Economic uncertainty mutes US transportation outlook

Reynolds Hutchins, Associate Editor | Nov 08, 2015 2:31PM EST

U.S. shippers and the surface transportation providers that serve them can be excused for feeling a bit jittery about the nation’s economic recovery. Nearly every day there’s a new data reading suggesting the U.S. economic rebound is slowing, as high inventories, weak exports, limping domestic factory output and global headwinds, exacerbated by a winded China, take a toll. With U.S. GDP slowing to 1.5 percent in the third quarter from a 3.9 percent clip in the prior quarter, and October’s miniscule retail sales growth, executives are gripping the rails ahead of uncertain holiday season and an even cloudier 2016.

Complicating matters for shippers and logistics providers is the inventory hangover from the West Coast port congestion that eased in the spring after the International Longshore and Warehouse Union and waterfront employers signed a six-year labor agreement after nine months of contentious negotiations. That inventory hangover has made the slowdown this year feel even slower, depressing demand for new orders and freight shipments well into the fall.

But it’s not all bad. Lower fuel prices are giving logistics managers some relief from rising transportation costs, and driving modal changes in some cases. And, that much-ballyhooed trucking capacity crunch didn’t appear this year, dashing fears that rates would skyrocket.

Many of those sentiments were reflected in Wolfe Research’s most recent survey of more than 600 shippers with annual transportation spends totaling more than $10 billion. The quarterly “State of the Freight” report from the New York-based transportation research firm provides an illuminating and nuanced view into what U.S. shippers see through the third quarter of 2016.

Rising inventories depress shipping demand 

The hangover from the U.S. West Coast congestion debacle lingers, although marine terminals have returned to productivity. “U.S. businesses are experiencing inventory overstock at a level we haven’t seen since the beginning of the financial crisis in the fall of 2008,” YRC Freight said in a statement last month.

Shippers, afraid of being out of stock on the store shelf or on the factory floor, pumped up inventories and inventory-to-sales ratios to 1.35 in August, the most recent data available, according to the U.S. Department of Commerce. Retail-only inventory-to-sales ratios are even higher. The adjusted retail sales ratio, which hovered between 1.42 and 1.43 for much of last year, shot up late in the year and had reached 1.47 by February.

That rise in the adjusted retail inventory-to-sales ratio coincided with the West Coast port crisis. The ratio fell to 1.45 by April but was back at 1.47 in August, indicating choppy progress toward destocking by retailers.

Those higher inventory levels muted shippers’ freight volume growth projections, with surveyed executives expecting on average a 2.3 percent increase  in same-store volumes through the third quarter. It’s an improvement over the 2 percent growth shippers reported in the second quarter, but still down from the 2.8 percent they forecast in the third quarter of 2014.

The Wolfe Research survey, conducted throughout September and early October, found that higher-than-average inventories among shippers nationwide have been a drag on freight volumes since the second quarter of 2015 and they will likely continue to tug on volume growth for the remainder of the year.

Some 22 percent of shippers surveyed said they intend to ship less in the fourth quarter of 2015, the highest level in 3 1/2 years and more than double the amount they said three months ago. Moreover, just 22 percent of respondents said they expect more shipping activity in the fourth quarter, “the lowest level since we started asking this question almost five years ago,” the research firm said.

While inventories were lower in the third quarter than in the second, they were still higher year-over-year, Wolfe Research reported.

Approximately 44 percent of shippers said current inventories were higher than a year earlier, down from 48 percent in the second quarter but still up from 35 percent in the third-quarter 2014 survey. Conversely, 27 percent of shippers surveyed said inventory levels were down compared to last year, up from 17 percent in the second quarter but slightly lower year-over-year.

Asked if they intended to increase, decrease or maintain inventory target levels over the next six to 12 months, most shippers said they expect inventory levels to remain the same. Nearly 52 percent of shippers polled said they expect to maintain current inventory targets, the highest amount in 1 1/2 years. Just 17 percent said they plan to increase targeted inventory levels, the lowest amount in two years, Wolfe Research reported. Meanwhile, the number planning to decrease targeted inventory levels remained flat at 31 percent.

“Again, this would suggest that inventory decisions could remain a near-term headwind to freight volumes,” Wolfe Research said.

That begs the question: After the disruptions of the past two years, are shippers willing to carry more inventory, and potentially pay higher carrying costs, to avoid disruptions and reduce stock-outs going forward?

Truck capacity goes from ‘crunch’ to ‘calm’

High inventory levels and the carrying costs that come with it might be keeping shippers up at night, but the bogeyman of the truckload capacity crunch is back in the closet. For the first time in five years, more U.S. shippers — 56 percent — are seeing a surplus of truckload capacity, and not one executive said they expected capacity to tighten in any meaningful way through the third quarter.

