Ask an economist or trucking industry analyst to sum up 2002, and you likely will get everything from optimism for steady improvement and recovery to, as one analyst put it, “bad, bad, bad.”
“The first thing you need to know about a forecast is that it’s wrong,” says Bob Costello, chief economist for the American Trucking Associations. “The question is, by what magnitude is it wrong?”
Certainly, different people will read the tea leaves differently. On the other hand, there’s also a tendency to unite behind certain key assumptions. To a certain extent, analysts do so to avoid the embarrassment of not only being wrong but also being the only one who is wrong. That way, no single person stands out as an idiot. They all go down together, just like the analysts who urged people to buy Enron stock just weeks or even days before its collapse.
In this case, most analysts suggest that an economic recovery – be it weak or strong – lies ahead in the second half of 2002. The consensus seems to be that the U.S. economy is bottoming out.
But an economic recovery and even higher freight volume tell only part of the story for trucking. A host of factors that may be independent of, or indirectly related to, the larger economy help shape the fortunes of individual trucking companies. There are some pluses – low fuel prices and a relatively more stable driver market, for example – but there are some big challenges as well. Liability insurance looms as the biggest crisis, and many trucking operations still face challenges posed by dramatically deflated equipment values and a continued credit crunch. Still, it’s fair to say that most trucking companies expect 2002 to be better than 2001.
“We think the economy is coming back,” says Donald Broughton, transportation analyst for A.G. Edwards. “But it won’t be without trials and tribulations.”
While supplies last
Major economies don’t start and stop on a dime. Manufacturers that had geared up to meet the overheated demand of the late 1990s soon found themselves swamped with inventory when customer demand slumped. At a fundamental level, this is what happened with truck manufacturers, although corporate strategies clearly intensified the problem. Throughout the economy, manufacturers responded with layoffs, plant closings and other measures that dried up freight feeding industrial production.
“There’s a major inventory correction going on,” Costello says. A good example is the automobile industry. Manufacturers are offering fire-sale terms like zero-percent financing to get surplus vehicles off their lots. Meanwhile, there’s little production going on. “People who haul chemicals, steel and rubber aren’t doing well,” Costello says.
The key to continued inventory reduction is, of course, sales. Unfortunately, sales have been sluggish, delaying the depletion of inventories.
“We tell our members to pay close attention to sales,” Costello says. “More important than inventory levels is the relationship of inventories to sales. If the drop in sales is greater than the drop in inventories, then inventories relative to sales, isn’t getting any better.”
Still, inventories are coming down, and that fact leads many to predict a rebound in manufacturing and shipping in the second half of 2002 based on anticipated consumer demand. “If the economy turns around, you’ll see a rapid decline in that ratio of inventories to sales and a ramp up in production and ordering,” Costello says. Today, people are spending, but they are looking strictly for discounts and special deals, he says.
“Inventories will come down to such a level that supply-and-demand will prompt manufacturing,” says Daniel Moore, transportation analyst for Stephens Inc. Moore expects this to begin occurring by the second half of the year.
“Very few retailers are ordering goods,” Moore notes. “The side of the supply chain that seems to be working very well is from the distribution center to the store.” Moore predicts that the draw-down in inventories will translate into a sharp rise in demand for expedited services.
Money to burn
As Costello points out, declining inventories set the stage for a rebound in freight, but they don’t help until sales accelerate. For sales to rise, disposable income must rise. This is especially important because exports are bleak today due to global recession and likely will be soft well into 2002. Plus, consumer spending must offset the hundreds of thousands of job losses, which would, of course, depress spending. Fortunately, there are several trends toward putting more money in U.S. consumers’ pockets.
One important positive development has been gasoline prices. The average price for regular gasoline dropped almost 50 cents between the beginning of September and the middle of December. Prices in May last year were almost 70 cents higher than they were last month. The effect is to free up money for other purposes. (See “When it’s good, it’s very good,” below)
Another shift in disposable income to consumers has come from lenders. Low mortgage rates have enticed many homeowners to refinance, which in many cases has put hundreds of dollars a month back into a consumer’s pocket. And the Federal Reserve’s string of federal funds rate cuts has opened the door to cheaper borrowing.
During the current recession, the federal government has tried to stimulate consumer spending by giving them access to more money. This summer, the government used the most direct approach – mailing out billions of dollars in $300 to $600 rebates. Now the debate is over an economic stimulus package that would return billions, primarily through tax cuts. The results, supporters say, would be more disposable income and more jobs.
