The first half of 2016 has seen its share of volatility. Globalization, central bank actions, the impact of the internet (speeding the flow of information and creating social networks), Presidential election politics, acts of global terror, and Brexit are all phenomena that have contributed. Historically, markets have not been as volatile.
Declining rail freight volumes continue to pressure North American Railroads[1]. July carloads declined 8.8%, led by coal at 17.5%[2] (U.S. coal production has dropped to its lowest level since 1981[3]). Crude by rail has declined 45% in 2016[4]. Class One railroads are storing more locomotives and railcars[5]. With less equipment on line increased train speeds have allowed the roads to more efficiently serve customers, further reducing equipment demand. Air travel is down due to terrorism and currency swings. Lower jet fuel pricing has improved margins and allowed air carriers to add capacity; the resulting competition has reduced revenue per available seat mile and increased pressure on air carrier yields.
Economic activity drives traffic, and demand for transportation influences equipment pricing at the margin. Transportation services cannot be ‘stored’. Unsold seats on a flight, unused air-cargo capacity, empty freight cars, and parked locomotives represent lost revenue. Are we at a bottom? The 34 nation Organization for Economic Cooperation and Development (‘OECD’) thinks so. The OECD expects U.S. growth, as measured by GDP, to slow to 1.8% in 2016, but to then accelerate in 2017 to 2.2%[6].
Political, policy, business, and investment leaders constantly grapple with the increasingly fickle cycles of consumer and business confidence. Is the world is in a ‘rut’ because of a chronic shortage of demand for goods and services and an extended period of low interest rates[7]? Short term thinking, uncertainty, over regulation, anxieties, and a lack of confidence in the future have impacted our economy’s structural growth rate and contributed to a deterioration in productivity. When economic freedom is suppressed, growth fades, and when growth fades it takes the American Dream with it. Our Presidential candidates? If elected, one has stated, “coal miners and coal companies will be put out of business[8]” as part of a clean energy agenda. In contrast, the other would reduce taxes and government regulation.
In this environment, agility, adaptability, and an open mind are essential tools. Asset allocation is critical and risk management is key. Volatility creates opportunities to buy equipment at discounted prices. Experience teaches staying the course proves its virtue in the long run. A long investment horizon diminishes the effects of volatility. Traffic may be down, but we expect it will stabilize through the rest of this year.
Choose wisely. Work with a firm that has a history of excellence, expertise and ethics. Call RESIDCO!
[1] Moody’s Investors Services, May 16, 2016.
[2] Association of American Railroads (‘AAR’) July, 2016 weekly U.S. rail traffic reports.
[3] Truewealth Publishing, July 21, 2016.
[4] August 3, 2016, U.S. Energy Information Administration, a division of the U.S. Department of Energy.
[5] Progressive Railroading, Rail News: Mechanical, Fleet Stats, July 2016.
[6] The Associated Press, June 17, 2016.
[7] Larry Summers, “Zero interest rates are a systemic inhibitor of economic activity.” Bloomberg Businessweek, May 12, 2016.
[8] May 2, 2016 Democratic presidential nominee, at a round table discussion with locals at the Williamson Health and Wellness Center in Williamson, W.V.
Aviation investment is driven by profitability and the prospect for future growth. Recent mergers have resulted in the number of major carriers in the U.S. decreasing from 10 to 4[1]. This consolidation has created an oligopoly and helped the remaining players[2] take a more balanced approach to capacity management. They now control 80% of the domestic market and a good portion of the international market. With better control of available seat capacity and a developing consensus that jet fuel pricing is going to stay low for the foreseeable future, the industry has become attractive to investors[3]. Add new sources of revenue like charging for baggage, premium seats, and early boarding, combined with fuel saving new engine and equipment technologies and you have double digit returns on invested capital. With high barriers to entry, pricing control, and management talent, the industry appears positioned for a bright future.
Operator fleeting decisions are based on mission, seat mile profits, operating cost, maintenance requirements, reliability, flexibility, and fleet commonality (for pilot substitution, training and spares inventory purposes). Earnings and profit making capability of equipment is valued. Newer aircraft have higher ownership acquisition cost but lower emissions, lower fuel cost, maintenance savings, and a better passenger experience; but, in the current fuel market, the efficiency gains of newer models do not offset their higher ownership cost. New equipment will be needed to serve market growth, but the economics of investing in mid-life aircraft remain.
