Bullish commentary from the trucking industry and positive intraquarter updates from carriers have confirmed what the data has been showing for several weeks now: Third-quarter earnings for trucking companies will be strong and that strength may continue for a while.
While second-quarter results came in ahead of lowered expectations, COVID-19’s impact on demand was evident in most financial reports. After a brief inventory restocking rally in March, trucking demand fell as manufacturing lockouts and municipal shutdown ordinances spread. A bottom formed in April with conditions improving throughout the quarter. The “less bad” trend throughout the second quarter has turned into year-over-year growth in the third quarter as carriers are seeing peak-type loads ahead of peak season.
What the data was saying all along has been confirmed as management teams from the publicly traded carriers have begun to vocalize the improvement and analysts have raced to up their earnings estimates for the current quarter and beyond.
Truck demand materially higher
Outbound tender volumes (SONAR: OTVI.USA) inflected positively year-over-year in mid-May as manufacturing, notably in the auto sector, came back online. The year-over-year growth in volumes accelerated throughout the bulk of the third quarter, cooling only for the Labor Day holiday, which occurred five days later this year than last.
At a recent investor conference, representatives from various carrier management teams provided anecdotes on the relative demand outperformance. Management from J.B. Hunt Transport Services (NASDAQ: JBHT) said they have seen incremental demand increases in each of the past six weeks. Schneider National’s (NYSE: SNDR) team indicated that a 10% to 15% drop in daily tendered loads would still leave the carrier with more freight than it could haul.
A change in consumer buying habits from experiences and services to hard goods that require shipping has driven the spike in truck demand. Retail sales, excluding motor vehicles, reached record levels in August at $428 billion, according to the U.S. Census Bureau. While only 2% higher year-over-year, it’s an important mark as it was the first month without the help of enhanced unemployment benefits afforded under the coronavirus-aid package.
E-commerce sales increased 45% year-over-year during the second quarter. The increase in at-home shopping has pressured supply chains and left many retailers in a struggle to replenish significantly depleted inventories.
Census Bureau data shows the retailers’ inventories-to-sales ratio remained near all-time lows in July at 1.23x, relatively flat with June’s record-low reading of 1.22x. The reading was also significantly lower than 1.35x in May and 1.68x in April, a month that was marred by the height of broad economic shutdowns. Many transportation equity analysts have pointed to the need for continued inventory restocking as a primary catalyst for raising carrier estimates moving forward.
Estimates moving higher
UBS (NYSE: UBS) freight transportation analyst Tom Wadewitz recently raised his truckload (TL) earnings-per-share (EPS) estimates by mid-single to mid-teen percentages for the back half of the year. “We note that inventory replenishment is a key driver of truckload and intermodal demand and low inventories point to strength in demand in 2H20 and likely into 2021,” Wadewitz said.
Deutsche Bank (NYSE: DB) analyst Amit Mehrotra advanced his forecasts for the rest of 2020 and all of 2021 on the carriers he follows. He increased his third-quarter earnings estimates for TL and less-than-truckload (LTL) companies by approximately 18%, resulting in his expectations being 12% to 32% higher than consensus estimates at the time. His full-year 2020 and 2021 estimates were increased by 9% and 10%, respectively. “The bottom line is we expect Transportation results to be very strong across the board, with likely more to come over the course of the next several quarters,” Mehrotra proclaimed.
LTL carriers ArcBest Corp. (NASDAQ: ARCB), Old Dominion Freight Line (NASDAQ: ODFL) and Saia (NASDAQ: SAIA) also reported improving demand during the third quarter. All three noted that tonnage inflected positively year-over-year in August for the first time since the pandemic idled large swaths of the manufacturing economy. ArcBest first saw LTL tonnage improve slightly year-over-year in July.
Truck broker Landstar System Inc. (NASDAQ: LSTR) recently increased its earnings expectations by 25% for the third quarter. The company now expects loads hauled by truck and revenue per load to increase at a low-single-digit percentage year-over-year versus its original guide calling for mid-single-digit declines.
Other tailwinds for demand
The National Association of Homebuilders housing market index, a survey of its members gauging current and future single-family home demand, reached an all-time high last week. The index’s 83 reading was 15 percentage points above September 2019 and the highest level in its 35-year history. The following day, Census Bureau data for August showed single-family building permits rose 6% from July (16% higher year-over-year), with new one-unit home starts increasing 4% sequentially for the month (12% higher year-over-year).
In efforts to further support economic recovery, the Federal Reserve announced last week that its new forecast calls for interest rates to remain near zero through 2023, which bodes well for the housing market as well as inventory restocking. A sustained low-interest rate environment would be conducive for the consensus that is forming around the likelihood of businesses holding additional product in storage to avoid future supply shocks.
