2007 Truck Market: Buy, Lease or Wait?
New emissions technology will most likely hurt sales, but full-service leasing could do well.
By Patricia Smith and Deborah Lockridge, Senior Editors
U.S. truck manufacturers came into 2007 braced for a bad year. New emissions rules – and the higher price tag for compliance – prompted many new truck buyers to shift trades and replacements from 2007 to 2006. At the same time, truck dealers stocked up on '06 technology trucks. Thus Class 8 production soared last year and is expected to fall off sharply in 2007. But nobody is quite sure when and how buyers will come back.
Industry analysts estimate the "pre-buy" at around 55,000 units. A large chunk of those went into big for-hire fleets. "Generally, large truckload carriers pre-bought the most because the cost and efficiency of equipment is most critical to their profitability," explained Peter Nesvold, a transportation analyst with Bear Stearns. "Smaller fleets might not have had the capital to pre-buy. The economics of pre-buying don't make sense to some private fleets who own trucks for 10-plus years. And less-than-truckload carriers were somewhere in between the TLs and private fleets."
Maverick Transportation has several hundred 2007 model year trucks with pre-2007 technology. In the third quarter they'll start taking delivery of trucks with 2007 engines.
"We've kind of taken a little more conservative approach than historically because we jumped in with both feet in 2003," said Chairman and CEO President Steve Williams, referring to the last emissions changeover. "I'm a firm believer in 'let's not change our trade pattern, let's just get it over with and move on.'"
C.R. England bought 1,600-1,700 new trucks last year and will buy far fewer this year, but Chairman Dan England said that pretty much follows their normal buying pattern. "It just so happens that we purchase on three cycles and one of our cycles is way bigger than the other two," he explained. Fortunately, 2007 is a small buy year. So is 2010 when emissions must meet even tougher emissions standards.
In a fourth quarter survey done by CK Commercial Vehicle Research, a little over half of fleets responding said they planned to order trucks with 2007 EPA-complaint engines before the end of the year. About a third of that group said their orders would likely be placed before the end of March. Researchers said data indicated a stronger demand from private fleets than for-hire or vocational fleets. They also noted that 49 percent of respondents said they had no plans to buy '07 EPA engines until 2008 or later.
"It's going to be a buyers market," predicted owner-operator Dave Sweetman. The veteran trucker (who also writes a column for Newport's RoadStar magazine) can't be considered a typical buyer. When he puts together a new truck he starts with a daycab and long frame rails to accommodate extra-large custom sleepers. He transports expensive sports cars and vintage vehicles for Horseless Carriage and his meticulously maintained rig routinely draws admiring inspections from celebrities like Jay Leno.
But Sweetman is also an astute negotiator who is "thinking seriously" about a 2008 model year Kenworth with an EPA '07 compliant Cummins engine. "I'm waiting on some of the incentives," he said. As the year progresses – and if sales remain soft – he expects manufacturer and dealer incentives will wipe out most or all of the emissions-related price increase. He also thinks engine manufacturers will throw in extended warranties at no extra cost and other component makers may be willing to further sweeten the deal. If not?
"There's no big hurry," he said. "My truck is a little over 4 years old and it still looks and runs like brand new."
As of early February few suppliers had publicly announced discounts. Nesvold said some manufacturers were offering incentives – mostly special financing – to spur dealer orders, but they didn't expect to see many manufacturer purchase incentives aimed directly at fleets. And instead of extended warranties, they expected uptime guarantees from engine makers.
At least early in the year buyers still had a shot at getting into trucks with pre-2007 engines. Citing statistics from A.C.T. Research, Nesvold estimated there were about 40,000 pre-2007 engines in the supply chain at the end of 2006 and a little more than 59,000 Class 8 trucks in inventory. "In all, that's roughly 100,000 '06-technology trucks that fleets will need to absorb," he said.
It may not be too late for some who didn't pre-buy, but availability doesn't necessarily drive sales. The owner of a small flatbed fleet confided that he'd been doing a little last-minute shopping, but was stopped short of buying by one simple fact: "We don't have the freight so we don't have the money," he said.
