Despite concerns over the Fed’s interest rate hikes air travel remains resilient. United expects continuing demand will drive profits through the end of this year. JetBlue expects strong demand for leisure travel through the fall and struck a deal in July to buy Spirit Airlines in a $3.8 billion deal to create the fifth-largest U.S. airline. Delta reported record third-quarter revenue of $14 billion, with domestic revenue exceeding pre-pandemic levels by 2%, “The demand for air travel remains very strong,” Ed Bastian, Delta’s chief executive, said on a call with analysts. More international travel is expected with the reopening of Japan to international tourists and the easing of hotel quarantines for arriving passengers in Taiwan. More passenger traffic will lead to more airfreight belly capacity. New aircraft deliveries remain delayed: Boeing’s 737 MAX 7 and 10 continue to wait for FAA certification. The MAX 7 is the shortest in Boeing’s family of single aisle jets, the MAX 10 the longest version. The MAX 10 was developed to compete with the Airbus 321 NEO and fill the gap left by the 757. The MAX 10 offers the same capacity as the A321neo but is 2.8 tons lighter, has lower fuel consumption and a slightly greater range. Both the MAX 7 and MAX 10 must be certified by the FAA prior to December 27, 2022 or will require flight crew alerting systems to be installed.1

Class One Railroads are reporting rising profits. Lumber and industrial materials traffic are down but coal continues to see strong demand. Rising interest rates will impact investment. Reductions in the level of the Mississippi River are diverting grain from barges to the railroads. The threat of a freight railroad strike is back. The Brotherhood of Maintenance of Way Employees Division voted to oppose the proposed five-year contract reached September 15th. The rails and rail unions have agreed to continue negotiations until November 19th, five days after Congress reconvenes in mid-November, after the midterm elections. To prevent a national strike, all 12 unions representing a total of 115,000 workers must vote to ratify the contract or Congress must act.

Jerome Powell started talking like a pilot when he said he would try to “land the plane softly.” That plane is the U.S. economy with 329 million passengers. Two years of COVID created ‘pent-up’ demand. Early in the pandemic people were saving up to 33 percent of their income. Now they are spending it aggressively, saving only 4%. For the 12 months ended September 2022 the annual inflation rate for the United States was 8.2% according to the U.S. Labor Department data published October 12. Jet fuel pricing reached $4.12 per gallon in June 2022. While it has come down since then, the OPEC+ countries production cuts creates a potential for higher prices.

The September core Consumer Price Index (CPI), which strips out food and energy prices, grew by 6.6% over the prior 12 months (the next update is scheduled for release November 10th). Employers added 263,000 jobs in September. Wages were up 5% over the past year. Cooling inflation may require the Fed to raise rates to 5.25% or higher next year.

The U.S. economy grew in the third quarter (+2.6% quarter over quarter), yet many expect a recession.2 After the midterms Aero and Rail investment opportunities will have to deal with a divided government, the likelihood of a nationwide rail work stoppage, continuing deglobalization, rising energy costs, Russia’s invasion of Ukraine, and China’s Xi. Remain agile. Identify and invest in pockets of opportunity. Call RESIDCO

Glenn Davis, 312-635-3161

davis@residco.com

[1] The MAX 8 and MAX 9 are already certificated.

[2] October 17, 2022, The Conference Board Economic Forecast for the US Economy

In an environment where uncertainty is commonplace, investment in transportation equipment is often driven by residual value estimates as lenders and lessors compete for market share. Many factors influence the future value of equipment. Most are not very predictable. All require an active aftermarket for the asset under consideration. Physical factors include wear and tear and useful life estimates. Technical factors impact value when newer (more efficient) designs appear causing demand factors to change. Regulatory factors occur from time to time as government imposes new requirements. The FAA’s current review of the 737 Max MCAS and safety procedures for earlier 737 models is an example. Additional flight crew training is expected (even on the 737NG models) including emergency procedures, maintenance training, and an evaluation of pilot response times. Macroeconomics, tax regimes, and global trade impact pricing. In both expanding and contracting markets, investors and their advisors track the behavior of sale prices purchased new, when returned from lease and sold into the secondary market, and similarly track lease rates for short, mid, and longer term leases. In these different environments releasing at lease end, prior to sale, adds value and reduces investment risk.

Residual valuation estimates future equipment value by establishing a relationship between the historical price of equipment and the most appropriate relevant factors. It is particularly useful when making long term investment decisions for both aviation or rail assets. Once you identify factor relationships you have access to a wide body of knowledge about basic economic variables such as GDP, interest rates, commodity pricing, and the impact of international politics on global trade. This is important simply because there are more experts with reasoned views on these topics than there are on the future pricing of air and rail assets.

