Clearing trend?

Donald Broughton, transportation analyst for A.G. Edwards, tracks business failures in trucking and has found that the number of failures is closely related to diesel prices. In many cases, marginal companies can hang on until they experience a problem – such as a fuel-price spike – that destroys their cash flow. Failures during 2002 are well below the spikes in late 2000 and 2001 but remain high.

Source: A.G. Edwards

How many times have you heard the past two or three years referred to as “the perfect storm” for trucking? The metaphor is absolutely fitting, but it quickly grew tired just the same. Eventually it became so trite that it lost all impact.

Fortunately, we can now say that the perfect storm has dissipated, or at least moved offshore. However you choose to view the current state of the trucking industry, we are no longer in a situation where all economic forces are clearly negative. For the most part, publicly traded carriers posted strong profits in the third quarter of 2002, at least compared with the dreadful third quarter of 2001. Few experts believe that the industry still suffers from overcapacity. The conventional wisdom is that the survivors of the perfect storm are positioned for strong profits. And most believe business spending probably will rebound at least by the end of 2003.

But elsewhere the forecast is cloudy at best. The fear of war in Iraq is keeping fuel prices high and further chilling business investment. A quick or avoided war could be a big boost to the economy, but a long and messy conflict could be a drag on fuel, consumer confidence and business spending. If freight volumes do rebound strongly, will carriers have to pay more than they are getting from shippers to keep their trucks filled with drivers? And is there any relief in sight to the insurance crisis?

So 2003 may be a storm after all. But at least we can take some comfort that it surely won’t be a perfect storm.

A little better off
The trucking industry generally heads into 2003 in a stronger position than it was in a year earlier, says Bob Costello, chief economist and vice president of the American Trucking Associations. Freight is up, for example. But higher freight volumes during 2002 are a bit deceiving, and don’t necessarily indicate a continuation of the trend.

“Much of the improvement had to do with changes of inventories rather than real demand,” Costello says. Trucking suffered during 2001 because businesses were drawing down bloated inventories. “Businesses did too good of a job of cleaning out inventories,” he says. “As they brought inventories up to realistic levels, trucking saw an improvement in freight in 2002.” Indeed, the industry has been seeing 5 percent year-over-year increases, Costello says, adding, however, that the inventory change is now essentially over.

In some respects, however, 2002 began better than it ended. Diesel prices in January 2002, for example, dropped to a retail average of $1.14 a gallon – the lowest level since July 1999. Unfortunately, that proved to be the bottom. From that point, diesel prices began a gradual but steady climb, hitting a peak of $1.47 in mid-October.

Rebound – or another recession?
If things aren’t too bad, credit the American consumer.

“The consumer has continued to spend, and that’s been the saving grace,” says Donald Broughton, transportation analyst for A.G. Edwards in St. Louis. “If that continues – and I think that’s reasonable to expect – and businesses start to spend, then 2003 could be far better than everyone’s expectations.”

But what if those two conditions – continued strong consumer spending and a rebound in business investment – don’t occur in 2003? The result could be what has become known as

Source: CCJ’s December 2002 survey of 276 for-hire and 356 private carrier executives

a “double-dip recession.” Consumers pulled the U.S. economy out of a brief recession, but those same consumers could send it back into a recession if they stop spending. Some economists worry that consumers will slow their spending due to mounting debt and high unemployment.

“I am not a double-dip person,” Costello says. “I don’t think we will see another recession for the trucking industry or the overall economy.” Costello doesn’t think consumer spending will plummet. Income is growing strongly enough, and unemployment, while higher than a few years ago, is not that bad, he says. “Do you know how many countries would love to have 6 percent unemployment?”

In addition, interest rates remain low, and consumer confidence is still at a good level, Costello says. “Consumers should continue to spend at a good rate.”

In the area of business spending, Costello sees signs that the decline in capital investment has bottomed out. But he doesn’t see an upswing in spending right away. “There’s ample industrial capacity out there – unlike the trucking industry.”

One concern that may be chilling business investment in the short term is the possibility for a war with Iraq. But a possible war is only one factor in a continued sluggish environment for business investment, Costello says. Perhaps an even bigger factor is fear that the economic turnaround may not be solid. And even if it is, businesses aren’t in a big hurry to invest because of available capacity.

