Fitch: Weak U.S. economy will challenge freight transportation in 2009

Unlike the railroads, which have seen ongoing pricing strength despite a weakening in volumes, the trucking industry has been increasingly challenged over the past year by a weakening in underlying base shipping rates, as the supply of available capacity has outstripped demand, Fitch Ratings said. This situation has improved somewhat in the truckload sector, as a large number of small operators have gone out of business, but the pricing environment in the LTL sector remains difficult.

The Trucker News Services

12/10/2008

CHICAGO — The past year has been very challenging for freight transportation issuers in the U.S., and global ratings agency Fitch expects conditions to be even more difficult in 2009.

Late last year, hopes were high for a rebound in freight demand in the second half of 2008, following nearly two years of slow demand growth, especially in the trucking industry, Fitch noted. But as 2008 wore on, it became increasingly clear that conditions were worsening, rather than improving, and Fitch now expects the U.S. recession to be a drag on the financial performance of both the trucking and railroad industries through much of 2009.

However, Fitch said there are very important differences between these two industries, and they are entering this period of extreme economic weakness from two very different financial positions.

Following a resurgence in the railroad industry over the past five years, the largest Class I railroads are well-positioned financially to confront the challenges of a recessionary economic period, according to the agency. Although volume growth has slowed over the past couple of years, the industry continues to enjoy a favorable pricing environment. This has resulted in strong margins across the industry.

In sharp contrast to the strong financial positioning of the U.S. railroad industry, the U.S. trucking industry is entering 2009 in a weakened state. Overcapacity, particularly in the less-than-truckload (LTL) sector, has eroded pricing over the past year, while high fuel costs have added to the industry's difficulties.

Although demand looked as though it had stabilized in the middle of 2008, volumes took another step down in September, and demand has remained weak through the fourth quarter.

The bankruptcies of a large number of small truckload carriers have helped to rectify the capacity situation somewhat in that sector, but the LTL sector continues to struggle with too many trucks chasing too little demand.

With expectations for weak consumer retail spending through much of 2009 and increasing challenges facing trucking's industrial customers, particularly the U.S. auto manufacturers, there is a heightened potential for a significant decline in industry credit quality next year, Fitch said.

As to the market environment, Fitch noted that that trucking and rail volumes have fallen off in the fourth quarter of 2008, and that trucking is closely tied to the shipment of cyclical products like retail goods and industrial components. As a result, the trucking industry is more exposed than the railroads to the relative strength of the U.S. economy.

As such, with expectations for ongoing economic weakness through much of next year, trucking volumes are also expected to be relatively sluggish. The volume weakness could stabilize toward the end of 2009, however, primarily due to the industry's lapping of the weakness seen toward the end of 2008, as opposed to expectations for any notable strengthening in the demand environment, Fitch said.

This situation has improved somewhat in the truckload sector, as a large number of small operators have gone out of business, but the pricing environment in the LTL sector remains difficult.

Among the LTLs, overall yield has been up through most of 2008; however, this has been almost entirely due to high fuel surcharges, which were especially high in the third quarter. Excluding fuel surcharges, base rates have been declining through the tail end of 2008, as truckers have been forced to offset a portion of the rise in surcharges with a decline in base rates.

Pricing in the LTL sector is expected to remain challenging through much of next year, although the sector's efforts at capacity control may help the situation somewhat. As with the railroads, overall yield is expected to decline as fuel surcharges reflect the steep drop in on-highway diesel fuel costs. ]

At this point, however, Fitch does not see a catalyst for a material rise in base rates, given the expectations for a very weak economic environment and a resulting decline in consumer spending. Should the weak environment actually force a shutdown of one or more LTL operators, the pricing environment could improve dramatically.

Fitch said it is important to note, however, that there also is historical precedent for irrational pricing to cause a meaningful decline in industry yields prior to the demise of an LTL carrier.

In the truckload sector, pricing is expected to be somewhat more favorable than in the LTL sector, as truckload capacity likely will remain relatively better matched to demand, although Fitch does not expect truckload pricing to be strong by historical standards.

In terms of cash flow, the trucking industry's weaker operating margins, driven by heavy competition and lower demand, will put significant pressure on operating cash flow in 2009, according to Fitch.

Free cash flow may fare somewhat better, however, as capital spending needs will be lower with the reduced level of demand. Fitch expects many trucking issuers to slow the replacement of tractors and trailers and to generally hold off on facility capacity growth while the economy remains weak.

Network rationalization by some LTLs could drive some facility capital spending, but overall capital expenditures are expected to be relatively low compared to historical levels.

Although the U.S. Environmental Protection Agency (EPA) again has tightened emissions regulations for diesel truck engines in 2010, Fitch does not expect to see most truckers pre-buying tractors next year, as many did in 2006 before the last EPA emissions change in 2007. This will help to keep capital spending on tractors down, despite the upcoming change in emissions regulations.

With greater free cash flow pressure in 2009, liquidity will become an increasingly important differentiator in assessing the credit quality of trucking issuers. For the industry in general, capital markets access likely will be more difficult for the truckers than for the railroads, and, notably, those truckers with high-yield ratings, such as YRC Worldwide, will have virtually no access to the markets.

This will increase the importance of maintaining larger-than-normal levels of cash and equivalents on balance sheets, as well as the need to keep significant levels of cash available on borrowing facilities, such as revolving credit facilities or receivables securitization programs. Financial flexibility will be an important determinant of ratings as the trucking industry moves through this very challenging market environment.

Kevin Jones of The Trucker staff can be reached for comment at kevinj@thetrucker.com.