For about three years now, analysts have been predicting that the business climate for trucking would be at least a little better a year later. And for about three years, they generally have been wrong. Freight volume remains soft. Pricing stinks. And there is still too much capacity.
Once again, the consensus seems to be that the situation a year from now will be better than it is today, although some analysts are only reluctantly optimistic. There is reason to be wary. A recovery in trucking depends on the balance between supply and demand, and we still have too many trucks chasing too little freight. Both elements – truck capacity and freight demand – seem to be moving gradually in the right direction, but it just isn’t clear how long the road to recovery will be.
“While certainly we’re not where we were a year ago, there’s nothing on the horizon to get excited about,” says Bob Costello, chief economist for the American Trucking Associations. Costello believes that 2010 will be the best year in a couple of years, but those were two very bad years. “I think that the end of the year will be somewhat better than the beginning of the year.”
“It’s going to be an interesting year,” says Eric Starks, president of transportation research firm FTR Associates. “In general, it will be a year of recovery. We will still have a few stops and starts, and it’s clear we won’t see a huge amount of growth.”
Others are even less confident regarding what 2010 holds for the trucking industry one way or the other. “There are a lot of question marks rather than answers for 2010,” says John Larkin, managing director and transportation analyst for investment banking firm Stifel, Nicholaus & Co. Will there be a recovery in 2010? “I don’t think it’s a slam dunk.”
Strengthening demand
Larkin is not optimistic about a near-term rebound primarily because of consumer spending. “Two-thirds of our economy is the consumer,” Larkin notes. “Until 12 to 18 months ago, the consumer was spending everything he had and then some. Consumers assumed that appreciation of their stock portfolios and home values would cover retirement, and now they realize that they can’t count on that.”
Larkin paints an ugly picture. People are saving more. The unemployment rate – if you take into account the people who are underemployed or have stopped looking – has hit about 17 percent. Those with jobs are afraid of losing them. And many companies have asked employees to take a pay cut, unpaid vacations or days off. On top of all of this, businesses are wary of making investments due to fears about the consumer, as well as developments in Washington.
“We have hit a stable depressed level,” Larkin says. “There’s a certain amount of freight that moves around the country just to support life. What makes the trucking industry healthy is all of the durable stuff.”
Although businesses have been watching inventories, dismal sales sent the inventory-to-sales ratio soaring at the end of 2008. Although the ratio dropped to more modest levels in 2009, the glut of inventory relative to sales was one reason that the trucking industry did not lead the economic recovery, says Bob Costello, chief economist for the American Trucking Associations.
There are some factors pointing toward improvement in the economy and freight demand, however. The coming year should see modest growth in freight volumes, predicts Donald Broughton, managing director and senior research analyst for investment banking firm Avondale Partners. He cites several factors pushing higher volumes, including:
• A weaker dollar that will mean more domestic manufacturing and exports;
• A greater willingness of banks to lend, but continued low interest rates; and
• Tight inventories that will mean more production and transportation once there is any increase in demand.
And there is another factor, Broughton says. “Improvements from where we have come are relatively easy.” In other words, there’s nowhere to go but up. All of that translates into at least a modest increase in truck tonnage by the end of 2010, Broughton says.
But again, the base for that growth is very low, notes Costello, who points to Gross National Product, which grew a scant 0.4 percent in 2008 and was projected to have declined 2.4 percent in 2009. That compares to historical average growth of just less than 3 percent, says Costello, who expects that GDP will grow in the range of 2 to 2.4 percent in 2010. Likewise, industrial production fell in 2008 and 2009 and is projected to grow 3.5 percent in 2010. “We’re not making up the contractions from the year before.”
There certainly has been some good news on the economy. For example, the Bureau of Labor Statistics reported that the U.S. economy lost only 11,000 jobs in November – a far cry from the hundreds of thousands per month reported earlier in the year. “While the latest unemployment reading is very surprising, I’m not hopeful that would stick,” Costello says.
Even if things are turning around, it will take time, Costello points out. The United States has lost more than 7 million jobs nationwide during the recession. Wages are down, and so are home values. And households are paying down debt. “That’s a positive factor in the long run, but not in the short run,” Costello says. “Household spending will remain muted in the near term.” Industrial production also has improved from its lows, but manufacturing output is at levels not seen since 2002, he says.
After about two years of contraction or no growth, the manufacturing sector began growing again in August 2009, according to the Institute of Supply Management's closely watched PMI. In this chart, any reading above 50 represents expansion.
Another obstacle to a rebound in demand has been inventories, Costello says. “The main reason trucking didn’t lead was the unprecedented increase in inventories relative to sales.” While inventories have come down, they remain soft, he says.
