Outlook ~ 2004~
More Freight, Higher Costs
Financing, insurance, fuel prices, safety and security make recovery an uphill climb - especially for newcomers and small fleets.
Patricia Smith
Senior Editor
The economy has been growing since the end of the recession in 2001 - but you wouldn't know it looking at freight measures or tractor and trailer demand.
"Unfortunately for truckers, while the economy has been expanding in aggregate, key freight sectors such as manufacturing and exports have been weak," explained Kenneth Vieth III of A.C.T. Research, an Ohio-based company that tracks freight trends and equipment sales.
"At the same time, carrier overcapacity, rising insurance premiums and stubbornly high fuel prices have sapped trucker profits."
Finally, however, we have good news. Low inflation, low interest rates, rising equity valuations and rising corporate profit expectation point to stronger economic growth in the second half of 2003 and into 2004, Vieth said. "With pockets full of household equity from refinancing, consumers should continue to hold up their majority share of the economy. Adding tax cuts, more rapid depreciation allowances and a falling dollar to the mix certainly bolsters the expectation that more broadly based spending is close at hand."
Moreover, trucking's biggest customer - manufacturing - appears to be picking up steam. August data compiled by the Institute for Supply Management indicates rising factory production, higher backlogs and dwindling inventories. It may be too early to call it a trend, cautioned ISM Chair Norbert Ore, but "there is strength in the various segments that we have not seen for some time."
In its early September "Beige Book" economic update, the Federal Reserve Board noted that 10 of its 12 districts reported increased manufacturing activity. Only Dallas and Richmond, Va., reported weakening or no change. Many districts said demand was up for autos and auto parts, high-tech equipment, semiconductors, pharmaceuticals and building materials. Some also reported a pickup in demand for machine tools and industrial equipment. The soft markets: paper, chemicals, textiles and furniture.
"After three-plus years of industrial stagnation, the U.S. economy is on the cusp of a business cycle recovery as short-lived durable goods purchased from 1998-2000 are becoming long-in-the-tooth," said Vieth.
The best example is our own industry where the flood of Class 8 tractors purchased from 1997 to 1999 is now four to six years old. "Ditto for the frothy tech demand generated by the Y2K scare and the dot com explosion," he added. "At some point, aging equipment has to be replaced."
High unemployment continues to be the cloud in an otherwise sunny outlook, but most economists say slow job growth isn't a surprise. "What generally happens in an up cycle is that you have an initial period of productivity increases, which means more output per existing worker," explained Peter Toja, president of Economic Planning Associates, Smithtown, N.Y. "But after a while you just back yourself up against a wall and you have to add jobs."
Vieth also warned that the continued flight of manufacturing jobs overseas could hurt U.S. employment - and it could hurt trucking since domestically produced goods require five to seven moves, from raw material source to retailer, while items made overseas only require two U.S. moves - from port to warehouse and warehouse to retailer. But as global growth returns, the weak dollar should put U.S. manufacturers in a strong position to boost exports, which also boosts employment and freight.
The American Trucking Assns.' seasonally adjusted Truck Tonnage Index rose 5.4% from June to July, the secondly consecutive month of growth. July freight was up 2.3% from a year earlier and truck tonnage year-to-date was 3.7% ahead of the same period in 2002. ATA Chief Economist Bob Costello said it was especially good news since summer shut downs by manufacturers can cause a dip in freight demand. "July's increase is further evidence that the trucking industry is on a recovery path and I expect volume to continue to improve as the economy does," he said.
Vieth said they expect trailer loads to increase in the second half of 2003, with a full year growth rate about even with 2002. The August issue of A.C.T's monthly Road Ahead report projected 2004 trailer-load growth at 3.4%.
Capacity And Rates
"It's hard to gauge the economy based solely on how busy transportation is today, because there have been so many people go out of business," said Herb Schmidt, president of Contract Freighters Inc. "There's slightly more freight to move, but there are fewer people who have the equipment to move it."
Capacity may remain tight for a variety of reasons. Schmidt said some carriers are still wary of the 2002 emissions-compliant heavy truck engines, thus are putting off buying new equipment as long as they can. Many carrier executives are not yet entirely convinced that the upturn will last. Finance and insurance issues will likely curb the usual flood of new entrants into trucking, even when more freight and higher profits make it tempting. And some believe the carriers themselves will try to keep a lid on growth.
"In previous upturns this is about the time the big carriers would start adding a bunch of new equipment," observed the executive of a mid-size fleet. "We're not seeing it yet. I think most of them are hoping to keep capacity low so they can raise rates."
It appears, however, that carriers are buying. A.C.T. is predicting a strong rebound in Class 8 orders starting in the latter part of 2003 as carriers begin to address pent-up replacement needs following three years of fleet aging. Economic Planning's Toja expects a strong truck and trailer market the rest of this year and a very strong 2004 and 2005.
