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
[1] Trading Economics, May 2023 data.
[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
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
Weight and balance limits of aircraft are crucial for ensuring flight safety. Incorrect weight distribution significantly impacts flight performance, and neglecting or performing incorrect preflight calculations can have fatal consequences. From 2008 to 2016, approximately 136 general aviation accidents were likely caused by pilots failing to complete or conduct preflight performance calculations for weight and balance. About one-third of these accidents led to fatalities for pilots and/or passengers1. The pilot in command holds the responsibility for aircraft loading, crew, passengers, baggage/cargo, fuel, and ensuring compliance with center of gravity limits and maximum weight restrictions.
With the adoption of Precision Scheduled Railroading (PSR), Class One railroads are operating longer trains. The arrangement of cars, whether empty or loaded, short or long, impacts a train’s ability to safely navigate the tracks. Poorly assembled trains elevate the risk of derailments. Longer trains enable fewer employees and locomotives to complete a trip compared to running multiple shorter trains. This reduction in equipment needs improves system velocity and lowers the operating ratio. Although distributed power units and dynamic braking enhance train handling, they do not rectify human errors in navigating challenging terrain or poorly assembled trains. Longer trains are more prone to derailments when there is improper weight distribution, leading to the train separating on inclines or curves2, or empty cars derailing due to trailing weight.
Mechanical issues with equipment are also a significant concern. Rail operators oversee the composition of trains and the placement of trackside “hot box” detectors3. Initial analysis of the recent Norfolk Southern East Palestine incident indicates that it was caused by an overheated wheel bearing. The East Palestine derailment could have been prevented if Norfolk Southern had placed hotbox detectors closer together. The Federal Government lacks regulations mandating the use of temperature detectors along tracks, as well as guidelines for their placement, inspection, and maintenance. Following the East Palestine derailment, the Federal Railroad Administration (FRA) released its initial advisory, urging railroads to enhance the positioning of trackside safety detectors. The American Association of Railroads (AAR) interchange rules outline the responsibilities regarding equipment inspection and necessary “running” repairs before railcars are interchanged. When cars go through interchange, the railcar owner bears the financial responsibility for repairs carried out by a railroad’s “running repair agent”. These repairs are invoiced at AAR labor rates4, which are notably higher than rates in private contract shops.
In aviation, new technologies often carry inherent risks. Pratt & Whitney’s PW1000G geared turbofan engine is a case in point, with many units requiring retrofits. The time on wing before overhauls is approximately 10,000 hours, roughly half the duration of existing Pratt & Whitney V2500 engines.
Effectively managing investment risk for Aero and Railcar portfolios entails considerations beyond lessee credit, lease term(s), pricing, and equipment service lives. The operations and maintenance practices of lessees can generate undesirable publicity and lead to intricate legal proceedings. Collaborate with an investment management team that possesses a deep understanding of these risks. Call RESIDCO.
Glenn Davis, 312-635-3161
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
[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
After increasing 3.2% in the third quarter year, the U.S. economy grew at a 2.9% annual rate in last year’s fourth quarter. The Federal Reserve’s preferred price index slowed to 3.2%. Inflation appears to be cooling, but labor, and supply chain challenges remain. Higher interest rates are impacting demand in manufacturing and services. The labor market remains tight. Unemployment is at 3.5%, matching a half-century low. Fourth quarter GDP reflected increases in inventory investment and consumer spending, partly offset by a decrease in housing.
Whether the Federal Reserve can engineer a soft landing or not, a slowing economy will impact rail freight traffic demand. Rail freight volume growth is now projected to be less than 1% for 2023. Train speed velocity is a key metric that impacts equipment availability. Class One “Scheduled Railroading” operational plans will need to be adjusted to emphasize velocity improvements. Train crew shortages must be resolved. Both the Roads and Rail Shippers face higher new car pricing, driven by railcar production cost, steel and tight component availability. Car availability has tightened as railcar retirements have outpaced new deliveries for the third consecutive year1. Railcars in storage are down. Thirty-seven percent of the stored fleet has been inactive for over 1 year and will either be scrapped or repurposed if economically possible. Covered hoppers are being converted to from 3,250 to 4,751 cubic feet, allowing different product service such as potash, sugar, grain, and distillers dried grains. Suboptimal units in storage are likely to be scrapped. Tight equipment supply is supporting existing car pricing and lease renewal rates for both originations and renewals.
