Investment and financing decisions involve an evaluation of risk, amount and timing of cash flows, and expected equipment values over an investment horizon. The outlook for Aero and Rail cash flows for the balance of 2022 have changed as the Global community reacts to Russia’s invasion of Ukraine. Even though Russia is a signatory to the Cape Town Convention it is holding more than 500 Western owned aircraft inside its borders in response to the European Union requiring lessors to terminate contracts with Russian airlines by March 28. Operating in an environment without the oversight of Western regulators will impact the value of these units when (if) they are recovered. Its evident values are lost when social and economic cooperation is stressed.
The U.S. has banned imports or is increasing tariffs on Russia’s top products including crude oil, petroleum, petroleum fuels, liquefied natural gas, coal, and iron and steel. Russia and Ukraine combined are the world’s second largest steel exporters and together supply almost one-third of the world’s wheat, a quarter of its barley, and three-quarters of its sunflower oil. Companies (and Countries) that rely on these products and raw materials will suffer. Crude oil and steel prices are up. Energy security in the U.S. (and more so in Europe), is now more important. Falling back on fossil fuels (coal), and boosting drilling is a likely immediate path for the U.S. as the transition to renewables will take years to accomplish.
Domestic freight rail will benefit. The conflict will drive U.S. domestic transport of agricultural and petroleum products, crude oil and coal. Recall that according to the American Association of Railroads, moving freight by rail is 4 times more fuel efficient than moving freight on the highways. Trains can move a ton of freight approximately 492 miles on a single gallon of fuel. On the aviation side, fuel is typically an airline’s second biggest expense after labor. But the surge in domestic air travel[1] is allowing air carriers to cover fuel price increases. In February, domestic ticket bookings and revenue rose above 2019 levels (for the first time since March 2020), and corporate travel booking has reached 70% of 2019 levels, the highest since the start of the pandemic.
In recent quarterly earnings calls railcar manufacturers and lessors are upbeat about rail market prospects. Rail traffic is continuing to improve driving fleet utilization, new equipment orders and lease renewal rates. Fourth quarter 2021 freight railcar orders grew by more than 50% from the third quarter. Orders in the fourth quarter of 2021 were 13,477 railcars compared to 8,607 railcars in the fourth quarter of 2020. The order backlog has increased sequentially for the past five quarters. Total rail carloads for the week ending March 19 were 232,770 carloads, up 1.1 percent compared with the same week in 2021. Five of 10 carload commodity groups posted increases compared with the same week in 2021 including coal, up 4,182 carloads to 63,929; chemicals, up 2,656 carloads to 34,178; and nonmetallic minerals, up 1,984 carloads to 31,151.
With the Consumer Price Index up 7.9% over the last 12 months the Fed is raising interest rates (.25% at its March meeting[2]). Expectations are rates will rise at each of the remaining Fed meetings this year while balance sheet reductions could start in May. Odds don’t favor stability as Geopolitical risk has splintered Globalization. Negative real rates persist and will continue to drive asset values up.
Be prepared for turbulence. Opportunities exist. Call RESIDCO.
Glenn P. Davis, 312-635-3161
[1] “We’re seeing an increase in demand that is really unparalleled” Delta Air Lines, investor conference, March 2022.
[2] Rates were last raised in December 2018
Coming out of the pandemic and in the early stages of a recovery, the world is responding to Putin’s choice to invade Ukraine. The impact on investor confidence is reflected in the market’s volatility. Crude oil prices are up. Rail and air freight capacity from Asia to Europe has been eliminated. The European Union Aviation Safety Agency (EASA) advises Ukrainian airspace and airspace within Russia and Belarus within 100 nautical miles of Ukraine borders pose flight risks (recall the Malaysia Airlines flight MH17 which was shot down over eastern Ukraine in 2014). Air carriers and countries are shutting down commercial flights. The UK banned Aeroflot (the Russian Flag carrier) and all Russian registered aircraft from landing in Britain. In response, Russia banned British airlines from landing at Russia’s airports (and from crossing its airspace). Hungarian airline Wizz Air and Ireland’s Ryanair have suspended flights. Poland and the Czech Republic have closed their airspace to Russian airlines. The FAA expanded the area in eastern Europe and Russia where U.S. airlines cannot operate. The expanded area includes all of Ukraine, Belarus and a western portion of Russia. Russian companies have 980 passenger jets in service, of which 777 are leased. Of the 777 aircraft, 515 are leased from foreign firms (generating $100 million every month from Russian firms to Irish based leasing companies). Dublin based AerCap has 118 aircraft managed or operated by Russian based carriers. As international payment transfers through SWIFT (the “Society for Worldwide Interbank Financial Telecommunication”) are disrupted, leasing companies will be forced to develop contingency plans.
