Textainer's High Dividend Not AAA But OK
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Textainer (NYSE: TGH) has been operating since 1979 and has grown to be the largest lessor of cargo containers with a total fleet of more than 2.4 million units -- 1.9 million of those are owned by TGH. The company has around 400 shipping line customers that lease its cargo containers. When a company is in the business of leasing equipment over a wide geographic territory, it’s critical to have enough inventory at the right locations to fill orders and TGH with its 2.4 million cargo containers at 440 depots is one the biggest in the business.
This is a capital intensive business. TGH buys new cargo containers continuously as around 5% of the worldwide fleet is retired every year and the demand requires replacement plus additions to the fleet to meet demand. TGH has been one of the largest buyers of containers among cargo businesses. In the past five years, prices ranged from $1,730 to $2,995 per container with recent prices nearer $3,000 due to shortages. The higher prices and need to replace a larger number of units sent TGH's capex to 5-year highs.
*Capital in millions $
*Fleet numbers in thousands
Other business segments include managing the leasing of containers they do not own and selling their own used containers at the end of their useful life of 12 to 15 years. They also trade in and out by buying then selling units owned by other businesses. The biggest business segment as a percentage of revenue is the fleet they own and it is their most important business.
Percent of revenue six months 2012
There are four types of leases.
- Term leases provide a specified number of containers for a specified period of time, typically ranging from three to five years. Term was 74.5% of business.
- Master leases provide a framework of terms and conditions valid for one year -- 17.7%.
- Finance leases provide an alternative means for purchasing containers-- 4.5%.
- Spot leases provide containers for a relatively short lease period and fixed pick-up and drop-off locations -- 3.3%.
The logistics of container economics are interesting and have undergone a few changes over the years. Worldwide demand has increased on average at 3 million TEU (Twenty foot equivalent unit *) per year meaning that a lot of production is needed to provide sufficient capacity. In 2009, a mere 450,000 TEUs were manufactured and even so, demand was so sluggish during the recession millions of containers were idle.
* one TEU represents the capacity of a 20’long,8’wide, 8.5’high container. It’s inexact and does not convert to number of containers in the world’s fleet.
As the recession began to ease, it left in its wake limited container capacity worldwide to accommodate increased shipping volume and high prices for cargo containers driving big capex spending due to shortages. The upside for TGH was record high utilization rates for TGH and great margins.
TGH utilization rate and margins
Expectations were for a weak 2010 until the back half. Contrary to predictions, shipping volumes were surprisingly strong and the container fleet increased 7% TEU in 2010 and 8.5% in 2011 to 31.5 million TEU. TEU at the end of 2009 was 27 million. In spite of the increased capacity, the container fleet supply appears to be tight at least until the end of 2012. The loss of units in the Japan tsunami disaster and larger loads used in slow steaming have also created some short fall. TGH has been the beneficiary of short supply and seen their utilization hit historic highs. This in turn has led to record margins.
After a banner 2011, the six-month operating margins for 2012 began show weakness and declined 10% year-over–year to 58%. For Q3 2012, operating margins were also at 58% as expenses began to increase at a faster pace than revenue.
At the start of 2011, there was an approximate shortfall of 3 million containers and TGH realized its highest utilization and margins.
The other recession-related impact on TGH is in capital spending on containers. Scarcity has driven up the costs to record highs of $3,000 and TGH capital spending was $823 million up from $402 million in 2010. They bought 270,000 containers. At $3,000 per unit, the price tag would be $810 million if they paid full price. The company is able to buy far cheaper stock in the used market to help rebuild the fleet. They recently bought 67,360 units from one of the managed fleet customers for a far more reasonable $980. It does not always require acquisitions to be at full price to increase the fleet and if they can buy used containers, capex spending benefts.
Margins and utilization will revert back to historic levels at some point, slowing operating and net income growth and pressuring cash flow from operations. Utilization and margins have already seen decreases in the first half of 2012. For the first six months utilization was 97.5% and down almost 1% over 2011. The key drivers of revenues are fleet size, rental rates and utilization. The company can manage fleet size, but utilization and pricing are determined by supply and demand. Container suppliy is up and several large global economies are beginning to slow including the U.S. and China. If these trends continue, utilization and contract pricing will both decline. The 20.5% slide in the stock’s price since July may be anticipating lower growth and overcapacity.
The positives of a worldwide return to normal capacity would be lower container costs as manufacturers lose the leverage of tight supplies. Less capex will be required to build the fleet (2011 was a record year for capex expense) and potentially, TGH might become free cash flow positive, putting them in a better position to pay and increase dividends. At present, they are using debt to finance not only growth but also dividend payments.
Corporate structure and shareholders
TGH is a holding company with no direct operations or tangible property. TGH has two wholly owned subsidiaries that in turn each own three subsidiaries.
TGH is dependent on loans, dividends and other payments from these subsidiaries to generate the funds necessary to meet financial obligations and to pay dividends. The subsidiaries are legally distinct from the holding company and could be prevented from paying dividends or paying into the holding company. One such condition would be the failure to keep the covenants on loans.
TGH is not a straight-forward corporate dividend payer like Johnson & Johnson (NYSE: JNJ) or Coca-Cola (NYSE: KO), but a more convoluted network of businesses put together under a holding company. While this does not necessarily put the dividend in more peril, it is harder to predict whether the company can continue to pay and raise or whether there will be cuts as each part has its own business operations that are somewhat opaque and seen only under the umbrella of Textainer.
