Refrigerated carriers need higher rates, analyst says

Acting on the premise that informed customers make better business decisions, Prime Inc holds annual meetings with representatives of its largest shippers in the form of a customer advisory board. The meeting allows Prime to provide company and industry information to its major shippers and to hear the concerns of shippers in a public, but informal setting.

Prime, based in Springfield, Missouri, is a large truckload carrier, providing primarily refrigerated service with a fleet of almost 3,000 tractors and more than 4,000 refrigerated trailers. The company also operates a small tank fleet and a fleet of flatbed trailers. In the Gross Revenue Report published every September by Refrigerated Transporter, Prime was the largest refrigerated carrier in the industry based on data from 2002.

Featured speaker at the Spring 2004 advisory board meeting was Thom S Albrecht, managing director of equity research at the investment-banking firm of BB&T Capital Markets in Richmond, Virginia. He is one of four analysts recently honored as top in their field by Forbes.com and StarMine. In addition, Albrecht has been honored by the Wall Street Journal as one of the Best on the Street among stock analysts for the sixth time. His area of expertise concentrates on truckload and LTL motor carriers. The advisory board meeting was held in Biloxi, Mississippi.

Working harder for lower profit

Among truckload carriers, refrigerated truckers report working harder and smarter to generate more revenue resulting in thinner profit margins, Albrecht said. Many carriers would like to return to their results in 1993 and 1994, two of the better years for financial results in the refrigerated freight sector. Analysts believe that refrigerated transportation represents an $8 billion market in a larger universe of $460 billion in sales by food manufacturers.

This is a huge market, both for food manufacturers and for motor carriers. However, this market has undergone substantial consolidation, Albrecht said. Not only have motor carriers been consolidating, but food manufacturers have consolidated as well. For instance, Kraft Foods acquired Nabisco in 2000. That same year, Unilever acquired Bestfoods and ConAgra bought International Home Products. In 2001, PepsiCo acquired Quaker Oats; General Mills bought Pillsbury; and Kellogg Company bought Keebler Foods Company. The result of all this activity is that not a lot of new customers are emerging for refrigerated carriers. This is in direct contrast to the environment for van carriers who always seem to find new customers in the form of a new apparel company, a new retailer, or the whole constellation of new electronics stores that have emerged in the recent past.

Motor carriers are not immune from consolidation either, Albrecht said. In the past few years, the original incarnation of Freymiller Trucking, Ameri-Truck, Aashce Transport, Alterman Transport, and the TLC division of Landstar have all gone through liquidation. Simon Transportation and Rocor International both went through Chapter 11 bankruptcy with Simon emerging at half its former size as Central Refrigerated and with selected assets of Rocor being purchased by Prime. In addition, KLLM Inc went through a leveraged buyout in 2000, and Frozen Food Express has struggled with its financial position, including violation of bank covenants a couple of times, he said.

One puzzling part of the turmoil among refrigerated carriers is that when it struck, five of the carriers involved were in or near the top 10 in the business, Albrecht said. “Shippers probably know about this problem at a subconscious level, but refrigerated carriers should probably make a formal announcement of it to their customers,” he said. “In contrast to the financial difficulty faced by refrigerated carriers, there has not been a single dry van carrier in the top 10 of that sector that has gone out of business in the past three years. In fact, only two dry van carriers on the top 25 list have failed, and that includes Builder's Transport, which failed a number of years ago.”

This consolidation has increased the buying power of the shipping community substantially, Albrecht said. At the same time, troubles within refrigerated trucking have contributed to the stronger position of their customers. “Every time a carrier goes out of business, its competitors may privately rejoice,” he said, “but the reality is that fewer competitors within the carrier community gives shippers even more buying power.”

Unloading improves

With all the bad news, it may be hard to see that some good things are beginning to percolate to the surface for refrigerated carriers, Albrecht said. For instance, the unloading situation at grocery warehouses is beginning to improve with a decrease in the necessity to hire lumpers. While the lumper situation still exists, it is nowhere as serious as it was just a few years ago. The lumper problem has improved and continues to head in the right direction, he said. The same thing goes for pallets; although, some unreasonable exchange programs and some uncooperative shippers still exist.

