Near the bottom?

Updated Jan 13, 2010

With all the economy’s troubles, 2009 may be worse for trucking than 2008. But if you can make it through the year, you probably will be rewarded with unusually good times.

The good news is that falling diesel prices are boosting trucking companies’ cash flow, lower gasoline prices are freeing up hundreds of billions of dollars in disposable income, and the federal government is poised to pump about a trillion dollars into the economy in 2009.

The bad news? Just about everything else. With financial markets in turmoil, credit almost nonexistent, job losses piling up, consumers cutting back on spending, the housing market in horrible shape and manufacturing on the skids, everyone agrees on at least one thing: 2009 will begin badly for the trucking industry and won’t improve quickly.

“The first half of 2009 is going to be very difficult,” says Bob Costello, chief economist of the American Trucking Associations. “We currently are in the worst recession since the early 1980s.” Consumer spending has kept more recent slumps in check even while other trends turned negative, Costello says. “We don’t see that happening right now.”

Consumers, investors and others view each development so negatively – even those aimed at instilling greater confidence, says Eric Starks, president of freight forecasting firm FTR Associates. “Every time you look up, something’s changing. Every time the Federal Reserve changes the program, it creates a feeling of instability.”

Negative sentiment becomes excessive and self-fulfilling, says Kenny Vieth, partner with and senior analyst for ACT Research Co. People don’t spend because they are afraid of losing their job, thereby increasing the chances that they will. “Fearing the fear is the situation we find ourselves in.”

Many observers see the bottom coming sometime in the middle of the year with low energy prices and government-led stimulus helping to ease the pain. And while there’s no consensus on when freight volumes will rebound, most agree that due to the capacity draining from the trucking industry, very good times lie ahead – eventually.

“The trick here is going to be to survive to get to the other side of the economic downturn,” observes John Larkin, managing director and transportation analyst for Stifel, Nicholaus & Co.

A lack of loads
It’s remarkable how long volume has been a worry. “Certainly this is the toughest freight environment since I have followed the industry,” Costello says. “Trucking has gone through what I would call ‘double dip.’ ” Freight volumes softened in 2006 and 2007, recovered somewhat in late 2007 and early 2008, “and then fell off a cliff.”

Changes in products and packaging – the rise in popularity of flat-panel televisions and concentrated laundry detergent, for example – are partly responsible for the current slump in tonnage. On top of that is volatility introduced by changes in shippers’ inventory management, Costello says. Instead of maintaining consistent inventories of materials, parts and so on as a cushion, companies are using information technology to manage those purchases on more of a just-in-time basis in response to changing sales demands or production needs.

But these structural changes don’t really explain the downturn, which is largely the result of a down business cycle. Even when Gross Domestic Product still looked reasonably healthy, the stronger growth had been in services – not the goods-producing economy trucking depends on, Costello says. Two of the most important sectors – housing and manufacturing – are seeing tough times.

In many ways, the housing market got us into this mess, and it may take the housing market to get us out. Costello believes that the economy won’t improve until the housing market hits bottom – probably midyear. “If we get to this summer and it hasn’t bottomed, that’s a red flag.”

But Larkin argues that housing woes are not uniform. There are the wildly overbuilt markets like California and South Florida, for example. “It could be 2013 before another new house is built in Florida.” But there also are many cities – such as Charlotte, Atlanta and Louisville – where you would best describe the housing market as soft, not dead.

And even where new construction has disappeared, lower mortgage rates have resulted in some sales of existing homes, Larkin says. Trucking companies may discount sales of existing homes – and certainly it’s not much help to flatbed carriers – but those transactions tend to result in activity that helps van carriers, such as flooring, paint, furniture, appliances and fixtures, Larkin says.

Housing aside, there’s plenty to worry about in manufacturing. In November, the PMI – the Institute of Supply Management’s composite index of manufacturing activity – dropped to its lowest level since May 1982. Perhaps even more worrisome is that the ISM index of new orders – a leading indicator of trucking activity – fell 4.3 percent to its lowest level since June 1980.

“The bad news is that the ISM index has been a great predictive indicator of truck demand,” says Donald Broughton, managing director and transportation equities analyst for Avondale Partners. “The good news is that the duration is very short.” The numbers don’t mean that much for truck tonnage six months or later from now, he says.

Until recently, exports had been a very bright spot, but a global economic slowdown and a stronger dollar relative to other key currencies hurt exports this fall. Even so, exports are stronger than a year ago and imports are weaker, Broughton says. In its semiannual forecast issued last month, ISM said purchasing managers in the manufacturing sector expect exports to be stronger, while imports will be weaker. Since exports involve both inbound and outbound trucking activity at plants, stronger exports would be welcome news.

Probably the two brightest prospects for better freight are higher disposable incomes due to dramatically lower gasoline prices and the huge economic stimulus package that President-elect Barack Obama could sign as early as his first day in office.

If gasoline prices were to stay about where they are now for all of 2009, that would amount to an increase of some $350 billion in disposable income over 2008, estimates ACT Research’s Vieth. That’s a huge economic stimulus that doesn’t get much attention, he says.

It’s not clear, however, that this gasoline-induced “windfall” translates directly into substantially higher spending. It could be that consumers are substituting newly freed-up cash for debt. In fact, the Federal Reserve found for the first time ever that consumer debt actually declined in November. Regardless, it’s fair to say that increased cash flow from lower gasoline prices is at least softening the decline in consumer spending.

As for government-sponsored economic stimulus, the hundreds of billions spent on stabilizing financial markets and bolstering the economy to date seem to have had only limited effects, but again, nobody knows whether things would have been worse without such infusions.

