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New Regime Decisions Reverberate Through Aero & Rail

A government shutdown averted, a stopgap spending bill signed (ensuring government operations through the end of September), government agency reductions in force, a 25% tariff on steel and aluminum imports from all countries and on imported goods from Mexico and Canada, all in the first quarter of 2025. Trade and reciprocal tariff uncertainties are causing volatility in the market and consumer confidence. The Administration’s long-term strategic goal (the “bigger picture”) is to attempt to ensure America’s competitive preeminence in the face of China’s global mercantilism by diverting production of goods to domestic factories, reducing deficit spending, and providing incentives to invest in America. The near-term impact, however, will be supply chain disruption, inflation, lost government jobs, reductions in entitlement spending, and the possibility of a lost ‘soft landing.’ Investment planning is becoming more challenging.

The choppy start of the first quarter has made air carriers’ capacity cautious. Delta, American, and Jet Blue have cut their first quarter guidance. United expects first-quarter earnings to come in at the ‘lower end’ of its forecast due to a 50% drop in government-related travel bookings. Scott Kirby announced early this month that United plans to retire 21 of its ‘most expensive’ aircraft early in 2025 and cut capacity to Canadian destinations. United’s mainline fleet comprises 1,010 aircraft, of which the oldest, on average, are the B767-300ERs (37, averaging 29.1 years), followed by the B757-200s (40, 28.2 years), the B777-200s (19, 28.1 years), and the B737-700s (40, 26 years). Kirby did not disclose which aircraft will be ‘retired.’[1] Delta’s Ed Bastian commented on March 10: “We’re noticing the biggest pullback in demand right now in terms of bookings, and what they are saying about the macro environment and the uncertainty that’s out there right now. We know in a broad sense what the President wants to do, but we’re a long way from seeing things put in place.”

In Rail, the administration is looking for ways to revive coal plants that have closed and prevent others from shutting down. According to the Institute for Energy Economics and Financial Analysis, the U.S. had been on track to close half of its coal-fired generation capacity by 2026. But Doug Burgum, the new Secretary of the Interior, and other officials have said keeping plants online can help lower energy costs for U.S. consumers. The administration wants to cut through red tape and empower the nation to compete in an AI arms race against China. AI data centers require immense amounts of energy which need stable base load sources. The Interior Department approved a federal mining plan modification by the Office of Surface Mining Reclamation and Enforcement for the Spring Creek mine in Big Horn County, Montana, operated by Navajo Transitional Energy. The agency said the decision extends the mine’s operational life by 16 years and lays the path for the production of about 40 million tons of ‘federal’ coal.[2] In 2024, coal units in Maryland, Indiana, Wisconsin, and Utah extended their retirement dates to 2036 or 2038 as generators aim to meet rising demand. CONSOL Energy CEO James Brock said, “If demand grows at even half the pace everyone is expecting, I think you’ll see these coal-fired plants run at least at a higher capacity, and they may even extend their retirements further.”

Focus on the bigger picture. Risk-adjusted hard asset cash flows with residual upside. Profit from the economics of uncertainty and grow your aero and rail investment. Call RESIDCO.

Glenn Davis 312-635-3161

davis@residco.com

[1] CH-Aviation, First quarter softness may be a buying opportunity, March 21, 2025.

[2] DOI, Interior Advances Energy Independence with Spring Creek Mine Expansion Approval, March 13, 2025.

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Growing Aero and Rail Investments

Boeing delivered 45 jets in January[1]. That’s 19 more than Airbus’ January deliveries. COMAC and Embraer each delivered three aircraft in January 2025. Airbus plans to deliver 820 commercial aircraft in 2025, 7% more than in 2024 (Boeing delivered 348 in 2024). Boeing’s 737 deliveries remain capped at 38 aircraft per month. The newly appointed Secretary of Transportation, Sean Duffy, has said he will keep the production cap in place until he is satisfied with Boeing’s safety standards. Safran[2] CEO Olivier Andries has made public statements expressing confidence that Boeing will hit a delivery rate of 38 per month in the first half of 2025 and 42 a month by the end of the year. The 45 aircraft Boeing delivered in January were the most in a month since December 2023. January was the company’s first full month of production since the seven-week machinists’ strike last fall. CFM International, the sole provider of the LEAP engines used on the 737 MAX is expecting to increase its LEAP production by 15 to 20% this year. That would allow Boeing to ramp up its 737 MAX production. Both OEMs face supply chain challenges involving issues with engines and aerostructures manufacturer Spirit AeroSystems. Spirit AeroSystems produces fuselage sections for Boeing’s 737 and 787 aircraft as well as flight deck sections. Spirit also supplies Airbus with fuselage sections and front wing spars for the A350 and wings for the A220.  

