An end to a prolonged freight recession could be approaching sooner than some investors may think, one equities analyst said Monday. The bullish call was largely centered on the need for inventories to be replenished after companies have spent the last few quarters drawing down overstocked levels.
“Shippers continue to remain on reorder ‘strike’ while they wait for stronger signals or more favorable conditions on macro but while destocking at the same time, which could lead to everyone wanting to restock at the same time, when the coast clears (or they run out of inventory),” Morgan Stanley (NYSE: MS) analyst Ravi Shanker told clients Monday.
He said that could kick off an inventory replenishment period, pushing freight volumes higher for the trucking and intermodal companies he follows. He believes an upcycle could occur as soon as the end of the first quarter. He acknowledged the call is “out-of-consensus” but said that most shippers had already purged excess merchandise from their shelves this summer.
The recent supply overhang was the result of miscalculations from supply chain managers looking to avoid the prolonged stockouts seen during the pandemic. Vowing to not endure a repeat of the 2021 holiday season, the country’s biggest brands executed a “just-in-case” ordering strategy heading into the back half of 2022, which ended up producing bloated warehouses and notable discounting.
Many large shippers have said their inventories have been right-sized in recent months, which has Shanker thinking an uptick in ordering could occur if consumer spending remains healthy as it did during the recent holiday season.
“The longer the limbo period lasts, the more pressure builds for the upcycle to come,” Shanker said.
Shanker pointed to a 20-year-old, proprietary survey of shippers, which has been successful in predicting prior cycle inflections. The fourth-quarter iteration released Monday showed inventory destocking continued “at a historic pace, even as inventory levels rapidly normalize.”
Of those polled, only 5% said they needed to increase inventory levels. Thirty-nine percent of respondents said they would reduce stock levels, which was a notable decline from the cycle-high of 48% that was registered during the second quarter.
“We believe record-high levels of destocking when inventory is already normalized are not sustainable as are record-high levels of shippers looking to ‘maintain inventory’ from here together with record-low ‘increase inventory,’” Shanker said. “We believe shippers will need to start increasing inventory soon if the rate of destocking (driven by consumer spending) keeps up at its current rate.”
After several quarters of year-over-year (y/y) declines, the truckload and intermodal sectors will benefit from easier volume and pricing comparisons in 2024. The survey showed y/y volume expectations for shippers moved back into positive territory, however, the group’s current expectation for TL and intermodal rates was still negative as they expect these modes to be the loosest from a capacity standpoint.
For the full year, 20% of shippers expect TL rates to be flat. However, the response category of “down more than 4% y/y” received the second-largest number of votes at 15%.
That might be wishful thinking from shippers as Shanker’s base case for TL rates — excluding fuel surcharges — is flat to up mid-single-digits for the full year. Again, the comps from the prior year are negative.
Shanker doesn’t expect management teams to express his exuberance when they report fourth-quarter results and provide full-year earnings guidance in the coming weeks. He’s expecting their outlooks to be a “tale of two halves,” with the first half clouded by broader macro uncertainties coupled with more constructive commentary around the back half.
He said the TLs and less-than-truckload carriers will likely be the winners in an upcycle, favoring the risk-reward setup for TLs more given the outperformance in shares of LTL carriers last year. His top pick is Knight-Swift Transportation (NYSE: KNX) followed by TFI International (NYSE: TFII) and Schneider National (NYSE: SNDR).
Shanker also noted a disconnect brewing in LTL as investors bullish on the space believe shippers will pay “super-premium rates” even though some carriers are now “sitting on 30-40% excess [terminal] capacity” following Yellow’s terminal auctions. While those terminals aren’t expected to be reopened all at once, Shanker said that rate scenario is likely “untenable … unless we have a record upcycle.”
This year will be a big year for two of those three carriers as they integrate billion-dollar acquisitions. Knight-Swift acquired U.S. Xpress for more than $800 million in July and TFI plans to close on its $1.1 billion bid for flatbed carrier Daseke (NASDAQ: DSKE) in the second quarter.
“We are more bullish as we believe the pressure to restock is likely to be more intense than carriers or shippers believe,” Shanker concluded. “We believe only a black swan event or severe recalibration of macro expectations will push the upcycle into 2025.”
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