Turmoil among refrigerated carriers may be slowing, allowing carriers to catch up with the effects of consolidation among shippers, Albrecht said. For instance, many carriers complain about their narrow tractor-trailer ratio, sometimes as low as 1.3 or 1.4 trailer to each tractor. Although small, that ratio can actually help the larger carriers, because many small fleets can barely afford to operate one refrigerated trailer for every tractor in their fleets, he said. “As shippers get bigger, the carriers that have more trailers available will be more attractive to shippers,” Albrecht said. “The key is figuring out a way to get paid for maintaining a larger trailer fleet.”

Length of haul remains both a positive and negative factor for refrigerated carriers, Albrecht said. Longer hauls produce more revenue; however, they also inhibit a carrier's ability to develop shorter regional lanes. Environmental concerns are a factor behind longer hauls. Many of the production areas for food, especially fresh beef and pork, are required to be located well away from major population centers. Additionally, food shipments are growing slowly — just barely 1.5% to 2% a year. That is roughly the same as the population growth, he said. “The food transportation industry was a $7 billion market 10 years ago and is only an $8 billion market today,” Albrecht said.

Two factors combine as bad news for refrigerated carriers. The business does not offer many opportunities for drop-and-hook operations, he said. As a result, the pay scale and the working conditions at dry van carriers are often more attractive to drivers than pay and conditions at refrigerated carriers. Coupled with slow growth for food shipments, all these factors conspire to result in lower rates, inadequate profit margins, and unacceptable financial returns, he said.

The average rate per mile for refrigerated carriers has gone up from $1.14 in 2002 to $1.16 per mile in 2003 according to a study by the American Trucking Associations. Seeing the increase is good, but that 2003 rate still is basically what carriers were generating 10 years ago, Albrecht said. At the same time, the operating ratio for the average refrigerated carrier is awful, with a lot of carriers posting ratios near 99 in 2002, the most recent year for which hard data is available. An average operating ratio for refrigerated carriers for the years 1998 through 2002 would be 96.7 — that time span includes two years when conditions for trucking were especially good. Margins like that do not give carriers enough income to reinvest in their fleets, he said.

Albrecht's analysis of motor carrier costs is based on dry van carriers, because the only two public refrigerated carriers, Frozen Food Express and Marten Transport, may not be truly representative of the industry. Based on pretax data, the cost per mile for an aggregate of 12 large publicly owned dry van carriers was $1.09 in 1999, rising to $1.23 per mile in 2003. That represents a cost increase of 3.1% per year, up from an increase of 1% per year from 1996 to 1999.

Knight costs increase slowly

In contrast to the rapidly rising costs for most carriers, Knight Transportation shows a cost per mile of $1.04 in 1999 that increased to $1.11 per mile in 2003 for an annual increase of less than 2%. For those same years, pretax margin at Knight was 16.9% in 1999 and has risen to 18% for 2003. In addition, Knight has made large strides in productivity. For instance, the number of drivers compared to the number of support personnel has increased from 4.2 drivers per non-driver worker in 1999 to 5.6 drivers per support worker today, Albrecht said. Not much more progress is possible for that benchmark; they might be able to reach nirvana with something near six drivers for every non-driver worker, he said.

Other carriers have not performed nearly as well as Knight. For instance, costs at Werner Enterprises rose from $1.12 per mile in 1999 to $1.33 per mile in 2003, an increase of 4.4% a year. “I don't know anyone who is willing to say that Werner is bloated with cost,” Albrecht said. “From 1999 to 2003, Werner's bottom line has decreased from 9.2% to 8.1%.”

Swift, despite its many problems, still deserves to remain in the top tier of truckload carriers, Albrecht said. In the past four years, costs have increased 3.4% a year from $1.13 per mile in 1999 to $1.29 per mile in 2003. During that same period, profit margins have dropped from 10.1% in 1999 to 5.3% in 2003.

Rising insurance deductibles

Moving from examples drawn from specific carriers, Albrecht took a look at some of the factors behind rising costs, such as rising prices for insurance. One of the indicators of rising insurance costs is the deductible carriers face in the form of self-insurance retention. In 1999, carriers were retaining $443,000 for self-insurance per incident. By 2004, that retention per incident has grown to $2.7 million. Insurance retention for worker compensation and for cargo claims are higher as well with retention for worker compensation rising from $275,000 per incident in 1999 to $800,000 per incident in 2004. Cargo claim retention is higher also, up from $61,000 per incident in 1999 to $285,000 per incident in 2004, he said.

