Still rolling along

If 2005 was good, 2006 probably will be too. Trucking industry observers see continuation over the next 12 months of the fundamentals in place today: tight capacity and strong freight demand. While forecasts show slower growth in consumer spending and the economy in general, the inability of trucking companies to find a stable supply of drivers and less volatility in diesel prices promise to keep carriers profitable.

Starting off strong
Heading into 2006, there are few signs of weakness for trucking activity. “The fall freight season may have started a little later than normal, but it was pretty robust,” says Bob Costello, vice president and chief economist of the American Trucking Associations. Costello knows of one carrier that was 120 percent booked for September and October. “At worst were those nearly fully booked.”

The strength doesn’t show up in volume growth, but it does appear in revenue growth, Costello says. Tonnage was only slightly ahead of the same 2004 periods. But carriers generally had no more capacity or sometimes – due to driver shortages – less capacity, so pricing continued to be strong. “2005 was probably the second-best year that carriers have seen. We have a lot of happy truckers out there despite fuel prices.” In fact, with the moderation of fuel prices from record highs at the end of the third quarter, carrier profits should be very strong in the fourth quarter, Costello says.

The strength of the fourth quarter is important for a couple of reasons. For starters, it’s an indicator of whether future consumer spending will be strong or weak. More directly, especially in the near term, holiday sales determine whether retailers begin the new year with surplus inventories. If holiday sales are strong, inventories will be depleted, setting the stage for more production in the first quarter. If sales are weak, retailers won’t need to replace inventory.

“The freight environment looks positive right now,” says Chris Brady, president of trucking analysis firm Commercial Motor Vehicle Consulting. “Inventories within the supply are lean, and any final sales are pulling freight through the supply chain. As long as final sales are expanding, freight volumes should be strong.”

Unfortunately for forecasters, holiday sales have become more difficult to predict at an early stage in recent years. “The American consumers have changed their buying patterns,” Costello says. Until recently, consumers bought most of their gifts soon after Thanksgiving, especially on so-called Black Friday. But consumers have realized they might save money by waiting for anxious retailers to offer better deals in the days before Christmas.

If November is any indication, however, holiday sales probably were strong. The Commerce Department reported that retail sales in November rose 6.3 percent over November 2004, despite the disruptions from the September hurricanes and higher fuel prices than last year.

Solid fundamentals
Regardless of the holiday sales, many economists expect weaker growth in consumer spending for several reasons, including higher levels of debt and, on average, higher fuel prices, which reduce disposable income. And slower growth in consumer spending will translate into solid but slower growth in the economy and in trucking activity.

“We see an environment of continued economic growth in 2006 driven by accommodative monetary and tax policies and a low dollar valuation that’s still partially thwarted by high energy prices,” says Donald Broughton, transportation equities analyst for A.G. Edwards. “Energy prices are acting as a governor on the economy.”

Broughton believes the attention given to rising interest rates is overblown. “Interest rates are still low, and the Federal Reserve has raised rates but at a slow place.To the creditworthy, credit is plentiful.”

Economic growth in 2006 will be softer than in 2005, but still quite good, says Ken Kremer, a Global Insight economist who follows the trucking industry. Global Insight projected 2005 Gross Domestic Product (GDP) growth at 3.7 percent – slower than 4.2 percent in 2004. The projection for 2006 is 3.5 percent growth due to slower growth in consumer spending, Kremer says. “We have a generally optimistic economic outlook. This economy has done pretty darn well, all things considered. There’s more momentum there than people expected.”

“We think that 2006 will be a good year but slower, mainly driven by the consumer,” Costello says. Business investment, however, should rise strongly in 2006 as it did in 2004 and 2005. GDP growth still should be above 3 percent in 2006, down from a little more than 3.5 percent in 2005, Costello says.

One reason that’s good news is that the Federal Reserve won’t have to get aggressive with interest rates, Costello says: “If they are increasing or decreasing rapidly, that’s an uh-oh.” Costello envisions an increase in tonnage over 2005 similar to the approximately 2 percent increase for-hire trucking recorded in 2005 over 2004.

“Unless the industry can figure out how to add capacity, the industry should continue to see expanded pricing power,” Broughton says. The industry saw 4 to 5 percent price increases in 2005 on top of 8 to 9 percent increases in 2004. Based on projected demand and the likelihood of continued driver shortages, “it wouldn’t surprise me to see 4 to 5 percent increases in pricing again.”

Broughton’s greatest concern is a strengthening dollar. A weak dollar has helped boost manufacturing activity in the United States by making U.S. exports attractive and encouraging suppliers to locate operations in the United States. “We have stolen as many manufacturing jobs from Europe as we lost to Asia,” Broughton notes. The dollar strengthened modestly in 2005, and several factors could continue that trend, including a continued rise in interest rates and strong economic growth relative to other industrialized nations.

On the other hand, Kremer thinks the dollar will be a positive factor. “We’re still looking for the dollar to drift down over the near term, so exports should pick up.”