Demand for air travel continues to outpace the industry’s ability to meet it. United, Delta, and American are all reporting resilient demand, seats packed and fares higher. Delayed new aircraft deliveries are restricting the industry’s ability to adequately respond to the rebound in passenger demand. At United’s January 18th earnings call, Scott Kirby, United’s chief executive, argued fundamental changes have occurred: “Across the board there are supply-chain constraints, technology infrastructure issues, a pilot shortage, workforce constraints (lower experience levels of new hires) and, airframers are struggling to meet delivery targets.” A logjam in engine repair capacity has left planes grounded as their engines are late coming out of overhaul. During last summer, more than 1,300 aircraft were returned to service from storage. Compared to pre-COVID levels more than 1,700 single-aisles and 900 twin-aisles remain in storage2. Detailed analysis of the stored single-aisle units project 60% are projected to return to service3.
Yields on short-term Treasurys have held above those of longer-term debt, a signal to expect slowing growth. Globalization isn’t dead but changing. More attention is being paid to geoeconomic risk. Nations are balancing growth and low inflation against defending national interests. While the risk of a recession cannot be dismissed, the odds of a soft landing are getting better. With Covid receding, longer run issues are coming into focus. Prices are likely to go higher as constrained supply continues to drive equipment values and lease rates.
Concerned about the path of demand and inflation? Call RESIDCO.
Glenn Davis, 312-635-3161
[1] Greenbrier CEO Lorie Tekorius, Midwest Rail Shippers Winter Conference, 2023 Rail Equipment Update, January 18, 2023
[2] Cirium Fleets Analyzer, Western-built passenger jets, New Year Resolutions, January 26, 2023
[3] Ibid.
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
For the past thirty years global supply chains helped keep U.S. inflation low. Globalization led to offshoring. Aero and Rail transport system efficiencies allowed ‘just in time’ inventory control. The pandemic exposed the over reliance on global supply chains. The U.S. fiscal policy response to the pandemic’s impact included more than $5 trillion of direct cash payments to individuals and businesses in 2020/2021. The Federal Reserve engaged in large scale asset purchase programs and kept interest rates too low for too long. Both have been a part of driving inflation to a forty year high. Supply chains never fully recovered from the pandemic’s shock. Now, Ukraine and geopolitical tensions between Western democracies, Russia, and China, are rising commodity costs (and security risks) even further. In response to the Federal Reserve raising interest rates1 in an attempt to fight inflation and get price growth under control, U.S. private sector business activity is contracting, in August the Composite Purchasing Managers Index to 45 from 47.7 and the Services PMI to 44.1 from 47.3.
Rail service issues are currently driving rail equipment demand. Shippers continue to complain to the Surface Transportation Board about railcar order delays and “unfilled railcar orders.” Each Class One reports “unfilled orders” slightly differently but generally it is the number of railcars a shipper ordered but did not receive. The STB recently issued an emergency service order directing the Union Pacific railroad to meet its common carrier obligations to a large California poultry and feed producer which leases four unit trains from UP as part of its grain-train shuttle program. Union Pacific was forced to add a fifth train set and prioritize both train crews and locomotives to meet its common carrier obligation. System congestion has forced the STB to order the four largest Class One railroads to submit weekly performance data as well as recovery plans.
Rail fleet utilization and lease renewal rates have risen in response. Trinity Industries reported a 97.2% lease fleet utilization, 4,335 new unit and delivery railcar orders, and 2,510 deliveries of units in its second quarter (industry wide railcar deliveries for the full year are expected to be between 40,000 and 50,000 units). The Greenbrier Companies reported new railcar backlogs of $3.6 billion and continued high lease fleet utilization in its rail leasing subsidiary. As rail labor issues persist a shutdown of the nation’s rail network is possible on September 16th, marking thirty days since the release of the Presidential Emergency Board recommendations for voluntary settlement of a 31 month labor dispute over wage, benefits, and work rules. Congressional intervention is all that would prevent a national shutdown.
Boeing resumed deliveries of its widebody 787 in August with American Airlines taking delivery of the first Dreamliner since May of 2021. American Airlines expects to take nine 787/8s this year, four in 2023 and twelve in 2024. Boeing launched the Dreamliner in 2004 and eighty customers have ordered nearly 1500 787s. Global air freight traffic is up and the passenger to freighter conversion backlog is over 550 units. The shift to e-commerce is driving air freight and market fundamentals are expected to remain strong. An example; Atlas Air Worldwide Holdings, Inc is being taken private by Apollo Global Management in an all cash deal valued at $5.2 billion2, a 57% premium over the 30-day average trading price of Atlas’ common stock. On the Rail side, J.P. Morgan’s Global Alternatives’ Global Transportation Group recently announced its acquisition of the InStar Group, LLC., a freight railcar lessor.