Since demand is sensitive to the business cycle and equipment supply, investment horizons require the ability to identify appropriate market entry and exit opportunities. Long asset lives require knowledge throughout the investment term and skill to determine the impact of new technologies, exogenous market events, replacement demand, competing aircraft values and investment economics[4].
There are a lot of different kinds of planes. Which are the most profitable? What is the optimal time to enter and exit? Keys include age, seats, units sold and remaining in service, combined with an analysis of a carrier’s mission, market, models, engines, avionics, and fleet operations dynamics. Is the equipment market liquid, can equipment be traded, reconfigured or parted out? Knowledge of asset values and lease rates allow a connection of investment choices with outcomes and translation of these opportunities into action. It requires searching for the best opportunities, both here and abroad, and an experienced management team with a focused investment strategy.
With profitable experience and deep relationships, we effectively manage asset concentrations, credit exposures, and counterparty risks. For long-term strategies and an in depth understanding of the characteristics of aviation equipment combined with the ability to select and manage asset investment for better than average returns contact us directly.
RESIDCO, aviation and transport investment specialists.
[1] Consolidations include Delta and Northwest in 2008, United and Continental in 2010, Southwest and AirTran in 2011, and American and US Airways in 2013.
[2] American, Delta, United, and Southwest.
[3] Warren Buffet picks a company or industry based on his estimate of its success over the next 10 to 20 years. He’s recently invested in U.S. airlines. Why? The industry is enjoying strong finances and good control over capacity.
[4] United Airlines, for example, recently decided to refurbish all 21 of its B767 aircraft that had originally been slated for retirement. Delta extended the use of 15 of its B757s.
Government taxes to encourage (or discourage) a variety of economic activities. The rates set influence the market’s required before-tax rates of return for both individual and business investments. From a social standpoint, taxes are designed to finance public projects, redistribute wealth, and provide basic services. Since self-interest is basic to human nature this creates private incentives to engage in tax planning. Such planning has long earned the blessing of the U.S. Courts.
When you invest, whether you are an individual, or a business owner, the taxing authority is your silent and ‘uninvited investment partner’. Effective planning involves more than being aware of current marginal rates; it requires an evaluation of the longer term results of your decisions, not just for yourself but for all participants. Each party and counter party has their own current and future marginal tax rates. These future expected after tax cash flows affect current actions and decisions. Understanding this concept is important since it directly influences the prices at which assets are traded now, and, what future pricing might be.
Naturally, most taxpayers pay no more tax than they believe they must. And they spend their time and money to arrange affairs to keep their tax bite as ‘painless’ as possible. Remember, money spent on tax planning is ‘tax deductible’, and the tax savings generated are ‘tax exempt’ because they reduce taxes payable.
Are increased taxes good policy? In 1997, Bill Clinton agreed to lower capital gains rates to 20% based on economic literature suggesting the lower rate would yield more tax revenue. It did. Yet Hillary has proposed to nearly double the top tax rate on long term capital gains to 43.4% from 23.8%. Under current tax policy, ‘capital gains’ are taxed as ‘ordinary income’ if an investor has held an asset for less than a year. After 365 days the current top long term gains rate of 20% applies (plus the 3.8% Obama Care surtax on ‘unearned’ income). Hillary has suggested a ‘sliding scale’ approach requiring ‘capital gains’ tax rates during the first two years holding period of 43.4%, year three, 39.8%, and 35.8% in year four. Investments would have to be held for more than six years to qualify for the current 23.8%[1].
Economists generally will agree that a system of competitive markets is remarkably efficient. Remember Ronald Reagan was elected in 1980 with his message that government is ‘the problem’ and economic freedom was ‘the answer’. The dominant lesson of the Great Depression and the Great Recession is that when Government overspends, overtaxes, and over regulates, economic freedom is suppressed and economic growth is impacted[2]. How is transportation investment best and ethically encouraged? Transportation asset Investors with a sound investment strategy hold diversified asset positions intended to weather volatility on the way to their longer-term objectives. Working with a firm that has a history of excellence, expertise and ethics produces results.
Call the air and rail transportation experts. Call RESIDCO!