Only 11 percent of the surveyed shippers complained of tight truckload capacity in the quarter, down from 28 percent in the second quarter and 85 percent a year earlier. That’s the lowest reading since early 2010.

It stands in marked contrast to the relative balance in the less-than-truckload market. Shippers seeing tight LTL capacity fell to zero in the third quarter, according to Wolfe Research, down materially from 8 percent in the second quarter and more than 40 percent a year earlier. Conversely, 43 percent of shippers said they saw overcapacity in the LTL market, up from 21 percent last quarter and 7 percent a year earlier. The remaining 57 percent of shippers said the LTL market remained balanced.

“This is the first time since 2010 that more shippers cited truckload overcapacity than LTL overcapacity,” Wolfe Research said. “It’s amazing how quickly the truckload market has gone from tight to overcapacity.”

It may be a surprise, but it’s not outside the realm of reason, Wolfe Research said.

Trucking executives ordered a record amount of fleet equipment last year expecting freight demand would take the high road in 2015 after accelerating in 2014. Major truckload carriers began expanding their fleets in the second quarter of 2014, often to bolster specific services, pushing the JOC Truckload Capacity Index up 7.4 percentage points year-over-year in the second quarter to 89.1, the highest index reading since 2008.

“We have not been seeing the volume growth in truckloads to support the amount of trucks coming into the marketplace,” Kenny Vieth, president and senior analyst at ACT Research, told last month’s JOC Inland Distribution Conference in Memphis.

New registrations of Class 8 tractors are expected to reach 250,000-plus units in the U.S. this year for the first time since 2006, and up from an estimated 229,000 units in 2014, according to IHS Automotive. Forty-two percent of those vehicles are part of fleets of 500 or more vehicles. Class 8 tractors registered through the second quarter of 2015 represent nearly 56 percent of all commercial vehicles leased or rented, according to IHS analysis.

The sudden spike in shippers’ reporting excess capacity, Wolfe Research concluded, “reflects a combination of the easier 34-hour restart rules this year, rising driver pay, the highest level of new truck builds this cycle and generally muted demand trends.”

The excess over-the-road capacity also can be attributed in part to bloated inventories that reduce the need for truckload services, especially in the retail arena.

Overall, 44 percent of shippers expect truckload capacity to tighten from current levels over the next year, although this is down from 52 percent in the second quarter and 55 percent in the first. Shippers expecting to see similar truckload capacity going forward rose to 44 percent in the third quarter, from 37 percent in the second and from 27 percent last year. Those expecting more truckload capacity stayed flat quarter-to-quarter at 11 percent, still an increase from 2 percent last year.

Truckload carriers are beginning to pull back on plans to deploy more capacity. Swift Transportation, the largest U.S. truckload carrier, canceled the purchase and trade of about 450 tractors, after adding more than 2,000 tractors over the past year to meet increased demand. “As we move into the fourth quarter and into 2016 our focus will be to drive improved utilization on our fleet,” Swift said.

Capacity got another boost when some new driver hours-of-service requirements were suspended last December. When the 2013 HOS rules were introduced, they “cost the truck industry more than they were able to make in rate increases,” said Mark Montague, industry pricing analyst at DAT Solutions. Changes to the rule’s 34-hour restart provision reduced productivity 2 to 5 percent, he said.

The rules required a 34-hour restart to include two consecutive 1 a.m.-to-5 a.m. periods. That often lengthened the restart well beyond 34 hours, preventing truckers who typically started their week on Sunday afternoon or evening from working until 5 a.m. Monday. When the requirements that tightened the restart were suspended last December, drivers had more time to drive per week, and capacity was pumped back into the market.

Not only have lower fuel prices helped loosen the purse strings for trucking companies nationwide — especially in parts of the U.S. where the energy boom has gone bust — but truck capacity that had been dedicated to oil and gas also has been freed up.

On the flip side, the majority of shippers, 57 percent, expect to see LTL capacity remain flat over the next year, down from 70 percent last quarter but still up from 49 percent a year earlier. According to Wolfe Research, 30 percent of shippers said they expect LTL capacity to tighten over the next year, up from 20 percent in the second quarter but down from 49 percent a year earlier. Only 13 percent of shippers expect to see even more LTL capacity, up from 10 percent in the second quarter and 2 percent a year earlier.

