Profits stayed strong for the trucking industry in 2005 and, although they didn’t match the extraordinary levels achieved in 2004, carriers felt confident their earnings streak would continue into 2006.
Yet trucking was dealt a curveball late in the year after hurricanes Katrina and Rita knocked segments of the U.S. petroleum industry offline, contributing to a record spike in diesel fuel prices that walloped the industry’s bottom line.
In addition, an ever-worsening shortage of drivers proved to be a Catch-22 for carriers. Lack of drivers made trucking capacity tight, allowing fleets large and small to charge higher rates and collect more in fuel surcharges. On the other hand the need for drivers resulted in more wage and benefit increases, adding to the pressure on carriers’ profits.
Hanging over all of these issues was the impending introduction of new emissions-reduction technology required on all medium- and heavy-duty trucks built after Jan. 1, 2007. The impact of that technology on sticker prices began to be revealed as 2005 drew to a close and it wasn’t pretty – as high as $10,000 per Class 8 truck. Those numbers convinced many fleets to try and pre-buy trucks ahead of the ’07 model year, making 2005 yet another record year for new truck sales, worrying OEMs that sales could drop by as much of 40% by the time 2007 rolled around.
Despite all of those issues, trucking remained on a roll in 2005 – and stood poised to keep rolling profitably into 2006. “We think the economy as a whole is going to grow 3% to 3.5% in 2006, with truck tonnage climbing 2% – mirroring the 2% growth we saw in 2005,” said Bob Costello, chief economist for the American Trucking Assn.
“That may not seem strong, but it is, largely because of truck capacity limits. Truck capacity is growing below 2% so it’s behind freight growth,” he said.
“A solid U.S. economy and a favorable relationship between shipping demand and truckload capacity contributed to a 5.9% increase in our average revenue per loaded mile,” noted Kevin Knight, chairman & CEO of Knight Transportation.
“Solid productivity, improved fuel surcharge collection, and a constant focus on expense control more than overcame cost increases relating to higher prices for equipment, higher diesel fuel prices, declining fuel efficiency due to emissions control regulations and increases in driver compensation,” he added.
“Customer demand for our services continued to be strong,” said Randolph “Randy” Marten, chairman and president of refrigerated carrier Marten Transport. “The combination of solid freight demand with limited industry-wide capacity and strong freight selection by our sales and operations team contributed to a 6.6% increase in our average freight revenue per total mile.”
Economic Growth is Key
Overall, U.S. gross domestic product grew 3.5% in 2005, compared with 4.2% in 2004. However, while the trucking industry experienced growth in tonnage it was below 2004 – 2% vs. 6%, said Costello. Yet that still represented a huge increase in freight: nearly 200 million tons (181 million t) more that the 9.8 billion (8.9 billion t) tons of freight hauled in 2004.
Costello said weakness in the automotive sector impacted tonnage in 2005 and while total manufacturing output was solid late last year, manufacturing output – when recalculated based on its importance to truck tonnage rather than value – was not quite as strong as it was in 2004.
“The falloff in durable goods consumption was expected due to large auto sales over the summer,” Chris Brady, president of Commercial Motor Vehicle Consulting. “That pushed sales that would’ve happened in the fourth quarter to the third quarter.”
Economic analysis firm FTR Associates added that a hotspot for freight movement continued to be business-related equipment, although it began to cool off in 2006. Equipment and software spending (i.e., business investment) grew a brisk 10.8% in 2005, the Dept. of Commerce said, accounting for about 8% of the economy. FTR forecast business investments to increase 8% in 2006.
Consumer spending, which accounted for 70% of the economy in 2005, expanded 3.6%, marking relatively brisk growth in the face of ballooning energy prices and rising interest rates. But, with no relief in sight for energy prices, growth in consumer spending was expected to slow to 2.6% in 2006, said Eric Starks, FTR’s president.
“The combination of a healthy labor market, solid business investment and a broad based global economy, still translates to a positive outlook for 2006,” he added. “The economy will be more vulnerable towards the end of the year, as housing and the consumer sectors downshift and the economy has to fill the void to keep expanding. Also, energy prices will remain a threat.”
Rising Fuel Bills
A rapid spike in diesel fuel prices following hurricanes Katrina and Rita proved to be the biggest problem for the trucking industry to deal with in 2005.
The ATA said the trucking industry spent $87.7 billion on diesel fuel in 2005 – some $21.8 billion more than the $65.9 billion spent in 2004. The increase largely was the result of spikes in global crude oil prices combined with 5% of the nation’s oil-refining infrastructure being temporarily knocked offline in the wake of the hurricanes along the Gulf Coast.
ATA President and CEO Bill Graves said the cost of diesel fuel remained the main concern of motor carriers, largely because fuel represented trucking’s second-highest operating expense behind driver wages and benefits. It accounted for as much as 25% of total operating costs. Higher fuel costs were a growing concern as the industry prepared to switch over to ultra-low-sulfur diesel (ULSD) by mid-October 2006. Some 80% of on-highway diesel fuel produced and sold after that date would have required to be ULSD as it is key in helping ’07-model low-emission diesel engines meet new Environmental Protection Agency regulations. “ULSD could add between five cents and 13 cents to the cost of producing and distributing on-road diesel fuel,” said Graves. “New engines, meanwhile, are expected to cost more and burn more fuel.”
