With the housing and auto industries still weak, it may take until 2011 for carriers to see improved pricing power and its payoff
Earnings in the trucking sector likely improved in the 2009 fourth quarter, but investors know better than to embrace the same level of cautious optimism that has surfaced in other industries that are expected to benefit as the economy recovers. While the broader economy has shown signs of improvement, the recession for freight haulers isn't over. In fact, some people think it's entering its fifth year, says John Larkin, an analyst who covers transportation stocks at Stifel Nicolaus in Baltimore. Unlike air freight carriers, and intermodal companies that use metal containers that can be transferred from railroads to ships in place of trucks, trucking companies are entirely dependent on the domestic economy, which isn't expected to recover as quickly as the global economy. Improvement in trucking revenues between the first and second halves of 2009 wasn't sustainable, says Larkin, since much of it was due to fiscal stimulus programs like "cash for clunkers" and the $8,000 tax credit for first-time homebuyers. Market optimism toward the sector will likely wane as the reality of still-harsh economic conditions sinks in, he says. "The modest recovery, combined with current lean inventory levels, makes it less likely that we will experience the sharp increase in freight volume that we have experienced in previous recoveries," Larkin wrote in a Jan. 5 research note. Without a major reduction in capacity, the return to a constrained supply-and-demand balance that would drive stronger pricing could take longer than many investors are now discounting in freight transportation and logistics stocks, the note said. supple/demand imbalance
How much capacity does the trucking industry need to shed? Little has been taken out in the past 12 months, as banks and leasing companies are reluctant to put trucking firms into receivership or bankruptcy because they don't want to own a lot of devalued truck assets they can't sell, says Larkin. With freight volumes down 22% from their peak in 2005 and rebounding slowly, he doesn't project a tighter supply/demand balance until at least mid-2010 and maybe not until 2011. The American Trucking Assn.'s advance seasonally adjusted For-Hire Truck Tonnage Index rose 2.7% in November, after a 0.2% decline in October. Seasonally adjusted tonnage was down 3.5% from November 2008, the best year-over-year result in 12 months, the ATA said in its Dec. 29 release. The Dow Jones Transportation Average (DJTA) rose 7.8% during the fourth quarter to finish at 4,099.63 on Dec. 31. The index closed as high as 4,262.86 on Jan. 11 but ended at 4,093.88 on Jan. 21. With just one pure-play trucking stock, Con-way (CNW), in the index, the rise in value since Sept. 30 is more reflective of improvement in the air freight, railroad, intermodal, and transportation logistics businesses. Keybanc Capital Markets in a Jan. 11 research note recommended truckload stocks—those that haul loads of 10,000 pounds or more—for 2010 based on how low retail inventories are compared with sales. That could prompt strong replenishment in the first half of this year and inventory restocking typically accounts for 60% to 70% of truckload volumes, equity analyst Todd Fowler said in the note. will tight credit will temper new capacity?
