October 01, 2012

Introduction

The trucking industry has faced challenges over the last few years as a result of the recession. Consumer spending decreased, as did demand for the freight transit of goods, which consequently led to a decline in industry revenues of 17% in 2009. Although the industry has begun its recovery, factors such as increased diesel fuel costs and increased internal and external competition have created a challenging operating environment.

Industry Revenues Recovering

The industry has seen intense competition as the many small players in this highly fragmented market struggle to make profits in the face of decreasing demand and rising costs. This competition has caused profit margins to shrink industry-wide. The rising cost of diesel fuel has also led to increased competition from the rail industry, which offers a less expensive, albeit less flexible, alternate mode of transport for clients.

Rising manufacturing and retail demand, as well as increasing construction activity, have helped to counterbalance increasing fuel prices and external competition. In addition, recent employment trends suggest the worst may be behind the trucking industry, with related employment recovering at a faster rate than that of the broader market.

Industry Cost Structure (2012)

Influencing Factors

Overall, employment is recovering from the 7% decline seen in 2009, showing modest growth of 1% and 2% in 2010 and 2011, respectively, and has been outpacing U.S. (non-farm) employment growth through 2011 on a trailing 12- month basis. Absolute employment figures are projected to recover to pre-crisis levels of approximately 1.9 million employed by 2014. Future growth estimates have also stabilized, with the trucking industry expected to grow at approximately 3% annually through 2017, in line with the overall economy.

Profit margins in 2012 are expected to be approximately 5% of sales, much lower than pre-recession 2007 levels. As an example, profit margins in the long distance trucking sub industry have dropped from 9% in 2007 to 5% in 2012. The single largest expense is employee wages making up approximately 31% of revenues. Second largest is fuel costs at approximately 14% of revenues. Wage costs as a percentage of revenue are expected to remain stable through 2017 on a percentage of sales basis, while diesel costs are expected to rise as a percentage of sales, which is driven by a projected 3% increase in crude oil prices annually through 2017.

US Trucking Employment Recovering

To help mitigate the effect of rising diesel costs, it is standard industry practice to pass along fuel increases in the form of fuel surcharges to clients. Consequently, although industry revenues are projected to increase at 2-3% annually through 2017, much of this increase will be attributable to these surcharges, and will not increase profits levels.

Fragmented Industry

A Look at the Competition

Despite the decrease in industry profit margins due to competition, concentration – or the presence of a few large companies comprising the majority of the market – is very low; 69.5% of enterprises have fewer than four employees, and 81.6% of enterprises have fewer than 10 employees. This large number of small players is driven by relatively low barriers to entry, as only a commercial driver’s license and a truck are required. This also leads to a constant stream of competition as new players enter the rebounding market.

Enterprise by Employment Size

Industry-wide, the top six carriers by sub-industry represent about 10% of the total market. The two largest players – YRC Worldwide Inc. and J.B. Hunt Transport Services Inc. – have just over 5% of the market combined. This low concentration increases competition and has pressured margins as all participants struggle to maintain revenues amid decreased demand, leading many firms to lower prices to gain market share, which has subsequently eroded profit margins throughout the industry.

Newer forms of competition are also on the rise. Over the past decade, there has also been an influx of private-equity backed companies. These companies generally have much higher levels of capital at their disposal. Traditional trucking companies have found their comparatively low access to capital a handicap, as private equity-backed enterprises are able to use this capital as a lever to accelerate growth by investing in capital-intense areas such as technology upgrades meant to improve route and driving efficiency and newer, state-of-the-art trucks and trailers that burn less fuel.

US Deisel Fuel - Cost per Gallon

In addition to internal competition, rising fuel costs and the resulting increase in truck shipping rates have increased competition from the railroad industry as clients search for the most cost-effective and efficient method of transporting goods. Compared to trucking, rail transport boasts a higher efficiency of 400 ton-miles per gallon on average, compared to 130 for trucking. However, improvements on the horizon can level the field. Trucking ton-miles per gallon can be increased to as much as 275 by employing state-of-the-art equipment, and increased to as much as 335 if additional trailers are added. Unfortunately, this is not the standard for the industry, and it will likely be some time before the industry has the excess capital to make these expensive conversions.

