IF YOU DO A GOOGLE SEARCH of the cyberspace universe for Truckable Economic Activity (TEA), you'll find exactly one match — a story posted on MacKay & Company's Web site that mentions the company's proprietary measure of demand for trucks and trucking services.
But Stuart MacKay, president of the market research and consulting firm, believes that it is a valuable statistic. In “The Aftermarket Economy: What Distributors Should Know,” he said that TEA — which counts only those components of Gross Domestic Product (GDP) that can move by truck — accounts not only for the activity that drives the use of trucks and the demand for trucks, but ultimately the replacement parts and service businesses.
He said TEA has been growing faster than the overall economy during most of the current expansion. In the past 10 quarters for which results are available, TEA has exceeded GDP nine times and equaled it once (first quarter of 2005). There have been three quarters in which TEA more than doubled GDP.
“We think this provides a better explanation of what has been going on in the industry,” he said. “We expect TEA to continue to grow at a healthy pace in 2006. We expect GDP to grow at a healthy pace in 2006. Bottom line: We're in very good shape.
“Several domestic challenges lie before us. We will get a new Federal Reserve chairman in 2006 who will be faced with some difficult decisions on the future course of interest rates. And fiscal policy will be heavily debated in front of the 2006 Congressional elections. The good news for 2006 is that it's not a presidential election year, so we can at least minimize the impact of some of the hot air and we can hold our breaths until Hillary Clinton and John McCain square off in 2008.”
He said the Fed just completed its efforts to remove the stimulus it had applied to help get the economy back on track. The rise in the Federal Funds rate from 1.00 to 4.25 was not a tightening, but could turn into one.
“The concern is that at some point in time, the Federal Funds rate tends to indicate we're moving into trouble,” he said. “All of the recessions have been preceded by a rise in the Federal Funds rate. The new chairman will soon have to decide whether rates have been raised enough. We're seeing signs of the change of growth in the economy.
“We know the truck business is coming down. New engines may have very significant downward pressure in new truck activity in terms of production and sales in 2007. We're also fairly confident with the fact that we will slow down in 2007. We're not looking at a recession, but we're getting concerned.”
Consumer spending could slow
He said the other major concern is whether the rise in rates that has taken place will slow consumer spending and business fixed investment and thereby cause employment growth to slow.
“Job growth in this expansion has been considerably slower than all prior expansions,” he said. “A softening job market would further induce caution on the part of consumers, which would feed back into spending and employment.”
He said the Aggregate Spread — which is MacKay and Co's preferred leading indicator of recessions — also is flashing yellow. He said it provides “20-20 hindsight nine months in advance,” and has reached a level suggesting that it may soon be time to start planning for a recession. He notes that all recessions since 1969 have been preceded by negative readings of the Aggregate Spread.
“The US economy is on firm footing, but adjustments will have to be made to both fiscal and monetary policy to insure that the expansion continues,” he said. “Caution needs to be the word. The global economy is also moving ahead at a healthy clip, but faces similar policy adjustment needs.”
He said the Class 8 industry has experienced a utilization rate of nearly 90% (“There is just not much excess capacity in truck use”); for-hire carriers are at 96%; lease/rental is at 95% (“the highest we've seen over the last two to three decades”); and construction/mining is at 85%.
He said Class 8 retail sales for 2006-2009 will be 935,000 trucks if there are no '07 engine problems, and 940,000 if there are.
MacKay said Class 8 units will fall by 40% in 2007.
“The good news from your perspective is that this really doesn't impact the aftermarket until about 2013,” he said. “I don't know how many of you were working on plans for 2013, but I'm not. We'll be back in business in a serious way in the truck business in 2008 and 2009. The problem in 2010 is that we have a new round of emissions controls coming into play. As you listen to your suppliers talking about the OE business, 2007 could be tough. If these engines really do fly and buyers embrace them, it might not be as tough. But from a planning perspective, anticipate a relatively soft year in the truck business.”
