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Freight Demand Sustains Transportation Equipment Investment

Air cargo represents less than one percent of global trade by tonnage but amounts to $6 trillion worth of goods moved every year – more than 36 percent of global trade by value.  Globally, half of that airfreight cargo has been carried on passenger jets rather than dedicated freighters. The rapid shutdown of passenger flights has eliminated passenger jet freight capacity, and air freight rates have responded, increasing significantly. 

With the cascading passenger flight cancellations (and flight restrictions), air carriers are moving idle passenger planes to freight in high-demand routes, taking advantage of the very high air cargo market rates at a time when fuel prices have plummeted (American Airlines Group Inc. is flying its first scheduled cargo service since 1984 between Dallas and Frankfurt).  As Asian manufacturing capacity comes back online, moving goods to the U.S. will further increase demand for airfreight. Equipment maker, John Deere & Co., is budgeting an extra $40 million in expedited freight cost for the second quarter to help ensure parts from Chinese suppliers can reach its facilities in Moline, Illinois.

Markets are telegraphing their uncertainty over how long the coronavirus will impact the domestic consumer activity which has driven our recent eleven-year bull market run.  The sell-off that’s occurring is being amplified by a constant media blitz of event cancellations, corporate travel bans, ‘shelter in place,’ school closings, and election-year ‘coronavirus politics’.  To stop the pandemic, we are forcing a recession.  Near-term, the impact will reduce second-quarter economic growth.  However, the politics of the fall election (and a $2 Trillion Stimulus package) will lead to a rebound in the second half.   

While commercial passenger air travel has been turned on its head, U.S. rail freight continues to move the essential goods we need to survive.  The slowing of the global and U.S. economies will delay domestic rail traffic improvement.  

But, as the summer appears, and the virus abates, domestic manufacturers and retailers will need to play inventory catch-up.  Companies will face such a need to restock there will be the potential for a significant freight traffic recovery in the second half of this year.  Longer-term, rail equipment demand uncertainty has been created due to the industry’s adoption of precision scheduled railroading (“PSR”). PSR (and trade) are driving the market dynamics, impacting rail equipment values and lease rates.  

Rail traffic (excluding coal and grain) is down year over year (still up from January lows).  First-quarter container volumes through the Port of Los Angeles, the largest U.S. gateway for inbound seaborne container shipments from China, are expected to be down 15% year-over-year.  Spring flooding will impact traffic along the Mississippi.  Oil’s slide will negatively impact the demand for crude oil tank cars and the frac sand cars that serve the shale oil industry.  

Air and Rail equipment values and lease rates are stressed.  But consider what the markets allow. Volatility creates opportunities. Now is the time to look for those gaps, weaknesses, and areas of growth; ask “Where are the most productive assets available?”

We have some answers.  Call RESIDCO.

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Demand Shock

The coronavirus was the turning point. Schools and universities are being closed. Public activities are being canceled. Air travel and supply chains are being disrupted. Companies are telling employees to stay put. The virus constitutes a force majeure event.  

Even before the U.S. ban on travel from Europe, Air Carriers were reacting by trimming capacity, reducing both domestic and international flights. Southwest Airlines Gary Kelly has said, “The velocity and the severity of the decline is breathtaking, there is no question this is a severe recession for our industry and for us, it’s a financial crisis” (Southwest had previously said reduced bookings could result in as much as $300 million in lost revenue in March alone).   

China, in an attempt to contain the outbreak from spreading imposed travel restrictions. Many Chinese factories halted production in February. Worldwide, these shutdowns will impact industries from auto parts to pharmaceuticals. 

A key trade flow indicator economists examine is the volume of the Trans-Pacific trade. This trade lane accounts for 40% of the world’s gross domestic product.  Despite the recent Phase-One trade deal, the volume of U.S. products moving to China remains depressed. As the virus spreads, political leaders throughout the world are imposing broad travel restrictions. The result is less passenger and freight traffic to move.  

Trading relations often come with unseen risks. China’s entry into global markets resulted in a global over-dependence on low-cost Chinese production. The virus has exposed this weakness, and its effects are rippling through the interconnected world economy. “This coronavirus is a wake-up call.  We are much more vulnerable than we thought.”  Business leaders are scrambling for solutions as they face supply chain disruptions and current market uncertainties. Finding alternative suppliers isn’t easy. Future patterns of trade among nations will change in order to create more supply chain redundancy.   

