When And Why To Enter The Equipment Market - railroad equipment leasing versus buying - Brief Article - Column

Railway Age, June, 1999 by Anthony Kruglinski

Diligent readers of Railway Age will have already discovered that in addition to this month's Financial Edge column, the magazine includes RA's 1999 Guide to Equipment Leasing.

We encourage you to give it a gander if leasing rolling stock is, or may be, in your future. What we would like to tackle in this month's column, however, is the complementary issue of when and why to take the step and acquire new railcars and locomotives. This acquisition can be in the form of a cash purchase or financing of some sort. It really makes no difference for the purposes of the question we are asking: When is it the right time to jump into the new equipment market?

If after reading the introduction of our Leasing Guide, you come away amazed that North America's operating lessors do not seem to be bailing out of the new railcar building market, you can join many in the audience. But that's the truth--they're buying new cars at the same time as they are parking others (and sometimes parking the new cars themselves!). Obviously, the same folks that take long views in other equipment types such as aircraft, are now applying these investment theories to rail.

But should you? Before we try to answer this question, let's make a few assumptions. Assume that: You are a railcar or locomotive end-user and have the financial wherewithal to acquire new equipment by purchase or long term lease; you have a verifiable, long-term need for the equipment in question; you have recent experience (through ownership or operating lease) with both new and used equipment for operation and maintenance cost analysis purposes.

Well then, is now a good time to jump into the market? When we asked the operating lessors this question, they generally quoted the logic of long-term deals with builders and strategic alliances. What they did not have to focus us upon was the obvious value to a builder of a multi-year contract to build its product and cover fixed costs no matter what the vagaries of the market for that product may be. Let's assume, therefore, that in addition to establishing a strategic alliance and getting guaranteed positions on the assembly line, that these multi-year deals also gave the new car buyers exemplary pricing!

However, what if you need 100 or 200 cars or 50 locomotives and will not, by definition, be the salvation of any particular builder? Well, there's always the tried and true strategy of tack-on equipment ordering. The actual cost to construct the 1,501st coal car has to be less than the 1st! You may not get the pricing the bigger customers get, but we'd bet it was close in the right circumstances. Now, remember, being the last guy on the ice skating whip is not the best of all possible worlds. Bigger customers get to set design parameters. You won't. Nor will you get to drive delivery schedules. Still, it's reasonable to think if manufacturers appreciate the large multi-year order for 1,500 cars, they will also appreciate a tack-on order for an additional 100 or 200 units. You just have do your homework and be patient (and flexible) in ordering your equipment.

On the other hand, perhaps the fact that the large operating lessors are committing to new building in a slack period is a good reason not to jump in and buy your own. Perhaps the leasing deals that may be available as these units deliver may be reason enough to sit it out as a purchaser and to, alternatively, short-term lease your equipment from the big guys. (Certainly, a number of Class I's appear to be taking this point of view).

What would this writer do? I'd buy! If not now, soon. Assuming again, that my end-user profile matched the assumptions above. Why? Several reasons. Interest rates are still hovering around historic lows. With people refinancing 7% mortgages and pocketing cash, it may not seem so, but significantly higher borrowing costs are clearly a possibility in years to come. Next, assuming you are in need of one of the many types of general purpose types of freight equipment, the chances of it not becoming obsolete are more than excellent. And if, in the future, your need for it changes, there will likely be a market for it.

Finally, I think the operating lessors have it right when they are investing in equipment that has been proven to be so long-lived. With railcars and locomotives consistently selling for upwards of 90% of original equipment values--25 years after going into service--the investment value is clearly there. Now if, despite matching my assumptions, your financial performance today will be enhanced by letting an operating lessor make the investment and take the concomitant risks of ownership, he deserves the upside in the equipment that you are abandoning. The question is, are you playing the game for the long term or the short term? Again, another good question.

If you are a publicly traded railroad, your horizon may be one that goes quarter to quarter and you may have to sacrifice long-term value for near-term performance. If you are not encumbered with this problem, I would advocate new building just as soon as the present order books at the builders develop some slack and new equipment prices moderate,