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
[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
[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
A strong labor market is driving wage inflation and a falling unemployment rate (now 3.6%, just above the 3.5% it was before the pandemic). Even though the U.S. GDP was down 1.4% in the first quarter, rail carloads originated in March were up 1.2% year over year. The unexpected GDP drop was driven by a decrease in exports (due to a stronger U.S. Dollar), and an increase in imports (which are a subtraction in the calculation of GDP). The Ukrainian conflict and China’s continuing lockdowns (Xi Jinping’s zero-Covid policy) are extending global supply chain disruptions. The International Monetary Fund reduced their 2022 global growth estimate to 3.6% from 4.4%, citing the Ukrainian war’s disruption of global commerce and its impact on oil and agricultural exports from Russia and Ukraine. While inflation is reducing consumer purchasing power in the U.S. (consumer prices are up 8.5% from a year earlier), the Conference Board is forecasting 3% growth for the U.S. economy.
High steel prices[1] are driving premiums on new railcar deliveries. This new equipment inflation has created opportunities in the secondary markets, benefiting existing equipment values and allowing lessors to reprice lease rates up. Overall rail traffic remains mixed. Chemicals, crushed stone and sand, food and wood products are up; grain, motor vehicles and parts, lumber and wood products, and petroleum and paper products are down. Coal is benefiting from an increase in coal-based electricity generation as natural gas prices have increased (coal’s share of U.S. electricity generation rose to 21.8% in 2021 from 19.3% in 2020). Corn and soybean prices have risen to near records (corn is more than twice as expensive than before the pandemic). Auto inventories remain at historical lows (the average new vehicle cost is $46,000 and used car prices are up 40%).
Domestic U.S. aviation passenger demand is growing[2] and business travel is returning. American Airlines said its bookings and revenue in March were the best month in the company’s history; “business travel is on track to reach 90% of 2019 levels in the second quarter.”[3] Given current world events, the international long-haul market remains a moving target and is not expected to recover until at least 2023. U.S. and European countries have closed their airspace to Russian aircraft and Russian carriers are not operating foreign leased aircraft outside of Russia’s borders. Sanction related shifts in economic activity, geopolitical uncertainty, and China’s lockdowns are impacting Boeing and Airbus order books[4]. Air freight load factors are lower, but prices are higher. Although Russia is party to the Cape Town Convention, Russia’s move to reregister Western lessor owned aircraft operating in Russia will impact the values of this equipment when (if) returned as without access to up-to-date flight and maintenance records aircraft are not considered airworthy.
Crude oil remains over $100 a barrel and elevated energy prices are a concern. Delta reported a 33% increase in jet-fuel prices for the first quarter to $2.79 a gallon with the expectation of $3.35 in the second quarter. In its efforts to reduce inflation, the Federal Open Market Committee is expected to raise its benchmark rate 50 basis points this month, and again in June with a target rate of 2.25% to 2.5% by the end of the year. The Bank of Canada has already raised its key rate by a half-point to 1%.
Existing midlife Aero and Rail equipment is significantly less expensive than new. Whether rebuilding and reconfiguring or managing aftermarket teardown and part out, there are opportunities in these hard assets. Headwinds will continue. The key to long-term portfolio profitability requires equipment specialists. Increase returns, control risk. Call RESIDCO.
Glenn P. Davis, 312-635-3161
[1] Two-thirds of the 6 million metric tons of pig iron imported by the U.S. came from Russia and Ukraine.
[2] 2.1 million people passed through airport checkpoints in late April, up from 1.4 million three months earlier.
[3] CNNBUSINESS, April 21, 2022
[4] Air Lease said it has written off more than $800 million in assets
Investment and financing decisions involve an evaluation of risk, amount and timing of cash flows, and expected equipment values over an investment horizon. The outlook for Aero and Rail cash flows for the balance of 2022 have changed as the Global community reacts to Russia’s invasion of Ukraine. Even though Russia is a signatory to the Cape Town Convention it is holding more than 500 Western owned aircraft inside its borders in response to the European Union requiring lessors to terminate contracts with Russian airlines by March 28. Operating in an environment without the oversight of Western regulators will impact the value of these units when (if) they are recovered. Its evident values are lost when social and economic cooperation is stressed.