Starks sees some other mild positives in the housing and automotive segments – mainly because those markets have been so bad in the recent past. “With regard to housing, we are at the bottom,” he says. “We won’t get to peak levels anytime soon, but there could be some modest growth.” The same is true for automobile manufacturers, Starks says. “The bleeding of the automotive market has stopped for the time being.”
But Starks agrees with other analysts that the consumer is unlikely to pull the economy through the recession. “The business sector will have to jump back in and start doing some investment.”
Shrinking supply
With truck capacity far greater than freight demand, pricing has been challenging for 2009, Larkin says. Soft pricing has taken various forms, from dramatically lower rates to revised fuel surcharge programs to payment terms of 60 to 90 days instead of 30 days, he says. “There doesn’t appear to be any catalyst short of a huge capacity reduction to change prices in the first half of 2010.”
Certainly on the surface, it would seem as if capacity should be fairly tight already. Payroll employment in trucking is down more than 200,000 from its peak in January 2007. During that same timeframe, about 6,350 trucking companies with five or more power units have exited the market, according to Avondale Partners.
Considering the poor freight volume and pricing that trucking companies face, failures remain surprisingly low, according to data compiled by investment banking firm Avondale Partners. Donald Broughton, managing director and senior research analyst for Avondale, believes failures will soar due to a cash crunch in the first quarter and an end of lender tolerance for delinquent payments on equipment.
The rate of trucking failures has slowed substantially since the third quarter of 2008, however. It was during the first three quarters of that year that diesel prices soared to unprecedented levels, causing many weak carriers to run out of cash as surcharge reimbursements lagged escalating fuel payments by 30 to 60 days or more. The reverse phenomenon benefitted carriers in late 2008 and early 2009.
Analysts generally agree that the dynamic keeping many carriers in business today is the unwillingness of lenders to take back greatly undervalued equipment. Broughton sees that dynamic changing now.
“In the first quarter, a lot of zombie truckers will finally give up the ghost,” he says. For starters, truck owners will face the usual annual renewals of insurance, licensing and registration. And with the door closing on the ability to buy 2007 emissions engines, used truck prices will start to firm up, making it more likely that lenders will start to foreclose on carriers that haven’t been paying their notes.
Lenders will have another reason to start getting tough, Broughton argues. They are facing annual audits where they will have to defend their decisions on bad loans. If they have written four 90-day forbearances, for example, they will have to explain why they are choosing to identify the loan as performing, he says.
Larkin sees the actions of lenders as absolutely key. “Short of a lot of capacity exiting, there will be a gradual volume recovery and no recovery at all in pricing,” he says. “And that won’t happen until financiers pull the plug on troubled companies.”Starks sees the situation in much the same way. “We expect to see a surge in bankruptcies once there’s a firming of asset values.” And there’s another reason this may happen, he argues. Given the low retail sales volume for new trucks since 2007, later-model used equipment soon could be in demand, and even older equipment might be in more demand than people might think. “It’s getting older from an age standpoint, but it’s not getting a lot of wear and tear on it,” Starks says. “We have seen trucks age this much before. You are not aging it on a work-life basis.”
In addition to promoting domestic manufacturing and greater freight demand, a weak dollar could help with truck supply, Larkin argues. “It could mean higher demand for used trucks in Eastern Europe and Asia, thereby giving lenders a reason to shut down fleet owners who are not paying their notes.”
And not only will an uptick in freight demand signal lenders to get tough, it will put other pressures on weak carriers, Broughton argues. Carriers will need more working capital, and lenders won’t be too eager to provide it to struggling trucking companies, he says.
“When you park a truck, it’s a positive cash flow event,” Broughton says. “You continue to collect on receivables for four to six weeks without the operating costs.” Putting that truck back in service means carrying the driver, fuel and other costs for the same period without revenue. In addition, weak carriers presumably have deferred maintenance that must be addressed if they need to press trucks back into service. Given all of these factors, Broughton predicts large reductions in capacity in the first and second quarters.
Another potential ally in capacity reduction could be the federal government, argues Larkin, who lists a number of developments that potentially could shrink the driver pool in the coming years – changes to hours of service, mandatory onboard recorders, tighter rules on driver health, and the Federal Motor Carrier Safety Administration’s upcoming Comprehensive Safety Analysis 2010 program. “These efforts could actually bring around a tightening of supply and demand earlier than would otherwise be the case,” he says.
Some analysts aren’t so worried about the need for dramatic reductions in capacity, however. “I think some people have underestimated how much capacity has been taken out during this cycle,” Costello says. That means that freight demand doesn’t necessarily have to match the peak levels before the recession for carriers to realize the pricing and profitability they saw during those good times.
That might just be the best news trucking companies will hear for quite some time.
