On November 18, 2020, the FAA rescinded its Emergency Order that had grounded the 737 MAX since March 13, 2019. The order allows Boeing to resume delivering the jets and will allow U.S. passenger flights to resume pending mandated fixes and additional pilot training. American Airlines had taken delivery of twenty-four MAX aircraft before the grounding and expects to take ten more before the end of this year. Starting December 29th, with one flight per day scheduled between Miami and New York’s LaGuardia, American will be the first air carrier to put the MAX back into regular commercial service. United, with 14 MAX aircraft currently in their fleet, will return the aircraft to service in the first quarter of 2021.1 Southwest, the largest 737 operator, will return the MAX to service in the second quarter of 2021. Other county regulators will individually determine airworthiness requirements and timing for a return to service.2 Even with MAX deliveries resuming Boeing executives do not expect the company to generate cash in 2021.

The collapse in traffic caused by the Covid pandemic forced a shift from 2019’s inability to meet demand to a 2020 industry-wide fleet oversupply. Air carriers parked 30% of their fleets (27% single-aisle, 41% twin-aisle).3 Both Airbus and Boeing have reduced production and cut jobs. Through October Boeing delivered just 111 jets compared to Airbus’ 413 jets. Operators are generating cash by selling aircraft to leasing companies and leasing them back. Delta entered into sale-leaseback arrangements to raise $1.2 billion. United has even sold 737 MAX models that have not yet been delivered.4 To meet changing demand patterns Southwest (with their all Boeing 737 fleet) is considering replacing their 737-700s, which are nearing retirement, with newer Airbus 220s to serve shorter to medium-haul markets more efficiently (Delta has ordered 95 A220 aircraft, 45 A220-100s and 50 larger A220-300s). 

Domestic flight operations break-even points are estimated to require 60% to 70% of pre-pandemic operating revenues. The timeline for U.S. passenger operations to reach these levels remains uncertain. It is clear single-aisle aircraft that serve domestic markets will recover first. Thanksgiving Holiday traffic confirmed this. Air Carriers struggled with flight cancellations caused by pilot shortages as airport screenings rose above 1 Million, their highest in more than eight months.  Wide-body routes continue to be negatively impacted by international travel restrictions.  Uniform measures must be developed to support a return of international passenger flight. European air traffic control (“Eurocontrol”) outlined its ‘most optimistic’ scenario with traffic returning to pre-pandemic levels by 2024 but said the ‘most likely’ scenario would be 75% by 2024.  

With vaccines expected to be available in the U.S. late December (widespread public availability by mid-2021), equipment opportunities will exist in the fleet surplus that is expected to continue through 2023. It is private capital allocation that identifies the opportunities that raise productivity. As the recovery begins, remain focused on what you can control.  Strengthen customer relationships and position your equipment portfolio to deal with 2021’s flight operations challenges. Contact: Glenn P. Davis CEO 312-635-3161 davis@residco.com

1 Southwest has 233 MAX aircraft on order.  Thirty-four have been delivered and are currently in storage.

2 European regulators are expected to lift the 737 MAX grounding in January 2021.

3 Cirium Fleets Analyzer, October 26, 2020.

4 United has sold and leased back 22 planes in bid to conserve cash, CNBC, April 19, 2020.

Our current environment is the result of external market shocks. Nearly every air and rail transportation asset now is faced with an unexpected demand profile. The pandemic’s lockdowns and stay at home orders have caused the largest global recession in history, impacting hotels, restaurants, commercial aviation, theaters, and live entertainment. Class One Railroad PSR business models are reshaping needs for locomotives and rail rolling stock. Business and consumer behaviors, habits, and preferences are shifting. McKinsey and Co. estimate that e-commerce penetration has achieved ten years’ growth in the last 90 days. Some of these changes may be permanent, others may not*.    

In September rail intermodal originations were 284,777 units, the fourth most for any month in history, up 7.1% over September 2019, and the biggest monthly percentage gain since December 2016.  The intermodal surge reflects an improving economy as firms restock and prepare for the holiday season.  August 2020 was the highest volume month ever at the Port of Los Angeles. Consumer confidence has rebounded. Auto sales are strong. The housing market is solid and home sales are now above pre-pandemic levels. The “HMI” (Housing Market Index), which measures builder confidence in the market for newly-built single-family homes, rose to 83 in September, matching the highest it has been in its 35-year history. The purchasing managers’ index (“PMI”) has been above 50 for five straight months (greater than 50 indicates expansion).  “Manufacturing performed well … with demand,” said Timothy Fiore, Chair of the Institute for Supply Management, “consumption and inputs registering growth indicative of a normal expansion cycle… the manufacturing community as a whole has learned to conduct business effectively and deal with the variables imposed by the COVID-19 pandemic.”  Excess capacity remains: 27.1% of the North American Rail Fleet is in storage, and an estimated 1/3 of the worldwide aircraft fleet remains parked.

