The Major Freight Transportation Stories of the First Half of 2013

As we approach the mid-point of 2013, here is a peek at some of the major trends that are having an impact on freight transportation.

Economic Growth to remain Modest and Uneven

The economy continues to deliver mixed signals. In the past week, the US and Canada reported strong growth in employment. In fact, the 95,000 growth in jobs in May of 2013 is the best monthly number in Canada in decades. The question is whether this was a one month aberration or an indicator of better days ahead? A look past the job numbers tells a different story. Only a few hot spots (such as the shales) are displaying significant growth. Housing and automotive are strong sectors. Additionally, NAFTA-related trans-border activity has presented opportunities for carriers.

At this point, it is hard to build a case that the 2H13 would be much better, especially in light of the mediocre Spring in so much of North America. However, strong automotive production (some plant shutdowns have been eliminated or cut short), the release of pent-up consumer demand accumulated during this year's elongated winter, continued recovery in housing markets, and hurricane/tornado repair/reconstruction efforts on the US could make the 2H13 stronger than some anticipate. But The Institute of Supply Management's monthly index or "PMI™ registered 49 percent in May, a decrease of 1.7 percentage points from April's reading of 50.7 percent, indicating contraction in manufacturing for the first time since November 2012 and only the second time since July 2009. This index will need to be closely watched in the months ahead to see if there will be a sustained improvement in economic activity.

Supply Chain Optimization is Lowering Freight Costs

Supply Chain Optimization is having an important impact on the freight market. The combination of (1) smaller, denser, more concentrated products (many of which are more efficiently packaged), (2) shorter supply chains, (3) the emergence of intermodal as a true solo-driver truckload substitute in long-haul, high-density lanes, (4) an industry wide focus on reducing empty miles, maximizing load factor, and optimizing available legal driver hours and (5) the increased use of TMS systems to optimize shipment sizes and mode choices makes it feel as though there is less freight in the system. In fact, there is less freight (measured in terms of weight or cubic dimension) and what freight exists is being handled more effectively.

Old Dominion leads LTL sector/YRC seeking to acquire ABF

The two biggest stories in the LTL sector in Q1 were probably: (1) the continued financial recovery of YRC Worldwide, after the near-death experience of recent years, as it made a quarterly operating profit in Q1for the first time since 2007 and (2) Old Dominion's excellent operating results that again left the rest of the LTL field far behind.

Though revenue growth at Old Dominion slowed a bit this quarter from the recent past (though still a healthy 7.1%), profits were up another 30%, as net income was 7.1% of revenues, versus -3% to plus 3% for the rest of the group. That was achieved by dropping its operating ratio to just 87.6%, versus 95.8% for the next best, Conway's LTL group.

Also of note in this sector, YRC is now seeking to acquire Arkansas Best, parent of LTL carrier ABF Freight to increase density in its lanes and to unite the two largest unionized LTL players. ABF has employed a "just go away" strategy on the offer, but YRC is now said to be looking at other routes to make the deal happen.

Truckload Carriers demonstrate Asset Discipline

TL carriers continue to maintain strong asset discipline, with that trend in some cases reinforced by trouble hiring drivers. The net result is that total capacity in the sector is growing slowly as best, allowing the carriers some pricing power and the chance to optimize their networks and customer bases. The operating ratio in the trucking segment was just 99%, meaning the segment operated just barely above breakeven, and the segment's meager profits represented just 1% of total operating profits, as the segment continues to shed trucks as well.

Trucking-only revenue in fact fell just under 1% in the quarter across the whole group, whereas total revenues (including fuel surcharge) were up as noted above 5.5%. This indicates a combination of a focus on non-core trucking by Hunt, Werner, and Swift, and some modest pricing power/rate increases in the quarter across the group. Profits for the group overall were strong, with net income up 20% in the quarter, or almost four times the level of revenue growth. Swift, Knight, Marten and Heartland saw profits up 277%, 44.8%, 32.2%, and 19% respectively in Q1 over 2012.

Rail Growth Driven by Pricing Power, not Volume Growth

For the rails, the story in Q1 was that despite flat or even slightly declining carload volumes for the quarter, the rail carriers were mostly able to drive up profits and improve their operating ratios, driven by continued pricing power and a relentless focus on network efficiencies.

Operating revenues were up among the four US rails just over 1%, and carload volumes ranges from a +3% gain at Norfolk Southern to negative 2% at both Union Pacific and CSX, as a slow economy, continued steep drops in coal shipments, slow agricultural shipments for most of these carriers resulting from the Midwest drought last summer combined to offset growth in intermodal cars.

Nevertheless, net income from the four in aggregate was up 9.6%, led by Kansas City Southern's 34% gain, while Union Pacific and Norfolk Southern saw net income grow in the 10% range. The Canadian rails also had a strong first half as CP Rail continued to perform well under Hunter Harrison and his team.

