Aero and Rail equipment investors focus on both current short term challenges and longer term benefits that support the underlying strategies of their transportation equipment clients. Short term headwinds include inflation, interest rates, a rail strike yet to be resolved, resurgence of COVID-19 in China, deglobalization, a strong U.S. dollar, and continuing gridlock in Congress after the recent midterm elections. It’s the expected future benefits of current capital investments that are a big deal for commercial air carriers and class one railroads. Investments that expand market share or improve efficient network operations appear over a number of years. Short term cash flows vary with operating labor and fuel, which is highly unpredictable in the current environment. Both are the largest components of variable operating cost. The Union Pacific’s operating expenditures were over $12 billion in 2021, with 33% allocated to labor and 16% to fuel. American Airline Group’s operating expenditures were over $30 billion in 2021, with labor and fuel accounting for 38% and 22%, respectively.
Fuel prices have increased significantly in 2022, however, the U.S. Energy Information Administration’s November 2022 short term energy outlook1 expects weakening global economic conditions to limit demand and create a potential for lower oil prices, even after considering Russia’s invasion of Ukraine. The Organization of Petroleum Exporting Countries and their Russian led allies are expected to leave their production cuts in place given the softening forecast for global oil demand. The European Union plans to ban Russian crude imports, forcing Russia to seek alternative markets, pending a price cap that remains to be negotiated.
Labor issues continue in both equipment markets. In the rail industry, the combination of precision scheduled railroading and accompanying labor force reductions during the pandemic, meant to reduce operating cost, are driving rail labor to strike. The earliest possible strike date is now early December as the International Brotherhood of Boilermakers voted down the Presidential Emergency Board recommendations2, which asked Congress to intervene and avert the strike. In the aero industry, global demand for pilots is expected to exceed supply. In North America alone, a shortfall of 30,000+ pilots is predicted by 20323. Continuing labor issues ultimately will lead to network capacity constraints.
The focus of network equipment investment is to provide current cash operating income along with longer term equipment benefits. GATX, whose existing railcar supply agreement with Trinity Industries is expiring at the end of 2023, entered into a new ‘cost advantaged’ multi-year agreement for delivery of 15,000 railcars from 2024-2028 to provide for base fleet reinvestment needs in North America. On October 26th, Boeing released Q3 2022 results and is expecting to deliver 375 737 MAX jets in 2022. Since June, Boeing’s 737 program has been producing 31 aircraft per month despite ongoing supply chain issues. Airbus released Q3 2022 earnings on October 28th and maintained its target of 700 commercial aircraft deliveries this year.
Addressing current opportunities that midlife equipment investment presents, and comparing those to expected future alternatives, require an enhanced capacity to perceive, interpret, and respond. In the real world all investment involves choices. Call RESIDCO.
Glenn Davis, 312-635-3161
[1] EIA Short-Term Energy Outlook, Nov. 2022
[2] Boilermakers Reject Labor Agreement With US Freight Railroads, Nov. 2022
[3] The U.S. Has a Pilot Shortage — Here’s How Airlines Are Trying To Fix It, Sept. 2022
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