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Triton International Limited (TRTN)
Q2 2019 Earnings Call
Jul 25, 2019, 8:30 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good day, and welcome to the Triton International Limited Second Quarter 2019 Earnings Release Conference Call and Webcast. [Operator instructions]
I would now like to turn the conference over to Mr. John Burns, Chief Financial Officer. Please go ahead, sir.
John Burns -- Chief Financial Officer
Thank you. Good morning, and thank you for joining us on today's call. We are here to discuss Triton's second quarter 2019 results, which were reported this morning. Joining me on this morning's call from Triton is Brian Sunday, our CEO; and John O'Callaghan, our Executive Vice President and Head of Global Marketing and Operations. Before I turn the call over to Brian, I'd like to note that our prepared remarks will follow along with a presentation that can be found in the investor section of our website.
I would also like to point out that the company will be making statements on this conference call that are forward-looking statements, as the term is defined under the Private Securitization -- Securities Litigation Reform Act of 1995. Any forward looking statements made on this call are based on certain assumptions and analysis made by the company and are not a guarantee of future performance. Actual results may vary materially from these -- those expressed or implied in the forward looking statements.
The company's views, estimates, plans and outlook, as described in this call, may change subsequent to this discussion. The company is under no obligation to modify or update any of these statements that are made despite any subsequent changes. These statements involve risks and uncertainties and are only predictions. A discussion of such risks and uncertainties is included in our earnings release and presentation as well as SEC filings.
In addition, certain non-GAAP financial measures will be discussed on this call. A reconciliation of these non-GAAP measures to the equivalent GAAP financial measure is included in our earnings release.
With these formalities out of the way, I'll now turn the call over to Brian.
Brian Sondey -- Chairman and Chief Executive Officer
Thanks, John, and welcome to Triton International's second quarter 2019 earnings conference call. I'll start with slide three of the presentation. Triton achieved solid performance in the second quarter of 2019. Triton generated $86.4 million of adjusted net income or a $1.15 per share, an increase of 4.5% from the second quarter of last year.
We also achieved an annualized return on equity of 16.2%. Triton achieved these solid results while facing mixed market conditions. In general, container supply and demand were well-balanced, but lease transaction and container pick-up activity remained slow. The second quarter typically marks the start of the summer peak season for dry containers.
We have not yet seen a real acceleration of activity. Growth rates have slowed in a number of major European and Asian economies. And the lack of resolution in the US-China trade dispute continues to generate uncertainty and impact trade. In this market, our utilization has decreased slightly and our investment in new containers has been limited.
Still, our financial performance remains strong and we're using our substantial and steady cash flow to drive shareholder value in a variety of ways. Our regular dividend provides over a 6% yield. We repurchased the remaining outside partnership interests in one of our container-owning subsidiaries and we have repurchased almost 9% of our shares since last August without increasing leverage.
I will now hand the call over to John O'Callaghan, our Global Head of Marketing and Operations.
John O'Callaghan -- Executive Vice President, Global Head of Field Marketing and Operations
Thank you, Brian. Turning to slide four. As Brian mentioned, Triton's operating performance continued to be solid in the second quarter of 2019, with utilization averaging 97.2%, down 40 basis points from the first quarter. Used container sale prices have decreased slightly, but overall held up well and continued to generate substantial gains.
Container pick-up activity was slow through the second quarter. The US-China trade dispute continued to create uncertainty. Our customers continued to run tight fleets and remain cautious about additional container capacity, whilst at the same time retaining their existing position. And as such, we've seen relatively few drop-offs. There was a limited amount of new container transactions in the second quarter.
We participated selectively in some transactions and walked away from others. Given the limited investment, Triton instead allocated equity cash flow to higher yielding investments. Overall, the market is poised. Our customers continue to expect trade growth to remain moderately positive. Inventory is under control. We expect our customers will continue to rely heavily on leasing. We are well-placed to serve their requirements and win the deals we want.
Turning to slide five. Slide five shows Triton's key operating metrics. The second quarter was unseasonably slow. Our utilization is slightly down by about 40 basis points over the quarter. That's a very reasonable change in the existing market, and utilization remains high and is presently at 96.8%.
The chart on the lower left of the slide shows our quarterly picks and drops of containers. You can see that although the picks remained low, there has been an increase. While over the same period, drops remained more or less static and at moderate levels. We expect drops to remain well controlled and container picks to increase as we get deeper into the third quarter.
