Conditions for fleets are deteriorating and it will get bloody
For the freight market, 2019 has been shaping up to as a tug of war between the bulls and the bears. The large enterprise carriers that rely heavily on committed business (commonly referred to as “contract business”) have been enjoying a decent year, while the small carriers that are heavily exposed to the transactional spot market have been faced with a very tough market.
The disagreement has been obvious on Wall Street earnings reports. The large carriers have spoken about decent freight conditions and have been far more optimistic than the Facebook message boards that are made up of small operators. Comments like “worst market ever” and “a bloodbath is coming” are common on Facebook groups like Rate Per Mile Masters. Groups like this are helpful to understand the current sentiment in the market, even if they tend to be highly emotional.
For observers who are trying to get a feel for the direction of the market, the discrepancy has been confusing. The struggle between the bulls and the bears is about to become clear and while it pains us to call it, the bears are going to be proven correct.
The reason that the large carriers do not feel that the market is soft is due to the quality of their shipper relationships and the reluctance of shippers to pull loads away from them. While there is a constant tug-of-war in the pricing game (even for the largest carriers), shippers will hold off pulling loads due to the fear of running out of trucks when the market tightens. In order for this to happen, volumes must remain consistent and shippers need to fear that freight might be left on their docks.
Until May, volumes had been close to 2018 peak levels. Throughout the year, truckload volumes have been within 3 percent of 2018 volumes, at times breaking 2018 year-over-year numbers. Considering the unprecedented demand that the market experienced last year, anything remotely close to last year’s volumes is impressive.
DAT Van Freight Rate Index (SONAR:DATVF.USA)
Meanwhile, spot rates have dropped like a rock. From the June 2018 peak, trucking spot rates are down over 36 percent. Last year’s peak DAT national van rate hit $2.11 per mile and today sits at $1.36 per mile. The reason – the market has been oversupplied with capacity. Carriers, big and small, added to their fleet counts last year. While carriers struggled to find drivers to seat those trucks, higher driver pay and incentives did generate successful outcomes.
The “driver shortage” and “capacity shortage” are two different things. The driver shortage commonly refers to the availability of drivers in the market to drive the trucks that are on fleet rosters, while the capacity shortage is a function of having enough trucks available for dispatch. Unseated trucks don’t generate revenue, while a capacity shortage gives the fleets pricing power as shippers and brokers struggle to find capacity. And in markets with a capacity shortage, carriers and drivers alike are big winners. Nothing brings driver pay up like a good old capacity shortage.
When times are good, carriers are eager to grow their fleets and attract the best drivers, which means they roll out the best perks and incentives to get the drivers to join their fleet. When times are tough, the thinking switches to the short-term. Many fleets are just fighting for survival.
According to the proprietary trucks in market index (SONAR: TRUK) that tracks the total amount of capacity in the truckload market on a daily basis (using electronic logging devices, or ELDs), truckload capacity in the market was up nearly 5 percent in the past year. This peaked in April. And since the volumes were consistent with 2018, but not high enough to soak up the additional demand, truckload spot rates dropped.
In recent weeks, trucks in market has started to drop back, showing that capacity is slowly leaving the industry. It appears that carriers have stopped growing their fleets and some owner operators who were enjoying record high spot rates in 2018 have reconsidered their profession.
Starting earlier this month, it appeared that the spring surge might deliver quality results in the second quarter. Volumes had been moving up since early April, showing a muted, but promising trend for the quarter. That all changed on May 9. On that day, the U.S. accelerated tariffs on Chinese imports, forcing importers to reconsider their supply chains. Port volumes have been driving the freight market for the past year, but that appears to be over.
Outbound Tender Volume Index (SONAR OTVI.USA)
FreightWaves’ proprietary Outbound Tender Volume Index (SONAR: OTVI), which measures the total amount of contracted freight in the market, peaked on May 9, dropping by over 6 percent on May 16. May is typically a strong month for freight volume, so the drop is even more significant.
In Asian import-heavy Los Angeles, the drop was even steeper. Volumes dropped over 28 percent from May 8 to May 16.
Right now, there is a “driver shortage” coupled with a capacity glut.
With a tight labor market, carriers are struggling to find and keep qualified drivers. Drivers can find work with better quality of life elements in construction and warehousing, and often the pay is competitive or comparable to truck driving jobs. When carriers stop getting the volume of loads from their “contractual shippers,” drivers will start sitting. Over-the-road drivers are typically paid per mile, so when the miles dry up, so does the pay. Drivers get restless and start to consider alternative sectors for employment.