Investment strategies, financing, and tax risk management all impact the evaluation of transportation equipment leasing. Near term market disruptions have created opportunities for longer term transportation asset investment. Call RESIDCO.
Glenn Davis, 312-635-3161
[1] Jerome Powell says Fed is resolved to fight inflation even if it brings economic pain
[2] Atlas Air Worldwide to be Acquired by Investor Group Led by Apollo Together With J.F. Lehman & Company And Hill City Capital for $5.2 Billion
Aero and Rail investment operate at the intersection of financial services and the real economy. The past decade of low interest rates has driven asset values up. Add the five trillion in aggressive stimulus spending passed by Congress and U.S. inflation is at a four-decade high. During the Covid lockdowns transportation operations were streamlined by reducing labor and equipment capacity. Now Commercial Air Carriers and Class One Railroads are struggling to meet demands as traffic has returned. With current elevated manufacturing cost and the U.S. economy unexpectedly contracting in the first quarter, Shippers are hesitant to pay for new equipment. The result? The impact of service disruptions and the inflationary environment has created strong demand for existing midlife equipment. There have been seven consecutive quarters of sequential increases in existing rail rolling stock lease renewal rates. Increases in the first quarter of 2022 have been in the mid-to high teens with average renewal terms of 30 months,[1] and, railcars in storage are down.
Economists are concerned record energy and food prices are creating consumer expectations that will sustain and continue high inflation. Over the last twelve months the Bureau of Labor Statistics reports the gasoline index up 48.7% ($5 a gallon gasoline prices are up 60% from a year ago). The fuel oil index is up 106.7% (the largest ever in the history of the series which dates to 1935). The electricity index is up 12%. The natural gas index is up 30.2% (the largest increase since July 2008). West Texas Intermediate and Brent crude futures is averaging over $120 per barrel. Rising inflation complicates pricing decisions and labor negotiations (United Airlines agreed last week to give their pilots a 14.5% raise through the end of next year). Since March the Fed has raised its benchmark federal-funds rate three times from near zero to a range between 1.5% and 1.75% and is signaling additional increases are coming. Concerns are growing that supply chain disruptions, commodity-price shocks, the risks of a wage-price spiral, geopolitical tensions, and the Fed’s higher interest rates will tip the U.S. into recession. The New York Fed’s internal economic modeling system is predicting a contraction this year and next.[2] “Historical experience points to a significant risk of a US recession in the wake of monetary tightening.”[3] And, the Federal Reserve Bank of Atlanta’s latest estimate (June 30) for 2nd Quarter GDP ‘growth’ dropped to -1% (recall 1st Quarter GDP declined at a 1.6% rate).
Rail service disruptions continue, and Rail Shippers are complaining cars ordered are not being delivered. When shippers are unable to receive cars ordered it disrupts markets throughout the broader supply chain. U.S. Code 49 U.S.C. 11101(a) provides railroads have a statutorily mandated ‘Common Carrier’ obligation ‘to provide transportation service on reasonable request’. The 1980’s Staggers Act removed many government regulations and resulted in an environment that led to rail duopolies in the eastern and western U.S. The Chair of the Surface Transportation Board (“STB”), Martin Oberman feels: “the pendulum has swung too far”. Regulatory risks are increasing as the roads struggle with clearing congestion.
Demand in the Aero and Rail secondary markets is strong and it’s expected to remain so through the remainder of this year. Real interest rates remain negative. Equipment finance firms that adjust operating practices now will be better positioned to compete and thrive. Hard assets with long lives, contractual cashflows, and robust residual values remain attractive. A correction in the economic outlook will create opportunities. Find the best spot market Aero and Rail values. Call RESIDCO.
Glenn P. Davis, 312-635-3161
[1] GATX 2022 First Quarter Conference Call, April 20, 2022
[2] Wall Street Journal, June 21, 2022, Fed’s Bullard, Wary of Inflation
[3] Fitch Global Economic Outlook, June 2022
As demand returns, post-COVID transportation markets are struggling to maintain service levels. Precision Scheduled Railroading (“PSR”) with its asset and workforce reductions worked to reduce Class One operating ratios. Over the five years before the pandemic the Class Ones had already reduced headcount 33% through attrition and layoffs. During the pandemic workforce reduction continued as additional workers were put on furlough. Railcars were returned and locomotives stored. Now post-COVID, as demand returns, the lack of workforce and equipment is resulting in severe service deterioration. In a letter to the STB the American Chemistry Council reported railcars were waiting at railyards for over a week and travel times for some routes had more than doubled. Factories were running out of materials because of lack of material deliveries.