Halco is a trust that owns 60.1% of TGH shares. In turn, Halco’s sole beneficiary is Trencor –- a South African exchange listed cargo container leasing company. It has owned a large number of shares since 1993. In 2007, the Halco percentage ownership was 72%, now down to 60.1%.
One of our shareholders, Halco Holdings Inc., is a company owned by a trust in which Trencor and certain of its affiliates are discretionary beneficiaries and could act in a manner with which other shareholders may disagree or that is not necessarily in the interests of other shareholders. Your interests as a holder of our common shares may not align with the interests of Trencor and its affiliates and shareholders.
Without a majority of shares, smaller shareholders have little voting power. In addition, company management has shares and options that bring ownership of shares up to 75% between TGH and Trencor. While this is a positive as, especially Trencor, receives substantial income from dividends and is unlikely to be in favor of dividend suspension, marginal shareholders have no meaningful input into company policies. Halco has the ability to influence the outcome of matters submitted to shareholders for approval, including the election of directors and any amalgamation, merger, consolidation or sale of all or substantially all of TGH subsidiary assets. Five of eleven directors are also directors of Trencor.
The company is moderately leveraged at 69% debt/capital. Total debt is now at $1,705 million. The debt is a combination of revolving credit, bonds and a secured debt facility. Interest on two of the bonds is the highest payment at 4.7% and 4.2%. The others are at variable rates with most less than 3% as of June. The interest coverage ratio has decreased from 6X to 3.7X in June as more debt was taken on. Of more concern to investors are the covenants that govern the debt.
The TL Credit Facility
- the total outstanding principal may not exceed the lesser of the commitment amount and a formula based on the company’s net book value of containers and outstanding debt
- limitations on certain liens, indebtedness and investments
- restrictions on TGH’s tangible net worth, leverage, debt service coverage and leverage and interest coverage
The 2005-1 Bonds, 2011-1 Bonds and the Secured Debt Facility
- restrictive covenants regarding the average age of TMCL’s container fleet
- certain earnings ratios
- ability to incur other obligations and to distribute earnings
- TGH’s container management subsidiary net income and debt levels
- overall asset base minimums,
TMCL and TGH’s container management subsidiary believe that they were in compliance at December 31, 2011. Most of these covenants cannot be independently ascertained by investors and there is no way to follow the ratios and other covenants to assess how close TGH may be to a breach. Breaking a covenant may result in the dividend being cut. High debt levels governed by covenants are of some concern for anyone buying the stock for its dividend.
In order to easily pay dividends, it’s a plus if the company has some positive free cash flow to work with and levels and maturities of debts that are not likely to supercede the dividend payment. TGH is free cash flow negative. Cash flow from operations is strong, but capital spending is using it and more for growth and funding it with debt and new shares. While this is fine for a growth stock, it sets up tension between growth and returns to shareholders through dividends and share repurchases. In the five years since the IPO, TGH has not had free cash flow that could be used to pay dividends.
In millions $
The result is that debt is used for capital spending and to make the dividend possible. While this can go on indefinitely, there is a danger of running up against the covenants, inability to refinance, and debt repayment taking precedence over dividends.
While I like this not-so-simple cargo container lessor that takes advantage of growing commerce by providing the steel boxes that make trade possible, there are a few unquantifiable and unpredictable parts of the business that could impact the dividend yield.
The forward yield is 5.6% and $1.68. The dividend has been increasing since 2008, but there are several unknowns that could change the course of the dividend.
1) Halco aka Trencor has 60% of the vote on shareholder matters. They also have seats on the board. Unfavorable dividend policy changes could be proposed by the board and marginal shareholders would have no recourse.
2) Debt covenants are not quantified in the filings. Investors are told TGH is in compliance. A covenant breach cannot be adequately anticipated.
3) Dividends and yields are high now at the point in the company’s history where margins and utilization are at historic highs. If they undergo a correction towards norms, paying the current dividend could be more difficult.
TGH is a good company, well run and profitable. Growth has been impressive. Operating income has doubled since the IPO and EPS has more than doubled. CFFO is increasing again after a rocky 2009.
The dividend is tempting and high but does come with some risks an investor will not gave to consider with a dividend paying stalwart like Johnson & Johnson (NYSE: JNJ) or Coca-Cola ((NYSE: KO). They are lower yielders but lower risk.
JNJ pays $2.44 for a dividend yield of 3.4% resting firmly on $8.6 billion in free cash flow in 2011. Debt will not be an issue for JNJ with a low debt/capital ratio 22.5% and a triple A credit rating. While revenue growth has averaged a sedate 4.8% per year over the last 7 years, the dividend has increased an average of 11% per year. JNJ has not been free cash flow negative any time over the last eight years. This dividend is as safe as a dividend can be and almost guaranteed to increase.
Coke pays $1.02 with a 2.8% yield backed by $6.6 billion in free cash flow. It takes positive free cash flow to pay a dividend reliably over decades. Coke has only had one free cash flow negative year in the last eight--in 2007 they made a $4 billion acquisition that put them in the red. The dividend has increased every year over that time by an average of 9% per year. The debt to capital ratio has increased over the years and is now at an eight-year high of 47&. They have no covenants and recently had a credit rating just 3 rungs short of the coveted AAA of AA-. The debt should never have to take precedence over paying shareholders.
If it looks like the dividend is a priority going forward and can be paid from cash flow as Textainer cycles through slower growth, lower utilization and contracting margins, it will be worth revisiting as an investment.
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