Transport Investment Limited

European wagon lessor Ermewa is reported as for sale, and bidders will need to make sense of a rapidly changing rail freight market, driven by changing energy policy, EU/China trade patterns, and Covid-induced business transformation

Recent press reports suggest that French state rail operator SNCF has instructed Lazards to initiate the process of selling its freight wagon leasing subsidiary, Ermewa.

This is in itself significant – an early sign that the huge financial stress created by Covid may encourage government-owned entities to explore asset sales as a means of controlling public debt and as an alternative to unpopular tax rises. This is in conflict with the currently-fashionable narrative that ultra-low interest rates, and monetary expansion, have removed any practical constraint on government borrowing, and will usher in a new era of state-controlled transport – which seems to be the current consensus within the UK political class.

It is a basic feature of the rail freight business that wagon types are highly specialised, and the fleet mix must relate to the traffic carried. There is usually limited scope to modify wagon types to carry alternative commodities, at least without significant engineering modification and cost. Investors therefore need to make sense of the fast-changing landscape for rail freight across Europe.

Research by TIL highlights the challenges and opportunities that bidders will need to confront.

Ermewa is large - the second largest wagon lessor in Europe:
- Almost 100,000 wagons in total:
  - c. 42,000 wagons
  - >350 wagon types
  - plus a further 60,000 tank containers through its subsidiary companies Eurotainer and Raffles
- operations across 13 European countries stretching across from Bulgaria and Romania to France, Spain and north west to the UK and Sweden
a fleet mix that may not meet future demands for wagon types, driven by huge market changes – see below
a significant opportunity to expand new wagon investments beyond its French home market

Interestingly, Ermewa now holds SNCF's core 'Fret SNCF' wagon fleet, and it will be interesting to see if this rolling stock is retained by SNCF, or sold as part of the portfolio and more importantly how will the cooperation continue in the longer term.

The sale represents a retreat from SNCF's previous policy of gradually increasing its shareholding in this business (it has held 100% since 2010), and highlights the pressure on even the mighty French state railway - whose accumulated debt was once memorably described as "visible from the moon".

In recent years Ermewa's policy has seemingly been to concentrate much of their new wagon investment in France, and to cascade older stock into eastern European markets that have been absorbed into the EU - which increasingly determines railway policy across its 27 members, and which has compelled rail freight liberalisation.

The new owners will need to make sense of an inherited wagon fleet that now faces multiple changes to the underlying market that drive demand for wagon types:

An accelerating shift in energy from fossil fuels to electricity, that will reduce demand for oil, gas, petroleum and coal wagons, and which has been worsened by Covid-induced reductions in demand
The EU's strengthened alliance with China, and the remarkable growth over the last five years in ultra-long-distance rail freight from China to/from Europe, which will require expanding fleets of suitable wagons
Growing political demands to substitute rail for road freight – driven by concern about road congestion and air pollution - which will require much bigger fleets of container flat wagons for general freight within European markets

These are the challenges of growth.

TIL's detailed analysis of Ermewa's fleet and traffic exposure suggests that bidders have to confront three simultaneous challenges:

Investment to replace ageing wagons that are approaching life expiry
big changes in the fleet mix, to meet the market changes listed above
new fleets for expanding markets

TIL's analysis suggests that Ermewa may be over-weight in certain types of wagons, and underweight in the rolling stock types needed to serve the most attractive growth markets.

Nonetheless, the opportunity for Ermewa is very large. Indeed, the market scope for rail freight may be the greatest for over 60 years. SNCF will not be alone in facing severe cash constraints, which suggests even more opportunities for wagon leasing businesses to gain scale from state railway operators who have traditionally bought and owned their own wagon and whose former freight monopolies have been eroded by EU liberalisation.

Substantial capital will be needed, but wagon leasing represents an attractive asset class, that provides investors with a means of playing long term economic trends around energy transition, globalisation and rail freight liberalisation.

Ermewa wagon fleet summary - extract from TIL database:

c 6,000 steel wagons - typically specialist wagons for carrying specific types of steel e.g. coil or pipes. Most based in France, with some on the Vallourec traffic out of the Ruhr area in Germany and a smaller gauge UK fleet for use in Llanwern and Port Talbot steelworks

c 5,000 tanks for carrying oil products - to carry heavy products such as fuel oil or lighter products such as petrol and jet fuel (both of which will be subject to lower demand in the short, if not, long term)

c 3,000 tanks for carrying gas products – As with their many grain wagons, many of these are very old, but are getting a 2nd lease of life in Eastern Europe working out of the Black Sea oil terminals.

c 3,000 intermodal flat wagons - nearly all in France. A small proportion of the overall fleet and a tiny fraction of the European market. Lots of opportunity to expand in this area

c 500 sugar and coffee polybulk wagons - A specialist wagon, with minimal growth prospects and all based in France

c 5,000 aggregates wagons - significant number registered in France and Germany (2nd hand vehicles from France) and some in use on chemical traffic in Czech Republic. Many are capable of being used for coal and coal products and in the long term the area of growth will be in the construction industry as each country tries to build its way out of its Covid financial troubles (e.g. HS2)

SOURCE: TIL ANALYSIS

For anyone interested in knowing more about the Ermewa fleet (wagon age, type, location, etc), the flows they operate on, who they operate for and the future prospects for these flows, please contact TIL - [email protected]