The U.S. economy expanded 2.5% in 2023 (3.4% in Q4). While growth slowed to 1.6% in 2024’s Q1[1] the International Monetary Fund expects U.S. GDP to expand 2.7% in 2024, up from their October forecast of 1.5%. Global economic output (in the face of geopolitical strife) is expected to expand by 3.2% in 2024 (up from an October 2.9% forecast). With air travel rebounding, Domestic Aviation’s Spring 2024 Air Travel forecast 167.1 million passengers between March 1 and April 30 (2.7 million per day)[2]. Delta expects strong summer demand. Overall IATA forecasts a 2024 record year of 4.7 billion passengers. Air carriers would like delivery of newer more fuel-efficient aircraft but both Boeing and Airbus deliveries are months late. The average age of airline-owned passenger aircraft was 16 years in 2024 (up from 14 in 2019). Planes typically are used for 25 years and many fly longer with proper maintenance. To keep up with the recovery of air travel air carriers are extending the service lives of existing mid-life equipment. Delta has not retired any aircraft in 2022 or 2023[3]. Lufthansa is bulk buying parts and developing their own in-house repair solutions. Delta’s maintenance and repair operations business (Delta TechOps) is currently focused on maintaining the in-service reliability of their existing Boeing 717s, 757s, and 767s. Industry-wide, a little under 200 Boeing 757s remained in service in 2023, and slightly over 200 767s are in service in 2024.

Newer aircraft are grounded due to the ongoing Pratt & Whitney engine issues. Cirium data shows 637 GTF-powered aircraft parked as of April 1.  Repair capacity limitations and parts shortages are constraining supply. Manufacturers’ higher prices on new engines have reduced the incentive to switch to newer equipment. The resulting undersupply of aircraft and engines has led to increased values and increasing lease rates. Typical lease rates for a 10-year-old Boeing 737-800 (which preceded the MAX), were around $220K per month in January 2024, up from $183K in January 2023 and $156K in 2022. In a recent KPMG Aviation Industry Leaders Report, Avolon CEO Andy Cronin stated “2024 markets are positive and likely to drive lease rates and residual values higher”. Some carriers are buying aircraft they have been leasing rather than negotiating lease extensions. Per Cronin, the industry is some 3,000 planes short (15% of global capacity) of what was expected pre-Covid due to pandemic disruptions and OEM equipment delivery delays. With the added 737 MAX delivery slowdown existing mid-life aircraft equipment will remain in service.

Trinity Industries[4] reports improving railcar lease fundamentals (their future lease rate differential is +23.7% and fleet utilization is 97.5%. Full-year average renewal lease rates were approximately 30% higher than expiring rates with average lease renewal terms of 54 months. GATX[5] similarly reports 99.4% fleet utilization, lease renewal rates 33% higher, and average renewal terms of 64 months. High steel prices have elevated the pricing of new railcars and led to increased scrapping of idle equipment.

Even with economic, political, and trade uncertainties, higher lease rates and strong secondary markets are creating opportunities.  Call RESIDCO.

Glenn Davis 312-635-3161

davis@residco.com

[1] U.S. Bureau of Economic Analytics, March 28, 2024.

[2] Airlines for America, Spring 2024 Air Travel Forecast.

[3] Aviation Week, April 22, 2024, Delta Eager to Grow Third-Party MRO Business.

[4] Trinity Industries, Q4 2023 Report, February 22, 2024.

[5] 1Q24 Demand ‘Solid,’ Railway Age, April 23, 2024.

