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Sequential Improvements Point to a Recovery

Second Quarter year over year comparisons are down but sequential growth is evident in the third quarter. A timeline towards recovery is beginning to take shape. 

Manufacturing is expanding (but from a lower base). Factories across the U.S., Europe, and Asia increased production in July but were held back by weak global trade (export orders were soft). Businesses are generally optimistic about future conditions and growth in manufacturing activity is expected to continue over the next six months. The U.S. Purchasing Manager’s Index grew in July for the third consecutive month reaching 54.2, up from a June reading of 52.6.  That’s the highest it has been since March 2019.  

On August 6, the U.S. Department of State, in coordination with the CDC, lifted the Global Level 4 travel advisory which had been in place since the end of March. “With health and safety conditions improving in some countries the Department is returning to our previous system of country-specific levels of travel advice.”  The virus does not appear to be spreading on planes due to air filtration, circulation, and mask requirements. Air travel and airports have not been hot spots. Delta’s CEO Ed Bastian reported there have been no cases that have been traced back to air travel passenger contact when sitting in rows near a passenger who later tested positive.    

Flight operations are focused on load and cost efficiency in each served air travel market.  With current lower flight demand levels, newer narrow-body aircraft are more desirable.  These are the first units returning to service. Older narrow bodies are next, subject to accumulated engine time and maintenance cycle demands. With country travel restrictions in place, long haul wide-body passenger flights are not economical. Many expect the Boeing 737MAX* (when it returns to service in extended twin-engine operations), along with the AirbusA321LR/A321XLR to be flying long-haul routes. These single-aisle aircraft are designed to allow point to point operations in a lower demand environment, making a business case for such aircraft to operate profitably on longer transatlantic routes in a recovering Covid-19 environment.  

On August 1, 504,043 freight cars remain in storage (30% of the North American rail freight car fleet). But rail carload traffic (excluding grain and coal) is trending in the right direction.  In July carload traffic originated on U.S. railroads averaged 208,403 units per week, the highest since March.  Auto sales in July were their highest since February with North American carloads of motor vehicles and parts reasonably close to their pre-pandemic levels.  It is well known that the consumer drives the U.S. economy and that consumer spending is driven by job growth.  That spending is closely correlated with the goods related side of the economy.  The economy created 1.8 million jobs in July down from 4.8 million new jobs in June, and 2.7 million in May.  Over 9 million jobs have been created in the last three months and unemployment has fallen to 10.2% in July, down from a record high of 14.7% in April.  

Sequential improvements are pointing to the beginning of a recovery.  If you are uncertain about the future, include cash, cost control, maintenance of financing flexibility, and implementation of investment strategies that will protect your competitive position. For opportunities that can deliver that and lead to long term value creation?  Call RESIDCO.

* The 737MAX has the same fuselage width at the B757 which flew trans-Atlantic regularly.

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Unlock Pockets Of Opportunity

The Global economy is projected to contract 4.9% in 2020, with World merchandise traffic falling 13 to 32% and a 50 to 60% decline in air passenger revenue miles. In response, more than two-thirds of governments across the world have scaled up fiscal support with budget measures now standing at 6% of GDP on average. Covid-19 lockdowns, trade disagreements, and changing Class One Rail operating methods have impacted the cash flows and profitability of transportation assets that serve the Air and Rail investment segments.

Despite deteriorating economic conditions, Rail carload freight has remained profitable for the Class One Railroads. The impact of Precision Scheduled Railroading (“PSR”) is evident as they have maintained profitable operations even with freight volumes decreasing (U.S. rail traffic for the first 29 weeks of 2020 decreased 12.8% compared to last year). Class Ones are focused on carload traffic which drives their PSR operating models.  ‘Pricing discipline’, longer train lengths, and a reduced need for equipment and labor have improved operating ratios. The Class Ones are all reporting second-quarter profits (examples: CSX $499 million, Union Pacific $1.1 Billion, Norfolk Southern $392 Million, Canadian Pacific C$635 Million, Canadian National C$545 Million and Kansas City Southern $109 Million).  

While Air cargo flights have surged, travel restrictions have resulted in a steep contraction of regional, mid-haul, and long-haul passenger demand.  Second-quarter losses across all the U.S. carriers demonstrate this. Delta, the world’s most profitable airline prior to the pandemic, reported a 91% decline in revenue and a second-quarter operating loss of $3.9 Billion (plus an additional $3.2 Billion non-operating write-down related to fleet restructuring and write-downs of investments). United’s revenues were down 87.1% with a reported net loss of $1.6 Billion (after adjustments a net loss of $2.6 Billion). American reported an operating loss of $2.5 Billion and a GAAP net loss of $2.1 Billion. Southwest (the only investment-grade rated carrier in the U.S. airline industry) reported a second-quarter net loss of $1.5 billion (excluding special items).  

All are parking portions of their fleets and adjusting network schedules as they focus on returning to break-even cash flow. The downturn has extended to aircraft manufacturers Boeing and Airbus.  Boeing delivered just 20 aircraft in the second quarter, down from 90 last year (their lowest quarterly total since 1963). Airbus delivered 74, down from 227. The International Air Transport Association aptly summarized the situation.  At the end of 2019, the commercial passenger jet fleet in service was 23,710 units (including regional jets, single-aisle, and twin-aisle).  The equivalent fleet needed to operate in 2020 is 16,360 units (at a 62% load factor).  

Gulfstream delivered more high-end private jets in the second quarter (32) than Boeing’s total commercial deliveries.  Budget carriers like Southwest can set up and dismantle specific point to point routes based on profitability (legacy carriers need their whole hub and spoke network to work to stay cash positive). Yes, the recovery’s timing remains uncertain, but transportation assets under a lease that span the expected term of the pandemic provide attractive alternative investments.  

To find and unlock these pockets of opportunity?  Call RESIDCO.

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