In any event, the industry certainly isn’t riding into 2003 on a wave of rapid freight growth. Bob Delaney, vice president of Cass Information Systems and a consultant with ProLogis, says there’s still not enough freight in the system. “Industrial production has been down for four straight months, and retail sales have been soft in the second half of [2002],” Delaney says. I’m looking for a turnaround in June, but I have learned not to bet.”

Economist Ken Kremer believes that much of the economic uncertainly will be over by the third quarter of 2003, giving businesses some comfort to invest. Businesses can delay investments for only so long, says Kremer, an economist with Global Insight, an economic and financial analysis firm formed from the merger of DRI and WEFA. Still, the consumer is the key, Kremer says. “A lot will have to do with how consumers feel about themselves. If the consumer is unhappy, it’s not a good thing for economy.”

Broughton dismisses the notion that consumer confidence has overriding importance. “If you try to correlate consumer confidence with consumer spending, there’s no fit.” There is, however, a direct correlation between disposable income and consumer spending, Broughton says. “The vast majority of consumers spend everything they make.”

Better rates?
Freight volume is only half of the revenue equation. The big question is whether carriers will be able to reel in higher freight rates. That could happen if trucks are hard to come by when freight volumes really hit high gear, and some carriers are already getting higher rates.

“I do believe that there has been a significant amount of capacity taken out of the system,” Costello says. Once freight levels pick up, carriers should be in a strong position.

Chris Brady, president of Commercial Motor Vehicle Consulting in Manhasset, N.Y., believes equipment utilization will be at a high enough level by the second half of 2003 that carriers will be able to increase freight rates. Carriers might have been in that position already, but last year’s pre-buy to avoid the new engines led them to acquire more capacity than would have been required by market fundamentals, Brady says.

Brady predicts an increase in truckload freight rates of 2.5 percent to 3 percent, bringing them back to 1999 levels. Others believe the rate increases will be even stronger.

In years past, the periods in which carriers could make rate hikes stick didn’t last long. Enticed by premium rates, carriers would add capacity and new carriers would come into the market. Supply would grow to meet or exceed demand, and rates would fall.

Broughton doesn’t see this scenario developing in the current cycle. Instead, the trucking industry is seeing pricing and asset utilization improvement and not capacity increases. “And I think it’s the new engines.” The emissions worries in 2002 ultimately will help carriers hold the line on rates during 2003 by taking away a threat to today’s tighter capacity, Broughton contends.

Broughton has seen some increases in freight rates already and believes more are coming. “Not only has capacity left the market, everyone is uncertain enough about the new engines that they aren’t planning to add meaningful amount of new capacity through 2003.” Instead, carriers will focus on utilization. “I suspect that as the economy improves, total miles run will continue to go up, and empty miles will continue to come down,” Broughton says.

Brady agrees that utilization is the key to recovery. “Utilization declines when carriers get overly optimistic.” Excess optimism leads carriers to add equipment in anticipation of new business, not in response to it. But Brady doesn’t think that will happen in 2003. “Carriers are very conservative because profitability is coming from very depressed levels.”

Costello argues that capacity will remain tight due to barriers to entry that are stronger than in many past upturns. Fuel prices are high and wildly fluctuating – significantly higher than the long-run price of $1.22 per gallon. Insurance remains a huge barrier, and capital remains tight. EPA plays a role as well, Costello says. The expense of new equipment and the shrinking supply of desirable used trucks is both a disincentive to adding capacity and a barrier to entry.

And there’s always the availability of drivers. “The driver shortage will worsen during the second half of the year,” predicts Brady. That will slow the growth of existing carriers and create still another barrier to entry.

Wage pressures
While a driver shortage may carry some benefits for holding down capacity, it will also serve to increase carriers’ No. 1 expense. Truckload carriers typically haven’t seen wage increases yet, but there are signs that they are coming.

“We have seen a pretty flat year for wages,” says Gordon Klemp, president of Hudson, Wis.-based SignPost Inc., which publishes “The National Survey of Driver Wages.” But Klemp has seen some strong early indicators of wage pressure. “What we have seen in the last quarter are referral and sign-on bonuses increase.”