Ukraine is a significant producer of uranium, titanium, iron ore, steel, ammonia, and agricultural products. Rising fuel, commodity, and fertilizer prices will impact inflation in Europe and the U.S. Prior to the invasion the U.S. Bureau of Labor Statistics reported the consumer price index rose 7.5% over the last 12 months (core inflation which excludes food and energy rose 6%). U.S. consumer price inflation is at its highest level in the last 40 years and is now expected to go higher. Fourth Quarter 2021 U.S. GDP growth was 7%[1] . For the year 2021, GDP grew 5.7% over 2020. The uncertainty of the impact of the Russian invasion of Ukraine on U.S. economic activity complicates the Fed policy response to domestic inflation. With the Fed balance sheet at $9 Trillion and U.S. debt approaching 130% of GDP, the Fed said last month it would approve a final round of $30 billion in bond purchases in February before ending its portfolio expansion in March. Fed officials are now expected to raise interest rates at their March 15-16 meeting. The question is by how much?
Solid growth in domestic freight rail traffic is expected from the Infrastructure Investment Jobs Act. The Railway Supply Institute’s American Railway Car Institute Committee (ARCI) reported a 50% increase in fourth-quarter 2021 freight railcar orders (compared to third-quarter 2021). Backlogs increased to 42,993 railcars. Class One profitability continues. Even with rail traffic totals down 9% year over year (through February 5th), coal carloadings are up (due to natural gas pricing inflation), crushed stone and sand gravel loadings are up, chemicals up, and grain loadings up. Auto component shortages continue and primary metal products, and lumber and wood product loadings are down (home sales reached a 15 year high in 2021). Labor force participation is at 62.2% in December, the highest since the pandemic (but inflation is causing adjusted wages to fall).
As the pandemic becomes a memory, the U.S. faces twin geopolitical challenges (Russia, China). With Globalization fractured, new equipment inflation and rising interest rates will create opportunities for placement of existing midlife Aero and Rail equipment.
Glenn P. Davis, 312-635-3161
[1] Bureau of Economic Analysis.
Unlocking Aero & Rail Equipment Values Amidst Surging Inflation
Global growth continues but is expected to slow to 4.1% in 2022 (down from 5.5% in 2021[1]). In the U.S., 2022’s growth is expected to be 3.7% (down from 5.6% in 2021). In the fourth quarter of last year, the U.S. GDP grew at a 6.9% annualized rate. With the domestic economy stronger, inflation has returned and labor markets are much tighter. Unemployment is down to 3.9% (December) from a record 14.7% in April 2020. The Fed is set to raise rates and conclude its purchases of Treasury bonds and mortgage-backed securities[2]. Expect a ‘bumpy’ transition.
Air carrier operations staff shortages and quarantine rules for air crew members complicated flight operations and led to flight cancellations last quarter. Fleet equipment and air crew planning became a challenge, even for freighter operations. In the fourth quarter of 2021, United lost $646 million, American $931 million, and Delta $408 million. Southwest reported net income of $68 million, its first quarterly profit during the pandemic (without the help of government aid). The good news is domestic leisure travel demand is back, and above 2019 levels (business and international travel recovery remains delayed). Carriers are facing steeper costs for labor and fuel. Jet fuel cost is expected to rise to $2.35 to $2.50 a gallon in the first three months of 2022, up from $2.10 a gallon in last year’s fourth quarter. Crude oil pricing is at its highest level since 2014 (West Texas Intermediate, the main grade of U.S. crude was up to $86.61 January 27th). Flight operations are being further disrupted by the 5G rollout, which impacts the reliability of radio altimeters used for low visibility approaches at airports with runways close to 5G C-band network antennas.
