The pre-buy leading up to the Environmental Protection Agency's 2010 engine-emissions standard will not be nearly as strong as it was before the 2007 emissions changes, according to A.C.T. Research senior partner Kenny Vieth.
Vieth presented the pre-buy as one of his five wildcards — key determinants of truck demand between now and 2010 — in a “2008-2013 Industry/Market Forecast” that also included Christopher Brady (economic issues), Martin Labbe (social issues), Stu Mackay (regulatory issues), and Wendy Leavitt and Jim Mele (“Trucking's Future: The Big Picture”).
“Our initial estimates suggest that EPA 2010 is likely to add another penny per mile to ownership costs for truckers,” Vieth said. “These days, truckers are working to remove costs at the hundredths-of-cents level. While there will be a pre-buy in 2009, it won't be nearly as strong. In 2006, the US economy was at the peak of its cycle and truckers were at the peak of their profit cycle, and manufacturers had been in the process of ramping up production for two years. The conditions were perfect for the storm of demand and supply that occurred.
“Ahead of 2009, the economy is trying to recover and trucker profits are under pressure from the combination of weak freight, lingering overcapacity, and high diesel prices. The timing of the economic rebound and trucker profitability will impact how big the pre-buy ultimately gets. The list of reasons truckers have pre-bought and will pre-buy again is familiar. Assuming there are any early buyers, they will get the bugs that weren't out and tested. Add to those reasons parts availability, mechanics' training, and a host of unknowns including new-purchase price and changes in operating costs, and you have a pretty compelling reason, at least initially, to avoid the new equipment.”
Vieth's other wildcards:
- Oil.
“To me, the most important economic indicator today is the price of oil because it tells you where the price of gasoline and diesel are headed. Every penny in the aggregate price of a gallon of gas and diesel converts to a billion dollars of consumption and investment to energy spending. Instead of buying goods that would have required trucks, we bought gas instead. There's been a lot of spending deferred in the past five years. From 2002 to 2005, gas prices rose nearly $1.50 per gallon — the equivalent of converting $300 billion every year from goods to gas. That's a lot of freight up in smoke. If we see $4 per gallon while the economy is still dealing with the aftermath of the housing bubble, economic weakness deeper in 2008 would appear to be unavoidable, and a second- or third-quarter recession would be the likely outcome.”
- Used equipment.
“One of the bright spots has been consistent pricing for used Class 8 tractors. The strength in pricing has been maintained even in the face of a freight recession and during a period of significant excess capacity. There are three factors: historic sales timing, rising new truck prices, and a jump in Class 8 exports.
“There was a surge in the export of used Class 8 equipment in 2007. For all of 2007, we anticipate that between 21,000 and 22,000 Class 8 units were exported — more than double the 9700 units exported in 2006. Back in 2001, when the market was swimming in used trucks and the dollar was extremely strong, only 2800 units were exported offshore. Three factors have propelled global demand for US equipment: (1) Dollar weakness. Since 2001, the dollar has fallen by nearly 65% vs the Euro and 60% vs the Canadian dollar. Little wonder that Class 8 exports to Canada nearly doubled in 2007; (2) commodity-price strength. Countries that are rich in commodities need to get those products to market. Russia and Nigeria nearly doubled their imports in 2007; and (3) there was a change in the law regarding sales of used equipment into Mexico, causing a 13-fold year-over-year increase in trucks heading south of the border.
- Southeast Asia.
“If you're already in China, congratulations. We've seen a three-fold increase in the size of the market the past eight years for trucks over 6 tons. Ditto for India. In China, nearly all the growth has been in the heavy end. In 2007, those two markets combined for nearly one million units. I expect those markets to go over 1.5 million units within the next five years. China is on the cusp of a transformation from a light- and medium-duty-based economy to a heavy-tractor-based economy. If you build parts for trailers, I predict China will go from nearly no trailer products to an economy that's going to require two to three million trailers to service it.
