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Is Textainer Group Holdings Limited a Buy?

Textainer Group Holdings Limited (NYSE: TGH) stock is down around 10% this year, but that includes a brutal 33% plunge in February. The shares have started to recover following that deep post-earnings drop, but investors still appear to be pricing in some bad news following the container shipping lessor's huge 180% stock advance in 2017. The thing is, there remains a lot to like about the investment story here if you're wondering if Textainer is a buy.

A simple business

Textainer buys intermodal shipping containers, generally using debt to finance its purchases. It then leases the containers out to shipping companies for five to seven years (about 40% of the lifetime value of a container). After that lease is up, it tries to lease the containers again (40%) before it eventually sells them (20%). There are a number of variables that impact the company's returns.

A cargo ship carrying shipping containers
A cargo ship carrying shipping containers

Image source: Getty Images

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The first is interest rates, since Textainer makes heavy use of leverage. A look at the balance sheet shows that long-term debt makes up around 70% of the company's capital structure. With U.S. interest rates on the rise, that's a clear headwind. However rates are still very low by historical standards, suggesting that this is an issue to watch but, perhaps, not one to get too concerned about right now.

The next issue is shipping container costs, which have been on the rise because of the increasing costs of materials like steel and paint, along with rising labor costs. That's a concern, but it can actually help Textainer: higher costs push marginal players out of the market. And as long as the spread between the rates Textainer can charge and the cost to finance containers is wide enough, the shipping container company can make a decent profit. All in all, rising container costs are probably a net benefit at this point, with prices in February up around 80% from their low point in 2016.

It's also worth noting that higher new container prices can help to increase the amount that the company charges for the containers it's selling. In February, used container prices were double what they were in 2016. Demand has been so strong, in fact, that containers were being sold above book value.

An image describing generally positive trends in the container leasing market, noting strong demand for containers, increasing container prices, prospects for solid growth opportunities in 2018 driven by 4% global GDP growth, a doubling of used container prices since 2016, and the fact that used containers are being sold above book value.
An image describing generally positive trends in the container leasing market, noting strong demand for containers, increasing container prices, prospects for solid growth opportunities in 2018 driven by 4% global GDP growth, a doubling of used container prices since 2016, and the fact that used containers are being sold above book value.

An update on the trends driving the container industry. Image source: Textainer Group Holdings LimitedIMAGE: http://investor.textainer.com/static-files/14adf77c-4ed8-47c1-9360-9e19d9a1d532 page 10

The last big determinant of Textainer's success is supply and demand. Demand has been strong lately, with the company expecting 2018 to be a solid year overall. For example, as 2018 got under way the lessor was signing new contracts at rates above its average lease rate. A strong market tends to lead to increased competition as competitors look to take advantage of the same positive trends that are spurring Textainer's results. Textainer is confident, however, that peers will remain disciplined, and that the leasing market will stay relatively strong.

The big drop

Investors, on the other hand, seem to have taken the news that competition could increase as a huge negative, and punished Textainer's stock following the release of its fourth quarter earnings in February. That, however, looks like a short-sighted view of the situation when you step back and consider the bigger picture.

TGH Chart
TGH Chart

TGH data by YCharts

For example, the container leasing market has improved notably, so even a slight pullback would leave the industry better off than it was during the worst of the downturn in 2016. Unless leasing prices fall off a cliff, which Textainer is not expecting, 2018 should be a relatively good year.

Then there's the nature of the business. Textainer signs leases that are between five and seven years long. That's been a headwind in recent years, as contracts with higher lease rates rolled off and new leases were signed with lower rates. This year is expected to be different, with older leases inked at lower rates running out and being replaced with new leases at higher rates. Those higher rates are locked in for the length of the new lease.

Investors should be watching the leasing market, of course, but it seems as if Textainer's story will remain strong even if the market softens a little. In fact, the company is expecting increasing profitability as it progresses through 2018. Unless management is seriously off the mark, this year should be a good one for Textainer.

More room to run

Despite the pullback in Textrainer shares, the fundamentals underlying its business still appear strong. That should remain true even if competition heats up a little bit. If you are wondering if Textainer Group Holdings Limited is a buy, there appear to be more positives than negatives right now. It's definitely worth a deeper dive.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends Textainer Group. The Motley Fool has a disclosure policy.