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Market Realities Transform Transportation Investment

Liquidity buffers, loans, restructuring operations, cost savings. As the pandemic lingers it continues to depress economic activity.  

The drop in passenger traffic is driving air carriers to constantly adjust network flight schedules and evaluate equipment needs and workforce reductions. United is exploring the possibility of a fall workforce reduction and American is considering similar plans. The major carriers are moving forward signing letters of intent lining up U.S. Treasury Department loans as their net bookings drop. Twin aisle and aircraft with higher operating costs are being parked. Newer more fuel-efficient single-aisle jets that can be filled with passengers more easily would be preferred. 

But with demand down and list prices near $120 million, financing is challenging. United’s CEO, Scott Kerby, earlier told an investor conference “We won’t be taking delivery of a single aircraft unless it is fully financed.” American’s CFO has told Boeing it will not take delivery unless aircraft are financed under terms similar to those it enjoyed prior to the pandemic; “No financing, no 737 Max deliveries.” Delta said it will not take delivery of any new jets this year. Of Boeing’s 737 MAX on the ground inventory, 41 units are currently unclaimed (about 10% of the total parked).  By year-end, as many as 155 may be without takers.  

Airbus has reduced production rates of its A320 by one-third. Its CEO, Guillaume Faury, said in late April, “we’re facing the gravest crisis this industry has ever experienced”. The engines that power these aircraft are sold at a loss in order to secure long term service revenues. Ninety percent of Rolls-Royce Trent engines operate under service agreements that require airlines to make payments based on flight time. General Electric and its joint venture partner Safran (SAF, France) manufacture the Leap engines which power the MAX. They operate under similar long-term service agreements. The demand downturn is forcing Rolls-Royce to reduce production. It has resulted in a 17% workforce reduction (9,000 jobs out of its global workforce of 52,000). GE Aviation is implementing similar workforce reductions.  

But discount carriers sense an opportunity as the legacy airlines retrench.  Low-cost Allegiant Travel, CEO Maurice Gallagher Jr.: “I expect we will thrive in this changed environment.” Jets at bargain prices will be available as the legacy carriers retrench and sell aircraft.

In Rail, U.S. Rail carloads improved slightly in June but are still down 22.4% from 2019.  Carload declines continue across the board with declines in coal, crushed stone, sand, gravel, motor vehicles and parts and chemicals. Coal continues to lose its share of U.S. electrical generation. Despite declining U.S. rail volumes Class Ones are improving their operating ratios (operating expenses as a percentage of revenues) as they focus on equipment and workforce efficiencies driven by Precision Scheduled Railroading. A third of the North American rail fleet remains in storage. But lower operating ratios make more cash available. With nonfarm payrolls rising by 4.8 million in June the unemployment rate fell to 11.1%.  As Glassdoor economist Daniel Zhao puts it: “It’s fair to say the recovery has started, but that’s not a guarantee that the recovery will continue uninterrupted.” Its timing and path will depend on a Covid-19 solution.

As business models are being disrupted market realities are transforming transportation investment management.  Identify and capitalize on current opportunities. Call RESIDCO.

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Identifying Midyear Opportunities

Aviation and rail equipment lease rates and equipment values are stressed as operators adjust equipment capacity to meet current levels of demand (and adjust to the Class One Roads implementation of Precision-scheduled railroading “PSR”). In the near term, lessees are focused on ensuring the sustainability of their business by attempting to defer new delivery commitments and restructure existing lease terms. OEMs are doing the same as they adjust production schedules in recognition market demand will be lower until the virus clears.  

The unknown duration of the path back to where the economy was before the pandemic adds complexity to evaluating equipment opportunities, whether under lease or currently stored.  Secondary market values are often impacted by new equipment pricing and specific lease maintenance and return conditions if under a lease. 

Technical factors also impact values.  Standard configurations and deep markets mean units are easier to place. Special features can help equipment retain value. An example: a higher maximum takeoff weight enhances an aircraft’s utility and consequently its value.  If it’s part of a family (e.g. A320/A321, or B737-800/900/MAX) equipment will retain value as operators benefit from lower investment in parts, equipment, and pilot training. Lower fuel prices improve demand for older aircraft.  If fuel prices advance, demand for older units will be depressed, shifting operators’ preferences toward newer, more efficient aircraft. Lease rates for the single-aisle Boeing 737-800, the 900ER, and Airbus A321s remain “relatively unscathed” with fleet weighted average declines of around 5% or less since January 30th.  And data shows the more fuel-efficient A320neos are being favored over the older A320ceos (54% of the A320ceo remain in storage, compared to only 30% of the A320neo).  

Older equipment may appear less attractive due to operating economics or functional obsolescence. But a lot of planes parked in the desert could offer better returns than new equipment. Fifteen percent fuel savings on new aircraft may not justify their capital cost.  As demand reappears some of these surplus units might be economically leased to second or third-tier operators or sold to another lessor or operator.

For Air, more than half of the world’s passenger jets are now in service.  In Rail, the combination of lower rail freight volumes and the Class Ones’ implementation of PSR has placed 31% of the 1.67 million-unit North American rail freight fleet in storage (520,729 freight cars). Maintaining customer relationships is the key to today’s markets. Rail ‘relationships’ are being tested as rail shippers are being required to transition their operations to comply with the Class One’s PSR schedules. Rail modal share will grow only if the Roads better integrate intermodal and trucking to give rail shippers an ‘end-to-end’ solution. 

The U.S. entered the recession as the strongest world economy. Now, “The big picture is the economy is on the road to recovery and we have passed the worst”. With fall elections approaching and an expectation of additional government spending on infrastructure, the recovery will continue.  A return to moderate growth means the outlook is becoming brighter.  Identifying opportunities is constant in portfolio management. Call RESIDCO.

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