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Rail Traffic – Simple Answers?

Rail Traffic Landscape

AAR statistics demonstrate rail freight traffic volumes correlate closely with changes in overall GDP (except for grain, coal, and crude oil product movements, which are not tied to GDP). With tax policy improving the outlook for GDP growth (2018 is now expected to be 2.9%[1]), the Conference Board index of leading indicators is the highest it has ever been (at 108.1); and similarly, consumer confidence is the highest it’s been since November 2000 (at 130.8[2]).

Improving jobs[3], wages, and higher after-tax pay will lead to rising consumer spending. More spending will lead to higher rail traffic (February was the best month ever for crushed stone and sand). Yet year to date rail traffic is failing to keep pace with 2017: what about those ‘other’ commodities that move independent of GDP?

Grain

Grain loadings include barley, corn, oats, rice, rye, sorghum, soybeans, and wheat. Overall demand of U.S. grains remains strong since U.S. farmers produce three-quarters of the nation’s food. But America’s agricultural dominance has eroded as our share of global corn, soybean and wheat exports has shrunk by more than half since the mid-1970s due to bumper crops from Brazil and Russia. At the margin, exports remain important (with Asia, driven by China, remains a top export market).

Coal

Coal based electricity generation now accounts for 30.1% of U.S. electricity generation, with natural gas at 31.7% and renewables at 9.6% (the balance generated by nuclear, hydro, and ‘other’). Global market forces are driving export of steam and metallurgical coal to Europe and other parts of the world. In the U.S. met-coal market is strong, but the steam side is weaker due to the market’s turn to the now less expensive natural gas (thanks to the fracking boom).

Crude Oil

Crude Oil output is increasing due to rising crude prices. Exports of crude and petroleum products have more than doubled since 2010 (restrictions on exporting domestically produced crude were lifted in December 2015). The Energy Information Administration reports U.S. crude oil production averaged 9.3 million barrels per day (“b/d”) in 2017 and expects U.S. crude oil production to be 10. 7 million b/d in 2018.

The result? As of March 1, 2018, 327,816 freight cars (19.9% of the 1.6 million-unit North American rail freight car fleet) have not moved loaded in the previous 60 days[4]. Car types in storage? Grain covered Hoppers 29%, Crude Oil Tanks 33%, Coal Gondolas 13% and Open Top Hoppers 13%.

Whether Trump’s ‘tariff gambit’ is a negotiating tool to ‘improve’ international trade and NAFTA renegotiations, or meant to improve U.S. domestic steel and aluminum production and jobs, steel imports continue to flow in [5]. Half of global steel production goes into buildings and infrastructure with sixteen percent used in automobiles, shipping and rail transport production. Lower priced imports have held inflation in check. From 2010 to 2015 annual inflation as measured by the CPI averaged 1.5%; but for 2016 and 2017 rates inched up to 2.1%. This January’s inflation report showed the Producer Price Index advancing by .7%! Tariffs will force railcar manufacturers to increase new car pricing. Scrap metal pricing will increase and encourage the retirement of older railcars. Expect asset values and lease rates on existing rail equipment to improve.

No simple answers. It’s data, knowledge, and experience that drives results. Call RESIDCO.

 

 

[1] Wall Street Journal, March 16, 2018, Forecasters Fret Over Trade Rifts, page A2.

[2] Additionally, the University of Michigan consumer sentiment index was 102.0 in March, highest since January 2004.

[3] Job growth was strong in February with 313,000 net new jobs created (the 89th straight month of net job gains, the longest streak on record).

[4] 296,376 moved empty since their last loaded move, while 31,440 that had not moved are believed to be in storage, still loaded.

[5] Even with the dollar weakening (since the beginning of 2017).

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An Investment Roadmap – Risk-Adjusted Returns

When comparing investment returns it is misleading to simply look at headline figures. At first glance, it might seem an investment that gained 12% last year is better than one that gained 9%. In reality, it depends on how much risk was involved in generating those returns. The more risk (or volatility), the less probable the returns. The simplest way to measure risk is to look at the standard deviation of the returns. The larger the standard deviation, the riskier the investment.

Investors use the ‘Sharpe’ ratio, a ‘rewards to variability ratio’ to better compare alternatives. The ratio uses the standard deviation (a measure of volatility) to measure the ‘risk adjusted’ return. It’s a measure of the excess return over the risk-free rate relative to the standard deviation. It helps answer the question: “Is the ‘risk adjusted’ return worth the investment risk I am taking”?

Investing in commercial aircraft has historically demonstrated returns that adequately compensate for variability. Aircraft are hard assets with long useful lives*. It’s common for a commercial jet to remain in service 25 years or more. Some even longer, such as a 1970 Boeing 737-200 (serial number 20335), which is still flying with Airfast Indonesia (registration PK-OCG, based in the city of Jakarta, Surabaya and Denpasar). At 47 years, it may be the world’s oldest commercial passenger aircraft still in service (the second oldest 737 is registered to Johannesburg based Interair, South Africa, and, Kenya’s Trans African Air has a 42-year-old 737).

Profitability is just as important as equipment longevity. The International Air Transport Association forecasts global air carrier profitability will rise to $38.4 billion in 2018, up from an expected $34.5 billion in 2017. Operating margin, overall revenue, passenger and air cargo traffic, and average profit per departing passenger are all improving. 2018 is expected to be the fourth consecutive year of sustainable profits with a return on invested capital of 9.4%, which exceeds the industry’s average cost of capital of 7.4%.

IATA’s Director General and CEO recently stated: “These are good times for the global air transport industry. Safety performance is solid. More people than ever are traveling. The demand for air cargo is at its strongest level in over a decade. Employment is growing. More routes are being opened.” Operator challenges include fuel, labor, and infrastructure expenses which are rising. Performance drivers? Passenger and cargo growth. All regions are expected to report improved profitability in 2018. Global connectivity is vital to our modern lifestyle.

As a pilot, you identify and avoid turbulence (and if in turbulence, slow your airspeed). Information limitations can impact your ability to see and avoid. Similarly, in piloting investments, techniques are available for avoiding turbulence while enhancing returns. The complexity surrounding aircraft investment and residual valuation requires sector-specific expertise. Generating income, while retaining upside and liquidity over your investment horizon requires contextual expertise. Blue skies or stormy weather? Modern weather and radar equipment suggest you work with investment managers who have demonstrated abilities structuring transactions that produce, regardless of the weather. Generating such results requires an appreciation of risk-adjusted returns.

Aviation and Rail teamwork. We have the investment roadmap. Call RESIDCO.

 

*Delta operates 860 aircraft with an average age of 17 years, including a 30-year-old 757, and 30-year-old McDonnell Douglas MD-80s. American also operates MD-80s, the oldest of which was delivered in 1986.  British Airways oldest aircraft is a 747, registration G-BNLK, which it received on May 4, 1990
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