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Investment Strategies in a Low-Demand Environment

Air and Rail networks have lost substantial revenues. First Rail freight traffic due to trade disagreements, tariffs, and the downturn in coal, and then both Air and Rail due to the impact of the Covid-19 shutdowns. Economics remains challenging. The landscape that has emerged was unexpected. Air Carriers are zero base budgeting equipment needs, personnel (payroll support ends in September), and optimizing networks. Flying point-to-point with few passengers onboard is not economically viable. Legacy carriers are rediscovering the virtues of ‘hub-and-spoke’ systems which work to maximize load factors. Operators are retiring older equipment from their fleets, preferring newer more fuel-efficient equipment and technology.

An example is the jumbo jets which are too big for current passenger demand.  The International Air Transport Association updated its projection of when it expects passenger air travel to return to pre-Covid-19 levels – 2024. This year, when Boeing finishes the last fifteen 747 freighters on order, 747 production will be discontinued.  The last passenger 747 was delivered in 2017. Older 747-400s are not expected to fly again. There are only 35 of the newer 747-8 variant flying. These four-engine aircraft are not as fuel-efficient as newer design dual-engine aircraft. The pandemic has grounded almost all of Airbus’ superjumbo A380s and Airbus will close A380 production delivering the last unit in 2021. The A380 was designed with little cargo space compared to the twin-engined A350 which has twice as much cargo capacity as the four-engine A380. With 500 seats on average, the A380 is just too much aircraft and too expensive to operate when most seats are empty.  Engine issues have delayed Boeing’s 777X which when certified will compete directly with the A350.

As fleets are repositioned trends are becoming apparent.  The pandemic has accelerated the adoption of video conferencing. Many see this resulting in a long-term reduction in higher-margin business travel. We’ll have to wait to see if Robert Crandall, former chief of American Airlines, will be right when he said, “You are never going to see the volume of business travel that you’ve seen in the past.”  Lower margin leisure travel is expected to return once a vaccine is available.  But even after a vaccine has been developed and tested it will take time for acceptance and coverage.  Then countries will have to standardize entry and documentation requirements for international travel to return.  Class One Railroads, using Hunter Harrison’s Precision Scheduled Railroading (“PSR”) strategy, are removing railcar capacity, locomotives, and employees.  Their focus is on reducing ‘operating ratios’ and improving short-term profitability.

The unexpected demand environment is forcing Bank Lenders, Operating Lessors, Private Capital, and those who service and support aviation and rail equipment investment to reconsider their investment strategies. Success rarely comes from projecting trends.  Rather it comes come from insights that define future demand. Even with no additional Washington stimulus, another 1.4 million jobs were created in August, unemployment declined to 8.4%, and labor force participation increased to 61.7% (only 1.7% below its February level).

The best investment strategy in a low demand environment?  Maintain liquidity, competitive market position, and key talent.  Be responsive to opportunities that deliver long-term value.  Call RESIDCO.

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Transportation Traffic – Better Than Before

Global freight traffic flows are recovering. U.S. and German manufacturers surveyed in late August reported a ‘jump’ in export orders, “Container traffic is approaching the level reached before the corona crisis”. In the U.S. seasonally adjusted imports (inbound TEU’s) are up significantly on the West Coast, and Domestic North American Intermodal container volumes have fully recovered to pre-pandemic volumes*.  The purchasing manager’s index rose to 54.2 in July from 52.6 in the previous month (which was above expectations of 53.6, and its highest reading since March 2019).  Economically sensitive Rail carload freight (excluding Ag/Petro/Coal) has improved but is expected to be down for the balance of 2020.  

First it was tariffs and trade tensions that impacted freight traffic.  Then the coronavirus lockdowns disrupted domestic and international supply chains.  During the second quarter of 2020, the World’s largest economies experienced the deepest contraction in six decades (record keeping began in 1960).  The previous largest drop in a single quarter had been -2.9% in the first quarter of 2009.  The pandemic exposed the strategic vulnerabilities of reliance on China as a sole source, low cost supplier.  Unnoticed until now China managed to capitalize on our appetite for access to their markets.  It has been a one-way street as China is now ‘adjusting’ their export of pharmaceuticals, laser technology, cryptography, and artificial intelligence, given the ‘rapid development’ of China’s ‘industrial competitiveness’.  National security concerns will impact future trade volumes as the world’s two largest economies drift apart.

Hope for a rapid vaccine deployment is keeping the Dow Jones Transportation Average near a record.  But weakening passenger demand in the US domestic aviation market and continued restrictions on international travel weigh heavily on airline recovery efforts.  The proportion of the global passenger jet fleet in storage has remained at approximately 33% with fewer than 30% of narrow bodies inactive versus more than 40% of widebodies.  This reflects the proportionally higher passenger demand for domestic and intra-regional travel compared with international long haul.  The most popular aircraft in the U.S. fleet remains the Boeing 737-800 and Airbus’ A320/321 (the MAX is now expected to return to service in early 2021). 

The Conference Board’s July economic indicators, both leading and coincident, are pointing to a recovery.  Economists expect a strong rebound in the Third Quarter.  But as long as the pandemic lingers, the economic shock across the aviation and rail equipment leasing sectors will continue.  As the recovery unfolds the big picture question will be how will existing aviation and rail equipment capacity (and supply chains) be efficiently managed while we wait for demand to fully recover?  Despite low interest rates and fiscal stimulus, low utilization of existing fleet assets is likely to continue through 2021.  Demand remains uneven.  A third of the railcar fleet is in storage, railcar lessors are reporting pricing pressure on lease rates, aircraft manufacturers face order deferrals, and aviation lessors are faced with widespread restructuring challenges.  We are better than before,but not yet back to pre-pandemic levels.  The present requires the ability to identify investment opportunities that perform in this uncertain environment.  It’s time to prepare for the rebound.  Call RESIDCO.

* Making Sense of What the Economy and Freight Markets are Telling Us, August 27, 2020, FTR + Midwest Association of Rail Shippers.

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