The early 2003 sales dip, blamed on the wobbly economy plus last year's pull ahead buying, will probably keep this year's Class 8 retail sales around 146,000 units - about the same as 2002. But Toja expects a continued economic upturn, particularly in the industrial sector, to boost Class 8 sales to 171,000 in 2004 and 183,000 in 2005.
Class 6 and 7 sales will benefit from increased consumer spending and the continued strong housing market, which means more electric and gas activities, phone lines and cable services. Although Class 7 sales this year are expected to be about 5% below the 66,000 units sold last year, he forecasts 2004 sales at around 86,000 units. Class 6 sales for 2003 are projected at 48,000, up 6% from last year, rising to 55,000 in 2004.
Trailer shipments this year are projected at more than 182,000 versus 138,000 in 2002. The forecast for 2004 is 211,750.
Supply and demand affects rates, and most trucking analysts believe that capacity is at the point where an upturn in freight will mean healthy rate increases. The last couple of quarters did see higher revenues for most of the publicly held carriers. Some was attributed to reduced industry capacity and higher freight rates. And some to the fact that many carriers were walking away from unprofitable business.
"Since the economic shakeout of a lot of weak players, I think there is an opportunity for the quality carriers to survive and grow," said Schmidt. "If they grow in concert with the economy, I think there's an opportunity to command fair prices for our services for a change."
Too-rapid fleet growth could dash those hopes - especially if much of the added capacity is newcomers who don't have a good handle on costs. In this upturn, however, the industry has some significant entry barriers, such as tight financing and expensive insurance.
Finance
"There is financing available for companies with experience and a solid operating history. That hasn't changed," stated Thomas Ball, head of marketing for CitiCapital's Transportation Management and Industrial Equipment Finance Groups.
What has changed is the number of lenders that are active in the truck and trailer markets - and the number of buyers who can qualify for leases or loans. As Ball noted, many finance companies have gone back to the credit basics - a healthy balance sheet, clean credit, and a proven track record in the business. "We learned some pretty tough lessons in the last couple of years and we're not anxious to repeat those experiences."
Companies with a solid financial footing should have no problem borrowing at attractive rates. Veteran drivers looking to buy their first truck may be able to parlay their experience into a reasonably priced loan - if they can show stability and can come up with a sizeable down payment. Cash-strapped newcomers will have the toughest time.
But the door to entrepreneurs hasn't closed entirely. Carrier-sponsored lease/purchase plans have drawn a good deal of criticism - not to mention lawsuits - from groups like the Owner-Operator Independent Drivers Assn. At their worst, they're what one owner-operator called "indentured servitude" where "you end up paying the carrier a lot of money for the privilege of fueling, maintaining, insuring and driving their truck." But at their best, the programs are a way for owner-operators with little investment capital or management experience to break into the business, and a way for carriers to attract and develop good contractors.
As for lenders, partnering with a financially sound carrier could be a way to stay involved in the important owner-operator and small fleet markets, but without some of the risks. Finance companies that have been around trucking for a while also see it as a chance to bring more than money to the table.
"Fleets aren't financial institutions, and whenever they get into the leasing business they're in unfamiliar territory," explained Ball. "If we can come to the marketplace with a product that has been vetted from a legal standpoint, and with certain groups like OOIDA, we can add value for the carrier and the owner-operator. This type of service enables us to provide more capital to the transportation business which, in the end, means more jobs for thousands of drivers who choose to be owner-operators."
Insurance
According to the American Trucking Assns., large truckload carriers in the 1990s were paying about 2% of revenues for property/casualty insurance. Today it's closer to 5% - and that 5% is buying less.
Fleet operators commonly used to buy umbrella liability coverage to protect their assets against lawsuits, recalled Tom Mulligan, Mulligan Insurance Agency, Sea Girt, N.J. "Today you pay the same for $1 million in liability coverage that you used to pay for $1 million in liability plus a $9 million umbrella. Companies can no longer afford the umbrella."
Deductibles as high as $1 million, $2 million or even more are becoming increasingly common, leading many to worry about the industry's risk. Higher deductibles mean lower premiums, noted Frozen Food Express Chairman Mit Stubbs Jr. in the company's second quarter financial report. "It also means that just one serious traffic accident can profoundly and negatively impact any quarter's profits. Our trucks traveled more than 60 million miles in this year's second quarter without a serious accident, but the issue was always there."
Mulligan said that some trucking companies are also taking a chance on the insurers they choose. "Where they used to insist on insurance carriers with the highest financial rating, some will take a risk on an insurance company which, according to A.M. Best and other rating agencies, is on slightly shakier financial ground."
