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Freight volumes, rates to rise in ’18: Analysts

Posted: October 12, 2017

MISSISSAUGA, ON – The coming year appears to hold the promise of a growing economy, tighter capacity, and ultimately higher rates for those who haul freight.

 “When you have the economy doing reasonably well, transportation tends to be generally picking up,” said Carlos Gomes, senior economist – Scotiabank, in a presentation during the Surface Transportation Summit in Mississauga, Ontario. He projects economic growth of about 2% in 2018, compared to the 3% seen in 2017.

“The Canadian economy recently has been very strong,” agreed Walter Spracklin, equity research analyst – transportation sector at RBC Capital Markets.

But where railways have enjoyed higher volumes against the backdrop of recent growth, trucks didn’t fare quite as well. Railway volumes surged in part because of the demand for fracking sand, feeding into the 6.5% boost in overall freight that moved over iron highways, he said. Intermodal freight volumes are growing as well, although grain volumes are likely to drop when compared to the strong crops of 2016. Of the Canadian railways, CN is seeing capacity tighten, leading to congestion challenges and a projected boost in capital spending.

With trucks, freight volumes appear to have reached a bottom and are showing signs of improving, Spracklin said, cautioning that factors like a high exchange rate means it’s still not a “slam dunk”.

 “It’s been a tough 11 years from a volume point of view,” observed John Larkin, managing director and head – transportation capital markets research at Stifel Financial. But truck tonnage has rebounded to levels seen during the peak of 2006 and should grow further, he said.

Tightening capacity

Then there’s the question of who will be left to move the freight – especially once Electronic Logging Devices are mandated in the U.S.

The route from Chicago to New York is 800 miles long, and shouldn’t be covered in a day, but smaller carriers are doing it to help offset higher costs for everything from equipment to fuel, Larkin said. “Many brokers will tell you sometimes over a beer that they give carriers those loads all day long, and miraculously those loads are delivered.”

Once the U.S. mandates Electronic Logging Devices in December, some of these carriers will no longer be economically viable, he said.

Still, recent increases in spot rates could convince some of these carriers to keep open their doors, he said. Not only that, there’s the question of whether individual states will enforce the Electronic Logging Devices the same way.

“Some may continue to cheat and run around weigh stations,” he added.

Higher rates

For 2018, Larkin expects intermodal rates to rise 4-8%, railroad rates to increase 3-4%, truckload rates to rise 5-10%, and Less-Than-Truckload rates to rise 4-6%.

He referred to a letter from JB Hunt that told good customers to budget for 10% rate increases, while those who had been squeezing the carrier’s rates should expect the increases sooner – or face the threat of fewer trucks to haul their goods.

“This is a really terrific opportunity for carriers to bring prices up,” he said of the current rate environment.

Spracklin projects continued strength in the parcel and courier sector, but softer growth in the longhaul Less-than-Truckload and specialty truckload segments. “We have seen some pressure, especially in truckload, but my hope is that will improve,” he said. “Demand is the cure-all. If we get better demand, that fixes a lot of problems.”

Revenue is only part of the equation, of course. When it comes to profitability, carriers that run a Profit and Loss statement for every truck continue to be the most profitable, Spracklin said. “The key to profitability is price your business appropriately.”

Other gains have been realized through acquisitions, although it can be difficult to get acquired businesses to integrate profitable strategies.

M&A

Spracklin expects a slowdown in fleet acquisitions. Gone are the days of income trusts that traded at eight times EBITDA but were buying companies at a multiple of four times EBITDA, he said. In the current business environment, the fleets that are shopping will be more selective.

“There’s not a lot more huge deals to happen in Canada,” he said, suggesting that the focus is turning to “tuck-in” acquisitions. Mullen will likely focus on Canadian companies, perhaps in eastern reaches of the country, while TFI International will continue to look at new and emerging U.S. markets like same-day parcel deliveries, he said.

Larkin said the super merger of Knight and Swift fleets has changed many minds about merger and acquisition activity. “There seems to be a lot of interest given how difficult it is to grow organically,” he said, referring to issues such as a shortage of skilled drivers. “Look for more industry consolidation in the truckload space.”

As for Less-than-Truckload carriers, that took place 15-20 years ago.

There is room for further consolidation to happen, too. While deregulation has been a reality for 37 year, the biggest carriers still control just 1-2% of the business, Larkin observed.

Doug Munro, president and owner of Maritime-Ontario Freight Lines, sees another advantage if carriers like TFI International that continue to grow. “Shippers are looking for other alternatives, and M-O becomes an alternative they may not have looked at in the past,” he said.

Truck sales

While Class 8 truck production is rebounding after a recent downturn, it’s not because fleets are adding equipment, Larkin suggested. He thinks it’s because the new generation of trucks is easier to maintain, reliable, and offers the benefit of automated transmissions that improve fuel economy and driveability.

“If you don’t have drivers for the trucks that are parked up against your fence, it doesn’t make sense to replace your fleet much,” he said.

NAFTA

Then there is one of the biggest unknowns – the structure of a renegotiated North American Free Trade Agreement. Panellists were cautiously optimistic about the outcomes, but questioned the direction of negotiations that involve U.S. President Donald Trump.

Larkin noted that Trump was elected on a pro-business platform. U.S. Secretary of Commerce Wilbur Ross “definitely has a better IQ than Donald Trump,” he said, adding that he thinks Larkin is “sensible enough” not to disrupt critical Canada-U.S. trade.

“Logic should prevail in most cases,” Spracklin agreed of the negotiations. “It’s too important to mess up. It is too integrated.”

But political decisions could throw this into disarray. “Logic doesn’t always prevail in politics. Especially in the politics we see going on right now,” he said, referring to tariffs on Bombardier as an example. “Things can get ugly.”

Spracklin’s advice is to prepare for the worst, but hope for the best.

Economic growth

In the meantime, the economy continues to accelerate. Gomes projects globally it will swell 3.6% next year, compared to 3.5% this year.

“We’ve seen the low point in the cycle and its broad base,” he said.

Consumer activity has been the primary driver, while business investment has lagged, with the latter dropping from 3.5% in 2014 to 1% in early 2016. Much of the drop in Canada has been linked to the downturn of the oil and gas sector, which accounts for 24 of business investment overall. “Thankfully, that’s beginning to recover,” he said.

It isn’t all good news, however. Close to home, the housing market is concerning, especially in Ontario where home sales over the past decade have been above traditional totals of 190,000 units per year. “We have been significantly above what is normal,” he said. Construction as a share of Gross Domestic Product has swelled to 18.5%.

Munro is equally unsure about 2018 because of challenges ranging from Trump’s policies to central bank activities. “It’s a bubble that’s been growing,” he said, adding that it will pop when interest rates rise. An “overblown” real estate market will be first.

“There are clouds on the horizon,” he said. “We could see a really strong downturn if we see an interest rate push up.”

His advice to fellow carriers: Be cautious. There are plenty of decisions to be made, but the wrong one could leave a business in trouble.


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