The global aviation passenger market and its related equipment demand will return once consistent international protocols that eliminate quarantine requirements are developed. The 737MAX recertification is in its “home stretch” as the FAA administrator Steve Dickson said after piloting the plane himself September 30th. Carriers are expected to resume taking deliveries early in 2021.  By 2027 over 2,000 current-generation Boeing 737NG and Airbus A320ceos will have reached 25+ years of age and are expected to be retired. The MAX, with its improved aerodynamics, redesigned cabin interior, and more powerful and fuel-efficient CFM International LEAP-1B engines will replace these older units.  

With the Fed expected to hold interest rates near zero for an extended period, core transportation assets provide attractive yield alternatives. If Democrats sweep in November, expect the undoing of Republican tax reform, more fiscal stimulus, and an attempt at ‘packing’ the Supreme Court. Shifting production back to the U.S. has broad bipartisan support so structural changes might be made to restore what has been lost to countries that have lower labor cost, lower environmental standards, bigger subsidies for domestic businesses, and cheaper currencies than the U.S. dollar. Air Carriers and Class One Railroads are reshaping their fleets.  

Searching for opportunities that generate value and long-term success?  Call RESIDCO.

*Microsoft is going to permit some staff to work from home on a regular basis, even after the pandemic fades.

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.

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.

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.

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.

Liquidity buffers, loans, restructuring operations, cost savings. As the pandemic lingers it continues to depress economic activity.  

The drop in passenger traffic is driving air carriers to constantly adjust network flight schedules and evaluate equipment needs and workforce reductions. United is exploring the possibility of a fall workforce reduction and American is considering similar plans. The major carriers are moving forward signing letters of intent lining up U.S. Treasury Department loans as their net bookings drop. Twin aisle and aircraft with higher operating costs are being parked. Newer more fuel-efficient single-aisle jets that can be filled with passengers more easily would be preferred. 

But with demand down and list prices near $120 million, financing is challenging. United’s CEO, Scott Kerby, earlier told an investor conference “We won’t be taking delivery of a single aircraft unless it is fully financed.” American’s CFO has told Boeing it will not take delivery unless aircraft are financed under terms similar to those it enjoyed prior to the pandemic; “No financing, no 737 Max deliveries.” Delta said it will not take delivery of any new jets this year. Of Boeing’s 737 MAX on the ground inventory, 41 units are currently unclaimed (about 10% of the total parked).  By year-end, as many as 155 may be without takers.  

Airbus has reduced production rates of its A320 by one-third. Its CEO, Guillaume Faury, said in late April, “we’re facing the gravest crisis this industry has ever experienced”. The engines that power these aircraft are sold at a loss in order to secure long term service revenues. Ninety percent of Rolls-Royce Trent engines operate under service agreements that require airlines to make payments based on flight time. General Electric and its joint venture partner Safran (SAF, France) manufacture the Leap engines which power the MAX. They operate under similar long-term service agreements. The demand downturn is forcing Rolls-Royce to reduce production. It has resulted in a 17% workforce reduction (9,000 jobs out of its global workforce of 52,000). GE Aviation is implementing similar workforce reductions.  

But discount carriers sense an opportunity as the legacy airlines retrench.  Low-cost Allegiant Travel, CEO Maurice Gallagher Jr.: “I expect we will thrive in this changed environment.” Jets at bargain prices will be available as the legacy carriers retrench and sell aircraft.

In Rail, U.S. Rail carloads improved slightly in June but are still down 22.4% from 2019.  Carload declines continue across the board with declines in coal, crushed stone, sand, gravel, motor vehicles and parts and chemicals. Coal continues to lose its share of U.S. electrical generation. Despite declining U.S. rail volumes Class Ones are improving their operating ratios (operating expenses as a percentage of revenues) as they focus on equipment and workforce efficiencies driven by Precision Scheduled Railroading. A third of the North American rail fleet remains in storage. But lower operating ratios make more cash available. With nonfarm payrolls rising by 4.8 million in June the unemployment rate fell to 11.1%.  As Glassdoor economist Daniel Zhao puts it: “It’s fair to say the recovery has started, but that’s not a guarantee that the recovery will continue uninterrupted.” Its timing and path will depend on a Covid-19 solution.