The U.S. has banned imports or is increasing tariffs on Russia’s top products including crude oil, petroleum, petroleum fuels, liquefied natural gas, coal, and iron and steel. Russia and Ukraine combined are the world’s second largest steel exporters and together supply almost one-third of the world’s wheat, a quarter of its barley, and three-quarters of its sunflower oil. Companies (and Countries) that rely on these products and raw materials will suffer. Crude oil and steel prices are up. Energy security in the U.S. (and more so in Europe), is now more important. Falling back on fossil fuels (coal), and boosting drilling is a likely immediate path for the U.S. as the transition to renewables will take years to accomplish.
Domestic freight rail will benefit. The conflict will drive U.S. domestic transport of agricultural and petroleum products, crude oil and coal. Recall that according to the American Association of Railroads, moving freight by rail is 4 times more fuel efficient than moving freight on the highways. Trains can move a ton of freight approximately 492 miles on a single gallon of fuel. On the aviation side, fuel is typically an airline’s second biggest expense after labor. But the surge in domestic air travel[1] is allowing air carriers to cover fuel price increases. In February, domestic ticket bookings and revenue rose above 2019 levels (for the first time since March 2020), and corporate travel booking has reached 70% of 2019 levels, the highest since the start of the pandemic.
In recent quarterly earnings calls railcar manufacturers and lessors are upbeat about rail market prospects. Rail traffic is continuing to improve driving fleet utilization, new equipment orders and lease renewal rates. Fourth quarter 2021 freight railcar orders grew by more than 50% from the third quarter. Orders in the fourth quarter of 2021 were 13,477 railcars compared to 8,607 railcars in the fourth quarter of 2020. The order backlog has increased sequentially for the past five quarters. Total rail carloads for the week ending March 19 were 232,770 carloads, up 1.1 percent compared with the same week in 2021. Five of 10 carload commodity groups posted increases compared with the same week in 2021 including coal, up 4,182 carloads to 63,929; chemicals, up 2,656 carloads to 34,178; and nonmetallic minerals, up 1,984 carloads to 31,151.
With the Consumer Price Index up 7.9% over the last 12 months the Fed is raising interest rates (.25% at its March meeting[2]). Expectations are rates will rise at each of the remaining Fed meetings this year while balance sheet reductions could start in May. Odds don’t favor stability as Geopolitical risk has splintered Globalization. Negative real rates persist and will continue to drive asset values up.
Be prepared for turbulence. Opportunities exist. Call RESIDCO.
Glenn P. Davis, 312-635-3161
[1] “We’re seeing an increase in demand that is really unparalleled” Delta Air Lines, investor conference, March 2022.
[2] Rates were last raised in December 2018
Coming out of the pandemic and in the early stages of a recovery, the world is responding to Putin’s choice to invade Ukraine. The impact on investor confidence is reflected in the market’s volatility. Crude oil prices are up. Rail and air freight capacity from Asia to Europe has been eliminated. The European Union Aviation Safety Agency (EASA) advises Ukrainian airspace and airspace within Russia and Belarus within 100 nautical miles of Ukraine borders pose flight risks (recall the Malaysia Airlines flight MH17 which was shot down over eastern Ukraine in 2014). Air carriers and countries are shutting down commercial flights. The UK banned Aeroflot (the Russian Flag carrier) and all Russian registered aircraft from landing in Britain. In response, Russia banned British airlines from landing at Russia’s airports (and from crossing its airspace). Hungarian airline Wizz Air and Ireland’s Ryanair have suspended flights. Poland and the Czech Republic have closed their airspace to Russian airlines. The FAA expanded the area in eastern Europe and Russia where U.S. airlines cannot operate. The expanded area includes all of Ukraine, Belarus and a western portion of Russia. Russian companies have 980 passenger jets in service, of which 777 are leased. Of the 777 aircraft, 515 are leased from foreign firms (generating $100 million every month from Russian firms to Irish based leasing companies). Dublin based AerCap has 118 aircraft managed or operated by Russian based carriers. As international payment transfers through SWIFT (the “Society for Worldwide Interbank Financial Telecommunication”) are disrupted, leasing companies will be forced to develop contingency plans.