Moving pieces. Third Quarter U.S. GDP growth was revised down to 4.9% from November’s 5.2% second estimate. The National Association for Business Economics is expecting 2024 GDP growth to slow to 1% with a recession risk in the next 12 months under 50%. As inflation slows and with a “soft landing” in sight, the Fed is leaving interest rates unchanged. The federal funds rate is expected to be 4.6% at the end of 2024 down from its current 5.5%, which implies three quarter-point cuts in 2024. Those rate reductions are dependent on the impact current rates have on economic activity and whether inflation is sufficiently close to the Fed’s 2% target (the Fed’s personal consumption expenditures index is expected to approach
2.4% by the end of 2024). The Bureau of Labor Statistics reported 2.7 million net new jobs created in 2023; 672,000 in government, 654,000 in health care, 298,000 in food services, 266,000 in social services, 197,000 in construction, and 12,000 in manufacturing. Transportation and warehousing lost 63,000 jobs[1]. The Index of Consumer Confidence rose to 110.7, in December up from 101.0 in November, reflecting more favorable consumer views of inflation, levels of personal income, and job availability.

U.S. Rail carload traffic for 2023 was 11,701,875, up .7%, the most for a full year since 2019. Carloads were up in 10 of the 20 AAR categories led by motor vehicles and parts, petroleum products, and crushed stone and sand. Intermodal at 12,667,354 units (containers and trailers) was down 4.9% for 2023 but up 5.5% in the fourth quarter over the fourth quarter of 2022, its biggest quarterly percentage gain since the second quarter of 2021. Coal remains the largest U.S. rail carload commodity accounting for 29.2% of total originated carloads. Lease fleet utilization and renewal rates remain favorable.

Boeing’s manufacturing quality control challenges continue as a door plug of a recently delivered 737 Max 9 blew out on January 6th shortly after takeoff. The next day, the FAA issued an emergency airworthiness directive, temporarily grounding 170 of the type to allow investigation and immediate inspection. The door plug involved in the incident was manufactured in Malaysia, and installed by Spirit AeroSystems in Kansas (Boeing’s fuselage supplier), and then apparently removed and reinstalled by Boeing at its Renton, Washington assembly facility[2]. The grounded jets are being allowed to resume flying after mandated inspections are completed. But there are now broader concerns regarding Boeing’s manufacturing assembly, supply chain, and inspection compliance as demonstrated by the FAA Administrator Mike Whitaker’s announcement, “We will not agree to any request from Boeing for an expansion in production or approve additional production lines for the 737 MAX until we are satisfied the quality control issues uncovered are resolved”[3]. As oversight increases Max 9 deliveries will be delayed, further delaying certification of the Max 7 and Max 10 and impacting 2024 air carrier fleeting plans as they consider alternatives[4]. New aircraft may have the latest technology, but OEM airframe and geared turbofan engine quality controls and supplier oversight issues are making air carriers and the flying public more comfortable with the reliability of existing midlife equipment. Identifying placement opportunities for Aero and Rail equipment investment requires expert market insight. Call RESIDCO.

Glenn Davis 312-635-3161
davis@residco.com

[1] The Employment Situation, January 10, 2024, Rail Time Indicators, American Association of Railroads.
[2] Wall Street Journal, “FAA Clears Path for MAX 9”, January 25, 2024.
[3] Federal Aviation Administration, January 24, 2024.
[4] United, Boeing’s biggest customer, is considering fleeting alternatives that do not include the Max 10 which is five years behind its original delivery date.

The Fed’s preferred inflation measure, the core personal consumption expenditures price index (“PCE”) fell to 1.9% in November. This latest data confirms inflation is slowing. On a year-over-year basis, the PCE was 2.6%, the lowest since February 2021. With the full impact of interest rates yet to be felt (housing is struggling, and the Conference Board’s index of leading economic indicators is down 3.3% in the past six months) the Fed remains concerned. “It’s far too early to declare victory and there are certainly risks[1]. The Fed held rates steady at its December meeting but is now anticipating three rate cuts in 2024. The pivot makes a recession less likely. December projections see the federal funds rate ending 2024 between 4.5% and 4.75%, down from the current range of 5.25% to 5.5% (.75% lower than today). The markets have responded. The S&P is up 14% over the last two months, the 10-year Treasury yield has fallen nearly a percentage point (to 4.03%), and the dollar has dropped 3% against major currencies[2]. The Fed’s estimate of the long-term “neutral” policy rate remains unchanged at 2.5%. That implies that a lower interest rate environment will return even though the Fed is continuing to allow $95 billion a month in proceeds from maturing bonds to roll off its balance sheet (with no indication of stopping).