The economy and the stock market plunge get much of the blame for high premiums. As Mulligan noted, only a handful of insurance companies actually made a profit from underwriting insurance. Most made their money on investments, so when investment earnings dried up insurance premiums had to go high enough to cover underwriting costs.
High jury awards also remain an issue. "Look at liability claims 10 years ago," said Gale Preston, vice president of underwriting and marketing, VanLiner Insurance. "If those claims occurred today they would settle out for vastly higher amounts."
The story seems to be about the same for workers' compensation insurance, where huge underwriting losses forced some insurance, companies into bankruptcy - and prompted many others to stop writing workers' comp insurance or at least pull out of the most costly states.
We've seen little progress on tort reform, mainly because trial lawyers have proven to be formidable opponents in state capitals and state courts. But the earnings-driven premium hikes may be coming to an end.
"I don't think we're quite there yet," said Preston. "We'll see some increases next year but not as dramatic as the past. Everybody is looking forward to more stabilization and I think we're coming up on that, whether it's going to be 2004 or 2005."
Fuel
Fuel prices remain the wild card. Most large for-hire carriers say they're much better at imposing fuel surcharges than they were a few years ago, when a sharp upturn in diesel prices put thousands of trucking companies out of business. But high prices still hurt owner-operators and small carriers, who often don't have the marketing clout to quickly tack on the extra charge. They hurt private carriers in competitive industries where it's difficult to raise prices. And fuel burned for non-revenue miles cuts into everybody's profits.
Despite a slight drop in diesel prices after Labor Day, the U.S. Energy Department's short-term forecast published in early September predicted "modest" price increases for distillates (diesel and heating oil) as the heating season approached. Crude oil prices had gone down slightly after the summer driving season ended, but low inventories made the market susceptible to price uncertainty. DOE said it did not expect price reductions for crude oil, even if Iraqi oil supplies increased. And if crude oil prices increased more than anticipated, distillate prices would do the same.
The agency also noted that distillate inventories were at the low end of normal. If supplies weren't built up by the start of heating season, an abnormally cold winter could also mean higher diesel and heating oil prices.
Equipment
Concerns regarding EPA '02 compliant engines still dominate talk of new truck sales, pricing and cost. "The new emissions have really lowered people's enthusiasm about purchasing new trucks because the engines are clearly less fuel efficient and, from our experimentations, less dependable than the previous generation of engines," said Schmidt. "Consequently, we have to believe they'll probably be worth less on resale." CFI, he added, will buy used rather than new or will rebuild what they have.
"From our perspective the issue that overshadows maintenance and fuel economy is life of the engine," said Mark Murphin, senior vice president, sales and marketing for Ruan Transportation Systems. "We know it will be shorter, but we don't know how much."
Accelerated depreciation provisions in the 2003 Tax Act may affect some purchasing decisions, but aren't expected to make a noticeable impact on truck sales. For 2003 through 2005, businesses with capital purchases up to $400,000 can expense as much as $100,000 in the first year - in addition to regular depreciation on the remaining amount. Bonus depreciation, adopted to stimulate business investment after the Sept. 11, 2001, terrorist attacks, has been extended to the end of 2004 and has been increased from 30% to 50% for equipment placed in service after May 5, 2003.
"Although tax laws can enhance investments, they don't change the demand for trucks over the long term," noted CitiCapital's Thomas Ball. The changes may help move hesitant buyers off the fence "but the economy and freight requirements will ultimately determine how many trucks and trailers are needed," he said.
"Don't automatically assume this is a good thing," cautioned Bill Robi of Hoag & Robi, a Westlake Village, Calif., accounting firm that specializes in trucking. "It could be beneficial for companies that need the quick write-off - and the new equipment. Bonus depreciation, which applies only to new equipment, may prompt some buyers to switch from used to new. It may also affect some lease versus buy decisions."
But, as Robi emphasized, there can be numerous complications. The extra-fast depreciation isn't allowed on some state tax returns and it can affect other deductions now and in the future. Equipment buyers also need to remember that this doesn't create additional deductions, it just accelerates deductions they already had. Owner-operators and small fleets may find it more advantageous to save some of the write-offs for later. His advice: Before making an acquisition decision, review tax exposure and equipment needs with an accountant who understands both.
Drivers
Despite slow growth of semi-skilled jobs, most fleets say the driver market is still tight, so wages will likely go up.
Teamster drivers for the major less-than-truckload carriers have already negotiated what the union claims it the highest wage and benefit increase in a decade - 3.4% over five years, plus an adjustment for inflation. Pay and benefit increases slowed among truckload carriers over the past few years but some of the big ones are expected to start upping the ante soon, if they haven't already.
Health care insurance has become a key part of driver pay packages while skyrocketing premiums have forced many companies to raise deductibles or required drivers to pay more of the costs for their families and themselves.
