Freight weakness likely will continue and may worsen into 2007, but analysts don’t expect a catastrophe.
For several years now, economic forces generally have worked to the advantage of the trucking industry. Following the dark days of 2000 and 2001, freight volumes grew strongly, at least through 2005. Meanwhile, the inability to hire enough drivers and the need to repair damaged balance sheets helped keep capacity a step or two behind freight demand, giving carriers much-needed pricing leverage.
All good things must come to an end. Freight demand stopped rising in 2006 and was down a bit over a strong 2005. Some sectors, like housing and automotive, saw bigger problems, which undoubtedly will continue into 2007.
“I think in general that 2007 will be the toughest year for the industry since the trucking recession of 2000-2001, but it won’t be as bad,” says Bob Costello, chief economist for the American Trucking Associations. But just how weak will 2007 be – and how long will the weakness last?
In some ways, 2007 will be a continuation of weakness that carriers have seen since fall. Indeed, many carriers have reported that they did not experience the usual peak season in the August-October timeframe. ATA’s For-Hire Truck Tonnage Index was down 4 percent in October 2006 compared to October 2005. That’s a bit misleading because major hurricanes in 2005 generated a significant amount of freight. Even excluding the hurricane effect, however, freight volume would have been down 1.1 to 2.7 percent.
ATA’s analysis of data from recent years, along with anecdotal evidence from shippers, suggests that the traditional fall freight season is flattening. There are slightly more shipments early in the season and more volume later in the season, says Costello. Another factor is the rise in popularity of gift cards, which shifts sales that previously occurred during the holidays into January, he says.
Unfortunately for trucking companies, the bigger picture can’t be explained by just a shifting of freight from one period to another. Overall economic growth is slowing, and that means slower freight demand.
“Our forecast is for a 2.7 percent advance in real gross domestic product (GDP) in 2007, down from about 3.3 percent growth in 2006,” says Steve Graham, vice president of market analysis for freight forecasting firm FTR Associates. Graham concedes that FTR Associates’ forecast of 2.7 percent growth is ahead of the consensus forecast. ATA’s own projection is a bit over 2 percent, lagging the long-term trend of 3 percent.
Graham’s forecast for industrial production is significantly lower – a 1.8 percent advance compared to a 4.3 percent increase in 2006. The two biggest factors in that projection are problems in housing and the automobile industry. “Basically, housing is the main impact on freight so far,” Graham says. “The biggest fear is that this will spread to other sectors.” Fortunately, there are signs – an increase in mortgage applications and a decline in long-term interest rates – that a bottom may be forming in the housing market, Graham says. Even so, residential investment in 2007 likely will be negative relative to 2006.
Manufacturing, which has been strong for quite some time, is showing signs of weakness, Graham says. Factory orders have fallen three of the last four months, although it’s too early to say what that means, he says. “It could be that we’re seeing an inventory correction or that manufacturing is entering into a recession. But definitely weakness is creeping in.” On the other hand, the U.S. dollar remains weak, which should ensure a healthy level of exports. Exports grew 8.6 percent in 2006 over 2005, and FTR Associates projects another 6 percent rise in 2007.
Chris Brady, president of market analysis firm Commercial Motor Vehicle Consulting, emphasizes the effect of holiday sales on freight volumes early in 2007. Sales in the range of what’s expected would have little impact, as inventories will remain about the same. “If sales come in stronger, that will be a stimulus for freight in the first half of the year. The risk is that sales come in below expectations.”
While holiday retail sales were expected to be OK – but not outstanding – there are signs that retail spending is slowing, says Donald Broughton, transportation analyst for A.G. Edwards. “In today’s economy, there is a bifurcation of wealth that’s primarily driven by education level.” People who buy the median-priced house or below have little liquidity, he says. “There’s a reason that Wal-Mart is reporting flat same-store sales.” On the other hand, high-end department stores like Nordstrom are doing well, he notes. If this trend continues, it’s not good news for trucking, which depends on high volume, not high value.