Boeing sold more aircraft than Airbus last year, but delivered half as many passenger jets. Boeing won orders for 909 planes (535 net new orders), while delivering 280 (up from 157 delivered in 2020). Airbus delivered 611 jets in 2021 and won orders for 771 (507 net). Backlogs for both airframe competitors extend out over the next several years. Boeing remains hampered by its 737 MAX crisis and production issues with its 787 Dreamliner (100 undelivered Dreamliners wait for regulatory approval). While Airbus’ A321neo family is outselling Boeing units, Boeing’s equipment availability led Allegiant to buy up to 100 MAX jets (new Airbus units could not be delivered until the end of the decade). A 12-year maintenance agreement with the engine provider (CFM International) is expected to lower Allegiant’s operating cost. United’s 777s (Pratt & Whitney engines) are expected to return to service this quarter. Qatar Airways recently agreed to purchase 34 freighter versions of Boeing’s 777X (777-8), which are not expected to be delivered until late 2023 at the earliest. Once the pandemic fades, air carriers are expecting traffic to surge.
Because of infection or Covid exposure, rail operations performance were similarly impacted by lack of operating crews on any given day. CSX is facing staffing shortages, offering $3,000 referral bonuses for recommendations for new hires, and spending $20 Million on initiatives to attract and retain workers. Slower train speeds, higher steel prices and railcar scrapping are helping support the railcar leasing markets.
As the Fed raises rates and global tensions continue (Ukraine, Taiwan) this year’s recovery will be bumpy and characterized by market volatility and inflation. With the improving outlook, inflation in new equipment pricing will favorably impact existing mid-life asset values and lease rates. To identify those investment strategies that unlock air and rail equipment values,
Glenn P. Davis, 312-635-3161
[1] World Bank forecast, January 11, 2022.
[2] The Fed balance sheet is now approaching $9 trillion, $8.3 trillion comprised of Treasuries and mortgage-backed securities.
The pandemic stopped a decade of profitable air carrier operations (in 2020 U.S. air carriers lost $35 Billion compared to a $14.7 Billion profit in 2019). In today’s lower traffic environment single aisle jets remain attractive, accounting for 70% of expected new equipment deliveries over the forecast horizon (split between the 150-seat market A320, Boeing 737MAX8 and the 180+ seat market A321neo and B737Max10[1]). Twin aisle aircraft will wait for the return of international travel as 2022 world travel is forecasted at 61% of pre-pandemic levels[2]. It is air cargo demand that is expected to exceed pre-pandemic levels by 13% in 2022. A desire to avoid crowded terminals, as well as major carrier cuts to smaller communities, resulted in more than 323,000 private jet flights this past October (the first 10 months of 2021 were up 9% from the same period in 2019 and were ahead of the previous high in 2007). Orders for new business jets are up more than 50% over the past year (new private jets sell for between $5 Million to $ 70+ Million). An example is the A220-100 (the “TwoTwenty”) operating as a (large) private business jet with 33% lower operating cost and a 5600 nautical mile range. The regional market is testing zero emission hydrogen/electric engines and United is planning to retrofit its existing United Express fleet with the ZeroAvia2000-RJ engine as early as 2028.
Unlike restrictions that have been imposed on people’s movements around the globe, global government policies are oriented toward maintaining the flow of goods and commodities. Freighter demand is benefiting, being driven by the growth of e-Commerce and continuing supply chain congestion. Record cargo revenues are expected to continue ($175 Billion in 2021, $169 Billion in 2022). Freighter equipment will split 70/30 between conversions of existing units and new deliveries. Increasingly newer generation aircraft are being converted including the A321, B737-800, A330 and B777-300ER. UPS recently ordered 19 (additional) 767s. UPS was the launch customer for the 767 freighter in 1995 and has ordered 91 of the type since. They operate Boeing 757s, 767s, 747s, MD-11s and the Airbus A330. Midlife equipment continues to operate even though the aircraft survivor curve analysis used for modeling forecasts an average economic life of 22 years for single-aisles and 20 years for twin aisles.