The main reason LTL capacity seems so much more balanced is because there are far fewer LTL carriers. Everyone with a tractor-trailer can be a truckload carrier, but to be an LTL carrier requires terminals with multiple doors for cross-docking, pickup and delivery trucks as well as linehaul and other equipment. The biggest LTL carriers are getting bigger, but there are fewer smaller LTL carriers than there were 20 or 30 years ago.

With shippers expecting truckload capacity to remain in excess, it’s perhaps not surprising that truckload pricing expectations fell the most sequentially among all modes of transportation. Shippers polled in Wolfe Research’s latest survey said they only expect truckload rates to increase 1.7 percent over the next year, down from 2.8 percent and 3.5 percent the prior two quarters. “The lowest level in two years in our survey,” Wolfe Research said.

According to the survey, 38 percent of respondents noted that spot market rates were below contractual rates in the third quarter, up from 22 percent in the second quarter and 7 percent a year earlier. Conversely, 36 percent of respondents saw higher spot rates compared to contractual rates over the past quarter, down from 47 percent in the second quarter and 74 percent a year earlier.

“This makes us increasingly cautious on truckload contractual pricing opportunities going forward,” Wolfe Research said. “We believe that contractual truckload pricing is likely to be muted.”

That’s certainly true as long as the capacity situation remains static. With carriers already taking steps to reduce excess capacity and inventory destocking under way, the market could swing once more next year — especially if unforeseen disruptions occur, like the winter storms of 2014.

The capacity “crunch” may have been postponed, but shippers and carriers say it remains a long-term concern.

Meanwhile, with LTL capacity more balanced, LTL pricing expectations accelerated in the third quarter. Shippers’ expectations for LTL rate increases increased to 2.7 percent from 1.9 percent in the second quarter. Shippers now expect larger LTL than truckload rate increases for the first time in more than two years, and the spread between LTL and truckload rate expectations reached its widest level in six years, Wolfe Research said.

The largest LTL carriers reported a stable pricing environment in the third quarter. YRC Freight, the third-largest standalone LTL carrier, won contractual rate increases in the 5 to 6 percent range, while ABF Freight raised contractual rates nearly 5 percent on average. Those gains come on top of rate increases last year, when the freight market was stronger.

“From my perspective, the LTL pricing environment remains steady,” James Welch, CEO of YRC Worldwide, told Wall Street analysts on Oct. 29. “Sometimes you see somebody doing something stupid in the marketplace, and we’ve seen some of that in isolated spots.” 

Shippers returning to intermodal

With truckload rates rising more moderately because of plentiful capacity, diesel prices down 30 percent year-over-year and intermodal rail service still below-par, it’s not much of a surprise that the shift of freight from highway to rail has slowed. But there appears to be a turn in the bend, with more U.S. shippers saying they shifted freight from over-the-road to rail than the other way around for the first time in nearly a year.

Surveyed shippers said they diverted 1.9 percent of their third-quarter volume from truck to rail, up from 1.2 percent in the second quarter. On the flip side, shippers moved 1.2 percent of their third-quarter freight from rail to truck, down from 2 percent in the second quarter. The end result was a net freight diversion to rail of 0.7 percent during the third quarter.

Shippers’ expectations for intermodal volume growth through next year’s third quarter were their lowest in more than three years, despite their belief that pricing gains will decelerate, according to the Wolfe Research report. Shippers said they expect a roughly 1.5 percent increase in intermodal volume over the next year, down from just less than 3 percent in the second quarter and from more than 4 percent last year.

“This is a material change from last quarter when expectations for domestic ground and intermodal volumes were the highest across all modes,” Wolfe Research said. “Shippers now have the highest expectations for (truckload) and global ocean volumes, both at a touch above 2 percent.”

Slower volume growth is due largely to “prior rail service issues” and “lower fuel prices” for over-the-road options, Wolfe Research said. Nevertheless, ongoing improvements to service helped railroads accelerate the rate of highway-to-rail conversions in the third quarter for the first time in about nine months.

“This ended three straight quarters of net diversions from rail to truck,” Wolfe Research reported.

The rate of highway-to-rail conversions picked up speed earlier this year, as lower diesel prices and rail service inconsistency made trucking options more viable for shippers. It’s something that some railroads, such as CSX Transportation, say they are now recovering from, while others, such as Norfolk Southern Railway, say they are still fighting.

“In 2014, we lost some intermodal business back to the highway due to the service issues. But we are actually seeing some of that volume return in 2015 as services improve,” Clarence Gooden, then CSX’s chief commercial officer and now the railway’s president, said in a second-quarter earnings call with investors and analysts.