Ukraine is a significant producer of uranium, titanium, iron ore, steel, ammonia, and agricultural products. Rising fuel, commodity, and fertilizer prices will impact inflation in Europe and the U.S. Prior to the invasion the U.S. Bureau of Labor Statistics reported the consumer price index rose 7.5% over the last 12 months (core inflation which excludes food and energy rose 6%). U.S. consumer price inflation is at its highest level in the last 40 years and is now expected to go higher. Fourth Quarter 2021 U.S. GDP growth was 7%[1] . For the year 2021, GDP grew 5.7% over 2020. The uncertainty of the impact of the Russian invasion of Ukraine on U.S. economic activity complicates the Fed policy response to domestic inflation. With the Fed balance sheet at $9 Trillion and U.S. debt approaching 130% of GDP, the Fed said last month it would approve a final round of $30 billion in bond purchases in February before ending its portfolio expansion in March. Fed officials are now expected to raise interest rates at their March 15-16 meeting. The question is by how much?
Solid growth in domestic freight rail traffic is expected from the Infrastructure Investment Jobs Act. The Railway Supply Institute’s American Railway Car Institute Committee (ARCI) reported a 50% increase in fourth-quarter 2021 freight railcar orders (compared to third-quarter 2021). Backlogs increased to 42,993 railcars. Class One profitability continues. Even with rail traffic totals down 9% year over year (through February 5th), coal carloadings are up (due to natural gas pricing inflation), crushed stone and sand gravel loadings are up, chemicals up, and grain loadings up. Auto component shortages continue and primary metal products, and lumber and wood product loadings are down (home sales reached a 15 year high in 2021). Labor force participation is at 62.2% in December, the highest since the pandemic (but inflation is causing adjusted wages to fall).
As the pandemic becomes a memory, the U.S. faces twin geopolitical challenges (Russia, China). With Globalization fractured, new equipment inflation and rising interest rates will create opportunities for placement of existing midlife Aero and Rail equipment.
Glenn P. Davis, 312-635-3161
[1] Bureau of Economic Analysis.
Unlocking Aero & Rail Equipment Values Amidst Surging Inflation
Global growth continues but is expected to slow to 4.1% in 2022 (down from 5.5% in 2021[1]). In the U.S., 2022’s growth is expected to be 3.7% (down from 5.6% in 2021). In the fourth quarter of last year, the U.S. GDP grew at a 6.9% annualized rate. With the domestic economy stronger, inflation has returned and labor markets are much tighter. Unemployment is down to 3.9% (December) from a record 14.7% in April 2020. The Fed is set to raise rates and conclude its purchases of Treasury bonds and mortgage-backed securities[2]. Expect a ‘bumpy’ transition.
Air carrier operations staff shortages and quarantine rules for air crew members complicated flight operations and led to flight cancellations last quarter. Fleet equipment and air crew planning became a challenge, even for freighter operations. In the fourth quarter of 2021, United lost $646 million, American $931 million, and Delta $408 million. Southwest reported net income of $68 million, its first quarterly profit during the pandemic (without the help of government aid). The good news is domestic leisure travel demand is back, and above 2019 levels (business and international travel recovery remains delayed). Carriers are facing steeper costs for labor and fuel. Jet fuel cost is expected to rise to $2.35 to $2.50 a gallon in the first three months of 2022, up from $2.10 a gallon in last year’s fourth quarter. Crude oil pricing is at its highest level since 2014 (West Texas Intermediate, the main grade of U.S. crude was up to $86.61 January 27th). Flight operations are being further disrupted by the 5G rollout, which impacts the reliability of radio altimeters used for low visibility approaches at airports with runways close to 5G C-band network antennas.