Market fundamentals for railcar leasing will improve in 2022[3]. Through November U.S. rail freight carload traffic is up 7% over 2020 (but remains down 8% from 2019). Freight rail traffic growth is projected in the mid-single digits for 2022[4]. November coal carloads were up over 11% reflecting the rising price of natural gas which is up more than 180% over the last 12 months[5]. High steel prices (up 137% October over October) are causing a 15 to 30% premium on new railcar pricing. Cars in storage are down from 32% in July 2020 to 20%. The Class One’s focus on precision scheduled railroading can be expected to continue low rail industry operating ratios which were above 85% in 1990 and now have declined to under 65%.
While the pandemic shut capacity, demand was driven by Washington’s fiscal stimulus. Spending came back faster than supply. The result – higher prices. The pandemic also led to the early phasing out of a number of relatively young aircraft. The high cost of new equipment now makes midlife air and rail equipment more attractive. Market disruptions often work to provide investment opportunities. As activity improves targeted midlife transportation investment opportunities exist.
Glenn P. Davis, 312-635-3161
[1] Cirium Fleet Forecast, cirium.com (Indigo Partners ordered 255 A321neos during the recent (November) Dubai air show to be placed with low-cost carriers, Wizz Air, Frontier Airlines, JetSmart and Volaris.
[2] IATA outlook, Boston, October.
[3] Trinity Industries, Railway Age, October 21, 2021.
[4] Cowen and Company Freight Transportation Equipment Analyst Matt Elkott, October 25, 2021.
[5] Coal will account for 23% of U.S. electricity generation in 2021, up from 19% in 2020.
The $1 Trillion infrastructure bill. When it passes it will be one of the most substantial federal investment programs and will drive demand for freight rail growth. For years global trade held inflation in check. The pandemic shut the system down. The Fed’s monetary policy and government spending have fueled strong consumer demand. Now we have constrained global supply chains, rising commodity prices and tight labor markets. Relaxing of pandemic border restrictions will result in transatlantic air travel rebounding in 2022 like domestic travel did this year. U.S. air travel restrictions are set to be lifted in November (with proof of vaccination and a negative coronavirus test – no quarantines required).
Consumers will have to manage through this period of higher inflation (the Fed’s updated inflation outlook – over 4%[1] for 2021). Intermodal operations remain backlogged as container[2] vessels wait for unloading berths off the Port of LA. Efficient transport requires goods to move seamlessly. Ocean vessels, ports, truckers, and railroads must work together. Containers are sitting dockside for an average of eight days, up from two before the pandemic. Trains are waiting for loads due to a lack of truck drivers. Delays in one area have led to bottlenecks in others. Global One in Joliet was so backed up in July that the Union Pacific temporarily halted all trains arriving from the West Coast so it could clear the yard. U.S. farmers can’t get containers as shipping lines are increasingly sending empty boxes back to Asia as quickly as possible rather than inland for grain export. Class Ones are running fewer trains, longer distances, on tighter schedules. Precision Scheduled Railroading resulted in thousands of rail workers being furloughed, and air carriers now face a pilot shortage as demand returns[3].
While a pilot shortage looms, aircraft values are recovering as the domestic stored passenger narrowbody fleet declines. Passenger twin aisles are currently being used on all cargo international flights. Industry sources expect less than 5000 aircraft will remain in storage at the end of 2021 (down from a high of 17,000 units at the peak of the pandemic). The in-service fleet is flying fewer hours. Widebody equipment values remain down, narrowbody valuations have on average recovered, (737NG/737-800 values are up), and regional aircraft values are up (ATR 72, E190). Competition and low interest rates have driven some lease rate factors to .55%.
Domestically, imported semiconductor component delays have led to a slowdown in manufacturing production. Third quarter U.S. Growth was hampered by the microchip shortage as supply chain disruptions caused by the pandemic impacted the automotive and industrial market segments. This demonstrates just how fragile the extended global supply chain has become. Bottlenecks are now expected to last through 2022. Commodity prices are edging up (West Texas Intermediate crude recently traded above $84 a barrel and Brent above $86.00). With inflation lasting longer than anticipated, bond markets are starting to reflect expectations of interest-rate increases. Tight labor markets, easy monetary policy, government spending, international tensions, and Asia Pacific travel restrictions will remain. Carbon, climate, and politics are wild cards.