Several carriers already had reported fuel economy losses from emission technology changes in ’02 and ’04 models. They were concerned that further reductions in miles per gallon coupled with more expensive fuel and engines could severely impact profitability down the road.
The negative impact of higher fuel costs on 2005 earnings compared with the prior year was 10 cents per share, according to Clarence Werner, chairman, president and CEO of truckload carrier Werner Enterprises. “It is difficult to estimate the impact of higher fuel costs on earnings because of changing fuel pricing trends, the temporary lag effect of rapidly changing fuel prices on fuel surcharge revenues, and other factors – so the actual impact of higher fuel costs on earnings could be higher or lower than estimated.”
He added that the percentage of his company’s truck fleet with post-October 2002 engines (the first phase of the EPA’s truck emission-reduction plan) was 89% by the end of 2005, and those trucks had experienced fuel economy loses of approximately 5% compared with tractors equipped powered by pre-2002 engines.
Still, the scarcity of trucking capacity allowed most fleets to offset higher fuel prices through increased fuel surcharges that shippers seemed more than willing to pony up.
Driver Shortage Continued
Recruiting and retaining qualified truck drivers is a continual challenge in the trucking industry – but it’s a challenge that got even tougher in 2005.
“The limited availability of experienced drivers continues to challenge the trucking industry,” said Russ Gerdin, chairman & CEO of Heartland Express. “We recently announced a driver pay increase for the third consecutive year and as a result our most senior and experienced company drivers will be earning 50 cents per mile while our owner-operators will be earning a base rate of 95 cents per mile by the end of 2006.”
That shortage restricted the ability of fleets to expand to meet rising freight demand.
“In our view, there is clearly a capacity shortage, largely the result of an overall shortage of competent drivers, partly the result of the hours of service changes that took place in early 2004 and partly due to the demographic characteristics of the industry,” said Steven Russell, chairman & CEO of truckload carrier Celadon Group.
“[Our] aging driver population is not being replaced by young people, and the industry is anticipating that we are likely to face an almost alarming shortage of drivers in the years ahead,” Russell said. “It does not appear to be a pay issue, but more of a lifestyle one – and continuing changes in hours of service regulations exacerbated the problem. Further, the ATA indicates that turnover among large fleets is now averaging approximately 125% and about 90% in the smaller fleet segment.” On top of that, despite strong third-quarter earnings from most major truckload and LTL carriers and a lack of capacity that pushed up rates, the trucking industry wasn’t growing, he noted.
“Anecdotally, Class 8 truck manufacturers are indicating that their customers are simply replacing older units, and not growing their fleets,” Russell pointed out. “Companies that finance the industry, such as GE Capital, indicated that they were seeing no growth among existing fleets and virtually no start-ups. Higher fuel prices are impacting this but the core issue still appears to be a lack of drivers.”
Truck Price Hikes Loom
The need to replace aging equipment and buying in advance of costly new emissions standards fueled strong big-truck sales growth in 2005.
The big worry, among truck makers and suppliers was how higher new truck prices would affect sales in 2007. Joe McAleese, president of brake maker Bendix Corp., for one, said his firm was planning for a 30% to 40% falloff in truck sales in 2007, but noted that sales would recover quickly in 2008 and 2009.
Truck makers already began releasing base price increases in late 2005 for the ’07 model year. International Truck & Engine Corp. said its medium-duty trucks and school buses would cost $5,000 to $6,000 more, with Class 8 tractors up $7,000 to $10,000. Volvo Trucks North America Inc. said ’07 emission requirements were going to add $7,500 to the price of its Class 8 tractors and vocational trucks, while its sister company Mack Trucks Inc. indicated an ’07-model increase of $7,000 on its Class 8 on-highway products.
Peterbilt Motors Co. said ’07 emission rules would add $2,000 to $4,000 to its medium-duty trucks and $6,000 to $9,000 on its Class 8 products. Freightliner LLC said customers should expect a $4,500 to $6,000 increase on its medium-duty trucks and $7,000 to $10,000 on its heavy-duty vehicles. Western Star, a Freightliner subsidiary, announced similar increases on its Class 8 base sticker pricing.
The cost of these changes, plus the headaches of maintaining new technology, worried many carriers in the industry, said ATA’s Graves.
“Clean air comes at a price,” he said, noting that all the components needed to lower truck emissions — the engine, new (CJ-4) engine oil, ULSD fuel, and exhaust aftertreatment system — are steeply increasing the purchase and maintenance costs for commercial trucks.
Earnings Still Strong
Yet despite all of the cost pressures, most carriers remained quite confident well into 2006 that trucking’s fundamentals remained in synch for continued profitability.
“This is an industry where capacity is short, so we can make the decisions necessary to strengthen the financial performance of our company,” Celadon’s Russell said. “It’s created an environment where a well-regarded fleet can be more direct with customers. In August, for example, we totally withdrew our trucks from an auto manufacturer who wouldn’t pay a fair fuel surcharge and would not pay detention for delays in loading. We were doing about $6 million in revenue with this customer, and now we are doing zero.” That ability to be customer-selective isn’t going to change soon, Russell added, as he expected the continuing shortage of drivers to keep the brakes on capacity growth in trucking.
“In fact, it is difficult to see what might change (tight freight capacity0, short of a collapse of the U.S. economy,” he said.