The National Association of Manufacturers has called passage of the economic stimulus package essential to recovery. “We are likely at the bottom of the business cycle, but the recovery will be ugly and U-shaped, in my judgment, without significant growth in investment and exports,” says NAM President Jerry Jasinowsky. “The outlook will be a lot worse if Congress doesn’t enact the economic stimulus legislation.”
Roadbocks to success
Economic recovery isn’t enough to return many trucking companies to health. Liability insurance, for example, has replaced fuel as the business-threatening crisis. (See “The coverage crisis,” above.) And trucking insurance isn’t even the only insurance problem.
Surges in workers’ compensation insurance, for example, have in some cases resulted in operating ratio increases of 1 percent to 2 percent, says A.G. Edwards’ Broughton. Trial attorneys have succeeded in getting courts to greatly lengthen the tail on workers’ comp claims, he says. A knee injury, for example, might draw compensation for a worker’s entire life.
Another major hurdle is, of course, the collapse in equipment values, which has essentially dried up many carriers’ access to capital because they no longer had equity in their trucks. But some analysts see light at the end of the tunnel.
“The bad news is that we have a used truck glut,” Broughton says. “The good news is that we don’t have a new truck glut.”
Some observers believe the desire to postpone the pain from the upcoming Environmental Protection Agency emission requirements on new engines will spur interest in used trucks. “We believe the used truck crisis will begin to fix itself in the third and fourth quarters,” says Stephens Inc.’s Moore.
Broughton believes the current trucking downturn, which dates back to the diesel fuel spike of January 2000 and continued with the crises in equipment values and insurance premiums, will finally result in a restructuring of the truckload industry.
“The reason so many of these smaller carriers have failed in this cycle and previous cycles is that they are rather unsophisticated in their ability to properly account for their costs -especially variable costs,” Broughton says. “When they have wide swings in variable costs, they are losing more money than they realize.”
Broughton sees the trend continuing. “Given the conditions as they now exist and the conditions that are now unfolding, small carriers will continue to fail at a pretty alarming rate.” The exceptions, he says, will be well-managed companies that can obtain high pricing and high lane density and develop a niche.
“You finally have some carriers that are big enough and have invested heavily enough in information technology that they can offer services and be profitable at a price that the small guys can’t even offer,” Broughton says. “It’s very much like when you get Park Place and Boardwalk and two or three other properties; it’s just a matter of time before you win.”
Whether or not the industry is headed toward fundamental restructuring, it does appear that the current cycle in trucking is beginning to bottom out. With many marginal, rate-cutting carriers driven out of the industry, the current journey should end with better times. “I’ve been saying for a while that if you can hang in there, you are going to do alright,” says ATA’s Costello. “That’s still the case, but it’s going to be harder and take longer.”
Optimistic on freight, steadfast on operations
Most trucking companies apparently believe the freight market has either hit bottom or will do so within a few months. Almost three-fourths of 390 for-hire, mostly on-highway trucking companies surveyed by CCJ in mid-December expect freight volume in 2002 to increase steadily or increase after falling initially. Very few carriers expect a downward trend. It’s not all rosy, however. Many carriers that expect freight volume to grow during 2002 also see getting an adequate freight rate a major challenge in the coming year. (See “The coverage crisis,” page 20.)
The general optimism seems reflected in carriers’ expectations for their own operations. A majority expects to hold their current fleet size, and almost a third more anticipate growth in 2002. Perhaps more to the point, less than 6 percent say they expect to reduce the number of trucks in their fleet during the coming year. As with freight volume, however, the outlook for 2002 may reflect more how bad last year was than how good this year will be.
The coverage crisis
The large numbers of trucking company failures in 2000 and 2001 generally coincided with the rise in diesel prices, as they have done for years, according to Donald Broughton, transportation analyst with A.G. Edwards.
But 2002 could be different. Diesel prices are low and might go lower, but some analysts, including Broughton, expect failures to continue their brisk pace. For those looking at the trucking industry from outside, liability insurance is the most underappreciated problem facing trucking companies, Broughton says.
The insurance crisis is certainly recognized within the industry. In a survey of 390 for-hire trucking companies conducted by CCJ in mid-December, almost 37 percent identified insurance costs as likely their greatest challenge in 2002. Freight rates were cited second at 24 percent.
