MacKay says economy should move into expansion phase this year, but it won't look the same everywhere

THERE'S no evidence that legendary college football coach Paul “Bear” Bryant knew anything about the truck and trailer industry.

But as Stu MacKay emphasized in his portion of the “Industry Forecast,” Bryant's advice still holds true for the industry: “Keep your chin strap buckled at all times.”

MacKay, president of MacKay & Co, said the economy should complete the transition from the recovery phase to the expansion phase of the business cycle in 2011, but because the recovery did not start everywhere at the same time, reports on overall economic conditions will continue to be mixed.

“The economy appears to have regained its footing and has started to expand again,” he said. “While employment growth will remain the focus of the recovery process, we expect progress on that front to be halting and uneven. The pace of inflation should increase, as commodity prices head higher.”

He said the recovery phase of the business cycle is the interval between the end of the recession and the resumption of full-scale expansion. The recovery phase has three main characteristics: it's uneven (doesn't start everywhere at the same time), unsettled (not all news is good news), and unique (every recession creates its own set of problems).

“We're still in the recovery phase,” he said. “We are not yet into an expansion.”

He said the performance of these three indicators over the next 12 months will tell us most of what we need to know about the recovery:

  • Single-family housing starts.

    “The housing sector is the poster child of this recession. At about 500,000 units, we are running at the replacement level of construction. Getting back to a 750,000 annualized pace in this construction season would suggest a recovery is in place.”

  • Total nonfarm payroll employment.

    “The job losses in this recession have been larger than in any other in both absolute and percentage terms. Nonfarm payroll employment progress will be uneven as public-sector hiring lags. Adding 150,000 per month would suggest a recovery is in place.”

  • Commercial and industrial lending activity.

    “The ultimate determinant of the viability of the recovery will be what happens to bank lending. In the last two recoveries, lending growth took years to get back into positive territory. It seems unlikely the Federal Reserve will allow that to happen again. The Federal Reserve is encouraging banks to accelerate the pace of lending. Moving the line above zero would suggest a recovery is in place.”

    He said 45% of Truckable Economic Activity (TEA) is driven by the consumer. TEA was down 12 points during the recession — twice the decline of general GDP — but has made a “significant recovery.”

    “We're six quarters into the recovery,” MacKay said. “TEA is positive and moving back up the scale, but it's a long way from a positive recovery. We're still down 200,000 truck transportation payroll employment jobs.”

Heavy-duty aftermarket

He listed the major changes from 2009 to 2010:

  • OEMs believe that EGR reduces engine life to overhaul by 25%.

  • MacKay & Co's 2010 fleet and operator surveys show an 11% to 14% reduction in miles to overhaul or rebuild. “It appears that is more or less directly tied to the impact recirculation exhaust gases have in the internal engine and the degradation of overall life.”

  • The type of replacement has shifted to more complete engine replacements resulting in higher cost per failure than a repair or rebuild.

  • These changes result in a 17.5% increase in power generation aftermarket demand in 2010 over 2009.

  • As the population of vehicles with ABS continues to grow and age, ABS component aftermarket potential continues to increase significantly.

  • The miles to replacement of other brake parts is down, resulting in an increase in demand.

  • The net effect is a 19.5% increase in demand for undercarriage parts and components. These two DataMac model factors account for 5.8% of the 13.5% year-over-year increase from 2009 to 2010.

“One of the things driving it is the Class 8 fleet,” he said. “The average age is 9.12 now after being 7.73 in 2006. Multiply the average miles per year and you know we're beyond the sweet spot. And that's one of factors that drove increases in the engine aftermarket and brake aftermarket.”

Projections for future Class 8 vehicle utilization: 84.5% this year, 86.6% in 2012 and then three years at 87.3%. Class 6-8 and trailer replacement parts demand will be up 7.8% this year, but will decrease each year until it's just a 1.7% increase in 2015.

“Some of that is driven by new trucks coming into the marketplace and replacing some of the trucks that have gone beyond the sweet spot that are generating a lot of aftermarket demand,” he said.

He listed these 2011-2020 “game changers”:

  • Continued consolidation

    “We see it continuing as it has the last decade — with the growth of the independent side.”

  • Channel transition

    “A lot of dealer principals and owners of independent heavy-duty distributor businesses will blend those companies into larger publicly or privately held enterprises.”

  • Service: taking the customer out

    “Fleets have told us in surveys that they want to reduce their service footprint, but have not been able to find a distribution system that can support what they need. I don't think that need is going to go away.”

  • Meaningful product and service differentiation

    “It's a very different ballgame today — proprietary engines, proprietary transmissions. The difference between nameplates and brands and product lines is broadening.”

  • The Chinese

    “We are going to have low-cost trucks. They'll be looking for distribution. I think we're looking at lots of changes.”