Aviation capacity issues continue. Airbus and Boeing will have delivered around 1,400 aircraft in 2023 (a 27% increase over 2022). However, the Aero industry continues to grapple with costly and time-consuming quality control issues. Regulators require close monitoring of parts for authenticity and quality. Dealing with manufacturing defects, the certification of aircraft engine components, and airframe maintenance is leading to the grounding of delivered aircraft as well as delays in new equipment deliveries. The resulting shortage of capacity leads to better returns on existing mid-life equipment. Out-of-production single-aisle aircraft have shown meaningful increases in lease rates as the lessor idle fleet returned to service (and there’s not a lot of existing equipment left). New equipment supply remains constrained, underpinning existing equipment values & lease rates. The result is mid-life single-aisle equipment remains in high demand (current OEM backlogs mean the first available delivery slots for new equipment will be in the 2030s).

Even with flat loadings, railcar prices up 12% to 15%. Scrap rates remain elevated. In the last twelve months, railcar lease rates are up 26% to 33%, with lease terms extending to five years[3]. Both GATX’s Lease Price Indicator and TrinityRail’s Forward Lease Rate Differential continue their upward trend. “Forward-looking metrics continue to point toward consistent strength in lease rates[4]. ”Key commodity market demand across all railcar types is driving substantial new equipment order backlogs at both Trinity and Greenbrier. The eleven North American railcar assembly plants have an estimated industry build capacity of up to 55,000 cars annually (FreightCar America’s new production facility in Mexico is expected to deliver 3,150 to 3,300 railcars in 2023). With a soft landing in sight for the U.S. Economy, concerns surrounding inflation and interest rates are subsiding. But, elevated geopolitical risk and 2024 election year dynamics require expert Aero and Rail equipment investment insight. Call RESIDCO.

Glenn Davis 312-635-3161

davis@residco.com

[1] Fed Chief Powell’s Post Meeting Press Conference, December 13, 2023.
[2] The Wall Street Journal, December 14, 2023 “Capital Account”.
[3] Railway Age, Sea Change in Railcar Supply, December 5, 2023. Higher new railcar prices drive higher lease rates on existing equipment.
[4] Trinity Industries, third-quarter 2023 earnings statement.

Rail traffic volumes remain challenged while Air Carriers face capacity constraints as they attempt to meet the rebound in domestic and international flights. United reported solid domestic and record-breaking international performance with third-quarter revenues up 12.5% year over year. The company set a record for the highest-ever daily average of revenue passengers carried in a quarter  (more than 482,000 passengers)1. Delta reported record September quarter revenue ($15.5 billion), a  double-digit operating margin (12.8%), and pre-tax income of $1.5 billion. American Airlines reported a third-quarter loss2 resulting from higher costs and a new pilot union contract. Higher labor and maintenance costs and delayed delivery of new aircraft are impacting available capacity and profitability for all three carriers. While fuel costs per available seat mile are lower3 than last year Air Carriers expect oil prices will be volatile over concerns the Israel-Hamas war might escalate.  

Airframer delivery delays are being caused by supply chain and new engine reliability issues. In  August, Boeing discovered manufacturing defects in the rear of 737 fuselages (mis-drilled fastener holes in a key structural part). That followed an earlier April production disruption caused by incorrectly installed brackets that connect the MAX’s aft fuselage with its vertical tail. As a result, Boeing’s September deliveries of their 737Max jets fell to their lowest level4 in more than two years.  The delivery delays and durability problems with the Geared Turbofan and LEAP engines are increasing the values and lease rates of existing mid-life Aero equipment and engines (in August the value of an Airbus A320-200 rose 10% and lease rates for the jet were up 6%).5  