Southwest is planning to sell some of its older 737NG aircraft and replace them with the newer 737 MAX8. The air carrier plans to retire 51 aircraft to operate an all-MAX fleet by 2031.  It’s additionally weighing whether to sell 10-737-800 aircraft. “These are midlife aircraft that currently have highly favorable market valuations.”[3] As new equipment deliveries continue to be delayed older aircraft are retained in service longer. Air carriers are facing lessor lease extensions of six years for older aircraft and eight to ten years for new aircraft. Engine durability challenges related to Pratt & Whitney’s geared turbofan (‘GTF’) and CFM’s LEAP engines continue to impact operators.  IATA’s chief economist Marie Owens Thomsen has said the wave of recent lease extensions has resulted in airlines operating the oldest fleet in modern history.

In North America, 26% of U.S. Freight ton-miles are moved by rail. Trinity Industries Fourth Quarter 2024 Investor Presentation reported continued strength in lease rates with their ‘future lease rate differential’[4] +24.3% and fleet utilization at 97%. Trinity feels the North American Railcar Market is ‘in balance’ and is forecasting approximately 35,000 new railcars to be delivered in 2025 (not including conversions). Trinity is a leading railcar manufacturer with 41% of industry deliveries in FY 2024. Their portfolio includes 270 different railcar designs serving approximately 900 different commodity groups, 52% Freight Cars and 48% Tank cars.The Conference Board’s January 28th report reveals consumer confidence is falling and expected inflation rising. For now, the Fed is holding interest rates steady. Deregulation, deficit reduction, and extending the 2017 tax cuts will help. Fleet investment provides stable cash flow, tax advantages, and hard asset inflation benefits. Release opportunities provide a natural interest rate hedge. Air traffic and rail freight support the economy. But the U.S. Economic Policy Uncertainty Index is higher now than at any time since the Great Recession. Are we at a peak in the value cycle?  To answer that question and successfully grow aero and rail investments, Call RESIDCO.

Glenn Davis 312-635-3161

davis@residco.com

[1] Boeing ended January with 5,554 aircraft in its backlog, 4,296 737s, 109 767, 427 777s and 722 787s.

[2] Safran is the joint venture partner with GE Aerospace in CFM International which is the sole provider of the LEAP engine the 737 uses.

[3] Tammy Romo, outgoing Southwest CFO, January 30, 2025.

[4] Trinity’s Future Lease Rate Differential calculates the implied change in lease rates for railcar leases expiring over the next four quarters.

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Looking Forward to 2025 Aero and Rail Investment

November’s jobs report exceeded expectations (payrolls increased by 227,000[1]) yet the Fed lowered its benchmark interest rate December 18th by a quarter of a percentage point (to between 4.25% and 4.5%). Fed Chairman Powell’s recap: “I think we’re in a good place, but I think from here it’s a new phase and we’re going to be cautious about further cuts.” Tariffs[2], inflation, and the Fed’s policy outlook may keep rates where they are for 2025. Legislative turbulence is evident even before the new administration takes office January 20, 2025. Government spending, regulatory rollbacks, federal agency reconfigurations, an emphasis on boosting production of oil and natural gas, revisiting the U.S.-Mexico-Canada free trade agreement and implementation of policies that advance domestic manufacturing while discouraging reliance on Chinese and foreign manufacturing are on the table. Most will recall President Jimmy Carter as the ‘great deregulator.’ His legacy includes both the United States Airline Deregulation Act of 1978, which removed federal control over fares, routes, and market entry of new airlines, and the Staggers Rail Act of 1980, which eliminated tariff filing requirements for railroads, enabling private contracts and improving the financial health of the railroad industry. Thanks in no small part to President Carter, air travelers have enjoyed benefits, and Class Ones have passed cost savings on to shippers in the form of lower rates. 

Long lived rail assets provide critical support to the domestic supply chain. Bulk transport of raw materials and finished goods will grow with domestic manufacturing growth.  Trump’s first term boosted business for North America’s freight railroads. Between 2018 when Trump first introduced tariffs, and 2023, freight flows between the U.S., Canada and Mexico rose 28% by value. The amount moving on railroads increased 17% over the same period.[3] For the week ended December 21, 2024 U.S. freight rail traffic climbed 7.8% to 523,912 carloads and intermodal units. Both carloads and intermodal units were up compared to the same week in 2023 (230,857 carloads in the week, a .3% increase, and 293,055 containers and trailers, a 14.6% increase). Through 51 weeks of 2024 carload traffic is down 3.0%, intermodal up 9.3% for an overall net gain of 3.4%.[4] Intermodal is up as it is a more cost effective alternative to full truckload transport.  Using rail for long distance hauls and trucks for shorter distances delivers both cost and environmental benefits. 