As business models are being disrupted market realities are transforming transportation investment management.  Identify and capitalize on current opportunities. Call RESIDCO.

Aviation and rail equipment lease rates and equipment values are stressed as operators adjust equipment capacity to meet current levels of demand (and adjust to the Class One Roads implementation of Precision-scheduled railroading “PSR”). In the near term, lessees are focused on ensuring the sustainability of their business by attempting to defer new delivery commitments and restructure existing lease terms. OEMs are doing the same as they adjust production schedules in recognition market demand will be lower until the virus clears.  

The unknown duration of the path back to where the economy was before the pandemic adds complexity to evaluating equipment opportunities, whether under lease or currently stored.  Secondary market values are often impacted by new equipment pricing and specific lease maintenance and return conditions if under a lease. 

Technical factors also impact values.  Standard configurations and deep markets mean units are easier to place. Special features can help equipment retain value. An example: a higher maximum takeoff weight enhances an aircraft’s utility and consequently its value.  If it’s part of a family (e.g. A320/A321, or B737-800/900/MAX) equipment will retain value as operators benefit from lower investment in parts, equipment, and pilot training. Lower fuel prices improve demand for older aircraft.  If fuel prices advance, demand for older units will be depressed, shifting operators’ preferences toward newer, more efficient aircraft. Lease rates for the single-aisle Boeing 737-800, the 900ER, and Airbus A321s remain “relatively unscathed” with fleet weighted average declines of around 5% or less since January 30th.  And data shows the more fuel-efficient A320neos are being favored over the older A320ceos (54% of the A320ceo remain in storage, compared to only 30% of the A320neo).  

Older equipment may appear less attractive due to operating economics or functional obsolescence. But a lot of planes parked in the desert could offer better returns than new equipment. Fifteen percent fuel savings on new aircraft may not justify their capital cost.  As demand reappears some of these surplus units might be economically leased to second or third-tier operators or sold to another lessor or operator.

For Air, more than half of the world’s passenger jets are now in service.  In Rail, the combination of lower rail freight volumes and the Class Ones’ implementation of PSR has placed 31% of the 1.67 million-unit North American rail freight fleet in storage (520,729 freight cars). Maintaining customer relationships is the key to today’s markets. Rail ‘relationships’ are being tested as rail shippers are being required to transition their operations to comply with the Class One’s PSR schedules. Rail modal share will grow only if the Roads better integrate intermodal and trucking to give rail shippers an ‘end-to-end’ solution. 

The U.S. entered the recession as the strongest world economy. Now, “The big picture is the economy is on the road to recovery and we have passed the worst”. With fall elections approaching and an expectation of additional government spending on infrastructure, the recovery will continue.  A return to moderate growth means the outlook is becoming brighter.  Identifying opportunities is constant in portfolio management. Call RESIDCO.

As the U.S. economy began to reopen, investors looked past the pandemic and optimism drove financial markets to within 4.5% of their all-time high.  Lockdowns eased and a stronger than expected jobs report (2.5 million new jobs added in May) indicated the U.S. economy was impatient to reopen. American and Delta reported progress in summer demand, shoppers are returning to stores, and Europe and Asia have restarted portions of their economies. After the Fed announced plans to keep interest rates near zero for an extended period (at least through 2022 indicating they are expecting an extended recovery) the markets retreated. 

The virus remains a reality and there are concerns over a possible recurrence of COVID restrictions. But a vaccine is expected to be available within a year (perhaps as early as this fall) and a June Wall Street Journal survey reports 69% of economists expect a recovery in the third quarter. The uncertainty that is driving daily volatility is dictating a ‘bumpy’ recovery.  

The nature of the passenger aviation industry is such that flight operations will have to deal with a slower recovery than the wider economy. S&P Global Ratings expects global air passenger numbers to drop 50% to 55% in 2020 compared with 2019, and travel demand to remain below 2019 levels until 2023. Idle U.S. passenger aircraft peaked in mid-May.   United is reinstating flights at over 150 of its U.S. and Canadian destinations in July to 30% capacity. American announced it will increase domestic flights in July, to 55% of its July 2019 schedule. Recovery of global passenger travel will take additional time and require the implementation of agreed international safety procedures and removal of quarantine restrictions.  