“Presently, Chinese companies have their hands full keeping up with domestic demand. They will be so busy at home and rising up the quality ladder that they won't be significant players in North America or Europe for five or 10 years. At some point, though, the Chinese and Indians will be your toughest competition. Today, you hold the technological edge. With money, time, and assistance from foreign partners, Chinese manufacturers are rapidly heading up the learning curve. They aren't throwing labor at their challenges, but capital. State-of-the-art machinery and robots are replacing older machines. Any supplier that wants to maintain control of his destiny has to be in India and China.”
- Intermodal.
“I consider intermodal the anti-wildcard. Because of the nonlinear and shorter haul nature of freight, it is unlikely to ever be more than a niche market — an important niche, but a niche nonetheless. Intermodal transportation thrives in containerized imports, where high-freight density and long freight corridors provide huge economies of scale. The modern American economy is dependent on trucks.”
Brady: economic issues
Brady, principal of Commercial Motor Vehicle Consulting, said Class 8 truck demand is a function of the macro-economic environment and supply chain.
“Consumer spending is decelerating,” he said. “Inflation is increasing, and that's slowing the growth of real wages. There is a decrease in wealth as housing prices decrease. Employment gains are slowing and credit conditions tightening. Business investment spending is projected to decelerate over the next few quarters as profit growth moderates due to slower business sales and rising input prices. Government spending, particularly state and local, is projected to decelerate as tax-revenue growth slows.
“We'll probably see an inventory correction in the first half of 2008 as wholesalers and retailers will partially meet sales by drawing down inventories, and we'll see a weak freight environment. One bright spot is exports, which remain strong as the global economy with India and China develops rapidly.
“An upturn in the second half of the year will be gradual in the freight environment. There's not going to be any snapback in truck volumes in the second half. In 2006, Class 8 capacity expanded at a lot faster rate than freight volumes due to the pre-buy, so utilization was declining throughout 2006 and into the first quarter of 2007, then increased at a sharp rate, but that was due to fleets dramatically reducing investment spending on trucks. If you look at the second and third quarters, retail sales were below replacement-demand volumes. That implies that fleet capacity decreased in the second and third quarters. The upturn in fleet capacity utilization will decelerate over the next several quarters because the freight environment is going toweaken due to an inventory correction.”
He said the slowing economic environment implies that business profits will decrease and businesses will extend truck replacement cycles to conserve cash flow.
He said fleets' profit margins are being squeezed, and utilization is low.
“It's a scenario for lower profits,” he said. “I don't expect profits to rebound in 2008. Diesel fuel that was $1.58 in 2002 is now averaging almost $3. If you look at what Warner Enterprise's fuel expenses were as a share of total operating expenses, it was 10% in 2002 and 20.2% in 2007. Fuel surcharges do not completely offset higher diesel prices. They cover about 85%. The reason is that fleets do not get paid for out-of-route mileage or idling. To make up that 15%, they have to increase basic freight rates. And in the current environment, they don't have the pricing power to pass along higher freight rates, so profit margins are squeezed.”
He said the average age of Class 8 trucks is going to be 7.4 this year — the highest level since 1991. Truck-ownership costs are rising because of the increase in new Class 8 truck prices and declining used-truck prices.
Labbe: social factors
Labbe, president of Martin Labbe Associates, said our aging population is purchasing less. More heads of households are now single, and purchase patterns are completely different than they were 20-30 years ago.
“It's see it and buy it,” he said. “We have to have an inventory on the shelf. If it's not on the shelf, they'll go to the store down the street.
“Many don't have recession experience, because the last one was in the early 1980s. They don't have an idea of what it's going to be like, so they continue to spend and spend and spend.”
He said consumers are more likely to buy immediatelyonline or through the use of gift cards. Combine that with the increased purchase of electronics, which don't weigh a lot, and it adds up to less truck tonnage.
Other issues:
- Travel.
“You and I want unrestricted access to every road any time. Congestion on roads is significant, not just in population but the fact that the population is driving more cars. When we first had a gas-price increase three years ago, there was a 9% decline in the purchase of gas in two weeks. It didn't take us long to reverse that.”
- Regulatory activity.