On the rail side, total U.S. carloads were down .3% in the third quarter. Union Pacific reported declining freight rail volumes and revenue across their key commodity groups6. UP’s revenue from coal, metals, industrial chemicals, and energy products fell. Carloads of forest products fell 13% as rising mortgage rates impacted home sales (thirty-year mortgage rates are 7.5%, the highest in 23  years). U.S. carloads of grain through the third quarter were down 12.7% from last year, the lowest for the first nine months since 2013 (due to lower exports). Levels of freight rail traffic imply a risk of an economic slowdown (the Manufacturing PMI remains in negative territory for the 11th straight month), but consumer spending isn’t collapsing. Third quarter U.S. GDP grew 4.9% compared to  2.1% in the second quarter. In September, motor vehicles and parts had the biggest carload gains.  Consumer sentiment remains stable supported by a strong labor market (a preliminary 336,000 net new jobs were created in September). The Services PMI remains in expansion territory while spending on services is rising faster than spending on merchandise. 

More than 300 suppliers are needed to build a Boeing 737 Max. Parts come from more than 50  countries. Geopolitical conflicts are not helping. To better understand and deal with current and expected values and lease rates for Aero and Rail assets, Call RESIDCO.  

Glenn Davis 312-635-3161

davis@residco.com

[1] In the first nine months of 2023, TSA Checkpoint volumes exceeded 2019 levels, Airlines for America, October 2023.

[2] American lost $545 Million in the third quarter. Revenue was flat with last summer and costs rose. United reported $814 million of expenses during the nine months ended September 30, 2023, associated with agreements with their Pilots Union and other Aerospace Work groups.

[3] Fuel cost per available seat mile (“CASM”) is down 14.3% from 1H23 vs. 1H22. Airlines for America, October 2023.

[4] Boeing reported 15 new 737 jets, 10 787s, and two 777s for a total of 27 deliveries for the month of September. Reuters, October 2023.

[5] Wall Street Journal, Heard on the Street, October 2023.

[6] Union Pacific Profit Declined as Freight Demand Weakens, Wall Street Journal, October 2023.

Most Aircraft operating leases provide that the lessee is responsible for maintaining leased aircraft to required industry standards. To ensure flight safety the FAA issues Airworthiness Directives (ADs) and aircraft manufacturers issue Service Bulletins (SBs). ADs are legally enforceable regulations meant to correct unsafe conditions. Airframes, engines, avionics, and other aircraft components (landing gear, auxiliary power units,  hydraulics, electrical, etc.) must be properly maintained to ensure flight safety.

Maintenance reserve payments are a critical part of Lessor/Lessee lease negotiations. These ‘supplemental rents’ are generally calculated on a  flight hour, flight cycle basis and usually paid on a monthly in arrears basis. New equipment OEM warranties do not cover scheduled maintenance or major inspections. A current example is the troubles with new Pratt  & Whitney Geared Turbo Fan (“GTF”) engines which are used in about 40% of Airbus A320neo single-aisle jets. Pratt & Whitney’s parent RTX (formerly Raytheon) Chief Executive Greg Hayes recently made calls to customers[1] (this past July 18th) announcing an investigation had determined that contaminants in a powdered metal used to produce the PW1100 engine’s high-pressure turbine discs (part of the engine core) could lead to premature failure. “Engines delivered between the fourth quarter of 2015 through the third quarter of 2021  will need to be inspected to determine whether repairs are required.” Given time in service, an initial group of  200 engines is scheduled to be checked by mid-September, and up to an additional 1000 engines will need to be removed from service over the next year. Inspection and possible replacement of affected discs requires removing the engine, disassembling, inspecting, and then reassembling; a process that can take up to 60 days for each engine. Air carriers have complained that the GTF engine has had durability issues since introduced.  In May, Bloomberg reported about one in eight A320neos and other aircraft with the GTF was in storage for 30 days or longer awaiting repairs (spare parts shortages continue).