Employee-drivers that leave the industry end up leaving truck cabs empty and sitting against the fence. This forces employers to raise driver pay on a per mile basis and creates cost inflation. Part of this is to make up for fewer miles (i.e. drivers are taking home less pay and therefore need to make more per mile to sustain the same amount of pay) and part is pure market economics (a job at an Amazon warehouse pays $15 per hour).
After all, driver pay is one of the largest cost centers for trucking fleets. Last year, the fleets found willing shippers to pass those costs on to; this year they will find the opposite.
Shippers are aware of the market conditions. Information is fairly ubiquitous and with brokers in the market calling up shippers and offering to undercut their “contracted rates,” shippers are taking advantage. One carrier shared an email from a top food shipper that told the contracted fleets that their “contracted rates” would not apply and they would have to match the spot rates offered by freight brokers. So much for contract rates.
The other major cost center is fuel.
Oil prices have been going up since the start of the year. The benchmark WTI oil price has rallied from $46.31 on January 2, 2019, to $60.97 on May 13, 2019, a 32 percent increase.
The increase has been felt at the pump. Truckstop retail diesel prices have moved from a low of $2.96 to $3.10 per gallon. Large carriers that buy at wholesale rack prices have seen their wholesale assessed fuel move from $1.70 to $2.20 per gallon since the start of the year. (Wholesale diesel rack prices do not include taxes or transportation.) The $0.50 per gallon swing will cost carriers that buy wholesale as much as $0.07 per mile in additional gross fuel expenses.
Diesel Truck Stop Actual Price Per Gallon (SONAR: DTS.USA)
The outlook for the rest of the year is even worse for diesel. IMO 2020, the new maritime fuel standard, goes into effect at the end of the year and by some extreme estimates could increase the cost of retail ultra low sulfur diesel (ULSD) by as much as $0.50 per gallon. FreightWaves’ internal estimates are more benign and call for a $0.22 to $0.25 per gallon increase of ULSD at the pump.
For carriers on fuel surcharges, much of this increase will be passed on to their shipper clients. For carriers that don’t enjoy fuel surcharges, it could mean $0.04 to $0.08 per mile in unrecovered fuel expenses.
The last nail in the coffin for many fleets will be the used truck market. Over the past two years, many carriers have taken advantage of a hot freight market to buy new trucks and expand their fleets. The used truck market has enjoyed steady pricing, even as market demand dropped. Since June 2017, prices of used trucks that are three to four years old have rallied by 25 percent as the secondary market experienced high demand. This will be the peak.
3 Year Old Used Truck Price Index (SONAR: DTS.USA)
As cash flow starts to dry up, the banks will start to foreclose on truckers that miss payments. Fleets with more flexibility will also start to dump their older and less fuel-efficient trucks as they trim back the size of their fleets, finding that a smaller network is more optimal in this environment. Used trucks will start piling up on dealer lots and dealers will start to get more aggressive in making deals to get those trucks off their lots.
Bankruptcies will start to increase in the industry and fleets with less efficient networks and less flexibility on the balance sheet will be washed out. Capacity will start to leave the industry as the industry right-sizes for the demand. Carriers should start planning defensively for this turn. Utilization will be key. Staying informed with the most current data is paramount. With a sloppy and low-demand market, maximizing your opportunities to get and stay loaded is critical.
Keeping costs under control will also be extremely important. And for carriers that are sophisticated, hedging their exposure to spot rates will give them an enormous cash-flow advantage in the market as industry rates start to reset.
The outlook is not all bad, of course.
The well-managed carriers will do better than most and will be in a better position to take market share. You can expect companies that have healthy balance sheets to be able to pick off synergistic acquisition targets. Companies that use technology and maintain high-quality shipper relationships will also do well in this cycle, relative to ones that are transactional and live/die in the spot market.
Carriers that have diverse service offerings will also be insulated from too much exposure to a single customer or sector. Over time, drivers will also figure out which carriers have the best networks and keep them running. Those carriers will be able to pick off the best drivers, even as the market overall struggles to find drivers. I would also expect some large carriers to buy some smaller and less-capitalized carriers near the bottom of the cycle, but we are a bit away from that.