Supply likely to be constrained for some time
Several headwinds face truck capacity. An oversupplied truck market and cost inflation, including a jump in insurance premiums, led to a high number of carrier bankruptcies and a low level of new truck orders in 2019.
While new truck orders have improved recently, many don’t believe they are keeping pace with replacement as banks have tightened lending requirements for many carriers. Net Class 8 truck orders were 19,400 in August, according to ACT Research, 5% lower than July but 74% higher year-over-year. This was the third time since December monthly orders were near 20,000 units, a level seen by most as the minimum required to replace retiring equipment and keep the entire industry fleet from declining.
At a forecasting webinar last week, ACT Research said it expects orders to ramp further as truck buying enters a seasonally strong point in the year. “July and August were the two best months since the fourth quarter of 2019,” said Kenny Vieth, ACT Research president and senior analyst. “We should be seeing [monthly] orders in the fourth quarter in the 25,000-26,000 average.”
However, Morgan Stanley (NYSE: MS) analyst Ravi Shanker provided some resistance in a note to clients, saying the August result came in lower than ACT Research’s seasonally implied forecast of 21,000 units, which “indicates signs of recent order momentum slowing.” He expects “supply headwinds to persist moving forward” and doesn’t expect “a sharp influx of supply.”
In its August report, freight data and research firm FTR Transportation Intelligence said it expects orders to remain in the “20,000 range for the next few months.” The firm said that the large fleets are continuing to buy but at levels only in line with normal replacement cycles and that only a few orders have been for fleet expansion.
The implementation of the Drug & Alcohol Clearinghouse in January as well as drivers opting for the sidelines — over concerns of contracting COVID-19 or finding sufficient replacement income through enhanced unemployment benefits — have further tightened the screws on truck availability. J.B. Hunt recently said the clearinghouse and stimulus payments have resulted in a decline of 100,000 available drivers.
Management from U.S. Xpress Enterprises (NYSE: USX) said that 30,000 drivers have failed drug tests, which could keep them from driving professionally for a couple of years. They believe the impacts from the clearinghouse as well as declines in driver school enrollment and favorable unemployment benefits have cut the driver pool by 100,000 CDL drivers through the first seven months of 2020. By the end of the year, they expect the number of available drivers to be down 200,000 compared to the end of 2019, worsening further if hair follicle testing is enacted.
Outbound tender rejects (SONAR: OTRI.USA), a proxy for truck capacity, remain elevated at 25% and near all-time highs.
Contract rates could go much higher
Deutsche Bank’s transportation and consumer-packaged goods (CPG) equity research analysts said they see trucking rates increasing as high as 15% to 20% for CPG companies next year. Their assumption is based on their recent conversations with freight and trucking industry experts. “Higher spot prices trending into year-end 2020 (and putting upwards pressure on 2021 contract rates)” is their base case moving forward. The firm sees the current supply-demand imbalance lasting “potentially well into 2021.”
U.S. Xpress expects rates to increase in the 10%-plus range in 2021 as two years of cost inflation hasn’t been captured in the past two rounds of contract negotiations. The company’s management team said there are opportunities for out-of-cycle rate increases as shippers are approaching carriers looking to lock in next year’s expected rate increases now before they potentially move higher.
Schneider National has seen a similar trend as shippers struggle to get their tendered loads accepted and J.B. Hunt has indicated that contracts negotiated earlier in the year don’t account for the pandemic and the current supply shortage. Both companies see the opportunity to address some of these contracts in the near term.
Dry van spot rates passed prior-year levels in mid-June with the gap widening since. Currently, spot rates are 38% higher year-over-year, presenting a favorable starting point for carriers negotiating renewing contracts. How long the current dynamics hold remains to be seen, but many in the industry see the current trucking bull market extending longer than in the past as several capacity constraints persist.
U.S. Xpress believes the supply deficit is likely to linger and that driver wage increases in the 15% to 20% range are required to get the number of drivers needed to meet demand. The company believes this trucking cycle could run longer than the historical average of six to eight quarters.
There are a couple of headwinds facing the hot trucking market. Stimulus payments and changes in spending habits have stoked the run on inventory and the need for continuous replenishment. The bulk of the outperformance in freight demand has come on the consumer’s willingness and ability to spend and without a meaningful contribution from a healthy industrial economy. The primary concerns for demand moving forward are reductions in stimulus and high unemployment. However, the continuation of this trucking boom may be on solid footing as a meaningful buildup in capacity doesn’t appear to be on the near-term horizon.