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, 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. “Historical experience points to a significant risk of a US recession in the wake of monetary tightening.” 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.
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.” 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.
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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 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 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.” 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. 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.
https://residco.com/wp-content/uploads/2022/05/Airplane-1.png600900residcohttps://residco.com/wp-content/uploads/2016/12/RESIDCO_Logo_225x72.pngresidco2022-05-05 08:00:002022-05-11 22:44:58A Storm of Fundamental Challenges Create Aero and Rail Opportunities
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 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). 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.
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% . 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.
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,
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). Twin aisle aircraft will wait for the return of international travel as 2022 world travel is forecasted at 61% of pre-pandemic levels. 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.
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.
 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.
 IATA outlook, Boston, October.
 Trinity Industries, Railway Age, October 21, 2021.
 Cowen and Company Freight Transportation Equipment Analyst Matt Elkott, October 25, 2021.
 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% for 2021). Intermodal operations remain backlogged as container 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.
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.
 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.”
 October 31, American Airlines cancelled about 1,800 flights due to a shortage of pilots and flight attendants
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).
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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.”
Rail traffic volumes remain challenged while Air Carriers face capacity constraints as they attempt to meet the rebound in domestic and international flights. United reported solid domestic and record-breaking international performance with third-quarter revenues up 12.5% year over year. The company set a record for the highest-ever daily average of revenue passengers carried in a quarter […]
Equipment and crew availability affect service levels for both Aero and Rail. Both Rail shippers and the flying public are interested in consistent, reliable service. Rail transit times from pick-up to the last mile are particularly important. The Surface Transportation Board (“STB”), responding to Shipper Rail service complaints, issued a Notice of Proposed Rulemaking (Ex Pate No. […]
Most Aircraft operating leases provide that the lessee is responsible for maintaining leased aircraft to required industry standards. To ensure flight safety the FAA issues Airworthiness Directives (ADs) and aircraft manufacturers issue Service Bulletins (SBs). ADs are legally enforceable regulations meant to correct unsafe conditions. Airframes, engines, avionics, and other aircraft components (landing gear, auxiliary […]