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Trucks, trailers, and aftermarket parts sales poised for growth

TWO leading market analysts are expecting good things from trailer, truck, and aftermarket sales in the near term, but the reasons to celebrate may be a little muted.

Eric Starks, president of FTR Associates, and Stu MacKay, president of MacKay & Company, both see improving conditions in the industry's future, but underlying forces must continue to strengthen for those improving conditions to produce real prosperity.

Speaking at the annual Heavy Duty Dialogue event sponsored by the Heavy Duty Manufacturers Association (HDMA), Starks gave his views on what the future holds for truck and trailer sales. MacKay spoke about leading economic indicators that his company follows, with a particular emphasis on trends in the heavy-duty aftermarket.

For Starks, the future is clear. People buy trucks to move freight. Figure out the reasons why freight volumes change, and truck (and trailer) sales will follow. And at this moment, the reasons to buy are better than they have been but not as good as they need to be.

Starks highlighted some of the things that are troubling over the next several quarters.

“Order activity in recent months has been a little sporadic,” Starks said. “But there was some strong activity late last year as people bought ahead of the implementation of the EPA mandate. October order activity was high, followed by a decline in November.”

EPA's diesel emissions regulation, which led to new technology and higher new truck prices, continues to affect sales and market forecasts. Starks, for example, was surprised at the strength of the orders that truck manufacturers received in December, but he quickly put those numbers in perspective.

“Don't be too excited about what happened in December,” he said. “More telling will be what happens in January, February, and March. All of this tells us that in the first part of 2010, we will see a little bump up from current projections. But the thing that concerns me is that we will be pulling forward some of the demand.”

Trucks sold early in 2010 may be powered by engines built in 2009. Eventually, however, that supply of engines will be consumed. With trucking conditions improving and freight increasing, the stage should be set for growth in truck sales. But because of the disruption of normal buying patterns, Starks said he can envision that heavy truck sales in 2010 could be lower than they were in 2009.

“That's a big fear of mine right now,” he said. “Obviously the economy is going to play a big factor in that. So it's important that we understand what the economy is going to look like.

“Right now, we are a lot more bullish about the economy than a lot of people. We are thinking that the economy is going to grow close to 5% during the first two quarters of 2010. If we are optimistic about the economy but are saying that the truck market will be in the doldrums, we have some upside potential for the truck market.”

Is this normal?

The magnitude of the economic downturn has led people to question the permanence of current conditions. Starks questioned the use of the phrase “the new normal” and presented a case that markets are behaving the way they can be expected to — given the conditions we have experienced.

“I don't understand this talk about ‘the new normal,’” he said. “Does this mean that the fundamentals have changed? The fundamentals have not changed. You still buy a truck to move freight.”

Starks said people believe that fundamentals have changed because of the severity of the downturn.

“It's possible that you in your lifetime have not seen this before, but what we are seeing is not new to the trucking industry,” he said. “It's just that we have not lived through a recession like we have this time. It's the worst recession since 1946. We haven't seen freight flat like this. It was close to these conditions in the 1980s, but the excess capacity that we have this time around has been phenomenal. We just have so much capacity out there. Equipment is sitting idle, and we are going to have to deal with that over the long term.”

Next Page: So what is normal?

Starks projects that freight will bounce back from the depressed levels of 2009, reaching record levels in 2014. Projecting a graph that tracked freight volumes through booms and recessions dating back to 1965, Starks showed that it takes approximately five years following a downturn for freight volumes to reach new peaks. In the 1980s, it took eight years. Other cycles required less time.

“The trouble for truck manufacturers is that while it took eight years in the 1980s for freight to reach a new peak, it took 15 years for truck demand to reach a new peak,” he said. “It actually skipped a full recession cycle.”

Starks said a return to the high level of demand that the industry enjoyed in 2006 is not realistic anytime soon. The reason — high levels of surplus equipment. Last year, an estimated 450,000 trucks were underutilized. That surplus is being reduced, but under Starks' projections going out to 2018, it is never completely eliminated.

“We probably will get back in balance sooner than that, but we do know that something has to give,” Starks said. “We need to see freight grow or somehow get more trucks back in use.

“When we look at capacity and utilization numbers, when capacity reaches 88%, all of a sudden, demand for big trucks goes up. That's when demand for equipment really spikes. But in our forecast, we never get above 88%. There is nothing that says manufacturers will have to really boost production at a rapid pace. This tells me that the industry will not need to add capacity for the next 10 years.”

So what is normal?

Just because markets are reacting normally does not mean that factors affecting truck and trailer sales aren't changing. One example is the durability of today's equipment.

“What is the new norm?” Starks asked. “One issue that seems to come up is the average age of the fleet. People look at the age of equipment and conclude that operators have to replace it. I don't believe it. It's all about useful life. It does not matter how old a piece of equipment is. How many miles does the equipment have? Can it be used another three or five years?