Taking equipment out of service for unplanned maintenance results in reduced capacity and disruption of flight crew and support personnel. As an OEM, Pratt & Whitney will be responsible for compensating customers for these engine inspections and repairs as planes are taken out of service. An initial charge of $500 Million has been taken to cover the cost of inspection, repair, and compensation for the first batch of GTF engines being checked. This adds to the more than 100 GTF-powered Airbus A320neo and A220 that have already been grounded due to earlier engine durability problems which included oil leak and vibrations concerns.  

For rail equipment, the Federal Railway Administration (FRA) and the Association of American Railroads (AAR) published a set of rules and regulations all railroad car owners (whether private or railroad-owned) must subscribe to in order to operate equipment in interchange service. The interchange rules are detailed in two manuals, the “AAR Field Manual” and the “AAR Office Manual[2]. The Manuals provide that Railcar Owners are responsible for repairs to their cars necessitated by ordinary wear and tear and for regulatory safety requirements set by the Association of American Railroads. Railinc is the operating arm of the AAR that is responsible for the publication of rules, regulations, and railcar equipment mechanical status. Each handling road is responsible for the condition of cars operating on their line. Railroads inspect and perform “running repairs” to ensure cars are safe to operate. The handling road has the right to send the car owner a bill for necessary repairs. Private (non-railroad) car shops (with lower labor rates) provide service for specialized car types,  heavy repairs, complete refurbishment, and an alternative to higher-priced railroad running repairs. There are literally hundreds of components and a myriad of reasons for railcar repairs. Proactive management and audit of repair bills are required to ensure the right repair is being made and the right price is being charged. The Manuals also provide for damage settlement occurring resulting from unfair usage or improper protection by the handling road. With a freight car fleet of 1,625,000 cars, imagine the amount of data that is available.  

Looking for answers? Call RESIDCO, a proven Aero and Rail equipment management team.  

Glenn Davis, 312-635-3161

davis@residco.com

[1] Jet Blue, Spirit, Hawaiian Airlines, Wizz Air, Lufthansa, Mexico’s Volaris, and others.

[2] Association of American Railroads (AAR), Digital Field and Office Manuals.

Pent up demand from pandemic lockdowns. Government stimulus ($5 Trillion). The Fed’s past abnormally low interest rate policy. These are the causes of the current distortions in economic activity. U.S. annual Core consumer price inflation remains high, 5.3%[1]. Wage growth continues. American Airlines pilots agreed to a new contract that boosts pay by 21% in 2023. Recent Class One national labor agreements resulted in a 24% wage increase during the five-year period from 2020 to 2024[2].

Current travel demand has driven Air Carriers back to nearly 100% of 2019 operations. Even with higher ticket pricing, there has been no slowdown in bookings. The lack of currently available new equipment[3] has resulted in a strong demand for immediately available narrowbody aircraft. Air transport markets are highly competitive, with low-profit margins. Fuel and labor are significant components of Air Carrier operating expenses. Any variation in these costs directly impacts operating profits. Lower energy prices and new engine technology provide direct economic benefits allowing more competitive pricing. Crude oil prices are down. July contracts for West Texas Intermediate (“WTI”) crude recently settled at $72.58 a barrel while Brent crude (the global benchmark) was $77.14 a barrel. China’s economic restart is stalling, Russian crude is continuing to flow, and the uncertain direction of the global economy is driving crude oil down further (WTI closed at $69.51 after the Bank of England raised interest rates to 5%). Without substantial technological improvements in alternative propulsion systems (or significant increases in the cost of crude), current equipment will remain competitive.

U.S. GDP data shows consumers are spending, and companies are hiring. In their June meeting the Federal Open Market Committee (“FOMC”) decided to leave interest rates unchanged (target range now between 5%-5.25%). Fed Chairman Powell signaled two more increases this year. Individual members of the FOMC expect a rate of 5.6% by the end of 2023. Rising interest rates paired with persistent inflation have led the Conference Board to predict, “A contraction of economic activity leading to a mild recession.” The Conference Board’s Leading Economic Index (“LEI”) is designed to provide an early indication of turning points in the business cycle. It’s declined in each of the last fourteen months. But 339,000 net new jobs were created in May (double what economists expected), auto sales are holding up, and April single-family housing starts were the most in four months.

