Manufacturing has led recovery, but growth recession is possible the economy, while not contracting, doesn't grow at robust pace

FTR Associates president Eric Starks says that before he gave his “Commercial Vehicle Trailer Update and Outlook” presentation at the NTDA Convention, people were encouraging him to throw them a bone.

They told him his previously downcast sessions had marked him as “Mr. Negativity” and “Mr. Pessimistic.” Could he give them anything that could make their day?

Yes, but he was cautious about it.

Starks repeated the now-familiar refrain: Trailers are bought to move freight.

“People do not go, ‘For $6000, that's a pretty good trailer — I think I'll buy it,’” he said. “No, if you don't have freight, you don't buy the equipment. It's that simple.”

He said the trucking industry is dependent upon the health of the economic recovery, and the two can never be disassociated. While there is a “substantial downside risk” to the economic recovery, a true double-dip recession is unlikely. He said a “growth recession” is more plausible — meaning the economy doesn't contract, but doesn't grow at a robust pace.

“Typically you like to see 3% to 3.5% of growth,” he said. “We are forecasting 2.5% to 3%. It's likely to be below the normal trend. But it's more likely to be sub-2%. Typically when you get below 2% GDP growth, we have a flat or falling freight market.”

On the positive side, the recent economic recovery has been led by manufacturing instead of retail, as it more commonly is, and transportation has thus benefited. Manufacturing continues to show expansion, but the rate of growth has been slowing. The ISM Manufacturing Index peaked at 60 in April and has been falling since. According to the three-month moving average on the Chicago Fed National Activity Index, the reading of minus-0.7 “clearly suggests the economy definitely is not going at full potential, and that's problematic. It needs to start moving in the other direction.”

The overall trend of core capital goods and new orders at factories continues to be higher. The inventory/sales ratio is near a record low and the retail sector is extremely lean, which is “good for trucking.”

Some trucking issues:

  • Many of the publically traded carriers are showing strong balance sheets.

  • Access to capital continues to be a problem for the small and medium-size fleets.

  • The looming driver shortage keeps getting pushed out

Further. “It is no longer a question of, ‘Will there be a huge shortage?’ but rather, ‘When?’ CSA 2010 will severely add to the driver shortage problem as some drivers will be pushed out of the system. They put a mechanism in place to rate drivers. Some drivers who have questionable documentation or are deemed to be unsafe are gone. In the past, the shipper didn't care. The dynamics have changed.”

  • Fleets are not looking to add capacity. They will utilize current units and search for “desirable” freight.

Healthy range

Starks said the FTR Trucking Conditions Index's current reading — just over zero, and into the “healthy trucking environment” — suggests that trucking is healthy but not anywhere near 2004, when it registered 22. (TCI measures freight, fuel, capacity, bankruptcies, and cost of capital.)

Monthly truck freight improved this year, with FTR's Truck Loadings Originated measurement growing from minus-9% in January to minus-6% in July. But it has flattened out since then.

“We're at the point where we need to see more to say, ‘Is it going to continue to flatten out or go back on trend to what we've seen the past nine to 12 months?’” he said. “We have to really pay attention to this. This is a crucial time for buying equipment.”

He said freight will grow above its historical average, with growth of 3% to 4% for each of the next three years, led by dry van and platform trailers.

He said the surge in trucking bankruptcies was short-lived and limited to the first quarter of this year, when there were over 700 involving fleets of at least five trucks. The “zombie” truckers seen in 2009 are nearly gone.

Active truck utilization was 94% in July, up from 85% in April 2009. During the downturn, fleets started parking large numbers of equipment to keep active utilization propped up.

“Ninety-four percent is very high,” he said. “I think it suggests significant pressure in the system.”

The forecast is for total trailer utilization to remain below the historical average, suggesting little pressure to expand the fleet until late 2012. It was 84% in the third quarter of this year and isn't expected to top 90% until the first quarter of 2010.