Boeing sold more aircraft than Airbus last year, but delivered half as many passenger jets. Boeing won orders for 909 planes (535 net new orders), while delivering 280 (up from 157 delivered in 2020). Airbus delivered 611 jets in 2021 and won orders for 771 (507 net). Backlogs for both airframe competitors extend out over the next several years. Boeing remains hampered by its 737 MAX crisis and production issues with its 787 Dreamliner (100 undelivered Dreamliners wait for regulatory approval). While Airbus’ A321neo family is outselling Boeing units, Boeing’s equipment availability led Allegiant to buy up to 100 MAX jets (new Airbus units could not be delivered until the end of the decade). A 12-year maintenance agreement with the engine provider (CFM International) is expected to lower Allegiant’s operating cost. United’s 777s (Pratt & Whitney engines) are expected to return to service this quarter. Qatar Airways recently agreed to purchase 34 freighter versions of Boeing’s 777X (777-8), which are not expected to be delivered until late 2023 at the earliest. Once the pandemic fades, air carriers are expecting traffic to surge.
Because of infection or Covid exposure, rail operations performance were similarly impacted by lack of operating crews on any given day. CSX is facing staffing shortages, offering $3,000 referral bonuses for recommendations for new hires, and spending $20 Million on initiatives to attract and retain workers. Slower train speeds, higher steel prices and railcar scrapping are helping support the railcar leasing markets.
As the Fed raises rates and global tensions continue (Ukraine, Taiwan) this year’s recovery will be bumpy and characterized by market volatility and inflation. With the improving outlook, inflation in new equipment pricing will favorably impact existing mid-life asset values and lease rates. To identify those investment strategies that unlock air and rail equipment values,
Glenn P. Davis, 312-635-3161
[1] World Bank forecast, January 11, 2022.
[2] The Fed balance sheet is now approaching $9 trillion, $8.3 trillion comprised of Treasuries and mortgage-backed securities.
The pandemic stopped a decade of profitable air carrier operations (in 2020 U.S. air carriers lost $35 Billion compared to a $14.7 Billion profit in 2019). In today’s lower traffic environment single aisle jets remain attractive, accounting for 70% of expected new equipment deliveries over the forecast horizon (split between the 150-seat market A320, Boeing 737MAX8 and the 180+ seat market A321neo and B737Max10[1]). Twin aisle aircraft will wait for the return of international travel as 2022 world travel is forecasted at 61% of pre-pandemic levels[2]. It is air cargo demand that is expected to exceed pre-pandemic levels by 13% in 2022. A desire to avoid crowded terminals, as well as major carrier cuts to smaller communities, resulted in more than 323,000 private jet flights this past October (the first 10 months of 2021 were up 9% from the same period in 2019 and were ahead of the previous high in 2007). Orders for new business jets are up more than 50% over the past year (new private jets sell for between $5 Million to $ 70+ Million). An example is the A220-100 (the “TwoTwenty”) operating as a (large) private business jet with 33% lower operating cost and a 5600 nautical mile range. The regional market is testing zero emission hydrogen/electric engines and United is planning to retrofit its existing United Express fleet with the ZeroAvia2000-RJ engine as early as 2028.
Unlike restrictions that have been imposed on people’s movements around the globe, global government policies are oriented toward maintaining the flow of goods and commodities. Freighter demand is benefiting, being driven by the growth of e-Commerce and continuing supply chain congestion. Record cargo revenues are expected to continue ($175 Billion in 2021, $169 Billion in 2022). Freighter equipment will split 70/30 between conversions of existing units and new deliveries. Increasingly newer generation aircraft are being converted including the A321, B737-800, A330 and B777-300ER. UPS recently ordered 19 (additional) 767s. UPS was the launch customer for the 767 freighter in 1995 and has ordered 91 of the type since. They operate Boeing 757s, 767s, 747s, MD-11s and the Airbus A330. Midlife equipment continues to operate even though the aircraft survivor curve analysis used for modeling forecasts an average economic life of 22 years for single-aisles and 20 years for twin aisles.
