LTL: Managing the way to profitability

David Ross was the first to see this latest industrial freight recession coming. Early last year, the veteran less-than-truckload (LTL) analyst at investment banking firm Stifel said that he saw industrial demand falling off at the most precipitous pace since the end of the Great Recession in 2010.

In fact, Ross nailed it. LTL freight demand cooled by the middle of last year, while some carriers unwisely added capacity—making rate increases tough to implement and forcing fuel surcharges to crater.

As a result of these actions, stock prices for the publicly held LTLs as a group were off 47% in 2015 compared with a 1% drop in the S&P 500 stock index. Today, with the U.S. manufacturing sector still showing further contraction and LTL carriers enduring the usually slow first quarter, is it time to be bearish on the LTL market?

“Not so fast,” says Ross to LTL investors. Despite weak fourth quarter LTL earnings from most publicly held carriers, Ross is actually now quite bullish on the sector. The key, he says, is how fast retailers and manufacturers burn off excess inventories. Once that happens, he is predicting a rebound for the LTL sector.

However, not everyone agrees. “Our business, as well as the balance of the U.S. economy, would benefit from more robust growth,” says Rick O’Dell, president of Saia, the nation’s largest multi-regional LTL carrier. Saia is heavily exposed to the oil and energy sectors, which have been battered by the recent collapse in world oil prices.

With that as a backdrop, LTL carriers have been relatively successful in passing along their cost increases to shippers with rate increases slightly above the rate of inflation. “Rates have been steady so far,” says O’Dell. “In the long term, in order to achieve an economic return on our capital, rates will increase in order to get compensated for continuing driver wage pressure, benefit costs, and the substantial equipment and technology investments to meet customer expectations.”

While this strong sentiment is echoed by several other LTL executives, analysts say that the keys to 2016 LTL pricing will be revealed depending on what happens in these first few months. Will the industrial economy rebound? Will carriers continue their pricing discipline? Will inventories shrink so that freight demand will surge upon replenishment? How will pricing and capacity in the larger truckload sector trickle down to LTL? 

These are all open questions that we recently put to some of the top trucking executives and analysts in the LTL sector. Will 2016 be a rebound year for LTL?

Capacity utilization is key
Rates are set in the LTL industry through a complicated matrix of time, distance and weight per shipment. Basically, shippers want next-day service—second-day if distance requires—as their shipments get lighter. How rates are set depends on city-pair lanes and the capacity available on those routes.

For example, ABF Freight System saw their total weight per shipment drop 3.5% to 1,267 pounds in the fourth quarter of 2015. The carrier saw their length of haul drop 1% to 1,014 miles during the quarter, while revenue-per-hundredweight fell 1.1% to $29.02 compared to the fourth quarter of 2014. On a sequential basis compared to the third quarter, ABF’s revenue-per-hundredweight fell 2.2% because of seasonality, changes in the freight mix, and a reduction in fuel surcharges.

As the ABF example illustrates, the LTL sector is also buffeted by the larger truckload sector, which often competes with lighter LTL shipments when overall freight demand softens. “The change in sequential revenue-per-hundredweight was also affected by truckload rated shipments handled at lower rates due to market capacity conditions,” says Judy McReynolds, president and CEO of ArcBest, ABF’s parent, during a recent conference call with analysts and investors.

LTL rates are also being affected by overcapacity, equipment utilization and freight demand. According to trucking analyst firm SJ Consulting, LTL terminal door capacity utilization (measured in tons per terminal door per day) rose between 2012 and 2014. But in 2015, according to preliminary estimates of the publicly held LTL carriers recorded by SJ Consulting, utilization dropped slightly in 2015 as terminal door capacity had a slight increase while demand ticked down.

While core LTL rate increases were in the 2.5% to 4.5% range last year, analysts and executives agree LTL carriers have enjoyed relatively good pricing because of their newfound discipline in adding capacity.

Plus, the LTL market offers inherent advantages compared to the larger, mostly non-union truckload (TL) sector. First, there’s market pricing power that gives LTL carriers better ability to pass along higher rates. Also, the freight mix between industrial and retail is about 50/50, allowing a natural hedge in case one sector softens.

Only Old Dominion Freight Line (ODFL), which owns the best operating ratio of the LTL carriers, is adding any significant capacity. But Ross and other analysts say that ODFL’s strong customer base and outstanding service allows it to add capacity without diminishing its ability to raise rates.

Still, LTL carriers have to stem the tonnage declines that most saw in the second half of last year. Also, some LTL freight has been diverted back to truckload moves as TL carriers lower their weight thresholds to attract further LTL business.

