The global rail market is on a roll and might just add some locomotion to the infrastructure sleeves within investor portfolios. Consider that the value of the global rolling stock market exceeds $50 billion, and is projected to reach about $65 billion by 2025, driven by an increase in demand for freight and passenger transportation. (Rolling stock is locomotives and other vehicles used on a railroad.) The bulk of the growth is projected to be in Eastern Europe, Latin America and Asia, and can be attributed to the ongoing expansion of railway networks. However, European and North American markets are anticipated to continue expanding at a compound annual growth rate above GDP growth, driven by demand for more sustainable and energy-efficient modes of transport. Fueled by the underlying growth of the rolling stock market, the rail leasing market is anticipated to expand.
The U.S. rail system consists primarily of more than 600 railroads developed for freight transportation. Freight rail networks are nearly always privately owned, with network and services typically controlled by the same entity, including some of the world’s largest rail freight companies. The government regulates rail freight services via the Department of Transportation and other regulatory bodies such as the Surface Transportation Board, which is responsible for approvals of new tracks, market access, transactions involving rail carriers, rates setting and service continuity. Passenger rail services make extensive use of freight rail networks, and are mainly government-owned, including Amtrak, while commuter rail networks are typically supported by state and local governments. The United States tends to lag other mature regions for the level of development of its passenger rail network, and high-speed passenger rail, with the new administration planning to allocate more than $60 billion for the modernization of networks over the coming years.
Several key drivers are expected to support the growth of the rail market globally. A dynamic global trade environment and continued technological evolution in the form of digitalization and automation of rail represent global trends driving the need for new rail capacity, while also having positive effects on safety. Emerging markets are supported by favorable demographics and ongoing urbanization underpinning rail demand. Developed markets, and Europe in particular, are characterized by increased focus on transport decarbonization and development of common rail standards.
Locomotives represent an essential component of the rail market, as they provide the motive power of a train. Across Europe investors can expect an increase in locomotive leasing, due to the ongoing liberalization of freight and passenger operations.
Locomotives have no payload capacity of their own, as their sole purpose is to move the train along the tracks. Demand for locomotives tends to be particularly predictable. In fact, despite demand for wagons proved relatively stable historically, the number of wagons used for a train may be in theory dependent on how demand for freight may fluctuate, while locomotives remain essential to power the train independently from the amount of train carriages. A classification of locomotives is based on their power source, mainly electricity or diesel. While European rail networks are largely electrified (54.3 percent) and employ electric locomotives, most of the North American passenger and freight rail market is powered by diesel locomotives, due to the lack of network electrification. Some European rail networks, such as in parts of the United Kingdom, may lack complete electrification. In these markets, dual-fuel locomotives may be used, which are capable of flexibly switching between diesel and electricity. As decarbonization policies evolve, there is likely to be more extensive use of biofuels and gas to reduce the emission of diesel locomotives and a gradual electrification of networks to reduce carbon emissions, where deemed economic to do so. In the medium term, as technological evolution progresses, expect new locomotives to use alternative fuels such as biogas or hydrogen, with indications that the first hydrogen-powered locomotives may come to the market by 2024. The global locomotives market is anticipated to expand, positioning the locomotive leasing market for growth over the coming years.
Rail freight is estimated to produce five times less greenhouse gas emissions than road freight. The European Green Deal calls for a substantial part of the 75 percent of inland freight carried today by road to shift to rail and inland waterways. As a result, the European Commission predicts rail freight traffic to increase by 50 percent until 2030 and to double by 2050. Rail Freight Forward, a coalition of European rail freight companies, aims to boost the share of freight rail from 18 percent in 2018 to 30 percent by 2030.
The market share of rail freight transport is generally above 25 percent of the total modal split in northeastern Europe, while across most western European countries, such as France and Spain, it is below 12 percent but expected to accelerate meaningfully over the coming decade.
Passenger rail includes various types of vehicles, such as multiple units, high-speed rail, metro and light rail, that provide services across different distance ranges and passenger markets segments, each with specific business fundamentals, risks and growth profiles.
Despite the expectation that traditional infrastructure be “bolted on the ground,” there has been interest in rail from infrastructure investors. Historically, private core infrastructure equity investors have focused on passenger rolling stock deals providing services to train operators, under long-term lease agreements with limited fleet re-lease risk and a transparent regulatory framework, such as the U.K. passenger rail franchise model. These deals focused mainly on long-term contracts with a limited number of high credit-quality customers, often directly backed by governments and public authorities. For this reason, core infrastructure investors focused mainly on countries with mature institutional frameworks, such as the United Kingdom, France and Germany. Core-plus strategies have historically focused on procuring new passenger rail fleets, with greenfield risk mitigated by long-term contracts and a transparent regulatory framework. More recently, core-plus investors have been acquiring stakes in operational locomotive and freight leasing wagons or industrial railcar platforms, with a diversified customer base and high contract renewal rates. These deals were also structured as joint ventures with European incumbents, leveraging combined operational and financial expertise to optimize profitability, while also supporting platform expansion and value creation via active asset management and M&A.
The industry of rolling stock manufacturers is relatively concentrated and supply is limited, particularly given the high technological expertise, sophisticated machinery and large upfront capital required for construction. Although locomotives manufacturers may sometimes differ from multiple unit train manufacturers, generally the five main global rolling stock manufacturers account for more than 70 percent of the global market share for rolling stock construction and play a pivotal role for maintenance. The rolling stock manufacturing process is complex, costly and time consuming, involving a variety of parts suppliers, and with a typical time lag of three to four years between signing of contract, design, manufacturing, assembling, testing and delivery. However, timeframes may vary materially, ranging from three to four years for trains, such as electric multiple unit trains, to one to three years for locomotives, and 12 to 18 months for wagons. Moreover, the procurement process for new trains is typically complex, and it can require more than 18 months to specify design, type and number of vehicles, budgeting and arranging financing.
The structural characteristics of the rolling stock manufacturing market are one of the key drivers supporting the growth of the rolling stock leasing market, particularly for freight.
Over the past two decades, U.K. regulation has incentivized a separation between rail owners and service providers for passenger transportation, contributing to the development of the European rolling stock leasing market. The need to modernize existing fleets — which have an average age of over 25 years across Europe and North America — and a growing passenger and freight rail market have contributed to increase demand for rail leasing services. Moreover, with the rolling stock procurement process requiring dedicated expertise and long lead times, freight operators have increasingly found in rolling stock leasing a solution for flexible fleet management, and a way to externalize noncore business.
Rolling stock represents a relatively niche market for private infrastructure investors, with global average transaction volumes of around $5.6 billion per year, representing about 2 percent of global annual transaction activity. The European market has historically been the most active, supported by liberalizations of the rail sector. There has been an acceleration in transaction activity since 2010s due to privatizations, sale and leaseback and greenfield transactions.
Given the relatively limited size of the rolling stock leasing market for private infrastructure investors, data availability on deal entry prices is relatively limited. Rolling stock leasing deals may support both core and core-plus private infrastructure investment strategies.
This article was excerpted from the DWS report Rolling Stock and Infrastructure Investors. Read the complete report at this link: https://bit.ly/3EMpKIf