Air transport is integral in the globalization of transport networks. More efficient engines and better aerodynamics have improved with each new generation of aircraft. Underlying price pressures and recession fears may lead to a slowing economy, but the U.S. economy continues to perform. The result is far fewer mid-life narrow-body aircraft are being retired. The pivot toward clean energy has begun but will take time and investment to complete.

It’s clear Aero and Rail needs will continue. Positioning transportation investment for the future requires underwriting discipline and an understanding of what drives demand for existing midlife Aero and Rail equipment. Build your portfolio strategically by focusing on practical solutions and best practices underwriting strategies. Call RESIDCO.

Glenn Davis, 312-635-3161

davis@residco.com

[1] Trading Economics, May 2023 data.

[2] American Association of Railroads, June 2023. “The average compensation of rail workers ranks in the top 10% of all industries, with an estimated average total compensation of $145,000 in 2022.”

[3] “We cannot make planes fast enough to satisfy demand” Guillaume Faury, Airbus, Paris Air Show.

Locomotives, typically classified as 50-year assets, are primarily electrically driven. Despite the common label as ‘diesels,’ they are better described as ‘hybrid-electric’ vehicles. This is because their diesel engine powers an alternator which generates the electricity required to operate the electric traction motors mounted on the locomotive’s axles. As reported by the American Association of Railroads, transporting freight by rail is three to four times more fuel-efficient than highway transportation. Trains are capable of moving a ton of freight, approximately 492 miles on just a single gallon of fuel1. Yet, investing in a current Tier 4 locomotive today implies that you may still be burning carbon-based diesel well past 2050.

As both the Aero and Rail industries strive to incorporate cost-effective zero-emission technologies, there is active investigation into next-generation equipment and fuel alternatives. Among these is the application of hydrogen, a ’clean’2 fuel, either through a hydrogen internal combustion engine or via a reaction with oxygen inside a hydrogen fuel cell. These fuel cells use hydrogen to generate electricity. The world’s first passenger trains powered by hydrogen fuel cells, which produce the electric power to drive the traction motors, are already in commercial service in Germany, specifically for short-haul suburban rail services. In the U.S., companies like Caterpillar, Wabtec, Progress Rail, Cummins, and others are undertaking efforts to verify the feasibility of hydrogen as a viable substitute for traditional fossil-based fuels in line-haul services.

There exist alternatives to batteries for achieving net-zero transportation. Fuels made from non-petroleum sources, often labeled as ‘sustainable’ fuels, are derived from alternative sources in contrast to fossil-based fuels. These include oils from plants, algae, greases, fats, waste streams, alcohols, sugars, or captured CO2. Hydrogen, the simplest known chemical element, offers the highest energy density of any fuel. The byproducts of using hydrogen as an energy source are environmentally friendly heat and water.

Aviation fuels are distinctive due to their ‘specific energy’3, or energy per unit of mass. The current Jet-A fuel is a carbon-based kerosene fuel. While hydrogen offers three times the energy of kerosene per unit of mass, it demands four times the volume of the current Jet-A kerosene-based fuel to achieve the same outcome. The possibilities for hydrogen-based aircraft propulsion include electric motors powered by fuel cells, hydrogen-powered gas turbines, or hybrid systems that incorporate both fuel cells and hydrogen-based gas turbines. For short to medium-range aircraft, conventional gas turbine engines could be modified to use liquid hydrogen combustion. Hybrid aircraft, powered by hydrogen fuel cells, are currently being explored as zero-carbon alternatives. However, integrating hydrogen as a fuel source will likely necessitate the redesign of aircraft configurations4.