Slide six looks at the key measures of container supply and demand. On the upper left chart, we see current expectations for trade growth. The container trade expectations from forecasters is that growth for 2019 will be in the 3% range. This is consistent with what our customers are also telling us. The bottom two charts are a measure of supply. Factory inventory increased about 1.1 million TEU, due to lower absorption volumes in the second quarter.
This represents about 3% of the global fleet. We're presently not seeing a rush for additional orders and are hearing that some container factories will be closing over August, taking capacity out of the market. The bottom right chart shows Triton's inventory. We've seen a small increase in our depth of fleet of our fires [Phonetics] in Asia but it remains under control. We have very few leasing containers in inventory outside of Asia.
To sum up, with trade growth expectations of 3% and supply under control, we have a good shelf of equipment and are ready to supply our customers and ramp up investment as and when the market picks up.
I'll now hand you over to John Burns, our CFO.
John Burns -- Chief Financial Officer
Thank you, John.
Turning to page seven. On this page, we presented our consolidated financial results. Adjusted net income for the second quarter was $86.4 million, or a $1.15 per share, up 4.5% on a per share basis from the prior year, supported by the solid operating performance of our lease portfolio and the repurchase of nearly 9% of our outstanding shares over the last year. These strong results represent a return on equity of 16.2%.
Turning the page eight. Our results for the quarter were driven by several factors. Leasing revenue increased 2.7%, reflecting an increase in our fleet size, driven by our strong fleet investment during the second half of last year. The benefit of this fleet growth was partially offset by a reduction in utilization.
While utilization remained high, averaging 97.2% for the quarter, it was down from 98.8% in the prior year quarter. In addition to the impact on leasing revenue, the lower utilization drove an $8 million increase in direct operating costs, reflecting higher storage and repair expenses.
Our container disposals results remain quite positive, generating combined gains on sale and trading margins of $12 million in the second quarter, down $3 million from the prior year, reflecting a moderation in disposal prices. So, these prices remain well above our accounting residuals.
We also continue to experience incremental benefits from purchase accounting adjustments related to our 2016 merger. And we realized further improvements in our effective tax rate. The last item driving our year-over-year increase in earnings per share is our share buyback program.
Turing to page nine. This page highlights our long-term financial stability and how this has enabled us to create significant shareholder value over an extended period. The keys to this financial stability and growth in shareholder value is our strong cash flow over multiple economic cycles, as shown in the graph in the top left.
These cash flows, together with the short order cycle for containers, enables us to maintain our leverage in a steady range over the long term, as shown in the graph on the bottom left. The graph on the right demonstrates how these strong cash flows and financial stability have enabled us to create significant shareholder value by steadily growing the book value of the business from $10 per share to $35 per share while paying over $25 per share in dividends.
I'll now return you to Brian for some additional comments.
Brian Sondey -- Chairman and Chief Executive Officer
Thanks, John. I'll continue the presentation with slide 10. This slide shows how Triton has invested our equity cash flow over the last few years. During 2017 and 2018, the vast majority of our equity cash flow was used to invest into our container fleet. And here the equity cash flow used for investments is shown as 25% invested amounts, reflecting our typical leverage.
Triton's high level of container investments in 2017 and '18 were driven by solid trade growth, the increasing share for leasing and Triton's large share of the leasing market. We estimate that Triton represented over 40% of new container purchases by leasing companies in 2017 and '18. And the projected lifetime, equity IRRs of those investments are well into the upper teens.
Over the last few quarters, we have shifted our focus from adding new containers to repurchasing portions of our business from investors. This change in focus reflects the limited number and size of new container leasing transactions this year, as well as tighter pricing on the available deals.
The shift in focus also reflects what we consider to be compelling values on our repurchases. In a series of transactions in the first and second quarters, we repurchased all the outside investor interests and one of Triton's container-owning subsidiaries for $103 million, which is well below the book value of the investor interests.
We've also been actively repurchasing our common stock. The average price we've paid for our shares is well below our adjusted tangible net book value and our projections for lease runoff value. It's also important to note that we are not increasing financial risk with our share repurchases. We've been able to repurchase almost 9% of our shares since last August without increasing leverage.