Market fundamentals for railcar leasing will improve in 2022[3]. Through November U.S. rail freight carload traffic is up 7% over 2020 (but remains down 8% from 2019). Freight rail traffic growth is projected in the mid-single digits for 2022[4]. November coal carloads were up over 11% reflecting the rising price of natural gas which is up more than 180% over the last 12 months[5]. High steel prices (up 137% October over October) are causing a 15 to 30% premium on new railcar pricing. Cars in storage are down from 32% in July 2020 to 20%. The Class One’s focus on precision scheduled railroading can be expected to continue low rail industry operating ratios which were above 85% in 1990 and now have declined to under 65%.
While the pandemic shut capacity, demand was driven by Washington’s fiscal stimulus. Spending came back faster than supply. The result – higher prices. The pandemic also led to the early phasing out of a number of relatively young aircraft. The high cost of new equipment now makes midlife air and rail equipment more attractive. Market disruptions often work to provide investment opportunities. As activity improves targeted midlife transportation investment opportunities exist.
Glenn P. Davis, 312-635-3161
[1] Cirium Fleet Forecast, cirium.com (Indigo Partners ordered 255 A321neos during the recent (November) Dubai air show to be placed with low-cost carriers, Wizz Air, Frontier Airlines, JetSmart and Volaris.
[2] IATA outlook, Boston, October.
[3] Trinity Industries, Railway Age, October 21, 2021.
[4] Cowen and Company Freight Transportation Equipment Analyst Matt Elkott, October 25, 2021.
[5] Coal will account for 23% of U.S. electricity generation in 2021, up from 19% in 2020.
The $1 Trillion infrastructure bill. When it passes it will be one of the most substantial federal investment programs and will drive demand for freight rail growth. For years global trade held inflation in check. The pandemic shut the system down. The Fed’s monetary policy and government spending have fueled strong consumer demand. Now we have constrained global supply chains, rising commodity prices and tight labor markets. Relaxing of pandemic border restrictions will result in transatlantic air travel rebounding in 2022 like domestic travel did this year. U.S. air travel restrictions are set to be lifted in November (with proof of vaccination and a negative coronavirus test – no quarantines required).
Consumers will have to manage through this period of higher inflation (the Fed’s updated inflation outlook – over 4%[1] for 2021). Intermodal operations remain backlogged as container[2] vessels wait for unloading berths off the Port of LA. Efficient transport requires goods to move seamlessly. Ocean vessels, ports, truckers, and railroads must work together. Containers are sitting dockside for an average of eight days, up from two before the pandemic. Trains are waiting for loads due to a lack of truck drivers. Delays in one area have led to bottlenecks in others. Global One in Joliet was so backed up in July that the Union Pacific temporarily halted all trains arriving from the West Coast so it could clear the yard. U.S. farmers can’t get containers as shipping lines are increasingly sending empty boxes back to Asia as quickly as possible rather than inland for grain export. Class Ones are running fewer trains, longer distances, on tighter schedules. Precision Scheduled Railroading resulted in thousands of rail workers being furloughed, and air carriers now face a pilot shortage as demand returns[3].
While a pilot shortage looms, aircraft values are recovering as the domestic stored passenger narrowbody fleet declines. Passenger twin aisles are currently being used on all cargo international flights. Industry sources expect less than 5000 aircraft will remain in storage at the end of 2021 (down from a high of 17,000 units at the peak of the pandemic). The in-service fleet is flying fewer hours. Widebody equipment values remain down, narrowbody valuations have on average recovered, (737NG/737-800 values are up), and regional aircraft values are up (ATR 72, E190). Competition and low interest rates have driven some lease rate factors to .55%.