He said the number of trucks operating in the US has grown from 864,916 in 1969 to 2,561,500 in 2005.
“The operating universe has declined only twice in the last 35 years: the recessions of 1982 and 1991 — 1% or less,” he said. “The operating universe remained flat once in the last 35 years: the 2001 recession. The largest recent increase in the operating universe was 6% in 1999. The point is, even in the lousy years, we're adding to the operating truck universe, which is good from your perspective. We hear negative noise about the new-truck business, but we're looking at continual growth in the heavy-duty aftermarket.”
Component durability
He said that 15 years ago, Class 8 parts consumption was very high for vehicles in their fourth and fifth years ($5,873 and $5,911 respectively), but now those years account for only $2,556 and $2,533 respectively, while the numbers have almost quadrupled for vehicles in their eighth and 10th years.
“As a result of component durability, the big hit doesn't catch us until Year Six,” he said. “We've pushed the parts demand back down the time zone. That's one reason why your business today is benefiting from all the trucks that were put into service in 1998-1999-2000.”
He said the average overhaul mileage for Class 8 diesel engines has increased from 276,000 to 695,000 since 1983. The first overhaul is coming at 8.9 years instead of 2.8.
“It's really changed the composition of the engine-service business and engine-parts business,” he said.
Where does independent distribution fit today? He said it's solid, with a 26% share at retail.
“The truck dealer is getting most of his product today from engine distributors,” he said. “This is in the process of change. Volvo is now 60% Volvo engines. International is bringing in an engine program in '07. Mack will benefit from Volvo and continue to have its own proprietary engines. Detroit Diesel was acquired by Freightliner and also is installing a Mercedes engine. So the growth of the engine distributor — Cummins, Caterpillar, Detroit Diesel — will be changing because of the impact of proprietary engines.”
He said the average truck dealer performance breaks down like this:
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Sales: new trucks, 58%, parts, 23%, used trucks, 11%, service/labor, 8%.
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Gross profit: parts, 39%, service/labor, 35%, new trucks, 20%, used trucks, 6%.
Parts sales by customer type: for customer installation, 40%, through dealer's shop, 39%; independent garage, 15%; and re-sellers (includes other truck dealers), 6%.
Independent distribution
He said his list of required reading includes Pete Pasdach's editorial in the December 2005 issue of Truck Parts & Service magazine. He said the “Gospel According to Pete” regarding independent distribution is that the business foundation is customer service, relationships, understanding customer needs, reducing downtime, and having a consistent, reliable parts and service source.
MacKay's concerns:
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Distribution channel cost compression. “Reducing the number of stops and steps and reducing the spread between original product cost and end user acquisition cost.”
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Distribution flow acceleration. “Increased turns, restricting inventory — basically doing business a different way.”
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Supplier consolidation.
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Customer consolidation.
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Competitive distribution consolidation. “Kenworth has a dealer network owned by one company that stretches from Colorado to Florida. One Peterbilt dealer has 44 locations. International is buying up and consolidating dealers. The structure around you is changing.”
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Enhanced OEM aftermarket leverage.
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Enhanced OEM systems capabilities.
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Improving OEM/OES talent base.
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Unbundling product and knowledge.
“Are proprietary engines a threat?” he asked. “I'm not sure. The auto business is 100% proprietary drivetrains, and the auto dealer has what, 20% of the aftermarket? So I'm not concerned — even though auto and heavy-duty markets are two separate businesses — that proprietary drivetrains really represent a threat of significance to independents.”
He said independent distribution probably can't be generalists, all things to all people, a “come to” business, price merchants, brand “fat”, service as a sideline, and truly independent.
“It will be necessary over time for more of you to function together as systems so you have the same kind of leverage, control, and perspective that your competitive channels are developing,” he said. “My speculation, looking ahead 15 years: There are going to have to be more of you tied together more tightly into a systems approach to be a more effective competitor on a local basis and on the national scene.”