A protracted downturn in freight has caused A.C.T. Research to lower its Class 8 production forecast for this year and 2009.
“Where the economy goes, freight follows, and where freight goes, truckers follow, and where truckers go, Class 8 demand follows,” said A.C.T. senior partner Kenny Vieth in a conference call, “Turn Signals: What's the Outlook for Commercial Vehicle Demand in 2008-2009?”
He said A.C.T.'s estimates for Class 8 builds were cut from 259,258 to 215,093 (2.0% year-over-year growth) for 2008 and from 382,528 to 328,859 (52.9% year-over-year growth) for 2009. He suggested that depending on the economy in 2008, there could be room for upside revisions to those estimates.
“If something goes spectacularly well into the first quarter, perhaps there is the potential of 245,000 for '08,” he said. “I would think splitting the difference would make sense.
“For 2009, the problem is that if the economy significantly weakens at the beginning of '08, you lose the production velocity you were supposed to carry into ‘09. So instead of going into ‘09 building at 1400 units a day, you go into ‘09 building at 1100 units per day. It becomes a game of catch-up. I think there is a little more variability in the ‘09 forecast. There is some opportunity to get into the 340,000-350,000 level, but we're going to have to see more positive things happen in ‘08. If you're more bearish, I think the 330ish number is better. If you're more bullish, 355 might be better.”
For 2010, he estimates 230,000.
“If we don't sell an extra 50,000 trucks in ‘08 and ‘09, we're probably going to sell them in 2010,” he said. “Demand for trucks doesn't go away. It's the amount of freight the economy generates. So when you sell those trucks, it has significant implications for manufacturers.”
Vieth said trade cycles put upward pressure on forecasts, adding that A.C.T.'s most recent channel checks along with third-quarter commentary out of Volvo and Rush Enterprises suggest that truck fleets likely will need to return to the market in ‘08 and ‘09, driven largely by normal trade cycles.
“A.C.T.'s current Class 8 forecasts imply production at or below replacement demand of roughly 215,000 per year in both 2007 and 2008 — before, roughly 40,000 trucks in each year generally were needed to support economically derived demand in a 2%-type Gross Domestic Product scenario,” he said. “While this happened in the 2001-2003 time frame, anemic freight volumes at the time were further exacerbated by an implosion in used-truck prices.
“We'd also note that even if a fleet decided to reduce the number of trucks it owns, that doesn't mean it will not buy new trucks — i.e., a carrier with 100 trucks that needs to replace 20 trucks and only buys 10 new trucks just reduced its fleet by 10%.”
Fewer optimists
He said that although there are fewer and fewer Class 8 optimists left, he believes there are some interesting dynamics lining up.
“Freight's already been bad for a year or more, so our sense is that we are incrementally closer to a rebound,” he said. “A.C.T.'s lowered forecasts imply two years of production at or below replacement demand in both ‘07 and ‘08. While this did occur during the ‘01-'03 downturn, bad freight fundamentals at the time were further exacerbated by an implosion in used-truck prices. Normal trade cycles will likely put upward pressure on replacement demand for the next three years.”
Vieth said excess capacity drives the lower Class 8 forecasts for ‘08 and ‘09. A.C.T. estimates that at the end of '06, there was excess capacity in the Class 8 active truck population.
He said that since the US economy softened just as the truck fleets completed their pre-buy ahead of the Environmental Protection Agency (EPA) ‘07 emissions deadline, the industry was not able to absorb this excess capacity — causing miles per tractor to decline as well from the fourth quarter of ‘06 through the third quarter of last year.
“In a nutshell, there are just too many trucks chasing too little freight,” he said. “Our population model suggests there were 5% too many trucks at the end of ‘06. We've seen tractor miles down 5-7% from the fourth quarter of '06 to the third quarter of ‘07. Making things worse was where the softness in the economy occurred. Housing and automotive are two key freight-generating sectors. That's added pressure to the whole enchilada.
“There is strength in non-traditional markets for new trucks. Unfortunately, it's more anecdotal than quantifiable. What those record export market levels are, we aren't sure. We think perhaps 10,000 units of late-model equipment might be headed offshore.”
He said profit margins for carriers were 4.1% in the third quarter of '07 — the lowest since the fourth quarter of '04 — but “it shows that shippers are respecting the fact that truckers are business partners, and they're not throwing them into the ditch as they did in ‘00 and ‘01.
“The economy generates the freight hauled by Class 8 tractors,” he said. “The economy also determines how many trucks and trailers you need. There are other factors such as trucker profits or emissions mandates, which always get back to trucker profitability. A fairly respected person in the trucking industry made the comment that it seems like truckers buy a lot of trucks at the beginning of a cycle and the end of a cycle, at least relative to economic activity. We see where truckers at the beginning of an economic cycle start out with trucks parked, and the first thing they do is use the parked trucks and then ramp up utilization rates and then start adding new capacity to fleets. At some point in the economic cycle, you're adding capacity and the economy slows down, and that's where you end up with too many trucks relative to the amount of freight. In the last part of the economic cycle, you're typically trying to recover.