New technologies frequently come with high costs and are not instantly practical. The economics and investment timelines needed to transition to reduced carbon alternatives remain subjects of exploration. This transition will entail long-term efforts in designing new equipment, developing necessary material supply chains, devising cost-effective energy production alternatives, and establishing Aero and Rail fuel distribution and logistics networks. Despite the remaining challenges, investment in current midlife Aero and Rail equipment appears more attractive. Opportunities with lower risk and existing cash yielding attributes are available. Call RESIDCO

Glenn Davis, 312-635-3161

davis@residco.com

1. Aii – Do Longer Trains Pose Problems or Solutions?

2. Office of Energy Efficiency & Renewable Energy – Hydrogen Fuel Basics

3. Wikipedia: Aviation fuel – Energy Content of Aviation Fuel

4. Siemens – Hydrogen Aircraft Technology

On March 23rd, 2023, the Federal Reserve voted unanimously1 to raise the interest rate paid on reserve balances by a quarter of a percentage point to 4.9%, marking the highest level since 2007. Although the federal funds rate range of 4.75% to 5% is above the Federal Reserve’s 2% target inflation rate, the annual inflation rate in the United States remains high at 6% for the 12 months ended February 2023, as per U.S. Labor Department data published on March 14th. This suggests that the Federal Reserve will continue to raise its benchmark rate. However, for Aero and Rail borrowers, higher interest rates will affect their ability to refinance maturing debt. Moreover, the banks are not accounting for duration risk in their ‘risk-weighted’ capital calculations. According to US GAAP, the value of “held-to-maturity investment assets” can be reported on the balance sheet at maturity values, which does not reflect their lower current market values in a rising interest rate environment. This is causing the current banking turmoil, which the Federal Reserve is addressing with a new Bank Term Funding Program (announced on March 12th), lending to banks at par against their held-to-maturity assets.

According to records dating back to 1988, February rail freight recorded its lowest total carload volumes (excluding intermodal originations). The decline in rail freight demand began in mid-2022. As retailers faced declining sales, they became more cautious and cut inventory levels. This was reflected in U.S. retail sales which were down 0.4% in February, the third decline in four months. In the first 11 weeks of 2023, rail freight volumes were down 5.2% compared to last year. February container imports at the ports of Long Beach and Los Angeles (the nation’s busiest) were down 38% year over year. Intermodal truck-rail was down 9.6% in the same period, with a 15.2% dip in the week ending March 18th. There is good news though. The Surface Transportation Board approved the CP/KCS merger2 4-to-1 on March 16th. The Board expects that this new single-line service will foster growth in rail traffic, shifting approximately 64,000 truckloads annually from North America’s roads to rail, and will support investment in infrastructure, service, quality, and safety. Moreover, rising interest rates make equipment leasing more attractive for both shippers and Class Ones, as they opt to maintain liquidity. This same dynamic will also influence commercial air carriers as they face similar market conditions. Although growth prospects for rail freight are mixed, these factors may help mitigate the decline in demand.

According to Delta’s Chief Executive, Ed Bastian, the airline recently had its highest sales days3 in its history. With more normal levels of aircraft utilization returning, air carriers are finding that the latest generation turbines (the LEAP and GTF engines used on the A320neo and 737MAX) are more fuel-efficient but not as reliable as existing technology CFM56 engines. The newer engines run hot, turbine components wear more quickly, and engine time on wing before removal and maintenance is required is not meeting expectations. Once in the shop, there are long waits for parts, and the availability of engine components is being impacted by the Airframer OEMs high demand for new engines. As a result, existing equipment remains in demand, as Air Lease Corp. Chairman Steven Udvar-Hazy stated that roughly 90% of aircraft leases are being renewed due to production delays at Airbus and Boeing.

The Bank stress that has appeared results from the extended period of unusually low interest rates. Equipment valuations and lease pricing will adjust in response. Regardless of ambiguities in the direction of demand, inflation, and geopolitics, capital should be allocated to productive opportunities. Existing Aero and Rail assets provide those opportunities. Call RESIDCO.

