Frac sand losses hit Trinity’s bottom line

Company sees opportunistic buyers in “down market” for railcar leasing

Joanna Marsh

4 years ago

A photograph of a row or Trinity-manufactured tank cars.

Trinity Industries’ (NYSE: TRN) exposure to the financial troubles in the frac sand sector hurt the company’s second-quarter net profits.

The railcar manufacturer and lessor reported an operating loss of $307.3 million, or $1.76 per diluted share, in the second quarter of 2020, versus operating profit of $107 million, or 29 cents per diluted share, for the same period in 2019.

A $369.4 million noncash impairment charge related to the small cube covered hoppers used by several frac sand companies was the main contributor to the second-quarter operating loss.

Trinity also reported lower manufacturing volumes in its rail products group and lower profits from railcar sales in its leasing group.

Trinity’s frac sand customers faced a “one-two punch,” according to Eric Marchetto, chief financial officer. The sourcing of frac sand has evolved, resulting in structural changes within the frac sand supply chain. Energy prices also experienced a “drastic fall,” and the energy market faced increased pressure related to the COVID-19 pandemic, Marchetto said.

As a result of these factors, four frac sand customers filed for bankruptcy, while others remain financially vulnerable, according to Marchetto. FreightWaves recently reported the bankruptcy of one of the companies, Hi-Crush.

For Trinity, these outcomes change “the expected recoverability of cash flows from the lease contracts for this railcar type,” Marchetto said. The $369 million charge reflects the fair value of the assets and their future salvage value.

About 55,000 to 60,000 of the 125,000 small cube covered hoppers available industrywide are “underutilized,” Marchetto said. “With our outlook for domestic drilling, and specifically Wisconsin white sand being used in the Permian [Basin], we don’t think that [market] is going to come back to the degree that it was,” he said.

Structural changes underway

To cope with evolving market conditions of frac sand, as well as fortify the company against economic uncertainty and the unclear outlook of the COVID-19 pandemic, Trinity has taken several steps, according to President and CEO Jean Savage.

“Industry metrics report that approximately 32% of the North American railcar fleet is underutilized. We expect the pricing environment for rail equipment — new and existing — to remain pressured as long as this number is elevated,” Savage said. “In this type of environment, our commercial focus is to maintain the utilization of our lease fleet and then meet demand for newly manufactured railcars as appropriate for our customers.”

The company said it underwent a reorganization from a holding company model to an operating model “aligned around our customers and markets,” Savage said. Marchetto said more details about its operational strategy would be unveiled during Trinity’s investor day following the company’s third-quarter earnings release.

Trinity is also seeking to outsource some of its lower-value fabrications as a way to cut overall company costs, according to Savage. This approach “would give us, one, the ability not to have to have as many people to produce a car, and two, to look for some opportunities to reduce overall costs,” she said.

The company is awaiting the outcome of potential production agreements before seeking to rationalize its production workforce. It has already reduced its manufacturing workforce by 35% since the start of the year, resulting in almost $40 million in overhead cost savings. Other workforce rationalizations among Trinity’s higher-cost footprint could also occur, Savage said.

Is it a buyer’s market?

Trinity executives acknowledged that because the market is in a down cycle, opportunistic buyers are in the marketplace. Trinity characterized the buyers as those seeking to replace their aging railcars. The company itself is also keeping an eye out for opportunities, executives said.

“Pricing is getting aggressive, and those who have some aging fleets that want to replace them or have some additional demand are coming out and looking for those opportunities,” Savage said.

Marchetto said, “Replacement demand will be a larger driver, rather than growth demand, over the next several quarters. And that’s where we’re seeing opportunities, as users of rail equipment that have some discreet replacement opportunities … [are] looking to take advantage of the current market.”

In the meantime, Trinity is eyeing the agricultural sector as an area of opportunity because of aging equipment in that space and fewer headwinds experienced by the sector. Trinity is also seeing replacement needs for boxcars and open hoppers and gondolas.

Second-quarter results

Trinity’s second-quarter revenue was $509.2 million, a 31% drop from the same period in 2019, amid fewer railcars sold from the lease fleet and lower deliveries in Trinity’s rail products group.

Expenses were $56.8 million, versus $69.8 million in the second quarter of 2019, on reduced employee costs.

Revenue from Trinity’s leasing and management services group fell 3.5% to $182.7 million on lower fleet utilization, despite offsets from higher lease rates and lease fleet growth. Revenue from the company’s rail products group slipped 42% to $405.6 million on lower deliveries.