I'll conclude the presentation with these summary comments on slide 11. Triton achieved solid results in the second quarter of 2019. We generated a $1.15 of adjusted earnings per share, and we achieved an annualized return on equity over 16 %.
Lease transaction and container pick-up activity were slow in the second quarter. But our operating metrics remain at a high level. We continue to support strong financial performance. And while our investments in new containers have been limited so far this year, we're putting our cash flow to good use. Our customers continue to expect trade growth will be modestly positive in 2019. And we expect some increase in third quarter leasing activity.
We expect our adjusted earnings per share will hold fairly steady from the second to the third quarters. Overall, we are optimistic we'll achieve another excellent year. Our financial performance remains strong. We've repurchased meaningful portions of our business for compelling values. Our customers and market forecasters continue to expect trade growth will be modestly positive. We expect our customers will continue to rely heavily on leasing. We have significant advantages in our market and our strong and stable cash flow gives us many levers to create shareholder value.
We'll now open up the call for questions.
Questions and Answers:
Operator
We will now begin the question-and-answer session. [Operator Instructions] The first question is from Scott Valentin with Compass Point Research. Please go ahead.
Scott Valentin -- Compass Point Research -- Analyst
Good morning, everyone. Thanks for taking my question. Just with regard to -- you mentioned US-China, the trade dispute having an impact. I think in the past you said that US-China trade is about 12% of global trade. Just wondering, one, if you can maybe -- I don't know if you can quantify maybe what decline has been in the US-China trade and maybe demand for containers.
And two, obviously, reports of supply chain shifts and movement around Vietnam, Indonesia, other countries picking up. Just wondering if you're seeing any supply shifts in consumer -- customer demand for containers with Inter-Asia. Is that growth in Inter-Asia able to offset some of the decline in US, China?
Brian Sondey -- Chairman and Chief Executive Officer
Yes. So in the past, our comment about the share of trade made up by US and China really was driven by statistics that are published around the deployment of vessel capacity. And where we don't really see the movements of containers on a daily basis, we see where they're picked up and dropped off. And so we don't have great real-time visibility into how trade patterns are changing. We just see really how the overall demand for containers and supply -- container supply and demand is changing. We hear from our customers. In fact, I think the Maersk CEO was quoted a few weeks ago, was saying that they have seen production shift, at least export shift from China to Southeast Asia. And that is making up some of the difference in the shortfall of China-US trade. But we don't really have a -- have great visibility for that.
Scott Valentin -- Compass Point Research -- Analyst
Okay. Fair enough. And then just a question regarding the manufacture of inventory. Obviously, it's grown quite a bit. I think it was [Phonetics] 1.1 million TEU, about 3%, back to where it was back in '15, which was a tough period. Just wondering $1,700 [Phonetics] seems like a low price for a new container given the seasonality. I know seasonality is weaker than usual, but I would have thought that you'd be maybe $1,850, $1,900 level for containers. Just wondering, one, if you can comment, I guess manufacturer profitability is going to be close to zero given steel prices have been, I think relatively flat. And two, expectations, if they do close factories in August, do you think that can boost container prices?
Brian Sondey -- Chairman and Chief Executive Officer
Yeah. So, certainly container prices are very low, both on absolute sense and also in particular, they're very low relative to steel prices. And we always track the margin between the price for the container and the cost of the steel in the container. And that margin is very close to historical lows. And in fact, probably only a few quarters in the last 12 years or 15 years have been in the range where it is now. And so I think, while we don't have perfect visibility into the manufacturing profitability, our guess is they're certainly not doing very well right now at these margins.
And I think, as John O'Callaghan mentioned, we have heard from several manufacturers that they are considering closing their factories or at least some of their factories for portions of the third quarter, which would certainly be helpful, both from a tightening of supply and then, ultimately helpful for the manufacturers, I think, in allowing them to sort of bunch orders after they reopen and get more normal margins. And so, our expectations would be that, all else equal, we should see container prices push up from here.
Scott Valentin -- Compass Point Research -- Analyst
Okay. All right. Thanks very much for answering my questions.
Operator
The next question is from Michael Brown with KBW. Please go ahead.
Michael Brown -- Keefe, Bruyette, & Woods -- Analyst
Hi. Good morning.
Brian Sondey -- Chairman and Chief Executive Officer
Morning.