Consumer demand and supply shortages will lead to inflation. Transportation equipment values will head up. Make informed decisions on where to find air and rail investment alternatives.
Glenn P. Davis, 312-635-3161
[1] Forbes, September 22.
[2] October 2, The Washington Post “This month, the median cost of shipping a standard rectangular metal container from China to the West Coast of the United States hit a record $20,586, almost twice what it cost in July, which was twice what it cost in January.”
[3] October 31, American Airlines cancelled about 1,800 flights due to a shortage of pilots and flight attendants
Finding Value In Midlife Air and Rail Equipment
Not so long ago the typical freight railcar had a new cost below $50,000. Today, a newly built freight railcar is in the $100,000 to $150,000 range. Both rail and aero assets present long-term investment opportunities. Railcars have up to a fifty-year interchange life. The economic useful life of an aircraft or aircraft engine is the period over which it is expected to be physically and economically feasible to operate in its intended role.1
What ends the life of the equipment is economics (when the cost of operating exceeds the cost of replacing). On average, the life of an aircraft, from purchase to retirement is between 20 to 36 years (Boeing and Airbus build their airframes to last 40 years: 51,000 flight hours and 75,000 pressurization cycles).
Today’s oversupplied secondary markets present opportunities to find value in midlife units. Finding those values requires the ability to identify well-maintained units with remaining service life while evaluating expected service alternatives. It’s the current spread between cost delivered new and secondary market cost that presents these investment opportunities.
The Boeing 757 is an example. Eastern Air Lines placed the original 757-200 in service on January 1, 1983. The last 757 was delivered in 2005. The modern narrowbody alternatives are more fuel-efficient, but the 757 is still active. When COVID appeared over 80% of the world’s 757s were grounded. Before COVID more airfreight was carried in the cargo holds of passenger aircraft than in dedicated freighters. With fewer passenger aircraft flying the parked 757s present the optimal narrow body for freighter conversion. To ensure dedicated freighter aircraft capacity, Atlas Air, the largest operator of 747 cargo aircraft in the world, recently announced it purchased three 747-400 aircraft that were previously leased and reached an agreement with lessors to take ownership of five more aircraft at the end of their existing lease terms next year.
Given the useful economic life of existing railcar equipment and the inflation in new railcar pricing (steel prices are up 215% since March 2020), it makes economic sense to evaluate opportunities to pursue existing rail equipment rather than new ones. Freight rail volumes are being influenced by several challenges, overreliance on global supply chains, the lack of microchips for autos, and the Delta variant, which is upending factory production in Asia. Among all rail traffic categories, Class One’s earned $5.97 billion from grain in 2020 (third behind intermodal and chemicals). But grain exports are down. Hurricane Ida flooded and damaged grain terminals along the Gulf Coast just weeks before the start of the Midwest harvest. More than 50 bulk vessels were lined up along the lower Mississippi in early September waiting to dock and load. On August 29th an all-time high of 47 container ships were at anchor off the ports of Los Angeles and Long Beach due to lack of berth space.
The strain on global supply chains is evident and Class Ones are hampered by capacity constraints resulting from COVID and the implementation of Precision Scheduled Railroading. With Thanksgiving and the Holidays expect port congestion and labor and capacity shortages at docks, warehouses, and trucking firms to continue.
The economics of logistics and transport investment are complex, but business cycles repeat. Volatility creates opportunity. Leverage our track record of transitioning equipment to its best and highest use. Times are excellent for midlife equipment investment strategies.
To model the equipment markets and manage risk, Call RESIDCO.
1 That’s the International Society of Transport Aircraft Traders’ (“ISTAT”) definition. ‘Longevity’ depends on market need and maintenance expense. Well cared for aircraft can have an almost unlimited life (but only with respect to safety and airworthiness: think the DC-3 aircraft that were in service in the late 1930’s and still fly today).
Rail and air transportation plays a central role in our nation’s economy. The government’s fiscal decisions, monetary policies, and administrative agency rulings influence the outcomes and the economics of transportation investment opportunities. The Surface Transportation Board’s unanimous ruling that the Canadian National hasn’t demonstrated its use of a voting trust would be consistent with the “public interest” follows the President’s recent Executive Order to “address overconcentration, monopolization, and unfair competition in the American economy.”