Domestically, imported semiconductor component delays have led to a slowdown in manufacturing production. Third quarter U.S. Growth was hampered by the microchip shortage as supply chain disruptions caused by the pandemic impacted the automotive and industrial market segments. This demonstrates just how fragile the extended global supply chain has become. Bottlenecks are now expected to last through 2022. Commodity prices are edging up (West Texas Intermediate crude recently traded above $84 a barrel and Brent above $86.00). With inflation lasting longer than anticipated, bond markets are starting to reflect expectations of interest-rate increases. Tight labor markets, easy monetary policy, government spending, international tensions, and Asia Pacific travel restrictions will remain. Carbon, climate, and politics are wild cards.
Consumer demand and supply shortages will lead to inflation. Transportation equipment values will head up. Make informed decisions on where to find air and rail investment alternatives.
Glenn P. Davis, 312-635-3161
[1] Forbes, September 22.
[2] October 2, The Washington Post “This month, the median cost of shipping a standard rectangular metal container from China to the West Coast of the United States hit a record $20,586, almost twice what it cost in July, which was twice what it cost in January.”
[3] October 31, American Airlines cancelled about 1,800 flights due to a shortage of pilots and flight attendants
Finding Value In Midlife Air and Rail Equipment
Not so long ago the typical freight railcar had a new cost below $50,000. Today, a newly built freight railcar is in the $100,000 to $150,000 range. Both rail and aero assets present long-term investment opportunities. Railcars have up to a fifty-year interchange life. The economic useful life of an aircraft or aircraft engine is the period over which it is expected to be physically and economically feasible to operate in its intended role.1
What ends the life of the equipment is economics (when the cost of operating exceeds the cost of replacing). On average, the life of an aircraft, from purchase to retirement is between 20 to 36 years (Boeing and Airbus build their airframes to last 40 years: 51,000 flight hours and 75,000 pressurization cycles).
Today’s oversupplied secondary markets present opportunities to find value in midlife units. Finding those values requires the ability to identify well-maintained units with remaining service life while evaluating expected service alternatives. It’s the current spread between cost delivered new and secondary market cost that presents these investment opportunities.
The Boeing 757 is an example. Eastern Air Lines placed the original 757-200 in service on January 1, 1983. The last 757 was delivered in 2005. The modern narrowbody alternatives are more fuel-efficient, but the 757 is still active. When COVID appeared over 80% of the world’s 757s were grounded. Before COVID more airfreight was carried in the cargo holds of passenger aircraft than in dedicated freighters. With fewer passenger aircraft flying the parked 757s present the optimal narrow body for freighter conversion. To ensure dedicated freighter aircraft capacity, Atlas Air, the largest operator of 747 cargo aircraft in the world, recently announced it purchased three 747-400 aircraft that were previously leased and reached an agreement with lessors to take ownership of five more aircraft at the end of their existing lease terms next year.
Given the useful economic life of existing railcar equipment and the inflation in new railcar pricing (steel prices are up 215% since March 2020), it makes economic sense to evaluate opportunities to pursue existing rail equipment rather than new ones. Freight rail volumes are being influenced by several challenges, overreliance on global supply chains, the lack of microchips for autos, and the Delta variant, which is upending factory production in Asia. Among all rail traffic categories, Class One’s earned $5.97 billion from grain in 2020 (third behind intermodal and chemicals). But grain exports are down. Hurricane Ida flooded and damaged grain terminals along the Gulf Coast just weeks before the start of the Midwest harvest. More than 50 bulk vessels were lined up along the lower Mississippi in early September waiting to dock and load. On August 29th an all-time high of 47 container ships were at anchor off the ports of Los Angeles and Long Beach due to lack of berth space.
The strain on global supply chains is evident and Class Ones are hampered by capacity constraints resulting from COVID and the implementation of Precision Scheduled Railroading. With Thanksgiving and the Holidays expect port congestion and labor and capacity shortages at docks, warehouses, and trucking firms to continue.