Tough from the start
Trucking companies won’t have much time to dread 2007; they probably will be in the worst of it from the beginning. “The trucking industry’s problems stem from the fundamental question of supply and demand,” Broughton says. “One of the biggest challenges that companies are dealing with now – and I don’t expect this to change through the first half – is that there is a significantly lower level of demand. There are now more trucks than loads,” he says.
“I think it will start as a very difficult year for both truckload and LTL,” says Thom Albrecht, managing director and lead transportation analyst for investment banking firm Stephens Inc. Albrecht expects shippers to put out more network bid packages than in the recent past. Some shippers saw their carriers cutting rates in the fourth quarter to keep their trucks moving. “Several told me that carriers have offered 5 to 10 percent discounts for the early part of 2007 – to get through the first quarter – based on volume guarantees.
The pendulum has not swung far to the shipper, however. “We’re probably at equilibrium or possibly a little excess supply [of trucking capacity],” Albrecht says. But it might feel like a big swing to a carrier that has been enjoying its leverage for a few years.
Brady agrees. “The imbalance between freight volumes and truck capacity is decreasing,” he says. “Carriers have had much more of an upper hand in pricing. The pricing environment will be much more competitive in 2007 relative to 2006. They will not be able to pass along cost increases as readily.”
Albrecht attributes the shift from carriers’ past leverage to several factors. GDP is slowing with 1 percent less growth. Carriers overbought new trucks by at least 3 or 4 percent, he says. Other factors include improved rail service and the absence of hurricanes in 2006. And some of the capacity that previously had been committed to housing and the automotive industries has shifted over to non-durable consumer goods.
“The biggest thing is that we bought too many trucks,” Albrecht says, adding that the problem is especially acute in truckload. “We estimate that the industry bought 47,000 to 55,000 too many trucks this year.”
Broughton also believes that trucking companies’ own actions are contributing to the pain. “Trucking is seeing a slight pickup in capacity because of a slight increase in drivers coming out of construction.” Even though carriers already are experiencing softness in freight, they are still in hiring mode and have the trucks due to the pre-buy, Broughton says. So capacity is growing a bit even as demand is sagging. Says Broughton, “Sir Issac Newton made an observation that arguably applies in this context: Bodies in motion will continue in motion. ”
According to Brady, truck capacity grew 5.9 percent in 2006, just as trucking was about to enter a slowdown. That’s well ahead of the growth in earlier years – 4.7 percent in 2005 and 2.8 in 2004, according to Brady – when freight growth was strong.
But Costello believes that the effect of the pre-buy on capacity can easily be exaggerated. “There’s no doubt that there’s more equipment out there, and capacity is definitely looser. But I don’t think it’s anything like we saw in the 1990s – primarily because we still have the driver issue.” Costello believes that a bigger factor in capacity growth, especially in dry van, is carriers that had been focused on transportation related to housing or automotive manufacturing are now seeking business in other markets.
Brady sees the same phenomenon. “It may be that some dry vans hauling building materials will shift that capacity to other segments.” The result is more trucks chasing the same freight.
Regardless of what’s happening with capacity, it’s the demand side that will really hurt, Broughton says. “We have had a record overbuild in housing.” And although Broughton is big on the U.S. manufacturing industry over the long term, he sees signs of near-term weakness. For example, intermodal volume was up 1.4 percent, but there was an increase of 8 to 12 percent in volume at ports. “That means domestic intermodal has to be negative.” What appears to be happening, Broughton says, is that domestic suppliers to manufacturers are being turned off faster than foreign ones.
Broughton sees the possibility that GDP will be negative in the first or second quarter, possibly both. Two straight quarters of negative GDP is a recession, but Broughton doesn’t think the industry will have to wait. “By February, truckers will see it as a recession.”