Some companies with fairly large fleets of trucks have folded in recent months and more will fail in the first quarter, especially as diesel fuel prices keep rising, Fowler told Bloomberg BusinessWeek in an interview. That does more than just reduce excess capacity. It causes a lot of freight to gravitate toward more stable trucking operators—mostly publicly traded—as the more savvy manufacturers and retailers try to avoid having freight tied up with financially unstable carriers, says Fowler, "[Shippers will realize] it makes sense to pair up with a carrier like Knight [Transportation] (KNX), Heartland [Express] (HTLD), or Werner [Enterprises] (WERN), and pay a little bit more," so the customer can be assured the carrier will be around in the future, he says. Jon Langenfeld, an analyst at Robert W. Baird & Co., is more sanguine than many transportation analysts about excess capacity. In a Jan. 15 research note, he said that firming freight rates in this weaker environment highlight show how much capacity has exited the market through a lack of new truck buying in the past three years. Improved discipline among carriers and tight credit will also temper additional new capacity and support higher truckload rates in 2010, he said. For the less-than-truckload carriers, which generally carry cargo from multiple shippers, each weighing 1,000 pounds on average, a lot of hope is riding on the eventual demise of beleaguered YRC Worldwide (YRCW), the biggest carrier in this part of the industry. A handful of less-than-truckload stocks got pumped up in the last few weeks of 2009 only to plummet in early January after YRC successfully completed a debt-for-equity swap worth more than $500 million that bought it some more time to meet debt maturities. Investors had been betting that troubles at YRC would prompt customers to move their business to other trucking concerns. Larkin thinks names such as Old Dominion Freight Line (ODFL) and Saia (SAIA) are now a fairly good bargain, while most of the stocks he covers are pricing in a more dramatic recovery than he thinks will materialize. what a YRC bankruptcy would mean
YRC's debt-for-equity swap makes it unlikely the company will have to file for bankruptcy before April, Fowler wrote in Keybanc's Jan. 11 research note. As a result, investors should expect at best muted pricing for less-than-truckload names in the short term and at worst a continued irrational environment, he said. YRC must have $45 million in third-party financing in place by March. At current cash burn rates, it could exhaust available credit by the second quarter. A YRC bankruptcy could allow less-than-truckload freight rates to rise 5% in the first year after the bankruptcy filing, as carriers negotiate higher rates for portions of their books each quarter. It would also result in market share gains and more efficient use of the network by competitors. A bankruptcy filing would also mean substantial upside in earnings for competitors. Con-way's earnings would rise from the current consensus estimate of $1.40 to $2.55, Arkansas Best's (ABFS) would go from 20¢ to $2.10, and Old Dominion's would climb from $1.30 to $2.10 a share, according to the Keybanc note. But Larkin at Stifel Nicolaus believes it's dangerous to bet too much on YRC disappearing. In past downturns, a company that's had all the trouble YRC has would have failed. "Banks, bondholders, and the Teamsters have bent over backwards to cut the company immense amounts of slack" because they think it's worth saving, he says. The company is saving $25 million per quarter from a one-year forgiveness on any cash interest or cash bank fees it owes. And it could get a tax refund of several hundred million dollars if Congress passes legislation designed to help keep struggling businesses afloat by returning any cash taxes they paid in the past five years. The refund would allow YRC to operate for five to six more months, he says. "It's conceivable [YRC] could last through this year," or even longer if there's even a fairly modest, steady recovery, he says. "I've given up trying to guess when the company's going to run out of cash because there always seems to be another stakeholder who's willing to lend the cash to allow them to continue operating. This can't go on forever [however]." If YRC folds, Larkin estimates the market would lose 15% to 20% of total capacity, some of which would be restored by competitors needing larger facilities to handle an increase in shipping volume. transport and logistics costs are apt to rise
Over the longer term, the "new normal" level of demand is likely to be higher than the current level but still depressed relative to the demand boom in 2004 and 2005, according to the Keybanc note. Rising fuel prices, tougher safety, security, and environmental regulations, and inadequate funding for infrastructure or development of an integrated nationwide freight transportation plan will likely increase transport and logistics costs over the next decade, the note said. Although intermodal companies such as JB Hunt Transport Services (JBHT) that diversified by adding an export business had an advantage during the freight recession, pure-play trucking companies such as Knight and Heartland have managed very well in the difficult environment, says Fowler. Knight's operating margins have deteriorated just five to six percentage points from a peak of 18% in 2005 thanks to cost-cutting. "That's very respectable for an industry that's lost a lot of money and is breakeven from a margin perspective over the course of a cycle," says Fowler. "There are some companies that will never get to the margin that Knight is running at even in this environment." Knight's fourth-quarter earnings are expected to fall 19% from a year ago to 16¢ a share on a 7% rise in revenue, to $153 million, before fuel surcharges, analyst Nate Brochmann wrote in a note from William Blair & Co. on Jan. 13. The first pure-play trucking company scheduled to report earnings for the 2009 fourth quarter is Celadon Group (CGI) on Jan. 25, while less-than-truckload outfits such as Arkansas Best and Old Dominion report on Jan. 28.