The lack of passenger revenues is driving temporary conversions of passenger aircraft to freighters and increasing sale-leaseback financing activity (since March 1st  lessors have closed multiple transactions with Delta, Southwest, American, and United). Virgin Atlantic increased its cargo-only flights by more than one-third to nearly 600 in June, breaking its record for freight carried in May. British Airways began operating two 777-200s as cargo-only flights with cargo on seats. China Eastern Airlines is using 13 reconfigured A330-200s in temporary cargo service. Emirates has converted 85 of its Boeing 777-300ERs as stand-in freighters (in addition to their 11 777Fs). Some carriers are considering repurposing 737NGs as freighters and then arranging to replace them with MAX sale-leaseback financing.  Older A380s can be moved to second lives as freighters.  A ‘shared space’ 747-400M, in service with KLM since 1989 continues to fly.  It has capacity for 268 passengers with a locked bulkhead on the main deck separating the cargo area from the forward passenger cabin. 

Rail volumes remain stressed. U.S. rail freight carloads fell 27.7% in May from the same period in 2019.  That is the largest year over year decline for any month on record.  May was also the worst month for U.S. coal carloads in history. Cars in storage increased to 520,729 units. But consumer confidence rose, and both the Purchasing Managers and Non-Manufacturing Indexes rose. ‘All indications are that we’re starting to bottom out”.  

To update your evaluation of the duration and volatility of factors influencing aviation and rail asset values, call RESIDCO. It’s key to setting the stage for tomorrow’s portfolio growth.

The past aviation super cycle was driven by growing demand from Asia’s emerging middle class (China) as well as the expansion of no-frills carriers.  With much of the world now subject to air travel restrictions more than two-thirds of the world’s passenger aircraft are parked.  The reality is that most of these aircraft will be parked for the remainder of 2020.  

Boeing expects air traffic may not return to 2019 levels for two or three years (David Calhoun at a recent investor presentation announced, “we will be a smaller company for a while.”)  Airbus, the European plane maker, is cutting jetliner production initially by a third, and embarking on a plan to ‘right-size’ its business.  In a ‘Best Case’ scenario traffic will return to ‘normal’ mid-2021.  While both are optimistic air traffic will eventually revert to its long-term growth path, the reality is they just do not know when.

‘Lockdowns’ are causing businesses to lay off workers where face-to-face interaction is unavoidable.  Over the past six weeks, the Labor Department’s initial jobless claims have totaled over 30 Million (unemployment is forecast at 20%, the highest since it reached 25% during the Great Depression).  With the U.S. economy shrinking at a seasonally adjusted annual rate of 4.8% in the First Quarter and a further decline expected in the Second Quarter, we are entering a recession.  

Conservative ‘Worst Case’ estimates expect a ‘U’ shaped recovery – two to three years for air traffic to return to trend line growth;  Domestic narrow body smaller aircraft traffic first, International traffic later.  Airline executives are now leaning toward smaller aircraft that can be more easily filled in a time of depressed demand. Delta is keeping all 31 of its fleet of A220s flying, despite grounding more than half of its fleet (it has firm orders for an additional 64). Boeing terminated discussions with Embraer SA (which produces a rival to the A220) and will now rely on returning its 737MAX to service.  Will cabins be configured to allow social distancing while we wait for herd immunity, require everyone to wear a face mask, take temperatures at the gate, or a vaccine appears? Ultimately, how quickly global traffic recovers will depend on how well the current outbreak is contained and how the global community chooses to work together to limit future outbreaks.

The trend toward younger fleets started after 9/11.  Markets were surprised when many U.S. carriers decided not to bring back the 737 Classic.  Similarly, the COVID crisis is creating a dynamic that is forcing Carriers to ‘right-size’ existing fleets, retaining newer models, taking delivery of aircraft in the current production inventory (e.g. Boeing’s 737MAX — with financing supplied by the added liquidity the Fed is providing), and retiring older units[1].  Air travel is not going away.  Look closely, the pandemic is likely to create asset investment opportunities.  But, be prepared for a ‘choppy sluggish’ recovery even after the virus is contained.  To navigate to tomorrow’s fleet environment, call RESIDCO.

[1] With oil’s collapse, economics (and load factors) will ultimately decide whether existing equipment remains attractive.