Primary insurance premiums have risen 30 percent to 100 percent, depending on the nature of the risk, but the greatest increases have been in higher-level coverage, known as reinsurance or umbrella coverage. “If your primary insurance carrier is unwilling to write higher limits, there are very few companies that are willing to offer the coverage,” says Bill Prester, president and CEO of Aon Truck Group, an insurance broker based in Schaumburg, Ill.
It’s basic economics. Demand for umbrellas has remained the same or risen while the supply of companies offering the coverage has dropped dramatically. The result, Prester says, are premiums that have risen 100 percent to 1,000 percent over the year before.
A typical trucking company today can’t afford umbrellas, Prester says. Carriers that do buy them do so because they can get relief, through rate increases, from shippers that demand coverage in excess of primary coverage or, as in the case of publicly held companies, to protect equity.
Carriers are responding to dramatic surge in premiums, Broughton says, by increasing their self-insurance and abandoning some of the upper levels of their umbrella coverage. That’s scary, he argues, because the average wrongful death is between $3 million and $4 million. One or two fatal accidents and many carriers are out of business, he says.
A smarter course of action, Prester says, is to take higher deductibles on primary coverage and use the savings to help offset high umbrella premiums. “There’s more predictability on the first $100,000 or $200,000 in losses than in losses of more than $1 million.”
When will the insurance market improve? Prester sees no relief in 2002, although he notes that the American Trucking Associations and the Truckload Carriers Association “have been working diligently on behalf of the trucking industry to identify the causes of premium increases and solutions.” He sees capital developing for reinsurance down the road, but he doesn’t look for stabilization until 2003. “The economy is not picking up as fast as we thought,” Prester says. “We still think investment portfolios will not perform as they should until the second half of 2002, which should help out the insurance market in 2003.”
Last month, the Truckload Carriers Association’s Truckload Academy sponsored a two-hour audio conference entitled “Surviving Today’s Insurance Crisis.” Audiotapes may be purchased by calling KRM Information Services at (800) 816-2640. Reference conference No. TCA65650.
When it’s good, it’s very good
When diesel fuel is your second largest expense item, it’s natural to think of diesel when discussing fuel prices. But trucking operations enjoy the benefits of low fuel prices – or, conversely, suffer the consequences of high fuel prices – twice. Diesel prices, of course, affect you immediately and directly. But gasoline prices have a major effect as well, although it may take months for you to see it.
“Fuel prices go directly to the bottom line of the industry,” notes Daniel Moore, transportation analyst for Stephens Inc. But gasoline prices also have an enormous impact on disposable income, which affects consumer spending. “If every soccer mom is saving $15 a week in gas money, that’s $60 a month and $760 a year,” Moore says.
In 1999 and through 2000, Moore says, high fuel prices resulted in a shift of discretionary income from retailers to commodities companies. Lower gasoline prices will shift discretionary incomeback to retailers.
“Just the drop in gasoline prices has put an extra $6 billion into the U.S. economy,” says Bob Costello, chief economist for the American Trucking Associations. “Clearly, energy is a plus for the economy.”
But will it continue? “Right now, fuel looks pretty good for next year,” Costello says. “The Organization of Petroleum Exporting Countries is having a hard time keeping production in place; non-OPEC production is good.” Unfortunately, another driver in lower fuel prices is lower demand due to a worldwide recession, Costello says. But at least the trucking industry has the silver lining. “Stability would be nice,” Costello says. “It’s these wide fluctuations that make business decisions so difficult.”
Diesel prices are near a historic average and may stay there for a while, says Mark Derks, an analyst with fuel services company T-Chek Systems. “Unless something crazy happens, it’s probably going to remain around this level,” Derks says. He attributes the favorable pricing to a variety of factors, including OPEC squabbling, recession, mild temperatures in North America and Europe and a cutback in airline service that has freed up crude oil that otherwise would go for jet fuel refinement.
Sept. 11 clearly played a role in OPEC’s slow movement toward cutting production, says Roger Simons, president of Simons Petroleum. OPEC probably would have cut production in September if not for the attacks, he says. “In the short term, there’s not going to be much change in prices,” Simons says. “It may be a little bumpy, but prices aren’t going back up until the economy picks up.”
– Avery Vise and Sean Kelley