SignPost has found that at least 13 major carriers have instituted bonuses or increased them. “That’s a leading indicator of wage increases,” Klemp says. Plus, more carriers are calling in to request the survey, which is further evidence that carriers are re-evaluating their current packages, he says.

“We’re poised for another move,” Klemp says. “I believe that driver wages will move up at a rate faster than inflation in 2003.”

For wage increases to follow a driver shortage is nothing new. But Klemp sees some wrinkles this time around. Perhaps most significant is a trend toward pay packages that offer per diems coupled with a lower rate per mile. Using per diems as compensation allow various tax advantages for carriers.

Covenant Transport is a prime example of this trend, Klemp says. A driver with three years of experience – a standard SignPost uses in its survey – has a choice between 30 cents a mile or

Health insurance costs continue to rise, forcing trucking companies to push more of the burden for premiums to their employees. “Expect to see co-pays on insurance going up briskly,” says Gordon Klemp, president of SignPost Inc., a Hudson, Wis.-based company that tracks motor carriers’ wage and benefit packages.

Source: SignPost

27.5 cents a mile in base pay plus 9.8 cents a mile per diem. “They are definitely providing incentive to move to a per diem pay package.” Although Covenant is one of the more aggressive players on per diem, Klemp is beginning to see the trend among other carriers.

Most other observers also see labor costs rising. “Assuming that the economy gradually improves, I would expect that there will be wage pressures,” Costello says. “We will very quickly see a shortage of drivers.”

Less-than-truckload carriers face a formal process for considering wage changes as the major unionized LTL carriers operate under the same negotiated master agreement. For LTL carriers, higher wages appear to be in the offing based on a wage hike at package delivery carrier United Parcel Service. “UPS agreed to a healthy increase, and I suspect LTLs will as well come March,” Broughton says.

Another factor for LTL carriers in wage talks is improved financial performance, which is related in part to lost capacity from the Consolidated Freightways shutdown and other failures. That development certainly was a net plus for the survivors, but the timing didn’t help with labor talks, Broughton says. “Long-haul LTLs could have walked into negotiations with Teamsters and cried poor.” He adds that he has confidence in the ability of the Teamsters “to extract as much operating margin as they can.”

Fuel for concern
The second biggest cost for most carriers is fuel, and most observers don’t see much reason to be optimistic. Even if the United States doesn’t ultimately go to war with Iraq, the showdown is already keeping prices a bit higher than they otherwise would be. “Nobody really knows for sure, but there’s probably a $3 to $6 premium on crude oil due to concern over war,” Costello says. Worries over possible future disruption of Middle East oil supplies have increased demand for crude, thus pushing up the price.

Brad Simons sees three possible scenarios for war, and two of them aren’t positive. The best situation obviously would be a quick, efficient and successful war, says Simons, vice president of Simons Petroleum’s Pathway Network, which offers buying strategies to manage fuel costs. That outcome might lower fuel prices due to the war premium already factored into the market.

Another scenario, Simons says, is an extended war, which would raise buyers’ concern of possible disruptions and send crude oil prices higher. But prices would come down once the conflict ended. The worst-case scenario, Simons believes, would be that the U.S. military backs Saddam Hussein into a corner and he responds by trying to sabotage Middle East oil fields. “If that happens we will see prices going up and staying up.”

Some observers are more concerned, however, with political turmoil in Venezuela. That country usually provides about 2.8 million barrels of oil a day to the world market, including about 1.5 million to the United States. A strike in Venezuela last month cut total oil output to about 500,000 barrels a day.

Simons sees other important factors affecting diesel prices. In the short run, winter weather in the Northeast and in Europe is key because home heating oil – popular heating sources in those regions – draws from the same distillate supplies as diesel. If the winter is severe, demand rises and so do prices.

Another concern is general availability. “We are seeing very low inventory levels for low-sulfur diesel fuel and distillates in general,” Simons says. With demand for the next couple of years expected to be greater than 2002, the trucking industry can’t expect much relief, he says. “Until the inventory situation changes, we feel that there’s a natural bottom to the market because of the fundamentals.”