Chuck Hammel, president of Pitt Ohio Express said "of course" they pre-bought trucks last year. Like most, they're concerned about the cost and performance of the new engines, but that won't stop them if new equipment is needed this year.
"You just don't order equipment for the heck of it," he said. "It depends on what the economy is like."
As of early February the picture was starting to look a little brighter, but fourth quarter 2006 was "one of the most challenging freight environments in recent memory," said Swift Transportation President and CEO Robert Cunningham in the company's financial reports. Along with downturns in the housing and automotive markets, he blamed the rough quarter on pre-buying, which added capacity at a time when demand was slowing.
Werner Enterprises also noted an increased supply of trucks in the company's primary markets. The accelerated purchase of new trucks "disrupted the supply and demand balance in the second half of 2006, contributing to a more challenging freight market for truckload carriers," the company said. Increased capacity led to lower rates for spot market freight (i.e. freight not hauled under contract) in the truckload market. Or as Werner put it, "the pendulum for spot market pricing swung from truckload carriers to shippers."
"It's disruptive to the market when you've got these huge pre-buys taking place," noted England. "That's one of the things that create overcapacity and we're victims of that right now." But he and many others believe the problem is short-term. "I think things are fundamentally sound, and I think we'll get through this overcapacity by the end of the year." Perhaps, he added, the truckload segment will even find itself in another undercapacity situation.
Trucking didn't get the seasonal bump it has come to count on every fall, which caused some speculation that many smaller, financially borderline carriers would close their doors. Bear Sterns' trucking company bankruptcy index showed a spike in filings during November, when the American Trucking Associations' for-hire freight index dropped 8.8 percent, but filings moderated during December when the ATA index showed improvement. "But even in November filings were 25 percent lower than they were in January 2000," Nesvold pointed out. "So bankruptcies have been gradually increasing but are still meaningfully better than they were late in the 1990s cycle."
Although there was some pull-ahead buying by vocational fleets (construction, refuse, logging, etc.), it wasn't as extensive as it was among the large, highway carriers, said Mack spokesperson John Walsh. "Customers in vocational applications generally retain and utilize their trucks for a longer period of time."
For them, too, the economy is the overriding concern. The owner of one small Oregon logging company bought new trucks and other equipment over the past few years mainly to take advantage of tax incentives. A recent slump in timber prices, coupled with higher interest rates, now has him struggling to keep up with the payments. "Our interest rates have gone from 6 percent to 8 percent," he noted. "For a company like ours, that's a lot of money."
The Leasing Option
One industry segment that may come out on the plus side of this technology changeover is leasing.
"If I had a private fleet, I'd lease right now. I wouldn't want to take the risk," said Hal Booth, senior vice president, PHH First Fleet, a Florida-based company that provides asset management and financial services to private fleets.
One consideration is resale values. Lease contracts are priced, in part, on estimated residual value. Under most arrangements if the equipment sells for less than expected, the leasing company swallows the difference. That's one selling point for leasing, but the bigger issues are maintenance costs and capacity.
"The manufactures like to say these new engines are as solid as pre-emissions engines, but there's no doubt that more maintenance will be required," noted Lance Bertram, vice president, Idealease. Full-service lessors will bump their maintenance rates slightly on the new trucks, basing their estimates on maintenance and repair information provided by engine makers and truck manufacturers. "That's the best case situation," said Bertram. "If something happens with those engines that the manufacturers don't foresee, we'll have some unsettling rising costs."
Full-service leasing and even maintenance contracts can isolate truck users from those maintenance surprises; it can also get them into well-staffed, well-equipped shops.
"Every time we see a technology shift we also see a lot of fleets reassessing their business model to decide if they want to stay in the truck maintenance business," said Olen Hunter, director of sales for Paccar Leasing. "The cost associated with equipping shops and training technicians can increase significantly with major new technology."
"It's getting more and more complicated to run your own fleet," noted Todd Renehan, executive vice president, sales and marketing for Ryder Fleet Management Solutions. It's getting harder and harder to find technicians, training is expensive, new diagnostics tools are needed, and shops must comply with strict environmental regulations. "As complexities increase that's good for us," he adds. "It's what we do for a living."
If the technology itself wasn't problem enough, a capacity crunch at dealer shops is reportedly forcing some truck owners to wait days for service.