“We can all argue whether they are doing the right thing,” Costello says. “But one of the important things is that our government is moving. Japan didn’t act, and they were in a funk for a decade.”

While pessimism reigns, some analysts are gloomier than others. “We see that the economy will be in a recession into at least mid-2010,” says FTR Associates’ Starks. He believes most analysts overestimate the amount of capacity that’s truly sidelined and sees a continued drop in utilization through at least the first half of 2009. And because there are plenty of trucks to be returned to service when freight begins to improve, it could be the middle of 2010 before freight rates begin rising, Starks says.

Avondale’s Broughton finds the hysteria over the state of the economy oddly reassuring. “When things are so good that they can’t get any better, they tend to get worse,” Broughton says. “When things are so bad that they can’t get any worse, they tend to get better. Not only are conditions bad, but expectations are even worse.”

Floating on fuel
While freight demand stinks, fleet owners are getting some relief on the expense side of the ledger. Most significant, of course, is the dramatic collapse in diesel prices since the middle of July after a similarly huge surge in prices during the first half of 2008. By the end of December, the national average retail price was about half the record $4.76 the Energy Information Administration reported in mid-July.

Perhaps more important than the profitability boost, though, plummeting diesel prices help with cash flow as surcharges coming in from loads hauled 30 or 45 days earlier exceed current fuel costs. That is, of course, the reverse of the dynamic last winter and spring that no doubt played a major role in the surge of failures.

“Without a doubt, a steady drop in the price of fuel has produced a windfall in margins,” says Broughton. But at some point, diesel prices will stabilize or rise, and carriers will lose this offset to weak freight revenue. Shippers will have more motivation to pursue rate cuts.

The steady drop in fuel surcharges is taking some of the pressure on rates away, Broughton says. “Normally, weak demand and sufficient capacity would produce some pressure on rates, but that hasn’t really happened yet.” But if surcharges start to rise again, some shippers may start to look for offsets and take advantage of the current environment to lock in lower freight rates, he says.

Also, the longer and deeper the recession proves to be, the more likely shippers will forget what happens to rates when demand does appear, Broughton says. But Larkin thinks that large, sophisticated shippers know better. “They are astute enough to know that if they got aggressive on price, it would accelerate the capacity downturn.”

Even if the freefall in diesel prices ends, fuel prices should remain a positive for carriers. Well, sort of. Broughton points out that higher fuel prices would point to an increase in worldwide demand, which would be good for the economy and trucking. “If they understood all the factors, most carriers would pray for fuel prices to increase.”

Brad Simons, president of Simon Petroleum’s Pathway Network, says the petroleum markets are pointing to higher fuel prices in the second half of 2009, but not dramatically higher. Oil contracts are trading below $55 a barrel for the first half of 2009 and higher in the second half. Based on current pricing, the risk is still on the upside with winter ahead and the potential for at least some recovery in global demand, Simons says.

Readying a rebound
Costello believes that although 2009 overall will be a rough year, “much of the difficulty will be frontloaded in the first half of the year.” That’s not to say that the second half of 2009 will be all that great, of course. “GDP growth doesn’t automatically make truck volumes grow. GDP needs to grow by 2 to 3 percent before there are nice gains in trucking, and we don’t think it will top 2 percent growth until the second quarter.”

Vieth thinks things will stop getting worse in the second quarter and that the third quarter will be positive – barely. He projects a .4 percent increase in goods-producing GDP in the third quarter of 2009 and perhaps 2 percent by the fourth quarter.

With the anticipated loss of trucking capacity in the coming months, even a slight recovery could feel pretty good. After all, freight volume alone doesn’t indicate the health of the industry.

Costello sees tight credit as knocking out many trucking companies in the first quarter. Carriers don’t have many avenues for obtaining credit for working capital – not even their equipment. “Used asset prices in the industry have plummeted,” Costello says. “Trucks are worth less and trailers worth a lot less.”

Starks argues that if carriers become upside-down in their tractors during this downturn, it will be a bigger problem than it was in 2000 and 2001. Back then, many carriers had the security of guaranteed buyback clauses, so it was the truck manufacturers that bore the greatest brunt. Without those protections now, the risk shifts to fleet owners, he says.

The first quarter of 2009 is key, Broughton says. At the same time freight hits probably the worst period of the year, carriers face renewals on licensing, premiums and so on at a time when the credit markets still appear to be nearly frozen.

One of the keys to the strength and timing of a recovery is how many companies exit in the first quarter, says Broughton, whose numbers on business failures are regarded as authoritative. “The number could be horrific enough to make it easier for the survivors.” He cautions, however, that if tonnage doesn’t pick up by early summer, that will be very bad news. “If demand does not rebound, making it through the first quarter may not be enough.”

But the loss of capacity is more than just failures, Larkin contends. Larger carriers increasingly are getting out of the truckload segment and focusing on things like brokerage, intermodal and dedicated. That is creating more demand for a traditional truckload carrier.

The supply of drivers is another constraint on capacity that’s lurking in the shadows. “We may be seeing a recession, but the demographics didn’t change on us,” Costello says. Once the economy rebounds, the trucking industry once again will be competing fiercely for workers in an aging labor pool that will be three to five years closer to retirement than during the last tight driver market.

Says Costello, “Once we do get to that next level of growth – it looks like it will be 2010 – it’s going to be very good for our industry.”

Almost as universal is the conclusion that 2009 will be a painful year is the conviction that the survivors are poised to enjoy some unparalleled good times beginning sometime in 2010.

About 2009, Larkin concludes, “I would call it a transition year from the worst economy since at least 1981-1982 to what will ultimately be the best market truckers will have seen since deregulation.”