Starks presentation graph

Excess inventories hamper transportation- related sales market, says FTR’s Eric Starks

Inventories to be ‘drag on transportation’

At any given point in time, business inventories traditionally have not had a significant impact in the freight market because they are part of the normal process. It’s only during extraordinary times when things dynamically change.

And we’re at that point right now, according to FTR CEO Eric Starks.

“We have seen a fundamental change where things have deteriorated, so it has a noticeable, negative impact,” he said. “This is at least a six- to nine- month period to be able to work those inventories down. So this will be a drag on transportation as we move through the end of this year.”

In an FTR webinar, “State Of Freight: Key Issues in Transportation,” Starks said there are two ways to work off inventory: stop producing and then inventories come down because the sales environment is already at a set level and it continues to work down; or there is a noticeable increase in economic activity and the sales environment picks up.

“The option of where the sales environment is OK but you have to hold back on the production side to eat away at inventory—that’s my sense of what will happen as we move through this year,” he said. “That will create an economy that is limited in growth. If we’d see a higher sales environment, I’d be ecstatic. But I have a hard time seeing that.”

Starks said that in order to understand inventory cycles, it’s important to go a bit deeper and look at what’s happening within total business inventories by comparing inventory levels to actual sales activity.

“If sales are sluggish and even if inventories aren’t too bad, they still might be a bit bloated,” he said. “You could look at the absolute level of inventory and say, ‘It looks OK,’ but if sales start taking off, you go, ‘Gosh, we don’t have enough inventory.’ So the best way is looking at the inventory-to-sales ratio. During the ‘90s, there was a dramatic decline as we started to move to more of a just-in-time inventory cycle. You can see it within manufacturing numbers. It came down noticeably. As we got into the Great Recession, we saw a significant spike within the inventory-to-sales ratio. It happened in the wholesale market and manufacturing, and to a lesser extent in the retail market. As we got out of the Great Recession, things came back to normal within the wholesale market and dropped below in retail, but manufacturing held higher. I think some of that has to do with transportation costs, because when costs started to go up, the willingness to hold onto more inventory compared to where we were before changed.

“As we move forward, we’re wanting to know if this inventory-to-sales ratio is moving up. The higher the number, the less pressure there is on transportation. It doesn’t need to be moved. You don’t have to generate more freight within the system to continue to produce or move those goods. But we see the retail market has moved up noticeably. We’re just getting back to the levels of 2005-2007. Retail is not awful, but is a little bit higher than we would like. Last year, we brought in a fair amount of goods due to the looming port strike, and that has had some carryover. Manufacturing has picked up from where we were, but it’s not a huge change.

“It’s still too high, and they clearly have too much inventory in the system. We saw the biggest jump at the wholesale level, so the whole market is holding onto a substantial amount of inventory that is having ripple effects all the way through, and specifically in manufacturing. If a wholesaler already has it, you don’t need to manufacture.”

Starks said truckers should expect six to nine more months of downward pressure on rates, but added that shippers should be cautious about aggressively pursuing cost reductions.

“We’re close to that neutral environment,” he said. “So the shipper doesn’t have the upper hand. It’s relatively balanced. As we go forward to the end of this year, we do anticipate the shipper will continue to have some ability to have favorable conditions. There are regulatory concerns we’re worried about in the trucking market. As that starts to happen, we would probably get into unfavorable conditions. However, the forecast we have is balanced. From a risk standpoint, we see it on the downside as regulations start coming into play.

“We have seen where rates have fallen off dramatically in the first part of 2016. They seem to be stabilizing. It seems to be holding at a low level right now. Everything we’re hearing when we talk to shippers and carriers is that shippers are pushing back heavily now. Some of the smarter ones are saying, ‘Look, we understand longer term that we could be having some issues, so we are going to try to lock in some longer term rates within the environment to make sure they have capacity as we move into 2017 and 2018.’ Clearly we know shippers out there who see nearer term and say, I’m ready to push back.’ You have to be careful. If you push too hard, then as things start to return, the carrier pushes back.”

Starks said industrial production basically has been flat for the last 18 months, indicating that we’re not moving into a recession. But this is a completely different environment than we’re used to.

“We’re not used to a completely stagnant manufacturing environment,” he said. “There are a couple of things in play: the first is businesses and core capital goods orders numbers. Businesses continue to shy away and order less and less. The latest data is not tremendously encouraging over the last several months. It continues to trend lower. So we don’t see businesses in the short term being a stimulus for freight growth. I think that’s a bit of a problem.

“However, we can’t put the consumer off to the side and say, ‘OK, they’re not a part of this equation.’ If we look at the retail market, it continues to trend higher. As we start looking at where things are going, we saw a flattening-out through 2015, but over the last several months, we’ve seen noticeable growth within that retail market. And that is a very positive sign. So the disconnect between what’s happening in the business environment and what’s happening on the consumer side is very noticeable. Can this continue for an extended period of time? I don’t think it can. I think we need to see things coming back into line. But we’re not seeing a significant imbalance in the fundamentals of the market.”

Starks said intermodal is now an environment in which carriers and railroads are in partnership with each other, and not competitors. Shippers are saying, “Just give me the most efficient way to get there. I don’t care what mode of transport it is.” Starks said the question is, “Is intermodal competitive so that it makes sense for people to convert their freight into the intermodal market?”

“In 2011-2013, it was very attractive for people to continue to look at conversion,” he said. “It came down noticeably in 2015 and over the last several months it started to pick up. Right now, it’s still attractive to move stuff to intermodal, but not nearly as attractive as was two years ago. We’re going to be paying attention to this closely as we go. Right now, intermodal is competitive but not as competitive as it was, especially as we see capacity out there for truckers, who are willing to move freight over the road rather than put it to the railroads.