Glenn Davis, 312-635-3161

davis@residco.com

[1] Implementation Note issued March 22, 2023 – https://www.federalreserve.gov/newsevents/pressreleases/monetary20230322a1.htm

[2] STB Approves CP/KCS Merger With Conditions and Extended Oversight Period – https://www.stb.gov/news-communications/latest-news/pr-23-07/

[3] Delta Air Lines CEO Ed Bastian: There is still unmet demand for airlines due to the pandemic – https://www.cnbc.com/video/2023/01/13/delta-air-lines-ceo-ed-bastian-there-is-still-unmet-demand-for-airlines-due-to-the-pandemic.html

The International Air Travel Association expects the global aero industry to earn a $4.7 billion profit in 2023. U.S. and major European air carriers are better off than Asian (particularly China) carriers. Coming out of the pandemic, pent up air travel demand increased domestic load factors. Equipment and labor became operational challenges. As capital costs increased lease rates climbed. Both major airframers, Boeing and Airbus, continue to deal with supply chain issues1 and are unable to ramp up production as much as they would like. Inflation continues to drive increasing labor costs. Delta pilots reached an agreement (after three and a half years of negotiations) for an immediate 18% pay raise and a cumulative raise of 34% after three years. To deal with the pilot shortage, single pilot commercial aircraft operations are being explored. Over 40 countries including Germany and the United Kingdom have asked the United Nations body that sets aviation standards to help enable single-pilot flights. In November, Congressional action blocked a rail strike with a 24% pay increase over five years through 2024. 

The $1.65 trillion Omnibus Appropriations bill funds the government through September 30, 2023. More spending will drive inflation down and continue job market strength. The Services PMI strengthened in November and is firmly in “expansion” mode. According to the “third” estimate released by the Bureau of Economic Analysis, the real gross domestic product (GDP) increased at an annual rate of 3.2% in the third quarter. The U.S. Bureau of Labor Statistics reports over the last 12 months the Consumer Price Index for all urban consumers increased 7.1% before seasonal adjustment2. At its December 14, 2022 meeting, the Federal Reserve raised its benchmark rate a half-point to a range of 4.25% to 4.5% (its highest level in 15 years). All indications point to higher rates in 2023.

Exemptions for the 737 Max 7 and 10 were included in the Omnibus Appropriations bill. Requirements include retrofitting with a synthetic enhanced angle-of-attack system and the ability to shut off stall warning and overspeed alerts. The retrofit work is to be completed (at Boeing’s expense) within three years from the time the 737 MAX 10 is certified and will be required on all 737 MAX jets.

Forecast farm net income is expected to surge to $160.5 billion this year3, the highest since 1973 when adjusted for inflation. Prices for corn and wheat have soared since Russia’s invasion of Ukraine. Reduced grain stock and continued pressure on Black Sea exports mean pricing strength will continue. Carloads of chemicals and grain are the second and third highest volume carload commodities for railroads. Carloads of coal are the single highest volume carload commodity4 at 28.4%, twice as much as chemicals at 14.2%, and three times as much as grain 9.6%. The International Energy Agency has stated, “Coal will continue to be the global energy system’s largest single source.” In Europe, coal use has returned with coal plants brought back online. In the first two weeks of December, Germany generated 49% more power with coal than in the same period a year ago as Russian coal has been banned as a result of sanctions on Moscow’s invasion of Ukraine.

Despite current macroeconomic conditions, lessors and equipment producers are seeing higher lease rates and equipment demand. We’re optimistic about 2023 opportunities. Call RESIDCO.

Glenn Davis, 312-635-3161

davis@residco.com

[1] Boeing suspends Russian titanium as Airbus keeps buying, Mar. 2022

[2] CPI Up 7.1% over the year ended November 2022, Dec. 2022

[3] High Commodity Prices Feed a Boom in the U.S. Farm Belt, Dec. 2022

[4] Rail Traffic for December and the Week Ending December 31, 2022, Dec. 2022

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

davis@residco.com

[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