Government action and the rules and regulations implemented by its many Administrative Agencies1 have attempted to address both economic and social goals. Traditional ‘economic’ regulation focused on markets and economic variables and dates back to 1887 when Congress created the Interstate Commerce Commission to address the concerns of dissatisfied shippers. Railroads were then required by law to charge rates that were ‘reasonable and just,’ (the ICC was disbanded in 1995 and replaced with the Surface Transportation Board). In 1938 Congress created the Civil Aeronautics Board and directed the Board to place ‘public interest’ ahead of profits.
Regulatory reform (‘deregulation’) began in the 1980s, notably in the air and railroad industries.
Rail was significantly deregulated with the 1980 Staggers Act. That Act reduced federal regulatory controls over the roads who then went on to abandon unproductive routes, reduce labor cost, and increase efficiency by offering freight discounts to ‘bulk’ unit trains (e.g., grain and coal). By 1988 the competition released by deregulation had produced lower prices in most commodity classifications (while not increasing prices in others). The D.C. Circuit has recognized that the statutory language of 49 U.S.C. Section 10101 2 mandates deregulation of the entire railroad industry to the maximum extent possible in conformity with national rail transportation policy.3 Similarly, the Airline Deregulation Act of 1978 (supported by both Democrats and Republicans during the Carter Administration) specified the Civil Aeronautics Board (“CAB”) would be dismantled (eventually completed in January 1985).
After the CAB no longer had the power to price and set routes, competition forced air travel prices to fall, and U.S. airline passenger volumes increased dramatically. Deregulation gave railroads the freedom to negotiate contract rates and make operational improvements. The roads improved the efficiency of their networks, tailored rates to shippers’ traffic, abandoned low-density lines, and (as a result of merger activity) eliminated the duplicate track. Precision Scheduled Railroading is an example of operational freedom that the Roads are implementing today in an attempt to provide faster, more reliable service.
Tension exists between the business of pursuing ‘economic’ goals and the politics of pursuing ‘social’ goals. Governments may set ‘policy’, but business investment is driven by economics. Politicians do not face the same ‘market’ discipline. Other than elections, accountability mechanisms for political decisions are not in place. Markets may not always function perfectly, but unintended consequences often follow government attempts to produce desired ‘social’ results.
Identifying effective investment strategies in this environment requires an ability to integrate today’s politics into your investment thinking. Call RESIDCO.
1 In a 2015 Senate Judiciary Committee hearing, Chairman Chuck Grassley (R-IA) noted: “The Federal Register indicates there are over 430 departments, agencies, and sub-agencies in the federal government.”
2 Title 49 – Transportation – Interstate Commerce – “National Transportation Policy.”
3 Brae Corp. v. United States, 740 F.2d 1023, at 1043 (D.C. Cir. 1984); also Ass’n of Am. R.Rs. v. Surface Transp. Bd., 237 F.3d 676, (D.C. Cir. 2001).
New railcar orders rose 80% to 6,227 in the first quarter of 2021 from the fourth quarter of 2020 as rail freight volumes improved. Lease rates are showing improvement (but remain “soft”1). Greenbrier: “We’re seeing a broad-based need across all sectors and all businesses. Shippers are pursuing larger, higher-capacity railcars as a means to optimize rail shipments while reducing their carbon footprint by using rail.” Canadian National earlier had placed an order for 1,000 new-generation, high-capacity grain hopper cars (Trinity built) as their grain shipments have achieved 14 straight months of record growth amid record high grain prices. Trinity: “We see positive carload trends for railcar types representing over 50% of the North American fleet.” Railcars are continuing to come out of storage as average scrap pricing has increased: forty-seven thousand railcars are expected to be scrapped in 2021 with the age of scrapped cars declining to 36 years from 43 years in 20162.
Class Ones are reporting record operating ratios3. “We are even more confident about growth for the balance of this year,” Norfolk Sothern’s CEO Jim Squires told investors and analysts on the railroad’s earnings call on July 28th. For the second quarter, Union Pacific set records for operating income, net income, and earnings per share, and an all-time record operating ratio.
