Commentary from management teams in the trucking industry so far through second-quarter earnings season points to a favorable conclusion to 2022. While the spot market has loosened significantly since March and rates have dropped, large carriers with heavy exposure to contractual freight are only seeing modest changes in demand.
"We're having a seasonally normal July," Shelley Simpson, J.B. Hunt Transport Services' (NASDAQ:JBHT) chief commercial officer and soon-to-be company president, told analysts on a quarterly teleconference. "We do think that there will be a peak [season], to what extent we're still not sure."
The tone among trucking's C-suite hasn't changed much since earlier in the year. The initial outlook called for a strong first half with the likelihood that conditions would moderate in the back half.
Large fleets derive the bulk of their revenue from contractual freight agreements negotiated annually. They opportunistically operate in the spot market to take advantage of favorable rates or to fill otherwise unutilized capacity. With spot market fundamentals in decline, routing guide compliance among carriers has increased as contractual rates remain firm.
Chart: (SONAR: NTIL.USA, VCRPM1.USA). The blue-shaded area is the National Truckload Index (linehaul only – NTIL), which is based on an average of booked spot dry van loads from 250,000 lanes and 10,000 daily spot market transactions. The NTIL is a seven-day moving average of linehaul spot rates excluding fuel. The green line represents the seven-day per-mile average rate for dry van contract loads excluding fuel (reported on a 14-day lag).
The American Trucking Associations for-hire truck tonnage index increased 2.7% on a seasonally adjusted basis from May to June. The index was 7.9% higher year over year (y/y), marking the 10th consecutive monthly increase and the largest in the past four years. The data set is heavily skewed toward contractual freight.
"Essentially, the market is transitioning back to pre-pandemic shares of contract versus spot market," Bob Costello, ATA chief economist, stated in the update. "Second, and perhaps equally important, while economic growth is expected to be soft overall in the second quarter, the goods economy wasn't as bad as feared."
Second-quarter freight payments data provided by U.S. Bank (NYSE:USB) showed truck shipments were up 2.3% from the first quarter but 0.9% lower y/y. However, the sequential increase reversed two quarters of modest declines in the data. Freight spending was up 3.3% sequentially in the period and 19.7% y/y.
In its second-quarter report, Heartland Express (NASDAQ:HTLD) noted that freight demand had stepped down sequentially from the first quarter. However, the carrier still finds itself in an oversold position.
"While the current levels are down compared against the unprecedented levels experienced in the later months of 2021, we continue to have significantly more opportunities to haul freight than we are able to cover with our existing fleet and available drivers," CEO Mike Gerdin said in the report.
He sees the dynamic holding through year-end.
The market reset was also evident in Landstar System's (NASDAQ:LSTR) second-quarter report.
Commonly referred to as a "spot broker," Landstar has seen pricing level from a spot market decline that began earlier this year. Revenue per mile for dry van loads hauled by its business capacity owners fell 6% sequentially in both April and May but has held steady since. The metric excludes fuel surcharges and is only off 13% from a February high.
"Given the current operating environment, I view Landstar's relatively stable revenue per load since May as a positive," President and CEO Jim Gattoni said in an earnings report.
Cost inflation is now the main driver of contractual rate increases.
During the pandemic, carriers benefited from a large supply-demand imbalance, booking rates significantly above inflation, which pushed margins to record levels. Even though the market has reset and become more balanced, carriers operating under contract appear poised to capture rates high enough to at least offset a multitude of higher expenses — wages, equipment, insurance, operating supplies, uncompensated fuel expense and interest expense, to name a few.
"We feel confident in the different areas of our businesses and how we're having conversations with our customers," Simpson continued. "I think our customers are prepared to have a good second half. I haven't had a lot of feedback on a significant downturn."
Over the last year, J.B. Hunt has added roughly 2,200 revenue-producing trucks to its dedicated fleet of nearly 13,000. Demand for the service continues to grow.
"We talked last quarter about seeing solid momentum in the business and that remains the case today as we continue to onboard new business," Nick Hobbs, COO and president of contract services, stated on the call.
Retail inventories not the concern originally thought?