"The great thing about leasing is that leasing companies offer priority service. If you bring your truck in Tuesday morning you get it back Tuesday afternoon," Bertram said.
Booth said First Fleet didn't encourage much pull-ahead buying. "We didn't think moving trucks ahead of cycle made any sense," he explained. "We didn't feel we should move our customers out of a truck that had a lot of good, useful life left in it just to avoid the 2007 emissions. If we make the correct decision this time, we'll probably do the same in 2010."
He won't disclose the number of trucks in their lease portfolio but said First Fleet has been growing about 15 percent annually for the past several years and will likely sustain that rate in 2007.
Other leasing companies made an effort to get their customers into pre-emissions units. One big reason: price. As Bertram noted, the "emissions premium" on a new medium-duty truck is in the $4,000 to $6,000 range. For heavy trucks it runs $7,000 to $10,000.
"When you're in the lease business the customer doesn't see a $4,000 or $9,000 price increase. What he sees is $60-$100 more per month for a straight truck and $75-$150 more for a tractor."
Prices on 2010 compliant engines are expected to make another big jump, but the typical lease term for a highway tractor is five to seven years so customers that got into pre-emissions trucks this time around should be able to sit out the initial 2010 changeover.
Trading before the changeover also gave Idealease a supply of well-maintained, late model used trucks. Prices reportedly lagged some last fall when carriers were getting rid of older equipment to make room for the pre-buys, but Bertram thinks those early trades will be "diamonds on the marketplace" when fleet supplies have diminished and new trucks with '06 engines are gone.
The major leasing companies were reportedly among the biggest pre-buy customers. As of early February many still had trucks with 2006 engines waiting to be leased or in their rental fleets. Estimates varied but, considering the slower than expected economy, many industry experts said those trucks could be still available through the first quarter and possible the first half of the year.
"If a fleet is going to need new trucks or replacements this year, my advice is to get them now, while pre-tech trucks are still available," said Ed Day, Ed Day and Associates, a Nashville-based transportation and fleet management consulting firm. If that's no longer an option he advised fleets to hold on to their existing trucks for another year – even two if possible – until any bugs have been worked out. Then set up a lease contract timed to avoid early 2010 engines.
Bertram said Idealease will probably buy 5,000 to 6,000 trucks this year, down from 8,000 last year but still a significant number. A lot of private fleets couldn't allocate funds to pre-buy or will need trucks for unplanned expansion, he explained. New trucks with the higher price tags will be one option. Converting pre-tech rental units to leasing is another possibility, but lease/rental companies will "think long and hard" before making that offer.
"They'll have to replace those rental trucks with post-emissions trucks and the rental fee for those units will have to be $10-$15 per day more because of the higher purchase price," he pointed out. "I don't want a fleet of rental trucks requiring more per day than the competition."
Renehan said Ryder saw some pull-forward activity among its customers last year, but they didn't push early trades for the lease or rental fleet.
"We're pretty disciplined from an asset management standpoint," he explained. "Our replacement strategy is based on fleet age and we don't necessarily do anything to avoid new technology. We think we're ready. We're buying 2007s and we'll buy 2008s, 2009s and 2010s. Bringing everything back early to avoid new technology would be a bad asset management decision and a bad return on capital decision."
PacLease also took a measured approach. "One of the things we try to do with our clients is help them build some aging into the fleet," said Hunter. "For instance, if a client needs 20 additional trucks we might recommend 15 new trucks and 5 similarly spec'd late model rental trucks on short-term contracts. That way they won't have to replace all 20 trucks at once." Sometimes, he added, "it makes sense to sprinkle a little bit of new technology into a fleet. You just have to make sure it's not too much at once. By adding new technology to a fleet you are able to test it early, find out what works well and what spec' adjustments need to be made to optimize the new equipment.
"With 16 percent average annual growth and an increasing lease/rental fleet, PacLease can't shy away from new technology," Hunter said. "We have to embrace it. That's just part of our business."
Moreover, he doesn't think fear of the 2007 engines will stop people from buying new trucks if they need them. "Everyone thought 2003 would be a down year, but we maintained our same level of sales. It's all about how you approach your customers with the new technology."