Major air carriers lifted their revenue guidance for the year’s final quarter as travel demand held steady. Higher-than-expected demand is driving an increase in revenue per available seat mile and is expected to carry over into 2025. The TSA logged the 10 busiest days ever in 2024 (it screened 3.09 million people on Thanksgiving Sunday (edging out the previous record of 3.01 million travelers reached in July). Midlife narrow-body aircraft are the workhorses of air carrier fleets. Focusing on midlife aircraft with a long remaining useful life creates lease investment alternatives that reduce risk. They can be monetized in multiple ways and produce ample in-service cash flows.

GDP rose 3.1% in Qtr3. The economy remains strong. There will be fiscal policy and geopolitical tensions in 2025, but the new year will bring a friendlier regulatory environment and a path to putting our economy on a better growth footing. Aero and Rail transportation equipment provide scalable opportunities with risk that can be segmented across equipment types and credits. For actionable insights that allow more informed decisions, Call RESIDCO.

 Glenn Davis 312-635-3161

davis@residco.com

[1] U.S. Department of Labor, December 6, 2024.

[2] Trump has pledged to use tariffs as a crucial part of his economic policy.

[3] Wall Street Journal, Railroad Looks Past Any Tariffs, December 3, 2024.

[4] AAR: North American Rail Volume Up Through Week 51, December 27, 2024. US rail traffic continues to gain.

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An Investment Roadmap – Risk-Adjusted Returns

When comparing investment returns it is misleading to simply look at headline figures. At first glance, it might seem an investment that gained 12% last year is better than one that gained 9%. In reality, it depends on how much risk was involved in generating those returns. The more risk (or volatility), the less probable the returns. The simplest way to measure risk is to look at the standard deviation of the returns. The larger the standard deviation, the riskier the investment.

Investors use the ‘Sharpe’ ratio, a ‘rewards to variability ratio’ to better compare alternatives. The ratio uses the standard deviation (a measure of volatility) to measure the ‘risk adjusted’ return. It’s a measure of the excess return over the risk-free rate relative to the standard deviation. It helps answer the question: “Is the ‘risk adjusted’ return worth the investment risk I am taking”?

Investing in commercial aircraft has historically demonstrated returns that adequately compensate for variability. Aircraft are hard assets with long useful lives*. It’s common for a commercial jet to remain in service 25 years or more. Some even longer, such as a 1970 Boeing 737-200 (serial number 20335), which is still flying with Airfast Indonesia (registration PK-OCG, based in the city of Jakarta, Surabaya and Denpasar). At 47 years, it may be the world’s oldest commercial passenger aircraft still in service (the second oldest 737 is registered to Johannesburg based Interair, South Africa, and, Kenya’s Trans African Air has a 42-year-old 737).

Profitability is just as important as equipment longevity. The International Air Transport Association forecasts global air carrier profitability will rise to $38.4 billion in 2018, up from an expected $34.5 billion in 2017. Operating margin, overall revenue, passenger and air cargo traffic, and average profit per departing passenger are all improving. 2018 is expected to be the fourth consecutive year of sustainable profits with a return on invested capital of 9.4%, which exceeds the industry’s average cost of capital of 7.4%.

IATA’s Director General and CEO recently stated: “These are good times for the global air transport industry. Safety performance is solid. More people than ever are traveling. The demand for air cargo is at its strongest level in over a decade. Employment is growing. More routes are being opened.” Operator challenges include fuel, labor, and infrastructure expenses which are rising. Performance drivers? Passenger and cargo growth. All regions are expected to report improved profitability in 2018. Global connectivity is vital to our modern lifestyle.

As a pilot, you identify and avoid turbulence (and if in turbulence, slow your airspeed). Information limitations can impact your ability to see and avoid. Similarly, in piloting investments, techniques are available for avoiding turbulence while enhancing returns. The complexity surrounding aircraft investment and residual valuation requires sector-specific expertise. Generating income, while retaining upside and liquidity over your investment horizon requires contextual expertise. Blue skies or stormy weather? Modern weather and radar equipment suggest you work with investment managers who have demonstrated abilities structuring transactions that produce, regardless of the weather. Generating such results requires an appreciation of risk-adjusted returns.

Aviation and Rail teamwork. We have the investment roadmap. Call RESIDCO.

 

*Delta operates 860 aircraft with an average age of 17 years, including a 30-year-old 757, and 30-year-old McDonnell Douglas MD-80s. American also operates MD-80s, the oldest of which was delivered in 1986.  British Airways oldest aircraft is a 747, registration G-BNLK, which it received on May 4, 1990
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