Full Speed Ahead For Leasing

Sheltam, prior to its recent change in name to Traxtion, was and continues to be well known for the leasing of rolling stock, with a fleet of 45 locomotives, 100 wagons and 10 cabooses, ready to go. Last October, following the investment by Harith through the Pan African Infrastructure Development Fund 2 into the Traxtion Group, the leasing business - Traxtion Leasing – was launched with the full support of Traxtion’s two major shareholders, Principle Capital and Harith.

Leasing of rolling stock offers an interesting business case both for the lessor and lessee. In an interview with Railways Africa, James Holley, CEO of Traxtion, goes into more detail on leasing and its benefits, why better rail infrastructure is the key to unlocking Africa’s potential, and the role of the Traxtion Group.

Full Speed Ahead For Leasing

Moving From What Was Traditionally Offered In Terms Of The Current Fleet, What Has Changed Under The New Brand And Investment:

What we have now is the ability to lease new rolling stock, and the ability to do much bigger deals, adding real capacity to Africa’s railways and freight companies. The difference is that in the past we did not have the capacity to invest in, for example, ten new General Electric C30ACI locomotives. Now, we have access to significant funding, and with the support of our shareholders we are open to funding projects and have the capacity to meet the needs of our customers and their specific application requirements.

What Are The Benefits To Leasing?

First and foremost is the ability to create additional capacity. Leasing takes the requirement to invest in capital-intensive assets away from the mining company, freight owner or railway, and places that capital investment requirement with the leasing company, keeping capital available for alternative projects. In many instances, there are competing requirements for capital, so it makes sense to rather hand over capital-intensive investments such as rolling stock to a third party on a lease model. In some instances owning the rolling stock that has a life span of between 30-50 years is not core to their business: there may be a need to retain operating control but outsource the capital deployment.

Leasing companies are specialists in what they do which brings with it product innovation. The difference between an old-school flatbed wagon with a tare of 16 tonnes and a new lightweight skeletal design with a tare of 12 tonnes does not sound like much, but across a trainset the efficiency that this brings is material. This allows for more cargo to be moved at any given time. Leasing companies can bring great innovation to an operation by understanding the requirements of the customer and making the right procurement decision. That is a core aspect of the partnership between ourselves and the customer.

The next thing a leasing company, particularly in Africa, needs is the ability to keep that asset working. The customer needs to know those assets will work to the kind of availability thresholds that makes them efficient. Leasing companies embrace the concept of residual value risk, knowing that at the end of the lease period, you will get an asset back that is worth what it was when it was first leased out. That can only happen with best-of-breed maintenance.

Maintenance Is A Key Deliverable In The Leased Environment

Companies need to understand the complexities of operating and maintaining assets in remote areas. Maintenance is about parts, people and processes. On the parts side, you have to understand your lead times to get parts to remote areas. In terms of people, you have to have the right skills: at Traxtion, we have a Rail School where we put training artisans through a three-year, TETA-accredited training programme to ensure we have the right level of skills in place. In addition, the profile of the person is important. Not everyone is willing to go and work and live in some of the remote areas that we operate in, where one constantly has to be able to find workable solutions to a variety of problems. The right processes are equally important: many people are good at fixing a locomotive, but you need to make sure the locomotive does not break down. That is where the ISO9001 certification comes into play. This gives and the customer comfort that we have the right processes, the right people and the right parts and stock levels to meet the required service level agreements.

Our unit exchange programme is a core component of the leasing programme. For this to really work you need to have capacity across a fleet of locomotives obviously with similar specifications.

Our Rosslyn workshop allows us to provide a maintenance hub for our leased fleets in Africa. Typically, the maintenance cycle requires the heavy refurbishment of these assets every seven to ten years, depending on the usage. Bringing the assets back to a central place with core skills allows us to do these overhauls as well as offer third party locomotive refurbishments. We are looking at developing our Rosslyn facility as a rail services hub and invite other companies to be part of this.