Fuel prices were already high when the customer advisory board met, and, although they have dropped some recently, continued to rise in general. Albrecht noted that a poll of a dozen shippers probably would result in reports of a dozen different surcharge rates. The reason for this, he said, is that fuel surcharges are based on national averages. However, surcharges do not provide a good method for holding refrigerated carrier costs at bay. Refrigerated carriers tend to operate in western states more than general truckload carriers with the result that fuel costs are higher. It is not the longer distances that drive up fuel costs, but regional fuel marketing differences. In general, fuel prices in the 11 western states are 11% higher than the national average. Recently fuel costs 40 cents per gallon more in California than the national average, he said.

Albrecht cautioned the advisory board not to hope for better conditions in the future. Even if fuel prices stabilize, fuel costs will continue to be a problem, because the new engines mandated by EPA in October 2002 use 8% to 11% more fuel than the engines they replace. The 3% to 5% decrease in fuel economy predicted by engine manufacturers must be for applications other than truckload carriage, because several large van carriers have provided hard data that indicates mileage degradation in the 8% to 11% range, he said. In addition, carriers probably will experience a drop in fleet utilization somewhere between 2% and 5% as a result of the new hours of service regulations.

Interest goes up in 2005

Politicians probably will work to contain interest rates through the election in November, but carriers should prepare to pay higher interest in 2005, Albrecht said. Costs for drivers and equipment will go up as well. Carriers should anticipate driver pay rising 3% to 5% in 2005; some increases may be in the 8% range. Equipment prices already have started rising. As steel and aluminum prices go up, tractors and trailers will cost more.

Some of the bad news in the total transportation industry may be good news for refrigerated carriers. For instance, 2001 and 2002 stand out as two of the three weakest years for trailers sales in recent history, Albrecht said. Trailer manufacturers may not like it, but low trailer sales are an indicator that carrier capacity is heading in the right direction, he said. Sales are up slightly in 2003, but the year will still be considered weak by the manufacturers. “The backlog of orders for new trailers is barely half what it was in the years of peak trailer production, which may bode well for refrigerated carriers as they seek to match their capacity to the demand for freight services,” Albrecht said. “Total refrigerated fleet capacity appears to be down at least 1.7% since 2001.”

A curious part of the market is that shippers have been raising prices for their products while refrigerated carriers have not been raising freight rates. Since 1994, food costs have risen 25% while freight rates for refrigerated goods have remained flat, Albrecht said. During the same 10 years, dry van rates have gone up 8.5%. In the past two years, dry van rates have risen 5% while rates for refrigerated carriers are lagging substantially.

Slow capital spending

Albrecht does not anticipate that motor carriers will spend the next several years in a rash of capital spending. The best estimate says that capital spending will be about 10% of motor carrier revenue. Most of these purchases will be for equipment replacement, he said. Shippers should not expect carriers to build capacity with the consequent reduction in freight rates, he said.

For the general economy, history suggests that the next two years hold the potential for substantial growth. This is based on an analysis of the past 14 election years going back to the Truman election of 1948. In only three of those 14 election years have the gross domestic product grown by less than 3%, Albrecht said. Presidents have an incentive to boost the economy going into election years. Only Jimmy Carter in 1980 stands as an exception to this principle, he said.

Tax cuts will help push the economy forward. Starting with the Kennedy tax cut, which Lyndon Johnson pushed through, the economy averaged 6.5% growth from 1964 to 1966, Albrecht said. Ronald Regan pushed a tax cut through Congress in 1983 and the GDP grew more than 7% in 1984. With the Bush tax cuts spread across several years, it is impossible to predict growth as high as in the past, but the economy still will grow in response to the tax cut, he said.

The election can be expected to have an impact on the stock market as well, Albrecht said. He used data from midyear and presidential elections going all the way back to 1918 and projected results through the 2004 election cycle. For all years, including the Great Depression, the stock market has gained an aggregate of 57% in election years. Discounting the down years of the 1930, the market has increased 62%, he said. “The market does not rise simply to repeat history, but it does go up in anticipation of the incentives the political process builds into the economy in election years,” he said. “Using data from past election years to project 2004, we could see a Dow Jones average approaching 11,600. I don't know how long the increase will last, but I feel fairly confident in the market for the next 12 months.”