“Freight is tepid,” says Chuck Hammel, president of LTL carrier Pitt Ohio. “It’s certainly not bad, but it’s not robust either.”
Other top LTL executives agree, but add that the difference is the pricing power LTL carriers enjoy because of the significant barriers to entry to the sector. Unlike the fragmented TL market where the top 10 carriers barely control 5% of the market place, the top 10 LTL carriers control about 80% of the $34 billion LTL market place.

“LTL is a more rational market in some ways,” says Brad Jacobs, president and CEO of XPO Logistics, which now runs a significant LTL operation since the purchase of Con-way Inc. last fall for $3 billion. “Carriers have learned a lot from the last downturn. We’re matching capacity additions to demand, and as a result, pricing is very good and continues to be that way.”

Against this backdrop, we’ll now take a deeper dive into the factors that are having an effect on volume, costs and capacity in the LTL sector. We’ll also see what top carrier executives are expecting in terms of help from the overall economy and, perhaps most importantly, what shippers can expect in terms of rate increases in 2016.

Seeking stability in the marketplace
XPO’s Jacobs described the overall LTL market as “stable,” adding that business is a little slow in the Midwest, but that’s being offset by fairly strong growth elsewhere. XPO, which trimmed about 150 excess positions from the former Con-way operation because of redundancy, is still hiring drivers in the west and Chicago areas, Jacobs says.

What XPO and other LTL carriers seek is a balance in freight demand that allows them to use their equipment and other assets in the most efficient ways possible. “The industrial economy has been slow for about a year,” says Jacobs. “For us, weakness in industrial is partly offset by health care, retail, and consumer products which are all still strong. So the net income from industrial slowdown has not been that significant for us.”

The cost pressures for LTL carriers remain the same—costs are rising steeply for equipment, compliant drivers and health care. A new Class 8 tractor is pushing $135,000 list price today, nearly double what it cost barely a decade ago. And because of the continued push for safer drivers and tougher standards for compliant drivers, truck drivers literally are in the proverbial “driver’s seat” when it comes to wage and benefit increases.

“Wage and benefit increases necessitate some form of price increase in 2016, and with weak volumes, pricing will need to go higher to avoid margin contraction at most carriers,” says Ross. “We believe that wages will be under less pressure than in TL but, should still move up around 3% this year.” ​

Ross says that, ironically, the key to LTL pricing this year will come from the TL market. “Just because supply/demand loosened up in 2015 doesn’t mean that underlying supply issues have gone away,” he says.

And while Ross doesn’t expect another “big tightening” of TL capacity in 2016, one in 2017 or 2018 would be a positive for LTL rates and volumes. That’s because the $320 billion TL market is much larger than the LTL market, and additional density would drive higher margins for those who manage it best.

“In a cyclical industry, there are always periods of capacity surplus and shortage,” says Saia’s O’Dell. “Since the last downturn, capacity has been removed, as measured by terminals and doors. In a future economic downturn, we feel that there would not be similar surplus capacity as experienced in recent history.”

Seeking pricing discipline
Satish Jindel, president of trucking analyst firm SJ Consulting, says that there’s excess LTL capacity now because “demand is not where it used to be,” adding that people are misguided when they look at GDP growth rates in the 2.5% area.

That reflects banking, the internet and things that never impact freight,” Jindel says. “People build capacity on the basis of 2.5% GDP growth, but that isn’t really the correct level.” He adds that the key to LTL profitability is managing capacity.

“Some, like Old Dominion, are managing it well,” says Jindel, noting that ODFL enjoyed a 6.1% increase in rates-per-hundredweight in the fourth quarter, excluding fuel surcharges. “While some are being careless, thinking they can grab market share because the market is soft. You have to be aggressive in pricing, but the best time to gain market share is when market is growing.”

Carriers on the margin will have a challenge in getting through this year, Jindel predicts. He frets that the 4.9% general rate increases taken by most carriers last year will be largely discounted away in 2016. “I worry that LTL pricing will be similar to that of furniture and mattresses, which always seem to be on sale,” he says. “Anybody who buys a mattress full price has not made a wise decision. LTL could be the same.”

In the meantime, carrier executives are optimistic on the LTL sector. “Customers always want fair price, that’s understandable,” says Jacobs. “For the most part, shippers understand that capacity will tighten up again sooner or later. They want quality capacity with stable carriers at a reasonable price. This allows them to hedge against eventual tight market later.”

And as fuel surcharges come down, says Jacobs, that’s taking pressure off shipper transportation budgets. “That’s given us flexibility to work on rates.”

However, the bottom the line is that there will not be any big rate increases in 2016, but perhaps they’re coming in 2017 or 2018. If fuel stays low, look for carriers to try and build increases into their base rates while shippers are still enjoying a net reduction in overall LTL transportation costs. And as always, higher margins will go to carriers that best manage their capacity.