A chief concern among investors ahead of the quarterly updates was recent inventory increases at large retailers would reduce the need for truck capacity in the back half of the year.
Numerous retailers ordered merchandise early and often in the second half of 2021 in attempts to navigate supply chain delays and avoid stockouts. Ultimately, many of those items didn't arrive in time and retailers now find themselves holding onto merchandise that is out of season or still out of position in the supply chain.
While the dislocation has inflated the inventory metrics for some retailers, other items like furniture, electronics and exercise equipment, which were some of the most difficult to find during the pandemic, are now in a true overstocked position.
Census Bureau data shows the retailers' inventories-to-sales ratio remains below long-term averages. A 1.2x reading in May, the latest available, was the highest since February 2021 and considerably higher than the 1.09x reading posted in October. However, the metric is still well below the pre-pandemic average of 1.45x.
Further, logistics real estate giant Prologis (NYSE:PLD) is still calling for inventories-to-sales ratios to reset 5% to 10% higher than before COVID. The outlook is rooted in the belief that companies will continue to take on safety stock to avoid supply chain delays.
"We have had concern from customers on inventory, having the wrong inventory and where it is located, but I've not heard any customers tell us that there's a downturn coming," Simpson added.
Whether there is a significant inventory overhang or not will likely be answered as the industry works through the 2022 peak season – and retail sales will have a big say.
Core retail sales, which exclude auto dealers, gas stations and restaurants, according to the National Retail Federation, were up 7% y/y in the first half of the year. The group expects full-year 2022 sales to be up by a similar amount. The numbers don't parse out inflation, which continued to step higher sequentially and on an annualized rate in June (+9.1%). Inflation-adjusted sales are down only modestly but still well north of pre-pandemic levels.
"June's numbers show consumers are powering through price pressures, but inflation is eating away at savings built up during the pandemic and is wiping out recent income gains," Jack Kleinhenz, NRF chief economist, stated in the release. "Inflation remains a challenge to consumers trying to make ends meet and will continue to be an issue even if it cools down in the months ahead. Despite that, consumers are holding up notably well and continuing to spend."
Of note, consumers have $32 trillion more in net worth than they had entering the pandemic, although they are now contending with higher interest rates in addition to inflation.
Oversupply less of a concern on the downside of this cycle?
Dave Jackson, president and CEO at Knight-Swift Transportation (NYSE:KNX), outlined an argument as to why this cycle could be different on a quarterly call with analysts on July 20. The company beat second-quarter expectations and raised guidance slightly. Embedded in the new guide is the assumption that consumer demand moderates and spot market opportunities continue to erode.
However, Jackson believes lower spot rates and a higher cost profile will continue to force small, spot market dependent carriers out of business, ultimately correcting any oversupply in short order.
He said the supply side is different this cycle because in past downturns small carriers had the benefit of low fuel prices, and falling used equipment prices allowed them to inexpensively jump into a newer truck and avoid the maintenance expenses associated with running older equipment. Further, prior to the electronic logging device mandate, carriers could run extra miles to make up for revenue shortfalls.
"Well, virtually every one of those factors is not the same this go-around," Jackson said.
"One thing we do know, that has been consistent from one cycle to the next, is when credit dries up, that brings religion to small carriers in terms of what they do to grow or refresh. And that process is well underway already."
He said supply appears to be leaving the market at a faster rate than demand is slowing.
"In our industry, we're much more sensitive to supply than we actually are to demand … and we didn't go into this one with a huge oversupply like we did in 2018 to 2019 or like we did in 2006 to 2007," he continued. "So that has us thinking that this could feel a little bit more orderly and less of a drop-off, just because the supply didn't get nearly as high and is leaving so early."
He also noted that production headwinds at the manufacturers will mean that new equipment will continue to be allocated on a limited basis throughout 2023, even to the biggest buyers.
"We're of the belief that there's definitely going to be resilience like there was in 2019 in the kind of contract business that we're able to do given size and scale," Jackson said. "A classic example of that would be, just look at the first half of this year. Look at how our business has performed relative to what it's been like for the smaller carriers … particularly those that were overly reliant on spot business."
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