Shipment volumes, revenues will continue to grow, but at a slower pace
Profitability in the for-hire trucking industry improved during the fourth quarter of 1997, providing earnings momentum as we headed into '98. Revenues increased 9.1% over the same period in '96, while expenses grew by only 6.6%. As a result, operating income in the fourth quarter of last year increased by nearly 101% over year-ago levels.
Revenue gains can be attributed to a combination of strong shipment growth and a moderate increase in freight rates. Industrial production, which is a measure of shipment activity, was nearly 6% higher in the fourth quarter of '97 as compared to the same quarter a year earlier. Freight rates were roughly 2% higher.
Freight revenue associated with contract carriage increased by nearly 13%, while that associated with common carriage increased by 8%. This differential can be explained by the fact that in an effort to squeeze costs out of their supply chain, shippers are forming closer relationships with carriers. Contract carriage provides shippers with dedicated capacity, while also allowing shippers to tailor services to their logistics systems.
The slowdown in the growth rate of operating costs during the last quarter of '97 can be attributed to the decline in the price of diesel fuel, which was 14 cents/gal. lower than the same period in '96. This is particularly significant in light of the increase in driver wages that occurred during this time. We can thank a tight labor market and expanding truck capacity, which requires a bigger work force, for this trend. Since driver compensation (wages plus fringe benefits), including the cost of owner-operators, made up nearly 55% of total carrier operating expenses in '96, we can see what a serious impact it has on fleet operating expenses. Fortunately, lower fuel costs helped offset higher driver wages.
The less-than-truckload (LTL) industry reported a sharp turnaround in financial performance during the fourth quarter of '97, as compared to the same period a year earlier. The 27 LTL carriers reporting results to the DOT recorded profits (after taxes and interest) of nearly $108 million, up from a loss of $8.7 million a year earlier. Gross profit margins for this sector increased to 4.35% from 1.71%.
How do we explain this? For starters, LTL carriers, and national carriers in particular, have been reconfiguring their distribution networks to help lower operating costs and increase service levels. The original hub-and-spoke networks used by LTL carriers gives them higher fixed costs than truckload (TL) carriers. Consequently, any changes to this system that lower fixed costs per shipment can have a tremendous impact on profits when volume goes up.
An increase in freight rates has also contributed to the financial turnaround of the LTL industry. According to the Bureau of Labor Statistics, LTL freight rates in the fourth quarter of '97 were roughly 5.7% higher than for the same period in '96.
As for the general-freight truckload segment, higher shipment volumes get the bulwark of the credit for the revenue increase, which climbed 9.8% in the fourth quarter of '97 from year-ago levels. In contrast, TL freight rates were up only 0.7% over year-ago levels, according to the Bureau of Labor Statistics.
A large increase in TL operating expenses, however, prevented the growth in revenues from having the kind of impact on profit margins that we saw in the LTL segment. TL operating costs increased by 8.7% in the fourth quarter of '97 over the same period in '96.
Why the change in operating costs? For the TL segment, changes in shipment volumes mean changes in variable costs. An increase in shipment volumes led to the higher wages needed to attract more drivers. Since variable costs represent such a large share of the operating expenses of TL carriers, an increase in this area has a greater impact on profit margins than it does in the LTL segment. Consequently, gross profit margins for the general-freight TL sector increased to only 5.49% in the fourth quarter of '97 from 4.56% a year earlier.
Specialized carriers reported a large improvement in financial performance during the fourth quarter of '97 over the same period in '96. Operating income increased to $54.6 million from $23 million a year ago, an increase of nearly 139%. In addition, fourth-quarter '97 revenues increased by 7.2%, while expenses grew by 4.5%.
Strong revenue growth, coupled with a moderate increase in expenses, indicates higher equipment utilization as measured by share of empty miles traveled. Since a large portion of specialized carriers' operating costs are variable, fleets in this segment can absorb higher volumes by decreasing empty miles traveled. This helps control the growth rate of operating expenses.
What are the chances of sustaining the growth rate in profits that we saw last year? Shipment volumes will continue to expand this year, but at a slower rate than last year. Since we expect a gradual slowdown in the economy, traffic growth should be stronger during the first half of the year than the second half, leading to a slower growth rate in revenues.
An increase in freight rates will partially offset slower revenue growth related to shipment volumes, some of which will be used to cover higher driver wages. The risk to the outlook is that carriers may expand capacity at a faster rate than shipment volumes, causing a decline in capacity utilization. This, in turn, could dampen profit growth. The large backlog of unfilled orders at truck OEMs suggests that fleets are likely to expand capacity at a faster rate than shipment volumes this year, assuming traffic growth slows as predicted.
ATA Trucking Information Services publishes a variety of reports on the financial and operating status of the motor carrier industry. For more information on available data and services, contact ATA at 703-838-1978.
[Editor's Note: For more information, see charts on page 21 and 22 of FLEET OWNER's May 1998 issue.]