Is Wall Street Right?
Veteran analyst challenges some popular assumptions regarding truckload capacity and LTL competition.
Patricia Smith
Senior Editor
"Shoe-horned into a bankrupt airline's 757 coach seat" and pondering the safety of an airline embroiled in mechanics dispute, veteran trucking analyst John Larkin "began to consider the numerous other issues currently facing the nation's transportation industry."
Once back on firm ground Larkin apparently huddled with David Ross and Daniel Taylor, his colleagues at Legg Mason Wood Walker Inc., to come up with what they call a "reality check" of the U.S. freight transportation industry. As the label implies, the Legg Mason team doesn't agree with much of Wall Street's "conventional wisdom." Following are some highlights of their report.
An end to the driver shortage?
Many Wall Street analysts have speculated that the chronic driver shortage may start easing soon. One reason: significant pay increases implemented by the big truckload carriers. Another reason: the ability of smaller carriers to offset lower pay and weaker benefits with that small company "personal touch."
But truck drivers "are not irrational people," the Legg Mason team points out. "At the end of the day, truck driving is not a highly coveted career choice, and our sense is that those workers who have an interest in the field and meet most carriers' qualifications are already employed as drivers and intend to be compensated well for their services."
Last year's pay raises simply enabled major carriers to poach drivers from other carriers - thus the historically high turnover levels. Now LTL carriers are reportedly trying to lure drivers from truckload carriers. That heightens the competition but does little to improve supply.
There is speculation that the railroads will step in to pick up more linehaul freight, which will ultimately ease the demand for hard-to-keep linehaul drivers. However, Larkin, Ross and Taylor note that the railroads have their own capacity constraints. Rail intermodal service is only offered in longer-haul, higher-density freight lanes, railroads are generally reluctant to add significant incremental capacity prior to earning their cost of capital, and two of the four major U.S. railroads are unable to absorb significant incremental volume due to outdated systems and infrastructure.
"Expansion of rail capacity is simply too costly and slow-moving to keep pace with - much less outstrip - growth in demand for intermodal service," they said, "and will not be able to absorb anywhere near enough truck freight to alleviate the driver shortage."
Overcapacity by the end of the year?
A surge in new truck orders last year prompted speculation that the capacity crunch would soon be history and the trucking industry could be dealing with overcapacity by the end of this year. That prediction goes back to the presumed ability of smaller carriers to attract new drivers, which would enable them to expand. And some analysts expect the bigger carriers to resume old practices and trigger a trend to "irresponsible" growth.
Legg Mason's response: The bulk of new Class 8 tractors entering the market are replacements for trucks kept beyond typical trade cycles because of 2002 emissions worries. And now many buyers have accelerated replacement schedules to avoid more stringent 2007 rules.
"Keeping the chronic driver shortage in mind, we find it difficult to deduce how truckload carriers are adding new trucks to their fleets if they can't find enough drivers to man them," the team said.
They also point out that shippers "are not the naive traffic managers of days gone by," but are highly educated logistics professionals who often use sophisticated systems and advisers to fine-tune supply chains. They're not going to overpay for transportation services, but the fact that many have accepted 5-15% rate hikes - on top of record high fuel surcharges - indicates a belief among shippers that the capacity crunch "has legs."
Some analysts point to the growth of C.H. Robinson, the nation's largest truckload broker, as an indication that trucking - and especially smaller carriers - are adding capacity. But the Legg Mason report counters that much of C.H. Robinson's success is due to a very successful broker/carrier recruiting effort, including an account receivables management program designed to attract small, cash-strapped carriers.
Rising costs and shipper consolidations continue to squeeze small fleets and owner-operators, forcing many to rely heavily on big brokers to keep them in business, the team said. "We expect the 2005 operating environment to erect greater barriers to entering the trucking market and to put a further strain on small carriers."
New dynamics for LTL?
One industry segment that appears to be adding capacity is the less-than-truckload sector. The demise of Consolidated Freightways significantly changed the LTL competitive dynamics. The inability of truckload carriers to get drivers shifted some freight to LTL. So did new hours of service rules, which made it uneconomical for truckload carriers to haul multi-stop traffic.
As the Legg Mason report explained, those developments, plus a manufacturing rebound, has enabled LTL carriers to grow tonnage without causing prices to erode. And that has prompted many LTL carriers - especially non-union carriers - to start adding capacity at an accelerated pace.
They also predict that expansion will push the LTL industry back to what they call "competitive substitution," where surplus capacity makes unionized carriers vulnerable to competitors with cost and/or service advantages such as truckload carriers, parcel carriers and non-union (usually interregional) LTL carriers.
"Many non-union LTL companies have taken advantage of this robust freight market to build pick-up and delivery, terminal, line-haul and break-bulk density, thereby lowering their respective unit-cost positions, in addition to expanding their geographic coverage areas," they said. "These carriers should continue to prosper as their growth drivers shift from 'total pie' expansion in this industry up-cycle to 'market share' expansion in the coming down cycle. Over the long run, we believe non-unionized carriers will easily win the battle for market share in the LTL space."
A cyclical industry?
These experts don't buy the idea that freight transportation is a textbook example of a cyclical market, which ebbs and flows in precise unison with the overall economy. Consumables like food, clothing and other non-durables make up the majority of domestic freight and tend to move regardless of GDP growth, they note. Moreover, the export of U.S. manufacturing appears to be a continuing and irreversible trend. Freight generated from what's left of domestic manufacturing is closer to a true cyclical model, but that freight is handled mainly by railroads, flatbed truckers and domestic airfreight companies.
"Our sense is that freight is less cyclical than most on the Street perceive it to be," they said. "Success in this fragmented market is driven in large part by a carrier's ability to execute its operating strategy effectively - not just by the direct impact of business cycle activity."