“This tells me there's still a fair amount of equipment that is not being put back into service,” he said. “We're moving at a rapid pace — much faster than we expected. But until 2012, there's not substantial pressure in the system to increase.”

Upward pressure on diesel fuel prices is expected throughout the forecast horizon, with prices expected to reach $3.25 by August 2011.

“What kills fleets is volatility,” he said. “It's one of the problems fleets have always had. It's very hard to manage a business. They've done a good job of managing it with the fuel surcharge.”

Some commercial vehicle issues:

  • Trailers are aging but have substantial “useful life” left.

  • The regulatory environment is likely to dampen the demand for trucks. There uncertainty regarding the impact on trailers. Potential changes to Hours of Service may reduce driving time. CSA 2010 will lead to a shortage of drivers. Both may lead to more “drop & hook” and a need for more trailers.

  • Upside potential: A strong cash flow for larger carriers could keep fundamental equipment demand stronger than is currently forecasted. Uncertainty in the market could benefit trailers, as they are significantly less expensive than a truck.

  • Other positives: the aftermarket is seeing strong growth; the used equipment market is seeing strength; orders are for near term production slots for both trucks and trailers.

Erratic correlation

Starks said the correlation between trailer production and truck freight is erratic right now. Normally, every 1% growth in freight demand leads to 5% growth in trailer production. Freight has been flat since 2009 and is expected to stay that way through 2013, with just 4% growth, and yet trailer production is projected to be up 25% next year and 40% in 2012.

“Given past history, this is not sustainable,” he said. “Given what we know with how the relationship works, is it realistic? Is it likely that we see freight demand higher? Possibly. Or is more likely that we see production demand lower than we forecast? I think it's probably a mixture of the two.”

He said Economically Derived Demand (EDD) is an understandable forecast of equipment demand: new demand (the number of vehicles needed to move additional freight) plus replacement demand. EDD leads retail sales.

“We have to be very cautious,” he said. “There is going to be a long cycle that will keep demand for equipment lower.”

In terms of US trailer demand, he said the overbuy from previous years is not seeing a correction in the forecast, which creates more uncertainty in the forecast.

According to the CK Commercial Vehicle Research Fleet Sentiment Report for the third quarter, 42% said they plan to place a trailer order in the next three months — up 12% from the second quarter and nearly double the rate in the fourth quarter of 2009. This is the highest rate since 49% in the third quarter of 2008.

Of those that said they were not going to order a trailer in the next three months, 22% said they would buy between 10 and 12 months, and 59% said they would wait at least 12 months. Just 8% were going to buy in four to six months, and 11% in seven to nine months.

US trailer production is not yet back to 2003 levels, when the recovery stalled.

“Are we going to get a plateau like in 1984?” he said. “Everybody's trying to understand, ‘Do I ramp up my production?’”

Some trailer issues:

  • Spot shortages of some components are starting to occur. “Is it going to be a game-changer? Probably not. Is it going to be a back-breaker? Probably not.”

  • The industry is able to ramp up quickly but is starting to get to the point of growing pains. The general rule of thumb is that coming out of a downturn, the industry can grow 25% to 30% without any problem. Between 30% and 50%, a healthy number of workers, capacity, and resources need to be added. Above 50%, the industry is stressed to a point that it can still meet demand but tends to be less profitable as it scrambles to add resources.

He said the industry is not expected to reach peak historical levels during the upcoming cycle, with an estimated 148,000 trailers in 2011, 210,000 in 2012, 225,000 in 2013, and 227,000 in 2014.

He said we are entering unchartered territory with the US trailer population age, which has gone from 7.4 in 2008 to 8.2 in 2010, with a projection of 8.3 next year.

“Some of this is that they're making better trailers,” he said. “But are we getting to the point where the age is two years difference since 1980? Is that continuing to be sustainable? I don't have an answer.”

He said if GDP growth is 1.5% to 2.5% for the next year, then that will reduce trailer production by 10%, with 116,000 in 2010, followed by 164,000, 193,000, and 210,000.

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