Intermodal Growth Rate to Continue

Thirty-one percent of Asian imports are related to the housing industry. Housing-related goods that move via rail intermodal include imported furniture and building materials; Home Depot is one of the largest intermodal customers. The importance of housing to intermodal is a major reason for the decline in total intermodal loadings at the beginning of the Great Recession. As the housing industry continues to recover, housing-related freight will likely contribute to above-average growth (relative to other transportation modes) in domestic intermodal volumes.

An increasing portion of imported goods is being transloaded into larger domestic intermodal containers rather than being moved in the smaller ISO containers. Currently, about 31% of intermodal loads originated in the Pacific Southwest are transloaded as compared with 26% in 1Q03. The trend toward increased transloading has generated incremental demand for 53' domestic containers over the years, putting the intermodal providers with access to large fleets of domestic containers at an advantage.

Intermodal has about a 20% share with trucking in tonnage with lengths of haul over 1,000 miles and it has just over 10% market share with truck in tonnage with lengths haul between 500-750 miles. The 500-750 mile intermodal length-of-haul lanes represent a market that is much less mature than the lanes that contain 2,000+ mile lengths of haul. Recent intermodal investment by railroads has been concentrated in areas that will go toward serving origin-destination pairs that were not historically served well by intermodal.

Carriers Becoming more Focused in Seeking Rate Increases as Shippers Retain Pricing Power

One of the major changes for shippers of the past ten years has been the prolific use of freight bids. The recent economic deceleration has created enough of a gap between supply and demand to give some shippers the confidence to be a little aggressive at a point in the seasonal cycle when bids seldom result in rate reductions. Some carriers report modest low single digit adjustments. Sometimes these rate adjustments apply to only a subset of a carrier's total lanes. Some carriers have exchanged capacity commitments for no rate increases.

Big Carriers doing better than Small Carriers

In a recent report from Richard Mikes of Transport Capital Partners, he highlights the variance in performance between carriers with less than $25 million in revenue as compared to larger carriers. Carriers with sales in excess of $25 million are achieving higher rate increases, are planning to add more capacity, derive less of their revenue from freight brokers, achieve superior miles per gallon on their fleets and are less likely to leave the industry that their smaller competitors. This suggests that another round of industry consolidation may be imminent.

One of the ironic by-products of the onslaught of federal and state regulations (designed to protect the "little guy") is that the "little guy" is in fact hurt. It is the large, sophisticated carrier that can access low cost financing, leverage purchasing economies, optimize his network, and deal scientifically/methodically with usually complex/tough to interpret/challenging to implement government regulations governing engine emissions, driver health and safety, equipment safety, as well as treatment of and benefits for employees. In a somewhat unplanned way, big government begets big business. Large carriers will have more competitive cost structures, the ability to more consistently deliver sufficient capacity, the ability to provide higher-levels of service, have better access to the capital markets, and stronger, more comprehensive systems to optimize operations and enhance customer service and satisfaction.

Shale Gas Is a Game-Changer for North American Manufacturing

North America has tremendous proven and potential shale development that has put it on par with Saudi Arabia as one of the lowest cost areas for natural gas in the world. Natural gas is 4x cheaper than oil on a BTU basis and natural gas prices seem certain to remain low for the foreseeable future. Many of the end products that are produced using chemicals that contain natural gas as a base feedstock are consumer non-durables. New factory announcements have been made in the chemical, resin, fertilizer, and steel industries within the past year. Limited numbers of traditional manufacturing companies have moved their operations back to the U.S. Plastics and rubber products should be among the first to be re-shored. Ethylene production capacity is expected to increase by up to 35% in the coming years after having already risen by 33%. Taylor Robinson, President of PLG Consulting believes that the U.S. energy cost advantage is likely to persist relative to other major manufacturing nations for at least 5-10 years.

Crude Oil Movements by Rail to Increase

Crude-by-rail is 50%-100% more expensive than pipelines, but crude-by-rail offers a number of offsetting advantages. The biggest advantage of crude-by-rail is that its flexibility allows traders to take advantage of the arbitrage opportunity of getting the crude to the location where it will

command the highest price. Other advantages of crude-by-rail, relative to pipelines, include lower capital costs, shorter contracts (2-3 year commitments vs. 10 years for pipeline), faster transit times, origin/destination flexibility, and construction of rail facilities is much faster.

The advantages of crude-by-rail has changed its role: The early objective of crude-by-rail was to bridge the gap until pipelines were built, but recently, crude-by-rail has become the primary transport mode for Bakken crude. Rail has a 70% market share of crude coming from the Bakken. Pipelines are operating below capacity and there have been some pipeline cancellations due to lack of subscriber interest.

There is currently ample takeaway capacity at the Bakken as a result of the development of the loading terminals in 2011 and 2012. North Dakota crude oil loading capacity now exceeds one million barrels per day with BNSF terminals representing about 80% of that capacity. As a result, BNSF handles more total crude carloads in North America than any of the other North American railroads, followed by Union Pacific due to its strong geographic presence in and around Texas, and Canadian Pacific, which has nearly a 20% market share in Bakken takeaway capacity.

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