One of the early consequences of weakness may be failures and consolidation, Albrecht says. “We may see 600 or 700 carriers go out of business in the first quarter. A lot of carriers are broke, but they just don’t know it.”
BAD THEN GOOD?
Broughton might not be optimistic for the next few months, but he doesn’t see the situation as dire. “The U.S. economy is extremely resilient. We won’t get a wholesale panic. That just doesn’t exist anymore.” Plus, the supply chain is based on lower inventories, which require a steady flow of goods to satisfy demand. Inventories have risen recently in manufacturing, but they remain dramatically lower than five, 10 or 15 years ago, Broughton says. These factors argue for a less severe cycle, he says.
Albrecht also sees lean inventories as a fundamental strength for trucking. “If sales soften, inventories could get bloated,” he notes. “But they are as lean as they have been in the past four or five years.”
Costello is a bit more concerned about the situation with inventories. “We’re seeing inventory-to-sales ratios coming back up.”
Albrecht believes that most trucking companies will look back on 2007 as two separate experiences. After a tough first half, he thinks the year will turn positive. If you only look at housing or automotive, or rely on anecdotal experiences of some trucking companies, you might expect a recession, Albrecht says. “If you look at everything at a macro level, it feels more like a soft patch – a six- to nine-month period with low GDP growth.”
Costello also believes the first half of 2007 will be worse than the second half, principally because the housing market is likely to bottom out by summer. He points to other strengths in the economy, especially low unemployment. “In general, the so-called soft landing is still most likely,” he says. “Hopefully, a year from now we’ll be talking about a solid 2008.”
In addition to housing bottoming out, Albrecht believes that consolidation of trucking companies early in the year and a working-off of the excess truck buy will fuel a rebound toward yearend. “I would be surprised that if by June or July, we’re not seeing some acceleration.” Dry van truckload, which was the first to experience softness, likely will be the first to rebound, Albrecht predicts. “LTL is more tied to the industrial economy, which just started to slow down this fall,” he says, adding that LTL carriers may not see improvement until August or September. And “flatbed could be suffering until the fall.”
On the cost side, while diesel is a wild card, other costs shouldn’t be as onerous as in the past, Albrecht says. Driver wages could be flat or up only 2 or 3 percent, and with the large pre-buy, most carriers won’t feel the full effects of the truck price increases until later years. “Operating ratios are going to deteriorate, and freight rates may go back a little. But the real story is that it won’t be two years of misery. By the end of 2007, the momentum will shift back to the carriers.”
Says Albrecht, “If I had to pick an analogy for 2007, it would be a musical crescendo that starts low but finishes with a big bang.”
Diesel outlook: High but not horrible
Slightly less price volatility seen in 2007
As trucking companies learned in both 2005 and 2006, high diesel prices are bad – but not as bad as volatile diesel prices. Even without a single hurricane hitting the United States, the retail price of on-highway diesel varied by 60 cents during 2006, notes Brad Simons, president of Simons Petroleum’s Pathway Network. Barring the unforeseen catastrophic event, volatility should be more in the range of 40 cents during 2007, he says.
There are some favorable factors. Diesel inventories are good, and mild weather so far this winter has helped keep demand in check. But if you are looking for a big drop in diesel prices, don’t hold your breath. Demand for crude oil remains strong globally. For example, in November, China imported twice the number of barrels of crude than had been expected, Simons says. And supply has been curtailed. OPEC cut crude production by 1.2 million barrels a day and just voted to cut another 500,000 barrels, effective Feb. 1. Even if those production cuts don’t hold – and often they don’t – don’t expect an increase in supply.
Simons Petroleum believes crude oil will trade in the range of $55 to $70 a barrel during 2007, Simons says. That’s the basis for his projection of a 40-cent price range for diesel. But everything points to upward pressure. “The thing that would change the upward trend is a slowdown in the economy.” Simons Petroleum, therefore, is recommending that clients look to fuel programs not to lower the current fuel prices but to “manage the volatility and cap upside exposure.”