Logistics as Percent of US GDP could Soar, John Larkin Says; Driver Shortage, Changing Carrier Strategies, New Regulations and More Could Hit Shippers over next 2-3 Years
As usual, the transportation sector analysts from Stifel, Nicolaus & Company did a great job refreshing the understanding of their clients and many others on the state of transportation during last week’s annual “Shaking the Sand Out of the Sneakers” teleconference detailing key logistics themes and trends.
The material from Stifel Nicolaus, as with other Wall Street analysts in the space, is really meant in the end to be of value to individuals, investment funds, and others interested in making investments in the sector, but nevertheless always contains insights valuable to shippers and transportation service providers.
Analysts John Larkin, Dave Ross and Michael J. Baudendistel delivered a comprehensive overview of conditions in the industry across modes, in general painting a picture that says supply and demand are roughly in balance at the moment across the truckload, LTL and rail sectors, but that there are some looming issues that could move that balance in the trucking industry’s favor over the next few years.
Larkin began with an overview of the economy, which is critical to the amount of freight moved and hence the capacity equation.
He said we are in a flat, slow growth mode in the US, which is likely to continue. The natural tendency to grow faster than the 1-2% levels seen in recent quarters coming out of recession is dampened by a variety of factors, including the seemingly never ending financial woes in Europe, more tension on the Middle East, a slowing Chinese economy, high unemployment and low levels of labor participation in the US, and worries over the looming “fiscal cliff” approaching at year’s end.
He noted that while retail sales numbers in general have looked reasonably strong, when backing out sales of gasoline and indexing for population growth and inflation, retail sales in the US are right now just at levels seen in 1998 – hardly bullish for freight. Retail sales are still down 8.6% today from their adjusted peak seen all the way back in 2006, even though the number is up substantially more than the bottom in Q4 2008.
Larkin also showed a chart that indicated sales growth at 10 of the largest US retailers was just 1.6% in Q2 – which exactly mirrored inflation, meaning real growth was flat.
He then presented some data to just level-set the audience in terms of the US freight transportation market.
As can be seen in the chart below, the US freight market represents nearly $750 billion in annual spend, the vast majority of which is a combination of common truckload carriers and private fleets. The same basic pattern holds true with respect to tonnage moved, although in that view the LTL sector shrinks (obviously indicating LTL is a pretty expensive way to move freight). Rail and intermodal still represent just a small share of the market, though growing more rapidly than the others.
Source: ATA, Stifel Nicolaus
While a balance in supply and demand characterizes most modes right now, Larkin said several factors may upset that equation. Notable are regulations such as CSA 2010, which is knocking many drivers out of the market for safety record reasons. New hours of service rules are compounding the driver challenge by reducing driver productivity. The cost of new trucks continues to rise due to both regulations and increased commodity costs.
All told, “We could see 5, 10 maybe even as much as 15% reduction in capacity in the industry,” over the next few years, Larkin said.
He also noted that in general truckers have maintained strong asset discipline since the recession, and that many of the larger players are eschewing traditional linehaul carriage in favor of intermodal, value added services and other strategies, finding that the pure truckload business is “too seasonal, too cyclical, too driver intensive, and too asset intensive to compete with intermodal.”
In the meantime, many smaller carriers are not turning over their fleets because they are having trouble getting the credit needed to buy the new, much more expensive new equipment (up some 30% per unit over the past few years). Many are simply exiting the business. This too will put pressure on capacity over time.
As a result of all this, Larkin said he believes the cost of logistics in the US, back on the rise after collapsing during the financial crisis and recession, will continue to head higher, perhaps moving from the current level of about 8.5% of GDP, to over 10% in the next five years or so, which would represent a substantial increase to shippers.
Finally in his opening segment, Larkin said he sees shippers moving to what he called “Core Carrier Programs Part II,” in which large shippers will make certain rate and volume commitments to their leading truckload carriers in return for capacity commitments over that same time frame, as shippers realize lack of capacity is becoming a growing threat to their supply chains. The implication, we see it, is that these commitments on both sides will be more firm than they have been in the past.
LTL Sector Has More Pricing Power, If Up from a Low Base
David Ross made the interesting observation that the less-than-truckload sector is largely driven by changes in manufacturing output, while the truckload sector is more dependent on retail sales to drive demand.
The stronger performance overall by the manufacturing sector versus the rest of the economy has helped LTL carriers finally achieve some level of pricing power, though it is still not where they need to be to achieve solid profitability, Ross said.
Ross noted that the LTL sector is even more concentrated than the TL group, with the top five carriers currently controlling about 55% of the total US freight market. Ten years ago, Ross said, the top five carriers controlled just 30% of the US freight market.
He expects rate increases to be in the 3-5% range for LTL providers through the end of the year and into 2013, whereas Larkin sees truckload rates flatter, up just 1-3% over the same period.
Ross sees most of the massive wave of consolidation over the last decade in the LTL sector having ended. One leader in that consolidation wave was of course YRC Worldwide, which continues to struggle with the hangover from a number of mergers.
He said that YRC Freight – the old Yellow Roadway – is the unit that continues to struggle the most, in part because of its dependence on national accounts, which can resist price increases more effectively than smaller and mid-sized shippers.
Ross added that if the company took the drastic step of shutting down YRC Freight, or even just reducing its network by shutting down a lot of terminals, it could benefit LTL carriers and lead to rising rates overall by taking out still more capacity.
He added that while LTL has continued to lose share versus other modes, it is probably close to a bottom, and may gain share if truckload capacity does tighten, with some “spillover” freight that can’t easily find a TL carrier being pushed to LTL.
Ross also noted that parcel shippers continue move more boxes via ground than express air shipments, especially as the greater efficiency of both UPS and FedEx serve to reduce the service difference between the shipping options. The challenges for both these carriers will be to redesign their networks to optimally accommodate this continuing trend, he said.
Ross also noted that freight brokers in the truckling industry continue to do well, with margins remaining high. However, he believes enough new players are entering the market (often carriers themselves) that the amount of competition may soon drive margins down, meaning lower prices for shippers as brokers compete for the business.