Economic contractions are not a ‘bug’ of free-market systems, but rather a feature. Short term incentives act to create unsustainable swings in everything from product designs to supplier and labor relations. Competition over the delivery of fuel-efficient planes drove the Airbus 320neo and Boeing’s 737MAX (over the past 10 years Boeing and Airbus orders totaled more than 20,000 jetliners). Then, air carriers were more concerned about the cost of jet fuel, their single highest expense after labor.  

Surprisingly, when Russia refused last week to join OPEC in its call for crude oil production cuts, the Saudi response was to make the biggest price cut to their crude in more than 30 years  Lower oil will help the U.S. consumer, hurt U.S. shale producers, but have little impact on current Air Carrier operations. 

The impact of the virus on travel is so large it has resulted in the International Air Transport Association increasing the potential demand shock to the global airline industry upward from its February estimate of $29 billion to a loss of $113 billion in revenues in 2020.  

Public market liquidity is a convenience, to be taken advantage of, or to be ignored.  We are at a turning point. For actionable insights, call RESIDCO.

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Turbulent Markets Lead to Opportunity

Air and Rail Investments

Investor interest continues to demonstrate market confidence in Air and Rail transportation equipment. Increasing interest in these ‘alternative investment’ categories has created a challenging environment. Rail transportation is a high-volume low-value freight business while air is a high-value passenger and freight business. Even with interest rate cuts (three in the last year by the Fed), falling global traffic levels across both modes have created caution flags for near-term investment activity. Whether the cause is tariffs, or the coronavirus outbreak (COVID-19), equipment demand, lease rates, and equipment values are being impacted. 

COVID-19 and Travel

China’s rise as the world’s second-busiest market has been a strong source of growth for the world’s major economies and airlines. The virus’ impact on supply chains and passenger traffic is complicated. Air travel is suffering as thousands of flights are being canceled. The International Air Transport Association has published an initial assessment that estimated global lost airline revenue is as high as $29 Billion (airlines in China would be the most impacted). 

U.S. carriers completely halted flights to China in January. The US Department of State has issued a level-4 travel advisory, meaning the public is advised not to travel to China. In February, the CDC issued a Level 3 warning, recommending avoiding all nonessential travel to China. In China, Cathay Pacific Airways asked all staff to take three weeks unpaid leave, Hong Kong Airlines Ltd., terminated 400 workers and Asiana Airlines Inc. (South Korea) asked thousands of staff to take unpaid leave. The number of infections worldwide is approaching 80,000 (China’s official count of 74,576 infected, and 2,118 dead is being updated daily1). China is bearing the immediate brunt, but the virus clearly presents a risk to the global economy.  

With the delay in returning the 737MAX to service (which is now impacting suppliers, e.g. GE LEAP engines), election-year politics, and the spread of the coronavirus beyond China, it’s difficult to assess the magnitude of impact. 

Favorable U.S. Developments?

The leading economic index indicates continued growth, US consumer confidence remains high, labor markets are tight, and existing home sales (supported by lower mortgage rates) are at a two-year peak. The possibility of slower economic activity requires thorough analysis, a sound underlying investment strategy, and downside protection. 

Minimize Risk

Risk is inseparable from the opportunity for profit, and whenever there is change, there is opportunity. Transportation equipment investment is no different. In every investment, risk is an exchange: the buyer holds the primary risk, while the seller has given up the chance that equipment values will go up. The biggest economic risk is buying at the wrong price, at the wrong time. 

Market intelligence, equipment configuration, and equipment condition are all critical. Equipment ownership and long-term contracts that ensure predictable cash flows and equipment values in difficult markets are needed. Often existing, well-maintained equipment is a better choice than new. Investors should be financially (and psychologically) prepared for volatility. It’s time to review your portfolio and ensure it’s properly positioned to weather the storm that might lie ahead. In times of uncertainty, think long-term and strive to minimize risk.

Prepare Now

We believe the current supply chain disruptions and turbulent global markets will lead to buy-side investment opportunities. Get ahead of today’s challenges. Call RESIDCO.

1 Wall Street Journal, “Coronavirus Wreaks Havoc on Airlines”, February 21, 2020.
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