The pandemic revealed the geopolitical risk of over-dependence on foreign production. China’s reluctance to approve the return of Boeing’s 737 Max to service reveals their focus on local certification of the C919 (by this year-end) and demonstrates their ambition to become a global power (Boeing has not placed any new aircraft orders there since 2017). China’s coerced joint ventures and industrial technology theft is moving it toward a new kind of predominance among Asian low labor cost countries, growing in sectors that are far less exposed to labor cost competition – particularly high-tech production that demands sophistication and reliability as well as cost efficiency. As China absorbs U.S. technology it plans to replace foreign corporations with domestic ones.
A more belligerent China now boasts an increasingly skilled labor force, growing middle class, strategic raw materials, highly developed manufacturing capabilities, and plans to further invest $1.4 trillion in advanced manufacturing and automation by 2025. With its high labor costs, US manufacturing will be forced to improve productivity and increase the efficiency of its workforce to effectively compete (of particular concern is 25 percent of the US manufacturing labor force is now age 55 or older). National security concerns and ongoing tensions have created this need to reduce dependence on manufactured imports. Smart strategies include building strong transportation links with Mexico and Canada that will develop competitive advantages.
Rail and air transport investment requires the ability to anticipate major changes, understand served markets, shipper logistics patterns, modal alternatives, and consumer behaviors. The U.S. economy grew at an annual rate of 6.5% in the second quarter and economists expect the third quarter to be better. For investment policy, portfolio composition, and asset management, look beyond the pandemic to position your rail and aero investments. Call RESIDCO.
1 GATX, CFO Tom Ellman, first-quarter 2021 earnings call, April 20th: “non-energy tank car lease rates remain down 15 to 25%, with freight car lease rates down more”.
2 CIT internal estimates as of June 1, 2021, MARS July Lake Geneva Summer Presentation.
3 NS 58.3%, CSX 43.4% (excluding one-time expense credits adjusted to 55.1%), Union Pacific 55.1%.
The U.S. economy is opening up. Forty-seven percent of the U.S. population has been fully vaccinated. Most states have lifted restrictions. Over the last year, Congress has passed $4 trillion in fiscal stimulus. The updated Congressional Budget Office forecast expects GDP growth to reach 7.4% in 2021. The recovery is exceeding expectations and may turn out to be the strongest U.S. economic growth since 1951. Boeing’s CEO, David Calhoun has called the recovery “more robust than I ever imagined.” But the snapback in demand is stressing global supply chains, creating bottlenecks, and causing price spikes. Low vaccination rates across Asia are resulting in manufacturing and supply chain disruptions, driving transport, storage, and inventory costs to near-record highs. In June the Fed raised its annual domestic inflation forecast to 3.4% from 2.4% in March.
As China pursues its heavily subsidized Comac C919 the U.S. and European Union have agreed to suspend their seventeen-year trade dispute over government subsidies to Boeing Co. and Airbus SE.1 The tariff elimination follows the U.S. led G7 preliminary effort to overhaul international tax rules to achieve a global minimum tax. With 130 countries in agreement, each country’s government will now seek to pass2 the right to tax profits where customers purchase not where the business has a physical presence.
June TSA traffic climbed above 2.1 million per day, almost double the traffic in March. Road trips and a return of domestic air travel have driven U.S. crude to $75 a barrel (a first since 2018). But U.S. shale producers are unlikely to increase output as they have pledged to hold production flat this year and cap growth in 2022 at 5% using higher prices to strengthen their balance sheets and return capital to investors.
The domestic aviation recovery is driving orders for the newest, fuel-efficient narrow body aircraft (fuel accounts for a third of airline operating expense). United moved to lock in lower pricing with the largest combined aircraft order in its history: 50 Boeing 737 MAX-8, 150 Boeing 737 MAX-10, and 70 Airbus A321neo (the MAX burns around 15% less fuel). While MAX retail pricing is $125 million, large orders are usually sold for half their list price (or lower). Of the worldwide passenger jet fleet, 29% or over 7,000 units remain in storage. Current appraisals by international advisory firm Ishka, show a 15-year-old 737 20% less expensive this April than in January 2020 (a wide-body 777-300ER, 45% less expensive). The availability of these aircraft presents competitive opportunities.
