Reefer carriers can expect rising rates, good results
While not reciting outright the “winter of our discontent” speech that opens Richard III, Thomas Albrecht, managing director of the investment banking house, Stephens Inc, used a general session of the annual meeting of the Refrigerated Division of the Truckload Carriers Association to describe a trucking economy with bright sun breaking through a previously overcast outlook. He forecast generally positive results for truckload carriers through 2010.
Some of this results in decidedly contradictory observations such as anecdotal evidence from carriers of extremely strong freight demand through the end of 2005 at a time when gross domestic product grew only 1.7%, Albrecht said. The whole scenario flopped in the first quarter 2006 when GDP growth was 5.4% and most truckers were moaning about slow business. The Refrigerated Division meeting was held on July 12 to 14, 2006, in Coeur d'Alene, Idaho.
Finding drivers remains a problem, Albrecht said. Some carriers report lower turnover rates at the same time that unseated trucks become more numerous. This indicates that retention is getting better while finding new drivers is becoming more difficult. The real problem with the driver supply is that all the levers used to generate new drivers have been pulled, he said.
Shrinking demographic pool
Finding new drivers will remain difficult, if not almost impossible, because the demographics are working against trucking, Albrecht said. From 2004 to 2007, the population in the age bracket from 20 to 44 is actually shrinking. Even when demographic growth resumes, probably in 2010, it will be only a fraction of the number actually needed. Assume that GDP growth in 2010 will be 10%. At the same time, growth in the 20-to-44 age group may be as low as 0.3%, only one-tenth of GDP.
Carriers could alter the situation slightly, perhaps lowering the standards for entry level drivers. However, that situation carries too much risk, particularly with regard to insurance costs, Albrecht said. One other tactic might be changing the average length of haul, but that depends a great deal on what shippers are willing to do.
The number of drivers available seems highly dependent on the economy, and the worse the economy becomes, the easier it becomes to find them. During the recently past trucking downturn, drivers became easier to recruit, Albrecht said. As fleets went out of business, orphaned drivers looked for new carrier homes. However, as the economy has recovered, beginning in mid-2003, finding drivers has become difficult again. As other job alternatives have become readily available, the driver supply got even tighter through the first quarter 2006, he said.
More minority drivers
Some analysts promote the idea of ending the driver shortage by hiring more women. It may sound good, but it apparently isn't working, because the percentage of women drivers in the truckload industry has been stuck between 4.5% and 5.5% since 1991, Albrecht said. In fact, the only success story about finding new drivers has been the increase of minorities in trucking, which has grown from 22% of drivers up to 31%, totaling about one million drivers. In contrast, the total number of women drivers is about 150,000, he said.
One of the levers remaining to be pulled is increased productivity, Albrecht said. However, nearly all the laws and regulations work against increasing capacity through enhanced productivity. For instance, the average miles per tractor per week peaked at 2,386 in 1997. By the end of 2005, tractors were averaging only 2,159 miles per week, a significant decline in productivity.
While layoffs in other business segments make drivers easier to find, fleets should not expect a soft economy to solve the driver shortage, Albrecht said. The numbers of drivers required compared to jobs lost in other occupations are just too large. The national fleet contains 10.5 million commercial vehicles in Class 3 through Class 8. In that fleet, 3.3 million are in Class 8, including about 300,000 baby 8 distribution vehicles. In the whole economy, Class 8 trucking represents 2.5% of total jobs in the US.
“Let's look at a hypothetical example,” Albrecht said. “Assume that 250,000 workers are laid off and looking for work. If the percentages hold, 2.5% of those workers, 6,250, might want to become truck drivers, not really enough to make any difference at all. Take that assumption much farther and decide that many of those 250,000 are desperate for work. If 40% of those unemployed workers looked to trucking for a job, that 100,000 drivers would represent only 1% of the total number of commercial vehicles in use. If 100,000 new drivers were available, how many of them would be willing to enter the truckload segment with its long hours and extended periods away from home?”
The point behind this example is to show that big layoffs can ease the driver shortage for three to six months in selected markets, Albrecht said. However, moving drivers from other industries to trucking does not represent a wholesale solution to the driver shortage.
Most evidence suggests that mixed fleets of company drivers and owner-operators don't seem to work too well, Albrecht said. The best environment for owner-operators is in fleets made up primarily of independent contractors. Fleets that handle 80% to 90% of their capacity with company trucks typically don't pay owner-operators very well, he said. Those fleets usually pay between 90 cents to $1 a mile with a possibility of 35 cents per mile for fuel surcharges plus five cents per mile for installing mobile communication equipment and to pay tolls. The entire package could total $1.30 per mile. Compare that to an average cost per mile of $1.50 for a company fleet.
