Mild recession, mild recovery

AMERICA'S economic recovery hasn't been a huge surprise because the elements of recovery seemed to be in place last summer, according to market analyst Eli Lustgarten.

Now for the bad news: Because the recession was not as dramatic as expected, the recovery will not be as dramatic as those that typically follow a recession.

Lustgarten led off The Work Truck Show's educational program with a hard-hitting economic update, which he subtitled, “Cautiously Optimistic About a Return to Normal.”

He said that inventory reduction, as usual, was one of the main factors that caused the pundits to look at the downturn and call it a recession. The difference this time is that the residential sector, because of very low interest rates and strong consumer spending, not only didn't contribute to the recession, but instead stayed near record levels. Along with a strong auto market, that has dampened talk of a strong recovery.

“Inventory is going to come back, but the two big markets that usually snap back — housing and autos — had no place to snap back to,” said Lustgarten, who is managing director of HC Wainright and Co, a member of the Institutional Investor All-American Research Team, and has been recognized five times by The Wall Street Journal All-Star Analyst poll.

“We had record housing and record autos, God bless 0% financing. So we are sitting at 16.5 million car sales, down from 17.4. We're sitting at 1.6 million sales in housing. There's no place to snap back to.”

Companies Manage Their Way

Lustgarten said most companies had been setting the stage for a substantial upturn in profit once the volume rose. They engaged in further cost-cutting, overhead reduction, and consolidation efforts because they recognized that although they couldn't control the economy, they could control how they ran their business. But he said most companies recognize they can't “cut their way to prosperity.”

He said the post-recession environment will be better than it was after the last recession, citing: the tax cut; interest-rate cuts (producing the lowest Fed funds rate since 1962); a big liquidity injection by the Federal Reserve; flat to falling energy prices; possible stimulus packages; slowing international trade; inventory correction nearing an end, with businesses possibly needing higher inventory at any given production level due to a slowdown of goods shipments; and less-than-normal recessionary restraint of aggregate household purchasing power.

He said the truck-market positives of 1997-1999 clearly were not sustainable because: the strong domestic economic and industrial production/capacity utilization growth was not sustainable; the Union Pacific/UPS strike was followed by Conrail/CXS integration problems; NAFTA benefits of increased Mexican and Canadian trade have waned; and the fleet-replacement cycle was shortened from 4-5 years to 3-4 years due to increased utilization, increased cash flow, driver enticements, flat-to-down prices, and guaranteed residual prices.

“God bless Freightliner and guaranteed residuals,” he said. “Wonderful market, but the other side of it is a disaster. What's the estimate of excess trucks in the used market? Most say 100,000 trucks sitting there called “used trucks looking for a home.” Freightliner is trying to walk away from guaranteed residuals. They're still in the market, but they're not at 40% — they're at 20%. If you bought an $80,000 truck and had a guaranteed residual of $40,000 over three years, at 400,000 miles, that's 10 cents a mile. Today, they'll only guarantee you $20,000 residual. So now it's $60,000 it'll cost you over three years at 400,000 miles, but it'll be 15 cents a mile. How do you make 10 cents a mile? Keep the truck another year longer.”

‘Negative Bias’ in Truck Market

He said the truck market for 2002 has a “negative bias”, with positives (low energy prices, low fuel prices) being outnumbered by negatives (lower freight tonnage, higher insurance costs, declining used-truck values, a record 4,200 truck company bankruptcies in 2001, and emissions requirements that have and will continue to raise truck prices).

“With proposed EPA fines of up to $14,000 per engine, it's guaranteed the engine cost goes up a few thousand dollars,” he said. “So here you are looking at the truck market and economic recovery is coming and you're not sure what you need and you've got those new economic standards coming, giving you a new engine at higher prices. Somebody may have to pay a fine, and God knows what the new engine warranty characteristics will look like.”

He said the forecast for Class 8 diesel-truck demand in 2003 is “a return to more normal.”

“The moral of the story is, we've turned after hitting bottom, and we're going to get somewhat better,” he said. “But regardless of the economy, 2002 in the heavy-truck market is going to be affected as much by the politics of EPA and the politics of Daimler-Benz, residuals, and used truck prices as anything else.

“In 2003, we'll still have a used-truck problem. We'll still have EPA problems. But a strong economy should drive the numbers back towards a more normal range, but probably at the lower end of more normal. But normal is not the 335,000 units of a couple of years ago. You don't want to run your business to plan for that. Normal is 200,000 to 225,000. We are clearly at a turning point. But the truck industry has some politics of its own in heavy trucks.”

News From The Labbe-oratory

In the truck industry market outlook portion of the session, Martin Labbe, president and CEO of Martin Labbe Associates, said that fleets are not looking to buy a significant amount of equipment, partly because profits aren't there.

“Typically, two-thirds of your investment comes from retained earnings you have in your business,” he said. “And if you have no retained earnings, you're not going to be able to buy a lot of equipment.”

He said the Class 8 first-owner population (five or fewer years old) will decline by 4% in four years, while the primary second-owner population (6-10 years old) will grow by 23%. The result: far too many used trucks are available for sale and will be for some time.

Labbe's conclusions on market conditions: freight growth will slow dramatically; fuel prices will be higher than historic averages; driver wages will increase 25% by 2004; insurance increases will be 15% per year; and 60% of operating costs will face increases in excess of 10% per year.

In the carrier market, he sees small- to medium-fleet bankruptcies, large-fleet mergers, a movement of owner-operators to fleet, and private fleets retaining more line haul.

His “Comments to the Choir:”

  • Class 8 write-down will exceed $2.5 billion overall for two to three years.

    “For SUVs in one year, it was about a $7 billion loss in residual value,” he said. “You look at the price of a 1999 SUV right now — Ford Explorer or higher — and you will have seen, over the last five or six months, a drop of $5,000 or $6,000. That's about $4,000 faster. $4,000 times 1.8 million equals $7.2 billion for that one model year. And there's more to come.”

  • Used-truck prices will be soft until 2004.

  • Trailer demand will remain soft through 2002 due to a glut of equipment.

“I was proved wrong in January,” he said, “but I can't see that sustained.”

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