  • State-of-the-art and best-of-breed, cost-effective procurement by specialists. Savings of 4 tonnes on the tare of a wagon or an additional 5 000 litres into a tanker wagon don’t sound like much, but over time the extra revenue and fuel savings are huge. The same applies to locomotive capacity.

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Full Speed Ahead For Leasing

The Leasing Model?

The leasing model is highly capital-intensive. You have a chunk of equity and a chunk of debt. The decision to raise debt and equity is similar, and in each instance the ultimate funder looks to the strength of the underlying cash flows. That rests on how strong the business case is and the balance sheet of the company that one is leasing to. Because of the nature of the heavy debt burden, the business case and the company wanting the lease need to be able to stand up to scrutiny and a due diligence. This is the first decision.

The next stage of discussion is around the right assets for the customer, the correct maintenance plan and whether there are adequate facilities to maintain those assets. The most critical aspect is ensuring that the deal is bankable and that we can go to our investors on behalf of the client and procure the equipment that our customer needs.

The operator’s state of infrastructure is also important, as this talks to the residual value of the asset. The locomotive or wagons need to come back in a condition that they can be redeployed at the end of the lease period - this is the whole point of a leasing company. Modern control systems on locomotives are there to protect the locomotive, so as a leasing company we are confident that the state-of-the-art on-board technology and telemetry will help to protect the locomotive.

We also have the ability to lease and train. Through our Rail School, we put in place a training programme that ensures that by the time the rolling stock arrives, the client’s team is trained and certified to the right level to both operate and protect the asset.

On wagons, the specifications are based on what will be transported, where it will be operated and how it will be offloaded, as this informs both the specification of the steel used, the bogies used, and the design. Each specification has a significant impact on the wagon and the efficiencies thereof. There are a number of ways that we as a company can work out the challenges that are unique to Africa.

Cost Packaging Around Leasing

The cost packaging associated with leasing depends on what the customer’s ultimate requirement - a full maintenance lease, or a dry lease. In either case, the company leasing the product needs to be geared towards that. For a leasing company to succeed in Africa, you need a strong maintenance capacity, so we would typically offer a full maintenance lease. Typically, in a lease, the capital portion of the lease - considered the dry portion, before you get to maintenance - is the majority of the total lease charge. Availability penalties typically only apply to the maintenance portion of the rate however where we maintain we can take some risk over the dry lease portion which really differentiates our offering.

Interoperability And The Challenges Of Africa

At the moment we have two primary gauges in Africa - Cape and Metre. With the addition of standard gauge, you get the problem of going down from a wide gauge to a narrow gauge. There is a lot more space to fit a traction motor to a standard gauge bogie than a Cape gauge bogie, so typically the traction motor under a standard gauge bogie is bigger. So moving a locomotive from standard gauge to a common gauge in Africa is a lot more challenging. The move from metre gauge to 1067 is not a problem: the interoperability of locomotives across the region is good and this happens frequently. As a leasing company, we can manage this and it is not a big cost to make the change and redeploy the asset elsewhere.

The vast majority of track in Africa is non-electrified, and I foresee this being the case for a number of years. We will maintain a diesel-based traction environment for some time.

A Leasing Pool

Take an example where there has been a derailment, and the operator needs an interim power solution quickly. We would then use our existing fleet, if the specifications fit, to meet those requirements. For a lease pool in the traditional sense to succeed, though, one needs a certain amount of activity and demand from the region, and whilst there is a market for this, it is not quite buoyant enough. Currently there is an over-supply of interim power.

  • Best-of-breed maintenance procedures. Leasing lives on the strength of the residual value of assets, so maintenance becomes critical. At Traxtion Leasing, we link leasing to Traxtion’s ISO9001 certified maintenance offering, which means the assets do what they are supposed to: they work!