Three months later, CSX’s domestic intermodal business expanded 15 percent year-over-year in the third quarter, driven by new highway-to-rail conversions after the company made some “strategic network investments,” said Frank Lonegro, chief financial officer and executive vice president.

Speaking about its third-quarter performance, however, NS said it still hadn’t rounded the bend as far as conversions were concerned. Total intermodal volume fell 1 percent year-over-year at NS in the third quarter to a little less than 1 million units. NS executives have been vocal that the railway was hurt specifically by the increase in rail-to-highway conversions.

During a tour of the railway’s Rossville, Tennessee, intermodal terminal in October, Shawn Tureman, NS’s director of domestic intermodal marketing, told JOC.com that the railway has lost market share to over-the-road competitors. “Growth has decelerated, and I think part of that is decreasing fuel prices,” he said. “When that happens, when fuel prices go lower, the advantages of rail compress and become closer to truck.”

The Wolfe Research survey is an early sign that the tide might be turning following months of net rail-to-highway diversions. “Our respondents expect the pace of intermodal share gains to reaccelerate somewhat from last quarter,” the research firm said.

Over the next six to 12 months, survey participants said they intend to move 0.5 percent of their volume from rails to over-the-road options, less than the 2.3 percent of shippers who plan to shift from truckload to rail. This implies a net gain of 1.7 percent for the railroads going forward, an improvement over the 1.4 percent gain Wolfe Research’s survey found in the second quarter.

“Still, the pace of share gains for intermodal remains lower than what we’ve historically seen in our survey,” the research firm said, noting that shippers’ net gain forecasts were still well below the 2.7 percent a year earlier. “We believe this data suggest that while intermodal growth will continue to outpace other transport modes over time, the growth potential is likely somewhat diminished at lower oil prices.”

Shippers’ expectations for rail pricing eased in the third quarter, but still lead among all forms of transport. Shippers in the third quarter said they expect a 2.7 percent rate increase from the railroads over the next year, down from 3.3 percent in the second quarter, according to the report.

Despite the slowdown, shipper expectations for rail rate increases led all other transportation modes for the 18th time in the past 19 quarters, and rail pricing expectations remain well above what Wolfe Research’s survey forecast throughout most of 2011, 2012 and 2013.

Although improved intermodal market share may not be a result of comparable pricing or lower fuel prices, it does reflect improved rail service levels, Wolfe Research said. Rail service rankings improved to the highest level in 2 ½ years, according to the research firm. “Rail service metrics, including dwell times and train speeds, were terrible throughout 2014, but have improved materially this year,” it said.

According to Wolfe Research, the Big Four U.S. Class I Rails — BNSF Railway, CSX, NS and Union Pacific Railroad — averaged a 6 percent year-over-year increase in velocity for carload and intermodal trains during the third quarter, up from 2 percent in the second quarter and the highest gain since late 2012. U.S. railroads also reported a decline in average dwell time of 6 percent year-over-year in the third quarter after a 4 percent improvement in the second.

In a third-quarter earnings call last month, Hub Group said it’s seen rail service improvements this year, especially in the third quarter and especially between its two primary rail partners NS and UP. “Overall rail service improved incrementally throughout the quarter. On-time service improved in the low double-digits on a year-over-year basis and high single-digits on a sequential basis,” Hub Chairmand and CEO David Yeager told investors.

According to Yeager, while transit times for Hub customers improved by two-tenths of a day year-over-year in the third quarter, they remain a half-day longer than they were in 2013. The recovery has been slow, Yeager said, but it’s been recovery nevertheless.

Average Class I train speeds in North America, an indication of network reliability, increased year-over-year for the third straight quarter after deteriorating in the prior eight quarters, according to Wolfe Research.Canadian Pacific Railway led the way, with train speeds increasing 20 percent year-over-year in the third quarter. Most recently, intermodal train speeds excluding CP fell in the third week of October, down 0.4 mph to 30.4, according to Larry Gross, a senior consultant at FTR Associates. They do, however, remain ahead of last year when speeds were at just above 28 mph. Gross echoed Yeager’s remarks, noting that while speeds are recovering slowly, they are recovering nonetheless, though not to their pre-2013 levels.

Improved and improving rail service played a large part in shippers’ expectations to continue using intermodal in the future, Wolfe Research said. On average, about 13 percent of shippers’ total over-the-road volumes are going through intermodal, up from 8 percent five years ago. And, looking ahead, shippers said they expect 15 percent of total over-the-road volumes to go through intermodal in five years.

“This suggests that even though intermodal share gains have recently slowed due to prior rail service issues and lower fuel prices, the pace of intermodal conversion should continue the next several years,” Wolfe Research concluded.