Commercial Vehicle Equipment Overview and Outlook

Eric Starks, president of FTR Associates

He said 3% GDP growth is expected this year, “but there is a lot of upside. Things are starting to look a lot better. And history suggests that we could see something substantially better than what we're talking about.”

His points in assessing the risk:

  • Economic upside potential is growing.

  • Concern remains over the European debt crisis, but currently is not spreading. “We tend to be worried about a shock to the system. But it seems to be contained.”

  • US debt and inflation are long-term concerns and will not hinder a recovery.

  • The trucking industry is dependent upon the health of the economic recovery.

  • The recent economic recovery has been a “manufacturing-led” recovery. “It cannot be sustained by itself. We have to have the participation of other parts of the economy. Thus, transportation has benefited.”

He said the economic outlook is for GDP growth below “historical recoveries.” Given the depth of the recession, “we would like to see 5% growth. We are watching to see if we get something in that 5% to 10% range. In this particular environment, things get a little crazy. It is a distinct possibility that we'll see stronger economic growth over that short term.”

Some trucking issues:

  • Many of the publicly traded carriers continue to show strong balance sheets. A lot of them have cash on hand and the ability to buy equipment.

  • Access to capital continues to be a problem for the small and medium-size fleets. “There are some indications that this may be ‘thawing’ a bit, but not to the point where everybody goes, ‘Whew!’ ”

  • The looming driver shortage keeps getting delayed, but it's only a matter of when it will hit. “It will somewhat translate into the equipment segment. It will be a major issue for your end customer. CSA 2011 and Hours of Service will have a negative impact. Fleets are not looking to add capacity now. They are utilizing current units and searching for ‘desirable’ freight.”

According to the FTR Trucking Conditions Index (TCI) — which measures freight, fuel, capacity, bankruptcies, and cost of capital — trucking improved in November but is not yet anywhere near the 2004 environment. However, TCI is forecast to reach 2004 levels by mid-2011.

“This suggests that 2011 will be a strong year for the trucking industry,” Starks said. “Freight is the key. Monthly truck freight has flattened over the past six to nine months. When you look at the annual number, you see between 3.5% and 5% growth over the next couple of years. That's pretty good. So we'll take it. But it doesn't get us back to the peak levels in 2006 (13%).”

Domestic intermodal is doing well, with October the second-highest month in history, and Starks said it continues to gain market share from true conversion, trucks, and transloading.

He said the HOS proposal of December 23, 2010, has proposed changes (no more than a seven-hour drive time without a break; at least one hour rest during a 14-hour driving window, and a 34-hoour reset with two night-time periods) that could result in a 6% drop in productivity, amounting to another 150,000 trucks on the road to move the same amount of freight.

CSA 2010, which will result in a driver's record following him (on-going updated scores) and fleets being rated based upon safety data, could have a huge impact:

  • Fleets will not expand (to keep a better score).

  • Large layoffs of questionable drivers.

  • Sooner replacement of equipment and components to avoid maintenance problems (to keep a better score).

  • Shippers will be looking to protect themselves from lawsuits.

  • A severe driver shortage will mean less freight moved. “It's a serious problem that we have to pay attention to. By 2012, we'll get back to equilibrium.”

  • More drop & hook, which means more focus on the trailer market.

He said there are more equipment changes on the horizon: new trucks need to be more fuel efficient, with a 10% to 20% reduction in fuel consumption by 2018; there will be a higher cost of equipment, with payback through lower fuel consumption.

“The increase in fuel cost per mile will open up opportunities for more fuel-efficient equipment, even before the proposed MPG rules in 2014,” he said.

In terms of truck utilization, he said active capacity is expected to reach 100% by mid-2011.

“The disconnect between active and total is a longer term structural issue,” he said. “Tightening active capacity is keeping truckload freight rates higher. Driver shortages will put additional pressure on rates.”

Starks said Class 8 North American net order activity for November was the highest since May 2006, with orders trending higher and a six-month annualized rate of 199,000.

He said Class 8 production in the US and Canada is turning around and “we're going to see several good years.” After just 120,000 in 2009 and 152,000 in 2010, projections are for 201,000 this year, 258,000 in 2012, 274,000 in 2013, and 275,000 in 2014.

FTR has upped its forecast for US trailer production in the past several months to reflect higher order demand and activity. After 132,000 in 2010, the projections are for 170,000 this year, 220,000 in 2012, 225,000 in 2013, and 227,000 in 2014.

“Trailer orders are accelerating and production levels are moving higher,” he said. “Suppliers are going to be hard-pressed to meet near-term demand because there are kinks in the system. We're already hearing of shortages in some sectors. As things continue to ramp up, it's going to be pervasive.”

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