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Transportation Bottoming Out Onto a Bumpy Road

As the U.S. economy began to reopen, investors looked past the pandemic and optimism drove financial markets to within 4.5% of their all-time high.  Lockdowns eased and a stronger than expected jobs report (2.5 million new jobs added in May) indicated the U.S. economy was impatient to reopen. American and Delta reported progress in summer demand, shoppers are returning to stores, and Europe and Asia have restarted portions of their economies. After the Fed announced plans to keep interest rates near zero for an extended period (at least through 2022 indicating they are expecting an extended recovery) the markets retreated. 

The virus remains a reality and there are concerns over a possible recurrence of COVID restrictions. But a vaccine is expected to be available within a year (perhaps as early as this fall) and a June Wall Street Journal survey reports 69% of economists expect a recovery in the third quarter. The uncertainty that is driving daily volatility is dictating a ‘bumpy’ recovery.  

The nature of the passenger aviation industry is such that flight operations will have to deal with a slower recovery than the wider economy. S&P Global Ratings expects global air passenger numbers to drop 50% to 55% in 2020 compared with 2019, and travel demand to remain below 2019 levels until 2023. Idle U.S. passenger aircraft peaked in mid-May.   United is reinstating flights at over 150 of its U.S. and Canadian destinations in July to 30% capacity. American announced it will increase domestic flights in July, to 55% of its July 2019 schedule. Recovery of global passenger travel will take additional time and require the implementation of agreed international safety procedures and removal of quarantine restrictions.  

The lack of passenger revenues is driving temporary conversions of passenger aircraft to freighters and increasing sale-leaseback financing activity (since March 1st  lessors have closed multiple transactions with Delta, Southwest, American, and United). Virgin Atlantic increased its cargo-only flights by more than one-third to nearly 600 in June, breaking its record for freight carried in May. British Airways began operating two 777-200s as cargo-only flights with cargo on seats. China Eastern Airlines is using 13 reconfigured A330-200s in temporary cargo service. Emirates has converted 85 of its Boeing 777-300ERs as stand-in freighters (in addition to their 11 777Fs). Some carriers are considering repurposing 737NGs as freighters and then arranging to replace them with MAX sale-leaseback financing.  Older A380s can be moved to second lives as freighters.  A ‘shared space’ 747-400M, in service with KLM since 1989 continues to fly.  It has capacity for 268 passengers with a locked bulkhead on the main deck separating the cargo area from the forward passenger cabin. 

Rail volumes remain stressed. U.S. rail freight carloads fell 27.7% in May from the same period in 2019.  That is the largest year over year decline for any month on record.  May was also the worst month for U.S. coal carloads in history. Cars in storage increased to 520,729 units. But consumer confidence rose, and both the Purchasing Managers and Non-Manufacturing Indexes rose. ‘All indications are that we’re starting to bottom out”.  

To update your evaluation of the duration and volatility of factors influencing aviation and rail asset values, call RESIDCO. It’s key to setting the stage for tomorrow’s portfolio growth.

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As Demand Recovers, What’s On The Horizon?

Domestic economies are beginning to reopen as evidenced by the number of TSA airport security screening checks.  They totaled 87,534 April 14th and by May 25th had tripled to 257,451.  “We’re past the trough in terms of peak damage”.  Much of the pickup reflects the states’ decisions to open parts of their economies.  While global supply chains remain fragile the mechanics of transportation decision making remain unchanged.  What is the payoff from the trip? Is it high value/time-sensitive? Where is traffic currently being allowed, and what mode is most cost-efficient?  

Globalization fostered the ever-increasing specialization of labor across countries.  The Covid-19 crisis has demonstrated the weakness of over-reliance on extended supply chains, whether for manufacturing automobiles, aircraft, or pharmaceuticals. ‘Just in time’ easily can become ‘just too late’. An example: the U.S. relies heavily on Mexico for parts and vehicle production.  Thirty-nine percent of auto parts ($60.8 billion) were imported from Mexico in 2019. Without Mexico, the Detroit auto industry will be unable to effectively restart production. Going forward the private sector must re-examine supply links, border restrictions, risks, and define solutions.  

Increased taxes financed the spending that helped the U.S. get out of the Great Depression in the 1930s.  From 1929 to 1939 the corporate tax rate rose from 11% to 19%, capital gains tax rates went up from 12.5% to 22.5%, and personal income tax rates jumped from 24% to 62% (the top marginal rate was 91% in 1960).  With the current level of deficit spending and lost tax revenues due to lockdowns, it’s not hard to imagine higher taxes. But borrowing now amounts to a transfer of economic activity from the future to the present.  

With air travel demand picking up, how full will planes be? Single-aisle airframes generally have 3+3 seating. Leaving all middle seats vacant implies a maximum load factor of 67%.  On a fleet-wide basis, the International Air Transport Association has said “social distancing would mean a maximum load factor of 62%.”  That would require a different business model than the airlines have been using.  Break-even loads vary with changing cost and airfare fluctuations (in 2019, the systemwide beak even load factor was 73.8% while the actual load factor was 84.6%).  

Class One Railroad operations remain strong with freight car velocity, terminal dwell, and car trip compliance improving. The Roads are running fewer and longer trains on tight schedules (Precision Scheduled Railroading). As traffic has declined, crews, locomotives, and freight car resources are being ‘balanced’ to meet the lower current volumes and improve operating ratios. New equipment deliveries are down and an equipment surplus hangs over the industry.     

The Global economy: the European Union’s borders remain closed to non-nationals until mid-June, and China has suspended entry of foreign nationals. U.S. tensions with China are escalating over trade, technology theft, the coronavirus, and Hong Kong’s independence. Managing a transportation portfolio in this turbulent ‘New Normal’ requires an ability to identify and seize opportunities the markets are currently offering. As demand recovers, focus on improving your odds of success. Call RESIDCO.

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