“We do see about 3% growth within the domestic intermodal market. There could be upside there as we start seeing pressure from the regulatory environment as we move into 2017. This is going to be a big issue. As you’re trying to put investment into play, you want to understand, ‘Will there be additional freight within the market?’ There will be a little bit of conversion within the system, but not significantly.”

Is capacity loose or tight?

Starks took a look at three areas:

Active truck utilization.

“This is if you have a driver sitting in a truck and saying, ‘Pick me, I’m ready to move freight.’ What is the utilization of that equipment? It’s sitting at 95% right now. During this latest cycle, that seems to be the norm. There is not a lot of pressure up or down. As we move into 2017, that will continue to get tighter. As we get close to 100%, that starts to put additional pressure on rates. If we include the equipment that is sitting idle, then the utilization is closer to 85%. So there is a fair amount of idled equipment out there. That’s having an impact on demand for new equipment in the marketplace. But as of now, the market is relatively balanced. It’s very easy to put additional capacity in the marketplace, and that’s putting some downside pressure on rates.”

Railcar capacity utilization.

“It’s suggesting we’re about 70% utilized, which is noticeably below that 80% historical norm, so this is putting additional pressure on the system. However, this is a good news/bad news situation. While utilization is down, we’re actually seeing the service level at railroads up and better velocity turn times of equipment. It becomes more difficult because shippers go, ‘Look, there’s excess capacity,’ and yet at the same time, railroads are going, ‘Look, we’re giving great service relative to where we were a year or two ago.’

Rails’ shift to non-energy freight.

“Traditionally, coal has been a very big part and very profitable part of the rail system. So then we saw the crude market become a bigger part, and was roughly 5-6% of all their freight. Not a huge amount of freight, but it was a noticeable growth sector for them. If we split this and look at what’s happening to the coal and crude market, we’re sitting just over 20%. We’ve seen that coming down. You can see a noticeable falloff starting around the time of the Great Recession. It started to ease back and then in 2012, 2013, 2014, things noticeably came down. 2016 has been a year where coal has declined at a significantly faster pace than many of us anticipated. When we look at the market share of freight within the rail system as part of the energy-related market, we expect it to continue to fall slightly, and if there is a risk here, there is a downside risk within the coal market. We could see a little bit of upside if you look at the crude market depending on the price of fuel. But clearly we have already been seeing this shift. So this is not necessarily a surprise within the market, but there is an adjustment period as that happens.

“We’re seeing there is significant disconnect. There is a significant oversupply within the coal and crude market, and sitting in that 60% utilization, there is a fair amount of equipment sitting idle. But in the non-crude and oil market, it’s below its historical average. But by the time we get to 2017 and 2018, it’s back to what is considered to be a normal historical level. So that disconnect is expected to continue for the foreseeable future. This is going to create some problems for railroads and shippers because sometimes shippers say, ‘Gosh, it looks like there’s excess capacity.’ But maybe there’s not excess capacity in the type of equipment you’re looking for. We would see a disconnect on pricing pressure as we move over the next two or three years, depending on whether it’s an energy-related or non-energy-related sector. So can you find freight growth in a sluggish economy? It’s not a very easy answer.”

 Starks’ items to watch going forward:

e-Commerce.

“e-Commerce is becoming so prevalent within the system that it is pervasive throughout. I would have never thought I’d be doing most of my Christmas shopping online. Also the virtual environment: Some of it has to do with how the younger generation is willing. I’m not just talking virtual environment in the sense, ‘Oh, we have people working offsite at home offices.’ I’m talking about everybody having an iPad or iPhone or tablet and expecting that they have instant access everywhere they go. If you look at the younger generation, they’re not doing it through email. They’re doing it through texting. The global market is one where everybody typically has a cellphone and access to it. So there are fundamental changes transportation needs to be able to adapt to.”

Truck of the future.

“We’re seeing better equipment and better fuel economy. That will come into play as we continue to move forward into 2020.”

Uberization of trucking.

“It is very popular among the younger generation. A large portion is using Uber. When you talk about it from a trucking perspective, it’s really a technology-driven issue. We already have what we consider to be Uber in the system. We have brokers. But what we’re really talking about is a real-time, instantaneous view of what’s going on and being able to say, ‘I want this load.’ I know where that truck is and I’m doing it in real time. We’re looking at some fundamental changes, but I still think it will be a small portion of the population. And we’re really talking more of a stock-market type of environment.”

Drones.

“Drones won’t have a huge impact on transportation. I’m more curious about drones from a technology standpoint. Can they continue to improve technology and come up with new ways to be able to move freight? We’ll be paying attention to that and see if that can take hold.”

3-D manufacturing/printing.

“That continues to be more prevalent and we’re seeing it in a lot of industries. We’re seeing it more in prototypes. If it becomes a standard in manufacturing, it will change the type of freight that gets moved. It’d be more of a bulk-commodity type of move rather than a finished-goods move. That would change the type of equipment, the type of freight that gets moved.”

Autonomous (semi-driverless) trucks.

“We’re looking at more of a platooning type of environment. That will start to be seen in 2017 on a limited basis. The likelihood this comes to fruition in the 2020s is relatively high, but it will depend on acceptance by the general population. We do know there will be likely safer equipment than a driver, but it comes down to, ‘Will the average person be willing to accept a semi-autonomous vehicle?’ The likelihood we will see a truck without a driver is relatively low. But the technology is definitely moving forward there.”

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