containers is very short (measured in weeks).  As a result, supply can be shut off very quickly and the industry is not prone to extended periods of oversupply and value-destructive pricing.

On top of those positive industry characteristics, I think that TRTN benefits from scale and network advantages that allow it to grow in excess of peers at higher returns (as has been the case).  The company’s size benefits in two general ways.  First, they are often the preferred provider of customers due to the performance focus that I just mentioned.  The second is that they also have more weight with container manufacturers in times when returns are high and supply is tight; this can be seen in times like the last few quarters when their order book market share has run closer to 40% vs their overall market share of 30%.  With respect to network advantages, the size and scale of a container lessor’s operation can significantly impact the LTV of their average container.  On a typical lease has three phases: 1) the initial lease, 2) the re-lease, and 3) sale.  Container location and customer relationships are of huge importance in phases two and three of this lifecycle.  TRTN’s breadth of locations and relationships allows it to consistently extract more value vs competitors in theses stages of the lease

Lastly, I believe that TRTN’s business quality has been improving.  CEO Brian Sondey has used strong markets not just to improve rates, but to make structural changes that benefit the business for years to come.  One example is contract terms: Brian has been a leader in the industry in terms of setting favorable terms for return locations – as one can imagine from the previous brief discussion on the re-lease and re-sale portions of a container’s lifecycle, given the low ratio of a container’s cost relative to its price of transportation, having a large network and favorable return terms can make a huge difference in the LTV of a company’s average container.  The second example is lease duration: whereas a decade ago a typical lease was 5-7yrs with “bull market” leases all coming off lease in the same time period, Brian has extended his average lease term to 12years and significantly staggered those leases, the result being that TRTN has significant locked-in earnings power for years to come, and much lower down market re-lease risk.

Cyclicality:

The elephant in the room re: an investment in TRTN, is the perception that we’re at a cyclical peak in the shipping industry, and TRTN’s earnings as a result.  To the contrary, I believe that there is less cyclicality in TRTN’s business model than generally perceived, that the container shipping industry is in structurally better shape than it has been in the past, and that the operating environment will likely stay stronger than people think.

Regarding the cyclicality in TRTN’s business model, CEO Brian Sondey describes the model in that it “drifts down” during downturns, as a result of the company’s long term lease structure.  This dynamic can be observed in prior results, and the “drift” will likely be markedly slower in the next downturn as a result of the materially longer duration and increasingly staggered lease portfolio.  Furthermore, there is some counter-cyclicality in the model.  In the P&L, re-sale volumes are very low now due to the current market, and would likely rise in a down market as shippers return containers more quickly as they come off lease.  In the cash flow statement, as with other leasing business models, capital expenditures fall materially and cash flows balloon during a downturn; this is what allowed the company to repurchase 17% of shares in the last two and a half years, the majority during the ‘19/’20 industry downturn.

TRTN’s customer base is also in significantly better shape than it’s been in the past.  There has been both consolidation and the strengthening of shipping alliances over the past several years and that has resulted in much more rational competitive behavior.  Evidence can be seen in the fact that during the initial COVID downturn, carriers blanked sailings in order to rationalize supply and keep rates from crashing, and that despite the very strong environment right now, the vessel order book is well below where it’s been in the past.  It’s also worth noting that in the one significant customer bankruptcy that TRTN has seen in the last decade plus – the Hanjin bankruptcy – the impact to TRTN’s business was very manageable and short-lived.  Currently, leverage at leading container shippers is between 0.5-1.5x and they have been exhibiting markedly more conservative behavior with their excess cash flow.

The relatively small size of the vessel order book versus the strong environment is also indicative of the fact that the current operating environment will likely stay stronger than is generally thought.  Other factors are also contributing to this dynamic; historic lows in inventories-to-sales, and lack of investment in port and logistics infrastructure, to name a few.  Lastly, while container production has surged so far in 2021, it is actually not a huge number relative to the cumulative underproduction vs normal in 2019 and 2020.