What’s hot? What’s not?
“Residential construction is where we’ll see the biggest hit,” Costello says. “Interest rates will finally catch up.” Automobile sales likely will suffer as well from higher interest rates, he says.

Housing starts in 2005 totaled about 2.05 million units, Kremer says. In 2006, that will fall to 1.89 million units, he says, adding that this still represents a strong housing market – just not as strong as recent history.

Nonresidential construction, such as highways and office buildings, is definitely on the upswing, says Stephen Latin-Kasper, director of market data and research for the National Truck Equipment Association. “The housing boom may be over – and it clearly is at this point – but nonresidential construction should do well in 2006.” According to Latin-Kasper, the biggest single driver in nonresidential construction is the recent enactment of the massive transportation authorization bill. “Lots of money will be pumped into road building.”

A stronger nonresidential construction market means a different mix of construction materials and supplies – more structural steel, aggregates, concrete, asphalt and construction equipment, Kremer says.

But Costello says rebuilding in the Gulf Coast region after hurricanes Katrina and Rita can crowd out investments in other parts of the country due to increased prices and lower supplies of lumber, steel and other key inputs. Although interest rates are the key driver, this inflation of materials costs is another reason for slower residential construction nationwide.

Another area of strong growth is the utility industry, Latin-Kasper says. “For the most part, the country has woken up to the fact that there isn’t enough electric production capacity. Capacity is being added.”

The driver is the driver
As the trucking industry has learned time and again, trucking does well when the supply of drivers is tight. So while driver availability is a problem for individual carriers, it has proven to be a boon for the industry as a whole.

“The reassuring part is that they are all still struggling to find drivers,” Broughton says. If carriers get enough drivers, they likely will grow and create overcapacity. That’s an obvious concern, but Broughton believes people often overlook a second worry that stability in driver availability suggests: Softer demand for manufacturing and construction. If carriers find recruiting easier, it’s often because those sectors are laying off people or slowing their hiring. “Like it or not, there’s a percentage of the blue-collar work force that views driving a truck as a job of last resort.”

The U.S. military presence in Iraq, Afghanistan and elsewhere also has an effect on driver supply because it artificially lowers the unemployment rate, Broughton says. And trucking feels the effects directly. “The local Army recruiter is looking for the same demographic as the trucking company recruiter.”

While everyone sees higher driver wages in 2006, no one believes those increases will stabilize the driver supply.

“Capacity has been growing and will continue to grow, but it hasn’t been able to grow at the rate of freight volumes,” says Brady. “What’s really constraining capacity growth is the driver situation, and that’s not going away.”

And that’s about the best problem you can have.

Fuel for thought
With freight demand strong and the supply of drivers tight, the price of transportation fuels and of energy in general is one of the principal variables in the health of the trucking industry. Fuel has a double effect on trucking, says Donald Broughton, transportation equities analyst for A.G. Edwards. “A moderation in fuel price would not only help profitability of motor carriers, but it also would increase disposable income for consumers.” Higher prices would have the reverse effects.

“The major risk is energy prices and how that affects buying,” says Chris Brady, president of trucking analysis firm Commercial Motor Vehicle Consulting. But based on the outlook for 2006 – as well as the experience last fall – that worry isn’t great, Brady says. “It appears that higher energy prices will not cause a decline in consumer spending.”

Diesel prices have the most direct effect on carriers, of course. The latest Department of Energy forecast for 2006 is an average of $2.54, says Brad Simons, president of Simons Petroleum’s Pathway Network. According to DOE, the average for 2005 was $2.41. Asian demand for petroleum appears to have slowed a little, “but we still think that supply will be tight.” Plus, Gulf Coast refining capacity damaged by hurricanes Katrina and Rita will not return to 100 percent until mid-2006, he says.

“Global supply and demand will be key,” Simons says. In the near term, winter temperatures in the United States and in Europe will drive demand for heating oil – a major competitor with diesel for distillate stocks. This is a concern in any winter, but it’s particularly important this year. The disruptions caused by the hurricanes have put particular prices on diesel supply and introduce greater winter pricing risk, Simons says.

A higher average price in 2006 probably is misleading, says Bob Costello, vice president and chief economist of the American Trucking Associations. The range in 2005 was between about $2 and more than $3, but barring another shock like a Gulf Coast hurricane, the range likely will be tighter in 2006.

Hurricanes Katrina and Rita demonstrated what the trucking industry has feared, Costello says. “Refining capacity is stressed essentially to the breaking point. If any refineries go down, we are going to see large swings in price.”

Diesel fuel particularly is susceptible to this problem, Costello says, because imports aren’t as readily available. In the weeks following Katrina and Rita, gasoline prices retreated from their record highs faster than diesel prices did. One reason is that Europe and Asia use diesel fuel as their primary source of transportation fuel, even in automobiles. So the world could spare some gasoline but not much diesel.