Rail carload and intermodal volumes again saw annual gains for the week ended June 26. Nine of the ten carload commodity groups the AAR tracks posted annual gains, including coal. Efforts to switch to renewables remain in their early stages and many now recognize coal provides ‘base load’ protection critical for maintaining grid reliability.
Midlife assets: economics and an experienced specialist management team drive successful investment results. Get answers to your questions. Think long term. Call RESIDCO.
1. The Boeing-Airbus dispute started in 2004 when the U.S. filed a complaint with the WTO, claiming the EU’s subsidies for Airbus put Boeing at a disadvantage. Both now recognize the Chinese Communist Party threat.
2. 130 Countries. But no agreement with Ireland, Hungary, Estonia, Nigeria, Kenya, Peru and Sri Lanka who argue low tax rates attract foreign investment. The new tax rules are to apply to large global business with profit margins of at least 10% and global sales of at least 20 Billion euros.
It was only fourteen months ago that Covid-19 appeared shutting down economies and disrupting international traffic. Last fall’s elections led to a new Administration and a continuation of tariffs on Chinese products1. First tariffs, then the pandemic. Both have significantly disrupted domestic and global aviation transportation. Those disruptions, and “Precision Scheduled Railroading” have also changed the dynamics of rail equipment investment.
What remains is a recognition that transportation networks form the backbone of trade and economic growth. With one in every three Americans fully vaccinated we are now entering a post-pandemic world. The Fed’s willingness to finance deficit spending is driving a return of domestic demand. U.S. GDP increased at an annualized rate of 6.4% in the first quarter of 2021 compared to the fourth quarter of 2020. At the end of the first quarter of 2021, U.S. GDP ended up less than 1% below its peak reached in late 2019. The April consumer price index rose 4.2% at an annual rate. The Atlanta Fed’s GDPNow prediction for second-quarter growth is 11%. The speed of the recovery is leading to supply chain shortages and increasing commodity and component costs. Bridgewater Associates’ Ray Dalio pointed out the current Administration’s economic agenda risks injecting too much money into the economy which will accelerate price increases as consumers spend to get what they want.
The lack of international passenger traffic ‘belly space’ has increased interest in passenger-to-freighter conversions. Larger passenger aircraft (the widebodies – A380s, A340s, and Boeing 747s) have been retired early. The acceleration of e-commerce, caused by the pandemic, is driving growing air cargo demand even for smaller freighters (from express parcel carriers FedEx, DHL, UPS, and Amazon). Boeing at its biennial World Air Cargo Forecast expects the air cargo market will grow at a 4% annual rate over the next 20 years. That requires a freighter fleet 60% larger than today. Current pricing of these older ‘retired’ ex-passenger jets allow economic cargo conversions. Even aircraft long-retired are returning to service (Georgian start-up Geo-Sky has re-activated a 1987-built 747-200 converted freighter – last operated in 2012).
The rail traffic recovery from the pandemic continues. U.S. carloads of grain, food, lumber, paper, scrap metal, and several other categories were higher in April 2021 than in either April 2020 or April 2019. Total carloads averaged 237,960 per week in April 2021, the most since November 2019. April’s intermodal weekly average loadings are the largest for any month in history. Intermodal is being driven by increased consumer spending triggered by the additional $1.9 trillion fiscal stimulus the ‘American Rescue Plan Act of 2021’ (signed March 11) is injecting into the domestic economy. Consumer spending rose 21.1% in March from February. That is the biggest percentage increase since 1959. As of May 1, 2021 railcars is storage continued to decline (365,379 freight cars down from 409,289 units at the start of this year).
The economies of the world depend on efficient transport. A transportation investor’s challenge is to maximize after-tax returns net of all non-tax costs over an asset’s expected market life. Long-duration assets are influenced by economic uncertainty. Uncertainty breeds opportunity. As demand begins to outstrip supply finding solutions for practical investment is challenging. Work with the professionals. Call RESIDCO.
Glenn P. Davis, 312-635-3161
1 Tariffs began in the first year of the Trump Administration, four years ago.
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
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