Refrigerated Division of the Truckload Carriers Association: Financial Analyst Defines Used Equipment Market

The health of motor carriers depends directly on the demand for freight services. If freight demand is high enough to outpace motor carrier capacity, equipment suppliers experience a boom in sales, said Kirk Mann, vice-president — marketing manager for transport finance at CitiCapital.

Mann spoke to the opening general session at the annual meeting of the Refrigerated Division of the Truckload Carriers Association. The meeting was held in Sonoma, California, July 11 to 13, 2001. CitiCapital is a new name for the financial services company long known to the trucking industry as Associates Commercial.

From the equipment suppliers' standpoint, the equations are simple, Mann said. Freight demand minus carrier capacity equals demand for equipment. Additionally, total demand equals equipment replacement plus equipment for growth.

Growth Created Excess Capacity

In the current business environment, the hold of these equations is fragile. The explosive growth of the past several years has led to excess capacity, Mann said. This has resulted in declining profits, which, in turn, led to a decline in capital spending, a loss in equity values, and layoffs of personnel. These results are troubling, because rising productivity and advances in technology have, in the past, been able to prevent inflation.

Some analysts worry that lower capital spending could result in a loss of productivity, Mann said. In addition, interest rate cuts by the Federal Reserve — six times in the first six months of 2001 — have not had the predicted effect. In fact, some economists believe that economic recovery, as a function of lower interest rates, will not begin for another six months at the earliest, he said.

Several other factors have had an impact on the transportation economy. Although driver wages now are stable, many carriers saw their costs rise from increased wages in 2000 when the shortage of drivers was considered critical, Mann said. Fuel prices appear to be stabilizing; however, the fuel market has been volatile for more than a year. The third cost factor to hit motor carriers has been the price of insurance, which has increased by as much as 25% for many carriers and as much as 50% to 100% for independent contractors. If those three factors were not enough, tractor manufacturers produced more Class 8 sleeper tractors than the market could absorb, causing rising inventories and lower used equipment values.

All these factors have resulted in changes in the financial climate, most particularly, causing many financing institutions to leave the transportation credit market or to tighten their credit standards severely, Mann said. While carriers and their suppliers could probably have survived any one of these situations without a lot of pain, the combination of all four at the same time has been nearly fatal to many, he said.

Securitization Increases Competition

Although the impact on carriers and their suppliers has seemed sudden, some of the financial problems the industry faces have been at work for 10 years or more. In the late 1980s, a concept called “securitization” lowered the barriers to entry in the equipment financing market. Securitization is the practice of selling the value of an equipment loan or lease. It allows the original lender to avoid most of the risk of a credit transaction. Coupled with the low interest rates prevalent in the late 1990s, securitization allowed the development of fierce competition between lenders for truck financing. In addition to insulating lenders from risk, this financial climate allowed equipment suppliers to sell at almost no risk to their own businesses.

Equipment manufacturers added to the problems by convincing carriers that new equipment was the only way to attract scarce drivers and by selling tractors with guaranteed residual values. This practice resulted directly in an excess of used trucks, Mann said. With the used truck market suffering from bloated inventories, finance companies either left the business or tightened credit. This became necessary, because delinquency on loans rose, increasing collection costs. Failure to pay notes has caused an unprecedented rise in equipment repossession. In fact, some drivers have voluntarily turned in their tractors. One estimate says that up to 35,000 owner-operators and 3,700 fleets with five or more trucks have gone out of business, he said.

New Truck Sales Drop

All of this has made lending for used trucks extremely difficult, Mann said, because institutions have a hard time establishing a true value for used equipment. Driver wages, fuel prices, insurance costs, and lending practices would seem to impact motor carriers the most, but they have had effects on new truck sales as well. In 2000, Class 8 truck sales declined 19.6%, a drop in sales of 51,000 trucks. That drop is projected to reach 36%, another 75,000 to 80,000 vehicles in 2001. A slight recovery is projected for 2002, but many experts say that sales will not reach the level of 2000 until at least 2005, when 213,000 trucks are projected to be sold, he said.

Recovery will take so long, because the industry is awash in excess trucks, Mann said. Some fleets have been turning down trucks previously ordered, which has added to the inventory of unsold tractors. In addition, finance companies have become less willing to assume risk, so credit is harder to find. A third reason for a slow recovery is fleet trade cycles. Some large fleets have begun extending their trade cycles, because manufacturers no longer offer the attractive sales incentives once available.

The easy availability of new tractors for the past several years has built the inventory of used trucks to enormous size, Mann said. Through most of the 1990s, the supply of new and used trucks remained relatively balanced. However, many owner-operators began to lose their trucks in 1999. These repossessions swelled used truck inventory. This inventory grew more as a result of short trade cycles and guaranteed residual value programs at large fleets.

Unsold Inventory Rising

As fleets work through the end of their guaranteed buyback programs, this inventory will continue to rise, Mann said. By the end of 2001, the inventory of unsold used trucks is projected to be 87,000 units. The unsold inventory will rise to 126,000 in 2002 and 171,000 by the end of 2003. At the end of 2004, the inventory of used trucks available to a second-user is projected to reach 209,000.

Cab configuration in this inventory will slow the sale of excess inventory in vocational or export markets. Most of the used trucks have conventional cabs with integral sleeper berths, a configuration that is almost impossible to convert for vocational applications such as mounting a dump body. In addition, long nose conventional cabs sell poorly in export markets, Mann said.

Demand for trailers follows the strength of the economy and profitability of motor carriers closely. With a fragile economy and low carrier profits, trailer orders have fallen to levels last seen during the recession of 1991, Mann said. The fall in orders started in March and has resulted in an industry backlog less than half the size it was only a year ago. Trailer production in the first quarter 2001 is 50% below production in the first quarter 2000. Through May 2001, manufacturers have built and shipped 8,243 refrigerated trailers, he said.

Trailer sales will not fall as far as tractor sales, but they are projected to decline 11% for 2001 and another 7% in 2002, Mann said. One factor that could help refrigerated trailer manufacturers is a projected increase in food production, which has remained stable for the past several years. Food production should rise in 2002.

Trailer Market Recovers First

Recovery will come in the trailer market first. New technology will allow fleets to use trailers more efficiently, improving productivity. In particular, manufacturers did not produce so many trailers that a massive oversupply was created, Mann said. Trailer manufacturers and dealers do not have a huge inventory of unsold new trailers sitting on their lots. Used trailer prices should not fall as far as the comparable price for used tractors, because used trailers have other uses such as storage.

The survivors in this environment will be the companies with healthy balance sheets and good cash flow, Mann said. Those who understand operating costs and have a disciplined pricing policy stand the best chance. In addition, it will help to be driver-friendly. Many carriers already have failed, and many experts believe that more will follow, he said.

To find financing for new equipment, carriers should analyze their businesses and develop a plan that shows both strengths and weaknesses to potential lenders. Create pro-forma plans that project cash flow. Send regular updates to lenders; keep them from having to ask for financial reports, Mann said.

Buying new equipment in a tight credit market is tough. Some lenders may require fleets to pledge other assets against the value of the proposed purchases, Mann said. Without other assets to pledge, the best bet may simply be maintaining current equipment carefully until the financial climate improves enough to allow purchasing.

Recovery will be slow with the trailer market improving first, probably in the first quarter 2002, Mann said. However, motor carrier profitability must improve before credit becomes readily available again.