House cleaning on the horizon - Financial Edge - railroad fleets - Brief Article - Statistical Data Included

Railway Age, March, 2002 by Anthony Kruglinski

For the first time in the 20 years that I have been surveying the North American railroad scenc, we are on the threshold of a real, wholesale house cleaning in our railcar and locomotive fleets. Until now, the rail equipment scene could always be summed up in terms of shortage or surplus, temporary or long term, but not in terms of scrapping physically viable units whose economic reason for existence evaporated. However, that was then and this is now. And for those who have been investing in rebuilding used equipment again and again to extend useful lives, it could be ugly.

We simply have too many older, mechanically healthy railcars and locomotives to find work in a marketplace where original equipment manufacturers are committed to staying in business. Part of this surplus of viable units is due to overbuilding in the last few years. But there is much more behind it. The Class I's are finally getting their acts in order and beginning to reap the real benefits of merger and industry consolidation. They are using equipment more efficiently. These efficiencies are occurring in the midst of one of the industry's largest periods of oversupply.

In a recession, the cost of utilizing one's investment in capital equipment is something upon which every end-user is concentrating. Based on what we are hearing in the marketplace, we would not put money into repairing equipment during this recession if we can avoid it. In acquiring new equipment for use--condition issues aside--we would always go for the more modern, more efficient unit. Retire, return, or sell as soon as possible any older, less efficient unit.

Things can change dramatically. Ignoring short term seasonal and weather related issues, the recession could end tomorrow with a burst of economic activity and a surge in the need to transport goods. Or the vagaries of various specialty markets could kick in. For instance, the steel market could come back quickly and strong. Or there could be a sea change in the grain market that could employ all the parked 4,750's and blur the distinction that the present market makes between these cars and their newer, larger cousins. It's even possible that the Class I's could somehow dig a new hole for themselves, leaving us with parked trains eating up car and locomotive surpluses.

What's next? Look for continued production of new locomotives and cars--perhaps in somewhat reduced numbers--for the future and beyond. You don't have to look for a cessation of conversions and rebuilding of older cars and locomotives for present service. This activity died some time ago.

Most important, look for fleet retirements on a massive scale. The Class I's will be first in the line to the scrap heap with their excess equipment, since they control the bulk of the older cars and locomotives and will want to dump them in favor of newer, more efficient equipment, probably leased. The nation's equipment lessors and their reaction to the situation is somewhat harder to handicap. To begin with, most will not have an inclination to dispose of out-of-date equipment that can be parked for a few bucks a day. They can also lease it for a fraction of what was anticipated when it was acquired as short as a few years ago in the market and thus avoid a book loss. On the other hand, a number of these lessors have, or may experience, management or ownership changes in the near future. New brooms can sweep clean.

Realistically, the actual "end" for many otherwise serviceable units will come when the need for regular, scheduled investment arises and the payback (whether for an owner/lessee or full service lessor) for that investment does not seem in the cards.

If you are in the business of investing in new rail equipment as a finance lessor, do not go running for the residual fire exits. The people getting hurt here are not finance lessors. They are full time operating lessors and other equipment players (including railroads who rebuilt their own equipment) who did not accurately foretell this situation in advance of investing in older cars and locomotives. The equipment likely to be scrapped will be at the end of its second or beginning of its third service life. The original finance lessor or lender was fully paid out more than a decade ago. If anything, the rush to re-equip with new cars and locomotives will only enhance residual values.

Tony Kruglibnki welcomes comments and controversy via email at tkruglinski@railfin.com.