Growth:

Over the past 15yrs, TRTN has grown its asset base at a CAGR of approximately 8%, which I think is a sustainable trend for the foreseeable future.  That CAGR can be broken down into three main components: 1) overall global trade growth, 2) increase in leasing industry market share vs ownership, and 3) increase in TRTN’s market share within the leasing industry.  The first point is fairly straightforward, so I’ll just touch on the second and third.  With respect to the second, most are likely familiar with the structural shift from ownership to leasing across a variety of asset classes.  This focus on asset efficiency has also been, and continues to be, a benefit to the container leasing industry.  ~10yrs ago, the leasing industry’s share of container ownership was closer to 40%.  Pre-COVID this number had improved to just over 50%.  Since COVID, on an order-book basis (I believe a good look at where the future is trending towards), that number has been closer to 70%.  The structural trend towards leasing in the container industry should be a steady tailwind on top of global trade growth for years to come.  Lastly, on top of the leasing industry’s market share gains, TRTN has, and continues to gain share within the leasing industry.  TRTN’s share gains within leasing are mainly due to the size competitive advantages that I’ve already discussed; they are often the preferred supplier from a customer standpoint, and the preferred customer from a manufacturer standpoint.

The sum of these three growth drivers suggests there are strong prospects for a continuation of the robust and steady asset growth that TRTN has produced over the last decade plus.

Management:

I think that Brian Sondey has done a terrific job managing TRTN, and TAL before that.  I mentioned before the steps he’s taken to improve the business, like lengthening and increasingly staggering lease durations, rather than just getting the highest rate on shorter-term leases.  I believe this behavior shows his long-term value focus.  I also think that Brian has been a disciplined and prudent capital allocator, buying back a very large percentage of TRTN’s shares (17% in the last two and a half years, for example) in weak markets, and having price discipline in the recent CAI transaction.  Brian is also using the current strong market to transition TRTN’s balance sheet to investment grade which we think will both improve the company’s competitive position, and also likely improve the company’s market valuation.

Valuation:

I think that a valuation discussion for TRTN is best with the following observations for context:

1)     TRTN has a history of producing attractive returns – ROEs in the teens, well above other asset leasing asset classes like railcar and aircraft.

2)     TRTN has a history of producing steady growth at these returns - ~8% asset growth, and a teens CAGR in growth of book value and dividends per share.

3)     The company has produced these returns and this growth while keeping leverage steady to trending down.

4)     The business “drifts down” in downturns due to the long-term lease nature of the business (which is becoming even more of a factor with longer and increasingly staggered leases).

I don’t believe TRTN’s business is at an imminent peak, and even if it was, I don’t think there would be much risk to earnings for reasons that we’ve discussed (long-term leases, counter-cyclicality of re-sale volumes, share repurchases, etc.).  Given that, and with the stock at 6x earnings and the business having prospects for continued returns in the teens, I think the prospective IRR for the shares is very strong.

From a book value perspective, the stock has generally traded 1.25-1.75x adjusted book value.  I think the current period is similar to back in 2010-2011 when we were coming out of the GFC and the industry was supply-constrained.  If you look at how the stock acted then, it pulled back for a period of time on “peak” concerns, and then BV per share accelerated and the multiple expanded, driving the stock higher over the ensuing few years.  The setup seems very similar today – the stock has pulled back on “peak” concerns, yet fundamentals are still strong and with good prospects, and book value is set to accelerate rapidly.

I think that if you’re looking at TRTN as a multi-year investment, you’re looking at a high-teens / low twenties IRR (their teens return with the normalized multiple increasing from 6x).  I think that if you’re looking at TRTN as a 6-18mo investment, the return is likely higher than that, given the current sentiment/environment and the post ‘10/’11 dynamic I just mentioned.

Catalyst

Continued strong operating performance