“In sharp contrast to the strong financial positioning of the U.S. railroad industry, the U.S. trucking industry is entering 2009 in a weakened state. Overcapacity, particularly in the LTL sector, has eroded pricing over the past year, while high fuel costs have added to the industry's difficulties.” –Fitch Ratings
It’s the kind of report no one really wants to read – because, frankly, every trucker knows there won’t be much good in it.
I’m talking about the 2009 freight transportation outlook released by Fitch Ratings late yesterday: a broad analysis of the railroad and trucking markets by one of the largest credit rating companies in the U.S.
[It should be noted that this very same company – and its brethren – are the ones that gave high marks to those wonderful mortgage-backed securities that ended up burning a super-sized hole in the global economy. Not the fault of Fitch’s transportation analysts, to be sure, but it’s a fact that should not be overlooked.]
Fitch’s experts note that while the past year has been very challenging for freight transportation, they expect conditions to be even more difficult in 2009. “Late last year, hopes were high for a rebound in freight demand in the second half of 2008, following nearly two years of slow demand growth, especially in the trucking industry,” the company said in its report. “As 2008 wore on, it became increasingly clear that conditions were worsening, rather than improving, and Fitch now expects the U.S. recession to be a drag on the financial performance of both the trucking and railroad industries through much of 2009.”
However, Fitch noted that railroads and truckers are entering this period of extreme economic weakness from two very different financial positions – and trucking, in their view, isn’t on fiscal high ground. Fitch said that, following a resurgence in the railroad industry over the past five years, the largest Class I railroads are well-positioned financially to confront the challenges of a recessionary economic period. Although volume growth has slowed over the past couple of years, the industry continues to enjoy a favorable pricing environment, the company added.
In sharp contrast, the U.S. trucking industry is entering 2009 in a weakened state. Overcapacity, particularly in the LTL sector, has eroded pricing over the past year, while high fuel costs have added to the industry’s difficulties. Although demand looked as though it had stabilized in the middle of 2008, volumes took another step down in September, and demand has remained weak through the fourth quarter. The bankruptcies of a large number of small truckload carriers have helped to rectify the capacity situation somewhat in that sector, but the LTL sector continues to struggle with too many trucks chasing too little demand.
“With expectations for weak consumer retail spending through much of 2009 and increasing challenges facing trucking's industrial customers, particularly the U.S. auto manufacturers, there is a heightened potential for a significant decline in [trucking] industry credit quality next year,” Fitch noted.
According to the American Trucking Associations (ATA), its seasonally-adjusted truck tonnage index fell 3% in October versus September, the fourth month in a row that the index declined from the prior month, highlighting the weakening of the demand environment, said Fitch. Generally, expectations would be for volumes to grow through the period, as shipment levels typically would increase ahead of the holidays. As such, the fourth-quarter ATA data suggest a significant weakening of demand in the latter part of 2008.
Trucking is closely tied to the shipment of cyclical products like retail goods and industrial components. As a result, the trucking industry is more exposed than the railroads to the relative strength of the U.S. economy. As such, with expectations for ongoing economic weakness through much of next year, trucking volumes are also expected to be relatively sluggish, the company noted in its report.
However – and here’s a tiny, tiny sliver of silver – this volume weakness could stabilize toward the end of 2009, but primarily due to the industry's lapping of the weakness seen toward the end of 2008, as opposed to expectations for any notable strengthening in the demand environment.
Yet, unlike the railroads, which have seen ongoing pricing strength despite a weakening in volumes, the trucking industry has been increasingly challenged over the past year by a weakening in underlying base shipping rates, as the supply of available capacity has outstripped demand, said Fitch. This situation has improved somewhat in the truckload sector, as a large number of small operators have gone out of business, but the pricing environment in the LTL sector remains difficult. Excluding fuel surcharges, base rates have been declining through the tail end of 2008, as truckers have been forced to offset a portion of the rise in surcharges with a decline in base rates.
At this point, Fitch said it does not see a catalyst for a material rise in base rates, given the expectations for a very weak economic environment and a resulting decline in consumer spending. In the truckload sector, pricing is expected to be somewhat more favorable than in the LTL sector, as truckload capacity likely will remain relatively better matched to demand, although Fitch does not expect truckload pricing to be strong by historical standards.
Whew! Wow! Got any more wonderful news for us this holiday season? Well, gee, yes they DO, as Fitch further believes the economic meltdown is going to put a bigger crimp on cash flow for truckers.
The trucking industry's weaker operating margins, driven by heavy competition and lower demand, should put significant pressure on operating cash flow in 2009, the company noted in its report – though free cash flow may fare somewhat better, however, as capital spending needs will be lower with the reduced level of demand.
Fitch expects many trucking issuers to slow the replacement of tractors and trailers and to generally hold off on facility capacity growth while the economy remains weak. Network rationalization by some LTLs could drive some facility capital spending, but overall capital expenditures are expected to be relatively low compared to historical levels.
Here’s an interesting projection you should note: Although the U.S. Environmental Protection Agency (EPA) is again tightened emissions regulations for diesel truck engines in 2010, Fitch does not expect to see most truckers pre-buying tractors next year, as many did in 2006 before the last EPA emissions change in 2007. This should help to keep capital spending on tractors down, despite the upcoming change in emissions regulations, the company noted.
With greater free cash flow pressure in 2009, liquidity will become an increasingly important differentiator in assessing the credit quality of trucking issuers. For the industry in general, capital markets access likely will be more difficult for the truckers than for the railroads, and, notably, those truckers with high-yield ratings, such as YRC Worldwide, will have virtually no access to the markets, Fitch noted.
This will increase the importance of maintaining larger-than-normal levels of cash and equivalents on balance sheets, as well as the need to keep significant levels of cash available on borrowing facilities, such as revolving credit facilities or receivables securitization programs, the company said. Financial flexibility will be an important determinant of ratings as the trucking industry moves through this very challenging market environment, Fitch noted in its report.
Well if THIS report doesn’t make you just want to croak “ho, ho, ho” and pass the hemlock, I don’t know what will. But, again, this is one credit rating agency’s VERY broad look at the market – and not all truckers are the same, mind you. Furthermore, quite a few shippers out there know the value good truckers provide, so while times will be tough for certain, more than a fair share of carriers should make it through to better times. That’s the way I’m going to look at things, at least.