Whether you're a newcomer to rail transportation or an established rail shipper, as a business owner, operational leader, or supply chain contributor, you're continually assessing your business's rail equipment requirements. Questions like, "Do I have enough railcars, or do I have too many?", "Do I have the appropriate type of railcars now and in the future?", and “Should I buy my railcar assets or lease them?” often come to mind.
For rail shippers, these are common questions that require unique consideration of current and future business needs. In this blog, we aim to provide insights into the advantages, disadvantages, and important considerations when deciding whether to purchase, lease, or engage in a leaseback (sale-leaseback) arrangement for railcars.
Railroad Supplied vs. Private Railcar Availability
Private railcar ownership continues to outpace railroad railcar additions. Statistics show that railcar ownership of Class I railroads is less than 33% of the total versus railcar ownership of private railcar owners/shippers which makes up about 67%. In an environment where railroad annual CAPEX spend is collectively $24 billion dollars, it makes sense that the railroads will continue to encourage customers to acquire their own private railcar assets. (https://public.railinc.com/about-railinc/blog/who-owns-railroad-tracks-north-america)
Evaluating the Financial Implications of Railcar Ownership
When considering railcar ownership, the primary financial implications include the upfront capital expenditure, ongoing maintenance/operating costs, and potential tax benefits from depreciation. Owning railcars can be a significant investment, but it can offer long-term cost savings. Moreover, railcar owners can claim MACRS depreciation, which is likely to provide tax advantages over the lifespan of the railcars.
Ownership also comes with the responsibility of maintenance, repairs, and ensuring regulatory compliance, which can be costly and require dedicated resources. Companies must weigh these financial responsibilities against the benefits of asset control when deciding if ownership aligns with their financial strategy.
Understanding Railcar Own vs. Lease Tradeoffs
The decision to lease instead of own railcars is common and can be pivotal for companies in the rail industry. Some features of leasing railcars are more beneficial to the lessee when compared to the alternative of owning the railcar assets themselves.
Leasing railcar assets preserves company capital for other business functions, which are often more important than incremental railcar equipment additions. Also, lease payments are typically considered operating expenses and occur synchronously with the income produced by using the railcars. This can improve expense planning and enhance business cycle flexibility. A simplistic view of a successful railcar lease model is that the railcars pay for themselves as they’re used instead of the company paying for the entire asset in one lump sum and then the railcar asset slowly paying the company back through revenue generation over time (ownership model).
Leasing railcars instead of owning them also protects the user/shipper from design incompatibility issues and regulatory changes that affect the value creation potential of the assets. Incompatible and potentially inferior railcars can be returned to the lessor at lease expiration to be replaced with more efficient railcars better suited for the commodity and loading/unloading facilities. Shifting regulatory environments can increase the cost of operating certain railcars with the stroke of a pen. In these situations, leased equipment can be returned at lease expiration or through a negotiated early lease return. The equipment can then be replaced with equipment better suited for the new regulatory environment. Replacing leased assets is typically faster, more cost effective, and less effort than selling owned assets and buying more costly railcar replacements.
Railcar Sale-Leaseback Agreements
By definition, a leaseback (or sale-leaseback) is when a company sells an asset but, as part of the sale terms, continues to use the asset through a lease from the purchaser. The seller becomes the lessee, and the purchaser becomes the owner and lessor. Railcar leaseback agreements offer several advantages. The immediate infusion of capital from the sale can enhance a company's liquidity and be reinvested into core business operations or growth opportunities. This is accomplished while ensuring that the seller retains the use of the railcar equipment for the duration of the lease. Keep in mind the lease duration is typically part of the overall leaseback negotiation, therefore a term beneficial to the lessee is typically pursued. Leasebacks can also shift the burden of maintenance and compliance to the leasing company, freeing up seller/lessee resources. Additionally, certain financial ratios are affected by selling assets from the balance sheet while maintaining their use. These benefits can be attractive compared to alternative means of raising cash like loans/debt or equity financing (stock issuance).
Conversely, the leaseback model means companies forego some financial benefits of railcar asset ownership, such as depreciation. Therefore, the decision to enter into a leaseback agreement should be based on a thorough analysis of these trade-offs. The new partnership means both companies adhere to lease terms which include return requirements and likely include usage restrictions.
Strategic Considerations for Long-term Railcar Fleet Optimization
To fully understand these options, one must evaluate the operational needs, financial strategy, and long-term goals of their business. These evaluations require careful consideration of factors such as long-term shipping needs, tax implications, balance sheet management, and asset control.
Ownership may be more suitable for companies with stable, long-term railcar usage needs and the financial capability to invest in potentially high-cost assets. It offers greater control over the fleet and the ability to customize/modify railcars to specific requirements.
On the other hand, leasing arrangements may be more strategic for companies seeking flexibility, especially in a fluctuating market or those prioritizing capital for other investments. The decision should factor in projected railcar utilization rates, market conditions, and the company's appetite for financial and operational risk.
Contact Nate by email at nate@tealinc.com or by phone at (708) 854-6307