Amid low demand, spot rates, US truckers look to cut costs

Amid low demand, spot rates, US truckers look to cut costs

Lower economic activity and high inventories have sent spot market truckload rates tumbling even lower than they fell in 2015, and are not expected to disappear any time soon.

This was supposed to be the year truckload capacity tightened and truck prices skyrocketed, cutting off access to trailer space for shippers that had not signed long-term deals with carriers and forcing the rest to pay a stiff premium to get freight on trucks. This was supposed to be the year when higher truckload costs pushed more freight to intermodal rail and less-than-truckload carriers, as happened in the expansion of 2014. This was supposed to be the year when shippers agreed to pay even more to fund higher truck driver wages.

This was supposed to be the year … but it was not, and it will not be. Instead, the first half of 2016 proved the softest for the U.S. economy since 2011. That’s still much better than 2008 or 2009, but cold comfort to businesses fighting to find traction in an increasingly digital economy evolving at unprecedented speed. Whether the economy improves in the second half of 2016 or slides toward recession, trucking companies will have to travel in new directions, driven by high inventories, e-commerce, new regulations and increasingly complex supply chains.

There are signs the trucking market already may have hit bottom and is inching upward early in the second half of 2016. Spot market load availability rose 28 percent in June thanks to seasonal freight, boosting total volume to levels seen in 2012 and 2013, and only 12 percent below 2015 totals, according to the DAT North American Freight Index. The load-matching service indicated a pickup in volumes after Memorial Day weekend, stating that “consumer goods are moving through the retail supply chain.” Freight shipment volumes have been rising since February, though they’re still weak compared with previous years, the Cass Freight Index shows.

As U.S. freight shipping picked up, for-hire trucking companies began hiring again, reversing a five-month decline in trucking employment in July. For-hire trucking companies added 1,700 jobs in July, after losing 11,500 since January, Labor Department data show, and motor carriers still say they have a hard time finding truck drivers who meet their qualifications.

However, the stockpile of goods clogging U.S. supply chains is growing, despite professed desire for destocking at many retailers. The value of overall business inventories inched up 0.2 percent to $1.8 trillion in May, the U.S. Census Bureau reported, after climbing 0.1 percent in April. By May, the retail inventory-to-sales ratio had been 1.50 or higher for four straight months, the highest level since May 2009, shortly before the end of the recession. U.S. retail inventories were 6 percent higher than a year earlier in May, according to Census.

“This second half is going to prove once again how little we know about what we’re doing,” said Walter Lynch, CEO and co-founder of third-party logistics operator Zipline Logistics in Columbus, Ohio. “Sure we have high inventories, but much of that inventory is in the wrong spot. One of our customers has spent more money transferring product from coast to coast than they’ve ever done before. They’ve struggled to get product to the right location.”

 

The U.S. economy created 255,000 jobs in July, a higher number than expected, keeping the unemployment rate at 4.9 percent. Stock market indices have hit record highs, and the Nielsen consumer confidence index for the U.S. climbed three points in July. Those indicators raise hopes that the gap between the freight economy and the overall U.S. economy is finally closing after a long correction from an overheated 2014. That may depend on whether consumers shift spending from services to goods, driving more freight shipping and reducing inventories.

Doing business the old-fashioned way is unlikely to pull trucking out of what some analysts are calling a freight recession, no matter how much muscle and sweat are spent. Trucking companies also cannot expect new safety rules that could eliminate some truck capacity to solve the oversupply problem. Betting on whether the electronic logging mandate will take effect as scheduled and how much capacity the mandate might actually eliminate is a risky gamble.

The trucking companies that will find ways to build speed in this slowdown are the ones that control costs with precision and learn to innovate, diversifying their business and improving processes. They will be large companies with the scale and resources to deploy technology and adapt quickly to changing markets. They will be small companies with an eye for opportunity that adopt technology that helps them offer services once limited to larger competitors.

A prime example of such a company might be XPO Logistics, which put its acquisition strategy on hold this year to focus on performance and profit within its diverse portfolio of businesses, which include the second-largest U.S. LTL operator. In the second quarter, the former Con-way Freight raised its operating profit 66 percent year-over-year to $115 million in a quarter where all of its peers but YRC Freight saw profit decline or go flat from a year earlier. XPO, balancing its asset- and non-asset-based businesses, reported its first quarterly profit in the quarter.

Another example could be Kottke Trucking. In some respects, Kottke could not be more different than XPO. XPO is a $15 billion company with thousands of assets worldwide. Kottke is a 175-truck carrier based in Minnesota, where it’s been hauling truckload freight since 1938. What the companies have in common is an eye for opportunity. Kottke just purchased Walbon & Co., another Minnesota-based carrier hauling refrigerated and dry goods.

The acquisition “allows us to make offerings today we couldn’t make two weeks ago,” General Manager Kyle Kottke said. “It’s broadened our offerings and has given us scale.”

You need sharp eyes to find such opportunities in 2016. Most trucking companies spent the first half of the year trying to rein in capacity, improve their core processes and limit the damage caused by unusually high inventories and low freight demand as the U.S. recovery began to lag.

“Typically, freight volumes improve during the second quarter as compared to the first three months of the year, but that has not been our experience during 2016 as freight volumes didn’t improve until mid-June,” Michael Gerdin, CEO of Heartland Express, said in a statement.