At the same time, fleet managers must deal with new and proposed rules that could affect the availability of drivers and the cost to hire and train them. The Federal Motor Carrier Safety Administration estimates that new hours of service restrictions, effective in early January, will require an additional 84,000 drivers. Fleets with multiple-stop runs say the number could be higher since many of the clock-stoppers, like lunch and breaks, won't be allowed.
Concerns regarding mandated criminal background checks for drivers with hazardous materials license endorsements have generally centered on implementation and enforcement.
"We are at a loss to understand the reluctance to include some form of notification when the entire reason for this rule is to deny access to equipment and materials to individuals that the federal government has determined pose a threat to national security," protested the Motor Freight Carriers' Assn., which represents the big LTL carriers. "If the felony that disqualifies a driver from receiving a hazardous materials endorsement is so egregious as to potentially be a threat to the nation's security, then the employer should know as soon as possible in order to block access to equipment, facilities and the potentially harmful hazardous materials."
FMCSA has proposed new minimum training standards for drivers of longer combination vehicles and new rules that would mandate additional training for entry-level drivers covering drug and alcohol testing, hours of service, whistle blower protections and wellness.
For years, driver screeners have complained about the inability to get adequate information on drivers from previous employers. Federal safety rules say they should ask but, with the exception of certain drug and alcohol test information, previous employers aren't specifically required to respond. Fearing lawsuits, many ignore the inquiries, or they confine their responses to employment verification.
Proposed new rules would require past and current employers to respond within 30 days and to provide specified information such as dates of employment, the driver's three-year alcohol and controlled substance history, completion of drug and alcohol rehabilitation if applicable, and information about accidents in which the driver was involved. Employers would get some protection against lawsuits by drivers but, in return, drivers would get the right to review and challenge information provided by previous employers.
Small fleets in particular have expressed concerns about the increased paperwork required to obtain and provide information not currently required. In comments to the proposal Stephanie Hart, safety/compliance director for Milwaukee-based Direct Drive Express, described a typical "mom and pop" operation with 20-40 drivers. In most small operations members of the administrative staff usually wear many hats, and this would add one more, she said. But her major concern was the driver's right to review and contest information provided.
"Anyone who has dealt with hiring knows there are always a few who will make an issue of the least little thing," she told FMCSA. "It would only take two or three to ruin a small company financially."
Security
Since 9-11, the possibility that trucks could be used as terrorist weapons has prompted the government and the transportation industry to focus money and attention on security. In trucking, hazardous materials haulers face the most new requirements, including mandated security plans and employee training. Down the road those that haven't already done so will likely be required to adopt security technology such as real-time tracking devices, remote vehicle tracking system and "out of route" warning systems.
Restricted access to ports and other security sensitive areas has prompted the need for a standardized worker identification system, now being developed by the Transportation Security Administration (TSA) and the U.S. Department of Transportation. The U.S. Department of Agriculture recently published a general guidance for shippers and transporters of meat, poultry and egg products with detailed instructions for safety plans, employee training and security measures.
At the same time, fleet executives are becoming increasingly concerned about security as their trucks carry more and more high-value loads like computers and electronic equipment.
"We're being seriously targeted for theft," said Schmidt. "With law enforcement focused on homeland security, terrorism and crimes against people, it's difficult to get them excited about chasing a load of plastic that happens to be computers - especially when a thief doesn't have to stick a gun in anybody's face to get it." Thus carriers will have to invest more in anti-theft devices and added security personnel.
Hours of Service
Barring some last minute court action, it appears that next January, commercial truck drivers will have to adopt FMCSA's 24-hour clock. That means a maximum 14 hours on duty versus 15 now, a maximum 11 hours driving versus 10 now, and 10 hours off duty instead of eight. Drivers won't legally be able to extend their day with meals and breaks. And drivers won't be able to stop the clock with a quick nap in the sleeper, which makes loading and unloading delays even more troublesome than before.
The change means that almost every just-in-time and logistics operation will have to be redesigned, said Murphin. "That's not necessarily bad," he adds, "because sometimes when you do that, you find things you might have otherwise overlooked."
Most customers will be as cooperative as possible, but sometimes they don't have much wiggle room. For instance, grocery retailers don't want a lot of trucks in their lots during busy shopping hours. "That store doesn't have a lot of sympathy for what's happening to drivers' hours of operation," Murphin explained. "They have a window when they want their groceries delivered and they're not going to change that just because our rules have changed."
In the end, said Schmidt, customers will have a choice. "If they don't want to create more efficiency in their operation in order to get freight on the trailer and moving as scheduled, they'll have to compensate the drivers and the trucking company on an hourly detention basis. Those shippers that choose not to do either won't get their freight moved."
Sidebars
Big Brothers for Little Fleets
Insurance: Safety Makes a Difference
