Lower freight revenues and higher costs are squeezing profits at Covenant Transportation Group and are likely to pressure earnings at other truckload carriers this fall.
While capacity is "plentiful" at the moment, thinner profit margins and rising costs could raise concerns about trucking companies' ability to reinvest in drivers and equipment.
Chattanooga, Tennessee-based Covenant said Thursday it expected its third-quarter net profit to drop by $4.4 million to $5.5 million year-over-year to a range of $2.1 million to $3.2 million.
Profits are being muffled by higher equipment depreciation costs, higher claims expenses, and lower average freight revenue per tractor, Chairman and CEO David R. Parker said.
He blamed the higher depreciation costs on the soft used truck market, which is making it harder for carriers to sell excess trucks. “A year-over-year increase in depreciation expense for these tractors will continue to affect our results for at least the next three quarters,” Parker said.
“Compared with the third quarter of 2015, depreciation increased $4.6 million,” rising to $19.3 million,” as a result of lowering the salvage values on a significant percentage of Covenant’s tractors, he said in a statement. Covenant’s insurance and claims expenses also rose $1.7 million, “primarily as a result of increased frequency and severity of accidents,” Parker said.
A “weaker truckload freight environment” combined with those higher costs to thin the truckload carrier’s profits. Average freight revenue per tractor declined 1.2 percent year-over-year in the quarter, Parker said. “These factors more than offset improved performance from our Solutions non-asset-based brokerage business and a favorable effective income tax rate,” he said.
Covenant plans to release third-quarter earnings in the afternoon Oct. 19 and hold an earnings conference call with investment analysts Oct. 20 at 10 a.m. After Thursday’s announcement, the company’s stock price dropped 17 cents overnight, opening at $14.68 a share Friday.
In the second quarter, Covenant’s freight revenue, excluding fuel surcharges, dropped 5.1 percent year-over-year to $144.4 million, while total revenue of $158.8 million, including surcharges, was down 9.5 percent. Net profit dropped from $11 million in the 2015 quarter to $3.6 million. Parker characterized the quarter as one of lackluster demand from rate-conscious shippers.
The market dynamics for truckload carriers didn’t change much during the summer. Recent interviews and discussions with shippers, analysts, and carriers indicate third-quarter earnings at many public truckload carriers will likely show further deterioration in revenue as a result.
“A lot of (shippers) are facing challenges from the C-level. They’re being asked, ‘If the first round of (rate) savings was in the 5 percent range, what’s stopping us from going to 10 percent?’” Matt Harding, vice president of the Chainalytics Freight Market Intelligence Consortium, said at the 2016 Council of Supply Chain Management Professionals conference in September.
Covenant’s 1.2 percent decline in freight revenue per tractor probably isn’t the worst Wall Street will see as truckers begin to report quarterly earnings. It’s better, in fact, than the company’s 3.2 percent drop in average revenue per tractor per week in the second quarter.
An ad-hoc survey on truckload pricing at the American Trucking Associations Management Conference showed those rates ranged from flat to down 10 percent from a year ago, Stifel Managing Director John G. Larkin said in an Oct. 13 note to investors.
“Down 1.2 percent year-over-year is on the right side of the bell curve,” Larkin said of Covenant, and better than Stifel had expected. “We are currently in a period of economic limbo with tepid GDP growth made to feel even less desirable by excessive inventory levels and soft consumer spending,” Larkin said. He does expect GDP growth to eventually accelerate to about 2 percent.
When that happens, Covenant is “well positioned to differentiate themselves from the competition with their expedited team driver service,” Larkin said. He also noted the carrier, like many competitors, is shifting capacity toward faster-growing markets, including e-commerce.
Trucking companies frustrated by lack of growth in general, over-the-road freight are increasingly likely to turn to last-mile delivery, dedicated trucking, and other faster-growing markets.