 

How slow was growth in the first half? Real gross domestic product in the U.S. inched up 0.8 percent in the first quarter and 1.2 percent in the advance estimate for second-quarter GDP. A year ago, the economy expanded 2 percent in the first quarter and 2.6 percent in the second. During the past two years, however, second-quarter GDP growth has dropped from 4 percent in 2014.

That lower economic activity, coupled with high inventories, sent spot market truckload rates tumbling even lower than they fell in 2015, putting more pressure on contract rates in 2016. From January through April, the average dry van spot truckload rate tracked by DAT Solutions dropped 14.1 percent, or 22 cents per mile. Rates rallied as demand rose in June and July, pushing the average dry van rate up 6.7 percent to $1.43 per mile by July 30. However, spot rates are still lower than this time in 2015, even when fuel surcharges are excluded.

Truckload carriers are responding to this market by reining in capacity, parking or selling older trucks or just not buying new ones. Preliminary Class 8 tractor orders for July were down 56 percent year-over-year and 19 percent from June following “several significant order cancellations,” according to transportation research firm FTR Associates. Individual carriers reported substantial cuts in their fleets. Covenant Transport, for example, reduced its fleet size by 130 tractors year-over-year in the quarter, while replacing 500 older trucks. Knight Transportation cut the average number of tractors it operates by 120 from a year earlier. The JOC Truckload Capacity Index, released quarterly, dropped from 88.4 in the first quarter and 89.1 in the 2015’s second quarter to 87.6. That was the lowest reading for the index, based on 2006 capacity levels at a $10 billion group of large, publicly owned carriers, since the first quarter of 2015.

At several large trucking companies, however, tractor counts were still above year-earlier levels in the second quarter, although they dropped from the first quarter. Just like weight, it’s harder to lose capacity than to gain it, especially after splurging on new trucks in 2014 and 2015.

The nation’s largest less-than-truckload carriers had one consolation in the second quarter: They were not truckload carriers. Revenue at most LTL carriers slipped year-over-year as the U.S. freight economy weakened, but not to the same extent as their truckload counterparts.

Only FedEx Freight, the largest U.S. trucking company and LTL carrier, gained revenue in its latest quarter, and that quarter did not include June, when most carriers said business picked up. Only two of the publicly owned LTL carriers, XPO and YRC Freight, increased profit in the second quarter. Overall, LTL volumes dropped rapidly, as did fuel surcharges, cutting into top-line revenue. Outside FedEx Freight, which increased shipments 8 percent in the three months that ended May 31, the other major LTL players saw shipments decrease from 0.3 percent at ODFL to 6.9 percent at UPS Freight. LTL pricing, rather than falling as fast as truckload rates, however, is holding fast, and contractual pricing is even rising at some carriers.

 

The pricing discipline LTL carriers gained since the 2008-09 recession and LTL price war appears to be holding despite the lackluster economy. ABF Freight System averaged an increase of 2.9 percent on contract and deferred pricing, while Saia reported contractual price increases averaging 5.4 percent. “The pricing environment remains much more rational in the LTL space” than in the truckload space, YRC Worldwide CEO James Welch said in his company’s earnings call. “We believe that our strategy of improving price and freight mix has positioned us well for the future.”

It also helps that LTL carriers, unlike truckload operators, are not burdened by excess capacity. Truckload carriers measure capacity in terms of trucks, but LTL trucking companies tend to measure it in terminal doors and network utilization.

What should U.S. truckers and shippers expect in the second half of 2016 and in 2017? Economists still see greater growth ahead, although not as high as projected earlier this year. Inventory destocking, which would benefit trucking, will depress GDP, as companies hold off investing in inventories until replenishment kicks into higher gear.

Looking ahead, few trucking executives expect their companies will be lifted by a rising economic tide. “From our point of view, LTL companies are focused on evolution of the supply chain distribution process and getting an adequate return on the capital,” Welch said.

David Jackson, president and CEO of Knight Transportation, expects capacity to tighten enough by the fourth quarter to put pricing power back into carrier hands, but more because of trucking bankruptcies and efforts to better utilize equipment than real growth in demand. “This feels a bit like 2013 did,” he said in an earnings call transcribed by Seeking Alpha. Noting that freight demand picked up in July, Jackson said “it feels like we’re beginning to see the signs of volume coming with pricing to come” in the fourth quarter.

Jackson and other truckload executives also believe the electronic logging mandate, which will require paper driver logs be replaced with electronic records starting in December 2017, will eliminate drivers and carriers that only survive by violating hours-of-service rules. Everyone believes they’re out there, but no one knows exactly how much capacity they represent.

It’s also not clear whether the mandate will take effect as scheduled. A court challenge from the Owner-Operator Independent Drivers Association could run the mandate off the road. Shippers are not waiting for the deadline or a court decision, though. Some are requiring their carriers to install ELDs ahead of the December 2017 deadline, creating a mandate of their own.

Kottke Trucking already has ELDs in its trucks, but the logging requirement is only one aspect of a changing regulatory environment, Kyle Kottke said. “I think the speed of change will catch many people off guard,” he said. “Staying in front of it will be very challenging. You add up all of what’s taking place in this industry, drop it in a basket, and it’s a ton of change to manage.” 

Contact William B. Cassidy at bill.cassidy@ihsmarkit.com and follow him on Twitter: @wbcassidy_joc.