A key component in this process involves estimating correlation between the various factors. Estimates of value are described in terms of a distribution rather than a point estimate. Standard deviation is a measure of risk and variability of returns. The higher the standard deviation, the higher the ‘riskiness’ of an investment. In simple terms, the standard deviation measures how much variance exists around the average. The coefficient of variation is useful in determining which investments have more relative risk when investments have different average returns. The coefficient of variation tells us the probability of experiencing a return close to the ‘average’ return. The higher the coefficient of variation, the riskier an investment per unit of return. Covariance is a measure of how price movements between investments are related to one another. Correlation is a scaled version of covariance that takes on values between -1 and +1. A correlation of +1 denotes that two assets are positively correlated. A correlation of zero denotes that assets are completely uncorrelated. A correlation of -1 denotes a perfectly negative correlation.

Investors are rational. Markets are efficient. Managing portfolio risk in an uncertain environment recognizes values can increase as well as decrease. Your tools should incorporate disciplined analysis combined with optimal use of available information. Uncertainty requires understanding there are factors which cannot be quantified.

Forethought, diligence, statistical analysis, confidence in equipment alternatives. Sound decision making in real time. Looking for Alpha? Call RESIDCO.

The Importance of Infrastructure

Infrastructure is one of the main factors of economic growth. This includes power, water, telecommunications, ports, roads, and rail. In a report by McKinsey Global Institute, the projected requirement for infrastructure investment is estimated to reach $57 trillion dollars from 2013-2030. This is to keep up with global GDP growth targets. According to PWC, globalization enabled free movement and distribution of goods around the world, while travel and people to people linkages enabled the movement of data and currency. Such massive activity is only possible through physical and digital infrastructure. Due to the expected shift in economic and demographic trends, there is an enormous need for boost infrastructure spending.

According to the Business Roundtable, statistics show the need for improvement in America’s infrastructure spending: the infrastructure quality of the U.S. currently ranks at no. 16 globally, behind France, Japan, and Germany. Among the world’s top 50 airports, the U.S. only has 4 included in the list; delays and congestion have amounted to $24 billion losses in 2012 alone. Around 25% of rails around the country is marked as “good” or “excellent.” Clearly, there is a lot of room for improvement. The U.S. economy would greatly benefit from massive infrastructure spending.

An article by the Council of Foreign Relations mentioned the current state of U.S. transportation infrastructure. Many highways and bridges in the U.S. will reach the end of their maximum expected lifespan, thus the need for adequate capital investment in order to conduct major repairs to these infrastructures. The last era where transportation infrastructure has benefited was during former President Eisenhower’s time until the 1980s. Afterward, spending on transportation infrastructure has significantly declined.

Short and Long-term Benefits of Infrastructure Investment

Infrastructure investment can have short-term and long-term economic benefits.  Building and construction efforts will result in a boost in employment; more jobs will be created. Long term gains involve sustained economic growth with greater benefit for the population, with better services and smoother flow of people, goods, and services associated with high-quality transportation, better roads, rail, airports, and seaports, among others.

Admittedly, transportation infrastructure requires a significant amount of capital investment, and traditional government funds may not be enough. This is where the private sector can come in. The Financial Times mentioned that some policy experts advocate for greater private sector involvement in infrastructure investments, mainly through public-private partnerships or PPPs. PPPs are projects done in long-term contracts, with direct cooperation between the public and private sector. Private capital can then fund infrastructure through municipal bonds. Ultimately, there are risks and returns to be considered but this may vary depending on the project involved. As mentioned in the article, a public-private sector partnership may result in lower costs in terms of technological or operational components or expertise, compared to a public sector-led initiative.

The bottom line is that there is a massive need for transportation infrastructure investment in the United States, and there is no better time to invest than now. Investing in transport infrastructure means investing in the future and ensuring long-term economic benefits for the country. This unique opportunity is sustainable and its effects are long lasting. As emphasized in the Business Roundtable report, the following benefits can be obtained with increased investments in the transportation infrastructure:

Increased GDP growth – investment in transportation infrastructure will generate more jobs; the maintenance and repair projects will further boost employment and create jobs that are permanent and well-paying, which can benefit the middle class, resulting in an increase in GDP growth.

Increased productivity – Efficient and modern infrastructure translates to greater productivity by improving safety, reducing labor costs, fuel expenditures, travel time and other unnecessary effects of uncertainty. Supply chains run more smoothly and the cost of doing business is lower.

Increased international competitiveness – High-quality infrastructure will attract foreign direct investments and encourage businesses to expand their operations.

Investing in Transportation Infrastructure

Investment in transportation infrastructure will result in highly sustainable, short- and long-term economic gains.  It is a win-win solution and a unique opportunity that businesses should take advantage of. Infrastructure plays a crucial role in providing employment opportunities, increasing productivity and boosting international competitiveness, and is a proven key factor in driving economic growth. To know more about investing in transportation infrastructure, call or visit RESIDCO for more details.