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Sale And Lease Back Projects

Provided it is well maintained, rolling stock has a long life cycle. A typical fleet will have an average age of 15-20 years, although it is not uncommon to see rolling stock in service that’s more than 50 years old. The intrinsic value of that rolling stock is significant, so where companies need to raise capital, one of the “low-hanging fruits” available to them is to enter into a sale and lease back agreement. The leasing company procures those assets, releasing cash back into that company for investment elsewhere, and then leases the assets back to the customer. This can include a few enhancements as part of the leasing programme, including the modernisation of that fleet, gradual upgrades and even a replacement programme over the fleet of rolling stock, be it wagons or locomotives. To upscale those assets to improves the efficiencies of those assets. Purchase options can be included as part of these programmes should the railway wish to bring these assets back on balance sheet.

There are also interesting things one can do around rail cargo management and extracting additional efficiencies from freight flows, ensuring better use of the assets. This is an area that we have not even begun to scratch the surface of in Africa, and we believe there is huge potential in this model.

Optimal Length Of Lease

The lease tenure really depends on the requirements of the customer first and foremost, and as a leasing company, one tries to be as flexible as possible. If a customer requires a short term - for example, the life of a mine or rights of an asset are only for a defined period - the leasing company will look at the redeployment possibilities of the assets at the end of the period. It also depends on finding the right sweet spot: in raising cost-effective finance, there is a period where the residual value of the assets and residual value of the debt is so high that it makes leasing for a short period very expensive. So the first thing is to try and develop a solution around what the customer needs and the cost-effective point of the underlying funding. By the same token, long-term leases are also not ideal, as the leasing company is then not embracing the residual value risk. Each situation needs to be looked at individually.

Developing The Business Case For The Mining Sector In Africa

The business case for the mining sector is becoming less about the type of commodity being bulk or refined and more about the economic fundamentals that underpin that commodity. Some commodities like copper and coal look good, but iron ore is looking tough. Bulk commodities are historically well-suited to rail: the heavier, the longer, the better for rail. However, the actual commodity is less important than the fundamentals of the business case. The rolling stock investment decision for a leasing company is always going to be based on the capacity of what the customer needs – so whether it is bulk coal or refined copper we can find a solution.

For railways to really succeed in Africa, you need the financial capacity to invest in what is below and above rail. One of the key challenges for the mining sector is access to rail-related infrastructure.

The strategic decision behind our recent investment and the launch of the Traxtion Group into separate business units allows us to service our customers based on what their need is: for leasing, there is Traxtion Leasing; for the development of infrastructure such as an investment into a spur or track refurbishment, we have Traxtion Projects; for rolling stock maintenance and rail operations, we offer this through Traxtion Sheltam. We develop skills for train drivers and formal operations through our Rail School. What this means is that we as the Traxtion Group are able to meet the specific needs of our customers by positioning ourselves as specialists in each service that we offer.

In The Leasing Environment How Does Insurance Work?

Typical asset insurance is relatively straightforward: we engage with insurers who have a presence on the continent. It gets interesting where we can access ECA funding, as this funding comes with commercial risk and political risk insurances. In the days when ECIC still had an interest rate subsidy, South African manufacturers were really efficient, as the funding lines we could get from South African banks were on a par with anything we could get in the rest of the world. This meant South African rolling stock manufacturers had a good leasing offering that they could put into the market with effective funding lines.

When leasing products into Africa there are commercial insurance products that one can buy when products are manufactured in South Africa, that cover both commercial and political risk, but they are expensive. If you are procuring from other countries with really cost effective commercial and political risk enhancements, this can be the difference between leasing or not leasing.

The Luxembourg Rail Protocol

The Luxembourg Rail Protocol brings to the rail sector the same benefits that the Cape Town Convention brought to the aviation industry: a central registry of ownership and title of railway assets. This brings certainty of ownership, which in turn brings a reduction in financing charges – which ultimately translates into a reduction of freight charges. This means that we can become more competitive against road, and we would be able to create more freight for our railways. It really is one of those steps that will allow Africa to advance and there is no downside to it.

The Luxembourg Rail Protocol should be embraced by every country in Africa with rail operations. What will really drive the success of the protocol is if that central registry is also recognised in local legislation. The Rail Working Group is making good progress in this.

For more on the Luxembourg Rail Protocol refer to www.railworkinggroup.org

Full Speed Ahead For Leasing

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