“Through 2009, there should be a lot more used-truck demand than there are used trucks flowing in — which should allow used-truck prices to hold up. Looking farther, there are some issues in 2010 and 2011 where there will be a lot of trucks flowing into the market. But again, we'll have another emission mandate by then, so maybe pricing can hold up. In general, used-truck prices — given freight conditions — have held up very well. Part of that was that new prices were so high, which made used trucks an attractive option. And then with used trucks going offshore, that helped limit domestic supply.”
Rising prices
Vieth said the industry is at a four-year low on backlog.
“In the backlog-to-build ratio, we like to see this number come out between four and five months,” he said. “It's kind of a steady-run-rate type of situation. If it falls below four months, that usually suggests production cuts. If it rises above five, that usually suggests production rates need to move higher. It was 3.7 in September. This is not what you want to be seeing if you want to be talking about an improving marketplace.
“The industry has been doing a nice job of cutting inventory, but sales rates have been falling. Even though they've been cutting inventory, falling sales rates have pushed the inventory sales ratio above three months. One and a half months to two months is ideal. We should have been at 35,000 or 40,000 in inventory, so we still have 10,000-15,000 too many units of inventory on the ground.”
Vieth said the only thing that seems certain about 2010 is that prices are going up.
“A.C.T's preliminary estimate is that Selective Catalytic Reduction (SCR) technology will only add a little less than $0.01/mile of operating costs to the average trucker,” he said. “We note that A.C.T. currently assumes SCR will increase fuel economy by 5% based largely on the fuel- economy gain seen on the Euro IV engines in Europe. However, our checks suggest the fuel-economy benefit for SCR in the US is likely to be only in the 2-3% range, which will largely be offset by a 2-5% urea-consumption rate.
“Fuel economy on non-SCR engines is uncertain for 2010, although CMI is saying ‘comparable’ fuel economy. Still, no matter which technology is adopted by the market in 2010, the cost of the truck is increasing not only from emissions regulations, but also from other safety regulations that will likely go into effect in the same time period. We think the upfront dollar content could be $1000 or more from these additional regulations — it's hard to estimate at this time with conviction — with uncertain impacts to operating costs.”
He says the following non-emissions regulations have gotten little attention:
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National Highway Traffic Safety Administration (NHTSA) braking regulations. The final rule is expected in January 2008, with implementation to be phased in starting in 2009. “We don't think there is a real issue here,” Vieth said. “It will add a little bit of a cost, but there should be some tradeoff with lower insurance premiums.”
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On-Board Diagnostics. California Air Resources Board (CARB) will require emission-control systems monitoring to be phased in beginning in 2010.
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Electronic On-Board Recorders (EOBR) as drivers log. The Federal Motor Carrier Safety Administration (FMCSA) issued a proposed rule in January 2007, with a final rule expected by 2010.
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Electronic Stability Control. The final rule is expected in 2010, with implementation around 2012.
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Tire pressure monitoring system (TPMS). The final rule is expected in 2010, with implementation around 2012.
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Speed limiters. The American Trucking Associations (ATA) petitioned NHTSA and FMSCA to require 68-mph speed limiters.
“There's a lot going on from a regulatory perspective,” Vieth said. “While the individual cost of each is still undetermined, we think it's likely that these regulations will also drive higher purchase and/or operating costs, which is a dynamic the industry has not previously dealt with at the same time as an emissions change.”
Addressing the US economy, Vieth said that the only “horrible spot” is residential investment.
“When you look at the bigger picture, it doesn't look so bad,” he said. “When you look at some of the indicators, real disposable income was over 3% in the past four quarters. So 70% of your economy is seeing wages grow by over 3%. That suggests things shouldn't be too bad. Unfortunately, energy prices have killed consumer sentiment.
“We consume about 200 million gallons of gasoline and diesel on an annual basis, so every penny change transfers $2 million from discretionary spending on goods to energy. So, moving from $2.80 to $3.80 a gallon, that's a $200 million swing in consumers' ability to spend on goods as opposed to on gas.
“If we do that from ‘07 to '08, consumers are going to have a meaningful challenge to spend money on discretionary purchases. And discretionary purchases of goods are freight. And if you get rid of $200 million of freight, you don't need a lot of trucks to haul not a lot of freight. It's like an instant tax on consumers. It's a hugely important short-term consideration.
“I don't see any silver bullets on the horizon. We have to go through the pain of higher oil prices. Wherever I was in China (on a recent trip), there were long lines of trucks at gas stations waiting for fuel to arrive. It wasn't that there weren't enough pumps; it was that there wasn't fuel in the tank. So China is suffering from a regional diesel-fuel shortage. I don't know whether it's on the refining side or the distribution side. That makes me think that we shouldn't expect a whole lot of relief on oil prices.”