[1] National Center for Policy Analysis, Hillary Clinton’s Capital Gains Tax Proposal, Brief Analysis No. 825, April 14, 2016 by Pamela Villarreal.
[2] WSJ, “Why This Recovery is So Lousy”, August 4, 2016, Phil Gramm and Michael Solon.
The most important decision an investor makes is the composition of his or her investment portfolio. That is what ultimately acts to determine the level and potential variability of returns. Research shows dissimilar asset classes act to increase returns while reducing risk. From an investment perspective, an aircraft or railcar under lease represents a stable and recurring monthly cash flow immune to short term swings in the market throughout the industry cycle. Real assets create real options, cash flow certainty, and economic value.
The world’s economic growth has dropped from 4.9 percent a year from 1951 to 1973 to an average of 3.1 percent for the balance of the last century. And, since 2000, GDP growth in the U.S. has been persistently low, averaging 2 percent, with world economic growth similarly sluggish. What drives market expansion and economic growth? New technologies, productivity improvements, the ability to produce, the desire to buy, access to capital, demographics, and investment in education and capital equipment. Broad based economic growth ‘lifts all ships’ creating opportunities, raising living standards, expanding access to services and most importantly allowing each of us to chart our own future.
Sound volume growth prospects are a major reason to include commercial aircraft in your ‘real asset’ investment spectrum. International air traffic has been distinguished by high growth rates. Global air traffic (passenger) has grown at an annual average of 4% in the last decade (despite 9/11 and other external shocks)[1]. This growth reflects increased globalization and the international division of labor. Air transport cost has tended to fall as a result of increased competition, improved engine technologies, larger aircraft, and lower cost jet fuel. On the rail side, the roads are focused on the fundamentals of providing reliable service and controlling cost as crude oil and coal freight volumes have fallen (there are many examples of striving to solve investment challenges only to find efforts defeated by events occurring in a larger context).
Holding air and rail investment requires management by a specialist organization. Risk management is complex and depends on portfolio credit quality and desirability of individual aircraft and railcar types. It’s not merely a question of loan or lease to value, but the relative importance of the unit to the operator, which governs whether they are likely to continue to operate the collateral in bankruptcy. In weak markets, extending the period an airline or rail carrier continues to operate the aircraft or railcar provides a better result than selling into that weak market.
Today, fixed income yields are low and the volatility and dampened expectations in the equity markets argue that portfolio construction and manager selection are critical. The future is uncertain. How do you grow and protect value over an investment horizon’s duration? It comes down to two important investment related disciplines; managing risk, and managing volatility. With investment clarity and consistent focus ‘real asset’ managers do this well. Our firm has a history of excellence, expertise and ethics. Team with experienced investment managers. Call the air and rail transportation experts.
Call RESIDCO!
[1] Source, IATA.
Government taxes to encourage (or discourage) a variety of economic activities. The rates set influence the market’s required before-tax rates of return for both individual and business investments from a social standpoint, taxes are designed to finance public projects, redistribute wealth, and provide basic services. Since self-interest is basic to human nature this creates private incentives to engage in tax planning. Such planning has long earned the blessing of the U.S. Courts.
When you invest, whether you are an individual, or a business owner, the taxing authority is your silent and ‘uninvited investment partner’. Effective planning involves more than being aware of current marginal rates; it requires an evaluation of the longer term results of your decisions, not just for yourself but for all participants. Each party and counter party has their own current and future marginal tax rates. These future expected after tax cash flows affect current actions and decisions. Understanding this concept is important since it directly influences the prices at which assets are traded now, and, what future pricing might be.
Naturally, most taxpayers pay no more tax than they believe they must. And they spend their time and money to arrange affairs to keep their tax bite as ‘painless’ as possible. Remember, money spent on tax planning is ‘tax deductible’, and the tax savings generated are ‘tax exempt’ because they reduce taxes payable.
Are increased taxes good policy? In 1997, Bill Clinton agreed to lower capital gains rates to 20% based on economic literature suggesting the lower rate would yield more tax revenue. It did. Yet Hillary has proposed to nearly double the top tax rate on long term capital gains to 43.4% from 23.8%. Under current tax policy, ‘capital gains’ are taxed as ‘ordinary income’ if an investor has held an asset for less than a year. After 365 days the current top long term gains rate of 20% applies (plus the 3.8% Obama Care surtax on ‘unearned’ income). Hillary has suggested a ‘sliding scale’ approach requiring ‘capital gains’ tax rates during the first two years holding period of 43.4%, year three, 39.8%, and 35.8% in year four. Investments would have to be held for more than six years to qualify for the current 23.8%[1].