John Burns -- Chief Financial Officer
Morning.
Michael Brown -- Keefe, Bruyette, & Woods -- Analyst
So, I mean, the new purchase of containers here today it's been light and I appreciate the color there. But how should we kind of think about your CapEx trajectory from here? I guess kind of relative to last year as well as, I mean, clearly, it seems like it's going to be trending lower. But some guidance there would be helpful.
Brian Sondey -- Chairman and Chief Executive Officer
Sure. So, we have the ability to turn on and to ramp down CapEx very quickly. And so I think our CapEx trajectory will mainly just reflect a trajectory in trade growth and the market. Our CapEx has been light for two reasons, mainly just the overall volume of lease transactions activity has been light. And that reflects the fact that, as we said, container supply and demand are well-balanced overall. But there's been very little interest in customers in expanding the size of their container fleets, both due to, say, cautious outlooks on what growth might be this year as well as just a very tight focus on cost control.
And so we have a reasonably good shelf of equipment ready to supply customers as we always do. And as soon as we see customers coming for containers and us winning deals because we like the returns. I think then we'll start buying again. And really the timing on that again just depends on the market. We still think we're very well positioned to win the deals we want to win. I think we're the supplier of choice still to most of the major shipping lines and the deals that have been out there this year that we haven't participated in, again, very much driven just by our preference to use capital for we consider it to be higher value uses rather than, say, a loss of competitive positioning or anything like that. We still think we're -- we can go out there and win the deals we want.
Michael Brown -- Keefe, Bruyette, & Woods -- Analyst
Great. And then -- I mean, kind of given this weaker start to the peak season, are you kind of seeing -- in the competitive environment, are you seeing some of your peers kind of giving concessions, whether they're capitulating on rate or terms on deals?
Brian Sondey -- Chairman and Chief Executive Officer
Yeah, certainly. Pricing is down from where it was in 2017 and 2018. In those years, it was -- we took a lot of leasing share and customers very much valued our capacity to supply large numbers of containers on short notice and that's a good pricing environment from a leasing company standpoint. This year, again, just due to the lack of deals, we have seen certain companies compete aggressively to win deals that are out there. And there always are a few leasing companies that seem to prioritize investment volume or achieving investment budgets above investment returns. At Triton, our priority always is on returns and also servicing our customers.
But I wouldn't say, like deal terms aren't crazy, but they're somewhere above our [Indecipherable] and participating in them, some are below and we're not. We do typically think we get a 3% to 5% ROE margin over most of our competitors. And so the deals that are marginal for us, we do question what they must look like over time to some of our peers. But that said, we don't know exactly what their thresholds are compared to ours.
Michael Brown -- Keefe, Bruyette, & Woods -- Analyst
Okay. And just one more from me. What's kind of your views on the outlook for the shipping industry? I mean, you've seen a pickup in amount of blanks sailings recently. So, are we kind of seeing any cracks in the outlook for the profitability of the shipping sector, anything that we should be kind of concerned about?
Brian Sondey -- Chairman and Chief Executive Officer
Yeah. I think in general, it's another year where it's a tough environment for the shipping companies. They're still -- where container supply and demand are relatively well-balanced, there still is excess vessel capacity for a variety of reasons. And that's been keeping freight rates now for many years at levels that don't provide a lot of profitability for most of the shipping lines, in particular, the smaller ones and medium-sized ones can struggle.
But I think so far, at least this year, looks like a lot of the last three years or four years. And so we don't see anything sort of uniquely challenging about it. The one thing that has been talked about from a credit standpoint is the IMO 2020 regulations that come on at the January of next year around the sulfur emissions. And that's requiring some of our customer -- requiring customers to either invest into scrubbers or LNG vessels or to -- will require them to purchase low-sulfur fuel. And most of the customers feel that they'll be able to pass those costs on effectively to the shippers. But -- and it doesn't seem like they or others in industry are terribly concerned about it, but that is something that's been talked about.
Michael Brown -- Keefe, Bruyette, & Woods -- Analyst
Okay. Thank you for taking my questions.
Brian Sondey -- Chairman and Chief Executive Officer
Thank you.
Operator
The next question is from Ari Rosa with Bank of America Merrill Lynch. Please go ahead.