Granted, an owner-operator doesn't have to support a large corporate overhead, Albrecht said. The downside is that an owner-operator doesn't have the same buying power of a large fleet.
Owner-operators fall into two categories, Albrecht said. Contractors leased to other carriers total about 116,000, while true independent operators may total only 58,000. In recent years, the number of single-truck owner-operators not leased to a larger carrier has been shrinking. The number of lease contractors has grown slightly. Since 2003, the number of operators leased to carriers has increased only 13,000 in a robust economy, which indicates that those operators do not stay in business long, he said.
Low cost environment gone
Several factors contribute to the difficulties carriers face, Albrecht said. The first is that the low cost environment that allowed many carriers to grow no longer exists. Many carriers could count on operating costs of about $1 per mile beginning in 1991. By 1999, costs had risen to $1.04 to $1.08, essentially an increase of less than 1% per year. Since fuel began its seven-year run of price increases, operating costs have gone up about 5% per year on average. However, averages can be misleading, because for the past few years, operating cost increases have been in double digits, he said.
If trucking capacity seems tight, it is because capacity really is tight, Albrecht said. Carriers will not add a lot of new trucks in the face of rising cost pressures.
Two vendors contributed to a change in the cost environment, Albrecht said. Those zany actors were Freightliner and Wabash National. The leaders of those two companies, Jim Hebe and Jerry Ehrlich, contributed significantly to the growth of trucking capacity in the 1990s. Both companies acted irrationally, he said. Wabash National increased its market share from 7% to 24%. “That doesn't happen in a mature industry without making some extremely aggressive deals,” Albrecht said. “They effectively were force-feeding capacity into the market. Freightliner followed the same pattern, increasing market share from 19% in 1990 to 32% in 1999. One good indication that Wabash was operating in unknown territory can be seen in the stockholders' equity that dropped from $400 million to $20 million.”
Freightliner lost $1.5 billion in 2001 and 2002. Since Wabash hit bottom, it has managed to rebuild stockholder equity to some extent, Albrecht said. The key evidence here is that the zany deals of the late 1990s no longer happen. While those deals caused considerable upheaval, the result has been good for the surviving carriers.
Profit margins remain thin
Despite three good years — 2003 through 2005 — profit margins at truckload carriers are not as good as they should be, Albrecht said. For instance, a big gap continues between the operating ratios for privately owned carriers compared to public stock companies. The public carriers have operating ratios around 91, while the private companies report operating ratios of 95 or higher. If the trucking economy feels squishy, it may be that some of the private fleets are uncomfortable and are not pursuing rate increases as aggressively as they did for the past two years, he said.
Carriers need not fear excess capacity, Albrecht said. Employment data for carriers shows that trucking is not hiring large numbers of workers in a strong capacity. That primarily relates to the difficulty of finding new drivers. Even if a period of excess capacity materializes, it should last no more than six to nine months, because the employment figures for trucking simply won't support it, he said.
Purchases of diesel fuel also support a conclusion that capacity will remain tight, Albrecht said. For the past 16 months, diesel purchasing has grown only 2.6% a month compared to the same month of the previous year. Some of that increased purchasing — possibly as much as half — results from decreased fuel economy for the engines mandated by the 2002 exhaust emission regulations. The other half may be increased trucking capacity, but none of this indicates any potential for runaway capacity growth, he said.
The challenging nature of the trucking economy can be illustrated by truck repossessions. Note that repossessions are not the same thing as bankruptcies, Albrecht said. For 10 quarters prior to the first quarter 2005, truck repossessions actually dropped compared to the same quarter of the previous year. The third quarter 2005 with high fuel prices and the impact of Hurricanes Katrina and Rita reversed that trend with repossessions for the quarter running 188% above the rate for the third quarter 2004.
Shippers worry about capacity
Shippers are concerned about having access to sufficient capacity to meet their needs. Albrecht said that capacity flows to the points of heaviest demand. For the first half of 2006, refrigerated loads increased 3.8% after growing 2.3% for all of 2005, he said.
The refrigerated market, based on the number of trailers produced, appears fairly strong with 35,929 trailers built in 2005. The national fleet of refrigerated trailers totaled 314,771 at the end of 2005, a 4.1% increase from the previous year, Albrecht said. Although refrigerated trailers have been manufactured at a relatively rapid rate, the average age of the fleet is not dropping like it has in previous periods of limited capacity. One reason for this is that carriers are increasing the number of trailers in their fleets relative to the number of tractors to allow for easier compliance with the new hours of service regulations. For many fleets, the trailer-to-tractor ratio has risen from 1.3 trailers per tractor to as high as 1.5 to 1.6 trailers for each tractor, he said.