Economists generally will agree that a system of competitive markets is remarkably efficient. Remember Ronald Reagan was elected in 1980 with his message that government is ‘the problem’ and economic freedom was ‘the answer’. The dominant lesson of the Great Depression and the Great Recession is that when Government overspends, overtaxes, and over regulates, economic freedom is suppressed and economic growth is impacted[2]. How is transportation investment best and ethically encouraged? Transportation asset Investors with a sound investment strategy hold diversified asset positions intended to weather volatility on the way to their longer-term objectives. Working with a firm that has a history of excellence, expertise and ethics produces results.
Call the air and rail transportation experts. Call RESIDCO!
[1] National Center for Policy Analysis, Hillary Clinton’s Capital Gains Tax Proposal, Brief Analysis No. 825, April 14, 2016 by Pamela Villarreal.
[2] WSJ, “Why This Recovery is So Lousy”, August 4, 2016, Phil Gramm and Michael Solon.
Times are changing! Expect a pro-growth business policy agenda in Washington (with little to no Congressional gridlock). Competitive tax rates. Less restriction on energy reserves, shale, oil and natural. Approval of the Keystone XL oil pipeline. A cut in regulatory red tape and an end to the ‘war on coal.’ A reform of Obamacare and a review of trade agreements. The objective? Benefit Americans and bring back jobs. Most economists now expect higher GDP, inflation, interest rates, and tax and regulatory relief, along with a stronger dollar in 2017.
In this environment, transportation equipment leasing equipment provides both an opportunity to invest and a source of cash. While it is affected by demand and supply changes, transaction activity and trends in the overall economy, it acts as a hedge against inflation since shorter term leases have the ability to reset rates, and inflated asset values are a source of leverage. Both Air and Rail investments operate in transparent markets with predictable cash flows, downside risk protection, and relative liquidity.
The rails transport the bulk of major products for industrial and personal use. This year a bumper grain crop and record soybeans (shipments are up 6.5% this year), with autos maintaining lofty levels are offsetting other commodity groups (coal, intermodal, and petroleum) which remain challenged. Expect rail fundamentals to improve with growth in the industrial economy.
Air operates in a global network. It generates strong cash on cash returns. Inefficient older engine technology is being replaced with new engine options which produce a 20% fuel efficient operating cost per seat improvement. Warren Buffet bought the Burlington Northern in 2009. Now he is investing in airlines. His Berkshire Hathaway SEC filings show the company has taken a stake in three of the four major U.S. airline companies[3] and an undisclosed stake in Southwest. Avolon is completing the acquisition of CIT’s aviation portfolio for $11 Billion. Airlines are issuing secured debt[4].
Transportation equipment investment means the ability to earn attractive profits. Exogenous shocks do occur. The solution is to invest in real assets where equipment valuation, utilization, rent levels and fundamentals are understood. Where are the tools and processes for making these investment decisions? Where is a reliable source of strategic insight? Build your portfolio with a team of experienced transportation equipment managers who are brilliant on the basics. A team that has practical tools and experience. A firm with a history of excellence, expertise and ethics.
Call the air and rail transportation experts. Call RESIDCO!
[1]The ability to pass legislation, ratify treaties, have Cabinet members and Supreme Court Judges approved comes with party control of both Houses and Administration. Will Republicans stay united?
[2] Renegotiate NAFTA? According to the treaty, any of the three signatories can withdraw from the agreement six months after notifying the other two parties.
[3] Deutsche Bank believes the sector will benefit from lower regulation under President-elect Donald Trump. The airlines contribute $1.5 trillion to the U.S. economy, and provide 10 million jobs, November 15, 2016, Investopedia.
[4] American issues $1.21 billion in EETCs to finance acquisition of 298 new aircraft with a book value of $1.66 Billion.
RESIDCO’s size and wholesale capability is a competitive advantage. We respond quickly and creatively to ever-changing market conditions.
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Chicago IL 60602 – 4275
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