Letter From the Chairman
GATX performed well in 2018, earning $5.22 per diluted share*, earning a 14% return on equity*, returning $185 million to our shareholders through dividends and share repurchase, and importantly, investing $943 million in our wholly owned rail businesses around the world.
This 2018 GAAP investment amount is not reflective of two new committed railcar supply agreements executed at Rail North America, under which 12,450 new railcars will be delivering, primarily from 2019-2023. It is also not reflective of an additional $969 million invested by GATX and Rolls-Royce within the Rolls-Royce and Partners Finance aﬃliates (RRPF), where GATX is a 50% partner. All considered, 2018 was a tremendous year for investment at GATX.
In our investor presentations, we regularly explain our “capital allocation framework.” Our first priority is to create value for our shareholders by investing in economically attractive opportunities in our core businesses (Investing Capital). Our second, closely related, priority is to maintain a strong balance sheet and access to attractively-priced capital so that we can consistently invest (Retaining Capital). Our third priority is to return capital that we cannot profitably invest to our shareholders through dividends and share repurchase (Returning Capital). Given the great year for investment we had in 2018, I’ll use this letter to communicate how we think about our first priority – Investing Capital.
The most important principles GATX considers when investing are: risk-adjusted returns, cyclical awareness, and maintaining consistent investment discipline.
GATX risk-adjusts each investment we make by varying both the equity return we require for the level of risk we are assuming, as well as the leverage that we believe each investment can support. Thus, the cost of capital we use for potential investments at GATX varies widely by a number of factors, such as the type of asset (railcars versus spare engines) and geography (North America versus India). This allows us to more accurately compare investments across the Company. It also causes us to pass on a number of investments that look great from a book accounting perspective, but fail to generate the necessary economic return. In the current environment, this methodology has caused us to invest more in our European and Indian rail businesses – as well as in RRPF, because we are seeing increasingly attractive risk-adjusted returns in these investments.
We also try to practice what we refer to as “cyclically aware” investing. The U.S. railcar leasing market has been historically characterized by extreme volatility. This is best demonstrated by historical railcar manufacturing backlogs:
We typically strive to place large, committed, multi-year railcar orders when the railcar leasing market is weak and manufacturers are eager to secure new business – because that is when we are able to secure the lowest future railcar cost. Our 2011 Supply Agreement is the best example of this strategy. We placed the order for 12,500 railcars just before the market started to recover, locking in attractive manufacturing margins. The cars delivered into a rapidly strengthening market, and we placed them with customers on long-term initial leases at very attractive lease rates. These railcars are expected to provide excellent shareholder returns for decades.
When the railcar leasing market is strong and asset prices are increasing, we try to look elsewhere for investment. Our 2014 $340 million fleet acquisition of 18,500 boxcars is a good example of acquiring older, out-of-favor, less costly assets at the market peak. We can’t always successfully execute “cyclically aware” investing – for instance, sometimes it is necessary to pay more than we would like for a new car in order to protect our competitive position with a customer – but it is something we continually strive for.
Consistent investment discipline is critical to our success, and it is the most diﬃcult principle in practice. A number of large railcar leasing fleets have changed hands over the last decade, and we have bid on almost all of them. We have come close a few times, and missed by a wide margin on others – but we did not relax our investment discipline on any of them. But the adage that “the best deal I ever did was the one I didn’t do” applies in this industry. We refuse to overpay for assets in a tremendously competitive market where you rarely control your pricing. Additionally, we are highly selective about the car types that we invest in, constantly striving for fleet diversity and limiting our exposure to railcars that are in high demand due to short-term trends. This investment discipline has resulted in higher fleet utilization and more attractive returns than our competitors. In contrast, we saw certain competitors “gain market share” through big fleet acquisitions, and then struggle mightily because of their cost basis and concentrated fleet composition – even causing some to exit the market. We have instead chosen to complete smaller acquisitions that have been less competitive or where we have a superior, relevant skill we think we can apply to the opportunity. The $229 million 3,100 railcar fleet acquisition we announced in November 2018 is a great example of this thinking. We will always try to maintain the discipline of only investing where we see an attractive risk-adjusted return; otherwise, we will return the capital to our owners.
Our Board of Directors plays a critical role in our investment strategy and how we think about capital allocation, as well as the other elements of our vision and strategy. They consistently prod, challenge, and debate with us about ways to provide value to our shareholders. Their input and support are invaluable to us.
GATX’s 2,225 employees performed at a high level in 2018, just as they have done in the 14 years that I have been in this role. Our strategy means nothing if they are not great at executing it, and it is a true honor for me to work with them all.
Lastly, we regularly reach out to our shareholders, and they give us great input on items ranging from strategy to capital allocation to corporate governance. Some of our large shareholders have been investors in GATX for almost 40 years. If we continue to execute, I believe they will be with us for decades to come.
Brian A. Kenney
Chairman, President and Chief Executive Officer