From testimony at the recent April Surface Transportation Board hearings: “Since the fourth quarter of 2021 rail service has deteriorated to such a degree that our industry is struggling…service disruptions have increased average transit times for Cargill’s private rail fleet by 15%…plants have had to slow production and temporarily shut down because there were no railcars available to deliver or ship product.”[1] PSR improved operating ratios by streamlining operations but it now appears it has resulted in the current service deterioration complained of by numerous shippers. Crew and locomotive shortages, and longer trains have worked to reduce train speed, increase asset and crew cycle times, and increase congestion. Rail shippers are faced with paying premiums to get the rail equipment needed to deliver raw material and ship product or switch to truck.
The past Memorial Day weekend demonstrated air travel is building on the resurgence that began earlier this spring. This year’s forecast marks the second highest single year increase in travelers since 2010 (2021 was the highest) bringing domestic volumes almost in line with pre-pandemic levels. Triple A expects 3 million people to travel by air, a 25% increase. Air carriers are planning for a record-breaking summer. The Chicago Department of Aviation is expecting an increase of 47.4% in travelers transiting through O’Hare compared to the same period last year. But air carriers have thousands fewer employees than in 2019. And the Federal Aviation Administration issued only 4,928 Airline Transport Pilot (“ATP”) certificates for the full calendar year 2021 (that’s less than half the number of pilots the commercial aviation industry projects it needs to hire this year). The industry’s outlook was summarized last month on a United Airlines April 21st earnings call, when CEO Scott Kirby said the airlines need to hire 13,000 pilots this year, but training produces just 5,000 to 7,000 pilots annually.
Both the airline and the rail industry cut capacity and implemented cost-cutting measures during the pandemic. Air carriers offered pilots incentives to retire early. The rails implemented PSR, reduced workforce and returned equipment. Deteriorating service levels show both have cut too deep and were unprepared to manage through a recovery. Add the challenges involved in restarting supply chains (which are still being influenced by China’s ‘Zero Covid’ lockdowns), market volatility resulting from Russia’s Ukrainian war’s impact on oil and grain and the negative impact of too much Covid stimulus and we now have U.S. oil prices hovering around $115 a barrel. As fuel demand disappeared during the pandemic, refiners around the world closed older, less profitable plants (one million barrels a day of refining capacity were closed in the U.S.). There are now fewer refineries to convert oil into fuel than before the pandemic (and there are no plans to add significant refining capacity as fuel demands grow).
Pricing pressures will continue. As the Federal Reserve raises interest rates, investment in existing aero and rail transportation will become more attractive. In a turbulent recovery there is opportunity. For results in this market, work with an experienced equipment focused specialist. Call RESIDCO.
Glenn P. Davis, 312-635-3161
[1] Cargill testimony at a recent Surface Transportation Board Hearing, April 26, 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
RESIDCO’s size and wholesale capability is a competitive advantage. We respond quickly and creatively to ever-changing market conditions.
70 W Madison St, Suite 2200
Chicago IL 60602 – 4275
Recent Posts
Aero & Rail Investment on the Brink of 2025December 5, 2024 - 4:01 pmHow will Republican lawmakers reshape tax policy? Will the “Department of Government Efficiency” recommendations result in reductions of regulatory red tape, cost, and Federal Government Agency restructuring? Are Tariffs a solution that will drive manufacturing growth when the real problem is the high cost of U.S. Labor?[1] Would a Domestic Manufacturing corporate tax reduction spur […]
Aero and Rail Investments Post-Election Prospects Remain BrightNovember 5, 2024 - 5:55 pmThe IMF expects the U.S. economy to grow 2.5% in the fourth quarter. Business investment, ample energy supplies, and consumer spending have led to increased productivity. After the Fed cut interest rates by half a percentage point in September economists are generally positive. The Conference Board’s leading economic index indicates continued moderate growth for the […]
Mid-Life Aero and Rail Equipment Delivering Higher YieldsSeptember 11, 2024 - 4:03 pmFor the third quarter of 2024, the Federal Reserve Bank of Atlanta’s “GDPNow” model is estimating real U.S. GDP growth of 2% (a seasonally adjusted annual rate)[1]. July’s World Economic Outlook Update expects the U.S. GDP to grow by 1.9% in 2025[2]. The Bureau of Labor Statistics (“BLS”) Consumer Price Index for all urban consumers, (CPI-U) […]