A report released Wednesday by Susquehanna Financial Group would be music to the ears of truck drivers: Rates may have a “melt-up.”
The report by analyst Bascome Majors expressed enough confidence in a coming upturn in trucking economics that it raised its ratings from neutral to positive for four companies: C.H. Robinson (NASDAQ: CHRW), Echo Global Logistics (NASDAQ: ECHO), Landstar (NASDAQ: LSTR) and Werner (NASDAQ: WERN).
“Truckload’s supply-side overhang on asset-based pricing and margins looks like the primary problem, as underlying volume grew (Susquehanna’s italics) through 4Q and spot pricing showed more than seasonal m/m tightening despite falling y/y for 16 straight months,” the report said.
Majors noted that both the economy and truckload volumes are on the rise, while supply is expected to shrink 1% this coming year compared to a 4% increase in both 2018 and 2019. “Seasonal-plus patterns (are) returning to volatile real-time rates.”
The end result? “We see the risk of a ‘melt-up’ in spot rates in 2020 as far greater than a meltdown,” the report said.
With that, Susquehanna sees both stock price multiples and share prices following, resulting in the four companies that had a neutral rating being boosted to the positive category. But at the same time, Susquehanna left its positive rating on Schneider (NASDAQ: SNDR) and Knight-Swift (NYSE: KNX).
The report spells out all the carnage that has led to consistently poor quarterly results for the trucking sector: contract rates in November down 3.5% y/y based on TruckloadRate.com data after declines the two prior months of 3.7% and 2.5%, respectively, and spot rates that have declined for 16 straight months.
But the Susquehanna report is more positive on the direction of those rates, projecting that the decline will “moderate.” Majors looked at “evidence of tightening rates to close out 2019, better than the usual seasonal improvement … and just a few points behind the ELD-inflated upside trend of December 2017.”
“We expect dry van spot rate declines to moderate from high single digits to low- to mid-single digits in early 2020 before inflecting favorably with a month or two of rate increases during spring bid season,” the report said. “In short, a supply-side shock (weather or consistent capacity reductions) has a real potential to drive a ‘melt-up’ this year.”
Majors’ report cites the well-known numbers on how much capacity has increased. Federal Motor Carrier Safety Administration data shows that the Class 8 tractor count has grown for 13 consecutive months. The data is up for both big and smaller fleets.
But it’s coming to an end, the report said. “Most carriers expect a slow bleed of this extra capacity as we move through 1H20 aided by depressed rates, increasing insurance costs and new regulations that are expected to limit supply,” the report said. Among those regulations are the Drug & Alcohol Clearinghouse, AB5 (though it’s on the shelf for now) and hair-follicle testing. The report cites various numbers showing that capacity is already starting to slide, including the enormous drop in new Class 8 orders, down 45% y/y in the fourth quarter through November. “As rates have cooled, net orders and backlogs have followed,” the report said.
The economics behind the upgrade in the C.H. Robinson and Echo Global ratings are fueled by what Majors sees as a moderation in the decline in spot rates while contract rates remain lower. “Contract rates have continued to outpace the spot market for the 16th straight month,” with contract rates down 3.8% y/y while spot rates are down 13.3% during the same period, the report said.
But the report adds that “our recent conversations with shippers and carriers point toward a tightening spot market, aided by capacity-rationalizing events,” and then repeats the same factors as in truckload: clearinghouse, high insurance costs and hair-follicle testing. That sets up a situation for brokers in which spot rate declines in the first part of 2020 slow their pace and could turn positive “while contract rates continue their y/y declines and continue to track subseasonal as we move closer to 2020 bid season,” the report said.
Susquehanna’s report was not bullish on intermodal, though it did not make any cuts in the rating for Hub Group (NASDAQ: HUBG), which held at positive, or for J.B. Hunt (NASDAQ: JBHT), which held at neutral. However, Susquehanna’s earnings estimate for Hunt was reduced 4% “on downside margin messaging for both intermodal and brokerage/ICS.” Hub Group had its estimate increased 12% on the results of recent cost-savings operations.
Although the long-term outlook is positive, most of the changes Susquehanna made in earnings forecasts were in the red. For example, for the fourth quarter of 2019, Knight-Swift’s earnings per share forecast was reduced 18%, Werner’s was cut 16% and Schneider took a 10% haircut. But the forecast was flat for Landstar and down just 4% for Robinson. (Knight-Swift already has projected lower earnings for the quarter.)
And even with talk of a rates melt-up, it was mostly red in the forecast changes in EPS for all of 2020, though far less than the 4Q 2019 projections. Werner was down 7%, Knight-Swift was down 11%, Hunt was cut 4% and Echo was down 3%. Hub Group saw a 12% increase.
Susquehanna is bearish enough that it said it is still below Wall Street consensus on most big companies. It’s 9% less for Echo, 9% for Werner, 5% for both Knight-Swift and Robinson and 4% for Hunt. But Majors noted, “We expect street estimates to drift downward as we move closer to company earnings.”