Even if Venezuelan turmoil, a Middle East war or other factors drive fuel prices higher, the problem might not be as severe as it was during the 2000 spike. “The industry as a whole has gotten markedly better at recovering fuel surcharges,” Broughton says. “Those that were really bad at recouping fuel expenses aren’t in business anymore.”

Simons recommends that carriers with purchasing volume consider programs aimed at capping diesel prices, even it means giving up savings if prices drop. Indications are that diesel prices during 2003 will stay at around $1.35, Simons says. But due to the possibility for stronger demand, smaller-than-usual inventories and global political factors, there’s risk of volatility, he says. “We believe that the next six months will be the most volatile.” But Simons doesn’t see much reason to think diesel prices will fall substantially during 2003.

Higher petroleum prices have one negative effect that carriers can’t manage, however. Rising gasoline prices reduce disposable income and depress consumer spending.

Unhealthy insurance
The crisis in liability insurance is no secret, but health insurance is a growing problem. In a recent CCJ survey, 11.2 percent of for-hire carriers listed medical and workers’ comp insurance as their greatest anticipated challenge for 2003. That might not seem high, but it ranked fourth, ahead of such worries as maintenance and fuel costs.

The cost pressures on trucking companies are reflected in the rise of premiums for drivers, says SignPost’s Klemp. Among the truckload carriers SignPost tracks, premiums paid by drivers have risen almost 75 percent since 1998. The average weekly premium for single coverage rose from $7.73 in February 1998 to $13.46 in November 2002. When you consider that carriers are undoubtedly eating some of the increase and that the dollar increase in family coverage is probably greater, that’s a significant hit.

Based on conversations he has had with some carrier executives, Klemp thinks there’s more to come. “Expect to see co-pays on insurance going up briskly,” he says.

Regarding liability insurance, most observers see the market stabilizing. But until premiums begin falling, carriers will see little relief. “The rate of increase seems to have slowed, but when you consider compounding, it’s still a problem,” says ATA’s Costello. “I see no sign of decreases in insurance premiums anytime soon.”

Among the biggest problems for insurance companies are the securities markets, which once provided excellent returns for their cash. Markets remain soft and volatile. “We had a hardening of the insurance market already happening,” says Broughton. “When return on investment dried up, there had to be an underwriting profit.”

Broughton believes that insurance costs are at about their peak, however. Not only will the overall market improve but also new capital will come into the insurance market due to the attractiveness of underwriting gains, he says.

Poised for recovery
“I am hoping that [2003] will be better for everybody,” Costello says. “Once businesses start to invest again, I think the trucking industry is poised to benefit significantly.”

“I think we will see continued improvement in demand,” Broughton says. “Credit will continue to be extremely tight, but the cost to the creditworthy will be low.” Wages will go up, but so will freight rates, he says. “Most carriers will focus on improving margins and paying down debt.”

What’s the outlook for 2003?
“We feel that the economy will slowly crank back up, but the fact will remain that some trucking companies will continue to underrate freight and will go away. We will then scoop up their freight.”
Royal Jones, president
Mesilla Valley Transportation
Las Cruces, N.M.

“Undercapacity will be very beneficial to the survivors. I hope the industry does not lose this opportunity.”
Tom B. Kretsinger Sr., president
Amercan Central Transport, Inc.
Liberty, Mo.

“At the present time I see an abundance of freight, but we have had a problem staffing enough drivers to grow with the customers’ demands. I think this trend will continue in 2003.”
David K. Baldwin, president and general manager
Menasha Transport Inc.
Neenah, Wis.

“With the loss of so many players in the trucking industry, those that survived 2001 and 2002 will be in a position to control their own destinies.”
Billy Nunnery, vice president
JR’s Trucking
Van Buren, Ark.

“Freight will improve, and driver supply will remain the same. Opportunities abound.”
Arthur J. Panke, president
SSC Freightways
Jackson, Miss.

“I expect freight availability to stay slow and fuel, insurance, driver pay and equipment to increase in cost. I think the very large companies will be the only ones to grow.” Bruce Bakke, sales and operations manager
Reliance Transportation Inc.
Fargo, N.D.

“Liability and workers’ comp insurance will sink a lot of us unless rates are more realistic.”
Charles Ramorino, chairman
Bob Rich Schroeder Trucking Inc.
Hayward, Calif.