The economics of logistics and transport investment are complex, but business cycles repeat. Volatility creates opportunity. Leverage our track record of transitioning equipment to its best and highest use. Times are excellent for midlife equipment investment strategies.
To model the equipment markets and manage risk, Call RESIDCO.
1 That’s the International Society of Transport Aircraft Traders’ (“ISTAT”) definition. ‘Longevity’ depends on market need and maintenance expense. Well cared for aircraft can have an almost unlimited life (but only with respect to safety and airworthiness: think the DC-3 aircraft that were in service in the late 1930’s and still fly today).
Rail and air transportation plays a central role in our nation’s economy. The government’s fiscal decisions, monetary policies, and administrative agency rulings influence the outcomes and the economics of transportation investment opportunities. The Surface Transportation Board’s unanimous ruling that the Canadian National hasn’t demonstrated its use of a voting trust would be consistent with the “public interest” follows the President’s recent Executive Order to “address overconcentration, monopolization, and unfair competition in the American economy.”
Government action and the rules and regulations implemented by its many Administrative Agencies1 have attempted to address both economic and social goals. Traditional ‘economic’ regulation focused on markets and economic variables and dates back to 1887 when Congress created the Interstate Commerce Commission to address the concerns of dissatisfied shippers. Railroads were then required by law to charge rates that were ‘reasonable and just,’ (the ICC was disbanded in 1995 and replaced with the Surface Transportation Board). In 1938 Congress created the Civil Aeronautics Board and directed the Board to place ‘public interest’ ahead of profits.
Regulatory reform (‘deregulation’) began in the 1980s, notably in the air and railroad industries.
Rail was significantly deregulated with the 1980 Staggers Act. That Act reduced federal regulatory controls over the roads who then went on to abandon unproductive routes, reduce labor cost, and increase efficiency by offering freight discounts to ‘bulk’ unit trains (e.g., grain and coal). By 1988 the competition released by deregulation had produced lower prices in most commodity classifications (while not increasing prices in others). The D.C. Circuit has recognized that the statutory language of 49 U.S.C. Section 10101 2 mandates deregulation of the entire railroad industry to the maximum extent possible in conformity with national rail transportation policy.3 Similarly, the Airline Deregulation Act of 1978 (supported by both Democrats and Republicans during the Carter Administration) specified the Civil Aeronautics Board (“CAB”) would be dismantled (eventually completed in January 1985).
After the CAB no longer had the power to price and set routes, competition forced air travel prices to fall, and U.S. airline passenger volumes increased dramatically. Deregulation gave railroads the freedom to negotiate contract rates and make operational improvements. The roads improved the efficiency of their networks, tailored rates to shippers’ traffic, abandoned low-density lines, and (as a result of merger activity) eliminated the duplicate track. Precision Scheduled Railroading is an example of operational freedom that the Roads are implementing today in an attempt to provide faster, more reliable service.
Tension exists between the business of pursuing ‘economic’ goals and the politics of pursuing ‘social’ goals. Governments may set ‘policy’, but business investment is driven by economics. Politicians do not face the same ‘market’ discipline. Other than elections, accountability mechanisms for political decisions are not in place. Markets may not always function perfectly, but unintended consequences often follow government attempts to produce desired ‘social’ results.
Identifying effective investment strategies in this environment requires an ability to integrate today’s politics into your investment thinking. Call RESIDCO.
1 In a 2015 Senate Judiciary Committee hearing, Chairman Chuck Grassley (R-IA) noted: “The Federal Register indicates there are over 430 departments, agencies, and sub-agencies in the federal government.”
2 Title 49 – Transportation – Interstate Commerce – “National Transportation Policy.”
3 Brae Corp. v. United States, 740 F.2d 1023, at 1043 (D.C. Cir. 1984); also Ass’n of Am. R.Rs. v. Surface Transp. Bd., 237 F.3d 676, (D.C. Cir. 2001).
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