“Age is less important this time. But when we look at the numbers, this is not outside the norm. We have better trucks that have a longer useful life. Add to that the excess capacity, and that is the concern going forward.”

Starks has noticed an increase in demand for refurbished equipment and for fleets to consider purchasing used equipment — including fleets that previously only bought new.

“That's not something that is normally talked about,” Starks said. “Who would have thought that some of these fleet managers would consider buying two-year-old equipment and adding it to their fleet? Some of them are fleet managers who never would have considered refurbished or used equipment.”

What about changes in size and weight laws?

“I think we will see some changes over the next 10-15 years. I think the first thing that will come into play will be the weight issue. But most dry-freight vans cube out first. From a productivity standpoint, the effect will be limited. More importantly will be changes to hours of service regulations. The government is revisiting this topic. The probability of keeping the current system in place is pretty high. But what if the limit is changed from 11 hours per day to eight hours? That is a substantial change in productivity that will have a major impact on equipment providers. Suddenly productivity goes down by 30%, and the need for new equipment goes up.

Buckle up for changes in the aftermarket

It has been a tumultuous couple of years for OEMs and those in the aftermarket. For better and worse, the changes will continue.

In his Heavy Duty Dialogue presentation, Stu MacKay shared economic data as well as his thoughts about what aftermarket parts departments can expect from a market that increasingly is turning to OEM dealers and distributors for their aftermarket needs.

MacKay is president of MacKay & Company, a management consulting and market research firm that specializes in heavy truck and aftermarket sales. In tracking the heavy-duty truck industry, he focuses on three key variables:

  • Truckable economic activity (TEA)

    TEA resembles gross domestic product (GDP), but it subtracts economic activity that does not contribute truck freight. It also includes a portion of the goods imported into the United States. Imports are not part of GDP because the goods are not produced domestically. They should be part of TEA, however, because the goods must be moved from the ports to the retail outlets. However, he includes only about half the value of imported goods when calculating TEA. That is because imports need to be transported to retail outlets, but they do not generate as much freight movement as goods manufactured completely in the United States.

  • Fleet utilization

    How much use are trucks and trailers getting?

  • Aggregate spread

    A metric developed by Robert Dieli, an economist who works with MacKay & Company. Based on the inflation rate and several interest-rate factors, aggregate spread has been show to change approximately nine months ahead of changes in economic activity.

Next Page:TEA points higher

TEA points higher

An upward shift in TEA is pointing to improved conditions for trucking.

“About the third quarter of 2007, the components of TEA began to sag or crater,” MacKay said. “Government was the only component of TEA that continued to increase. The third quarter of 2007 was about the time that the housing industry began to decline. TEA dropped into negative territory in 2008 and into serious negative territory in 2009.”

Demonstrating the benefit of using TEA instead of GDP, MacKay reviewed GDP performance in recent years — strong in 2006, stronger in 2007, flat in 2008, and down modestly in 2009. This obviously was no indication of what happened in the heavy truck and trailer markets during that period.

MacKay showed a graph that compared TEA and changes in the population of Class 8 trucks. In the graph, TEA was holding relatively steady between 2005 and 2007. The population of Class 8 trucks, however, grew significantly during that time as fleets bought trucks ahead of the 2007 diesel emissions mandate from the Environmental Protection Agency. The implication: more trucks were sold during that time than were needed, an indication that it will take longer than expected for new truck and trailer customers to get back into the market.

“It really takes a long time to burn up that surplus equipment before we start to see any improvement of any consequence in the new truck business,” MacKay said. “The good news is that we are starting to see TEA coming up. We are starting to see equipment that had been parked being put back into service.”

Aggregate spread moves higher

Based on the direction the aggregate spread has been taking, MacKay says the economy bottomed last summer and is moving up.

“The mess that we are in began to turn around somewhere late in the third quarter,” MacKay said. “In spite of the increase, we are still in the tank in the first quarter. We should begin easing back up in the second quarter. The aggregate spread points to extremely positive for the fourth quarter of 2010. The data that we see indicates that we can expect a sharp rebound in economic activity. It's a very encouraging sign from our perspective.”

Matching up TEA and heavy-duty aftermarket parts sales, MacKay said 2009 was the worst year since he has begun tracking it. According to a graph that MacKay showed, the 1990-1991 recession was bad, with two consecutive years of decline in TEA and in parts sales. This time around, the retraction has been deeper and more prolonged. TEA has declined every year since 2004.

Along with the decline in TEA, parts sales showed a real loss in 2008 and an almost 10% decline in 2009. This has been a far more serious retraction than other recent downturns. Parts sales, for example, never went into negative territory during the most recent recession of 2001-2002.