“We're in a new environment. We have Democrats in the House and Senate, and possibly the White House. If we think we've seen some regulations up to this point … There are overlapping jurisdictions as far as regulations: We have EPA, DOT, and Homeland Security, and all of them are trying to control one or more facets of transportation.”
- Foreign outsourcing.
“There is a skill set that we hadn't seen. You've heard about the rise of the middle class in India and China. Those countries are going to want the goods and services we have here. They can see what we consume, and they want to consume the same thing. That's going to be good for some production, but it's going to divert it from others and drive up the price of commodities.”
- More efficient equipment.
“Why don't we have side curtains on every single trailer so you can offload and onload them quickly? Because we don't have the docks to be able to do that, or the personnel trained. But that's where we have to go if we want to move freight quickly.”
- Time.
“Time is what these individuals have to be able to manage more efficiently than they have in the past. Time for unloading and loading, time for driving, training, maintenance, repairs. What's happening is that we're squeezing more and more on each of these companies. It's $30 an hour for a vehicle to operate as a fixed cost for its normal capacity of 60 hours a week. That number has to be reduced. The way we reduce it is by increasing the utilization of that equipment or being sure it's on the road every single minute it has available to it.”
Mackay: regulatory issues
Mackay, president of Mackay and Co, addressed the following topics:
- Engine emissions.
“We are probably going to be in the position post-2010 where sucking on a tailpipe of a Class 8 diesel engine will be healthier than breathing the air in many cities in this country. We have come a long way, but not without a lot of expense, pain, and cycles in this business. The good news is that we've dramatically decreased the emissions level. The bad news is that it's taken a toll on the industry and suppliers in the industry.”
- Alternative fuels.
“Ethanol: Are the economies of that really solid? I don't see it. Biodiesel: If we're backing up to McDonald's and taking fat that's been used to make french fries and putting it with stuff and making biodiesel, that make sense. We're not growing anything to make that alternative fuel. The challenge is that we have more ethanol now than we can practically use, and those 535 people in Congress are saying we're going to have a lot more. Europe has biodiesel sitting around. There simply isn't enough demand for what's been produced. There is a role for alternative fuels. It doesn't appear we have found it yet.”
- Hybrids.
“Probably the most effective short-term applications are in high-idle, high-utilization, relatively short-haul applications. Will that have a lot of impact short term on the truck business? Probably not, because while we're increasing the price of a truck to have hybrid equipment in it, generally speaking these are long-period cycle vehicles. It's not uncommon for a vehicle like this to be in service in the hands of a first owner for 12, 14, 16 years. Having said that, once the lease-rental industry, which buys a big chunk of medium-duty vehicles, moves aggressively into hybridization and we see Ryder and Penske putting a lot of vehicles into their fleets, it will have a big impact.”
Leavitt and Mele: trucking's future
Leavitt, director of editorial & market development for Fleet Owner magazine, said Selective Catalytic Reduction (SCR) is fairly affordable and widely and successfully used in Europe and “if we're really lucky, it will provide a fuel-economy boost,” but there is no infrastructure and “no one has a clue” how to enforce the correct mix.
“Other solutions are emerging,” she said. “There are solutions called NOx absorbers and some work being done in solid SCR. But whatever solutions emerge for NOx control in 2010, rest assured it will not be the technological challenge we all saw in 2007.”
Mele, editor-in-chief of Fleet Owner, said there is a “lot of pain right now” among for-hire carriers regarding capacity.
“2007 saw a fairly significant drop in tonnage and was reflected in pressure on rates, and certainly in bottom lines,” he said. “However, if you look at the long term, it's a pretty rosy picture for trucking. We expect over 30% growth in tonnage in the next decade.
“However, there have been some numbers in the last year that raise open-ended questions. GDP and tonnage traditionally have moved in parallel. However, last year we saw modest growth in GDP but tonnage fell. To add to that, while tonnage fell, the number of shipments remained flat. Fleets don't know yet whether that was just an anomaly and they'll go back to the classic relationship between GDP and tonnage once the tonnage comes back or whether it really represents a fundamental change in transportation patterns.”