Rail’s ability to undercut trucking has put pressure on pricing and subsequent profits. Even though rail offers a relatively less expensive option per ton shipped, many shipments are time sensitive or require door-to-door shipment such as produce and other spoilable goods. Additionally, the adoption of just-in-time delivery among manufacturers has differentiated trucking from rail, as this process requires many small and precisely timed shipments that rail cannot accommodate due to long lead times.

Going forward, optimum capacity utilization will be a key success factor across the industry as higher fuel prices have made it increasingly necessary to use vehicles efficiently. In reaction, many large companies have invested in technology to help streamline operations by monitoring vehicle activity, while smaller outfits are sharing drive time on single trucks to avoid as much down time as possible.

Increased Regulation

The trucking industry is also facing increases in regulation from the Federal Motor Carrier Safety Administration, specifically regarding the hours of service rule (HOS). This rule is meant to regulate the amount of time a driver can be on duty in a given period, effectively ensuring that drivers get the rest they need before and after long periods of driving, thus reducing accidents associated with driver fatigue.

Effective in February 2012, with a full compliance date of July 2013, all drivers will need to comply with the new ruling. The new HOS ruling retains the 11-hour daily driving limit from the previous ruling, but reduces the maximum hours a driver can work in a given week by 12 hours from 82 to 70 hours per week. The ruling also requires drivers to take a mandatory 30-minute break during work periods of eight hours and requires that all drivers who maximize their weekly allowance must have at least two nights of rest when their bodies demand it most, between the hours of 1:00am – 5:00am. This is part of the “34-hour restart” provision that allows drivers to effectively restart their work week (once per week), after taking 34 consecutive hours to rest. Strict penalties coincide with violations. Trucking companies that allow their drivers to exceed the 11-hour daily maximum can be fined up to $11,000 per occurrence, with drivers personally liable up to $2,750 per offense.

While it is yet to be seen how these new regulations will truly affect the industry, it is likely that these regulations will have negative consequences in the form of reduced productivity and higher costs. As previously legal shipping routes become illegal, trucking companies will need to hire more drivers, leading to increased wage costs, which will ultimately be passed on, at least partially, to the end consumer in the form of increased shipping rates. Many in the industry argue the ruling over-burdens the industry and will produce no significant safety gains. To this point, a number of trucking groups have filed lawsuits claiming that the ruling is much too restrictive. The American Trucking Association also added that trucking-related fatalities are down nearly 30% since the current rules went into effect in 2004, arguing that previous, less restrictive rules were working to improve safety, and new, more restrictive rules are not needed. These suits will dictate if these regulations will stay in effect, but for the time being, the industry will need to adjust accordingly.

M&A Deal Volume - Quartlerly

M&A Activity

Industry merger & acquisition activity has recovered from the 20% drop seen during 2009, totaling 84 deals in 2011, up from 65 in total for 20091. Over the next five years, industry activity is expected to rise as larger players in the market look to other ways of increasing profitability, expanding into adjacent spaces such as freight forwarding, logistics, and other value-added services.

Trailing Enterprise Value to EBITDA

Increase in Public Market Valuations

Market valuations for selected publicly traded, non-over-the-counter, companies within the industry have also been trending upward since the recession and have remained near 8x EBITDA over the last four quarters, up from multiples between 4 and 5x EBITDA in late 2008 and early 2009. This data suggests that the market has stabilized, and with U.S. economic growth on the horizon, the industry should remain stable as demand returns to a relative state of normalcy.

Conclusion

The U.S. trucking industry has contracted since the recession as decreased demand, rising oil prices, and increased competition took its toll, forcing many companies to reduce their work forces, reorganize, or exit the market entirely as already low profit margins were reduced.

Despite these difficulties, the industry seems poised for a steady recovery. As the U.S. economy shows signs of growth, the need for shipping should follow, inducing growth for the industry. Additionally, employment is increasing at a faster pace than the overall economy, and there has been an increase in M&A deal activity as well as an increase in public market valuations.

However, the industry still faces increasing competition from rail amid rising oil prices that will continue to drive price competition and suppress margins. Increases in regulation will also be an obstacle on the road to recovery. Only time will tell if the recovery in revenues that we have seen thus far will translate to margin and earnings growth as well.