Not the Best or the Worst of Times: Trucking Industry Holds Steady

by Gary Kempinski November/December 2016

Like many markets in 2016, the transportation finance industry has faced its share of highs and lows. Navistar’s Gary Kempinski examines the overall picture, including excess capacity, economic uncertainty, regulatory pressure and healthy replacement demand. Although he expects to see some contraction in the first half of 2017, a return to growth mode is on the horizon.

Gary Kempinski,
General Manager,
Navistar Capital, BMO Transportation Finance

As 2016 winds down, it’s fair to say that the transportation finance industry is in a good news/bad news situation. Excess capacity and economic uncertainty have taken a chunk out of sales, and regulatory issues loom for 2017. But a deeper look at the underlying fundamentals indicates that the industry is still in good shape and there’s room for improvement next year.

Coming Down to Earth

After record-setting sales in 2014 were eclipsed by an even better 2015, we’re in a market that’s down about 20% for the year. That’s no surprise given that the previous two years led to excess capacity in the system.

Trucking volumes continue to decline, thanks to weakness in the manufacturing and energy sectors. In fact, anything tied to energy has been negative for about a year because of the decline in shale oil production. However, indications are that shale drilling is back on the upswing.

There are a few bright spots. Construction has been solid, which leads to strength in the flatbed segment required to haul lumber and building materials. The automotive sector has been fairly healthy, and the consumer sector has been showing signs of life lately.

The Uncertainty Principle

When talking to our customers, it’s clear they’re willing to purchase the trucks they need for replacements, but they’re not looking to increase their fleets until they have a better understanding of the economic climate.

Given the lack of freight volume, net trailer orders have steadily declined throughout the year. Even as the industry anticipated a seasonal boost in September, orders fell 16% compared to August and were 66% lower from the prior year, according to FTR. It’s clear that fleets are being cautious about their capital expenditure commitments, and all signs indicate that will continue into 2017.

There’s also a lot of uncertainty around the political environment and what’s going to happen with interest rates. Right now, rather than invest in their business growth, fleet operators have been stuck in neutral. In an uncertain environment, it’s only natural that businesses are hesitant to invest any more than they absolutely must. More clarity around interest rates would help both lenders and customers.

Holding Steady

But it’s not all bad news. While operators aren’t expanding their fleets, we’re seeing a fairly healthy demand for replacement purchases. We expect conditions to stay at about the same level through mid-2017, with possible improvement in the second half of the year if the economy strengthens.
To move beyond replacement demand, more sectors of the economy will need to start showing stronger growth and the stronger performing sectors must be more consistent. New home construction, for example, is very important to the flatbed sector. But after a strong first half, new housing starts fell 9% in September, the slowest pace in 18 months. That comes on the heels of a 5.6% dip in August.

To navigate this slow growth environment, trucking companies are managing their businesses on the cost side. They’re trying to be judicious about their expenses because, quite frankly, there isn’t enough freight available to grow their way out.

But that’s not necessarily a bad thing. During the extraordinary growth over the previous two years, it was natural for operators to lose sight of the expense side in favor of revenue growth. But taking a step back and focusing on personnel costs, insurance, fuel costs and capital expenditures means more operators are returning to the fundamentals of cost and risk management.

Regulatory Pressures

Regulatory changes are also putting pressure on operators, particularly the Federal Motor Carrier Safety Administration’s mandate for implementing electronic logging devices to ensure drivers stay within mandated hours of service, which is scheduled to take effect in December 2017.

While the industry doesn’t dispute that these types of safety initiatives make sense, they add costs at a time when fleet operators are looking to shed expenses. Also, limiting the number of hours a driver can be on the road limits how much money they can make, and that has an impact on recruiting new, younger drivers. This is bad news for an industry that has already been dealing with a shortage of drivers.

According to a 2015 American Trucking Associations (ATA) report, the industry had a shortage of 48,000 drivers by the end of 2015. The ATA predicts that number could reach 175,000 by 2024 if current trends hold. And the workforce is aging, with a median age of 49 (52 for private fleet drivers), compared to 42 for the U.S. workforce as a whole.

As a result, the larger carriers with better capital structures will probably have the upper hand, as opposed to the smaller fleets that don’t have the balance sheets to implement these regulatory changes.

2017 Outlook

There is one strategic partnership worth noting that should start to bear fruit in 2017. In September, Volkswagen AG paid $256 million for a 16.6% stake in Navistar, an alliance that will likely be an excellent development for both sides. From Navistar’s perspective, it gives it financial stability, a technology partner and — eventually — access to European markets.

On the other side, VW, a company that already has a large U.S. automotive presence, is now aligned with a trucking company that has a big North American footprint. It also gives VW access to Navistar’s dealer network. We think this deal will ultimately lead to additional sales for Navistar.
Given that 2014 and 2015 sales were well above replacement demand, it’s not a surprise that sales would regress a bit in 2016. But all things considered, we’re at a healthy level of demand. While the first half of 2017 will be in contraction mode on an annualized basis, the second half should see a return to growth mode.

In essence, it’s not the best of times, but it’s not the worst of times either.

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