Ariel Rosa -- Bank of America Merrill Lynch -- Analyst
Hey. Good morning, guys. So, I just wanted to get a little bit of additional color. You said, your outlook for the second half was a little bit more optimistic. Maybe you could just give a little bit more color around what you're seeing specifically that leads you to that conclusion?
Brian Sondey -- Chairman and Chief Executive Officer
Sure. So, it comes from a few different things. I mean, first, as -- I think we mentioned a few times, we are hearing from customers that despite the uncertainty created by the trade dispute, that they still expect trade growth to be in the 3% range. And based on that and just the way that containers will age out of service, on a regular basis, we expect them to have to come to market and supplement their container fleets, which will drive leasing demand.
We've also been seeing over the last month or two, customers regularly coming to market for spot requirements. And so we know that their fleets are fairly tight and driving demand at a particular port, at a particular time. And those requests and spot requirements have increased over the last month or two. And we think we'll remain at a higher pace than they were earlier in the year. And so it's really two of those things.
Ariel Rosa -- Bank of America Merrill Lynch -- Analyst
Got it. But it's not like it's contingent on a resolution to the US-China trade dispute or something of that sort?
Brian Sondey -- Chairman and Chief Executive Officer
No, I don't think so. I think if you asked the most people in the industry -- the last time we did our call at the end of April, would we see a resolution? I think everyone was quite confident we would. I think the base case expectations now have shifted to who knows, and no one's counting on it in the near term.
Ariel Rosa -- Bank of America Merrill Lynch -- Analyst
Okay. That's helpful. Sounds good. Thanks.
Operator
The next question is from Helane Becker with Cowen. Please go ahead.
Tyler Kenyon -- Cowen and Company -- Analyst
Hey. This is Tyler on for Helane. I'm just curious. The deals that you walked away from in the quarter and I know that you walk away from deals all the time. But I'm wondering, what were the primary factors of you deciding to walk away from a few of the deals in the quarter?
Brian Sondey -- Chairman and Chief Executive Officer
So generally, we look at expected returns, which includes not just the most likely return, but a balance of upside opportunity relative to risk. And most of the deals we walked away from had some combination of just expected returns and most likely returns below our thresholds, which typically for us are thresholds are somewhere in the low-teens equity IRR, as we typically like to do much better than that on average. And so some combination of expected returns below that level and coupled with -- or leasing structures like large possibilities for returns of containers outside of demand areas or giving away repair conditions and things like that or credit situations that we just didn't feel comfortable with. But it was a variety of those factors that just led us to conclude that those deals didn't provide the kind of returns we'd like to get on our capital. And I think just also driven by the fact that we have very good deployment opportunities in the other things we've been doing.
Tyler Kenyon -- Cowen and Company -- Analyst
Got it. And then this might be more for John. Just out of curiosity, LIBOR is going away in a few years and I'm wondering, you guys have a little exposure to the benchmark. I'm wondering if you have thought at all about a new benchmark in how you plan to roll over that debt when LIBOR goes away, I think in 2021 or 2022? Thank you.
John Burns -- Chief Financial Officer
Correct. Yeah, that's correct, Tyler. When the industry is responding, all the refinancings of LIBOR-based debt that we have over the last year and a half has included a language that we would work with the lenders to make the adjustment to whatever the index is at that time. People seem to be very much focused on SOFR, which is the secured overnight lending rate and exactly how that rolls out remains to be seen. But all of our facilities are incorporating that type of language as we've refinanced them.
Tyler Kenyon -- Cowen and Company -- Analyst
Got it. Thank you, guys.
John Burns -- Chief Financial Officer
Yeah.
Operator
[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Burns for any closing remarks.
John Burns -- Chief Financial Officer
Yeah. We'd just like to thank, everyone, for your continuing interest in Triton International. And we look forward to speaking with you soon. Thank you.
Operator
[Operator Closing Remarks]
Duration: 28 minutes
Call participants:
John Burns -- Chief Financial Officer
Brian Sondey -- Chairman and Chief Executive Officer
John O'Callaghan -- Executive Vice President, Global Head of Field Marketing and Operations
Scott Valentin -- Compass Point Research -- Analyst
Michael Brown -- Keefe, Bruyette, & Woods -- Analyst
Ariel Rosa -- Bank of America Merrill Lynch -- Analyst
Tyler Kenyon -- Cowen and Company -- Analyst