In the fleets that are increasing trailer numbers, most of the increase is coming from keeping existing trailers longer rather than expanding with new trailers, Albrecht said. Apparently, the average age of refrigerated trailers in the national truckload fleet is 5.48 years. Historically, about 8% of the fleet is scrapped annually; the precise number is 7.8% for 2005 with the same number likely to be taken of service in 2006. That figure should be a little higher in 2007 as the economy slows slightly, he said.
Good conditions through 2010
Refrigerated carriers have been operating in a positive environment for the past several years and will continue to experience good results through at least 2010; although, part of 2006 and the first quarter 2007 may present some special challenges, Albrecht said. Those challenges will appear as the maximum number of new trucks bought ahead of the 2007 engine regulations is delivered. The first quarter 2007 will be soft, because first quarters historically are soft, and because truck deliveries will slow as fleets put off buying for at least a while. Fleets may want to hunker down a little for the first quarter 2007, he said.
Stephens Inc estimates that trucking demand will grow 4% to 5% for all of 2006 and that trucking capacity will grow about 6%, Albrecht said. Capacity will actually outstrip demand by 1% to 2%. For contrast, capacity dropped 3% in 2004 and stayed the same in 2005. Once the results of the pre-buying rush to avoid the first deliveries of 2007 engines are swept aside, capacity will begin to dwindle again. Capacity will probably be 2% to 5% below demand for 2007, he said.
From September 2000 to February 2004, trucking interests spent 42 months without making adequate investments in the national fleet, Albrecht said. Truck manufacturers say the industry needs to buy 18,000 to 20,000 trucks a month just to replace aging equipment. Based on purchases for the 42 down months, the industry bought 220,000 fewer trucks than it should have. From February 2004 to the end of 2006, truck sales should total more than 900,000 units, which looks like a lot of extra vehicles. However, when the deficit of 220,000 trucks is factored into the equation, the excess sales above historical norms is only 32,000 units. In the national fleet, 1.585 million trucks are eight years old or less, he said.
The rate environment for dry vans and for refrigerated carriers has the potential to be special, Albrecht said. Through the 1990s, except for 1994, van rates were essentially flat. After the massive reduction in capacity at the end of the 1990s, rates started up, rising 2.6% in 2003, 7.2% in 2004, and 6.2% in 2005. This is an unprecedented increase in rates since the beginning of deregulation in 1980. “We think rates will go up 4% to 6% through 2006,” he said.
Rates for refrigerated carriers have not gone up as fast, rising only 1.3% in 2003, 4.8% in 2004, and 6.2% in 2005, Albrecht said. “My sense is that reefer rates started 2006 with better momentum than van rates but by the second quarter had begun to under-perform dry van rates,” he said. “The outlook for the entire year 2006 should be an increase of 4% to 5%. Our conversations with shippers indicate that they are willing to pay at least that much. For instance, Target is concerned about capacity and is prepared to pay 6% to 8% higher rates to ensure service.”
The new tractor market will remain a roller-coaster for the next three years with the result that new tractors will be 10% to 13% more expensive in 2007 and 2008, Albrecht said. Carriers bought tractors early in 2002 to avoid the new engine regulations that became effective in October 2002, and they are buying again to get ahead of the 2007 emissions standards. The early purchase of trucks prior to January 2007 has been relatively kind to operators that like to buy used trucks, because it has allowed those fleets to buy engines from the 2001 and early 2002 model year, he said.
The next big purchase cycle will change that dynamic. When carriers purchase early to fend off the 2010 emission rules, they will be selling trucks from the 2004 and 2005 model years, Albrecht said. That will be the first exposure to the late 2002 engines for those fleets that buy used trucks. The used truck buyer is in for two shocks. The trucks will cost more, because the post-October 2002 engines cost more; and the more expensive engines will not produce the fuel economy of the earlier engines. That additional financial pressure may push the industry into another round of consolidation, he said.
Sellers of used trucks may see residual value dropping some through the end of 2006, Albrecht said. While used trucks are still a good value, the driver shortage is affecting the ability of some fleets to sell their used equipment. The ability to sell used equipment has become more difficulty. “In the past, fleets having trouble selling used trucks or trailers could count on Jim Hebe or Jerry Ehrlich to come along with a sweet deal and bail them out of their bind,” he said. “That no longer happens.”