Trucking activity as measured by the Morgan Stanley Truckload Freight Index is another reason for optimism, MacKay said. Throughout the first three quarters of 2009, that index was well below the level of recent years (2003-2008). But beginning in the fourth quarter, the index began to exceed 2008 levels and was on par with 2006.

“This is a very positive indication,” MacKay said. “This will stimulate demand for trucks and, over time, the sale of aftermarket parts.”

Getting back to work

A third factor that MacKay tracks is fleet utilization. To get an idea how effectively fleets are operating their equipment, MacKay & Company surveys between 700 and 900 fleets. By MacKay's measure, fleet utilization bottomed out in the first quarter of 2009 and moved higher in both the second and third quarters before leveling off in the fourth.

“We still have room for improvement,” MacKay said. He pointed to 2007, when fleet utilization was at 87-88%. His most recent survey showed it at about 83%. Nevertheless, fleet utilization is markedly better than in the first quarter of 2009, when it was below 77%.

“The point I would make is that utilization has turned, but we are a long way from the kind of utilization that would trigger serious new truck activity and serious aftermarket demand.”

As has been the case with other indicators, fleet utilization hit bottom in 2009. It was at comparable levels in the early 1990s, a low point which MacKay explained was caused by the aftermath of deregulation.

Aftermarket variables

In spite of the positive economic news, aftermarket parts sales are facing several hurdles before they can work their way out of this recession. They include:

  • Too many trucks

    There are still more trucks than needed to move the current amount of freight. At one point, more trucks were sitting idle than at any time MacKay had seen since at least 1982.

  • Parts cannibalization

    “We had a bit of this in 1982 as a result of deregulation,” MacKay said. “But I haven't seen parts cannibalization like this in any of the previous recessions.”

    Based on an electronic survey of 300-400 fleets along with a large number of distribution businesses, MacKay concluded that approximately 15% of parts demand was being met through cannibalization.

  • Inventory pull-down

    Parts inventories are being trimmed to historic lows. At some point, however, shelves will need to be restocked.

Aftermarket outlook

A year ago, MacKay forecast that parts demand would decline 1.3% in 2009. “But when we looked at all the parked trucks, cannibalization, and the impact of inventory reduction, the number went to -8.3%,” he said.

“So where are we headed? We think for 2010 and probably not until the third quarter, the number of parked trucks will be reduced to 1.5% to 3.5% of the population,” MacKay said. “In 2009, 7.6% of Class 8 trucks were parked.”

Utilization rates will improve in the coming years, but nothing like we saw in 2005-2006, he said. But as utilization rates improve, parts and service departments can expect to see more business. The equipment from some of the big production years will be reaching the overhaul and replacement cycles.

“That should drive a 4.5% increase in the aftermarket compared with where we are right now,” MacKay said.

Parts should also get a boost as the cannibalization process runs its course. After all, a part is only cannibalized once.

All of these factors combine to lead MacKay to expect an 8% increase in aftermarket parts sales in 2010. However, he does not expect a lot of growth long term in the aftermarket. The reason: components last much longer. MacKay pointed out that engines used to receive an in-frame overhaul after 250,000 miles of service and an out-of frame overhaul after 450,000 miles. That is being stretched to as much as a million miles today. The same trend can be found throughout the drivetrain.

MacKay is forecasting an 8.3% increase in parts demand for trailers and for Class 6-8 trucks in 2010, followed by an additional 2.2% increase in 2011. But because of the improved quality in components, he believes parts sales will edge down 1.5% in 2012, 1.8% in 2013, and 1% in 2014.

Parts sales for trailers and container chassis could drop by 6-7% as fleets continue to adopt technology that allows them to utilize their equipment more effectively.

On the positive side, MacKay expects annual mileage to increase for trailers and Class 8 trucks. In 2009, trailers averaged 49,650 miles for the year. That should increase to 54,042 by 2014.

Looking out to 2020, MacKay identified several trends to watch:

  • Slow growth in the population of trailers and Class 8 trucks.

  • Class 8 truck manufacturers increasingly will place proprietary engines in their vehicles.

  • Increased acceptance of medium-duty hybrid trucks and heavy-duty trucks powered by alternative fuels.

  • Universal use of onboard electronics.

  • A minimum increase of 20% in repair/replacement mileages.

  • Increased desire on the part of fleets to outsource service.

  • Improved availability of service technicians.

  • A $55,000 increase in the purchase price of a Class 8 truck.

Looking out to 2020, MacKay predicted two significant changes in the aftermarket:

  • The OE dealer will get more of the parts business. The reason for the shift will be that trucks will become more complex.

  • Independent dealers increasingly will become part of a buying group.

“Short term, we are going to have better market in 2010,” MacKay said. “It's appropriate to gear up for a market rebound. Long term, buckle up for distribution changes.”

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